-----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, IecQ8c0nZLmevgaw7Ki82DlpAqUi3JGJMQ3hp0sSfLm91xv2aMT2sLnIRrjgNSTo opjP8KAnjwkD4ymdV01P+g== 0001045969-98-000724.txt : 19981202 0001045969-98-000724.hdr.sgml : 19981202 ACCESSION NUMBER: 0001045969-98-000724 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980928 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VIRTUALFUND COM INC CENTRAL INDEX KEY: 0000857470 STANDARD INDUSTRIAL CLASSIFICATION: 3555 IRS NUMBER: 411612861 STATE OF INCORPORATION: MN FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-18114 FILM NUMBER: 98716702 BUSINESS ADDRESS: STREET 1: 7156 SHADY OAK ROAD CITY: EDEN PRAIRIE STATE: MN ZIP: 55344 BUSINESS PHONE: 6129418687 MAIL ADDRESS: STREET 1: 7090 SHADY OAK RD CITY: EDEN PRAIRIE STATE: MN ZIP: 55344 FORMER COMPANY: FORMER CONFORMED NAME: LASERMASTER TECHNOLOGIES INC DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: RASTER DEVICES CORP DATE OF NAME CHANGE: 19900708 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 1998 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________ to __________________ Commission file number 0-18114 VIRTUALFUND.COM, INC. (FORMERLY LASERMASTER TECHNOLOGIES, INC.) --------------------------------------------------------------- (Exact name of registrant as specified in its charter) MINNESOTA 41-1612861 - - ------------------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 7090 Shady Oak Road Eden Prairie, Minnesota 55344 - - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (612) 941-8687 -------------- Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered None ------------------- ----------------------------------------- ------------------- ----------------------------------------- Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share - - -------------------------------------------------------------- (Title of Class) 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. [ X ] Yes [ ] No [COVER PAGE 1 OF 2] 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 the 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. [ X ] The aggregate market value of the voting stock held by non-affiliates of the registrant as of August 31, 1998 was $53,278,000 based on the last sale price for the common stock as recorded by the National Association of Securities Dealers on that date. As of August 31, 1998, there were 15,778,866 shares of the registrant's common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE: None. [COVER PAGE 2 OF 2] 2 PART I ------ ITEM 1. BUSINESS - - ------- -------- GENERAL Pursuant to shareholder approval received at its annual meeting on April 2, 1998, LaserMaster Technologies, Inc. changed its name to VirtualFund.com, Inc. ("the Company"). The name change highlights the Company's intention to diversify and expand its product and growth strategy around two business units: The Digital Graphics Business Unit and the Internet/Software Business Unit. The Internet/Software Business Unit is in the development stage and expects initial products to include business to business electronic commerce ("E-Commerce") software marketed under the brand E-Com Tools(TM). This business unit is also in the process of identifying Information Technology ("IT") Consulting companies as potential acquisitions and intends to grow through the acquisition process in the beginning stages of its operations. The Company has contracted an investment banking firm to assist in acquisition activities. The unit's business plan calls for the cross-selling of services and software to its customers. Establishing recurring service revenues from the installation and service of the E-Com Tools software is considered a major priority of the business unit. Throughout fiscal 1998 and the first quarter of fiscal 1999, the Company has invested personnel resources in developing this new business unit. Revenue from this business unit is not material at this time and as a result all references to "the Company" will refer to the Digital Graphics Business Unit. The Company's Digital Graphics Business Unit, which is comprised of the Company's primary operating company, ColorSpan Corporation and its subsidiaries, ColorSpan Europe, LTD., ColorSpan Asia/Pacific, Inc., ColorSpan Latin America, Inc. and the newly acquired Kilborn Photo Products, Inc., designs, manufactures and markets wide-format (up to a recently introduced 72" wide prints), high-resolution color inkjet printers, chemical-free film imagers ("filmsetters"), and related image processing equipment for professional printing applications. In addition, the Company sells related consumable products ("consumables") for its installed base of printers, consisting primarily of ink, media (such as specialty papers, canvas, vinyl, etc.), film, toner (ink-like powder) and process units (which facilitate transfer of toner to the media surface). The Company's products combine advanced computer technology with the Company's own sophisticated software, hardware and proprietary printers ("engines") to produce professional-quality printed output at an affordable cost. The Company's HiRes 8-Color printer series (the DisplayMaker 4000, 5000, 6000 and 7000 or "DMX"), along with the Giclee PrintmakerFA(TM), DesignWinder(R) and the DisplayMaker(R) Professional, DisplayMaker XL60 and DisplayMaker Express Big Color(R) wide-format, digital inkjet printers, are designed to be a cost-effective solution for short-run computer printing of photo-realistic, posters, signs, and banners. The PressMate(R)-FS, a proprietary desktop chemical-free FilmSetter(TM), is capable of film output generated without the use of chemicals (dry film) typically associated with developing film, with effective resolution of 2400 dots per inch. The ColorMark(R) Pro 3000 Print Server is a raster image processor ("RIP") which is capable of supporting a combination of Giclee PrintMakerFA, DisplayMaker Professional, DesignWinder, DisplayMaker Express, DisplayMaker HiRes 8-Color series printers and PressMate-FS Personal FilmSetters(TM) simultaneously, as well as offering time-saving features specifically designed for high-volume, production environments. The RIPStation(TM) is an entry-level raster image processor print server. Until 1993, the Company's principal products were monochrome laser printers that were based on printer hardware or "engines" manufactured by others but included the Company's proprietary software (including "TurboRes(R)") and hardware designed to generate significantly higher effective resolution. Print resolution, commonly expressed in terms of "dots per inch" (dpi--the number of digitally placed dots on a line), approached the resolution used in professional typesetting previously dominated by photographic processes and was described as "plain-paper typesetting." Although the Company believes that it was a market leader in high resolution laser printing and continued to enhance its products, from 1991 through 1996, many of the Company's competitors, including Hewlett-Packard(R) (HP), increased the performance of their printer offerings, impacting the volume and margins achieved on sales in the high resolution laser printer marketplace. The Company focused its research and development efforts on other sectors of the printing market during this period (specifically on the development of proprietary printing hardware and related consumables) and ceased actively promoting its plain-paper typesetting products entirely in the fourth quarter of fiscal 1996, which resulted in a continuing decline in sales of plain-paper typesetting products over the next four quarters. 3 The bulk of the decline in sales from plain-paper typesetting products during this period was replaced by sales of new, wide-format color inkjet printers developed by the Company. The Company introduced its wide-format (36 inch), photo-realistic color printer, the DisplayMaker in 1993 followed later that year by the DisplayMaker Professional. Although still based on a printer "engine" developed by others, the DisplayMaker integrates a high performance computer print server and the Company's own software with a proprietary ink delivery system ("Big Ink(TM) ") to enhance speed, functionality and the quality of output to generate photo-realistic, poster size prints and banners. As the market has grown and demand increased, competitors have licensed the printer "engines" from the Company's supplier and have introduced their own competing products, which have negatively impacted the Company's margins. As part of its longer term strategy to reduce its susceptibility to new market entrants, maintain product differentiation and lengthen its product life cycles, the Company began development of several proprietary printer "engines" in 1993 and has continued with this strategy through the present. The first of these products targeted a niche in the laser typesetting market by eliminating the need for the use of photographic processes and chemicals in creating an image on a photographic film used to create a metal printing plate. In 1994, the Company introduced a proprietary printer engine and associated software, PressMate, which uses heat-sensitive film rather than photosensitive film that allows dry process imaging on the desktop rather than chemical image development in the darkroom. The Company enhanced this printer and introduced a reconfigured version as the "PressMate-FS" in August, 1995. During the past four years, the Company has developed three new proprietary color printer products using different engine platforms to address the wide-format color printing market. The first of these products, the DisplayMaker Express, is a 54 inch wide, photo-realistic roll-fed color printer that uses phase-change inks (solid inks that are melted during the printing process). It was introduced in 1995. The second color printer product developed during this time, the DesignWinder, was introduced in September 1996. The DesignWinder is a drum-based, eight head, cut-sheet printer that produces high-quality wide-format (36 by 48 inch) prints in as little as six minutes. Since 1994, the Company has also introduced the ColorMark Pro Print Servers, RIPStations (raster image processing computers), and the Halon(TM) copier interface to enhance and expand the utility, functionality and applications for the color products. In September 1997, the Company introduced its newest HiRes 8-Color proprietary printing architecture. The ColorSpan DisplayMaker 6000 was exhibited at the Print '97 trade show in Chicago, Illinois and several other shows later that month. The DisplayMaker 6000 is a 62 inch wide, roll-fed device with eight thermal inkjet printheads. Also available in this series are the DisplayMaker 4000 (42" wide) and DisplayMaker 5000 (52" wide) printers with the same feature set. During fiscal 1998, this product series was enhanced to add two additional versions of each printer length. The DisplayMaker 4100, 5100 and 6100 series printers were introduced in December 1997. This product was designed to be driven by third-party RIPs and opened up a sales channel not previously available to the Company. A customer that already possesses a wide-format printing solution is now able to add the productivity and quality features of the DisplayMaker series without purchasing a separate, dedicated RIP to drive the printer, thus saving money. The Company signed an OEM agreement with Ilford Imaging to distribute the product and signed a number of system integration agreements with well known third-party RIP developers such as Onyx Graphics Corp. and ScanVec Ltd. In April 1998, the Company released the DisplayMaker 4200, 5200 and 6200 versions of the product. This product, which comes with a RIP embedded into the printer hardware, addresses many entry level concerns by reducing the entry level price point for a relatively cost-conscious customer. In August 1998, the Company introduced new 72 inch versions called the 7000, 7100 and 7200. The 7200 version is expected to begin shipping in October 1998. The 7000 and the 7100 began shipping in August 1998. On August 25, 1998, the Company announced its newest product, the Giclee PrintMakerFA. The primary users of the Company's products are commercial printers, reprographic service bureaus, photo labs, quick printers, exhibit builders, in-house print shops, printers, publishers, government and educational facilities, and corporate marketing departments. Applications include point-of-purchase signs, trade show exhibit graphics, banners, billboards, courtroom graphics, pre-press positional proofing (proofs or other quick output to demonstrate concepts for advertising or graphics layouts), digital photo imaging and backlit signage. The products are sold through a network of domestic resellers and international value-added distributors. In the U.S./Canada, the Company uses a factory sales team to assist the resellers in the sales process. In August 1997, the Company began selling wide-format inkjet media for HP, Encad and other wide-format printers via the world wide web. The Company's domestic offices are in Eden Prairie, Minnesota. The Company's European sales subsidiary is headquartered in Hoofddorp, The Netherlands. The Company's Asia/Pacific sales and technical support facility is 4 located in San Jose, California and its Latin America sales facility is located in Miami, Florida. In addition, the Company has opened a research and development office in Santa Clara, California and a small business development office in San Jose, California. Kilborn Photo Products, Inc., a media coating facility, is located in Cedar Rapids, Iowa. MARKET According to WORLDWIDE PRINTER & SUPPLIES MARKET REPORT, a March 1998 market survey commissioned by the Information Management Institute and conducted by IT Strategies, a research and consultancy firm serving the digital printing markets, the Color Wide-Format Graphics Printing market for color inkjet hardware and consumables is projected to grow from annual sales of approximately $6.2 billion in 1997 to approximately $14.3 billion in 2000. The rapid growth in this market is being driven primarily by the increasing desire and need for customized, large-format color graphics, as well as significant advances in short-run printing and desktop publishing technologies. Traditional graphics printing methods, consisting of photographic, screen and offset printing, do not meet the requirements for production of short-run print jobs due to the time-consuming, multi-step processes and set-up costs involved. With the growth in computing power and the associated reduction in the cost of memory and other components, digital printing has developed to fulfill the unmet demand of short-run users by allowing graphics to be printed directly from desktop publishing systems with dynamic interchange of data to print onto a variety of media. There are a number of digital printing technologies, including inkjet (piezo and thermal), pen, electrostatic, and photographic that allow users to produce wide-format output. Each of these technologies has specific qualities that can be critical to any given application, including resolution, speed, accuracy, color fill capability, fade resistance, reliability and cost. A combination of characteristics has made inkjet printing one of the fastest growing technologies in the wide-format color printer market. The characteristics of wide-format inkjet printers include relatively low cost, high resolution, faster speed and the ability to print high-quality color. Inkjet printers (using either thermal or piezo printhead technology) typically form images, lines and other characters by placing very small dots of ink as the printhead moves horizontally (called a raster scan) while the media is typically scrolled vertically. Because inkjet printheads move above the media and do not actually make contact with the media, there is less mechanical wear and tear than experienced with other types of printing devices. Most inkjet printers can print on a variety of media or other materials used for signage or display. Electrostatic printers generally are more expensive to purchase than inkjet printers or thermal printers and require the use of special media. They offer certain advantages to users requiring low cost per square foot and high speed printing characteristics. Thermal printer/plotters are similar to electrostatic printers in that they require special paper, but also require ink ribbons to take advantage of the thermal printhead. Thermal printers are typically more costly than comparable-size inkjet printers. Other technologies that can be adapted to wide-format use include photographic output, electrophotographic output and dot matrix printers. These printers have disadvantages, including high costs, when compared to inkjet technology. STRATEGY The key elements of the Company's strategy are: INTERNET/SOFTWARE BUSINESS UNIT DESIGN, DEVELOP AND MARKET A SERIES OF BUSINESS TO BUSINESS AND BUSINESS TO CUSTOMER SOFTWARE PRODUCTS CENTERED AROUND ELECTRONIC COMMERCE AND THE INTERNET WHICH OFFER BUSINESS SOLUTIONS FOR MIDDLE AND SMALL MARKET CUSTOMERS. The Internet/Software Business Unit has been established and has identified this market as fragmented and very dynamic. As a result, the Company believes opportunities exist to service the small to medium sized companies desiring to expand their business to include E-commerce. This Business Unit has been developing software products it intends to sell under the brand name of E-Com Tools. The Business Unit expects initial shipments and implementations of its products to occur in the fall of 1998. 5 BUILD AN INFORMATION TECHNOLOGY CONSULTING BUSINESS THROUGH ACQUISITIONS. The business plan of the Internet/Software Business Unit is dependent on identifying and acquiring the IT consulting resources necessary to implement and service the E-Com Tools customers. In addition, the Company believes there is significant untapped revenue potential in these areas that can be accessed by a marketing program to cross-sell and cross-market goods and services to the customers of this Business Unit. DIGITAL GRAPHICS BUSINESS UNIT TO MAINTAIN AND ENHANCE ITS POSITION AS A LEADING PROVIDER OF AFFORDABLE, HIGH QUALITY, PROPRIETARY, CUSTOMER FOCUSED PRODUCTS AND AFTERMARKET CONSUMABLES SUPPLIES TO THE PROFESSIONAL PRINTING MARKET. A growing portion of the Company's products are proprietary printer architectures (the printer engine including ink and media delivery systems) which were designed, manufactured, and marketed by the Company. PressMate-FS and DisplayMaker Express were the first two proprietary printer engines developed by the Company. In September 1996, the Company introduced the first member of its HiRes 8-Color printer platforms, the DesignWinder. The DesignWinder platform is also the basis for the Company's first OEM partner. Agfa-Gevaert commenced selling its product, the AgfaJet Atlas, in August 1997. In September 1997, the Company, under its new ColorSpan brand, introduced a family of HiRes 8-Color printers with printing widths varying from 42 inches to 62 inches. During fiscal 1998, additional product features were developed and in August 1998, a 72 inch version of the product was released. The Company's family of products is expected to grow with the changing marketplace while meeting the needs of professional printing applications. TO DEVELOP AND PRODUCE VALUE-ADDED SOFTWARE WHICH DISTINGUISHES ITS PRINTER SOLUTIONS. The Company has consistently taken market standards to a higher level of performance. Management has been committed to continually enhancing its products by adding features and options to its current family of devices through software enhancements. These enhancements continually evolve with products over their lives through increasing print speeds, allowing use of additional media and inks for various applications, improving color matching and print quality and continuing compatibility with other vendors' software and operating systems. TO CONTINUE TO DEVELOP A GLOBAL RESELLER CHANNEL WHICH UTILIZES THE COMPANY'S SALES EXPERTISE. The Company has been successfully developing its targeted markets through direct mail and telemarketing efforts. The Company intends to continue to enhance its global third-party distribution channels while continuing to focus on its core direct market development and user education approach in partnership with its reseller focus in the U.S. and Canada. TO DEVELOP ADDITIONAL MEDIA, INK AND FILM FOR USE WITH THE COMPANY'S PROPRIETARY PRINT ENGINES TO ENHANCE PRINTING APPLICATIONS AND MARKET EXPANSION. In September 1996, the Company entered into a strategic alliance with Sihl-Zurich Paper Mill on Sihl AG (Sihl), a leading European manufacturer of specialty paper and related media, to enhance the development of unique and high-quality media for use with the Company's print engines. Sihl is a primary vendor in the Company's "Print and Hang(TM)" media offerings for outdoor use released during 1997. The Company added 21 new inkjet media offerings during fiscal 1997. Included in these offerings are WaterFast PolyFilm, WaterFast Poster Paper and Banner Tyvek(R) for outdoor applications. The release of specialty media for use with the Company's DesignWinder added Artist Gloss Canvas and Artist Matte Canvas offerings, along with FirstLook(TM) Proofing Paper and FineArt(TM)Archival Paper for use in the fine art reproduction market. The Company also increased the number of widths and lengths offered in a number of core media offerings. These media are tuned to provide the highest quality output when used in conjunction with ColorSpan's ink and proprietary ColorMark(R) color matching capabilities available on the Company's hardware product lines. In addition, the Company released multi-density ink offerings for its HiRes 8-Color DesignWinder products in both dye-based (Ultra Wide Gamut) and pigmented (LightFast(TM) ) versions. In July 1998, the Company purchased Kilborn Photo Products, Inc. for 600,000 shares of the Company's common stock. Kilborn is a media coater and research center that will provide additional inkjet media offerings for the Company. TO INCREASE INTERNATIONAL SALES. International sales have been an important part of ColorSpan's core business. The Company is committed to increasing its market share in Europe, Asia, Africa and Central and South America through its physical presence in Europe as well as by building ongoing relationships with its Value Added Distributors (VADs) throughout the world. The Company opened a new technical support and sales office in San Jose, California to enhance the support of its Pacific Rim operations going forward and has opened a sales office in Miami, Florida to focus on the Latin American market. 6 TO DEVELOP ORIGINAL EQUIPMENT MANUFACTURING (OEM) CUSTOMERS FOR THE COMPANY'S PROPRIETARY PRODUCTS. The Company announced the signing of its first significant OEM relationship in August 1997. The Agfa-Gevaert group began selling its AgfaJet Atlas imaging system in August 1997. The product is based on the Company's DesignWinder platform. During fiscal 1998, the Company signed an agreement with Ilford Imaging to sell the DMX product under the Ilford name. The Company is actively exploring relationships which would result in additional OEM customers for its various product offerings. The Company has plans to allow its proprietary engines to be accessed by third-party print servers and color management systems. During fiscal 1998, the Company signed agreements with third-party RIP providers such as Onyx Graphics, ScanVec, LTD and Colorbus. Augmenting the Company's existing distribution channels with high-quality OEMs could help gain market acceptance of the Company's products and expand its customer base for after-market consumables sales. TO EXPAND CONSUMABLE SALES BY OFFERING A LINE OF CONSUMABLES (PRIMARILY MEDIA) TO USERS OF PRINTERS MANUFACTURED BY OTHERS. In August 1997, the Company announced the opening of its Mediao Byo Air division. This internet sales model markets a line of inexpensive, high quality, commodity media and relies on electronic commerce for marketing, order acceptance and shipment. It partners with a number of third-party suppliers to offer overnight delivery of printing supplies to inkjet supplies consumers. During 1998, the Company expanded this division and renamed it Supplieso Byo Air ("SBA"). SBA has expanded its internet profile to include multiple language support and an enhanced E-commerce enabled web site which is the first implementation of the Company's E-Com Tools software packages. COLORSPAN PRODUCTS ColorSpan's six wide-format Big Color inkjet printer lines, DisplayMaker Professional (initial shipments in December 1993), DisplayMaker Express (initial shipments in December 1995), DesignWinder (introduced in September 1996), DisplayMaker XL60 (initial shipments in April, 1997), DisplayMaker HiRes 8-Color printer series (initial shipments in September 1997) and Giclee PrintMakerFA (initial shipments in September 1998), provide photo-realistic digital color output. These products are designed to be cost-effective solutions for short-run digital printing of photo-realistic wide-format color output. The printers work with most commercially available desktop digital color manipulation and composition software applications. Using third-party graphics and page-layout software applications that allow printed pages to be "tiled", the DisplayMaker products can be used to create virtually unlimited image sizes. The Company's Big Color products incorporate a number of proprietary software advances, including ColorMark color management and SmoothTone(TM) image enhancement technologies. The DisplayMaker HiRes 8-Color series adds features like AutoSet(TM) calibration which automatically adjusts cartridge positions, AutoJet(TM) mapping which makes adjustments for misfiring jets, AutoTune(TM) which allows users to calibrate in an unattended mode, and AutoInk(TM) which allows users to load two separate ink types and switch between two dye-based ink products and one pigmented ink product through software. These features utilize a CCD camera to make calibrating the printer, changing ink cartridges and unattended printing easier and more reliable. ColorMark is the Company's color management system that ensures accurate and consistent color from print to print. This technology allows the user to print multiple copies of the same file and achieve near perfect matching of colors, even after changing ink and media. SmoothTone is an image-enhancement technology that significantly boosts the apparent resolution of the printing engine to provide output with near continuous-tone quality. This product is the subject of one OEM agreement and three technology support agreements in which third-party RIP vendors have agreed to support the DMX product as a printing solution with their customers. Suggested list prices for the Company's printer products range from $13,995 to $34,995. The RIP Print Server prices range from $4,495 to $10,995. The Company's ThermalRes(R) technology, for which three United States patents have issued with additional U.S. and foreign patents pending, accomplishes an even higher degree of resolution enhancement for text and line art in monochrome and four-color pre-press printing applications. ThermalRes technology is used in the Company's desktop chemical-free filmsetter product, PressMate-FS. DISPLAYMAKER PROFESSIONAL AND DISPLAYMAKER XL60. These Big Color printers are 4-head, 36-inch and 60-inch wide, photo-realistic, roll-fed, 4-color inkjet printers capable of printing poster-size images up to 36 inches wide and 60-inches wide and, depending on the software application, up to 200 feet long. DisplayMaker Professional and DisplayMaker XL60 are based on third-party-supplied inkjet marking engines and the Company's patented Big Ink(TM) Delivery System. The ColorMark color management system incorporated into the ColorMark print server ensures consistent color quality from print to print. 7 DISPLAYMAKER EXPRESS. The Company's second proprietary printer is a 54-inch wide, photo-realistic, high-speed, roll-fed, 4-color inkjet printer which utilizes phase-change inks together with piezo printhead technologies for which the Company has special marketing rights for certain wide-format applications. DisplayMaker Express prints over 100 square feet per hour, or an E-size (34 inches by 44 inches) print in approximately six minutes. DisplayMaker Express is capable of producing prints 54 inches wide and in excess of 150 feet in length. DisplayMaker Express uses specially formulated ColorMark solid pigmented ink pucks, rather than dye-based aqueous inks used by other inkjet printers, which provides improved UV stability and water resistance. DisplayMaker Express requires the use of ColorMark qualified or certified media, which ensures proper print functionality and quality. DESIGNWINDER. The Company's third proprietary printer and first of the HiRes 8-Color printer platforms is a 36-inch wide, drum-based, cut-sheet, inkjet printer which utilizes a revolutionary eight printhead design to produce high-quality signs, photos and digital art and sets a new five minute benchmark for producing E-size prints. The Company's first OEM supply agreement, signed in August 1997, also uses this platform. DesignWinder is capable of producing apparent 1200 dpi (dots per inch) resolution prints up to 35.5 inches by 47.25 inches in size utilizing its patent-pending multi-density printing technique which uses additional inks to address more discreet colors within the color gamut. The high-precision, spinning, drum-based design provides superior dot placement accuracy and repeatability, setting a new standard in Big Color print quality, previously unattainable in traditional roll fed inkjet plotter devices (print engines that use a moving printhead traveling perpendicular to a moving web of paper to attain print coverage). GICLEE PRINTMAKERFA. This product combines the outstanding color attributes of eight color printing with the accuracy of drum-based architecture to produce output with an apparent resolution of 1800 dpi. The product targets a portion of the Fine Art reproduction market which, according to market research presented by the International Association of Fine Art Digital Printers (IAFADP), is estimated to be a $160 million market currently and growing at a rate of 60% per year. PRESSMATE-FS. In March 1995, the Company began shipping production quantities of its PressMate desktop chemical-free filmsetter. PressMate, the Company's first proprietary printer engine, is a desktop device that uses a dry process to produce specially designed films necessary for making the printing plates used in offset printing. Traditionally, these films were produced by photographic (or wet process) type imagesetters or cameras, using chemicals and darkrooms to develop the image to be reproduced. PressMate permits printing of text, line art and images used for four-color separations, at resolutions considered by the Company to be equivalent to 2400 dots per inch using a heat-sensitive, chemical-free film. This fidelity was previously unavailable in a plain-paper or thermal printing device. PressMate shipments were suspended in August 1995 to improve registration tolerance across multiple layers of film required for the highest quality, four-color separations desired by the Company's customers. In December 1995, the Company began shipping production quantities of PressMate-FS, which incorporated these technical improvements. The PressMate-FS is a desktop unit that is easily integrated into office or computer network environments. COLORMARK PRO 3000. The DisplayMaker printers, DesignWinder, Giclee PrintMakerFA and PressMate are all driven by the Company's ColorMark Pro 3000 print server, a raster image processor that is based on a 300 MHz, 32-bit microprocessor. The ColorMark Pro 3000 features advanced file spooling (a queue method) for multiple users, "RIP Saver(R) (which stores processed files to avoid redundant rasterization) and job management and logging features that track ink and paper consumption for job-costing and work-flow planning, among other things. This device has connectivity capacity to handle several devices simultaneously including one DesignWinder or Giclee PrintMaker FA, up to two DisplayMaker Professional or XL60, one DisplayMaker Express, one DisplayMaker HiRes 8-Color printer, and up to two PressMate-FS. RIPSTATION. The RIPStation is an entry-level raster image processor color server. It is based on a 200 MHz, 32-bit microprocessor. It functions similarly to the ColorMark Pro 3000 without the added advanced and multiple engine connectivity features offered by the ColorMark Pro 3000. CONSUMABLES. Color printing consumes significant quantities of inks and media. ColorSpan products include a range of consumables, such as specialized dye-based inks for indoor use and pigmented inks for outdoor use. The Company performs qualification testing on these consumables before releasing them for customer shipment. The specialized inks are created specifically for ColorSpan products to optimize image quality and printer performance. The Company currently offers a variety of media for its wide-format inkjet printers that include recent introductions such as WaterFast PolyFilm, WaterFast Poster Paper and Banner Tyvek for outdoor use with its roll-fed aqueous inkjet products. The 8 Company sells over 100 different media options and has almost 200 different ink products. During fiscal 1998, the Company tested and released Perma-Chrome(TM) LightFast Pigmented ink and Endura-Chrome(TM) LightFast Dye ink products to increase the variety of printing solutions available from ColorSpan related products. The Company sells the consumables (inks, media and film) required for optimum use of the printing products it sells. The Company offers various ColorMark consumables for its Big Color printers, including a dye-based version and a waterfast, lightfast pigment-based version of 500 ml Big Ink packs for use with the DisplayMaker HiRes 8-Color printer series, DisplayMaker Professional, DisplayMaker XL60 and DesignWinder. The Company also sells uniquely configured 150 ml ColorMark solid ink pucks required for the DisplayMaker Express. The Company introduced dye-based and pigment-based ColorMark multi-density inks for use with DesignWinder during 1997. In addition to the basic media offered for DisplayMaker Express in the past (ColorMark Bond, ColorMark Vinyl and ColorMark WaterFast Removable Tyvek), during 1997 the Company introduced ColorMark WaterFast Durabanner(TM), ColorMark Laminate Bond, to be used when encapsulation of the output is desired, and two lower priced versions of previously released media; ColorMark EconoVinyl and ColorMark EconoBond. The Company also offers a variety of print media in various widths and lengths such as Coated Gloss paper, PolyGloss(R), FineArt Canvas, matte, ClearFilm(TM), and TransWhite(R) translucent backlit film (used on back-lighted signs) for use with DisplayMaker Professional, DesignWinder, DisplayMaker XL60, and the DisplayMaker HiRes 8-Color series of products. As part of the ColorMark system, the 500 ml Big Ink packs, and 150 ml ColorMark ink pucks ship with ColorMark profilers (recyclable circuit boards) that plug into the printer, and provide information to ensure accurate, consistent color output from print to print. The domestic price per dye-based Big Ink pack is $199 per color. The price for pigment-based Big Ink packs is $299 per color. The ColorSpan wide-gamut dye-based Big Ink packs sell for $229 each and the pigmented versions sell for $299 each. The domestic price per ColorMark ink puck is $175. The domestic prices of the ColorMark paper and other media range from $65 to $450 per 100- to 150-foot, 36-inch wide rolls and from $119 to $1,159 per 40- to 175-foot, 60-inch wide rolls. The Company's PressMate-FS Personal FilmSetter(TM) requires specially developed ThermalRes film rolls which are also supplied by the Company. This unique specialty film is manufactured to the Company's specifications. The domestic price is $295 for a 90-foot roll of ThermalRes film. The Company's Unity(TM) line of plain-paper typesetters require toner and process units for operation. The domestic price for toner is $69 per unit, and process units list for $699 per unit. PRODUCT DEVELOPMENT The Company's continued success depends on making ongoing investments in product development to ensure the timely introduction of high-performance products in response to changes in technology, market demands and customer requirements. For certain important additional cautionary factors, risks and uncertainties, refer to Exhibit 99 of this Form 10-K. Accordingly, the Company is committed to creating specialty printing products that yield performance superior to standard marking engines, designing new engines and enhancing existing products to achieve higher levels of performance. The Company is also committed to designing and enhancing products to increase the Company's aftermarket consumables business. As of June 30, 1998, the Company employed approximately 70 people in product development activities. The Company's product development organization consists of multiple project teams based in three main product areas: drum-based products, carriage-based products and consumable development and testing. Staffing for these teams is flexible, allowing individual engineers to handle multiple and sometimes overlapping development objectives. The Company's software development group creates and enhances software technologies which improve the usefulness, cost-effectiveness and productivity of printers offered by the Company, and the quality of such printers' output. The Company's hardware group works to enhance existing hardware components and products and works with the software group to develop printer products for specialized applications and markets. The consumables group creates and tests new product offerings for the Company's installed base of printers. SALES AND MARKETING The Company sells its products primarily through its factory sales professionals, partnered with its dealers in the U.S. and Canada, and value added distributors ("VAD") internationally. As of June 30, 1998, the Company employed an 81 9 person telemarketing sales force including sales professionals focused in part on developing relationships with major national printing accounts and new dealers and resellers. The Company changed its domestic distribution model in February 1997 and now sells its color hardware products only through its reseller VAD and OEM networks. The Company's sales efforts are supported by a direct mail marketing program designed to achieve frequent contact with its potential customers, including PostScript(R) and reprographic service bureaus, photo labs, quick printers, sign shops, exhibit houses and corporate marketing departments. The Company complements its direct mail efforts by advertising in trade journals and by exhibiting regularly at industry trade shows. The Company invests significant resources in developing and training its sales professionals and has implemented computerized sales management and sales communications systems. Sales representatives participate in continuous training programs so that they understand product features and benefits as well as customer applications and business requirements. Sales professionals are compensated on a salary plus bonus and commission basis. DOMESTIC AND CANADIAN SALES. The Company's domestic and Canadian sales and marketing operations are based at its headquarters in Eden Prairie, Minnesota. The products are sold through a network of domestic resellers and international value added distributors. In the U.S./Canada, the Company uses a factory sales team to assist the resellers in the sales process. For its Big Color products, the Company has also established relationships with independent copy shops and local service printers that have purchased Big Color products. These Big Color Digital Printing Centers are provided cooperative marketing support to promote Big Color printing services and products in their area. The Company's sales professionals refer potential customers to these local Big Color Digital Printing Centers or resellers to observe the use of the Company's Big Color products. From time to time, the Company pays a fee to the showcasing center or reseller following a sale. The Company believes that this marketing approach permits the Company to price its Big Color products at competitive levels. OEM SALES. The Company signed its first significant OEM contract in August 1997. Pursuant to this agreement, the Company is selling its DesignWinder product and Big Ink Delivery System for use with the DesignWinder to Agfa-Gevaert for private labeling. Agfa began selling its AgfaJet Atlas imaging system in August 1997. In February 1998, the Company signed an OEM agreement with Ilford Imaging to market and distribute a version of the Company's new DMX series printers. The Company is currently exploring other relationships which would result in OEM customers for its various printer engines. The Company desires to expand the market acceptance of its proprietary products and widen its distribution network for both hardware and after market consumables. Relationships with quality OEM partners are a method of attaining this goal. The Company has plans to allow its proprietary engines to be accessed by third-party print servers and color management systems. The Company signed three agreements during fiscal 1998 to allow third-party vendors to support the Company's HiRes 8-Color product line. Expanding the installed base of ColorSpan hardware products will allow the Company an opportunity to sell more consumables products. INTERNATIONAL SALES. The Company currently sells its products in all of the Western European nations and in the principal Eastern European, Latin American, Pacific and Asian markets. The Company's European sales, support and warehouse facility is located near Amsterdam, The Netherlands. The Company conducts sales operations for Europe, the Middle East and Africa from its European headquarters. Pacific and Asian markets are managed from the new technical support and sales office in San Jose, California, while Latin America is served from the sales office located in Miami, Florida. All other international sales are managed from its headquarters in the United States. In international markets, the Company sells its products through a network of non-exclusive VADs. VADs are granted the right to purchase ColorSpan products at discounted prices from list price and distribute those products within a specified territory outside the United States. VAD agreements require the VAD to promote, market and support ColorSpan products and are typically for a one year period with automatic one year renewals. Either party may terminate the agreement with or without cause, with a 30 day written notice. The Company may appoint other VADs and may sell directly to customers inside these territories. For the year ended June 30, 1998, sales to customers outside of the United States accounted for approximately 42% of the Company's total revenues. See Note 14 of Notes to Consolidated Financial Statements for additional information regarding international operations. 10 SERVICE AND SUPPORT At June 30, 1998, the Company had 48 technical and customer support representatives responding to telephone inquiries from customers and dealers. The Company offers a limited warranty for all of the products it manufactures. Under its limited warranty, the Company will repair or replace any defective product on a factory return or central depot basis for a period ranging from 90 days to one year following purchase. In addition to its factory warranty, the Company offers its customers the option of on-site installation and maintenance services in most markets, through third-party support organizations. MANUFACTURING The Company performs final assembly, functional testing and quality assurance for essentially all of its products and related components, parts and subassemblies at its facilities in Eden Prairie, Minnesota. For some of its products, the Company currently purchases fully assembled printer marking engines directly from manufacturers and other components, parts and subassemblies from outside sources. For its PressMate-FS, DisplayMaker Express, DesignWinder, Giclee PrintMakerFA and DisplayMaker HiRes 8-Color series products, the Company purchases components and uses them to manufacture the printer engine. The Company designs controller boards and software for use with these print engines and components. The Company utilizes a computerized material requirements planning (MRP) and monitoring system to integrate its purchasing, materials handling and inventory control functions. Certain components used in the Company's products, including printer marking engines, printheads and custom fabricated components, are currently available only from sole sources. Certain other components are available from only a limited number of sources. The Company has experienced delays in the past as a result of the failure of certain suppliers to meet requested delivery schedules. The Company sources ink cartridges from a supplier that also competes in the wide-format digital printing market. During fiscal 1998, revenues based on the components supplied by this competitor accounted for approximately 67% of the Company's total revenue. Should the Company have problems obtaining the inkjet cartridges for any reason, it will have a significant adverse impact to the Company. In August 1996, the Company experienced a severe shortfall in piezo head components due to a yield problem with one of its key vendors. That shortfall caused a reduction in revenues for the DisplayMaker Express product line in the September 1996 quarter. The Company worked through the process problems with this vendor during the December 1996 quarter and is currently able to obtain adequate supplies. The Company's potential inability to obtain sufficient sole or limited source components, or to develop alternative sources, could result in delays in product introductions, interruptions in product shipments or the need to redesign products to accommodate substitute components, any of which could have a material adverse effect on the Company's operating results. For certain important additional cautionary factors, risks and uncertainties, refer to Exhibit 99 of this form 10-K. In fiscal 1994, the Company made the strategic decision to migrate away from products based on standard marking engines manufactured by unrelated third parties and to focus on engine products designed and manufactured by the Company. In fiscal 1995, the Company began active production of its first proprietary print engine, PressMate, a chemical-free filmsetter. A production line was also established for DisplayMaker Express which was released in December 1995. The Company introduced a proprietary printer engine, DesignWinder, in September 1996, and introduced another proprietary product series, the DisplayMaker HiRes 8-Color 4000, 5000, and 6000 products in September 1997 and 7000 in August 1998. The Giclee PrintMakerFA was also introduced in August 1998. Production of proprietary engines has required the Company to increase its inventory beyond historical levels, requiring the use of additional working capital. The Company has also experienced increases in production and overhead costs which have had a significant, negative impact on the overall gross margins of the Company. A portion of the total manufacturing cost of the Company's filmsetter and Big Color products is represented by certain components whose prices have fluctuated significantly in recent years. Significant fluctuations in price or availability of certain components could have a material adverse effect on the Company's operating results. Because the Company normally fills orders within a few days of receipt, it usually carries less than one month's backlog. In addition, customers may generally cancel or reschedule orders without significant penalty. For these reasons, the Company believes that backlog is not a meaningful indicator of future sales. Manufacturing plans and expenditure levels are based primarily on sales forecasts and historical trends where applicable. The absence of a material backlog could contribute to unexpected fluctuations in operating results. 11 COMPETITION The computer printer industry is intensely competitive and rapidly changing. Some of the Company's existing competitors, as well as a number of potential competitors, have larger technical staffs, more established and larger marketing and sales organizations and significantly greater financial resources than the Company. For important additional cautionary factors, risks and uncertainties, refer to Exhibit 99 of this Form 10-K. The Company's Big Color inkjet printing products compete in the short-run, wide-format, photo-realistic color printing market with photographic methods, electrostatic and inkjet digital printers. Some of the competing manufacturers and vendors in this market include Hewlett-Packard Co., ENCAD, Inc., Raster Graphics, Inc., Xerox Corp., Electronics for Imaging, Inc., Iris Graphics, Inc., CalComp, Inc., Roland, Mutoh, Epson,Tektronics, Inc. and a variety of competitors who purchase ENCAD's printer engines on an OEM or systems integration basis. Xerox, Fuji and Canon are expected to or already have released new products which will compete for market share in this industry this year. Competition in this market is generally based on equipment cost, printing quality, production and printing speed, operating costs and the costs of maintenance and upkeep. The traditional photographic approach, employed to produce photo-realistic output one page at a time, is expensive, time-consuming and labor-intensive, especially when an image includes text. This approach also requires skilled personnel and special production facilities and creates chemical wastes. Digital printers, used with software that permits manipulation of images and text, can create photo-realistic output without the use of the photographic process, eliminating the need for chemical production facilities. The electrostatic printers that compete with the Company's Big Color products are expensive, costing from $50,000 to over $200,000, and can involve significant maintenance and operating costs. They can also require controlled environments and sophisticated front-end processing systems. Although electrostatic printers provide significantly faster printing speeds and lower per-square-foot consumables costs than those of the Company's products, the Company believes it competes favorably with such devices on the basis of lower initial purchase price, easier operation, higher quality output and lower ongoing maintenance and environmental requirements. While other vendors have introduced wide-format printers based on engineering plotter engines, at prices comparable to or below those of some of the Company's products, the Company believes that its software and hardware technologies, including SmoothTone image enhancement, ColorMark color management and the newly-released features of the DisplayMaker HiRes 8-Color product line which include AutoSet calibration, AutoJet mapping, AutoTune unattended printing and AutoInk swapping, offer it a competitive advantage in terms of higher printing quality, easier operation and lower ongoing operating costs. In particular, with issued United States patents on its Big Ink Delivery System and other patents pending in the US and elsewhere, the Company believes it has a competitive advantage in high-capacity, wide-format, closed-loop color graphics printing using a unitary system. The Company's chemical-free filmsetter, PressMate, competes with phototypesetting equipment produced by a variety of manufacturers such as Varityper, Inc., Linotype-Hell, Inc. and Agfa-Gevaert. Many of the competitive imagesetting systems require a darkroom, other dedicated facilities for storing chemicals required for processing the film, hazardous materials, special insurance and handling capabilities, and strict adherence to OSHA requirements. The Company's PressMate is chemical-free and does not require a special environment for operation. This reduces the cost of operation for users as well as time required to produce documents by allowing the user to control the film production process without the use of chemicals. PressMate competes on the basis of price, speed, creative control, convenience and environmental concerns. The Company's new Internet/Software Business Unit will compete in markets that it considers highly fragmented and diverse. Competition in those markets is also very intense. The IT Consulting Business will compete for acquisitions with many competitors who have more experience and resources and can apply more capital to the acquisition process. Substantially all of the Big 5 Accounting firms, General Electric, USWeb and a large number of smaller firms are competing to locate, hire or purchase resources in this area. The Business Unit's software products will also compete with some of the same competitors listed above. There can be no assurance that the Company will be able to locate and acquire the resources necessary to implement its strategy for this new Business Unit. For important additional cautionary factors, risks and uncertainties, refer to Exhibit 99 of this form 10-K. 12 PROPRIETARY RIGHTS The Company's ability to compete effectively depends, in part, on its ability to maintain the proprietary nature of its technologies through patents, trademarks, copyrights and trade secrets. Important features of the Company's products are represented by proprietary software, some of which is licensed from others and some of which is owned by the Company. The Company attempts to protect its proprietary software with a combination of copyrights, trademarks and trade secrets, employee and third-party non-disclosure agreements and other methods of protection. Despite these precautions, it may be possible for unauthorized third parties to copy certain portions of the Company's products or to reverse-engineer or obtain and use information that the Company regards as proprietary. In addition, there can be no assurance that others will not independently develop software products similar or superior to those developed or planned by the Company. In addition, the Company's products compete in a market in which much intellectual property has been developed and patented by competitors of the Company. Although the Company performs patent searches and employs both outside and inside patent counsel, there can be no assurance a competitor will not dispute the uses or methods employed by the Company's products. For important additional cautionary factors, risks and uncertainties, refer to Exhibit 99 of this Form 10-K. The Company has been granted four United States patents for inventions related to its TurboRes approach to enhancing the vertical resolution of conventional laser printer engines, four United States patents relating to the Company's Big Ink Delivery System, and three patents relating to its ThermalRes approach to enhancing vertical resolution of printheads which use thermal marking engines, and one patent for VideoNet(R) which is a high-speed communications method for connecting print engines to print servers. Additional patent applications are pending relating to the Company's TurboRes, FastPort, Big Ink Delivery System, and other imaging and image enhancement and wide-format print engine technologies and techniques. There can be no assurance that patents will issue from any of these pending applications. In addition, with regard to current patents or patents that may issue, there can be no assurance that the claims allowed will be sufficiently broad to protect the Company's technology or that issued patents will not be challenged or invalidated. Applications to patent the basic TurboRes, ThermalRes and Big Ink Delivery System approaches and related technologies have been filed in selected foreign countries. Patent applications filed in foreign countries are subject to laws, rules and procedures which differ from those of the United States and thus there can be no assurance that any foreign patents will issue as a result of these applications. Furthermore, even if these patent applications result in the issuance of foreign patents, some foreign countries provide significantly less patent protection than the United States. LICENSES The Company licenses Pipeline Associates, Inc.'s PowerPage(R) printer-language software for enhancement and use in its products to provide support for and compatibility with the PostScript page description language. PowerPage is used in the majority of typesetter and all Big Color products. The license agreement provides for a per unit royalty on printers shipped by the Company, subject to minimum quarterly requirements. The Company has a license to remanufacture inkjet cartridges used in its Big Color printer products. The Company pays a related royalty based on the number of inkjet cartridges purchased from Hewlett-Packard for resale. The Company has licensed operating software from Novell, Inc. and Microsoft Corporation for use in its Unity typesetters and Big Color products. These license agreements provide for a per unit royalty on printers shipped by the Company. EMPLOYEES At June 30, 1998 the Company had a total of 404 employees. None of the Company's employees are represented by a labor organization and the Company has never experienced a work stoppage or interruption due to a labor dispute. Management believes its relationship with employees is good. 13 ENVIRONMENTAL MATTERS The Company believes that it is in compliance with all material aspects of applicable federal, state and local laws regarding the discharge of materials into the environment. The Company does not believe that it will be required to spend any material amount in compliance with these laws. ITEM 2. PROPERTIES. - - ------- ----------- As of August 31, 1998 the Company leases an aggregate of 314,077 square feet of office and warehouse space in Eden Prairie, Minnesota of which 168,034 square feet is from a related party (see Item 13), pursuant to leases expiring at various times through December 2010. The leases require payments of property taxes, insurance and maintenance costs in addition to basic rent and contain renewal options for periods ranging from one to three years. The Company leases approximately 15,867 square feet of office and warehouse for its European headquarters in Hoofddorp, outside of Amsterdam, The Netherlands. The Company leases 14,472 square feet of office space in San Jose, California for its Asian sales and technical support staff and an advanced research and technology center. The Company also leases 1,713 square feet of office space in Miami, Florida for the ColorSpan Latin America sales staff and owns approximately 25,000 square feet of office and production space in Cedar Rapids, Iowa for its media coating operations. Management expects to acquire additional facilities, most likely through leasing, in fiscal 1999 to accommodate the anticipated growth in the Internet/Software Business Unit. ITEM 3. LEGAL PROCEEDINGS. - - ------- ------------------ In October 1995, a shareholder of the Company (Becker) filed an action against the Company and four of its officers and directors alleging violations of the Securities and Exchange Act of 1934. The Becker claims have been pled as a class action. In February 1996, one of the directors named in the suit was dismissed from the case without prejudice. A class of plaintiffs was certified as including all purchasers of the Company's stock during the period of December 3, 1993 through December 8, 1994. In August 1997, the Company announced a settlement agreement with shareholder class representatives and preliminary court approval of the settlement in the class action securities litigation. In October 1997 the court issued its final approval of the settlement and dismissed all claims against the Company and its officers and directors. Pursuant to the settlement the Company has contributed stock valued at $636,000. The settlement obligation is included in the special charges for the quarter ended June 1997. In October 1995, LaserMaster Corporation (LMC) filed suit against Sentinel Imaging, a division of Sentinel Business System, Inc. ("Sentinel") and Brian Haberstroh, an employee of Sentinel ("Haberstroh"). The complaint alleged, among other things, misappropriation of trade secrets, and interference with contractual relationships. The Company alleged that Sentinel misappropriated trade secrets related to LaserMaster's Big Ink delivery system for the Big Color product line and customer information related to customers and users of the Big Ink product. In October 1997 the case was tried before a jury which found in favor of LMC and against Sentinel and Haberstroh and awarded damages to LMC in the amount of $2.174 million dollars. The court awarded interest on the verdict and entered judgment in the amount of $2.363 million dollars. Sentinel appealed from the judgement. In February 1998, ColorSpan Corporation ("CSC") filed another suit against Sentinel alleging tortious interference with contract, contributory copyright infringement, copyright infringement and unfair competition related to CSC's software license for the ColorMark color management software. Sentinel has counterclaimed alleging copyright misuse and unfair competition. In March 1998, Sentinel filed for protection under chapter 11 of the federal bankruptcy code. Since the bankruptcy filing, the Company acquired Kilborn Photo Products, Inc., a media coating facility which is a supplier to Sentinel and also has a claim in the approximate amount of $575,000 against Sentinel for product supplied. The Company does not know whether the claims of ColorSpan or Kilborn will be challenged. At this time a plan of reorganization has not been filed in the case. It is uncertain whether a plan of bankruptcy will be submitted and approved, and what, if anything, the Company may recover from Sentinel in the bankruptcy. In addition, the creditors committee involved in this case is considering a potential "preference" claim associated with approximately $1.8 million in payments from Sentinel to Kilborn during the year prior to the filing of the petition for bankruptcy. 14 The Company's European subsidiary is involved in a dispute with a distributor which alleges that the Company wrongly refused to enter into a distribution agreement with the distributor. An adverse determination of the liability aspects has been rendered against the Company's subsidiary, but there has been no determination of damages that may be due to the distributor. The Company believes that the amount of damages that the distributor may recover is not expected to have a material effect on the financial condition of the Company. The Company is involved in legal proceedings related to customers credit and product warranty issues in the normal course of business. In certain proceedings, the claimants have alleged claims for exemplary or punitive damages which may not bear a direct relationship to the alleged actual incurred damages, and therefore could have a material adverse effect on the Company. At this time none of the proceedings is expected to have a material effect on the Company's operations or financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. - - ------- ---------------------------------------------------- The Annual Meeting of the shareholders of VirtualFund.com, Inc. was held on April 2, 1998, pursuant to notice to all shareholders of record at the close of business on February 27, 1998. As of the notice of the meeting there were 14,877,533 common shares outstanding. The following matters were presented for a vote of the security holders: 1. Election of director Jean Louis Gassee to a three year term. Shareholders passed the resolution with 13,790,566 votes in favor and 83,915 votes against the proposal. There were no abstentions. 2. Election of director Rohan Champion to a three year term. Shareholders passed the resolution with 13,788,466 votes in favor and 86,015 votes against the proposal. There were no abstentions. 3. Election of director George Kline to a two year term. Shareholders passed the resolution with 13,787,966 votes in favor and 86,515 votes against the proposal. There were no abstentions. 4. A proposal to change the name of LaserMaster Technologies, Inc. to VirtualFund.com, Inc. Shareholders passed the resolution with 13,516,116 votes in favor and 230,925 votes against the proposal. There were 127,440 abstentions. Mr. Kline subsequently resigned his position as a director in June 1998. 15 PART II ------- ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER - - ------- ------------------------------------------------------------- MATTERS. -------- DIVIDENDS The Company has never paid cash dividends on its Common Stock. The Company currently intends to retain any earnings for use in its business and, accordingly, does not anticipate paying any cash dividends in the foreseeable future. Any payment of dividends in the future will depend upon the capital requirements, earnings, and general business and financial condition of the Company, as well as other factors which the Board of Directors may deem relevant. MARKET INFORMATION Since July 17, 1990, the Company's Common Stock has traded on the Nasdaq National Market System (Nasdaq symbol: VFND formerly LMTS). The following table sets forth the high and low sale prices reported in the Nasdaq National Market System: Common Stock ------------ High Low ---- --- Fiscal Year 1997 First Quarter...................................... $ 5.75 $ 3.25 Second Quarter..................................... 6.25 4.63 Third Quarter...................................... 5.88 4.13 Fourth Quarter..................................... 4.25 1.63 Fiscal Year 1998 First Quarter ..................................... 3.63 1.69 Second Quarter..................................... 5.00 2.63 Third Quarter...................................... 5.25 3.50 Fourth Quarter..................................... 5.25 3.75 Fiscal Year 1999 First Quarter (through August 31, 1998)............ 5.25 3.44 - - ------------------------------- As of August 31, 1998, the last reported sale price of the Common Stock was $4.00 per share. As of such date, there were approximately 216 record holders and 2,900 beneficial holders of the Common Stock. ITEM 6. SELECTED FINANCIAL DATA. - - ------- ------------------------
Fiscal Years Ended June 30, ------------------------------------------------------------- (In thousands, except per share amounts) 1998 1997 1996 1995 1994 ---------- ---------- ---------- ----------- ---------- Statement of Operations Data: Net Sales................................. $ 80,732 $ 86,563 $ 93,592 $ 119,438 $ 105,849 Cost of goods sold........................ 48,051 61,912 (a) 64,379 (b) 72,857 59,852 ---------- ---------- -------- --------- ---------- Gross profit...................... 32,681 24,651 29,213 46,581 45,997
16
Operating expenses: Sales and marketing........................ 14,335 18,131 21,109 27,091 21,810 Research and development................... 6,503 6,387 6,149 6,210 3,335 General and administrative................. 9,506 10,097 11,310 11,552 9,634 Restructuring and other special charges.... 4,936 (a) 4,431 (b) ---------- -------- --------- ---------- ----------- Operating profit (loss)............... 2,337 (14,900) (13,786) 1,728 11,218 Other expenses (primarily interest)........... (610) (1,011) (1,823) (1,433) (1,160) ----------- --------- --------- ---------- ----------- Earnings (loss) before income taxes........... 1,727 (15,911) (15,609) 295 10,058 Income tax (provision) benefit................ (1,289)(a) 5,147 (89) (3,394) ---------- --------- -------- ---------- ----------- Net earnings (loss)........................... $ 1,727 $ (17,200) $ (10,462) $ 206 $ 6,664 ========== ========== ========== ========== ========== Net earnings (loss) per common share: Basic......................................... $ 0.12 $ (1.25) $ (0.93) $ 0.02 $ 0.65 ========== ========== ========== ========== ========== Assuming dilution............................. $ 0.11 $ (1.25) $ (0.93) $ 0.02 $ 0.57 ========== ========== ========== ========== ========== Weighted average common shares outstanding.... 14,716 13,706 11,305 11,097 10,192 ========== ========== ========== ========== ========== Weighted average common and dilutive potential common shares outstanding........... 15,602 13,706 11,305 12,206 12,189 ========== ========== ========== ========== ==========
(a)In June 1997, the Company incurred special pre-tax charges of $8.4 million. The charges were related to the phase out of two proprietary printer products and settlement of litigation. $3.5 million was charged to cost of goods sold and $4.9 million to operating expenses. In addition, the Company recorded a special income tax provision charge of $6.5 million related to the revaluation of deferred tax assets. (b)In May 1996, the Company incurred special pre-tax charges of $9.9 million, consisting of restructuring and other special charges of $4.4 million and a special charge to cost of goods sold of $5.5 million related to a revised business plan and technical problems in one of its products. June 30, ------------------------------------------------- 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- (In thousands) Balance Sheet Data: Working capital $ 9,326 $ 9,732 $ 2,580 $ 13,708 $ 13,973 Total assets 33,120 32,631 46,545 59,161 47,401 Current liabilities 17,286 18,298 30,087 30,933 21,042 Long-term debt, less current maturities 67 185 820 1,599 1,590 Stockholders' equity 15,767 11,915 15,638 25,293 23,139 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - - ------- --------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- (Tabular information: dollars in thousands, except per share and percentage amounts) CAUTIONARY STATEMENT The statements in this Management's Discussion and Analysis that are forward-looking involve numerous risks and uncertainties and are based on current expectations. Actual results may differ materially. Refer to exhibit 99 of this form 10-K for certain important cautionary factors, risks and uncertainties related to "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Act"). RESULTS OF OPERATIONS The following table sets forth certain items from the Company's Consolidated Statements of Operations expressed as a percentage of net sales: 17 Fiscal Years Ended June 30, --------------------------- 1998 1997 1996 ----- ----- ----- Net sales .................................. 100.0% 100.0% 100.0% Cost of goods sold ......................... 59.5 71.5(a) 68.8(b) ----- ----- ----- Gross margin ............................... 40.5 28.5 31.2 Expenses: Sales and marketing ................... 17.7 20.9 22.5 Research and development .............. 8.1 7.4 6.6 General and administrative ............ 11.8 11.7 12.1 Restructuring and other special charges 5.7(a) 4.7(b) ----- ----- ----- Total operating expenses ................... 37.6 45.7 45.9 ----- ----- ----- Operating profit (loss) .................... 2.9 (17.2) (14.7) Other (expense) income: Interest expense ...................... (0.9) (1.6) (1.9) Other ................................. 0.1 0.4 (0.1) ----- ----- ----- Earnings (loss) before income taxes ........ 2.1 (18.4) (16.7) Income tax (provision)benefit .............. (1.5)(a) 5.5 ----- ----- ----- Net earnings (loss) ........................ 2.1% (19.9)% (11.2)% ===== ===== ===== (a)In June 1997, the Company incurred special pre-tax charges of $8.4 million related to the revised estimates of the net realizable value of certain assets associated with the Company's first two proprietary printers along with the Company's obligation for the settlement of litigation. In addition, the Company incurred a special income tax provision of $6.5 million for the revaluation of deferred tax assets. The impact of the special charges on cost of goods sold, operating expenses and income tax provision was 4.0%, 5.7% and 7.5% of net sales, respectively. (b)In May 1996, the Company incurred special pre-tax charges of $9.9 million related to the Company's revised business plan and technical problems in one of its products. The impact on cost of goods sold and operating expenses was 5.9% and 4.7% of net sales, respectively. NET SALES Net sales were $80.7 million, $86.6 million and $93.6 million in fiscal 1998, 1997 and 1996, respectively. The decrease in net sales of 6.7% in fiscal 1998 was the result of a 21.1% decrease in hardware sales, partially offset by a 6.8% increase in sales of consumables. The decrease in hardware sales in fiscal 1998 is due to a $2.9 million decrease in sales of PressMate, a $3.5 million decrease in sales of plain-paper typesetting equipment and a $3.5 million decrease in sales of Big Color servers (raster image processors or RIPs). The decrease in sales of PressMate and plain-paper typesetting products is primarily related to a reduction in marketing resources devoted to these products. The decrease in sales of Big Color servers is the result of the Company's introduction in 1998 of a version of its HiRes DisplayMaker that is designed for third-party RIP support and another version that includes an embedded PostScript-language compatible RIP. Consumables sales, consisting primarily of ink, media and film, along with maintenance contracts and spare parts, as a percentage of total net sales was 58.9%, 51.5% and 39.7% in fiscal 1998, 1997 and 1996, respectively. The increase in consumables sales over the past two years is primarily due to an increased installed base of 8-Color printers such as DesignWinder and the new HiRes DisplayMaker series. These 8-Color printers typically use more ink than 4-Color printers, such as DisplayMaker Professional, in order to achieve a higher apparent resolution. The increase in sales of ink related to 8-Color printers more than offset a $2.4 million decrease in sales of plain-paper typesetting consumables and a $1.6 million decrease in sales of ink related to 4-Color printers. 18 The decrease in net sales of 7.5% in fiscal 1997 was the result of a 23.7% decrease in hardware sales, partially offset by a 15.5% increase in sales of consumables. The decrease in hardware sales included an $8.9 million decrease in plain-paper typesetting products, a $1.2 million decrease in PressMate, a $1.8 million decrease in DisplayMaker Express and a $4.2 million decrease in DisplayMaker Professional. The decrease in sales of plain-paper typesetting products and PressMate is primarily related to a reduction in marketing resources devoted to these products. The decrease in sales of DisplayMaker Express is primarily the result of lower average selling prices in fiscal 1997 as unit sales were only slightly lower in fiscal 1997 than fiscal 1996. The decrease in sales of DisplayMaker Professional is due to the fiscal 1997 introduction of DesignWinder, the Company's third proprietary printer. DesignWinder replaced DisplayMaker Professional as the Company's leader in volume shipments in fiscal 1997. The following table sets forth net sales by product line expressed in thousands and as a percent of net sales: Fiscal Years Ended June 30, ---------------------------------------- NET SALES 1998 1997 1996 ---- ---- ---- Consumables............... $47,578 58.9% $44,566 51.5% $37,174 39.7% Big Color................. 29,730 36.9 32,030 37.0 35,190 37.6 Plain-paper Typesetting... 1,474 1.8 4,951 5.7 13,834 14.8 PressMate................. 1,947 2.4 4,871 5.6 6,028 6.4 Other..................... 3 145 0.2 1,366 1.5 Total net sales........... $80,732 100.0% $86,563 100.0% $93,592 100.0% ======= ====== ======= ====== ======= ====== INTERNATIONAL SALES Japan, Asia/Pacific sales decreased $4.9 million or 34.3% and Latin American sales decreased $1.9 million or 30.7% in fiscal 1998 primarily as a result of unstable economic conditions in these regions throughout most of fiscal 1998. Japan, Asia/Pacific sales increased both as a percentage of total net sales and in dollars from fiscal 1996 to fiscal 1997 as a result of increased penetration of the Asian markets. The release of DesignWinder in fiscal 1997 and DisplayMaker Express in fiscal 1996 generated significant sales in Asia. Decreased sales in the European market in fiscal 1997 is attributable to increased competition in the plain-paper typesetting and Big Color product lines as well as the Company's realignment of its European distribution channels. These decreases in Europe were somewhat offset by sales of DesignWinder and DME and also increases in consumables. The following table sets forth international sales expressed as a percent of total net sales and in thousands: Fiscal Years Ended June 30, ---------------------------------------------- INTERNATIONAL SALES 1998 1997 1996 ---- ---- ---- Europe................ $17,226 21.3% $17,410 20.1% $19,656 21.0% Japan, Asia/Pacific... 9,451 11.7 14,382 16.6 13,235 14.1 Latin America......... 4,286 5.3 6,184 7.1 5,146 5.5 Canada................ 2,965 3.7 2,118 2.5 2,892 3.1 ------- ----- ------- ----- ------- ---- Total net sales....... $33,928 42.0% $40,094 46.3% $40,929 43.7% ======= ===== ======= ===== ======= ===== SALES OUTLOOK Based on the success of the Company's most recent product introductions, anticipated products and expectations for the revenue potential in its new Internet/Software Business Unit, management believes the Company now has the products, infrastructure and systems in place to increase its revenue base in fiscal 1999 over fiscal 1998 levels. However, there can be no assurances that the Company will be able to increase its revenue base in fiscal 1999. 19 GROSS MARGIN Gross margins, expressed as a percent of net sales, were 40.5%, 28.5% (32.5% excluding special charges) and 31.2% (37.1% excluding special charges) for fiscal 1998, 1997 and 1996, respectively. Gross margin as a percent of net sales increased in fiscal 1998 by 5.4% as a result of changes in product mix and pricing and 6.6% as a result of reductions in direct labor and overhead (of which 4% is related to special charges in fiscal 1997). Gross margin was negatively impacted throughout fiscal 1997 from excess capacity related to lower than expected hardware volumes on PressMate and DisplayMaker Express and aggressive pricing of DisplayMaker Express, as lower-priced alternative products offered by the Company and its competitors became available. In addition, gross margin was negatively impacted in fiscal 1997 by aggressive pricing of plain-paper typesetting products and some Big Color products developed as a systems integrator, in an attempt to maintain market share against heavy discounting generated by broad distribution from its third-party OEM supplier of the platform used in the DisplayMaker Professional printer. In fiscal 1998, 1997 and 1996 the Company's gross margins were favorably impacted by increasing sales of after-market consumables which typically have higher gross margins than hardware sales alone. Included in fiscal 1997 cost of goods sold is a special charge of $3.5 million related to the revaluation of PressMate and DisplayMaker Express inventory. This charge is based on the Company's estimate of the net realizable value of the related inventory as of the time the charge was incurred. Included in fiscal 1996 cost of goods sold is a special charge of $5.5 million consisting of $4.2 million in inventory revaluation associated with the transition from certain product lines developed as a systems integrator and $1.3 million to cover replacement costs, product returns, and inventory revaluation related to the Company's older model PressMate product. These charges were based on the Company's estimates of net realizable value of the related inventory and for expected returns of the older model PressMate as of the time the charges were incurred. Also included in cost of goods sold is amortization of capitalized software development costs of $2.5 million and $2.7 million for fiscal 1997 and 1996. In June 1997, the Company incurred a special charge of $3.2 million to operating expenses related to the revaluation of capitalized software development costs. There was no amortization of capitalized software development costs in fiscal 1998. SALES AND MARKETING Sales and marketing expenses were $14.3 million, $18.1 million and $21.1 million in fiscal 1998, 1997 and 1996, respectively. The decrease in expense of $3.8 million in 1998 from 1997 included decreased expenses related to sales of $249,000, marketing of $3.3 million and technical support of $368,000. The decrease in marketing expenses in 1998 is attributable to reductions in marketing of PressMate and plain-paper typesetting products along with a reduction in the Company's direct mail programs for Big Color products. The Company is now placing more reliance on its reseller channels for end-user marketing while still providing certain marketing materials and new product introductions. The decrease in sales and marketing expenses of $3.0 million in 1997 from 1996 included decreased expenses related to sales of $2.4 million and marketing of $918,000, offset by increases in technical support of $331,000. The decrease in sales expenses is related to an overall decrease in sales volume. RESEARCH AND DEVELOPMENT The Company capitalized software development costs of $1.6 million and $2.7 million in fiscal 1997 and 1996, respectively, as required by FASB No. 86 (see Note 1 of Notes to Consolidated Financial Statements). No significant capitalizable software development costs were incurred in fiscal 1998. The decrease in capitalized software development in 1998 and 1997 from previous years reflects the Company's focus on developing proprietary printer engines compared to a much greater reliance on the systems integrator type of products as was done in the past. Research and development ("R&D")expenditures, including amounts expensed and capitalized, were $6.5 million, $7.9 million and $8.8 million in fiscal 1998, 1997 and 1996, respectively. As a percent of overall sales, these expenditures represented 8.1%, 9.2% and 9.4% in fiscal 1998, 1997, and 1996, respectively. The decrease in gross R&D expenditures in 1998 and 1997 compared to prior years is attributable to reductions in personnel and other resources 20 allocated to this area as a result of increased efficiency in the Company's development activities and lower sales volume. The future success of the Company depends on continually developing new and better products for the markets it serves. As a result, the Company does not anticipate a material change in the rate it invests in this area. Software development costs capitalized during these periods relate primarily to DisplayMaker Professional, DisplayMaker Express, PressMate, and DesignWinder. In June 1997, the Company incurred a special charge of $3.2 million to operating expenses related to the revaluation of capitalized software development costs. GENERAL AND ADMINISTRATIVE General and administrative expenses were $9.5 million, $10.1 million and $11.3 million in fiscal 1998, 1997 and 1996, respectively. The decreases in 1998 and 1997 from prior years are the result of reductions in the infrastructure necessary to handle lower sales volumes, offset in 1997 and 1996 in part by costs associated with the defense of the shareholder lawsuit (see "Legal Proceedings" for further details). RESTRUCTURING AND OTHER SPECIAL CHARGES In June 1997, the Company incurred special charges of $4.9 million consisting of $4.3 million related to the revaluation of intellectual property and $636,000 related to the settlement of the shareholders' lawsuit. The revaluation of intellectual property was primarily the result of a change in the estimated net realizable value of capitalized software development costs associated with the Company's proprietary products. In May 1996, the Company incurred $4.4 million in restructuring and other special charges as a result of its revised business plan which was intended to accelerate the Company's migration from a systems integrator to a manufacturer of proprietary printing engines. Included in the $4.4 million charge is $3.3 million for the revaluation of intellectual property tied to certain technologies and contract rights and $282,000 for severance related to workforce reductions. The charge also includes $443,000 for expected losses on the disposal of property and equipment and $403,000 in commitments under non-cancelable leases as a result of consolidating foreign sales offices and certain domestic operations. At June 30, 1998, approximately $629,000 of the $4.4 million charge remains in current liabilities. INTEREST EXPENSE Interest expense was $715,000, $1.4 million and $1.8 million in fiscal 1998, 1997 and 1996, respectively. The decrease in interest expense in 1998 is attributable to a decrease in average debt levels resulting from increased cash flow from operating activities and conversion of the debenture to equity. The decrease in interest expense in 1997 is attributable to a decrease in average debt levels with the addition of $12 million in equity in September 1996 and also as the Company's operations and related borrowing capabilities decreased. INCOME TAXES The effective income tax rate was (8.1%) and 33.0% in fiscal 1997 and 1996, respectively. The Company did not record a provision for income taxes in fiscal 1998 as the availability of net operating loss carryforwards more than offset the pre-tax income generated in fiscal 1998. In June 1997, the Company incurred a special charge to income taxes of $6.5 million related to the revaluation of deferred tax assets. The revaluation was done as a result of a change in the estimated net realizable value of deferred tax assets. At June 30, 1998, the Company had approximately $4.8 million in net deferred tax assets. Realization of $4.8 million in net deferred tax assets will require the Company to generate future taxable income of approximately $14 million within the next 15 years to receive full taxable benefit. Management believes the losses incurred from normal operations in fiscal 1997 and 1996 were the result of rapidly declining revenue from older products that exceeded the revenue generated from newer products as evidenced by a 7.5% and 21.6% decline in net revenue in fiscal 1997 and 1996, respectively. Although there can be no assurance that additional charges related to product transitions or future strategies will not be necessary or that further revenue declines will not occur, management believes it now has the products, infrastructure, and systems in place to maintain or increase its revenue base and generate sufficient profits to realize the $4.8 million deferred tax asset. See Note 11 of Notes to Consolidated Financial Statements for further disclosures relating to income taxes. 21 LIQUIDITY AND CAPITAL RESOURCES Liquidity needs during the years ended June 30, 1998 and 1996 were satisfied by cash flows from operating activities. Liquidity needs during the year ended June 30, 1997 were satisfied primarily by the issuance of common stock and warrants. Operating activities provided cash of $6.9 million in 1998, consumed cash of $4.0 million in 1997 and provided cash of $6.2 million in 1996. The increase in cash provided from operations in 1998 is due primarily to profitable operations and lower levels of inventory resulting from increased efficiencies in forecasting and planning. The decrease in cash provided from operations in 1997 compared to 1996 is the result of a $17.2 million net loss incurred by the Company. Cash used in investing activities was $1.1 million, $3.0 million and $6.3 million in fiscal 1998, 1997 and 1996, respectively. The decrease in cash used in investing activities in 1998 and 1997 compared to prior years is the result of lower expenditures for property and equipment, capitalized software development costs and other intellectual property. The Company does not expect significant increases in expenditures for property and equipment in fiscal 1999 compared to fiscal 1998. Financing activities used cash of $1.3 million in 1998, provided cash of $7.4 million in 1997and used cash of $365,000 in 1996. In order to meet the cash shortfall in September 1996, the Company privately placed 2,285,715 shares of its common stock for a purchase price of $4.375 per share, together with warrants to purchase an additional 2,285,715 shares with an exercise price of $7.00 per share, for an aggregate consideration of $10 million. Of such shares, 1,371,429 shares were sold to Sihl-Zurich Paper Mill on Sihl AG, a Swiss corporation ("Sihl"), for $6 million. Sihl conditioned its investment on an investment of $4 million by the Company's Chief Executive Officer or an entity with which he is affiliated. In satisfaction of such condition, TimeMasters Inc. and affiliates ("TMI") purchased 914,286 shares for $4 million and received warrants to purchase an additional 914,286 shares at $7.00 per share. A portion of the proceeds from the private placement of common stock to TMI was offset against ColorSpan's indebtedness to TMI for a demand note in the principal amount of $1.765 million, as permitted by the subordination and forbearance agreement. In September 1996, the Company also privately placed 410,256 shares of its common stock for a purchase price of $4.875 per share, together with warrants to purchase an additional 471,286 shares with an exercise price of $6.79 per share, for an aggregate consideration of $2 million. The shares and warrants were issued to General Electric Capital Corporation ("GE"), the Company's senior lender. In September 1996, the Company also entered into a series of agreements with one of its largest trade creditors and their supplier, converting approximately $1.7 million of trade payables and a promissory note of $859,516 into a $2.5 million convertible subordinated debenture. The debenture contains voluntary, automatic and mandatory conversion provisions. Under the voluntary conversion provision, the debenture is convertible in whole or in part into common stock of the Company at $6.00 per share at any time that the market price of the Company's common stock is less than $6.00 per share. The debenture is automatically converted at the rate of 30,000 shares a week at the market price of the common stock at any time that the market price equals or exceeds $6.00 per share. The automatic conversion provision contains limited price protection under certain circumstances. Under the mandatory conversion provision, the debenture will be converted on a quarterly basis at market prices and in share quantities equal to specified threshold amounts, less any shares converted under the other provisions. The mandatory provision is effective for the quarter ending March 31, 1997 and continues until the debenture is fully converted. The debenture contains certain registration rights and also limits the number of shares that may be sold in the open market in any one week. A related agreement required the supplier to provide approximately $1.5 million in inventory to the Company in resolution of quality issues with the product previously supplied by the trading partner. In the first quarter of fiscal 1996, ColorSpan Corporation borrowed $1,765,000 from TMI with a demand note to cover a short-term cash shortfall. In January 1996, ColorSpan replaced the operating line of credit that it maintained through a commercial bank with a new, three-year credit agreement with a commercial financing company. The new agreement allows ColorSpan to borrow up to $10 million based on availability equal to 65% of net eligible accounts receivable and 25% of net eligible inventory. The agreement expires January 17, 1999 and requires the borrower to meet various financial covenants involving capital expenditures, additions to capitalized software and intellectual property, minimum debt service coverage ratio, and maintenance of a minimum net worth. The agreement also requires ColorSpan to meet 22 various non-financial covenants. As part of this agreement, the commercial finance company required that the loan from TMI be subordinated to the rights and security interest of the lender, and that a forbearance agreement restrict repayment of the TMI debt to permit repayments of specified amounts only if certain financial conditions were met, or upon the sale of common stock. In consideration for agreeing to such subordination and forbearance, TMI was issued a warrant to purchase 277,953 shares of the Company's common stock at an exercise price of $6.35 per share. The warrant and note to TMI were approved by shareholders at the Company's annual meeting in May 1996. Each of the foregoing transactions was approved by a disinterested majority of the Board of Directors of the Company, by shareholders, or by both. The Company believes that each such transaction is on terms at least as favorable to the Company as could have been obtained from an unaffiliated entity. The Company does not have any current significant commitments for capital expenditures however, it does expect to incur substantial expenditures related to its acquisition strategies in fiscal 1999. Management expects to finance acquisitions through the issuance of additional equity securities, cash flow from operations and short-term borrowings under its line of credit. Management expects to finance operations throughout the remainder of fiscal 1999 through cash flow from profitable operating activities. If sales are less than expected or reasonably priced sources of alternative financing are not available, the Company may be required to delay its acquisition strategy or further restructure its capitalization. The Company's Senior Debt Agreement, which is secured by substantially all of the Company's assets, expires in January 1999. Based on negotiations to date and management's assessment of current conditions in the overall financing market, management believes it will be able to secure new financing on terms at least as favorable as its current agreement. FOREIGN CURRENCIES In general, the impact of foreign currency gains/losses are immaterial to the Company as a whole. ColorSpan Europe, Ltd. ("CSE") extends credit in the normal course of business in five relatively stable European currencies. In addition, CSE's financing agreement allows it to factor those receivables and receive Dutch Guilders in which it pays its expenses. The impact of this is to effectively hedge the Company's exposure to foreign currency risk. Essentially all other transactions are in U.S. dollars. YEAR 2000 The Company is currently working to resolve the potential impact of the Year 2000 on the processing of time-sensitive information by its computerized information systems. Year 2000 issues may arise if computer programs have been written using two digits (rather than four) to define the applicable year. In such case, programs that have time-sensitive logic may recognize a date using "00" as the year 1900 rather than the year 2000, which could result in miscalculations or system failures. The Company utilizes a number of computer programs across its entire operation. Year 2000 issues could impact the Company's information systems as well as computer hardware and equipment that is part of its telephone network such as switches, termination devices and SONET rings that contain embedded software or "firmware." The Company's exposure to potential Year 2000 problems exists in two general areas: technological operations in the sole control of the Company, and technological operations dependent in some way on one or more third parties. The majority of the Company's exposure in potential Year 2000 problems is in the latter area where the situation is much less within the Company's ability to predict or control. The Company's business is heavily dependent on third parties, many of whom are themselves heavily dependent on technology. The Company cannot control the Year 2000 readiness of those parties. In some cases, the Company's third-party dependence is on vendors of technology who are themselves working towards solutions to Year 2000 problems. The Company has initiated projects to identify and correct the potential problem in all of its enterprise systems. The costs incurred to date total less than $30,000 and have been expensed in the financial statements. The Company is using internal resources to test the software modifications. Funding for this area is expected to, and has come from, cash flow from operations. Management expects that additional costs for this issue will not be material. THE COMPANY'S PRODUCTS. The Company designs and sells products which are heavily reliant on software. While the Company has taken appropriate steps to ensure the readiness of this software and believes it to be compliant, the 23 Company cannot be certain that the software will operate error free, or that the Company will not be subject to litigation, whether the software operates error free or not. However, the Company believes that based on its efforts to ensure compliance and the fact that the calculations needed in and by its products are not date dependent, it is not reasonably likely that the Company will be subject to such litigation. CONTINGENCY PLANS. The Company has not yet completed its planning and preparations to handle the most reasonably likely worst case scenarios described above. The Company intends to develop contingency plans for these scenarios during fiscal 1999. The Company believes that this is the appropriate timeframe for developing such plans and that efforts prior to that time should be focused on renovation, testing and verification of its system modifications. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. - - ------- -------------------------------------------- See Financial Statements and Supplementary Data attached. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - - ------- --------------------------------------------------------------- FINANCIAL DISCLOSURE. --------------------- None 24 PART III -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. - - -------- --------------------------------------------------- THE FOLLOWING TABLE SETS FORTH INFORMATION, AS OF AUGUST 31, 1998, CONCERNING THE DIRECTORS OF THE COMPANY: Year Became Name, Age, Positions, Principal Occupations, Directorships Director - - -------------------------------------------------------------------------------- DIRECTORS WHOSE TERMS EXPIRE IN 1999 MELVIN L. MASTERS; age 44; Mr. Masters co-founded the Company in 1989 February, 1986 and has been Chairman, Chief Executive Officer and President of the Company since it acquired LMC in May 1989. Mr. Masters is also the sole shareholder, director and CEO of TimeMasters, Inc. (TMI), a company established for the purpose of property management which has additional investments in the fields of wireless voice and data communications, internet services and personal motor sports products. RALPH D. ROLEN; age 44; Mr. Rolen is Senior Vice President and Manager 1989 of the Retail Credit Division of First Tennessee National Bank of Memphis, Tennessee, a position he has held since January 1989. DIRECTORS WHOSE TERMS EXPIRE IN 2001 ROHAN CHAMPION; age 40; Mr. Champion has been Vice President, Strategy 1998 and Alliances at Federal Express Corp., since 1996. Prior to joining Federal Express, he was Vice President, Corporate Strategy and New Services for AT&T. He has also held positions at Novell, Inc., ARINC-Endeavor Group and Oracle Corporation. JEAN-LOUIS GASSEE; age 54; Since 1990, Mr. Gassee has been Chairman and 1990 Chief Executive Officer of Be, Inc. of Menlo Park, California. That company is involved in personal computer technology. From August 1988 until September 1990, Mr. Gassee was President of the Apple Products Division of Apple Computer, Inc. Prior to that time he held the offices of Senior Vice President of Research and Development (1987 to August 1988) and Vice President of Product Development of Apple Computer, Inc. from 1985 to 1987. Mr. Gassee is also a director of Electronics for Imaging, Inc. of San Bruno, California and 3COM, Inc., Sunnyvale, California. THE FOLLOWING TABLE SETS FORTH INFORMATION, AS OF AUGUST 31, 1998, REGARDING THE EXECUTIVE OFFICERS OF THE COMPANY: Name Age Positions - - -------------------------------------------------------------------------------- Melvin L. Masters 44 Chief Executive Officer, President and Chairman of the Board Lawrence J. Lukis 50 Chief Engineer Robert J. Wenzel 47 Chief Operating Officer and President ColorSpan Corporation Thomas D. Ryan 40 Executive Vice President James Horstmann 37 Chief Financial Officer David Alexander 39 Secretary Timothy N. Thurn 42 Treasurer 25 MR. LUKIS is the Chief Engineer and a co-founder of the Company. MR. WENZEL has been Chief Operating Officer of the Company since October 1991 and President of ColorSpan Corporation, the Company's principal operating subsidiary, since October 1989. He joined ColorSpan as General Manager of the PC Division in May 1989 and became Executive Vice President shortly thereafter. MR. RYAN has been Managing Director of ColorSpan Europe, Ltd. since January 1995 and assumed the Executive Vice President position for the Company in May 1996. From 1985 to July 1994, Mr. Ryan worked for Mentor Corporation as Vice President and General Manager of its Minnesota operations. MR. HORSTMANN has been Chief Financial Officer of the Company since May 1997, and prior to that was the Vice President of Materials and Administration for ColorSpan Corporation. Mr. Horstmann has been with the Company since April 1994. Prior to joining the Company, Mr. Horstmann was with the accounting firm of Boulay Heutmaker Zibell & Co., PLLP. Mr. Horstmann is a Certified Public Accountant (CPA). MR. ALEXANDER has held the position of Vice President of Information Strategy of the Company since September 1997 and has been Secretary of the Company since January 1998. Mr. Alexander joined ColorSpan Corporation in 1990 and has held a variety of management positions in Research and Development, Marketing and Business Development. MR. THURN has been Treasurer of the Company since June 1989 and of ColorSpan Corporation since March 1987. Mr. Thurn has experience as both a public and private accountant. Mr. Thurn is a Certified Public Accountant (CPA) and Certified Management Accountant (CMA). Officers of the Company are elected annually by the Board of Directors. All of the current officers have been re-elected to serve in the same positions for the coming year. 26 ITEM 11. EXECUTIVE COMPENSATION. - - -------- ----------------------- SUMMARY COMPENSATION TABLE The following table sets forth the cash and noncash compensation for each of the last three fiscal years awarded to or earned by the Chief Executive Officer of the Company and the four other most highly compensated executive officers of the Company whose salary and bonus earned in the fiscal year ended June 30, 1998 exceeded $100,000 for services rendered.
=============================================================================================================== Annual compensation Long term compensation -------------------------------- ------------------------------- Awards Other --------------------- Payouts/ All other annual Restricted LTIP compen Name and principal Year Salary ($) Bonus ($) compens stock Options/ payouts -sation position ation award(s) SARs (#) ($) ($) ($) ($) - - ------------------------ ------ ----------- ---------- ------- ---------- --------- -------- ---------- Melvin Masters 1998 $ 175,000 $ 8,904(1) Chief Executive Officer 1997 208,333 7,536(1) 1996 246,875 6,736(1) - - ------------------------ ------ ----------- ---------- ------- ---------- --------- -------- ---------- Robert Wenzel 1998 $ 175,000 Chief Operating Officer 1997 208,333 1996 203,125 220,000 - - ------------------------ ------ ----------- ---------- ------- ---------- --------- -------- ---------- Thomas D. Ryan 1998 $ 175,000 120,000 Executive Vice 1997 175,000 President 1996 131,458 $ 16,500 40,000 - - ------------------------ ------ ----------- ---------- ------- ---------- --------- -------- ---------- Larry Lukis 1998 $ 149,479 $12,628(1) Chief Engineer 1997 177,083 11,578(1) 1996 150,000 10,908(1) - - ------------------------ ------ ----------- ---------- ------- ---------- --------- -------- ---------- James H. Horstmann 1998 $ 158,125 120,000 Chief Financial Officer 1997 * 1996 * ===============================================================================================================
*Became executive officer during fiscal 1998. (1)Premiums for life insurance where the Company is not the beneficiary. STOCK OPTIONS The Company maintains a Stock Option Plan pursuant to which executive officers, other employees and certain non-employees providing services to the Company may receive options to purchase the Company's common stock. The following table summarizes grants of stock options during fiscal 1998 to the Chief Executive Officer and the Executive Officers named in the Summary Compensation Table: 27 OPTIONS/SAR GRANTS IN LAST FISCAL YEAR
========================================================================================================= Potential Realizable Value at Assumed Annual Rates Individual Grants of Stock Price Appreciation for Option Term - - ------------------------------------------------------------------------ ------------------------------- % of Total Options/ Options/ SARs Granted Exercise or SARs to Employees Base Price Expiration 5% ($) 10% ($) Name Granted in Fiscal Year ($/Share) Date (#) - - ------------------ ----------- -------------- ----------- -------------- ---------- ---------- Thomas D. Ryan 120,000(1) 11.4% $3.00 September 2007 $226,404 $573,732 - - ------------------ ----------- -------------- ----------- -------------- ---------- ---------- James H. Horstmann 120,000(1) 11.4% $3.00 September 2007 $226,404 $573,732 - - --------------------------------------------------------------------------------------------------------
(1)Options vest nine years from date of issuance with accelerated vesting contingent upon meeting performance goals as established by the Chief Executive Officer. The following table summarizes exercises of stock options during fiscal 1998 by the Chief Executive Officer and the Executive Officers named in the Summary Compensation Table:
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES =============================================================================================================== Number of Value of unexercised in- unexercised the-money options/SARs options/SARs at FY- at FY-end ($) Shares acquired on Value realized ($) end (#) exercisable / exercisable/ Name exercise (#) unexercisable unexercisable (1) - - ---------------------- ------------------ ------------------ --------------------- ------------------------ Melvin L. Masters -0- -0- -0- -0- - - ---------------------- ------------------ ------------------ --------------------- ------------------------ Robert J. Wenzel -0- -0- 62,500 / 202,500 $ 139,581 / $ 202,031 - - ---------------------- ------------------ ------------------ --------------------- ------------------------ Thomas D. Ryan -0- -0- 70,000 / 170,000 $ 109,375 / $ 265,625 - - ---------------------- ------------------ ------------------ --------------------- ------------------------ Larry Lukis -0- -0- -0- -0- - - ---------------------- ------------------ ------------------ --------------------- ------------------------ James H. Horstmann -0- -0- 41,250 / 168,750 $ 64,453 / $263,672 ===============================================================================================================
(1) Represents the difference between the closing price of the Company's common stock on June 30, 1998 and the exercise price of the options. LONG-TERM INCENTIVE PLAN AWARDS Other than the Stock Option Plan reported on above, the Company does not maintain any long-term incentive plans. DIRECTOR COMPENSATION For fiscal year 1998, there was no plan for compensation to non-employee directors. All directors were reimbursed for their expenses incurred in attending meetings. Jean-Louis Gassee and Rohan Champion also acted as consultants to the Company. Consulting fees of $12,000 were incurred for services provided by Mr. Gassee during fiscal 1998. Jean-Louis Gassee has significant expertise in the personal computer industry and in the management of research and development of hardware and software products. His expertise in the trends and issues in this industry was not available within the Company and could only be obtained through a relationship with a specialized consultant or highly compensated employee, if one could be identified and retained. Mr. Gassee consulted with the Company on a number of issues including industry trends, and product development issues. Consulting fees of $29,169 were incurred for services provided by Mr. Champion during fiscal 1998. Mr. Champion has significant expertise in electronic commerce and supply chain management. The consulting fees paid to Mr. Gassee and Mr. Champion were determined and set based on anticipated consulting services and the market cost therefor. The Company believes that the consulting fees 28 paid to Mr. Gassee and Mr. Champion represent the approximate market value for the consulting services performed and that which might be obtained from similar arrangements with non-affiliates. EMPLOYMENT AGREEMENTS At June 30, 1998, the Company had employment agreements with Messrs. Masters, Lukis, Wenzel, Ryan, Horstmann and several other members of management. The agreements for Messrs. Masters, Wenzel and certain members of management renew automatically on an annual basis unless terminated by either party by written notice prior to the renewal date. The agreement with Mr. Lukis continues until terminated on 60 days notice. The agreements provide for continuation payments equal to 36 months pay for Mr. Masters and one other non-officer. Mr. Lukis' agreement provides for a continuation of payments for a period depending upon the length of the non-competition period requested by the Company following termination. Agreements are in place for 12 months pay for Mr. Wenzel, Mr. Ryan, Mr. Horstmann, and certain other members of management upon termination of employment in certain circumstances, including change of control. As of June 30, 1998 minimum salary levels of $250,000 were set for each of Messrs. Masters, Lukis, and Wenzel. By agreement, these individuals reduced their compensation to $175,000 in March 1997, and the compensation has not been adjusted to the levels previously set. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Chief Executive Officer of the Company, Melvin L. Masters, is a member of the Compensation Committee. Mr. Masters' compensation is set by the Board of Directors as a whole with Mr. Masters abstaining. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. - - -------- --------------------------------------------------------------- The following table sets forth, as of August 31, 1998, certain information with respect to beneficial share ownership by the directors, individually; by all persons known to management to own more than 5% of the Company's outstanding Common Stock, individually; and by all executive officers and directors as a group. Except as otherwise indicated, the shareholders listed below have sole investment and voting power with respect to their shares. Number of Beneficially Owned Percent of Shares Name of Beneficial Owner Shares Outstanding - - ------------------------ ------ ----------- Sihl-Zurich Paper Mill on Sihl AG (1) 2,742,858 14.7% Melvin L. Masters (2) 2,550,525 13.7% 3213 South Duluth Avenue Sioux Falls, SD 57105 Lawrence J. Lukis (3) 1,003,222 5.4% 3250 Fox Street Long Lake, MN 55356 Jean-Louis Gassee (4) 85,000 * Robert J. Wenzel (5) 74,300 * James H. Horstmann (6) 41,250 * Thomas D. Ryan (7) 77,000 * Rohan Champion (8) 20,000 * All officers and directors as a group (11 persons) (9) 3,977,946 21.3% * Less than 1% 29 (1) Includes warrants to purchase 1,371,429 shares. (2) Includes 411,428 shares and warrants to purchase 963,667 shares owned by TMI; 274,286 shares owned by GRAMPI; 228,572 shares and warrants to purchase 228,572 shares owned by GRAMPI #2. (3) Includes shares owned by Donna Lukis, Mr. Lukis' spouse. Includes 173,000 shares held by the Lukis Foundation, of which Mr. Lukis is a director. Mr. Lukis disclaims beneficial ownership both of Ms. Lukis' shares and those held by the Lukis Foundation. (4) Includes 60,000 shares issuable to Mr. Gassee under options which are exercisable. (5) Includes 62,500 shares issuable to Mr. Wenzel under options which are exercisable or will become exercisable within 60 days. Also includes shares held as trustee for four education trusts. (6) Includes 41,250 shares issuable to Mr. Horstmann under options which are exercisable or will become exercisable within 60 days. (7) Includes 70,000 shares issuable to Mr. Ryan under options which are exercisable or will become exercisable within 60 days. (8) Includes 20,000 shares issuable to Mr. Champion under options which are exercisable or will become exercisable within 60 days. (9) Includes 326,400 shares issuable under options which are exercisable or will become exercisable within 60 days and warrants to purchase 1,192,239 shares. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - - --------------------------------------------------------- The Company has the following arrangements with certain of its directors, executive officers or five percent shareholders: (1) The Company leases space it currently occupies in Shady View I & II, with Grandchildren's Realty Alternative Management Partnership I (GRAMPI), a Minnesota limited partnership. The general partner of GRAMPI is TimeMasters, Inc., a Minnesota corporation which is owned by Melvin L. Masters. One of the limited partners of GRAMPI is the Masters Trust I, of which Ralph Rolen, a director of the Company, was Trustee at the time of the negotiations. The Company retained the services of an outside law firm as well as an independent commercial real estate brokerage firm in negotiating the lease. The Company leases 168,034 square feet of space under this agreement which has a term of fifteen years and a monthly base rate as of August 31, 1998, of $100,083. The base rate escalates periodically over the term of the lease. The Company is also required to pay its pro-rata share of property taxes, utilities and essentially all other operating expenses. There is no renewal option. Rent expense under this lease was $1,547,000 in fiscal 1998. (2) Under a Use Indemnification Agreement and certain related Board of Directors' actions, the Company has the right to sponsor business and business-related occasions at facilities owned by Masters Trust I and/or Melvin L. Masters and/or TimeMasters, Inc and/or GRAMPI and/or GRAMPI #2. In addition, the Company occasionally uses an airplane that is owned by a Company controlled by Mr. Masters, for business-related travel. The Company indemnifies the owners against loss or damage, reimburses out-of-pocket expenses and pays a usage charge based on what management believes are market rates. The Company also uses the services of a travel agency which is controlled by Mr. Masters. In the fiscal year ended June 30, 1998 charges totaled $198,723. (3) The Company has installed a campus-wide TimeMasters, Inc. wireless voice system in its Eden Prairie facility. There are no monthly call operating charges for unlimited use of that system. The system hardware was 30 acquired in fiscal 1995 for $211,000 based on competitive proposals for two other comparable systems. Upgrades to the system amounted to $52,970 in fiscal 1998. TimeMasters, Inc. is a Minnesota corporation wholly-owned by Melvin L. Masters. (4) During September and October 1995, ColorSpan Corporation's (CSC's) cash needs exceeded available cash. To cover short-term cash needs, CSC borrowed $1,765,000 under a demand note from TimeMasters, Inc. (TMI), a corporation controlled by the Company's Chief Executive Officer. The note had stated interest at prime rate plus 1.75% and was satisfied in full in December 1996 through an offset of a note receivable from TMI arising from the sale of common stock by the Company (see item (5) below). In consideration for providing financing to CSC and executing a subordination and forbearance agreement with the Company's senior lender, TMI was issued a warrant for the purchase of 277,953 shares of the Company's common stock at an exercise price of $6.35 per share. This transaction was submitted to and approved by the shareholders at the Company's annual meeting in May 1996. (5) In September 1996, the Company issued 914,286 shares of restricted common stock in a private placement to TimeMasters, Inc., GRAMPI and GRAMPI #2 (together as a group known as the TimeMasters group), which is controlled by Melvin L. Masters, the Company's CEO. The shares were issued at the market price of $4.375 per share for a total of $4 million. The TimeMasters group was also issued a warrant for the purchase of an additional 914,286 shares at $7.00 per share with an expiration date of September 16, 2004. The TimeMasters group has the right to require the Company to effect up to five demand registrations under the Securities Act within ten years of the closing date of the transaction. The agreement also provides for incidental registration rights during this same period. In addition, shares acquired by TimeMasters upon the exercise of the warrant or conversion right, obtained pursuant to the $1,765,000 demand note discussed in item (4) above, have preferential incidental registration rights expiring September 2006. The Company offset a portion of the proceeds from this sale with CSC's indebtedness to TMI (see item (4) above). (6) The Company has occasionally prepaid the rent and lease expense to GRAMPI for the Shady View I and II properties. When rent is prepaid there is an adjustment of the amount paid for rent at the next regular payment date to reflect the prepayment. In addition, interest is charged during the interim period. (7) Melvin L. Masters, the Company's CEO, borrowed $585,000 from the Company in November 1996. The amount borrowed was repaid in December 1996 together with interest at 10%. (8) In June 1998, the Company loaned $250,00 to GRAMPI. The note is personally guaranteed by Mr. Masters and is secured by certain shares of the Company's common stock owned by GRAMPI, bears interest at the Prime Rate plus 2.0% and is due February 25, 1999. Each of the foregoing transactions was approved by a disinterested majority of the Board of Directors of the Company, by shareholders, or by both. The Company believes that each such transaction is on terms at least as favorable to the Company as could have been obtained from an unaffiliated entity. (9) The Company and TimeMasters, Inc. share facilities and expenses from time to time. The intercompany receivable at June 30, 1998 was $87,460. The amount bears interest at 10%. (10) The Company purchases certain inventory from Sihl-Zurich Paper Mill on Sihl AG, a greater than 5% shareholder of the Company. Total purchases in fiscal 1998 from Sihl were $2,721,156. 31 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. - - -------- ----------------------------------------------------------------- (a) 1. Financial Statements Consolidated Financial Statements of VirtualFund.com, Inc. and Subsidiaries: Independent Auditors' Report Consolidated Balance Sheets as of June 30, 1998 and 1997 Consolidated Statements of Operations for the fiscal years ended June 30, 1998, 1997 and 1996 Consolidated Statements of Stockholders' Equity for the fiscal years ended June 30, 1998, 1997 and 1996 Consolidated Statements of Cash Flows for the fiscal years ended June 30, 1998, 1997 and 1996 Notes to Consolidated Financial Statements (a) 2. Financial Statement Schedules VirtualFund.com, Inc. and Subsidiaries Schedule I -- Condensed Financial Information of the Registrant (Parent Only) Schedule II -- Valuation and Qualifying Accounts Schedules not listed above have been omitted because they are either not applicable or required information has been given in the consolidated financial statements or notes thereto. (a) 3. Listing of Exhibits Exhibit Number Description - - ------ ----------- 10.1 Amendment No. 3 to Credit Agreement dated May 14, 1997 between LaserMaster Corporation and General Electric Capital Corporation. 10.2 Amendment No. 4 to Credit Agreement dated October 14, 1997 between ColorSpan Corporation and General Electric Capital Corporation. 10.3 Fifth Amendment to Credit Agreement dated February 17, 1998 between ColorSpan Corporation and General Electric Capital Corporation. 10.4 Sixth Amendment and Consent to Credit Agreement dated June 30, 1998 between ColorSpan Corporation and General Electric Capital Corporation. 10.5 Seventh Amendment and Consent to Credit Agreement dated July 15, 1998 between ColorSpan Corporation and General Electric Capital Corporation. 10.6 LaserMaster Technologies, Inc. minutes of shareholder meeting dated April 3, 1998 which amends Article I of the Articles of Incorporation to change the company name to VirtualFund.com, Inc. 10.7 Promissory Note with Grandchildren's Realty Alternative Program I, LP, Pledge Agreement and Guaranty. 27.1 Financial Data Schedule. 99. Cautionary Factors Under Private Securities Litigation Reform Act of 1995. 32 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. Date: September 25, 1998 VIRTUALFUND.COM, INC. By /s/ Melvin L. Masters ------------------------- Melvin L. Masters, President, Chief Executive Officer and Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/Melvin L. Masters President, Chief Executive Officer - - ------------------------ and Chairman of the Board Melvin L. Masters (Principal Executive Officer) /s/Rohan Champion Director - - ------------------------ Rohan Champion /s/Ralph D. Rolen Director - - ------------------------ Ralph D. Rolen /s/Jean-Louis Gassee Director - - ------------------------ Jean-Louis Gassee /s/James H. Horstmann Chief Financial Officer and - - ------------------------ Principal Accounting Officer James H. Horstmann 33 INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders VirtualFund.com, Inc. and Subsidiaries Eden Prairie, Minnesota We have audited the consolidated balance sheets of VirtualFund.com, Inc. (formerly LaserMaster Technologies, Inc.) and Subsidiaries (the Company) as of June 30, 1998 and 1997 and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended June 30, 1998 and financial statement schedules listed in the index at Item 14(a)(2). These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedules 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 consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of VirtualFund.com, Inc. and Subsidiaries as of June 30, 1998 and 1997 and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1998 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements, taken as a whole, present fairly in all material respects the information therein set forth. Deloitte & Touche LLP Minneapolis, Minnesota August 7, 1998 F-1 VIRTUALFUND.COM, INC. (formerly LaserMaster Technologies, Inc.) AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - - --------------------------------------------------------------------------------
June 30, 1998 June 30, 1997 ------------- ------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 5,011,181 $ 484,106 Accounts receivable, less allowance for doubtful accounts and sales returns of $1,662,000 and $1,987,000, respectively (Notes 5 and 13) 11,648,638 12,129,091 Inventory (Notes 3, 5 and 13) 6,819,968 9,184,671 Other current assets 1,918,258 2,158,833 Deferred income taxes (Note 11) 1,214,000 4,073,000 ------------ ----------- TOTAL CURRENT ASSETS 26,612,045 28,029,701 PROPERTY AND EQUIPMENT, NET (Notes 4, 6 and 13) 2,776,339 3,570,662 DEFERRED INCOME TAXES (Note 11) 3,552,000 693,000 ACQUIRED TECHNOLOGY, PATENTS AND LICENSES, less accumulated amortization of $747,719 and $743,284, respectively (Note 5) 179,286 337,570 ------------ ----------- $ 33,119,670 $32,630,933 ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Notes payable (Notes 5 and 13) $ 2,015,988 $ 2,781,468 Current maturities of long-term debt (Notes 6 and 13) 259,550 636,665 Convertible subordinated debenture (Note 7) 375,866 Accounts payable (Note 13) 10,524,613 10,232,865 Accrued payroll and payroll taxes 1,475,317 1,623,558 Other current liabilities (Note 13) 1,412,021 1,649,062 Deferred revenue 1,222,265 1,374,447 ------------ ----------- TOTAL CURRENT LIABILITIES 17,285,620 18,298,065 CONVERTIBLE SUBORDINATED DEBENTURE (Note 7) 2,233,414 LONG-TERM DEBT, less current maturities (Notes 6 and 13) 66,746 184,729 COMMITMENTS AND CONTINGENCIES (Note 10) STOCKHOLDERS' EQUITY: (Notes 7, 8, 9, 11, 16 and 17) Common stock, $.01 par value; authorized 30,000,000 shares; 15,178,866 and 14,432,462 shares issued and outstanding, respectively 151,789 144,325 Preferred stock, $.01 par value; authorized 5,000,000 shares; no shares issued or outstanding Additional paid-in capital 32,995,320 30,876,964 Accumulated deficit (17,379,805) (19,106,564) ------------ ----------- TOTAL STOCKHOLDERS' EQUITY 15,767,304 11,914,725 ------------ ----------- $ 33,119,670 $32,630,933 ============ ===========
See notes to consolidated financial statements. F-2 VIRTUALFUND.COM, INC. (formerly LaserMaster Technologies, Inc.) AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS - - --------------------------------------------------------------------------------
Years Ended June 30, --------------------------------------------------------- 1998 1997 1996 ----------- ------------ ------------ NET SALES (Note 14) $80,731,534 $ 86,563,422 $ 93,592,044 COSTS OF GOODS SOLD (Notes 2 and 13) 48,050,731 61,912,116 64,378,882 ----------- ------------ ------------ GROSS PROFIT 32,680,803 24,651,306 29,213,162 OPERATING EXPENSES Sales and marketing 14,335,306 18,131,483 21,108,559 Research and development 6,503,287 6,387,642 6,148,919 General and administrative (Note 13) 9,505,652 10,096,910 11,310,135 Restructuring and other special charges (Notes 2 and 16) 4,935,563 4,431,273 ----------- ------------ ------------ 30,344,245 39,551,598 42,998,886 ----------- ------------ ------------ OPERATING PROFIT (LOSS) 2,336,558 (14,900,292) (13,785,724) OTHER INCOME (EXPENSE) Interest expense (Note 13) (715,048) (1,388,247) (1,784,365) Interest income (Note 13) 118,494 154,559 17,728 Other income (expense) (13,245) 223,292 (56,173) ----------- ------------ ------------ (609,799) (1,010,396) (1,822,810) ----------- ------------ ------------ EARNINGS (LOSS) BEFORE INCOME TAXES 1,726,759 (15,910,688) (15,608,534) INCOME TAX (PROVISION) BENEFIT (Note 11) (1,289,000) 5,147,000 ----------- ------------ ------------ NET EARNINGS (LOSS) $ 1,726,759 $(17,199,688) $(10,461,534) =========== ============ ============ NET EARNINGS (LOSS) PER COMMON SHARE - BASIC (Note 12) $ .12 $ (1.25) $ (.93) =========== ============ ============ NET EARNINGS (LOSS) PER COMMON SHARE - ASSUMING DILUTION (Note 12) $ .11 $ (1.25) $ (.93) =========== ============ ============== Weighted average common shares outstanding (Note 12) 14,716,003 13,705,609 11,305,232 =========== ============ ============= Weighted average common and dilutive potential common shares outstanding (Note 12) 15,602,071 13,705,609 11,305,232 =========== ============ =============
See notes to consolidated financial statements. F-3 VIRTUALFUND.COM, INC. (formerly LaserMaster Technologies, Inc.) AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - - --------------------------------------------------------------------------------
Retained Common Stock Additional Earnings ---------------------------- Paid-In (Accumulated Shares Amount Capital Deficit) Total ------------ ------------ ------------ ------------ ------------ BALANCES, JUNE 30, 1995 11,176,382 $ 111,764 $ 16,626,953 $ 8,554,658 $ 25,293,375 Issuance of common stock - Stock options exercised (Note 9) 249,752 2,497 577,602 580,099 Stock option tax benefit (Note 11) 226,000 226,000 Net loss (10,461,534) (10,461,534) ---------- ------------ ------------ ------------ ------------ BALANCES, JUNE 30, 1996 11,426,134 114,261 17,430,555 (1,906,876) 15,637,940 Issuance of common stock - Private placements (Note 8) 2,695,971 26,960 11,810,376 11,837,336 Conversion of debentures (Note 7) 105,000 1,050 361,763 362,813 Stock options exercised (Note 9) 180,357 1,804 339,520 341,324 Services rendered 25,000 250 99,750 100,000 Litigation settlement (Note 16) 636,000 636,000 Stock option tax benefit (Note 11) 199,000 199,000 Net loss (17,199,688) (17,199,688) ---------- ------------ ------------ ------------ ------------ BALANCES, JUNE 30, 1997 14,432,462 144,325 30,876,964 (19,106,564) 11,914,725 Issuance of common stock - Conversion of debentures (Note 7) 525,000 5,250 1,985,146 1,990,396 Stock options exercised (Note 9) 80,071 801 134,623 135,424 Litigation settlement (Note 16) 141,333 1,413 (1,413) Net earnings 1,726,759 1,726,759 ---------- ------------ ------------ ------------ ------------ BALANCES, JUNE 30, 1998 15,178,866 $ 151,789 $ 32,995,320 $(17,379,805) $ 15,767,304 ========== ============ ============ ============ ============
See notes to consolidated financial statements. F-4 VIRTUALFUND.COM, INC. (formerly LaserMaster Technologies, Inc.) AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (NOTE 15) - - --------------------------------------------------------------------------------
Years Ended June 30, ----------------------------------------------------------- 1998 1997 1996 ------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings (loss) $ 1,726,759 $ (17,199,688) $ (10,461,534) Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 1,843,802 5,526,593 5,859,577 Amortization of deferred financing costs 214,679 221,385 240,335 Revaluation of acquired technology, patents and licenses 1,024,374 2,582,840 Revaluation of capitalized software 3,214,690 768,059 Loss on sale of property and equipment 102,875 149,395 528,840 Gain on settlement of product quality issues (1,416,665) Litigation settlement 636,000 Deferred income taxes 1,084,000 (4,318,000) Stock option tax benefit 199,000 226,000 Change in current assets and current liabilities: Accounts receivable 730,453 415,306 4,541,241 Inventory 2,364,703 5,789,962 8,085,173 Other current assets 25,896 403,566 (571,353) Income tax receivable 400,781 (400,781) Accounts payable 424,596 (4,049,438) (1,027,772) Accrued payroll and payroll taxes (148,241) (292,350) (191,625) Income taxes payable 273,273 (201,768) Other current liabilities (237,041) 175,525 (185,849) Deferred revenue (152,182) (519,815) 698,622 -------------- -------------- ------------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 6,896,299 (3,964,106) 6,172,005 CASH FLOWS FROM INVESTING ACTIVITIES: Notes receivable - related party (250,000) (585,000) Collection of notes receivable - related party 585,000 Additions to property and equipment (815,336) (1,058,108) (1,660,716) Additions to capitalized software costs (1,557,931) (2,660,717) Proceeds from sale of property and equipment 24,600 82,357 53,968 Additions to patents and other assets (43,163) (500,596) (2,056,156) -------------- -------------- -------------- NET CASH USED IN INVESTING ACTIVITIES (1,083,899) (3,034,278) (6,323,621) CASH FLOWS FROM FINANCING ACTIVITIES: Net payments under revolving credit lines (765,480) (1,740,053) (1,918,979) Proceeds from note payable to related party 1,765,000 Proceeds from notes payable 271,149 Repayments of notes payable (293,550) Proceeds from long-term debt 307,514 Payments on long-term debt (655,269) (1,246,968) (1,075,989) Issuance of common stock 135,424 10,378,660 580,099 ------------- ------------- ------------- NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (1,285,325) 7,391,639 (364,756) ------------- ------------- -------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 4,527,075 393,255 (516,372) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 484,106 90,851 607,223 ------------- ------------- ------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 5,011,181 $ 484,106 $ 90,851 ============= ============= =============
See notes to consolidated financial tatements. F-5 VIRTUALFUND.COM, INC. (FORMERLY LASERMASTER TECHNOLOGIES, INC.) AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES BUSINESS VirtualFund.com, Inc. (the Company) designs, manufactures, markets and sells wide-format digital color printers, aftermarket inks and specialty coated media for graphic arts professionals. The Company also develops and sells Internet-based electronic commerce software and offers aftermarket customization and support services. CREDIT RISK The Company sells its products on a prepaid basis, on a COD basis, through nonrecourse third-party leasing arrangements and by extending credit in the normal course of business. Its customer base is comprised primarily of resellers and end users in the graphic arts, prepress and desktop publishing industries throughout the world. Credit risk is spread across a significant number of customers and geographic areas such that no material credit risk resides with one or a small number of customers or in a given geographic area. The Company performs ongoing credit evaluations of its customers' financial condition and generally requires no collateral. CONSOLIDATION The consolidated financial statements include the accounts of VirtualFund.com, Inc. and its subsidiaries, Embedded Data Systems, Corp. and ColorSpan Corporation (CSC) (formerly LaserMaster Corporation), and CSC's subsidiaries, ColorSpan Europe, Ltd. (CSE) (formerly LaserMaster Europe, Ltd.), ColorSpan Asia/Pacific, Ltd. (CSA) (formerly LaserMaster Asia/Pacific, Ltd.), and ColorSpan Latin America, Inc. (CSLA) (formerly ColorMasters, Inc.). All significant intercompany balances and transactions have been eliminated in consolidation. REVENUE RECOGNITION AND WARRANTIES Product sales are recorded on shipment. Reserves are established for anticipated returns of product and bad debts. The Company offers extended maintenance agreements with revenue from these agreements recognized ratably over the contract period. The Company provides a warranty for labor and materials on certain products sold. No other stock balancing programs or product rebate programs exist outside of the terms of the limited warranty. The estimated warranty liability is included in other current liabilities in the consolidated balance sheets. CASH EQUIVALENTS All highly liquid cash investments with a maturity of three months or less at the date of purchase are considered to be cash equivalents. INVENTORIES Inventories are stated at the lower of cost or market, with cost determined using the first-in, first-out (FIFO) basis. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets of two to seven years. CAPITALIZED SOFTWARE Software development costs incurred subsequent to establishment of the software's technological feasibility are capitalized. Capitalization ceases when the software is available for general release to customers. The recoverability of capitalized software development costs is continually evaluated, and provisions for estimated losses are recorded in the period such losses are determined. Amortization of capitalized software development costs is provided at the greater of the amount computed using (a) the ratio of current gross revenues from a product to the total of current and anticipated future gross revenues from the product or (b) the straight-line method over the remaining estimated economic life of the product. Generally, an original estimated economic life of three years is assigned to capitalized software development costs. Amortization of capitalized software development costs included in cost of goods sold aggregated $2,494,154 and $2,732,829 for the fiscal years ended June 30, 1997 and 1996, respectively. Provisions for impairment losses totaled $3,214,690 and $768,059 for the years ended June 30, 1997 and 1996, respectively. These provisions reduced the Company's capitalized software development costs to zero at June 30, 1997. Software development costs incurred during fiscal 1998 were not significant, and as such, no costs were capitalized. F-6 ACQUIRED TECHNOLOGY, PATENTS, AND LICENSES Acquired technology, patents, and licenses are amortized using the straight-line method over the estimated useful lives of the assets, generally from three to five years. Amortization of acquired technology, patents and licenses included in general and administrative expenses aggregated $200,957, $710,838 and $596,277 for the fiscal years ended June 30, 1998, 1997, and 1996, respectively. The recoverability of these assets is continually evaluated by comparing the remaining unamortized cost to the estimated future cash flows of the associated assets. Provisions for estimated losses are recorded in the period such losses are determined and totaled $1,533,837 and $2,582,840 for the years ended June 30, 1997 and 1996, respectively. ACCOUNTS PAYABLE Accounts payable include $1,243,101 at June 30, 1997 related to issued checks which had not cleared the Company's bank accounts reduced by deposits in transit and cash on deposit in the Company's depository banks. FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards (SFAS) No. 107, "DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS," requires disclosure of the fair value of certain financial instruments. Cash and cash equivalents, accounts receivable, short-term debt, accounts payable, and accrued liabilities are reflected in the financial statements at their estimated fair value. The carrying amount of the Company's long-term debt approximated its fair value at June 30, 1998 and 1997 due to the debt agreements containing market interest rates. INCOME TAXES The Company utilizes the asset and liability method of accounting for income taxes as set forth in SFAS No. 109, "ACCOUNTING FOR INCOME TAXES." Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement and tax bases of existing assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. RESEARCH AND DEVELOPMENT The Company is involved in the development of new products and improvement of existing products. Research and development costs are charged to expense as incurred. ADVERTISING The Company expenses the costs of advertising the first time the advertising takes place, except for direct-response advertising, which is capitalized and amortized over its expected period of future benefits. Direct-response advertising consists of printing, postage, and mailing list costs relating to direct mail advertising. The capitalized costs of the advertising are amortized over the period during which the benefits of the mailings are expected, up to two months following the mailing date. At June 30, 1998, $21,000 of advertising was included in other current assets as compared with $7,000 at June 30, 1997. Advertising expense was $3,549,000, $6,298,000 and $7,343,000 for the fiscal years ended June 30, 1998, 1997, and 1996, respectively. NET EARNINGS (LOSS) PER COMMON SHARE The Company adopted SFAS No. 128, "EARNINGS PER SHARE" effective December 28, 1997. As a result, all prior periods presented have been restated to conform to the provisions of SFAS No. 128, which requires the presentation of basic and diluted earnings per share. Basic earnings (loss) per share is computed by dividing net earnings (loss) by the weighted average number of common shares outstanding during each period. Diluted earnings (loss) per share is computed under the treasury stock method and is calculated by dividing net earnings (loss) by the weighted average number of common shares and dilutive common equivalent shares outstanding during the period. Common share equivalents included in the calculation reflect the dilutive effect of outstanding stock options, warrants, convertible debenture (Note 7) and the litigation settlement (Note 16) . During fiscal years 1997 and 1996, common equivalent shares are excluded from the calculation because they are anti-dilutive. STOCK-BASED COMPENSATION In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION." The Company has elected to continue following the guidance of Accounting Principles Board Opinion No. 25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES," for measurement and recognition of stock-based transactions with employees and has adopted the disclosure provisions of SFAS No. 123 in fiscal year 1997. F-7 USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure 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. SIGNIFICANT ACCOUNTING ESTIMATES The Company's reserves against inventories are based on the Company's best estimates of product sales prices and customer demand patterns, and/or its plans to transition its products. However, the Company participates in a highly competitive industry that is characterized by aggressive pricing practices, downward pressures on gross margins, frequent introductions of new products, short product life cycles, rapid technological advances, and continual improvement in product price/performance characteristics. As a result of the industry's ever-changing and dynamic nature, it is at least reasonably possible that the estimates used by the Company to determine its reserves against inventories will be materially different from the actual amounts or results. These differences could result in materially higher than expected inventory reserve costs, which could have a materially adverse effect on the Company's results of operations and financial condition in the near term. The Company's warranty and related accruals are based on the Company's best estimates of product failure rates and unit repair costs. However, the Company is continually releasing new and ever-more complex and technologically advanced products. As a result, it is at least reasonably possible that product could be released with certain unknown quality and/or design problems. Such an occurrence could result in materially higher than expected warranty and related costs, which could have a materially adverse effect on the Company's results of operations and financial condition in the near term. NEW ACCOUNTING STANDARDS The Financial Accounting Standards Board has recently issued SFAS No. 130, "REPORTING COMPREHENSIVE INCOME" and SFAS No. 131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION". The Company intends to adopt these standards in fiscal 1999 by making the required disclosures. Therefore, the adoption of these standards is not expected to have an effect on the Company's financial position or results of operations. The Financial Accounting Standards Board has also recently issued SFAS No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" which will be effective for the Company in fiscal 2000. The Company is reviewing the requirements of this standard and has not yet determined the impact on the financial statements of the Company. 2. RESTRUCTURING AND OTHER SPECIAL CHARGES In June 1997, the Company incurred pre-tax charges of $7.8 million related to the revaluation of intellectual property and inventory and $636,000 for settlement of the shareholders' lawsuit (Note 16). Of this amount, $3.5 million was charged to cost of sales and $4.9 million was charged to operating expenses. The special charges were incurred primarily as a result of a change in the estimated net realizable values of the Company's PressMate and DisplayMaker Express products. These two products represent the Company's first two proprietary printers developed and manufactured in-house. In May 1996, the Company incurred pre-tax charges of $9.9 million, consisting of restructuring and other special charges of $4.4 million and a special charge to cost of sales of $5.5 million related to its revised business plan and technical problems in one of its products. Included in the $4.4 million charge is $3.3 million for the revaluation of intellectual property tied to certain technologies and contract rights associated with the transition from a systems integrator to a manufacturer of printing engines. The charge also includes a $1.1 million provision for severance related to workforce reductions, expected losses on the sale of tangible assets and expenses under non-cancelable leases as a result of consolidating foreign sales offices and certain domestic operations. At June 30, 1998, approximately $629,000 of the total $4.4 million charge remains in current liabilities. At June 30, 1997, approximately $766,000 of the total $4.4 million charge remained in current liabilities. Included in the $5.5 million charge to cost of sales is $4.2 million in inventory revaluation associated with the transition from certain product lines developed as a systems integrator. In addition, the charge includes $1.3 million to cover replacement costs, product returns, and inventory revaluation related to the Company's older model PressMate product. F-8 3. INVENTORY Inventory consists of the following: June 30, 1998 June 30, 1997 ------------- ------------- Raw materials $ 3,285,194 $ 4,178,139 Work in process 207,303 123,664 Finished goods: Consumables 2,604,318 2,824,753 Hardware 723,153 2,058,115 ------------- ------------- $ 6,819,968 $ 9,184,671 ============= ============= 4. PROPERTY AND EQUIPMENT Property and equipment consists of the following:
Life Used for Depreciation June 30, 1998 June 30, 1997 ---------------- ------------- ------------- Computer equipment 2 - 5 years $ 10,086,605 $ 10,416,254 Trade show computer equipment 2 - 5 years 217,369 470,007 Capitalized tooling 3 years 440,710 263,693 Furniture and fixtures 5 - 7 years 4,123,670 4,359,607 Purchased software 3 years 1,112,377 1,065,817 Vehicles 5 years 209,738 264,171 Leasehold improvements 5 years 2,897,817 2,918,862 ------------- ------------- 19,088,286 19,758,411 Accumulated depreciation and amortization 16,311,947 16,187,749 ------------- ------------- $ 2,776,339 $ 3,570,662 ============= =============
Property and equipment includes assets under capital leases as follows:
June 30, 1998 June 30, 1997 ------------- ------------- Computer equipment and purchased software $ 340,446 $ 237,085 Furniture and fixtures 233,435 709,774 ------------- ------------- 573,881 946,859 Accumulated amortization 230,247 426,308 ------------- ------------- $ 343,634 $ 520,551 ============= ============= 5. NOTES PAYABLE Notes payable consists of the following: June 30, 1998 June 30, 1997 ------------- ------------- Note payable under revolving line of credit (1) $ 1,708,956 Note payable under revolving line of credit (2) $ 2,015,988 1,072,512 ------------- ------------- $ 2,015,988 $ 2,781,468 ============= ============= Weighted average interest rate 5.81% 8.48% ============= =============
(1) On January 17, 1996, CSC entered into a credit agreement with a commercial finance company. The agreement allows CSC to borrow up to $10,000,000 based on availability equal to 65% of the net eligible accounts receivable and 25% of the net eligible inventory. Borrowings are secured by inventory, accounts receivable, and general intangibles and bear interest at a defined bank reference rate (prime) plus 2.0% (10.5% F-9 at June 30, 1998) with a 0.5% unused line fee. At June 30, 1998, approximately $5,259,000 of eligible financing was unused under this credit line. Availability under this credit line fluctuates daily. The agreement expires January 17, 1999 and requires the borrower to meet various financial covenants involving capital expenditures, additions to capitalized software and intellectual property, minimum debt service coverage ratio, and maintenance of a minimum net worth. The agreement also requires CSC to meet various non-financial covenants (Note 13). (2) CSE, a subsidiary of the Company's CSC subsidiary, maintains a receivables financing arrangement, which has no stated expiration, with a commercial finance company whereby CSE may borrow up to 80% of eligible accounts receivable, with a maximum advance of $2,500,000. At June 30, 1998, approximately $484,000 was unused under this credit line. Borrowings are due in Dutch Guilders on demand and bear interest at the Promissory Note Discount Rate of the Dutch Central Bank plus 2.5% (5.81% at June 30, 1998). Borrowings in U.S. Dollars are due on demand and bear interest at a rate that fluctuates with the market (8.55% at June 30, 1998). 6. LONG-TERM DEBT Long-term debt consists of the following:
June 30, 1998 June 30, 1997 ------------- ------------- Notes payable to a finance company, with monthly payments aggregating $9,758, including interest at the "One-Month" Commercial Paper rate plus 4.0% (9.49% at June 30, 1998), due through May 1999, secured by certain domestic property and equipment (Note 13) $ 60,295 $385,198 Note payable to a bank paid in fiscal 1998 2,922 Obligations under capital leases for equipment, payable in monthly installments (Note 10) 266,001 433,274 --------- -------- 326,296 821,394 Less current maturities 259,550 636,665 --------- -------- $ 66,746 $184,729 ========= ========
Excluding capital lease obligations, the balance of $60,295 at June 30, 1998 is due in fiscal 1999. 7. CONVERTIBLE SUBORDINATED DEBENTURE In September 1996, the Company entered into a series of agreements with one of its largest trade creditors, converting approximately $1.7 million of trade payables and a promissory note of $859,516 into a $2.5 million convertible subordinated debenture. The debenture is due September 12, 1998 together with accrued interest at an annual rate of 8.0%. The debenture contains voluntary, automatic and mandatory conversion provisions. Under the voluntary conversion provision, the debenture is convertible in whole or in part into common stock of the Company at $6.00 per share at any time that the market price of the Company's common stock is less than $6.00 per share. The debenture is automatically converted at the rate of 30,000 shares a week at the market price of the common stock at any time that the market price equals or exceeds $6.00 per share. The automatic conversion provision contains limited price protection under certain circumstances. Under the mandatory conversion provision, the debenture will be converted on a quarterly basis at market prices and in share quantities equal to specified threshold amounts, less any shares converted under the other provisions. The mandatory provision is effective for the quarter ending March 31, 1997 and continues until the debenture is fully converted. The debenture contains certain registration rights and also limits the number of shares that may be sold in the open market in any one week. As of June 30, 1998, 630,000 shares had been converted aggregating $2,353,209. The principal balance outstanding at June 30, 1998 is $375,866. F-10 8. STOCKHOLDERS' EQUITY In September 1996, the Company privately placed 2,695,971 shares of its common stock, together with warrants to purchase an additional 2,757,000 shares, for $12 million ($11.8 million, net of transaction costs) to three separate groups. Sihl-Zurich Paper Mill on Sihl AG, a Swiss corporation, was issued 1,371,429 shares and warrants to purchase an additional 1,371,429 shares, at an exercise price of $7.00 per share, for an aggregate $6 million. TimeMasters, Inc. and affiliates, which are controlled by the Company's Chief Executive Officer, were issued 914,286 shares and warrants to purchase an additional 914,286 shares, at an exercise price of $7.00 per share, for an aggregate $4 million. The Company received $2.2 million from TimeMasters and affiliates and offset the remaining $1.8 million against a note payable and accrued interest due to TimeMasters. General Electric Capital Corporation, the Company's senior lender, was issued 410,256 shares and warrants to purchase an additional 471,285 shares at an exercise price of $6.79 per share, for an aggregate $2 million. 9. STOCK OPTIONS AND WARRANTS On May 23, 1996, the stockholders approved the adoption of the "LaserMaster Technologies, Inc. 1996 Stock Incentive Plan". The aggregate number of shares of the Company's common stock which may be issued pursuant to the plan is 1,500,000. Under the plan, incentive stock options and non-statutory stock options may be granted to key employees, directors, and consultants of the Company at exercise prices not less than 100 percent of the fair market value of the common stock at the date of grant and 110 percent for incentive stock options granted to individuals owning 10 percent or more of the Company's common stock. The plan is administered by a Stock Option Committee appointed by the Board of Directors. The committee establishes all terms and conditions of each grant, except that, in the case of incentive options, the term may not exceed 10 years. The Company also has a 1990 Restated Stock Option Plan with 3,513,309 shares authorized. Warrant activity and activity under the stock option plans is summarized as follows:
Weighted Average Weighted Average Warrants Warrant Price Options Option Price Outstanding Per Share Outstanding Per Share ------------ ---------------- ----------- ---------------- Balance, June 30, 1995 15,000 $ 5.50 2,140,686 $ 3.38 Granted 277,953 6.35 1,322,000 4.29 Exercised (249,752) 2.32 Forfeited (449,824) 4.18 Repriced* (1.23) ------------ ---------- Balance, June 30, 1996 292,953 6.31 2,763,110 3.54 Granted 2,757,000 6.96 954,381 4.07 Exercised (180,357) 1.89 Forfeited (729,024) 4.37 Repriced** (0.55) ------------ ---------- Balance, June 30, 1997 3,049,953 6.90 2,808,110 3.38 Granted 1,051,500 2.97 Exercised ( 80,071) 1.69 Forfeited (15,000) (150,500) 3.07 Repriced*** (0.89) ------------ ---------- Balance, June 30, 1998 3,034,953 $ 6.91 3,629,039 $ 3.11 ============ ========== Exercisable, June 30, 1996 292,953 $ 6.31 722,339 $ 2.50 Exercisable, June 30, 1997 3,049,953 6.90 779,308 2.65 Exercisable, June 30, 1998 3,034,953 6.91 1,034,513 2.71
*The Company's Board of Directors approved the repricing of 249,250 non-statutory stock options to the closing Nasdaq price on July 3, 1995 ($5.40 per share). These options had original exercise prices ranging from $5.63 to $8.50 per share with an average exercise price of $6.75 per share. The Company's Board of Directors approved the repricing of 210,000 F-11 non-statutory stock options to the closing Nasdaq price on April 23, 1996 ($4.00 per share). These options had original exercise prices ranging from $5.00 to $5.40 per share with an average exercise price of $5.09 per share. ** The Company's Board of Directors approved the repricing of 929,250 non-statutory stock options to the closing Nasdaq price on July17, 1996 ($3.63 per share). These options had original exercise prices ranging from $4.00 to $6.50 per share with an average exercise price of $4.18 per share. *** The Company's Board of Directors approved the repricing of 776,000 non-statutory stock options to the closing Nasdaq price on September 26, 1997 ($3.00 per share). These options had original exercise prices ranging from $3.38 to $4.75 per share with an average exercise price of $3.89 per share. Pro Forma Information: The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION" (SFAS 123). Accordingly, since options have been issued with exercise prices at or above market value of the Company's stock, no compensation expense has been recognized for the stock option plans. Had compensation expense for the Company's stock option plans been determined based on the fair value at the grant date for awards in fiscal 1998, 1997 and 1996 consistent with the provisions of SFAS 123, the Company's net earnings (loss) and net earnings (loss) per share would have been adjusted to the pro forma amounts reflected in the following table:
June 30, 1998 June 30, 1997 June 30, 1996 ------------- ------------- ------------- Reported net earnings (loss) $1,726,759 $(17,199,688) $(10,461,534) Pro forma net earnings (loss) 1,129,090 (17,545,997) (10,482,957) Net earnings (loss) per share: As reported - basic .12 (1.25) (.93) As reported - diluted .11 (1.25) (.93) Pro forma - basic .08 (1.28) (.93) Pro forma - diluted .07 (1.28) (.93)
Statement No. 123 method of accounting has not been applied to options granted prior to July 1, 1995, thus the resulting pro forma compensation cost may not be representative of that to be expected in future years. The fair value of each option grant has been estimated as of the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in fiscal 1998, 1997 and 1996:
June 30, 1998 June 30, 1997 June 30, 1996 ------------- ------------- ------------- Expected dividend yield $ - $ - $ - Expected stock price volatility 60% 60% 60% Risk-free interest rate 5.50% 6.22% 6.22% Expected life of options (years) 4.5 4.5 4.5
The per share weighted-average fair value of stock options granted during 1998, 1997 and 1996 is estimated as $1.60, $2.23 and $2.34, respectively on the date of grant using the Black-Scholes option pricing model. The following table summarizes information about the Company's stock option plans at June 30, 1998:
Range of Number Weighted Average Weighted Number Weighted Exercise Outstanding at Remaining Average Exercisable at Average Prices June 30, 1998 Contractual Life Exercise Price June 30, 1998 Exercise Price -------- --------------- ---------------- -------------- ------------- -------------- $ .34 to 2.00 57,372 45 months $1.58 37,122 $1.35 2.01 to 3.00 2,454,817 86 months 2.79 802,291 2.53 3.01 to 4.00 972,750 90 months 3.78 175,250 3.63 above 4.00 144,100 98 months 4.74 19,850 4.69 --------- ----- --------- ----- 3,629,039 $3.11 1,034,513 $2.71
F-12 10. COMMITMENTS LEASES The Company leases certain equipment under leases which meet the criteria for capital lease classification. These agreements have been capitalized at the lesser of the fair market value of the equipment or the present value of the future minimum lease payments. The Company also leases other equipment under operating leases. In addition, the Company leases its office and warehouse facilities under operating leases which expire at various dates through December 2010. The leases require payments of property taxes, insurance, and maintenance costs in addition to basic rent and contain renewal options for periods ranging from one to three years. Certain of the facilities leases are under a 15-year commercial lease with Grandchildren's Realty Alternative Management Program I ("GRAMPI"), a Minnesota limited partnership controlled by the Company's Chief Executive Officer, for space it currently occupies in Shady View I & II. The Shady View space is approximately 54% of all space leased by the Company. GRAMPI purchased the real estate in April 1995, after the Company's Board of Directors declined to do so. GRAMPI sold the property in October 1996 in a sale-leaseback transaction and remains the lessor to the Company. The Company's Board of Directors retained services of an outside commercial real estate brokerage firm and outside legal counsel to negotiate the lease with the landlord's outside legal counsel. Management and the outside brokerage firm and legal counsel believe that the lease is at market rate. Rent expense under all equipment and facilities operating leases (including property taxes, insurance, and maintenance costs) was as follows:
Year Ended June 30 -------------------------------------------- 1998 1997 1996 ------------ ------------- ------------- GRAMPI $ 1,547,000 $ 1,525,000 $ 1,355,000 Other parties 1,037,000 1,104,000 1,211,000 ------------- ------------- ------------ Total $ 2,584,000 $ 2,629,000 $ 2,566,000 ============ ============= ============
Future minimum lease payments under capital and operating leases in effect at June 30, 1998 are as follows:
Operating Leases Capital ------------------------------- Year ending June 30: Leases GRAMPI Other ----------- ------------- ------------ 1999 $ 213,690 $1,201,000 $ 1,280,000 2000 69,430 1,327,000 1,255,000 2001 1,327,000 770,000 2002 1,272,000 754,000 2003 1,244,000 784,000 Thereafter (2004 through 2010) 10,250,000 2,725,000 ----------- ------------- ------------ 283,120 $ 16,621,000 $ 7,568,000 ============= ============ Less interest (17,119) ----------- Present value of net minimum lease payments $ 266,001 ===========
EMPLOYMENT AGREEMENTS The Company has employment agreements with twelve of its officers and executives which renew automatically on an annual basis. Two of the agreements provide continuation payments equal to 36 months pay upon termination of employment in certain circumstances, including change of control. The other ten agreements provide for 12 months notice of termination, other than for cause, or payment in lieu of notice. Three of the agreements also provide for acceleration of option vesting in the event of a change in control or termination without cause. As of June 30, 1998, minimum annual salary levels set for the twelve individuals was, in aggregate, $2,875,000. EMPLOYEE BENEFIT PLAN The Company has a qualified defined contribution 401(k) plan covering substantially all employees. The plan offers an employee savings feature and discretionary Company matching contributions. There were no employer contributions to the plan for the years ended June 30, 1998, 1997, and 1996. F-13 11. INCOME TAXES The (provision) benefit for income taxes consists of the following:
Year Ended June 30, --------------------------------------------------- 1998 1997 1996 ------------- ------------- ------------- Current: Federal $ - $ (193,000) $ 835,000 State - (12,000) (6,000) ------------- ------------- ------------- - (205,000) 829,000 Deferred, primarily federal - (1,084,000) 4,318,000 ------------- ------------- ------------- $ - $ (1,289,000) $ 5,147,000 ============= ============= =============
A reconciliation of the expected federal income tax (provision) benefit at the statutory rate of 35% with the (provision) benefit for income taxes is as follows:
Year Ended June 30, --------------------------------------------------- 1998 1997 1996 ------------- ------------- ------------- Tax (provision) benefit computed at statutory rates $ (604,000) $ 5,569,000 $ 5,463,000 State income tax, net of federal benefit (31,000) 288,000 283,000 Graduated tax bracket benefit (provision) 17,000 (159,000) (156,000) Change in valuation allowance 457,000 (7,339,000) (821,000) Other 161,000 352,000 378,000 ------------- ------------- ------------- $ - $ (1,289,000) $ 5,147,000 ============= ============= =============
Under SFAS No. 109, deferred tax assets and liabilities are classified as current and noncurrent on the basis of the classification of the related asset or liability for financial reporting. Deferred taxes are recorded for temporary differences between the bases of assets and liabilities for financial reporting purposes and tax purposes. Temporary differences comprising the net deferred taxes shown on the consolidated balance sheets are as follows:
June 30, 1998 June 30, 1997 --------------------------------------- ------------- Assets Liabilities Total Total ------------ ----------- ----------- ----------- Allowance for doubtful accounts and sales returns $ 565,000 $ 565,000 $ 676,000 Inventory costs 2,612,000 2,612,000 2,782,000 Acquired technology 304,000 Litigation settlement 216,000 Accrued vacation 145,000 145,000 182,000 Other 174,000 $ (318,000) (144,000) (87,000) ------------ ----------- ----------- ----------- Current 3,496,000 (318,000) 3,178,000 4,073,000 Property and equipment basis 682,000 682,000 594,000 Net operating loss carryforwards 6,573,000 6,573,000 6,162,000 Research and development credit carryforwards 1,773,000 1,773,000 1,773,000 Alternative minimum tax credits 225,000 225,000 225,000 Other 38,000 38,000 99,000 ------------ ----------- ----------- ----------- Noncurrent 9,291,000 - 9,291,000 8,853,000 ------------ ----------- ----------- ----------- Gross 12,787,000 (318,000) 12,469,000 12,926,000 Valuation allowance (7,703,000) (7,703,000) (8,160,000) ------------ ----------- ----------- ----------- Net $ 5,084,000 $ (318,000) $ 4,766,000 $ 4,766,000 ============ =========== =========== ===========
F-14 The valuation allowance for deferred tax assets as of June 30, 1998 and 1997 is $7,703,000 and $8,160,000, respectively. The net change in the total valuation allowance for the year ended June 30, 1998 was a decrease of $457,000. Realization of the entire deferred tax asset will depend on the Company's ability to generate sufficient taxable income. The valuation allowance reduces the deferred tax asset to what management believes is realizable in the foreseeable future. At June 30, 1998, the Company has net operating loss carryforwards for federal income tax purposes of approximately $17.4 million which are available to offset future taxable income, if any, through 2013. The Company also has alternative minimum tax credit carryforwards of approximately $225,000 available to reduce future federal income taxes, if any, over an indefinite period and research credit carryforwards of approximately $1.3 million available to reduce future federal income tax, if any, through 2011. The Company recognized income tax benefits of $199,000 and $226,000 in 1997 and 1996, respectively, pertaining to the exercise of stock options, which are reflected in additional paid-in capital. 12. EARNINGS PER SHARE CALCULATION In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "EARNINGS PER SHARE." The following table summarizes the reconciliation of the basic and diluted average common shares outstanding:
1998 1997 1996 ---------- ---------- ---------- Average common shares outstanding 14,716,003 13,705,609 11,305,232 Assumed conversion of stock options 716,117 Assumed conversion of debentures 28,998 Assumed issuance of common stock at beginning of year related to settlement of litigation 140,953 ---------- ---------- ---------- Average common and assumed conversion shares 15,602,071 13,705,609 11,305,232 ========== ========== ==========
The following table summarizes the securities that could potentially dilute basic earnings per share in the future that were not included in the computation of diluted earnings (loss) per share because to do so would have been antidilutive for the periods presented:
1998 1997 1996 ---------- ---------- ---------- Stock options 142,000 2,808,110 2,763,110 Warrants 3,034,953 3,049,953 292,953 Convertible debenture 794,687 Shares issuable relating to settlement of litigation 141,333 ---------- ---------- ---------- Average common and assumed conversion shares 3,176,953 6,794,083 3,056,063 ========== ========== ==========
13. RELATED PARTY TRANSACTIONS The Company is involved in various transactions with TimeMasters, Inc. (TMI), a corporation controlled by the Company's Chief Executive Officer. The Company also purchases certain inventory from a greater than 5% shareholder and maintains its employee 401(k) plan investments with an affiliate of its senior lender. The Company's senior lender is also a shareholder. Transactions with related parties are as follows:
Year Ended June 30, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Interest expense (Notes 5 and 6) $ 336,816 $ 727,630 Interest expense (a) 7,440 83,696 $ 139,398 Interest income (b), (e) 4,696 38,882 Rent expense (Note 10), (e) 1,547,000 1,525,000 1,355,000 Operating expenses (c) 198,723 88,240 30,788 Equipment purchases (d) 52,970 49,075 47,853 Inventory purchases 2,721,156 1,569,844
F-15 Balances outstanding with related parties are as follows: June 30, ---------------------- 1998 1997 ---------- ---------- Notes payable (Notes 5 and 6) $ 60,295 $2,094,154 Accrued rent 178,388 Accounts payable 597,608 70,389 Note Receivable (b) 250,000 Accounts receivable (e) 87,460 (a) During September and October 1995, CSC borrowed $1,765,000 under a demand note from TMI. In January 1996, CSC obtained a new line of credit with a commercial finance company that required the indebtedness to TMI be subordinated to the line of credit and not be repaid unless certain financial covenants were achieved. In return for such subordination and for the significant restrictions on repayment, the Company issued to TMI a warrant to purchase 277,953 shares of common stock. The warrant is exercisable at $6.35 per share through January 17, 2002. In December 1996, the principal balance of $1,765,000, along with $53,715 in accrued interest, was offset against a similar amount due from TMI related to an equity investment in the Company (Note 8). Fiscal 1998 expense represents interest paid to GRAMPI for past due rent payments. (b) In September 1996, the Company issued 914,286 shares of common stock and warrants to purchase an additional 914,286 shares of common stock to a group affiliated with TMI in exchange for promissory notes aggregating $4 million (Note 8). In addition, Mel Masters, the Company's CEO, borrowed $585,000 from the Company in November 1996. The amount borrowed was repaid in December 1996 together with interest at 10%. On June 26, 1998 GRAMPI borrowed $250,000 from the Company. The note is personally guaranteed by Mr. Masters and is secured by certain shares of the Company's common stock owned by GRAMPI, bears interest at the Prime Rate plus 2.0% and is due February 25, 1999. (c) Under a Use Indemnification Agreement and certain related Board of Director's actions, the Company has the right to sponsor business and business-related occasions at facilities owned by Masters Trust I and/or Melvin L. Masters and/or TimeMasters, Inc. In addition, the Company occasionally uses an airplane that is owned by a company controlled by Mr. Masters for business-related travel. The Company indemnifies the owners against loss or damage beyond available insurance, reimburses out-of-pocket and operating expenses, and pays a usage charge based on what management believes are market rates. The Company also uses the services of a travel agency which is controlled by Mr. Masters. (d) The Company has installed a campus-wide TMI wireless voice system in its Eden Prairie facility. There are no monthly call operating charges for unlimited use of that system. The system hardware was acquired in 1995 for $211,362 based on competitive proposals for two other comparable systems. The Company acquired additional hardware and upgrades in 1998, 1997 and 1996. (e) The Company subleases space to TMI. Rent charged to TMI reduces rent expense and was $18,820, $18,608, and $4,599 for the years ended June 30, 1998, 1997 and 1996 respectively. The Company also performed services and paid various amounts on behalf of TMI. Interest is accrued on the unpaid balance at a rate of 10%. F-16 14. SEGMENT INFORMATION Financial information by geographic location is as follows:
Year Ended June 30, 1998 1997 1996 ------------- ------------- ------------- Sales: North America and other $ 54,054,188 $ 54,771,696 $ 60,701,808 Europe 17,226,431 17,410,002 19,655,566 Japan, Asia, Pacific 9,450,915 14,381,724 13,234,670 ------------- ------------- ------------- Total sales $ 80,731,534 $ 86,563,422 $,,93,592,044 ============= ============= ============= Operating profit (loss): North America and other $ (179,740) $ (20,396,052) $ (17,227,577) Europe 1,651,966 2,115,152 (106,343) Japan, Asia, Pacific 864,332 3,380,608 3,548,196 ------------- ------------- ------------- 2,336,558 (14,900,292) (13,785,724) Interest expense and other (609,799) (1,010,396) (1,822,810) ------------- ------------- ------------- Earnings (loss) before income taxes $ 1,726,759 $ (15,910,688) $ (15,608,534) ============= ============= ============= June 30, 1998 June 30, 1997 ------------- ------------- Assets: North America $ 22,702,031 $ 23,195,621 Europe 4,690,326 4,589,271 Japan, Asia, Pacific 5,727,313 4,846,041 ------------- ------------- Total assets $ 33,119,670 $ 32,630,933 ============= =============
Throughout the fiscal year ending June 30, 1998, the Company has been investing resources in a diversification effort designed to enter the Internet Software and Information Technology Consulting markets. The financial results of this diversification effort are not material to the fiscal 1998 operations. 15. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION AND NON-CASH FINANCING ACTIVITIES
Year Ended June 30, ----------------------------------- 1998 1997 1996 ---------- ---------- ---------- The Company paid cash for the following items: Interest paid $ 452,023 $1,246,358 $2,001,050 Income tax paid (received), net 7,677 (668,054) (452,451) Financing transactions not affecting cash: Accounts payable converted to note payable 859,516 Accounts payable converted to convertible subordinated debenture 1,668,314 Note payable converted to convertible subordinated debenture 859,516 Convertible subordinated debenture and accrued interest converted to common stock 1,990,396 362,813 Note payable to related party offset against note receivable from related party 1,765,000 Accrued interest offset against note receivable from related party and interest receivable 53,715 Common stock issued for services 100,000 Litigation settlement in exchange for common stock 636,000 Capital lease obligations 160,171 228,374
F-17 16. LITIGATION In October 1995, a shareholder of the Company (Becker) filed an action against the Company and four of its officers and directors alleging violations of the Securities and Exchange Act of 1934. In December 1995, similar claims filed by other shareholders were consolidated into the Becker claim as a class action to include all purchasers of the Company's stock during the period of December 3, 1993 through December 8, 1994. The basic allegation was that the Company and the named defendants knew of material, negative, non-public information and withheld such information from the market so that they could personally benefit by selling shares of common stock at an inflated price. A settlement in this case was reached between the Company and the plaintiffs and was approved in October 1997. The settlement included an amount from the Company's insurance carrier and $636,000 from the Company. The Company's portion of the proposed settlement was to be paid in cash or common stock at the Company's discretion. The Company elected to contribute common stock and issued 141,333 shares on June 30, 1998 in settlement of the obligation. The Company recorded its $636,000 share of the proposed settlement as expense and additional paid in capital as of June 30, 1997. In the ordinary course of its business the Company experiences various types of claims which sometimes result in litigation or other legal proceedings. The Company does not anticipate that any of these proceedings will have a material effect on the Company's operations or financial position. 17. SUBSEQUENT EVENT On July 15, 1998, the Company issued 600,000 shares of common stock in exchange for all of the common stock of Kilborn Photo Products Inc. (Kilborn). Kilborn is a manufacturer of specialty coated media and is based in Cedar Rapids, Iowa. The business combination will be accounted for as a pooling of interests in fiscal 1999. Kilborn reported net sales of $1.9 million (unaudited) for the year ended December 31, 1997. Assets acquired and liabilities assumed include the following as of July 15, 1998: (Unaudited) Accounts receivable $ 155,000 Inventory 411,000 Property, plant and equipment, net 280,000 Other assets 91,000 Notes payable and accrued interest 2,956,000 Other liabilities 7,000 18. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)
Quarter Ended ---------------------------------------------------------- Fiscal Sept. 28 Dec. 28 Mar. 29 June 30 Year --------- --------- --------- --------- -------- FISCAL 1998: Net sales $ 15,306 $ 21,647 $ 21,273 $ 22,506 $ 80,732 Gross profit 5,584 8,571 8,956 9,570 32,681 Net (loss) earnings (1,646) 898 921 1,554 1,727 Net (loss) earnings per share: Basic (.11) .06 .06 .10 .12 Diluted (.11) .06 .06 .10 .11
F-18
Quarter Ended ---------------------------------------------------------- Fiscal Sept. 29 Dec. 29 Mar. 30 June 30 Year --------- --------- --------- --------- -------- FISCAL 1997: Net sales $ 21,452 $ 24,597 $ 19,384 $ 21,130 $ 86,563 Gross profit 7,930 7,849 5,102 3,770 (a) 24,651 (a) Net (loss) (238) (483) (2,450) (14,029)(b) (17,200)(b) Net (loss) per share Basic (.02) (.03) (.17) (.97) (1.25) Diluted (.02) (.03) (.17) (.97) (1.25)
(a) Includes a special pre-tax charge to cost of sales of $3.5 million related to the Company's revised estimates of net realizable value of two of its products. (b) Includes pre-tax special charges of $4.3 million and a special pre-tax charge to cost of sales of $3.5 million related to the Company's revised estimates of net realizable value of two of its products, $636,000 related to the settlement of litigation, and a special provision for income taxes of $6.5 million related to the revaluation of deferred tax assets. F-19 Schedule I VIRTUALFUND.COM, INC. (formerly LaserMaster Technologies, Inc.) AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT (PARENT ONLY) CONDENSED BALANCE SHEETS - - -------------------------------------------------------------------------------- June 30, June 30, ASSETS 1998 1997 -------------- -------------- CURRENT ASSETS: Cash and cash equivalents $ 337,702 $ 329,993 Accounts receivable 266,391 1,463 Receivable from subsidiary 3,620,920 8,604,283 Other current assets 152,450 112,981 -------------- -------------- TOTAL CURRENT ASSETS 4,377,463 9,048,720 PROPERTY AND EQUIPMENT, NET 648,396 649,563 INVESTMENT IN SUBSIDIARIES 12,338,019 5,484,595 -------------- -------------- $ 17,363,878 $ 15,182,878 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current maturities of long-term debt $ 85,154 $ 8,830 Convertible subordinated debenture 375,866 Accounts payable 583,920 589,455 Accrued payroll 215,949 151,481 Accrued expenses 268,939 274,586 -------------- -------------- TOTAL CURRENT LIABILITIES 1,529,828 1,024,352 CONVERTIBLE SUBORDINATED DEBENTURE 2,233,414 LONG-TERM DEBT, less current maturities 66,746 10,387 STOCKHOLDERS' EQUITY: Common stock 151,789 144,325 Additional paid-in capital 32,995,320 30,876,964 Accumulated deficit (17,379,805) (19,106,564) -------------- -------------- TOTAL STOCKHOLDERS' EQUITY 15,767,304 11,914,725 -------------- -------------- $ 17,363,878 $ 15,182,878 ============== ============== See notes to condensed financial information of registrant on page F-22. F-20 Schedule I (Continued) VIRTUALFUND.COM, INC. (formerly LaserMaster Technologies, Inc.) AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT (PARENT ONLY) STATEMENTS OF OPERATIONS AND RETAINED EARNINGS (ACCUMULATED DEFICIT) - - --------------------------------------------------------------------------------
Years ended June 30, ---------------------------------------- 1998 1997 1996 ------------ ------------ ----------- REVENUES (management fees from subsidiaries) $ 4,730,000 $ 4,200,000 $ 4,200,000 OPERATING EXPENSES 5,090,665 5,418,186 4,653,138 ------------ ------------ ----------- (LOSS) BEFORE INCOME TAXES AND EQUITY IN EARNINGS (LOSS) OF SUBSIDIARIES (360,665) (1,218,186) (453,138) EQUITY IN EARNINGS (LOSS) OF SUBSIDIARIES 2,087,424 (9,844,502) (10,157,396) INCOME TAX (PROVISION) BENEFIT (6,137,000) 149,000 ------------ ------------ ----------- NET EARNINGS (LOSS) 1,726,759 (17,199,688) (10,461,534) (ACCUMULATED DEFICIT) RETAINED EARNINGS AT BEGINNING OF YEAR (19,106,564) (1,906,876) 8,554,658 ------------ ------------ ----------- (ACCUMULATED DEFICIT) AT END OF YEAR $(17,379,805) $(19,106,564) $(1,906,876) ============ ============ ===========
See notes to condensed financial information of registrant on page F-22. F-21 Schedule I (Continued) VIRTUALFUND.COM, INC. (formerly LaserMaster Technologies, Inc.) AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT (PARENT ONLY) CONDENSED STATEMENTS OF CASH FLOWS - - --------------------------------------------------------------------------------
Years Ended June 30, ------------------------------------------ 1998 1997 1996 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings (loss) $ 1,726,759 $(17,199,688) $(10,461,534) Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities: Equity in (earnings) loss of subsidiaries (2,087,424) 9,844,502 10,157,396 Depreciation and amortization 320,439 345,493 368,828 Litigation settlement 636,000 Stock option tax benefit 199,000 226,000 Loss (gain) on sale of property and equipment 26,794 (14,250) 402 Net change in operating current assets and liabilities 360,798 (3,714,392) (712,331) ------------ ------------ ------------ NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 347,366 (9,903,335) (421,239) CASH FLOWS FROM INVESTING ACTIVITIES: Notes receivable - related party (250,000) Additions to property and equipment (197,893) (224,023) (146,461) Proceeds from sale of property and equipment 300 55,450 ------------ ------------ ------------ NET CASH USED IN INVESTING ACTIVITIES (447,593) (168,573) (146,461) CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock 135,424 10,378,660 580,099 Payments on long-term debt (27,488) (10,691) (8,466) Net payments under short-term debt (41,485) ------------ ------------ ------------ NET CASH PROVIDED BY FINANCING ACTIVITIES 107,936 10,367,969 530,148 INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 7,709 296,061 (37,552) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 329,993 33,932 71,484 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF YEAR $ 337,702 $ 329,993 $ 33,932 ============ ============ ============
NOTES: See consolidated financial statements for details of and changes in stockholders' equity. See Note 7 to consolidated financial statements for information regarding the convertible subordinated debenture. Capital lease obligations of $160,171 and $25,000 were incurred during the years ended June 30, 1998 and 1996 respectively. No cash dividends have been paid to VirtualFund.com, Inc. by the subsidiaries. F-22 Schedule II VIRTUALFUND.COM, INC. (formerly LaserMaster Technologies, Inc.) AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED JUNE 30, 1998, 1997, AND 1996 - - --------------------------------------------------------------------------------
Balance Charged Balance beginning to costs Accounts at of and written end of period expenses off period Description ---------- ---------- ---------- ---------- 1998: Allowance for doubtful accounts and sales returns $1,987,000 $ 683,000 1,008,000 $1,662,000 1997: Allowance for doubtful accounts and sales returns $2,475,000 $ 764,000 $1,252,000 $1,987,000 1996: Allowance for doubtful accounts and sales returns $2,051,000 $1,472,000(a) $1,048,000 $2,475,000
(a) Includes special charge of $1 million to cover product returns related to the Company's older model PressMate product. F-23 EX-10.1 2 AMENDMENT NO. 3 TO CREDIT AGREEMENT Exhibit 10.1 AMENDMENT NO. 3 TO CREDIT AGREEMENT This AMENDMENT NO. 3 TO CREDIT AGREEMENT (this "Amendment") is entered into as of this 14th day of May, 1997 by and between LASERMASTER CORPORATION, a Minnesota corporation ("Borrower"), and GENERAL ELECTRIC CAPITAL CORPORATION, a New York corporation as Agent and Lender ("Agent"). Unless otherwise specified herein, capitalized terms used in this Amendment shall have the meanings ascribed to them by the Credit Agreement (as hereinafter defined). RECITALS WHEREAS, Borrower and Agent have entered into that certain Credit Agreement, dated as of January 17, 1996, as amended by that certain First Amendment to Credit Agreement, dated as of May 15, 1996 (as further amended, supplemented, restated or otherwise modified from time to time, the "Credit Agreement"); and WHEREAS, Borrower and Agent wish to enter into certain amendments to the Credit Agreement, all as more fully set forth herein; NOW THEREFORE, in consideration of the mutual covenants herein and other good and valuable consideration, the parties hereto agree as follows: SECTION 1. Amendments to the Credit Agreement and Schedule Schedule H to the Credit Agreement is amended as follows: (i) clause (c) is amended and restated to read in its entirety as follows: (c) Minimum Net Worth. Borrower and it Subsidiaries (other than LaserMaster Europe) on a consolidated basis shall maintain from March 31, 1997 through June 30, 1997 Net Worth equal to or greater than $1,930,000, and a Net Worth equal to greater than $2,500,000 at all times thereafter. (ii) clause (d) is amended and restated as to read in its entirety as follows: (d) Minimum Debt Service Coverage Ratio. Borrower and its Subsidiaries (other than LaserMaster Europe) on a consolidated basis shall have at the end of each Fiscal Month, a Debt Service Coverage Ratio for the 12-month period then ended (or for the Fiscal Months ending on or before June 30, 1997, the period of July 1, 1996 to such date) of not less than .23 to 1.0 with respect to the Fiscal Months ending March 31, 1997, April 30, 1997 and May 31, 1997 and not less than 1.0 to 1.0 with respect to each Fiscal Month ending thereafter. SECTION 2. Representations and Warranties. 2.1 Borrower. Borrower represents and warrants that: (a) the execution, delivery and performance by Borrower of this Amendment have been duly authorized by all necessary corporate action and this Amendment is a legal, valid and binding obligation of Borrower enforceable against Borrower in accordance with its terms, except as the enforcement thereof may be subject to (i) the effect of any applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting creditors' rights generally and (ii) general principles of equity (regardless of whether such enforcement is sought in a proceeding in equity or at law); (b) each of the representations and warranties contained in the Credit Agreement is true and correct in all material respects on and as of the date hereof as if made on the date hereof, except to the extent that such representations and warranties expressly relate to an earlier date; (c) neither the execution, delivery and performance of this Amendment nor the consummation of the transactions contemplated hereby does or shall contravene, result in a breach of, or violate (i) any provision of Borrower's certificate or articles of incorporation or bylaws, (ii) any law or regulation, or any order or decree of any court or government instrumentality or (iii) indenture, mortgage, deed of trust, lease, agreement or other instrument to which Borrower or any of its Subsidiaries is a party to by which Borrower or any of its Subsidiaries or any of their property is bound, except in any such case to the extent such conflict or breach has been waived by a written waiver document a copy of which has been delivered to Agent on or before the date hereof; and (d) no Default or Event of Default will exist or result after giving effect hereto. SECTION 3. Reference to and Effect Upon the Credit Agreement (a) Except as specifically amended above, the Credit Agreement and the other Loan Documents shall remain in full force and effect and are hereby ratified and confirmed. (b) The execution, delivery and effectiveness of this Amendment shall not operate as a waiver of any right, power or remedy of Agent or any Lender under the Credit Agreement or any Loan Document, nor constitute a waiver of any provision of the Credit Agreement or any Loan Document, except as specifically set forth herein. Upon the effectiveness of this Amendment, each reference in the Credit Agreement to "this Agreement", "hereunder", "hereof", "herein" or words of similar import shall mean and be a reference to the Credit Agreement as amended hereby. SECTION 4. Costs and Expenses. As provided in Section 11.3 of the Credit Agreement, Borrower agrees to reimburse Agent for all fees, costs and expenses, including the fees, costs and expenses of counsel or other advisors for advice, assistance, or other representation in connection with this Amendment. SECTION 5. GOVERNING LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AS OPPOSED TO CONFLICTS OF LAW PROVISIONS) OF THE STATE OF ILLINOIS. SECTION 6. Headings. Section headings in this Amendment are included herein for convenience of reference only and shall not constitute a part of this Amendment for any other purposes. SECTION 7. Counterparts. This Amendment may be executed in any number of counterparts, each of which when so executed shall be deemed an original but all such counterparts shall constitute one and the same instrument. [signature pages follow] IN WITNESS WHEREOF, the parties have executed this Amendment as of the date and year first above written. LASERMASTER CORPORATION By:__________________________ Title:_______________________ Revolving Credit Loan GENERAL ELECTRIC CAPITAL CORPORATION Commitment: $10,000,000 as Agent By:__________________________ Title:_______________________ EX-10.2 3 AMENDMENT NO. 4 TO CREDIT AGREEMENT Exhibit 10.2 AMENDMENT NO. 4 TO CREDIT AGREEMENT This AMENDMENT NO. 4 TO CREDIT AGREEMENT (this "Amendment") is entered into as of this 14th day of October, 1997 by and between COLORSPAN CORPORATION (f/k/a LaserMaster Corporation), a Minnesota corporation ("Borrower"), and GENERAL ELECTRIC CAPITAL CORPORATION, a New York corporation, as Agent and Lender ("Agent"). Unless otherwise specified herein, capitalized terms used in this Amendment shall have the meanings ascribed to them by the Credit Agreement (as hereinafter defined). RECITALS WHEREAS, Borrower and Agent have entered into that certain Credit Agreement dated as of January 17, 1996, as amended by that certain First Amendment to Credit Agreement dated as of May 15, 1996, that Second Amendment to Credit Agreement dated as of January 3 1, 1997, that Third Amendment to Credit Agreement dated as of May 14, 1997 (as further amended, supplemented, restated or otherwise modified from time to time, the "Credit Agreement"); and WHEREAS, Borrower and Agent wish to enter into certain amendments to the Credit Agreement, all as more fully set forth herein; NOW THEREFORE, in consideration of the mutual covenants herein and other good and valuable consideration, the parties hereto agree as follows: SECTION 1. Amendments to the Credit Agreement and Schedules. Schedule H to the Credit Agreement is amended as follows: (i) Clause (c) is amended and restated to read in its entirety as follows: c) Minimum Net Worth. Borrower and its Subsidiaries (other than LaserMaster Europe) on a consolidated basis shall maintain Net Worth equal to or greater than the following respective amounts measured as of the last day of the following respective quarters: Fiscal Quarter Ending Minimum Net Worth June 30, 1997 ($5,441,000) September 30, 1997 ($7,767,000) December 31, 1997 ($7,636,000) March 31, 1998 ($7,660,000) June 30, 1998 ($7,083,000) (ii) Clause (d) is amended and restated to read in its entirety as follows: (d) Minimum Debt Service Coverage Ratio. Borrower and its Subsidiaries (other than LaserMaster Europe) on a consolidated basis shall have at the end of each Fiscal Month, a Debt Service Coverage Ratio for the 12-month period then ended (or for the Fiscal Months ending on or before June 30, 1997, for the period of July 1, 1996 to such date) of not less than .23 to 1.0 with respect to the Fiscal Months ending March 31, 1997, April 3 0, 1997 and May 31, 1997, and not less than the following ratios for the following respective periods: Period Ratio ------ ----- Twelve months ended June 30, 1997 (4.74) Three months ended September 30, 1997 (2.20) Six months ended December 31, 1997 .12 Nine months ended March 31, 1998 .68 Twelve months ended June 30, 1998 and as of the last day of each Fiscal Month thereafter 1.43 SECTION 2. Representations and Warranties. 2.1 Borrower. Borrower represents and warranties that: (a) the execution, delivery and performance by Borrower of this Amendment have been duly authorized by all necessary corporate action and this Amendment is a legal, valid and binding obligation of Borrower enforceable against Borrower in accordance with its terms, except as the enforcement thereof may be subject to (i) the effect of any applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting creditors' rights generally and (ii) general principles of equity (regardless of whether such enforcement is sought in a proceeding in equity or at law); (b) each of the representations and warranties contained in the Credit Agreement is true and correct in all material respects on and as of the date hereof as if made on the date hereof, except to the extent that such representations and warranties expressly relate to an earlier date; (c) neither the execution, delivery and performance of this Amendment nor the consummation of the transactions contemplated hereby does or shall contravene, result in a breach of, or violate (i) any provision of Boffower's certificate or articles of incorporation or bylaws, (ii) any law or regulation, or any order or decree of any court or government instrumentality or (iii) indenture, mortgage, deed of trust, lease, agreement or other instrument to which Borrower or any of its Subsidiaries is a party or by which Borrower or any of its Subsidiaries or any of their property is bound, except in any such case to the extent such conflict or breach has been waived by a written waiver document a copy of which has been delivered to Agent on or before the date hereof, and (d) no Default or Event of Default will exist or result after giving effect hereto. SECTION 3. Conditions to Effectiveness. This Amendment will be effective upon satisfaction of the following conditions: (a) Execution and delivery of four counter-parts of this Amendment by each of the parties hereto. (b) Payment to the Agent of an Amendment Fee in the amount of $50,000, which amount Agent is authorized to charge to the outstanding balance of the Revolving Loan upon execution and delivery of this Amendment by Borrower. SECTION 4. Reference to and Effect Upon the Credit Agreement. (a) Except as specifically amended above, the Credit Agreement and the other Loan Documents shall remain in full force and effect and are hereby ratified and confirmed. (b) The execution, delivery and effectiveness of this Amendment shall not operate as a waiver or any right, power or remedy of Agent or any Lender under the Credit Agreement or any Loan Document, nor constitute a waiver of any provision of the Credit Agreement or any Loan Document, except as specifically set forth herein. Upon the effectiveness of this Amendment, each reference in the Credit Agreement to "this Agreement", "hereunder", "hereof', "herein" or words of similar import shall mean and refer to the Credit Agreement as amended hereby. SECTION 5. Waiver. In consideration of the foregoing, Borrower hereby waives, and covenants not to sue Agent with respect to, any and all claims it may have against Agent, whether known or unknown, arising in tort, by contract or otherwise prior to the date hereof. SECTION 6. Costs and Expenses. As provided in Section 11.3 of the Credit Agreement, Borrower agrees to reimburse Agent for all fees, costs and expenses, including the fees, costs and expenses of counsel or other advisors for advice, assistance, or other representation in connection with this Amendment. SECTION 7. GOVERNING LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AS OPPOSED TO CONFLICTS OF LAWS PROVISIONS) OF THE STATE OF ILLINOIS. SECTION 8. Headings. Section headings in this Amendment are included herein for convenience of reference only and shall not constitute a part of this amendment for any other purposes. SECTION 9. Counterparts. This Amendment may be executed in any number of counterparts, each of which when so executed shall be deemed an original but all such counterparts shall constitute one and the same instrument. [signature pages follow] IN WITNESS WHEREOF, the parties have executed this Amendment as of the date and year first above written. COLORSPAN CORPORATION By:____________________________ Title:_________________________ Revolving Credit Loan GENERAL ELECTRIC CAPITAL Commitment: $10,000,000 CORPORATION, as Agent By:____________________________ Title:_________________________ EX-10.3 4 FIFTH AMENDMENT TO CREDIT AGREEMENT Exhibit 10.3 FIFTH AMENDMENT TO CREDIT AGREEMENT This FIFTH AMENDMENT TO CREDIT AGREEMENT (this "Amendment") is entered into as of this 17th day of February, 1998 by and between COLORSPAN CORPORATION (f/k/a LaserMaster Corporation), a Minnesota corporation ("Borrower"), and GENERAL ELECTRIC CAPITAL CORPOPATION, a New York corporation, as Agent and Lender ("Agent"). Unless otherwise specified herein, capitalized terms used in this Amendment shall have the meanings ascribed to them by the Credit Agreement (as hereinafter defined). RECITALS WHEREAS, Borrower and Agent have entered into that certain Credit Agreement dated as of January 17, 1996, as amended by that certain First Amendment to Credit Agreement dated as of May 15, 1996, that Second Amendment to Credit Agreement dated as of January 31, 1997, that Third Amendment to Credit Agreement dated as of May 14, 1997 that Fourth Amendment to Credit Agreement dated as of October 14, 1997(as further amended, supplemented, restated or otherwise modified from time to time, the "Credit Agreement"); and WHEREAS, Borrower and Agent wish to enter into certain amendments to the Credit Agreement, all as more fully set forth herein; NOW THEREFORE, in consideration of the mutual covenants herein and other good and valuable consideration, the parties hereto agree as follows: SECTION 1. Amendments to the Credit Agreement and Schedules. Schedule A to the Credit Agreement is amended as follows: The definition of Borrowing Base is amended to read in its entirety as follows: "Borrowing Base" shall mean, as of any date of determination by Agent, in its reasonable discretion from time to time, an amount equal to the sum at such time of: (a) sixty-five percent (65%) of Eligible Accounts, less reserves (provided that in no event shall the amount calculated in this clause (a) with respect to Asia/Pacific exceed $1,000,000 at any time) and (b) twenty-five percent (25%) of the book value of Eligible Inventory valued on a first-in, first-out basis (at the lower of cost or market), in each case, less reserves. Section 2. Representations and Warranties. 2.1 Borrower represents and warranties that: (a) the execution, delivery and performance by Borrower of this Amendment have been duly authorized by all necessary corporate action and this Amendment is a legal, valid and binding obligation of Borrower enforceable against Borrower in accordance with its terms, except as the enforcement thereof may be subject to (i) the effect of any applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting creditors' rights generally and (ii) general principles of equity (regardless of whether such enforcement is sought in a proceeding in equity or at law); (b) each of the representations and warranties contained in the Credit Agreement is true and correct in all material respects on and as of the date hereof as if made on the date hereof, except to the extent that such representations and warranties expressly relate to an earlier date; (c) neither the execution, delivery and performance of this Amendment nor the consummation of the transactions contemplated hereby does or shall contravene, result in a breach of, or violate (i) any provision of Borrower's certificate or articles of incorporation or bylaws, (ii) any law or regulation, or any order or decree of any court or government instrumentality or (iii) indenture, mortgage. deed of trust, lease, agreement or other instrument to which Borrower or any of its Subsidiaries is a party or by which Borrower or any of its Subsidiaries or any of their property is bound, except in any such case to the extent such conflict or breach has been waived by a written waiver document a copy of which has been delivered to Agent on or before the date hereof, and (d) no Default or Event of Default will exist or result after giving effect hereto. SECTION 3. Conditions to Effectiveness. This Amendment will be effective upon satisfaction of the following conditions: (a) Execution and delivery of four counter-parts of this Amendment by each of the parties hereto. SECTION 4. Reference to and Effect Upon the Credit Agreement. (a) Except as specifically amended above, the Credit Agreement and the other Loan Documents shall remain in full force and effect and are hereby ratified and confirmed. (b) The execution, delivery and effectiveness of this Amendment shall not operate as a waiver or any right, power or remedy of Agent or any Lender under the Credit Agreement or any Loan Document, nor constitute a waiver of any provision of the Credit Agreement or any Loan Document, except as specifically set forth herein. Upon the effectiveness of this Amendment, each reference in the Credit Agreement to "this Agreement", "hereunder", "hereof', "herein" or words of similar import shall mean and refer to the Credit Agreement as amended hereby. SECTION 5. Waiver. In consideration of the foregoing, Borrower hereby waives, and covenants not to sue Agent with respect to, any and all claims it may have against Agent, whether known or unknown, arising in tort, by contract or otherwise prior to the date hereof. SECTION 6. Costs and Expenses. As provided in Section 11.3 of the Credit Agreement, Borrower agrees to reimburse Agent for all fees, costs and expenses, including the fees, costs and expenses of counsel or other advisors for advice, assistance, or other representation in connection with this Amendment. SECTION 7. GOVERNING LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AS OPPOSED TO CONFLICTS OF LAWS PROVISIONS) OF THE STATE OF ILLINOIS. SECTION 8. Headings. Section headings in this Amendment are included herein for convenience of reference only and shall not constitute a part of this amendment for any other purposes. SECTION 9. Counterparts. This Amendment may be executed in any number of counterparts, each of which when so executed shall be deemed an original but all such counterparts shall constitute one and the same instrument. [signature pages follow] IN WITNESS WHEREOF, the parties have executed this Amendment as of the date and year first above written. COLORSPAN CORPORATION By:________________________________ Title:_____________________________ Revolving Credit Loan GENERAL ELECTRIC CAPITAL Commitment: $10,000,000 CORPORATION, as Agent By:________________________________ Title:_____________________________ EX-10.4 5 SIXTH AMENDMENT & CONSENT TO CREDIT AGREEEMENT Exhibit 10.4 SIXTH AMENDMENT AND CONSENT TO CREDIT AGREEMENT This SIXTH AMENDMENT AND CONSENT TO CREDIT AGREEMENT (this "Amendment") is entered into as of this 30th of June, 1998 by and between COLORSPAN CORPORATION (f/k/a LaserMaster Corporation), a Minnesota corporation ("Borrower"), and GENERAL ELECTRIC CAPITAL CORPORATION, a New York corporation, as Agent and Lender ("Agent"). Unless otherwise specified herein, capitalized terms used in this Amendment shall have the meanings ascribed to them by the Credit Agreement (as hereinafter defined). RECITALS WHEREAS, Borrower and Agent have entered into that certain Credit Agreement dated as of January 17, 1996, as amended by that certain First Amendment to Credit Agreement dated as of May 15, 1996, that Second Amendment to Credit Agreement dated as of January 3 1, 1997, that Third Amendment to Credit Agreement dated as of May 14, 1997 that Fourth Amendment to Credit Agreement dated as of October 14, 1997 and that Fifth Amendment to Credit Agreement dated as of February 17, 1998 (as further amended, supplemented, restated or otherwise modified from time to time, the "Credit Agreement"); and WHEREAS, Borrower and Agent wish to enter into certain amendments to the Credit Agreement, all as more fully set forth herein; NOW THEREFORE, in consideration of the mutual covenants herein and other good and valuable consideration, the parties hereto agree as follows: SECTION 1. Name Change; Location Change. Agent and Lenders consent to the change of name of ColorMasters, Inc. to ColorSpan Latin America, Inc. ("CSLA") and to the establishment of an office for CSLA at 3785 Northwest 82nd Avenue, Suite 300, Miami, Florida 33166. Borrower represents to Agent and Lenders that the FEIN for CSLA is 41-17615-II. SECTION 2. Transfer of Assets. Agent and Lenders hereby consent to the transfer from Borrower to CSLA of accounts, inventory, general intangibles and books and records relating to business conducted by Borrower in Latin America. SECTION 3. Amendments to Credit Agreement. (a) Definitions. Schedule A to the Credit Agreement is amended as follows: (i) to delete the definition of ColorMasters and insert the following definition in its place: "CSLA" shall mean ColorSpan Latin America, Inc., a Minnesota corporation. (ii) to delete the definition of "Asia/Pacific" and insert the following definition in its place: "Asia/Pacific" shall mean ColorSpan Asia/Pacific, Inc., a Minnesota corporation (iii) clause (a) of the definition of Borrowing Base is amended to read in its entirety as follows: (a) sixty percent (65%) of Eligible Accounts, less reserves, provided that in no event shall the amount calculated in this clause (a) with respect to Asia/Pacific exceed $1,000,000 at any time or the amount calculated in this clause (a) with respect to CSLA exceed $250,000 at any time. (b) General Amendment. All references in the Credit Agreement and other Loan Documents to ColorMasters shall be changed to refer to CSLA. (c) New Negative Covenant. The following additional negative covenant is added to the Credit Agreement: 6.24 CSLA. Borrower shall not cause or permit CSLA to incur obligations or indebtedness other than (a) obligations owing to Borrower, (b) obligations arising solely by operation of law, (c) Indebtedness permitted under Sections 6.3(i) and 6.7(iii), and (d) obligations under any lease of real estate which do not exceed $300,000 per year. (d) Amend Section 6.3(i). Clause (i) of Section 6.3 is amended to read as follows: (i) Indebtedness of Borrower, Asia/Pacific and CSLA permitted under Section 6.7. (e) Amendment to Section 6.7(iii). The parenthetical carve-out in clause (iii) of Section 6.7 is amended to read as follows: "(provided that the aggregate amount incurred by Asia/Pacific shall not exceed $300,000 at any time and the aggregate amount incurred by CSLA shall not exceed $300,000 at any time.)" SECTION 4. Representations and Warranties. Borrower represents and warranties that: (a) the execution, delivery and performance by Borrower of this Amendment have been duly authorized by all necessary corporate action and this Amendment is a legal, valid and binding obligation of Borrower enforceable against Borrower in accordance with its terms, except as the enforcement thereof may be subject to (i) the effect of any applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting creditors' rights generally and (ii) general principles of equity (regardless of whether such enforcement is sought in a proceeding in equity or at law); (b) each of the representations and warranties contained in the Credit Agreement is true and correct in all material respects on and as of the date hereof as if made on the date hereof, except to the extent that such representations and warranties expressly relate to an earlier date; (c) neither the execution, delivery and performance of this Amendment nor the consummation of the transactions contemplated hereby does or shall contravene, result in a breach of, or violate (i) any provision of Borrower's certificate or articles of incorporation or bylaws, (ii) any law or regulation, or any order or decree of any court or government instrumentality or (iii) indenture, mortgage, deed of trust, lease, agreement or other instrument to which Borrower or any of its Subsidiaries is a party or by which Borrower or any of its Subsidiaries or any of their property is bound, except in any such case to the extent such conflict or breach has been waived by a written waiver document a copy of which has been delivered to Agent on or before the date hereof, and (d) no Default or Event of Default will exist or result after giving effect hereto. SECTION 5. Conditions to Effectiveness. This Amendment will be effective upon satisfaction of the following conditions: (a) Execution and delivery of four counter-parts of this Amendment by each of the parties hereto. (b) Delivery to Agent from CSLA of a UCC-3 amendment for filing in Minnesota and a UCC- I for filing in Florida. SECTION 6. Reference to and Effect Upon the Credit Agreement. (a) Except as specifically amended above, the Credit Agreement and the other Loan Documents shall remain in full force and effect and are hereby ratified and confirmed. (b) The execution, delivery and effectiveness of this Amendment shall not operate as a waiver or any right, power or remedy of Agent or any Lender under the Credit Agreement or any Loan Document, nor constitute a waiver of any provision of the Credit Agreement or any Loan Document, except as specifically set forth herein. Upon the effectiveness of this Amendment, each reference in the Credit Agreement to "this Agreement", "hereunder", "hereof', "herein" or words of similar import shall mean and refer to the Credit Agreement as amended hereby. SECTION 7. Waiver. In consideration of the foregoing, Borrower hereby waives, and covenants not to sue Agent with respect to, any and all claims it may have against Agent, whether known or unknown, arising in tort, by contract or otherwise prior to the date hereof. SECTION 8. Costs and Expenses. As provided in Section 11.3 of the Credit Agreement, Borrower agrees to reimburse Agent for all fees, costs and expenses, including the fees, costs and expenses of counsel or other advisors for advice, assistance, or other representation in connection with this Amendment. SECTION 9. GOVERNING LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AS OPPOSED TO CONFLICTS OF LAWS PROVISIONS) OF THE STATE OF ILLINOIS. SECTION 10. Headings. Section headings in this Amendment are included herein for convenience of reference only and shall not constitute a part of this amendment for any other purposes. SECTION 11. Counterparts. This Amendment may be executed in any number of counterparts, each of which when so executed shall be deemed an original but all such counterparts shall constitute one and the same instrument. [signature pages follow] IN WITNESS WHEREOF, the parties have executed this Amendment as of the date and year first above written. COLORSPAN CORPORATION By:_______________________________ Title:____________________________ Revolving Credit Loan GENERAL ELECTRIC CAPITAL Commitment: $10,000,000 CORPORATION, as Agent By:_______________________________ Title:____________________________ EX-10.5 6 SEVENTH AMEND & CONSENT TO CREDIT AGREEMENT Exhibit 10.5 SEVENTH AMENDMENT AND CONSENT TO CREDIT AGREEMENT This SEVENTH AMENDMENT AND CONSENT TO CREDIT AGREEMENT (this "Amendment") is entered into as of this 15th of July, 1998 by and between COLORSPAN CORPORATION (f/k/a LaserMaster Corporation), a Minnesota corporation ("Borrower"), and GENERAL ELECTRIC CAPITAL CORPORATION, a New York corporation, as Agent and Lender ("Agent"). Unless otherwise specified herein, capitalized terms used in this Amendment shall have the meanings ascribed to them by the Credit Agreement (as hereinafter defined). RECITALS WHEREAS, Borrower and Agent have entered into that certain Credit Agreement dated as of January 17, 1996, as amended by that certain First Amendment to Credit Agreement dated as of May 15, 1996, that Second Amendment to Credit Agreement dated as of January 31, 1997, that Third Amendment to Credit Agreement dated as of May 14, 1997 that Fourth Amendment to Credit Agreement dated as of October 14, 1997, that Fifth Amendment to Credit Agreement dated as of February 17, 1998, and that Sixth Amendment and Consent to Credit Agreement dated as of June 30, 1998 (as further amended, supplemented, restated or otherwise modified from time to time, the "Credit Agreement"); and WHEREAS, Borrower and Agent wish to enter into certain amendments to the Credit Agreement, all as more fully set forth herein; NOW THEREFORE, in consideration of the mutual covenants herein and other good and valuable consideration, the parties hereto agree as follows: SECTION 1. ACQUISITION OF INTERCOMPANY DEBT Agent and Lenders consent to the partial repayment of intercompany loans owing by Borrower to VirtualFund.com, Inc. (fka LaserMaster Technologies, Inc.), a Minnesota corporation ("Holdings"), in an amount not to exceed Three Million Five Hundred Thousand Dollars ($3,500,000) for the purpose of contributing such funds to the capital of Virtual Acquisition Corp. II, a Minnesota corporation ("VAC IIA"), or loaning such funds to VAC IIA so that VAC IIA may loan to, or contribute such funds to the capital of, Kilborn Photo Products, Inc., an Iowa corporation ("Kilborn"), and Kilborn may use such funds to repay amounts owing to its former stockholders, concurrently with the purchase by VAC IIA of all of the outstanding stock of Kilborn, in exchange for stock of Holdings. SECTION 2. AMENDMENTS TO DEFINITIONS IN CREDIT AGREEMENT. (a) Definitions. Schedule A to the Credit Agreement is amended as follows: (i) to delete the definition of Holdings and insert the following definition in its place: "Holdings" shall mean VirtualFund.com, Inc., a Minnesota corporation. (ii) to insert the following definitions: "Kilborn" shall mean Kilborn Photo Products, Inc., an Iowa corporation. "VAC IIA" shall mean Virtual Acquisition Corp. IIA, a Minnesota corporation. SECTION 3. AMENDMENT TO ELIGIBLE ACCOUNTS TO INCLUDE CSLA ACCOUNTS. The preamble of Schedule B to the Credit Agreement is amended and restated to read in its entirety as follows: Eligible Accounts shall include all Accounts of Borrower, Asia/Pacific and CSLA, except any Account SECTION 4. AMENDMENT TO NEGATIVE COVENANTS: Clause (c) of Section 6.2 of the Credit Agreement is amended to read in its entirety as follows: (c) loans or Investments by Borrower in or to Asia/Pacific, CSLA and/or Kilborn in an aggregate amount not to exceed (A) $800,000 per fiscal year, plus (B) 50% of the Cumulative Net Income Investment Basket, if positive, from and after January 1, 1996, plus (C) 100% of the amount of any cash, proceeds of sales of common stock and/or capital contributions received by Borrower (net of any fees, costs and expenses incurred in connection with any such sale or contribution, including, without limitation, underwriters' discounts) from and after the Closing Date (but excluding any equity proceeds (x) invested in or otherwise used to benefit LaserMaster Europe or (y) used to repay the TimeMasters Debt pursuant to Section 5(d) of the TimeMasters Subordination Agreement); provided that in the case of loans to Kilborn, (i) no Default or Event of Default shall have occurred and be continuing at the time such loans are made, (ii) Borrower shall have Excess Availability of $2,000,000 or greater after giving effect to any such loans, (iii) the Average Payable Days are less than 60 days, and (iv) such Investments shall be made solely by means of intercompany loans evidenced by promissory notes that are pledged and delivered to Agent. SECTION 5. REPRESENTATIONS AND WARRANTIES. 4.1 Borrower represents and warranties that: (a) the execution, delivery and performance by Borrower of this Amendment have been duly authorized by all necessary corporate action and this Amendment is a legal, valid and binding obligation of Borrower enforceable against Borrower in accordance with its terms, except as the enforcement thereof may be subject to (i) the effect of any applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting creditors' rights generally and (ii) general principles of equity (regardless of whether such enforcement is sought in a proceeding in equity or at law); (b) each of the representations and warranties contained in the Credit Agreement is true and correct in all material respects on and as of the date hereof as if made on the date hereof, except to the extent that such representations and warranties expressly relate to an earlier date; (c) neither the execution, delivery and performance of this Amendment nor the consummation of the transactions contemplated hereby does or shall contravene, result in a breach of, or violate (i) any provision of Borrower's certificate or articles of incorporation or bylaws, (ii) any law or regulation, or any order or decree of any court or government instrumentality or (iii) indenture, mortgage, deed of trust, lease, agreement or other instrument to which Borrower or any of its Subsidiaries is a party or by which Borrower or any of its Subsidiaries or any of their property is bound, except in any such case to the extent such conflict or breach has been waived by a written waiver document a copy of which has been delivered to Agent on or before the date hereof; and (d) no Default or Event of Default will exist or result after giving effect hereto. SECTION 6. CONDITIONS TO EFFECTIVENESS. This Amendment will be effective upon satisfaction of the following conditions: (a) Execution and delivery of four counter-parts of this Amendment by each of the parties hereto. (b) Delivery to Agent of pledge agreements executed by (i) Holdings with respect to the stock of VAC IIA, and (ii) VAC IIA with respect to the stock of Kilborn, along with share certificates for all of the outstanding capital stock of VAC IIA and Kilborn and stock powers endorsed in blank. (c) Delivery to Agent of a Phase 1, and, if requested, Phase II, environmental audits regarding real estate operated by Kilborn. SECTION 7. REFERENCE TO AND EFFECT UPON THE CREDIT AGREEMENT. (a) Except as specifically amended above, the Credit Agreement and the other Loan Documents shall remain in full force and effect and are hereby ratified and confirmed. (b) The execution, delivery and effectiveness of this Amendment shall not operate as a waiver or any right, power or remedy of Agent or any Lender under the Credit Agreement or any Loan Document, nor constitute a waiver of any provision of the Credit Agreement or any Loan Document, except as specifically set forth herein. Upon the effectiveness of this Amendment, each reference in the Credit Agreement to "this Agreement" "hereunder","hereof', "herein" or words of similar import shall mean and refer to the Credit Agreement as amended hereby. SECTION 8. WAIVER. In consideration of the foregoing, Borrower hereby waives, and covenants not to sue Agent with respect to, any and all claims it may have against Agent, whether known or unknown, arising in tort, by contract or otherwise prior to the date hereof. SECTION 9. COSTS AND EXPENSES. As provided in Section 11.3 of the Credit Agreement, Borrower agrees to reimburse Agent for all fees, costs and expenses, including the fees, costs and expenses of counsel or other advisors for advice, assistance, or other representation in connection with this Amendment. SECTION 10. GOVERNING LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AS OPPOSED TO CONFLICTS OF LAWS PROVISIONS) OF THE STATE OF ILLINOIS. SECTION 11. HEADINGS. Section headings in this Amendment are included herein for convenience of reference only and shall not constitute a part of this amendment for any other purposes. SECTION 12. COUNTERPARTS. This Amendment may be executed in any number of counterparts, each of which when so executed shall be deemed an original but all such counterparts shall constitute one and the same instrument. [signature pages follow] IN WITNESS WHEREOF, the parties have executed this Amendment as of the date and year first above written. COLORSPAN CORPORATION By:____________________________ Title:_________________________ Revolving Credit Loan GENERAL ELECTRIC CAPITAL Commitment: $10,000,000 CORPORATION, as Agent By:___________________________ Title:________________________ EX-10.6 7 MINUTES OF SHAREHOLDER MEETING Exhibit 10.6 LASERMASTER TECHNOLOGIES, INC. MINUTES OF SHAREHOLDER MEETING The undersigned, Chief Executive Officer of LaserMaster Technologies, Inc., a Minnesota corporation organized pursuant to the provisions of Minnesota Statute Chapter 302A, certifies that in a meeting of the shareholders of the corporation duly called and held on April 2, 1998, that the majority powers of the authorized and outstanding shares of common stock par value .01 per share, such shares being the class of the common stock of the corporation outstanding, duly adopted the following resolution: RESOLVED, that Article I of the Articles of the Incorporation is hereby amended to read as follows: ARTICLE I The name of the corporation shall be VirtualFund.com, Inc. FURTHER RESOLVED, that the Chief Executive Officer of the corporation or any other designated officer is authorized to file an Amendment of Articles of Incorporation to effect the amendment authorized herein and to undertake such other filings that may be necessary to change the name of the corporation. IN WITNESS WHEREOF, I have set my hand this 3/rd/ day of April, 1998. ________________________________________ Melvin Masters Chief Executive Officer EX-10.7 8 PROMISSORY NOTE, PLEDGE AGREEMENT & GUARANTY Exhibit 10.7 PROMISSORY NOTE $250,000.00 Eden Prairie, Minnesota June 26, 1998 FOR VALUE RECEIVED, the undersigned, Grandchildren's Realty Alternative Management Program I L.P., a Minnesota limited partnership ("Maker"), hereby agrees and promises to pay to the order of VirtualFund.com, Inc., a Minnesota corporation ("Holder"), at its address of 7090 Shady Oak Road, Eden Prairie, MN 55344, or at any other place designated by the Holder hereof, in lawful money of the United States, the principal sum of Two Hundred Fifty Thousand Dollars and No Cents ($250,000.00), with interest thereon at the rate of two percent (2%) above the Prime Rate (as herein defined). The term "Prime Rate" as used herein means an annual interest rate equal to the rate per annum publicly announced by Norwest Bank, N.A. or any successor thereto ("Norwest") as being its prime rate. The Prime Rate shall change automatically, without notice and simultaneously, with each change in the per annum rate announced by Norwest. The principal amount and interest accruing hereunder shall be due and payable on February 25, 1999. This Note may be prepaid without penalty, in whole or in part, at any time and from time to time prior to February 25, 1999. This Note is secured by a Guaranty of even date herewith made by Melvin L. Masters and by a Pledge Agreement of even date herewith between Maker and Holder. This Note shall be due and payable (together with unpaid interest) immediately, without demand or notice thereof, if a petition in bankruptcy is filed by or against the Maker under the United States Bankruptcy Code, as amended, and such petition is not withdrawn or dismissed within thirty (30) days. The Maker agrees to pay all costs of collection, including reasonable attorneys' fees and legal expenses, in the event this Note is not paid when due, whether or not legal proceedings are commenced. This Note is a Minnesota contract and Holder may seek to enforce it in any court sitting in the State of Minnesota, and Maker specifically consents to both the subject matter and personal jurisdiction of such courts. Service of process may be made by registered or certified mail in addition to the methods allowed by law. Maker waives its rights for presentment, demand for payment, notice of dishonor or protest. GRANDCHILDREN'S REALTY ALTERNATIVE MANAGEMENT PROGRAM I L.P. By:____________________________ Its:___________________________ Maker's Address: ________________________ ________________________ PLEDGE AGREEMENT THIS PLEDGE AGREEMENT is entered into and effective as of June ___, 1998, by Grandchildren's Realty Alternative Management Program I L.P., a Minnesota limited partnership (the "Pledgor") and an affiliate of Melvin L. Masters (the "Masters"), in favor of VirtualFund.com, Inc., a Minnesota corporation (the "Secured Party"). A. The Pledgor has issued a promissory note of even date herewith (the "Note") payable to the order of the Secured Party in the original principal amount of Two Hundred Fifty Thousand Dollars and No Cents ($250,000.00) in connection with a loan from the Secured Party to the Pledgor (the "Loan"). B. Masters, as the sole shareholder of the general partner of the Pledgor, will benefit indirectly from the Loan and, as such, has agreed to guaranty payment of the Note pursuant to the terms of a guaranty executed by Masters on the date hereof (the "Guaranty"). C. To secure the obligations of Masters under the Guaranty and the obligations of the Pledgor under the Note, the Secured Party requires that the Pledgor grant the Secured Party a security interest in Eighty Thousand Nine Hundred Ninety-Three (80,993) shares of common stock of the Secured Party owned by the Pledgor (the "Shares") in accordance with this Pledge Agreement, and the Pledgor agrees to grant the Secured Party such a security interest. For good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Pledgor hereby agrees as follows: 1. Terms of Pledge. --------------- (a) Pledge. The Pledgor does hereby pledge and grant to the Secured Party a security interest in all of the following described property (the "Collateral"): (1) The Shares; and (2) The proceeds of any dividend or other distribution attributable to the Shares (payable other than in cash) or any shares of stock or securities of the Company or of another corporation payable with respect to the Shares in connection with any change in the corporate structure or shares of the Company or pursuant to any merger or recapitalization or otherwise. (b) Delivery of Collateral. The Secured Party hereby acknowledges receipt of the certificate evidencing the Collateral together with a stock power therefor duly endorsed. The Pledgor agrees to deliver promptly to the Secured Party, in the exact form received, all securities and other property which come into the possession, custody or control of the Pledgor which would be included within the definition of Collateral in Section 1(a) above. (c) Actions Prior to an Event of Default. Until the occurrence of an Event of Default (as defined in Section 3(a) below) the Pledgor will have the sole right (a) to vote the securities constituting the Collateral and to give consents, waivers and ratifications in respect thereof, provided that no vote shall be cast, or consent, waiver or ratification given or action taken that would violate or not comply with any of the terms and provisions of this Pledge Agreement; and (b) to receive any and all cash dividends declared and paid on the securities constituting the Collateral that are not otherwise in violation of any of the terms and provisions of this Pledge Agreement. (d) Termination of Security Interest and Return of Collateral. Upon such date as the entire principal sum and all accrued interest on the Note shall have been paid in full, (i) all of the Collateral shall automatically, and without any further action of the parties hereto, be released from the security interest of the Secured Party created by this Pledge Agreement and (ii) the Secured Party shall deliver the certificate or certificates representing the Collateral to the Pledgor. 2. Representations, Warranties And Covenants of the Pledgor. -------------------------------------------------------- (a) Power and Authority to Pledge. The Pledgor has full power and authority to execute and deliver this Pledge Agreement and to perform the Pledgor's obligations hereunder. (b) Enforceability. This Pledge Agreement is the valid and binding obligation of the Pledgor, enforceable against the Pledgor according to its terms, subject to applicable bankruptcy, insolvency, moratorium and other laws affecting creditors' rights and remedies and the judicial limitations on the right to specific performance. Upon delivery of the Shares to the Secured Party, this Pledge Agreement shall create a valid first lien upon, and perfected security interest in, the Shares. (c) Title to Collateral. The Pledgor warrants and represents to the Secured Party that it holds title to the Collateral free and clear of any liens, encumbrances, security interests and restrictions on transfer and assignment thereof, except for the security interest created by this Pledge Agreement and as required by federal and state securities laws. (d) Preservation of Rights on Collateral. The Pledgor will take any action necessary to preserve redemption, conversion, warrant, preemptive or other rights (and be aware of the dates limiting the exercise of such rights) concerning the Collateral. (e) Maintenance of Security Interest. The Pledgor will do and enact all things deemed necessary or appropriate by the Secured Party from time to time to establish, determine priority of, perfect, continue perfection, terminate and enforce the Secured Party's interest in the Collateral and the Secured Party's rights under this Pledge Agreement. 2 3. Events of Default and Remedies. ------------------------------ (a) Events of Default. The occurrence of one or more of the following shall constitute an "Event of Default" hereunder: (1) The Pledgor defaults in the performance or observance of any of the terms or covenants in this Pledge Agreement unless cured within ten (10) days of notice of such occurrence from the Secured Party; (2) Any representation or warranty made by the Pledgor in this Pledge Agreement is untrue in any material respect unless cured within ten (10) days of notice of such occurrence from the Secured Party; (3) Any default under the Note; or (4) Any default or failure to perform under the Guaranty. (b) Secured Party's Right to Sell Collateral. Upon the occurrence of an Event of Default, the Collateral shall be forfeited by the Pledgor to the Secured Party unless the Secured Party, in its sole discretion, permits the Pledgor to continue to make payments under the Note and to retain his rights and interest in the Collateral. The Secured Party shall be entitled to sell the Collateral upon ten (10) business days' written notice to Pledgor, at a private sale. Thereafter the Collateral shall be held by the Secured Party for its own account and the Secured Party may cause the Collateral to be registered in its name and, to the extent permitted by law, may vote the Collateral (whether or not transferred or registered in the name of the Secured Party) and give all consents, waivers and ratifications in respect thereof, and may receive all dividends, interest and other distributions thereon. The Secured Party may limit sales to purchasers who are acquiring for investment and not with any view to distribution and may condition any sale or sales upon restriction against future transfers to the extent that the Secured Party as it may be advised by counsel as necessary to protect the Secured Party from any liability under the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, state securities laws, and any like or similar laws now or hereafter in effect. (c) Rights Cumulative. All rights and remedies of the Secured Party hereunder are in addition to rights and remedies afforded the Secured Party under the Note, any other document or under law. All remedies are cumulative and may be exercised by the Secured Party concurrently or consecutively. No failure or omission of the Secured Party to exercise any such right or remedy shall constitute a waiver thereof. 4. Termination. Upon payment in full of the obligations under the Note, this Pledge Agreement and the security interest granted herein shall terminate and be of no further force and effect, and the Secured Party shall thereupon promptly return to the Pledgor such of the Collateral and such other documents delivered by the Pledgor as may then be in the Secured Party's possession. 3 5. Application of Proceeds. The proceeds of any sale of the Collateral shall be applied as follows: (a) First, to the payment of the costs and expenses of such sale, and all expenses (including reasonable fees and expenses of counsel); (b) Second, to the payment of all amounts owing under the Note; and (c) Finally, to the payment to Pledgor, or to its successors and asigns, or as a court of competent jurisdiction may direct, of any surplus then remaining from such proceeds. 6. Miscellaneous. (a) Agreement Binding. This Pledge Agreement shall be binding upon and inure to the benefit of the successors and permitted assigns of the Pledgor and the Secured Party. This Pledge Agreement may not be assigned by either party without the prior written consent of the other party. (b) Severability. In the event that one or more provisions of this Pledge Agreement should be declared to be invalid, illegal or unenforceable in any respect by a court of competent jurisdiction, the validity, legality and enforceability of the remaining provisions herein shall not in any way be affected or impaired thereby. (c) Survival of Representations. All representations and warranties made herein are, and shall continue to be, true and correct in all material respects until the Note is paid in full. (d) Notices. All notices and other communications required or permitted to be given hereunder shall be given and become effective when deposited in the U.S. Mail postage prepaid, return receipt requested addressed to the parties at the addresses of the parties set forth in the stock records of the Company, or such other address as the parties may designate from time to time. (e) Governing Law. This Pledge Agreement shall be construed, interpreted and governed according to the laws of the State of Minnesota. (f) Nature of Obligations. The obligations of the Pledgor under this Pledge Agreement shall be absolute and unconditional and shall remain in full force and effect without regard to, and shall not be released, suspended, discharged, terminated, lessened or otherwise affected by, any circumstance or occurrence whatsoever, whether or not the Pledgor shall have notice or knowledge, including, without limitation, (a) any renewal, extension, substitution, amendment or modification of or addition or supplement to or deletion from the Note, the Guaranty, this Pledge Agreement or any permitted assignment or transfer of any thereof; (b) any waiver, consent, extension, indulgence or other action or inaction under or in respect of the Note, the Guaranty, this Pledge Agreement, or any exercise or nonexercise of any right, remedy, power or privilege under or in respect of the 4 Note or this Pledge Agreement; (c) any furnishing of any additional collateral or security to the Secured Party or its assignee or any acceptance thereof or any release of any collateral or security in whole or in part by the Secured Party or its assignee under this Pledge Agreement or otherwise; (d) any limitation on any party's liability or obligations under the Note, the Guaranty or under this Pledge Agreement or any invalidity or unenforceability, in whole or in part, or any such instrument or any term thereof; or (e) any bankruptcy, insolvency, reorganization, composition, adjustment, dissolution, liquidation or other like proceeding relating to the Pledgor, or any action taken with respect to this Pledge Agreement, the Guaranty or the Note by any trustee or receiver, or by any court, in any such proceeding. IN WITNESS WHEREOF, the parties have executed this Pledge Agreement as of the day and year first above written. GRANDCHILDREN'S REALTY ALTERNATIVE MANAGEMENT PROGRAM I L.P. By:____________________________ Its:___________________________ VIRTUALFUND.COM, INC. By:____________________________ Its:___________________________ 5 GUARANTY IN CONSIDERATION OF and in order to induce VIRTUALFUND.COM, INC., a Minnesota corporation (the "Company"), to extend credit to GRANDCHILDREN'S REALTY ALTERNATIVE MANAGEMENT PROGRAM I L.P., a Minnesota limited partnership (the "Borrower"), Melvin L. Masters (the "Guarantor") does hereby: 1. Unconditionally and absolutely guarantee to the Company the full and prompt payment, when due, of all indebtedness, obligation and liability of whatsoever nature of the Borrower to the Company, whether now existing or hereafter created and whether due or to become due, absolute or contingent, direct or indirect, or joint or joint and several, including, without limitation, indebtedness, obligation and liability created or arising under that certain promissory note of Borrower, dated of even date herewith, in the original principal amount of $250,000.00 payable to the order of the Company (such indebtedness, obligation and liability herein collectively referred to as the "Obligations"), and the prompt and full performance of all other duties of the Borrower to the Company, together with any and all costs and expenses of and incidental to the collection of the Obligations or the enforcement of this Guaranty, including, but not limited to, reasonable attorneys' fees. 2. Waive presentment, demand, notice of nonpayment, protest and notice of protest on the Obligations and notice of the creation of the Obligations by the Borrower. 3. Agree that the Company may from time to time, without notice to the Guarantor, extend, modify, renew, or compromise the Obligations and the liability of the Guarantor under this Guaranty, in whole or in part, without releasing, extinguishing or affecting in any manner whatsoever the liability of the Guarantor under this Guaranty. 4. Agree that this Guaranty shall be construed as a continuing, absolute and unconditional guarantee without regard to (i) the validity, regularity or enforceability of the Obligations or the disaffirmance thereof in any insolvency or bankruptcy proceeding relating to the Borrower, or (ii) any event or any conduct or action of the Borrower to the Company or any other party, which might otherwise constitute a legal or equitable discharge of a surety or guarantor but for this provision. 5. Agree that the Company is expressly authorized to forward any or all collateral and security which may at any time be placed with it by the Borrower or the Guarantor or any other person, directly to the Borrower for collection and remittance or for credit, or to collect the same in any other manner and to renew, extend, compromise, exchange, release, surrender, or modify the terms of, such collateral and security with or without consideration and without notice to the Guarantor and without in any manner affecting the absolute liability of the Guarantor hereunder; that the liability of the Guarantor hereunder shall not be affected or impaired by any failure, neglect, or omission on the part of the Company to realize upon the Obligations, or upon any collateral or security therefor, nor by the taking by the Company of any other guaranty or guaranties to secure the Obligations, nor by taking by the Company of collateral or security of any kind nor by any act or failure to act whatsoever which but for this provision might or could in law or in equity act to release or reduce the Guarantor's liabilities hereunder; and that no failure or delay on the part of the Company in exercising any right or remedy hereunder shall operate as or constitute a waiver of such right or remedy; nor shall any single or partial exercise of any right or remedy hereunder preclude any other or further exercise thereof or the exercise of any other right or remedy granted hereby or by law. 6. Agree that so long as any portion of the Obligations are due and owing or to become due and owing by the Borrower to the Company, the Guarantor shall not, without the prior written consent of the Company, collect or seek to collect from the Borrower any claim acquired by the Guarantor through payment of any part of the Obligations, whether by subrogation or otherwise. 7. Waive any rights of subrogation, indemnity, reimbursement and contribution which would otherwise arise or be acquired by the Guarantor by reason of payment by the Guarantor of any part of the Obligations. 8. Agree that the liability of the Guarantor hereunder shall be reinstated to the extent the Company is required at any time to disgorge or repay any amounts then previously received in payment of the Obligations, for any reason, including, without limitation, amounts recovered pursuant to preference claims in connection with bankruptcy proceedings of the Borrower. 9. Agree that this Guaranty shall inure to the benefit of the Company and its successors, assigns, and legal representatives and that the Guarantor shall have no right to assign or otherwise transfer his rights and obligations under this Guaranty to any third party without the prior written consent of the Company; and that any such assignment or transfer shall not release or affect the liability of the Guarantor hereunder in any manner whatsoever. 10. Agree that the Guarantor may be joined in any action or proceeding commenced against the Borrower in connection with or based upon the Obligations and recovery may be had against the Guarantor in any such action or proceeding or in any independent action or proceeding against the Guarantor under this Guaranty should the Borrower fail to duly and punctually pay any of the principal of or interest on the Obligations, without any requirement that the Company first resort for payment or performance to, or assert, prosecute, or exhaust any remedy or claim against, the Borrower or any other person or entity. 11. Agree that this Guaranty shall be deemed a contract made under and pursuant to the laws of the state of Minnesota and shall be governed by and construed under the laws of such state and that, wherever possible, each provision of this Guaranty shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Guaranty or any part thereof shall be prohibited by or invalid under applicable law, such 2 provision shall be ineffective without invalidating the remainder of such provision or the remaining provisions of the Guaranty. 12. Agree that all notices pursuant to this Guaranty shall be given by facsimile or by notice in writing, hand-delivered or sent by first-class mail, postage prepaid, to the parties hereto at the following addresses: The Company: VirtualFund.com, Inc. 7090 Shady Oak Road Eden Prairie, MN 55344 Attention: General Counsel The Guarantor: Melvin L. Masters 3213 South Duluth Avenue Sioux Falls, SD 57105 or to such other number or address as such party shall designate in a written notice to the other party. All such notices shall be effective upon delivery to the designated address. 13. Represent, acknowledge and agree that: (a) The Company's willingness, upon receipt of this Guaranty, to extend credit to the Borrower would also inure to the benefit of the Guarantor and constitutes good and valuable consideration to the Guarantor; and (b) The Company may from time to time determine at its sole discretion that the financial condition of the Borrower and/or the Guarantor is not adequate to support additional extensions of credit to the Borrower and that the Company may request additional assurances of payment and of the Borrower's ability to pay the Obligations to the Company, and if such assurances are not forthcoming, may refuse to extend additional credit to the Borrower without in any way affecting the liability of the Guarantor hereunder. Dated as of the ____ day of June, 1998. ________________________ Melvin L. Masters STATE OF______________________) ) ss. COUNTY OF_____________________) This instrument was acknowledged before me this _______ day of June, 1998, by Melvin L. Masters. ________________________ Notary Public 3 EX-27 9 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM INTERNAL FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 3-MOS 12-MOS JUN-30-1998 JUN-30-1998 MAR-30-1998 JUL-01-1997 JUN-30-1998 JUN-30-1998 0 5,011,181 0 0 0 11,648,638 0 1,662,000 0 6,819,968 0 26,612,045 0 2,776,339 0 16,311,947 0 33,119,670 0 17,285,620 0 0 0 0 0 0 0 151,789 0 15,615,515 0 33,119,670 22,506,090 80,731,534 22,506,090 80,731,534 12,935,937 48,050,731 12,935,937 48,050,731 0 0 0 0 64,655 715,048 1,553,869 1,726,759 0 0 1,553,869 1,726,759 0 0 0 0 0 0 1,553,869 1,726,759 .10 .12 .10 .11
EX-99 10 CAUTIONARY FACTORS Exhibit 99 EXHIBIT 99 CAUTIONARY FACTORS UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 VirtualFund.com, Inc. desires to take advantage of the "safe harbor" provisions contained in the Private Securities Litigation Reform Act of 1995 (the "Act"). Contained in this Form 10-K are statements which are intended as "forward- looking statements" within the meaning of the Act. The words or phrases "expects", "will continue", "is anticipated", "management believes", "estimate", "projects", "hope" or expressions of a similar nature denote forward-looking statements. Those statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or from those results presently anticipated or projected. The Company wishes to caution readers not to place undue reliance on forward-looking statements. Readers should also be advised that the factors listed below have affected the Company's performance in the past and could affect future performance. Those factors include, but are not limited to, the risk that a product may not ship when expected or may contain technical difficulties; uncertain demand for new or existing products; the impact of competitor's advertising, products or pricing; availability or reliability of component parts, including sole source parts; manufacturing limitations; availability of sources of financing; economic developments, both domestically and internationally; new accounting standards; and, the impact of the initiation, defense and resolution of litigation. Other factors include the following: Cash Needs. The Company has a credit agreement with a commercial finance company that has adequately financed its cash requirements in the past. Previously, net operating losses in fiscal 1996 of $10,461,534 and fiscal 1997 of $17,199,688 resulted in a need for additional financing. In September 1996, projected cash requirements in excess of available sources required the issuance of private placements of common stock and warrants to purchase common stock in the Company. There can be no assurances that cash availability under the credit agreement will be adequate to meet future needs, or that other sources of financing would be available to the Company on favorable terms, or at all, if the Company's operations are further affected by declining revenue from a lack of sales or significant returns of existing products, introduction difficulties with new product lines, competitive product introductions, or by market conditions in general. In addition, there can be no assurance that the Company can achieve or maintain profitability on a quarterly or annual basis in the future. Potential Acceleration of Senior Debt. The Company's Senior Debt Agreement includes financial covenants, which the Company must meet. Currently, the Company is in compliance with all of the financial covenants required by its Senior Lender. For further information, refer to Form 10-K, Item 14(a)1. Financial Statements, Note #5 of the Notes to Consolidated Financial Statements. The financial performance of the Company in the past has made it necessary for the Company to renegotiate the financial covenants to avoid being declared in violation of the covenants by General Electric Capital Corporation. If future financial performance were to cause covenant violations and the Company is unable to renegotiate its loan covenants at that time, it could be forced to seek replacement financing at prices which may not be favorable to the Company. If adequate sources of financing are not available, the Company may be required to sell certain product lines or technologies on less than favorable terms. As of June 30, 1998, no amounts were owed to the Company's Senior Debt Lender. However, the Company anticipates additional borrowings under the agreement in the future. 1 Technology and Industry Pressures/Reliance on New Technology. The pre- press and wide-format color printing industries are highly competitive and are characterized by frequent technological advances and new product introductions and enhancements. As product life cycles get shorter, the resulting consumable stream generated by the installed base may be negatively impacted. Accordingly, the Company believes that its future success depends upon its ability to enhance current products, to develop and introduce new and superior products on a timely basis and at acceptable pricing, to respond to evolving customer requirements, and to design and build products which achieve general market acceptance. New Product Design and Development. The process of developing new products involves adopting new and emerging technologies and components which may not have product histories or long term use testing to establish expected life cycles in the field or to assure long term field use. Product Quality Issues. Any quality, durability or reliability problems with existing or new products, regardless of materiality, or any other actual or perceived problems with the Company's products could have a material adverse effect on market acceptance of such new products. Any quality problems with components could result in "epidemic" or wide-spread failures of the products in the field causing return and refund requests that would likely have a material effect on the financial results of the Company and future sales potential. There can be no assurance that such problems or perceived problems will not arise with respect to any existing products. Product Acceptance/Market Anticipation. There is no assurance the Company's products will achieve market acceptance. In addition, the market anticipation or the announcement of new products and technologies, whether offered by the Company or its competitors, could cause customers to defer purchases of the Company's existing products, which could have a material adverse effect on the Company's business and financial condition. The Company is currently undertaking a number of development projects and has introduced a new family of printers, the DisplayMaker(R) 4000, 5000 and 6000 or HiRes 8-Color series, during September 1997. Two new versions of these printers have been introduced since February 1998. The DisplayMaker 7000 was introduced in August 1998. Sales of these and the related products comprise approximately 43% of the Company's total revenues for fiscal 1998. Additionally, in August 1998 the Company introduced the Giclee PrintMakerFA, an 8-Color HiRes drum-based printer. Although the Company has had successes introducing new products in the past, some earlier products have experienced limited market acceptance, the introductions of some products have been delayed, and the quality and reliability reputation of certain products may unfavorably affect new products. There can be no assurance that the Company will be successful with the new DisplayMaker series or future product introductions, that future market introductions will be timely and competitive, that future products will be priced appropriately, or that future products will achieve market acceptance. The Company's inability to achieve market acceptance, for technological or other reasons, could have a material adverse effect on the Company's financial condition. Product Malfunction. The Company is aware of intermittent customer issues with the performance and formulation of certain inks used in the Company's printers. The Company has taken steps to address the ink issues with its supplier. However, failure to address ink functionality issues, or some other failure of the product to perform as expected by the customer may result in customer requests for compensatory supplies or other requests which could have a material adverse effect on the Company's financial performance. Dependence on Suppliers. The Company is dependent on sole source suppliers for the heads for PressMate-FS(R) and DisplayMaker Express (DME). Over the time that the Company has worked with its 2 supplier for the PressMate printheads, there have been quality and consistency issues with the printheads supplied. The Company does not have a written agreement with this supplier and cannot purchase the supplies from another source. Currently, the Company does not sell significant numbers of the PressMate-FS printers which utilize the sole-sourced component. However, the Company has an installed base of printers who purchase consumables from the Company and could experience head failure or need a replacement. Overall, the percentage of the Company's revenues related to the product utilizing this head is less than 7% of fiscal 1998 revenue. The Company is also dependent upon a sole source supplier for the heads for the DME printer. Quality and consistency of the printheads delivered by this supplier have also been a problem. Although the Company currently sells very few new DME printers, there is an installed base of printers who purchase consumables from the Company and could experience printhead failure or require replacement. The Company has a written agreement with the sole source supplier of the DME heads. The written agreement includes the manufacturing specifications and directions which would allow a second supplier to produce the printheads should the current supplier be unable to cure any defaults under the manufacturing and supply agreement. The adverse effect upon the Company if the Company were unable to resolve an issue with the supplier, may be considered material if the effect were a significant increase in the returns of the DME printer based on the inability to supply replacement printheads. Overall, the percentage of the Company's revenues related to the product utilizing this head is less than 9% of fiscal 1998 revenue. The Company's aqueous inkjet printers are based on a printhead supplied pursuant to a written contract with Hewlett-Packard Company. The Company does not anticipate availability or quality issues which would affect the supply of printheads supplied by Hewlett-Packard Company (HP). The revenues of the Company associated with sales of this product or products including those components represent approximately 67% of the Company's fiscal 1998 revenue. If the Company is unable to resolve a potential future availability or quality issue, the Company's production, support of its installed base, and quality requirements will be materially adversely affected. Competitive Pricing/Product Introductions. Various potential actions by any of the Company's competitors, especially those with a substantial market presence, could have a material adverse effect on the Company's business, financial condition and results of operations. Such actions may include reduction of product price, increased promotion, announcement or accelerated introduction of new or enhanced products, product giveaways, product bundling or other competitive actions. Additionally, a competitor's entry into the wide- format market in such ways as to compete more directly and effectively with the Company's products could adversely affect operational results. Uncertainty Regarding Development of Wide-Format Market; Uncertainty Regarding Market Acceptance of New Products. The Wide-Format market is relatively new and evolving. The Company's future financial performance will depend in large part on the continued growth of this market and the continuation of present Wide-Format printing trends such as use and customization of large- format advertisements, use of color, transferring of color images onto a variety of substrates, point-of-purchase printing, in-house graphics design and production and the demand for limited printing runs of less than 200 copies. The failure of the Wide-Format market to achieve anticipated growth levels or a substantial change in Wide-Format printing customer preferences could have a material adverse effect on the Company's business, financial condition and results of operations. Additionally, in a new market, customer preferences can change rapidly and new technology can quickly render existing technology obsolete. Failure by the Company to respond effectively to changes in the Wide- Format market, to develop or acquire new technology or to successfully conform to industry standards could have a material adverse effect on the business and financial condition and results of operations of the Company. 3 Technological Advancements. The digital color inkjet printing market is rapidly moving to two distinct technologies for the placement of ink on a substrate: thermal inkjet cartridges and piezo-electric printheads. Any company without a secure, economical source of one or both of these products will face serious competitive pricing and margin pressures going forward. The Company currently has a license to remanufacture specific HP 300 dpi inkjet cartridges for use in its wide-format, roll-fed color inkjet printers. HP has introduced a new inkjet cartridge with a capability of producing output resolution of 600 dpi. The Company has secured the use of this product in non-roll fed devices and has introduced a product based on this cartridge. However, the market for non-roll fed devices is considered a low volume market niche by Company management. In addition, Lexmark has developed a 600 dpi inkjet cartridge. Both companies are competitors in the wide-format color market. At this time the Company does not have a source of 600 dpi printheads for use on roll fed printers. The Company is considering several component suppliers in its search for a dependable, manufacturable piezo-electric printhead. No one source has been identified for use in a future product as of this time. Should the market for wide-format color demand the increased resolution provided by these new products and the Company be unable to secure adequate supplies at reasonable prices or develop a reasonably priced substitute from other sources, the Company's sales of printer engines and the related gross margins could be negatively impacted. The Company's products target the market for high quality printing output. Hardware and software technological advances have enhanced actual and perceived resolution. There is no assurance that other companies will not achieve actual or apparent resolution with less expensive printers and supplies and therefore capture the market held by higher cost printers. Expansion and Diversification to Software and Services Outside of the Core Printer Business. The Company's continuing efforts to expand sales and increase profits and desire to reposition itself as a diversified technology company is stimulating a series of new product development activities. Currently the focus of these new business opportunities is primarily internet based software and service businesses. During this past year, the Company launched an electronic commerce (e-commerce) initiative for selling specialty media for wide-format printers under the brand name of Supplies.By.Air(TM). Internet based software and service activities represent an extension of many of the printing and publishing tools which are integral to the core technology of the Company. The Company is currently developing a commercialization of its internet software and has not generated any revenue from sales of this product. Expansion into technologies outside of the core hard-copy base printer business involves significant risk. Such risk includes, but is not limited to, the following factors: New products may not meet customer needs or may face significant competition from companies with lower overhead and product costs and/or greater marketing and promotional budgets. In addition, the Company may not be able to attract and retain key personnel and it may not be able to develop the products in the time needed to gain market acceptance. Due to the early stage development, the Company may not be able to predict product features needed to gain market acceptance, development may require more time and resources than anticipated for the development, or it may turn out that the product can not be feasibly developed. Diversification also carries the risk that the new activity will distract management time and resources from focusing on the core hard-copy based printer business. In addition, diversification may involve risks related to the resources required to participate in this new business including, but not limited to, risks related to raising cash or obtaining cash investments, doing business with one or more "partners" as a partnership or joint venture, and risks related to acquisitions or other combinations of businesses. 4 Intense Competition. The computer printer industry is intensely competitive and rapidly changing. Some of the Company's existing competitors, as well as a number of potential new competitors, have longer operating histories, greater technical resources, more established and larger sales and marketing organizations, greater name recognition, larger customer bases and significantly greater financial resources than the Company, which may result in a competitive advantage. Suppliers of wide-format print engines and systems compete on the basis of print quality, color, print time, print size, product features, including ease of use, service, and price. Competitive product sales practices such as price reductions, increased promotion, product giveaways and bundling, or announcement or accelerated introduction of new or enhanced products could have a material adverse effect on the sales and financial condition of the Company. New product introductions and changes in pricing structure by competitors have had, and can be expected to continue to have, a significant impact on the demand for the Company's products. Currently, Hewlett-Packard has announced and is supplying a new 54-inch wide-format inkjet printer. ENCAD has announced and is shipping a new version of its printer line with 600 dpi cartridges. These products are expected to compete for market share with the Company's current DisplayMaker 5000, 6000 and 7000 series of printers. It is possible that the Company's sales of certain products will compete with, or displace sales of, other products sold by the Company. The Company's DisplayMaker HiRes 8-Color series and DesignWinder product platforms products are based on relatively new technology, are complex and must be reliable and durable to achieve market acceptance and enhance revenue opportunities. Development and production of new, complex technologies and products often have associated difficulties and delays. Consequently, customers may experience unanticipated reliability and durability problems that arise only as the product is subjected to extended use over a prolonged period of time. There can be no assurance that the Company has completely resolved operational problems that have occurred in the past or that the Company will successfully resolve any future problems in the manufacture or operation of the Company's existing printers or any new product. Failure by the Company to resolve manufacturing or operational problems with its existing printers or any new product in a timely manner could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's HiRes 8-Color DisplayMaker series of printers and the DesignWinder product platforms utilize HP licensed inkjet technology. The Company also purchases licensed inkjet cartridges from HP who is a sole source of the cartridge component for the Company's aqueous ink consumable offerings. The Company also competes with HP in the wide-format digital color printing market. Both Companies design and market wide-format printing devices. Currently, the Company has been granted access to these and selected new technologies for use in its products and pays a royalty for those rights. Revenues associated with the sale of these products or products including those components represented approximately 67% of the Company's fiscal 1998 revenues. As new technologies are developed, there can be no assurance the Company will be able to negotiate additional licenses for newly developed technologies or that the new terms are equal to the terms currently in place. Certain companies that supply the Company with consumable products such as ink and media compete with the Company by selling directly to users or selling to competitors who may offer the products to the users. Additionally, OEM private label ink products that may be used in the Company's own products may compete with ColorSpan(R) products. Further, a number of competitors have introduced consumables which they allege to be compatible with the Company's products and have priced the consumables below the ColorSpan-branded consumables. Although the Company believes that its Big Color(R) products possess certain advantages over the competitors' products, the increased competition has impacted sales volumes and margins and may continue to impact volumes and margins in the future. The Company has generally competed in these markets by 5 introducing technologically advanced products that create new market demand and products which offer optimum performance characteristics. There can be no assurance that the Company will be able to continue to innovate to the extent necessary to maintain a competitive advantage in these markets or that other competitors will not achieve sufficient product performance to achieve customer satisfaction with their products offering better pricing or other competitive features. Industry Consolidation. As a growth industry, the wide-format digital printing market has generated many new entrants into the fragmented market with new products and new technologies. As the market matures, and the industry's growth rate slows, companies with technological or manufacturing efficiency advantages will emerge as the market leaders maintaining or increasing their market share. Those companies with less marketable advantages will face significant pressure on revenue growth and gross margins. In order to remain competitive, the smaller companies within this sector may have to seek merger or consolidation opportunities with other companies. If the Company were to merge with another company within the printer industry, short-term financial results and the market price of the Company's stock may be negatively impacted. Merger or consolidation of competitors may enhance the financial strength and competitive abilities of such competitor(s) which could adversely affect the Company's sales and financial performance. Dependence on Component Availability and Costs. Certain components used in the Company's current and planned products, including printer marking engines and other printer components, are currently available from sole sources, and certain other components are available from only a limited number of sources. Substantially all of the Company's revenue is subject to these risks. The Company has in the past experienced delays as a result of the failure of certain suppliers to meet requested delivery schedules and standards of product performance and quality. In addition, losses from operations of the Company have in the past restricted cash availability and the ability to keep supplier debt current or within the established credit limits. The potential requirement to bring certain component suppliers' debt obligations current, or other restrictions in credit terms of such component suppliers, could result in an inability to manufacture certain product lines and thereby adversely affect the financial performance of the Company. The Company's inability to obtain sufficient supply of components, or to develop alternative sources, could result in delays in product introductions, interruptions in product shipments, the need to redesign products to accommodate substitute components or the need to substitute alternative components which may not have the same performance capabilities, any of which could have a material adverse effect on the Company's operating results. A portion of the total manufacturing cost of the Company's typesetting and Big Color products is represented by certain components whose prices have fluctuated significantly in recent years. Significant increases or decreases in the price or reductions in the availability of certain components could have a material affect on the Company's operating results. The Company is dependent on a sole-source supplier for the printheads and hot melt ink used in DisplayMaker Express. The Company has experienced availability and quality issues with this supplier that have affected shipping schedules and customer satisfaction and have negatively impacted operating results in the past. While the Company has taken strong corrective measures in dealing with this supplier, there can be no assurance that this supplier will be able to meet the Company's production requirements in the future or that the quality of on-going product supply will be acceptable. The Company sells consumable print media and inks for use with its Big Color product line, and film used with the PressMate-FS. The Company depends on the availability of consumable products to support its installed base of print engines. There is no assurance that the suppliers of these consumables will continue 6 to offer their products to the Company, or that the consumable products will continue to be available to the Company at the same quantity, pricing and terms. The unavailability of consumable products or negative changes in quality could adversely impact the market acceptance of the Company's new and existing products, and may adversely affect sales of consumables. Fluctuations in Quarterly Operating Results. The Company's quarterly results of operations have fluctuated and are expected to continue to fluctuate significantly. These fluctuations have been caused by various factors, including, but not limited to: the timing of new product announcements; product introductions and price reductions by the Company and its competitors; the availability and cost of key components and materials for the Company's products; fluctuations and availability in customer financing; the relative percentages of sales of consumables and printer architectures; risks related to international sales and trade; and general economic conditions. In addition, the Company's operating results are influenced by the seasonal buying patterns of its customers, which have in the past generally resulted in reduced revenues and earnings during the Company's first fiscal quarter. Further, the Company's customers typically order products on an as-needed basis, and, as a result, virtually all of the Company's sales in any given quarter result from orders received in that quarter. The Company rarely operates with a backlog of orders from quarter to quarter. Certain products require significant capital expenditures, causing some customers to delay their purchasing decision. Delays in purchases of low-volume, high-cost printers may cause significant fluctuations in the sales volume for a given period. Also, the Company's manufacturing plans, sales staffing levels and marketing expenditures are primarily based on sales forecasts. Accordingly, deviations from these sales forecasts may cause significant fluctuations in operating results from quarter to quarter and may result in unanticipated quarterly earnings shortfalls or losses. Historically, a large percentage of orders have been received and shipped near the end of each month. If anticipated sales and shipments do not occur, expenditure and inventory levels may be disproportionately high and operating results could be adversely affected. Returns Reserves. The Company has established reserves for the return of merchandise. The amount of the returns reserve is based on historical data regarding returns of products. For new products there may be insufficient information to accurately predict return rate and therefore the required reserve may not be sufficient. Additionally, there is no assurance that there will not be an unknown or unanticipated problem with a product or any component thereof, or a defect or shortage of repair components or the consumable media or inks that are needed to use the product which could cause the actual returns to exceed the reserves. Returns of a product which exceed reserves could have an adverse effect on the financial operations and results of the Company. Dependence on Consumables Revenues. The Company anticipates it will derive an increasing component of its revenues and operating income from the sale of ink, paper, film and other consumables to its customers. During fiscal 1998, consumables revenue was 59% of total revenue. To the extent sales of the Company's consumables are reduced because its customers are unsuccessful in marketing their own printing services, product iterations by competitors and the Company make the Company's products obsolete or customers substitute third-party or private label consumables for those of the Company, the Company's results of operations could be adversely affected. Reduced life cycles of hardware products are expected to negatively impact consumable revenues. Further, although the Company's consumables are manufactured specifically to operate with its printing products to produce optimum results, there can be no assurances that other manufacturers of printing inks and papers will not develop products that can be sold and compete with the Company's printing products, or that other products will not produce results which are satisfactory to the customer at a lower cost. The Company alleges that at least one manufacturer has improperly used the Company's trade secrets to commence such competition. Although the Company is involved in legal action against such manufacturer for misappropriation of trade secrets, there can be no assurances that other 7 manufacturers will not independently and legitimately develop competing consumable products. In addition, product quality issues, limitations in the availability of sole source consumables or changes in credit or trade terms from sole sources could adversely affect the sales of consumables. Intellectual Property and Proprietary Rights. The Company's ability to compete effectively will depend, in part, on its ability to maintain the proprietary nature of its technologies through patents, copyrights and trade secrets. Important features of the Company's products are incorporated in proprietary software, some of which is licensed from others and some of which is owned by the Company. The Company attempts to protect its proprietary software with a combination of patents, copyrights, trademarks and trade secrets, employee and third-party nondisclosure agreements and other methods of protection. Despite these precautions, it may be possible for unauthorized third parties to copy certain portions of the Company's products or to reverse- engineer or obtain and use information that the Company regards as proprietary. Further, the Company's intellectual property may not be subject to the same level of protection in all countries where the products are sold. There can be no assurance that the measures taken by the Company will be adequate to protect the intellectual property or that others will not independently develop or patent products similar or superior to those developed, patented or planned by the Company, or that others will not be able to design products which circumvent any patents relied upon by the Company. The Company has been granted various United States patents for inventions related to resolution of conventional laser printer engines, high-resolution imaging and image enhancement and wide-format printing technologies and techniques, the Company's Big Ink(TM) Delivery System, product patents, and consumable formulations. Additional patent applications are pending. There can be no assurance that patents will be issued from any of these pending applications. With regard to current patents or patents that may be issued, there can be no assurance that the claims allowed will be sufficiently broad to protect the Company's technology or that issued patents will not be challenged, invalidated or violated, requiring expenditures of cash to pursue and enforce the Company's rights in the patented technology. Applications to patent the basic TurboRes(R), ThermalRes(R) and Big Ink Delivery System approaches and related technologies have been filed in selected foreign countries. Patent applications filed in foreign countries are subject to laws, rules and procedures which differ from those of the United States, and there can be no assurance that foreign patents will be granted as a result of these applications. Furthermore, even if these patent applications result in the issuance of foreign patents, some foreign countries provide significantly less patent protection than the United States. The Company relies on a variety of trademarks in the promotion and identification of its products. The Company has a variety of trademarks which are registered, and others that are not registered, or cannot be registered. There is no assurance that there will not be some challenge to the rights of the Company to use one or more trademarks, or an allegation that the use or display of one or more trademark violates the trademark rights of another party, which could subject the Company to damages and losses related to the inability to use recognized marks in the promotion of its products. Additionally, patent, copyright and trademark protection has not been sought, or may not be available in all foreign countries. Although the Company has not received any notices from third parties alleging intellectual or proprietary property infringement, there can be no assurance that third parties will not assert infringement claims against the Company in the future or that any such assertion will not require the Company to expend funds defending such claims or requiring the Company to enter into royalty arrangements on such terms as may be available, which may adversely affect financial performance of the Company. Any claim that the Company's current or future products or manufacturing processes infringes on the proprietary rights of others, with or without merit, could result in costly litigation which could adversely affect the financial performance of the Company. 8 The Company is actively pursuing development of new and unique print solutions and processes, media and inks. There are a significant number of patents which are already filed relating to printing cartridges, printing methods and processes, mechanical printer features, medias and inks. Many of these patents are held by companies which are larger and have greater resources to pursue violation of intellectual property. Although the research and development process involves an analysis of protected proprietary rights in any technology that is being pursued, there is no assurance that all applicable patents have been completely reviewed and analyzed, or that competitors or others will not interpret any such products or processes developed by the Company as violating protected intellectual rights and pursue legal action, which could be costly and may affect the financial performance of the Company. In addition, although the Company does not have any knowledge of violations of its intellectual property rights, there can be no assurance that the Company will not be forced to take action to protect its intellectual property portfolio. Such enforcement activity could require the expenditure of significant cash resources and could affect the financial performance of the Company. Although the Company has not received notices from third parties alleging infringement claims that the Company believes would have a material adverse effect on the Company's business, there can be no assurance that third parties will not claim that the Company's current or future products or manufacturing processes infringe the proprietary rights of others. Any such claim, with or without merit, could result in costly litigation or might require the Company to enter into a royalty or licensing agreement. Such royalty or licensing agreements, if required, may not be available on terms acceptable to the Company, or at all, which could have a material adverse effect upon the Company's business, financial condition and results of operations. If the Company does not obtain such licenses, it could encounter delays in product introductions while it attempts to design around such patents, or it could find that the development, manufacture or sale of products requiring such licenses could be enjoined. In addition, the Company could incur substantial costs in defending itself in suits brought against the Company on such patents or in bringing suits to protect the Company's patents against infringement, which could adversely affect the Company's financial condition or results. If the outcome of any such litigation is adverse to the Company, the Company's business and financial results could be adversely affected. Litigation and Litigation Costs. The Company has instituted action against a competitor for copyright violation and other causes of action. The competitor has counter-claimed for copyright misuse by the Company. Although the Company does not believe any of its practices violate applicable copyright laws, there is no assurance that claims or actions will not be commenced by customers, competitors or governmental authorities based on copyright, trade or anti-trust claims which could affect the Company's operations and cash position. The Company is also engaged in various actions related to transactional matters, employee matters, customers' credit and product quality and/or warranty issues. Some of these actions include claims against the Company for punitive, exemplary or multiple damages. An award of punitive damages may not bear a direct relationship to the actual or compensatory damages claimed from the Company. Although the Company does not believe there are any actions pending or threatened against the Company which would have a material adverse impact on the financial position of the Company, there is no assurance that there will not be an adverse award of multiple punitive or exemplary damages which could adversely affect the cash position of the Company. 9 Any litigation which the Company is involved in may have an adverse impact on the Company's operations and may result in a distraction or diversion of management's attention, thereby adversely affecting the operations of the Company. International Operations. The Company expects that international revenues will continue to represent a substantial portion of its total revenues. (In fiscal 1998, international operations composed 42% of total sales.) International operations are subject to various risks, including exposure to currency fluctuations, political and economic instability, differing economic conditions and trends, differing trade and business laws, unexpected changes in applicable laws, rules, regulatory requirements or tariffs, difficulty in staffing and managing foreign operations, longer customer payment cycles, greater difficulty in accounts receivable collection, potentially adverse tax consequences and varying degrees of intellectual property protection. Fluctuations in currency exchange rates could result in lower sales volume reported in U.S. Dollars. Fluctuations in foreign exchange rates are unpredictable and may be substantial. From time to time the Company has engaged in limited foreign currency hedging transactions. The Company's European subsidiary extends credit in the normal course of business in five relatively stable European currencies. In addition, the financing agreement in place allows the subsidiary to factor those receivables and receive Dutch guilders in which it pays its expenses. The impact of this is to effectively hedge the Company's exposure to foreign currency risk. Substantially all other transactions are in U.S. dollars. There can be no assurance that the Company will be successful if it engages in such practices to a significant degree in the future. Dependence on Key Personnel. The Company's success depends to a significant extent upon certain key personnel, including Mr. Masters, its Chief Executive Officer and President, Lawrence Lukis, Chief Engineer, and key research and development staff. The loss of key management or technical personnel could adversely affect the Company's business. The Company maintains key person life insurance in the amount of $2,000,000, payable to the Company, on each of Mr. Masters and Mr. Lukis. In addition, the Company has certain non-compete and continuation contracts with key personnel. The Company also depends on its ability to attract and retain highly skilled personnel. Competition for employees in technology related markets is high and there can be no assurance that the Company will be able to attract and retain the employees needed. In addition, past financial performance of the Company may limit the ability to hire and retain management professionals. The Year 2000 Issue. The Company is currently working to resolve the potential impact of the Year 2000 on the processing of time-sensitive information by its computerized information systems. Year 2000 issues may arise if computer programs have been written using two digits (rather than four) to define the applicable year. In such case, programs that have time-sensitive logic may recognize a date using "00" as the year 1900 rather than the year 2000, which could result in miscalculations or system failures. The Company utilizes a number of computer programs across its entire operation. Year 2000 issues could impact the Company's information systems as well as computer hardware and equipment that is part of its telephone network such as switches, termination devices and SONET rings that contain embedded software or "firmware." The Company's exposure to potential Year 2000 problems exists in two general areas: technological operations in the sole control of the Company, and technological operations dependent in some way on one or more third parties. The majority of the Company's exposure in potential Year 2000 problems is in the latter area where the situation is much less within the Company's ability to predict or control. The Company's business is heavily dependent on third parties, many of whom are themselves heavily dependent on technology. The Company cannot control the Year 2000 readiness of those parties. In some cases, the Company's third-party dependence is on vendors of technology who are themselves 10 working towards solutions to Year 2000 problems. The Company has initiated projects to identify and correct the potential problem in all of its enterprise systems. The costs incurred to date total less than $30,000 and have been expensed in the financial statements. The Company is using internal resources to test the software modifications. Funding for this area is expected to, and has come from, cash flow from operations. Management expects that additional costs for this issue will not be material. The Company's Products. The Company designs and sells products which are heavily reliant on software. While the Company has taken appropriate steps to ensure the readiness of this software and believes it to be Year 2000 compliant, the Company cannot be certain that the software will operate error free, or that the Company will not be subject to litigation, whether the software operates error free or not. However, the Company believes that based on its efforts to ensure compliance and the fact that the calculations needed in and by its products are not date dependent, it is not reasonably likely that the Company will be subject to such litigation. Contingency Plans. The Company has not yet completed its planning and preparations to handle the most reasonably likely worst case Year 2000 scenarios described above. The Company intends to develop contingency plans for these scenarios during fiscal 1999. The Company believes that this is the appropriate timeframe for developing such plans and that efforts prior to that time should be focused on renovation, testing and verification of its system modifications. Environmental. The Company is subject to local and federal laws and regulations regarding the use, storage and disposition of inks used with the Company's print products. Although the Company believes it is in compliance with all such laws and regulations, and the Company is not aware of any notice or complaint alleging any violation of such laws or regulations, there can be no assurance that there will not be some accidental contamination, disposal or injury from the use, storage, or disposition of inks or other materials used in the Company's operations. In the event of such accident, the Company could be held liable for any damages that result and any such liability could have a material adverse effect on the Company's financial condition. In addition, there can be no assurance that the Company will not be required to comply with environmental claims, laws, or regulations in the future which could result in significant costs which could materially adversely affect the Company's financial condition. Tax Liability. The Company sells its products from its offices in Eden Prairie, Minnesota and reports sales and income tax liability based on sales occurring at that location. It is possible that one or more state or local taxing authorities could determine that there have been taxable transactions occurring within their jurisdiction and seek recovery of taxes for current and/or past periods. In addition, it is possible that local, state or federal taxing authorities will take issue with the reporting or determination of tax liability and seek additional taxes for current and/or past periods. The Company currently has a net operating loss ("NOL") carryforward that may be used to offset future federal taxable income. However, there is no assurance that the NOL will continue to be available as an offset against future federal taxable income or that there will be sufficient taxable income to fully utilize the NOL. Volatility of Stock Price. The trading price of the Company's common stock is subject to wide fluctuations in response to variations in operating results, changes in the laws or regulations to which the Company may be subject, announcements of new products or technological innovations by the Company or its competitors, overall economic conditions and indicators, market conditions unrelated to Company performance, and general conditions in the industry. Factors such as quarterly variation in actual or anticipated operating results, changes in earnings estimates by analysts, and analysts' reactions to Company statements and actions also contribute to stock price fluctuations. In addition, the prices of securities of many high 11 technology companies have experienced significant volatility in recent years for reasons frequently unrelated to the operating performance of the specific companies. These fluctuations may materially affect the market price of the Company's common stock. One time in the past, following fluctuations in the market price of the Company's stock, a securities action was commenced alleging that the Company and certain insiders had knowledge of certain material, adverse information about the Company prior to the time that such information allegedly caused a drop in the market price of the stock. Because the Company's stock has historically fluctuated significantly, it is possible that following a significant change in the market price of the stock another securities action could be commenced against the Company. Such action, whether commenced by one or more individuals or by a class of securities holders, could result in substantial costs and diversion of management's attention and resources and thereby cause an adverse affect on the business and financial performance of the Company. Brand Awareness. The Company is currently in the process of changing its name to VirtualFund.com, Inc. and has changed the name of its principal operating subsidiary from LaserMaster Corporation to ColorSpan Corporation. The Company has significant brand awareness associated with its LaserMaster trade names. If the market is unable to accept or delays the acceptance of the name change, the Company's financial performance and sales may be negatively impacted. Control of the Company's Stock. As of August 31, 1998, officers and directors as a group beneficially owned 21.3% of the outstanding shares of the Company's stock. One of the Company's suppliers owns 14.7% of the Company's outstanding shares. Although the impact of the holdings of the officers and directors and the supplier is not believed to be material. Such control may have the effect of reducing liquidity of the stock which may affect shareholder value. The Company's Board has considered, but has not yet adopted, a shareholder rights plan. The Company's Board of Directors has authorized issuance of preferred shares of stock which may be utilized in undertaking a shareholder rights plan. Minnesota Statutes govern "control share acquisitions" and require potential acquirers of at least 20% of the Company's stock to provide notice and information to the Company about the proposed acquisition of stock and limits voting rights in acquired stock unless such voting rights are approved by an affirmative vote of shareholders and the control share acquisition is consummated within 180 days after shareholder approval. The effect of the statute is to limit the opportunity for a hostile takeover of control of the Company unless there is a majority of shareholders consenting to the acquirer's control. There is no assurance that the control share acquisition statute will not adversely affect shareholder value. Dilution. The Company has outstanding a large number of stock options and warrants to purchase the Company's Common Stock. To the extent such options or warrants are exercised, there will be further dilution. The Company expects to seek additional acquisitions in pursuing its strategies and intends to grant additional stock options and stock bonuses to the employees of the acquired companies. For these reasons, the Company's acquisition program will result in further substantial ownership dilution to investors. Risks Related to Acquisitions. A key component of the Company's growth strategy is the acquisition of Information Technology professional service firms that meet the Company's criteria for revenues, profitability, growth potential and operating strategy. The successful implementation of this strategy depends on the Company's ability to identify suitable acquisition candidates, acquire such companies on acceptable terms and integrate their operations successfully with those of the Company. There can be no assurance that the Company will be able to identify suitable acquisition candidates or that the Company will be able to acquire such candidates on acceptable terms. Moreover, in pursuing acquisition opportunities the Company 12 may compete with other companies with similar growth strategies, certain of which competitors may be larger and have greater financial and other resources than the Company. Competition for these acquisition targets likely could also result in increased prices of acquisition targets and a diminished pool of companies available for acquisition. Acquisitions also involve a number of other risks, including adverse effects on the Company's reported operating results from increases in goodwill amortization, acquired in-process technology, stock compensation expense and increased compensation expense resulting from newly hired employees, the diversion of management attention, potential disputes with the sellers of one or more acquired entities and the possible failure to retain key acquired personnel. Client satisfaction or performance problems with an acquired firm could also have a material adverse impact on the reputation of the Company as a whole, and any acquired subsidiary could significantly underperform relative to the Company's expectations. The Company's pursuit of an overall acquisition strategy or any individual pending or future acquisition may have a material adverse effect on the Company's business, results of operations and financial condition. To the extent the Company chooses to use cash consideration for acquisitions in the future, the Company may be required to obtain additional financing, and there can be no assurance that such financing will be available on favorable terms, if at all. As the Company issues stock to complete future acquisitions, existing stockholders will experience further ownership dilution. 13 -----END PRIVACY-ENHANCED MESSAGE-----