FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
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 No. 2-331855
Sensory Science Corporation
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 86-0492122
- ------------------------ ------------
(State of Incorporation) (IRS E.I.N.)
7835 East McClain Drive, Scottsdale, Arizona 85260
- -------------------------------------------- ---------
(Address of principal executive offices) (Zip code)
(480) 998-3400
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
13,890,791 shares of Common Stock were outstanding as of October 14, 1999
<PAGE>
SENSORY SCIENCE CORPORATION
INDEX
Page No.
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Part I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets --
At September 30, 1999 and March 31, 1999 3
Consolidated Statements of Operations --
Three and Six Months Ended September 30, 1999 and 1998 4
Consolidated Statements of Cash Flows --
Six Months Ended September 30, 1999 and 1998 5-6
Notes to the Interim Consolidated Financial Statements - 7-9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 10-12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 14
Part II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 14
Signatures S-1
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS "FORWARD LOOKING STATEMENTS" WITHIN
THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED AND SECTION
21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. SUCH STATEMENTS REFER TO
FUTURE EVENTS OR INCLUDE TERMS SUCH AS: THE COMPANY "BELIEVES", "EXPECTS",
"INTENDS", "PLANS", AND OTHER USES OF FUTURE TENSES. SEE NOTES TO THE INTERIM
CONSOLIDATED FINANCAL STATEMENTS AND "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS". ALSO SEE "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" ON
PAGES 10-12, FOR A DISCUSSION OF IMPORTANT FACTORS THAT COULD AFFECT THE
VALIDITY OF ANY SUCH FORWARD LOOKING STATEMENTS. SUCH FACTORS INCLUDE THE
FOLLOWING: BUSINESS CONDITIONS AND GENERAL ECONOMIC CONDITIONS; INDUSTRY,
REGULATORY, AND LEGISLATIVE INITIATIVES, INCLUDING THE DIGITAL MILLENNIUM
COPYRIGHT ACT, THAT MAY AFFECT THE COMPANY'S ABILITY TO DEVELOP, MANUFACTURE,
AND MARKET ITS PRODUCTS; COMPETITIVE FACTORS, SUCH AS PRICING AND MARKETING
EFFORTS OF RIVAL COMPANIES; TIMING OF PRODUCT INTRODUCTIONS; SUCCESS OF
COMPETING OR FUTURE TECHNOLOGIES; ABILITY OF CONTRACT MANUFACTURERS TO MEET
PRODUCT PRICE AND TECHNOLOGY OBJECTIVES AND DELIVERY SCHEDULES; THE PACE AND
SUCCESS OF PRODUCT RESEARCH AND DEVELOPMENT; AND THE SUCESSFUL INTERGRATION OF
CALIFORNIA AUDIO LABS.
2
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SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, 1999 March 31, 1999
------------------ --------------
ASSETS (unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 344,880 $ 358,038
Receivables - less allowance for doubtful
accounts of $136,000 and $98,500 respectively 19,502,759 10,526,335
Inventories 13,517,719 13,934,301
Prepaid expenses and other assets 636,549 191,519
Net investment in discontinued operations 414,794 115,415
Deferred tax asset 378,000 100,000
------------ ------------
Total Current Assets 34,794,701 25,225,608
------------ ------------
EQUIPMENT AND IMPROVEMENTS:
Furniture, fixtures & equipment 984,992 875,270
Leasehold improvements 219,105 212,830
Office equipment 1,266,624 1,131,546
Tooling 2,375,886 1,587,602
------------ ------------
Gross equipment and improvements 4,846,607 3,807,248
Less accumulated depreciation and amortization (2,905,527) (2,561,827)
------------ ------------
Equipment and improvements - net 1,941,080 1,245,421
------------ ------------
PATENTS, net of amortization 141,250 149,381
GOODWILL, net of amortization 1,142,617 1,173,316
MARKET EXCLUSIVITY FEE, net of amortization 1,801,198 2,085,598
DEFERRED TAX ASSET 470,000 470,000
OTHER ASSETS, net of amortization 287,227 280,705
------------ ------------
TOTAL $ 40,578,073 $ 30,630,029
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 5,635,798 $ 4,147,579
Accrued expenses 1,856,798 1,395,460
Other current liabilities 1,261,575 1,471,586
Warranty reserve 204,501 222,000
Income tax payable -- 2,724
Line of credit 17,894,883 9,335,363
------------ ------------
Total Current Liabilities 26,853,555 16,574,712
------------ ------------
Long term liabilities 442,640 426,677
Mandatory convertible subordinated debt -- 211,675
------------ ------------
Total Liabilities 27,296,195 17,213,064
------------ ------------
STOCKHOLDERS' EQUITY:
Common stock 13,891 13,658
Additional paid-in capital 21,983,810 21,708,124
Accumulated deficit (8,715,823) (8,304,817)
------------ ------------
Total Stockholders' Equity 13,281,878 13,416,965
------------ ------------
TOTAL $ 40,578,073 $ 30,630,029
============ ============
</TABLE>
3
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SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
For The Three For The Six
Months Ended September 30, Months Ended September 30,
----------------------------- -----------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
SALES $19,582,961 $17,074,191 $33,719,145 $27,869,510
COST OF SALES 15,290,966 12,894,899 26,436,356 20,562,168
----------- ----------- ----------- -----------
Gross profit 4,291,995 4,179,292 7,282,789 7,307,342
----------- ----------- ----------- -----------
OTHER OPERATING COSTS:
Sales and marketing 1,707,766 1,126,628 3,283,097 2,166,430
Research and development 1,009,418 384,960 1,891,896 742,816
General and administrative 1,246,374 1,215,018 2,234,816 2,285,288
----------- ----------- ----------- -----------
Total other operating costs 3,963,558 2,726,606 7,409,809 5,194,534
----------- ----------- ----------- -----------
Operating income 328,437 1,452,686 (127,020) 2,112,808
----------- ----------- ----------- -----------
OTHER (EXPENSE) REVENUES:
Interest income 3,145 6,895 4,896 10,267
Interest expense (315,996) (252,940) (580,167) (387,431)
Other income (expense) 10,138 300 13,285 375
----------- ----------- ----------- -----------
Total other expense (302,713) (245,745) (561,986) (376,789)
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE PROVISION
FOR INCOME TAXES 25,724 1,206,941 (689,006) 1,736,019
PROVISION (BENEFIT) FOR
INCOME TAXES -- 108,069 (278,000) 160,957
----------- ----------- ----------- -----------
INCOME (LOSS) FROM
CONTINUING OPERATIONS 25,724 1,098,872 (411,006) 1,575,062
----------- ----------- ----------- -----------
DISCONTINUED OPERATIONS
Income (loss) from operations -- (98,524) -- (36,104)
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ 25,724 $ 1,000,348 $ (411,006) $ 1,538,958
=========== =========== =========== ===========
NET INCOME (LOSS) PER
COMMON SHARE:
Continuing operations $ 0.00 $ 0.08 $ (0.03) $ 0.12
Discontinued operations -- $ 0.00 -- 0.00
----------- ----------- ----------- -----------
Net Income (Loss) per Common Share $ 0.00 $ 0.08 $ (0.03) $ 0.12
=========== =========== =========== ===========
NET INCOME (LOSS) PER COMMON
SHARE - ASSUMING DILUTION
Continuing operations $ 0.00 $ 0.07 $ (0.03) $ 0.10
Discontinued operations -- $ 0.00 -- 0.00
----------- ----------- ----------- -----------
Net Income (Loss) per Common Share -
Assuming Dilution $ 0.00 $ 0.07 $ (0.03) $ 0.10
=========== =========== =========== ===========
</TABLE>
4
<PAGE>
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
For the Six
Months Ended September 30,
--------------------------
1999 1998
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ (411,006) $ 1,538,958
Adjustments to reconcile net income to net cash
provided by operations:
Depreciation and amortization 666,930 315,114
Deferred taxes (278,000) --
Provision for bad debt 37,500 (33,799)
Loss on sale of equipment -- 10,320
Discontinued operations -- 36,104
Change in operating assets and
liabilities - net of acquisition:
Receivables (9,263,924) (2,496,206)
Inventories 416,582 (9,280,684)
Prepaids (445,030) (532,960)
Other assets (6,522) (41,178)
Accounts payable 1,488,219 2,143,206
Accrued expenses 486,354 574,092
Other current liabilities (210,011) 559,267
Warranty reserve (17,499) (50,000)
Other long-term liabilities (78,464) 3,704
Income taxes payable (2,724) 121,200
------------ ------------
Net cash used in operating activities (7,476,091) (7,132,861)
------------ ------------
INVESTING ACTIVITIES
Market exclusivity fee -- (1,248,350)
Cash paid for acquisition net
of cash acquired -- (773,904)
Equipment and improvement expenditures (255,075) (391,014)
Investment in discontinued operation (299,379) 316,212
Tooling expenditures (534,283) --
------------ ------------
Net cash used in investing activities (1,088,737) (2,097,056
------------ ------------
FINANCING ACTIVITIES
Proceeds from the issuance of capital stock 39,228 286,118
Payments on capital lease obligations (47,080) (47,320)
Payment of debt assumed in acquisition (1,205,833)
Net borrowings (payments) under line of credit 8,559,522 10,308,053
------------ ------------
Net cash used in financing activities 8,551,670 9,341,018
------------ ------------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (13,158) 111,101
CASH AND CASH EQUIVALENTS, beginning of period 358,038 445,925
------------ ------------
CASH AND CASH EQUIVALENTS, end of period $ 344,880 $ 557,026
============ ============
5
<PAGE>
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
For the Six
Months Ended September 30,
--------------------------
1999 1998
---------- ----------
SUPPLEMENTAL INFORMATION TO CASH FLOW
STATEMENT:
Cash paid for Interest $576,412 $ 123,009
Cash paid for Income Taxes $ 16,300 $ --
======== ==========
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Conversion of subordinated debt and accrued
interest to common stock $236,691 $ 216,666
======== ==========
In connection with the acquisition,
liabilities were assumed as follows:
Liabilities assumed $ -- $1,690,778
Fair value of assets acquired, including
$33,799 in cash $ -- $1,231,207
------- -------- ----------
Excess of cost over fair value of assets
acquired $ -- $1,233,475
======== ==========
6
<PAGE>
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
GENERAL
In the opinion of the Company, the accompanying unaudited consolidated financial
statements contain all adjustments (consisting of normal recurring accruals)
necessary to present fairly the financial position of the Company and the
results of its operations and changes in its financial position for the periods
reported. The results of operations for interim periods are not necessarily
indicative of the results to be expected for the entire year. The consolidated
financial statements include Sensory Science Corporation and its wholly owned
subsidiary, California Audio Labs, LLC ("Cal Audio"). All significant
intercompany balances and transactions have been eliminated.
Certain reclassifications have been made to the prior financial statements to
conform to the current classifications.
On April 1, 1998, the Company acquired all of the equity interests of Cal Audio.
The purchase price was $.8 million, plus $1.2 million of debt assumed plus the
assumption of other liabilities of $0.5 million. The acquisition was accounted
for using the purchase method of accounting for business combinations. The
excess of assets acquired over liabilities assumed of $1.2 million has been
allocated to goodwill and is being amortized over twenty years.
Inventories at September 30, 1999 consisted of $1.5 million of raw materials and
service parts, and $12.0 million of finished goods.
The Market Exclusivity Fee of $1.8 million represents the unamortized balance of
a $2.3 million fee paid by the Company to Loewe Opta GmbH ("Loewe Opta") for the
exclusive right to market and distribute in North America a line of digital
direct view televisions specifically developed and manufactured by Loewe Opta
for the Company. The Company began amortization of the fee in November 1998 on a
straight-line basis over the initial term of the agreement, which ends on
January 1, 2003.
The Company is engaged in the design, development, and marketing of consumer
electronic audio, video, and television products. In April 1999, the Company
entered into a Memorandum of Understanding to sell most of the assets of the
Security Products Division to the senior management of the division for cash.
The Company expects to complete the sale of the assets of the Security Products
Division by December 1999 but there is no assurance that it will be able to do
so, or that it will recognize the full estimated values for the division's
assets. Completion of the sale is subject to numerous conditions including the
execution of a mutually acceptable purchase agreement, the buyer's ability to
obtain sufficient financing, and the buyer's ability to negotiate various
agreements with the manufactures. The Company's financial results show the
operations of the Security Products Division as discontinued operations.
Sales of the Company's Dual-Deck videocassette recorder have constituted
substantially all of its revenue for the last five fiscal years. For the six
months ended September 30, 1999, the Company's largest customer represented 15%
of total revenues and the Company's second largest customer represented 12% of
revenues. No other customer represented 10% or more of the Company's revenues.
Accounts receivable from these two customers at September 30, 1999 were $3.9
million and $2.5 million.
7
<PAGE>
Deferred income taxes reflect the net tax effects of (a) temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes, and (b) operating loss
and tax credit carryforwards. The tax effects of significant items comprising
the Company's net deferred tax asset as of September 30, 1999 are as follows:
Deferred Tax Assets:
Current - reserves not currently deductible $ 1,104,000
Noncurrent:
Differences between book & tax
basis of property $ 337,000
Operating loss carryforwards 4,594,000
Tax credit carryforwards 189,000
Other intangibles 77,000
-----------
Net Deferred Tax Asset $ 6,301,000
Valuation Allowance (5,453,000)
Net Deferred Asset $ 848,000
===========
SFAS No.128, "Earnings Per Share", requires a reconciliation of the numerator
and denominators of basic and diluted earnings per share as follows:
For the Three Months
Ended September 30,
-----------------------------
1999 1998
----------- -----------
Income From Continuing Operations $ 25,724 $ 1,098,872
----------- -----------
Average Outstanding Common Shares 13,784,975 13,311,129
----------- -----------
Basic Income From Continuing Operations
Per Share $ 0.00 $ 0.08
----------- -----------
Diluted Income from Continuing Operations
per Common Share:
Income available to common stockholders,
from above $ 25,724 $ 1,098,872
Add interest on presumed conversion of
convertible debt 6,250 11,333
----------- -----------
Net income available for diluted
earnings per share $ 31,974 $ 1,110,205
=========== ===========
Average outstanding common shares, from above 13,784,975 13,311,129
Additional dilutive shares related to stock
options and warrants 1,083,673 1,324,980
Additional dilutive shares related to
subordinated notes 0 406,000
----------- -----------
Average outstanding and potentially
dilutive common shares 14,868,648 15,042,109
=========== ===========
Dilutive Income From Continuing
Operations per share $ 0.00 $ 0.07
=========== ===========
8
<PAGE>
Options and warrants to purchase 1.6 million shares of common stock at various
prices were outstanding during the three months ended September 30, 1999 but
were not included in the computation of diluted earnings per share because the
exercise prices of the options and warrants were greater than the average price
of the common shares.
For the Six Months
Ended September 30,
-----------------------------
1999 1998
------------ ------------
Income (Loss) From Continuing Operations $ (411,006) $ 1,575,062
------------ ------------
Average Outstanding Common Shares 13,724,603 13,076,683
Basic (Loss) Income From Continuing
Operations Per Share $ (.03) $ 0.12
------------ ------------
Diluted (loss) Income from Continuing
Operations per Common Share:
(Loss) income available to common stockholders,
from above $ (411,006) $ 1,575,062
Add interest on presumed conversion of
convertible debt 0 31,000
------------ ------------
Net (loss) income available for diluted
earnings per share $ (411,006) $ 1,606,062
============ ============
Average outstanding common shares, from above 13,724,603 13,076,683
Additional dilutive shares related to stock
options and warrants 0 1,230,100
Additional dilutive shares related to
subordinated notes 0 508,000
------------ ------------
Average outstanding and potentially
dilutive common shares 13,724,603 14,814,783
------------ ------------
Dilutive (Loss) Income From Continuing
Operations per share $ (.03) $ 0.11
============ ============
Options and warrants to purchase 1.6 million shares of common stock at various
prices were outstanding during the nine months ended September 30, 1999, but
were not included in the computation of diluted earnings per share because the
exercise prices of the options and warrants were greater than the average price
of the common shares.
The information presented within the financial statements should be read in
conjunction with the Company's audited Financial Statements for the fiscal years
ended March 31, 1999 and 1998 and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" from the 1999 Annual Report on
Form 10-K.
9
<PAGE>
ITEM 3. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED WITH THE THREE MONTHS ENDED
SEPTEMBER 30, 1998:
Net sales increased $2.5 million or 15% to $19.6 million during the three months
ended September 30, 1999 from $17.1 million during the three months ended
September 30, 1998. The increase in sales resulted from a $3.1 million increase
in revenues from new product lines. These new product lines include the RaveMP
Portable Internet Media Players, Digital Televisions and California Audio Labs
digital home theater products. Dual-Deck VCR ("DDVCR") unit shipments for the
three months ended September 30, 1999 increased 17% compared to the same period
one year prior. A shift in sales mix and one-time price reductions and
allowances primarily associated with a DDVCR model changeover caused DDVCR net
sales to decline 3% in the three months ended September 30, 1999 from the same
period in the prior year. Sales from new product lines are expected to continue
being a growing percentage of the company's sales in future quarters as the
Company expects to introduce a new product line of DVD (Digital Video Disk)
products and expand its California Audio Labs CL 2500 Series system.
Gross profit was approximately $4.3 million and $4.2 million in the three month
periods ended September 30, 1999 and September 30, 1998, respectively. Gross
profit as a percentage of sales decreased to 21.9% in the current quarter ended
September 30, 1999 from 24.5% in the same period last year. The decrease in
gross profit percentage was primarily due to discounted prices and allowances
relating to the sale of older model DDVCR's. Gross profit as a percentage of
sales for new products was also lower than the company's historical gross margin
rates due to special programs and allowances necessary to initiate distribution.
The Company believes that it will be able to improve gross margins in future
quarters as a result of lower DDVCR manufacturing costs which will offset the
downward trend in VCR market prices and the Company expects higher margins
associated with the continuing sales of new product lines.
Sales and marketing expense increased 51.6% to $1.7 million for the three months
ended September 30, 1999 from $1.1 million for the three months ended September
30, 1998. The increase in sales and marketing expense was primarily due to
increased sales commissions on higher overall sales levels, and the addition of
selling and marketing expenses across all categories incurred to support the
sales of the Company's new product lines. As a percentage of sales, sales and
marketing expense increased from 6.6% in the three months ended September 30,
1998, to 8.7% in the three months ended September 30, 1999.
Research and development expense increased 162% from $0.4 million for the three
months ended September 30, 1998 to $1.0 million for the three months ended
September 30, 1999. The increased research and development costs are due to
product development costs incurred to develop the company's new product lines.
As a percentage of sales, research and development expense increased from 2.3%
for the three months ended September 30, 1998, to 5.2% for the three months
ended September 30, 1999.
General and administrative expense remained level at $1.2 million for the three
month periods ended September 30, 1999 and September 30, 1998. General and
administrative expense declined as a percentage of revenues to 6.4% for the
three months ended September 30, 1999 from 7.1% in the same period last year.
As a result of the above, the Company recorded an operating profit of $0.3
million for the three months ended September 30, 1999 as compared with an
operating profit of $1.5 million for the three months ended September 30, 1998.
The Company recorded net interest and other expense of $0.3 million for the
three month periods ended September 30, 1999 and, September 30, 1998.
10
<PAGE>
SIX MONTHS ENDED SEPTEMBER 30, 1999 COMPARED WITH THE SIX MONTHS ENDED SEPTEMBER
30, 1998
Net sales increased $5.8 million or 21.0% to $33.7 million during the six months
ended September 30, 1999 from $27.9 million during the six months ended
September 30, 1998. The increase in sales resulted from a $4.6 million increase
in revenues from new product lines. These new product lines include Digital
Televisions, RaveMP Portable Internet Media Players and California Audio Labs
digital home theater products. Dual-Deck VCR ("DDVCR") unit shipments for the
six months ended September 30, 1999 increased 27% compared to the same period
one year prior due to increased consumer demand. Special programs and allowances
primarily associated with a DDVCR model changeover caused DDVCR net sales to
increase only 4.5% in the six months ended September 30, 1999 from the same
period in the prior year.
Gross profit was approximately $7.3 million in the six months ended September
30, 1999 and 1998. Gross profit as a percentage of sales decreased to 21.6% in
the current quarter ended September 30, 1999 from 26.2% in the same period last
year. The decrease in gross profit percentage was primarily due to discounted
prices and allowances relating to the sale of older model DDVCR's. Gross profit
as a percentage of sales for new products was also lower than the company's
historical gross margin rates due to special programs and allowances necessary
to initiate distribution.
Sales and marketing expense increased 51.5% to $3.3 million for the six months
ended September 30, 1999 from $2.2 million for the six months ended September
30, 1998. The increase in sales and marketing expense was primarily due to
increased sales commissions on higher overall sales levels, and the addition of
selling and marketing expenses across all categories incurred to support the
sales of the Company's new product lines. As a percentage of sales, sales and
marketing expense increased to 9.7% in the six months ended September 30, 1999,
from 7.8% in the three months ended September 30, 1998.
Research and development expense increased 155% to $1.9 million for the six
months ended September 30, 1999 from $0.7 million for the six months ended
September 30, 1998. The increased research and development costs are due to
product development costs incurred to develop the company's new product lines.
As a percentage of sales, research and development expense increased to 5.6% for
the six months ended September 30, 1999, from 2.7% for the six months ended
September 30, 1998.
General and administrative expense remained level at $2.2 million for the six
month periods ended September 30, 1999 and September 30, 1998. General and
administrative expense declined as a percentage of revenues to 6.6% for the six
months ended September 30, 1999 from 8.2% in the same period last year.
As a result of the above, the Company recorded an operating loss of $0.1 million
for the six months ended September 30, 1999 as compared with an operating profit
of $2.1 million for the three months ended September 30, 1998. The Company
recorded net interest and other expense of $0.6 million for the three months
ended September 30, 1999 compared to $0.4 million in the same period of the
prior year. The increase was caused by higher interest expense associated with
higher borrowings in the Company's line of credit required to fund higher
working capital.
SEASONALITY
The Company's product lines compete within the consumer electronics industry,
which generally experiences seasonal peaks in sales from September through
January, covering the holiday selling season. The Company expects to continue to
exhibit seasonal peaks of its sales in line with industry experience.
YEAR 2000 COMPLIANCE
The Company recognizes the problems associated with Year 2000 transactions and
has evaluated its management information systems and the possible effect of Year
2000 hardware and software issues. The Company believes all but one of its
internal management information systems is Year 2000 compliant. The one internal
system that is not Year 2000 compliant is a customer contact management system
that the Company expects to replace by December 1999. The Company has
11
<PAGE>
communicated with its significant suppliers, financial institutions, customers,
and other parties that purchase products or provide critical services or
supplies to assess their respective compliance with Year 2000 issues. The
Company has not received sufficient information from key suppliers, financial
institutions, or customers about their Year 2000 compliance and remediation
plans to predict the outcome of their efforts. If the Company's larger customers
are not Year 2000 compliant, payments to the Company could be delayed and the
Company's cash flow would be affected. If the Company's contract manufacturers
are not Year 2000 compliant, the Company's receipt of inventory may be disrupted
which could affect its sales and cash flow. If the Company's financial
institutions are not Year 2000 compliant, its operations could be disrupted as
vendors and employees await payment for goods and services provided and the
Company awaits collection of its accounts receivable. The Company is in the
process of designing a contingency plan, which it expects to complete by
December 1999. However, the Company cannot provide assurances that its
significant suppliers, financial institutions, and customers will properly
address and resolve critical Year 2000 issues. The Company has incurred and
expects to continue to incur expenses to make all of its internal systems Year
2000 compliant. The Company currently estimates that these costs will total less
than $200,000. The costs of Year 2000 compliance and the date on which the
Company plans to be completely Year 2000 compliant is based on its current
estimates. These estimates reflect the Company's assumptions about future
events, including the continued availability of third party remediation plans.
The Company cannot be sure that these estimates will be achieved, and its actual
results could differ materially from its plans. Specific factors that could
cause material differences include the availability and cost of personnel
trained in this area, the ability to locate and correct relevant computer source
codes and embedded technology, the results of internal and external testing and
the timeliness and effectiveness of remediation efforts of third parties.
FUTURE RESULTS
The Company's expectations for results of operations and other forward-looking
statements contained in this report on Form 10-Q, particularly statements
relating to the sustainability of profitable growth, the impact of year 2000
issues, and expected results from the Company's product line diversification
into the digital television and audio markets, involve a number of risks and
uncertainties. Among the factors that could affect future operating results are
the following: business conditions and general economic conditions; changes in
legislation or industry initiatives that may affect the ability of the Company
to sell its products; competitive factors, such as the pricing and marketing
efforts of rival companies; timing of product introductions; success of
competing or future technologies; ability to negotiate reduced product
manufacturing costs; the ability of contract manufacturers to meet product
specifications, target pricing, and shipment schedules; and the pace and success
of product research and development, particularly with the digital television
and audio products; and the successful integration of California Audio Labs
which was acquired by the Company effective April 1, 1998. The Company's future
results may be affected by the Digital Millennium Copyright Act of 1998 which,
among other requirements, requires all analog VHS format video cassette
recorders sold in the United States after April 2000 to recognize anti-copying
technology that uses the automatic gain control feature. Conforming to the
automatic gain control copy technology would prevent consumers from using the
Company's videocassette recorders sold after April 2000 from copying certain
technically protected tapes. The Company intends to modify its products to
comply with the requirements of this new legislation by the relevant effective
dates. The Company is unable to determine what the effect of the required
modification may be on future sales of its video cassette recorder products, but
believes that any negative effects may be mitigated by the fact that the
Company's Dual-Deck VCR offers numerous feature benefits to consumers over
single-deck VCR's and by the Company's success over the last several years in
significantly reducing the price premium paid by consumers for the added
features of its line of Dual-Deck VCR's over single-deck VCR's.
12
<PAGE>
CAPITAL RESOURCES AND LIQUIDITY
Net cash used by operating activities was $7.5 million for the six months ended
September 30, 1999, representing an increase of $0.4 million as compared with
the six months ended September 30, 1998. The more significant factors comprising
the net cash used for the six months ended September 30, 1999 were the net loss
of $0.4 million, and an increase of $9.3 million in accounts receivable. The
increase in the accounts receivable balance from March 31, 1999 to September 30,
1999 was primarily due to the timing of sales in the three months ended
September 30, 1999. Of the total sales of $19.6 million for the three months
ended September 30, 1999, $10.8 million, or 55%, occurred in the month of
September. This increase in the accounts receivable balance was partially offset
by a $1.5 million increase in accounts payable, which was primarily due to the
timing of payments to the company's various product suppliers.
The Company had net working capital of $7.9 million and $8.7 million at
September 30, 1999 and September 30, 1998, respectively. At September 30, 1999,
the Company's current ratio (the ratio of current assets to current liabilities)
was 1.3 to 1.
The Company funds its cash requirements through a combination of cash flow from
operations and loans under a line of credit with Congress Financial Corporation.
During the fiscal year, the Company's sales seasonality generally requires
incremental working capital for investment primarily in inventories and
receivables. The Company's primary source of funds for the six months ended
September 30, 1999 was the line of credit. The financing agreement with Congress
Financial was first entered into in October 1992 and was last amended in August
1998. The maximum line of credit is $20.0 million, limited by a borrowing base
determined by specific inventory and receivable balances. The line provides for
cash loans, letters of credit, and acceptances. The agreement, as amended,
expires in November 2002 with a maximum prepayment (if applicable) fee of 1%.
Loans are priced at prime plus 1/2%. All assets of the Company are pledged as
collateral for the line of credit. The unused and available line of credit at
September 30, 1999 was approximately $2.1 million. All closing costs related to
the origination and amendment of the financing agreement had been fully
amortized by March 31, 1999. The Company has completed preliminary negotiations
with, and had received tentative approval from, Congress Financial Corporation
to increase the current line of credit to $30.0 million. The Company believes
that its current financial resources will be sufficient to support operations
over the next twelve months.
In August 1996, the Company sold $1.5 million of convertible subordinated notes
in a private placement with institutional holders. As per the terms of these
instruments, the remaining $0.2 million of notes outstanding as of August 1999
have been converted to common stock.
Effective January 1, 1998, the Company entered into an agreement with Loewe Opta
GmbH of Kronach, Bavaria, Germany, to develop and market a line of digital
television products designed specifically for the North American market. The
initial agreement is effective through January 1, 2003 with built in five-year
extensions. The Company incurred fees totaling $2.3 million for the exclusive
right to market and distribute Loewe Opta direct view televisions in North
America. The Company received its first shipments of product from Loewe in
November 1998.
On April 1, 1998, the Company acquired California Audio Labs, L.L.C.
("California Audio Labs"). California Audio Labs designs, develops, and
assembles digital audio and video products marketed to the high-performance home
theater market under the California Audio Labs and Cinevision brand names. The
Company has incurred and expects to continue to incur increased expenses related
to the integration and development of the California Audio Labs business and
therefore anticipates operating losses from its line of California Audio Labs
products during the fiscal year ending March 31, 2000.
13
<PAGE>
The Company leases a 33,000 square foot corporate office and warehouse facility
in Scottsdale, Arizona, which is fully utilized and in good condition. The lease
began in January 1996 and expires in January 2003, with one three-year extension
at the Company's option. The Company also leases a 7,800 square foot engineering
and manufacturing facility in Blue Lake, California, which is fully utilized and
in good condition. The lease began in June 1997 and expires in May 2002. The
Company is currently evaluating its space requirements in relation to its
business plan, which anticipates increased needs for personnel, office, and
engineering space. As a result, the Company expects to remodel its existing
space, and lease space in a building adjacent to the Scottsdale headquarters
location.
INFLATION
Inflation has had no material effect on the Company's operations or financial
condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not utilize market risk sensitive instruments.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
27 Financial Data Schedule
14
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
SENSORY SCIENCE CORPORATION
` (Registrant)
Date: November 11, 1999 By /s/ Roger B. Hackett
-----------------------------------------------
Roger B. Hackett
Chairman of the Board, Chief Executive Officer,
President and Chief Operating Officer
Date: November 11, 1999 By /s/ Thomas E. Linnen
-----------------------------------------------
Thomas E. Linnen
Senior Vice President
(principal financial and accounting officer)
S-1
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 10-Q FOR
THE FIRST QUARTER ENDED SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> APR-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 344,880
<SECURITIES> 0
<RECEIVABLES> 19,502,759
<ALLOWANCES> (136,000)
<INVENTORY> 13,517,719
<CURRENT-ASSETS> 34,794,701
<PP&E> 4,846,607
<DEPRECIATION> 2,905,527
<TOTAL-ASSETS> 40,578,073
<CURRENT-LIABILITIES> 26,296,195
<BONDS> 0
0
0
<COMMON> 13,891
<OTHER-SE> 13,267,987
<TOTAL-LIABILITY-AND-EQUITY> 30,578,073
<SALES> 33,719,145
<TOTAL-REVENUES> 33,719,145
<CGS> 26,436,356
<TOTAL-COSTS> 7,409,809
<OTHER-EXPENSES> (18,181)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 561,986
<INCOME-PRETAX> (686,006)
<INCOME-TAX> (278,000)
<INCOME-CONTINUING> (411,006)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (411,006)
<EPS-BASIC> (0.03)
<EPS-DILUTED> 0
</TABLE>
