SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from N/A to N/A
Commission File No.2-331855
Sensory Science Corporation
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 86-0492122
- ------------------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7835 East McClain Drive
Scottsdale, Arizona 85260-1732
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (480) 998-3400
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
- ------------------- -----------------------------------------
Common Stock American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
(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. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Based upon the closing price of the stock quoted on the American Stock Exchange
on June 24, 1999, the aggregate market value of common stock held by
non-affiliates of the Registrant was approximately $43,800,000. See Item 5 of
this Form 10-K.
The number of shares of common stock outstanding as of June 24, 1999, was
13,658,052.
Documents Incorporated by Reference: Portions of the Registrant's Proxy
Statement relating to its Annual Meeting of Stockholders to be held August 19,
1999 are incorporated by reference in Part III of this Form 10-K.
Exhibit Index at page 18
<PAGE>
TABLE OF CONTENTS
PART I
Item 1. Business........................................................... 1
Executive Officers of the Registrant............................... 9
Item 2. Properties........................................................ 10
Item 3. Legal Proceedings................................................. 10
Item 4. Submission of Matters to a Vote of Security Holders............... 10
PART II
Item 5. Market for the Registrant's Common Stock and
Related Security Holder Matters.................................. 10
Item 6. Selected Financial Data........................................... 10
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 11
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........ 16
Item 8. Financial Statements and Supplementary Data....................... 16
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure....................................... 16
PART III
Item 10. Directors and Executive Officers of the Registrant................ 17
Item 11. Executive Compensation............................................ 17
Item 12. Security Ownership of Certain Beneficial Owners and Management.... 17
Item 13. Certain Relationships and Related Transactions.................... 17
PART IV
Item 14. Exhibits, Financial Statement, Schedules and Reports
on Form 8-K...................................................... 18
SIGNATURES.................................................................. S-1
THIS ANNUAL REPORT ON FORM 10-K 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: WE "BELIEVE", "EXPECT", "INTEND",
"PLAN", AND OTHER USES OF FUTURE TENSES. SEE ITEM 1, ITEM 5, AND ITEM 7. ALSO
SEE "MANAGMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" IN PART II, ITEM 7 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; AND THE PACE AND
SUCCESS OF PRODUCT RESEARCH AND DEVELOPMENT.
<PAGE>
PART I
ITEM 1. BUSINESS
OVERVIEW
Sensory Science Corporation designs, develops, and markets consumer electronic
products. We believe we are the only company which offers video cassette
player/recorders ("VCR's") with two decks built into one unit, which we call the
Dual-Deck(TM) VCR, in North America. We have several patents covering our
Dual-Deck technology which uses hardware circuitry and software we designed to
perform duplicating, dual recording, editing, and video view switching functions
not available from regular VCR's. The Dual-Deck VCR has constituted
substantially all of our revenues since the company was founded. We expanded our
product line into home and business video security and surveillance products in
1995 and further expanded our product line into home theater audio, video, and
television products in 1998. In March 1999 we decided to exit the video security
and surveillance business to focus exclusively within the consumer electronics
market. In addition to the Dual-Deck VCR, our current products include digital
televisions, digital versatile disk (DVD) players, and CD players. We plan to
introduce a line of Internet audio (MP3) players and several new home theater
products over the next year including a surround sound processor, a video
switcher, and a high-powered five-channel amplifier. We describe these products
in more detail below.
Sensory Science Corporation was incorporated in 1984 in Arizona as Go-Video,
Inc. We completed our initial public offering in 1986 and reincorporated in
Delaware in 1987. In March 1999 we changed our name from Go-Video, Inc. to
Sensory Science Corporation.
We typically design and develop our products and then arrange for their
manufacture by independent manufacturers. As our products are manufactured, they
are shipped to our warehouse facilities and then marketed and distributed to our
customers. Our customers include consumer electronic retailers, general
retailers who sell substantial amounts of consumer electronics, catalogs,
distributors, custom installers, and specialty retailers such as home shopping
channels. We conduct our sales and marketing activities through our Consumer
Electronics and Home Theater divisions.
Our executive office is located at 7835 East McClain Drive, Scottsdale, Arizona,
85260-1732, and our telephone number is (480) 998-3400.
BUSINESS STRATEGY
Our objective is to develop, market, and distribute innovative, high performance
consumer electronic products that incorporate advanced technology, ease of use,
and superior industrial design. We believe there is a significant segment of the
consumer electronics market that desires high-performance products that offer
value to the consumer and profit opportunities to dealers. Because many of our
competitors are focused on higher volume, lower priced product lines where
product and service differentiation is difficult to sustain, we believe we can
capitalize on our technology, engineering and industry know-how, product
distribution network, and reputation for bringing innovative products to the
electronics marketplace to pursue our objectives and increase our revenues and
earnings.
We intend to achieve our objectives by pursuing the following business strategy:
* Reducing the manufacturing and selling costs of our core Dual-Deck VCR
product line to increase consumer demand and distribution; and
* Developing and marketing new high growth and/or high margin audio, video,
and Internet digital products for the consumer electronics market that
leverage and build upon our product development, marketing, sales, and
distribution experience.
1
<PAGE>
DISCONTINUED OPERATIONS
In March 1999, we completed an evaluation of our video security products
business. We concluded that while the video security products business continued
to offer good revenue and profit opportunities, our new digital video, audio,
and Internet products had more substantial and immediate potential to create
shareholder value. We also concluded that these new opportunities would require
substantial capital and management resources and that we should concentrate our
resources to pursue our growth strategy. As a result, we decided to sell or
close down our security products business.
In April 1999, we entered into a Memorandum of Understanding to sell most of the
assets of our Security Products Division to the senior management of the
division for cash. The sale is subject to the parties reaching agreement on a
purchase contract, which we are currently negotiating. We expect to complete the
sale of the assets of the Security Products Division by July 31, 1999 but there
is no assurance that we will be able to do so, or that we will recognize the
full estimated values for the division's assets.
Our financial results have been restated to show the operations of the Security
Products Division as discontinued operations, and we recognized an estimated
loss on the sale of the division in the quarter ended March 31, 1999.
INDUSTRY BACKGROUND
The consumer electronics industry is highly competitive and is characterized by
declining prices and constant innovations in quality and features. Manufacturing
and core technology is dominated by large companies, all of which compete with
us for market share in the consumer electronics market. Manufacturing dominance
is maintained by substantial technological and entry cost barriers.
Sales of consumer electronic products in the United States have become
increasingly consolidated into large national and regional consumer electronics
chains, warehouse clubs, and mass merchants, all of which exercise considerable
purchasing power. Independent and smaller regional retailers have, in many
cases, abandoned lower and mid-priced consumer electronic product categories to
concentrate on premium consumer electronic products, such as high-performance
home theater systems, specialized audio components and speakers, and custom
installations of home entertainment systems.
As a result of industry consolidation, there are substantial hurdles for
bringing new products to the consumer electronic marketplace, particularly if
the company offering the product is not already distributing other consumer
electronic products. Consumer electronic retailers have considerable negotiating
power and generally require that suppliers have sufficient financial,
operational, and marketing wherewithal to provide a high level of support for
product lines carried by that retailer.
PRINCIPAL PRODUCTS
We develop, market and distribute products that are primarily used by consumers
for home entertainment, although some products like our Dual-Deck VCR also have
industrial and institutional customers. The table below shows the product mix
for our sales over the last three fiscal years:
PRODUCT SALES
FY 1999 FY 1998 FY 1997
--------------- --------------- ---------------
($ thousands) $ % $ % $ %
------- --- ------- --- ------- ---
Dual-Deck VCR's $58,206 92% $46,189 98% $38,346 98%
Digital Televisions 2,199 3% -- 0% -- 0%
Digital Audio/Video 1,824 3% -- 0% -- 0%
Service and Parts 1,322 2% 955 2% 678 2%
------- --- ------- --- ------- ---
Total $63,551 100% $47,144 100% $39,024 100%
2
<PAGE>
DUAL-DECK VCR's: The principal consumer electronic product offered by our
company has been the Dual-Deck VCR. We offer several models of Dual-Deck VCR's
that vary from one another by features and configuration (the two VCR decks are
either side-by-side or stacked on one another). The market for VCR's has
continued to grow, with increasing unit shipments offsetting lower average
selling prices. Our Dual-Deck VCR strategy is designed to capture an increasing
share of the worldwide VCR market. The majority of sales of VCR's consists of
replacement, upgrade, and second-unit purchases. We believe that our principal
North American competition is currently from top-end single-deck VCR's offering
a variety of features and price points, most of which are less expensive than
comparable Dual-Deck VCR's.
All of our current Dual-Deck VCR models contain our patented "AmeriChrome"
technology and proprietary software which allows a near-identical copy to be
made from an original VHS tape. Some prerecorded tapes contain anticopying
signals that take advantage of single deck VCR design weaknesses, causing single
deck VCR's to make poor or unusable copies of videotapes.
AmeriChrome is not normally affected by these signals.
We have designed and marketed the Dual-Deck VCR for use as a full featured video
cassette recorder. Our marketing literature and owner manuals caution consumers
that the Dual-Deck VCR should not be used in a manner which infringes on the
rights of owners of copyrighted material. However, we cannot predict the
likelihood that distribution of current or future Dual-Deck VCR models will be
challenged. All VCR's, including the Dual-Deck VCR, are affected by Federal
legislation that was passed in October 1998 commonly referred to as The Digital
Millennium Copyright Act. One of the effects of this new law will require us to
modify the operations of Dual-Deck VCR's sold after April 2000 so that our VCR's
will recognize a type of anticopying signal and prevent consumers from making a
usable copy of videotapes encoded with that type of anticopying signal. We are
modifying Dual-Deck VCR models manufactured after May 1999 so that if they are
purchased prior to April 2000 they will continue to operate as originally
designed for the lifetime of the VCR, but if they are purchased after April 2000
they will recognize and respond to the anticopying signal. We are unable to
determine what the effect of the required modification may be on future sales of
our Dual-Deck VCR's, but believe that negative effects may be mitigated by a
combination of the numerous other feature benefits to consumers of Dual-Deck
VCR's over single-deck VCR's and by our success in recent years of reducing the
price premium paid by consumers for our line of Dual-Deck VCR's over single-deck
VCR's.
While, to our knowledge, no other company is selling a consumer VHS-to-VHS
Dual-Deck VCR in the United States, several companies have the technical skill
and practical ability to design, manufacture, and sell such a product. It is
possible that a potential competitor could attempt to introduce competing
products in the United States or other world markets. However, we believe that
it is unlikely that a competing Dual-Deck VCR will be introduced in our primary
market, North America, due to our patented technology rights and the
industry-wide transition from analog products like the VCR to digital products
such as digital versatile disk (DVD).
One of our principal manufacturers, Samsung, has the right to manufacture and
sell Dual-Deck VCR's worldwide using our technology in exchange for royalty
payments. This agreement, which we signed in 1989, allows Samsung to compete
with us. While Samsung has never exercised its license rights and has not
communicated to us an intention to do so, we believe that if Samsung were to
exercise its license rights, our revenues and profitability could be affected in
a materially adverse manner. We have also licensed Samsung and Goldstar USA the
worldwide, nonexclusive right to manufacture and sell 8mm-to-VHS format
Dual-Deck VCR's (see "LICENSING"). To our knowledge neither company is currently
selling 8mm/VHS Dual-Deck VCR's.
We anticipate that VCR's will begin to face obsolescence issues in the future
from digitally-based home player/recorder consumer products. Two companies have
recently introduced digital home video recording devices that use hard drives to
record and store video, and other types of digital recording devices are likely
to be introduced in the future. Nevertheless, these new products face
considerable marketing and consumer acceptance obstacles. We are not aware of
any product that is currently being offered that is widely considered today to
be a viable replacement for the VCR as the primary home video recording device.
However, we cannot predict how long the VCR in its current form will remain the
primary home video recording device.
We expect that Dual-Deck VCR's will account for a decreasing percentage of our
total sales in future years due to our product diversification efforts.
3
<PAGE>
DIGITAL TELEVISIONS: In 1997, we entered into a development, marketing, and
distribution agreement with Loewe Opta GmbH ("Loewe"), a German manufacturer of
digital televisions. Under the agreement, we jointly designed a line of
high-performance, digital direct view televisions for sale in North America
under the Loewe brand name. These televisions incorporate advanced digital
technology that converts analog television signals into a digitally-enhanced
picture. The televisions also accept a VGA digital input and show it in the
set's native 760 by 480 line progressive scan format. Each of the five models
currently offered feature an attractive industrial design and an intuitive
owner's operating system. We introduced four of the models in November 1998 and
the fifth model was introduced in March 1999. The five models range in screen
size from 30" to 36" in the 4:3 and wide-screen 16:9 formats and also come in
different cabinet finishes and colors.
The market for traditional analog televisions continues to grow, with increasing
unit shipments offsetting lower average selling prices. The market for digital
televisions has not been established, and we do not know how quickly the market
will develop. We believe that the upcoming conversion from analog to digital
broadcasting will create significant demand for televisions that can take
advantage of the enhanced picture quality available from digital signals. In
addition, our televisions convert today's analog signals into a
digitally-enhanced picture, with the goal of providing the consumer the best
available picture regardless of the type and source of the consumer's
programming.
We anticipate that all major television manufacturers will offer digital
televisions with a wide array of features and price points. Most of these
manufacturers have numerous competitive advantages, including greater access to
capital and better brand awareness. In addition, we are currently dependent to a
large extent on engineering and other technological support from Loewe for
development and expansion of our line of televisions.
Digital Audio and Video Products: In April 1998, we purchased California Audio
Labs L.L.C. ("Cal Audio"). Cal Audio designs and develops high-performance
audio, video, and projection television products. Our acquisition of Cal Audio
added DVD players, CD players, digital-to-analog converters, and front
projection television products to our home theater product line, with a five
channel amplifier and digital surround sound processor scheduled to be
introduced in July 1999.
We believe that there is substantial market demand for higher-performance,
higher-margined products which is not being adequately addressed by current
industry participants and that the high-performance market segment offers us
substantial future profit opportunities. Furthermore, consumer buying patterns
have been shifting in recent years such that many consumers are increasingly
demanding complete home theater solutions (purchasing all or most of the
components from a single manufacturer to ensure the highest levels of
compatibility, ease of use, and consistent appearance). As a result, we believe
there is substantial marketing and financial benefit to offering a complete and
integrated line of products within the consumer electronics segments that we
compete. For that reason, we have pursued both internal development and external
relationship sources for television, audio and video products as a part of our
home theater strategy.
We expect to commit substantial resources and management attention to the
further expansion and integration of our home theater product line including our
Loewe digital television and Cal Audio products.
INTERNET PRODUCTS: We plan to introduce several models of internet audio
players, more commonly known as MP3 players, in July 1999. These players can
store computer files downloaded from a personal computer and can also store and
playback music files compressed using the MP3 format. We intend to sell our
internet audio players through many of the same retail stores as our Dual-Deck
VCR under the RaveMP brand.
LICENSING
We entered into a License Agreement with Samsung Electronics of Korea in
February 1989 under which we granted Samsung the use of our patented and
proprietary technology to: (i) on an exclusive basis, manufacture and distribute
Dual-Deck VCR's in the Republic of Korea; (ii) manufacture Dual-Deck VCR's for
us; (iii) on a non-exclusive basis, manufacture and distribute Dual-Deck VCR's
in all markets except the United States and its territories; and (iv) on a
non-exclusive basis, manufacture and distribute Dual-Deck VCR's in the United
4
<PAGE>
States and its territories under Samsung's own trademark and trade names.
Samsung is required to pay us a royalty for sales of Dual-Deck VCR's by Samsung
to any party other than us. To date, we have not received royalty payments under
the Agreement and we are not aware of any sales by Samsung that entitle us to
royalties. The License Agreement requires that we offer improvements in our
Dual-Deck technology without additional fees or royalty to Samsung throughout
the life of the License Agreement. The License Agreement will expire in October
2004 unless it is terminated earlier by Samsung.
We also have a Manufacturing Agreement with Samsung which is automatically
renewed in one year increments unless either company gives at least six months'
notice of cancellation. The Manufacturing Agreement currently extends through
February 2000 (see "PRODUCT DEVELOPMENT AND MANUFACTURING").
In 1994 we licensed Goldstar U.S.A., Inc., on a non-exclusive, non-assignable,
non-transferable basis, to manufacture and distribute worldwide 8mm-to-VHS
VCR's. We received payment for the license in July 1994 as a one-time fee. Our
license with Goldstar expires when the last patent covering the 8mm-to-VHS VCR
held by us expires. In April 1996, we licensed Samsung to manufacture and sell
the 8mm-to-VHS format Dual-Deck VCR's. We received payment for the license in
April 1996 as a one-time fee.
SALES AND MARKETING
We conduct our sales and marketing activities through our Consumer Electronics
and Home Theater divisions. The Consumer Electronics Division's actual and
target customer base includes major national consumer electronic retailers,
catalogs, warehouse clubs, home shopping channels, and mass merchants. Products
are primarily sold under the Go-Video brand and, new for fiscal 2000, RaveMP for
our new line of internet audio (MP3) players. Our Home Theater Division, which
performs sales and marketing activities for Loewe televisions and Cal Audio
product lines, is pursuing distribution through regional and specialist
audio/video retailers and custom home theater installers. In most cases we sell
our product lines with the support of independent sales representatives that
represent specific product categories and geographic territories throughout
North America and who also represent other consumer electronic companies.
The Consumer Electronics Division sells products to over two hundred accounts in
North America, including some of the better known retailers, catalogs, and
warehouse clubs such as Circuit City, Sam's Club, QVC, Costco Warehouse, Damark,
Sears, The Good Guys, Nobody Beats The Wiz, Montgomery Wards, Rex Stores, and
Fry's Electronics. Our marketing methods include attendance at trade shows,
trade publication advertising, television, radio, and print advertising, sales
promotion and other sales support programs, and publicity.
Home theater products include televisions with screen sizes over 27" that are
combined with audio and video components and multiple speakers designed to
replicate the movie theater experience in a consumer's home. Home theater
products are differentiated by wide variations in price, performance, design,
user interface, technology, and marketing and distribution strategy. The home
theater market is served by large, multinational consumer electronic
manufacturers as well as smaller companies that compete mostly in the
higher-priced, specialist audio/video segment. Our Home Theater Division sells
its products to specialist audio/video retailers and custom installers who
primarily service consumers with more demanding performance requirements.
We compete in the consumer electronics industry, which experiences seasonal
buying patterns with a majority of sales occurring between September and
January. Our product line is subject to the same seasonality. We usually
experience seasonal peaks in our sales during our third fiscal quarter which
covers the months of October, November, and December.
Our terms of sale vary according to the quantity and price of units purchased
and the creditworthiness of the customer, but generally do not exceed thirty
days. Warranty terms vary according to the product offered. The most extensive
warranties offered are three months labor and one year parts for VCR's, one year
parts and labor on television products (two years for the picture tube), and one
year parts and labor on Cal Audio products. We have service agreements for our
products with independent service centers located throughout the United States,
and we also provide service work at our Scottsdale, Arizona and Blue Lake,
California locations. We believe we have established adequate reserves for our
future warranty claims.
5
<PAGE>
SIGNIFICANT CUSTOMERS
The following table shows the customers who represented at least 10% of our
annual sales in each of the last two fiscal years:
Customer Fiscal 1999 Fiscal 1998
- -------- ----------- -----------
Sam's Club 18% 28%
Circuit City 12% 13%
QVC 10% --
Although our significant customers fluctuate over time, the loss of a
significant customer would have a materially adverse effect on our operating
results.
BACKLOG ORDERS
Our practice is to maintain sufficient inventories to fill orders promptly and
not carry a backlog of orders. Thus, we did not have a material level of backlog
at June 24, 1999 or June 24 of the previous year.
PRODUCT DEVELOPMENT AND MANUFACTURING
Our product development activities consist of hardware, firmware, and software
design and engineering as well as co-development and engineering of products
with manufacturers and technology partners. We have focused our research and
product development on the development of lower-cost Dual-Deck VCR's, a line of
digital direct view televisions, internet audio devices, home theater audio
products, and evaluation of potential new products, acquisitions, or joint
ventures.
Most of our products are manufactured for us by independent companies. Our
Dual-Deck VCR's are manufactured by two independent manufacturers: Samsung
Electronics (Korea) and Shintom (Japan). We signed a Manufacturing Agreement
with Samsung in February 1989. The agreement provides that Samsung will
manufacture Dual-Deck VCR's to our specifications in conformity to the highest
standards of quality maintained by Samsung in the manufacturing of VCR's.
Quality control and assurance is performed by Samsung at the manufacturing
facility in Korea and we verify product quality by sample testing upon the
product's arrival in the United States. We generally place purchase orders two
months prior to production based on our sales forecasts and inventory levels.
The agreement with Samsung establishes statistical defect tolerances and
provides that the costs of quality defects above the level of standards is to be
borne by Samsung. We purchase products from Samsung F.O.B. Korea on open account
with payments due thirty days after the product was shipped. The Manufacturing
Agreement is automatically renewed for one year periods unless either we or
Samsung provide at least six months advance notice in writing. The Manufacturing
Agreement currently extends to February 2000.
We entered into a Dual-Deck VCR Manufacturing Agreement in January 1996 with
Shintom Corporation. The agreement provides that Shintom will manufacture
Dual-Deck VCR's to our specifications in conformity to the highest standards of
quality maintained by Shintom in the manufacturing of VCR's. Quality control and
assurance is performed by Shintom at its manufacturing facility in Indonesia and
we verify product quality by sample testing upon the product's arrival in the
United States. We generally place purchase orders three months prior to
production based on our sales forecasts and inventory levels. The agreement with
Shintom establishes statistical defect tolerances and provides that the costs of
quality defects above the level of standards is to be borne by Shintom. We
purchase products from Shintom F.O.B. Singapore on open account with payment due
thirty days after the product is shipped. The agreement is automatically renewed
for one year periods unless we or Shintom provide at least twelve months advance
notice, and currently extends to January 2001.
We use two manufacturers for our line of digital televisions: Loewe Opta GmbH
(Germany) and Five Rivers Electronic Innovations, LLC (Tennessee). We signed a
Development, Marketing and Distribution Agreement with Loewe which was effective
January 1998. The agreement provides that Loewe will manufacture televisions to
our specifications in conformity to the highest standards of quality maintained
by Loewe in the manufacturing of televisions. Quality control and assurance is
6
<PAGE>
performed by Loewe at its manufacturing facility in Germany and we verify
product quality by sample testing upon the product's arrival in the United
States. We generally place purchase orders three months prior to production
based on our sales forecasts and inventory levels. The agreement with Loewe
establishes statistical defect tolerances and provides that the costs of quality
defects above the level of standards is to be borne by Loewe. We purchase
products from Loewe F.O.B. Germany using commercial letters of credit opened
approximately thirty days prior to shipment. Payment for the product is by
acceptance due twenty days after the ship date. The initial term of this
agreement is five years to January 2003 and will be automatically renewed for an
additional five year period unless we or Loewe provide notice by January 2001
that the agreement should not be renewed. The agreement also has early
termination provisions for both companies, including Loewe's ability to
terminate the agreement if we fail to purchase certain minimum numbers of
televisions in each year of the agreement.
We entered into a television manufacturing agreement in December 1997 with Five
Rivers Electronic Innovations, LLC ("Five Rivers"). The agreement provides that
Five Rivers will manufacture televisions to our specifications in conformity to
the highest standards of quality maintained by Five Rivers in the manufacturing
of televisions. Quality control and assurance is performed by Five Rivers at its
manufacturing facility in Tennessee and we verify product quality by sample
testing products that are shipped to our warehouse facility in Scottsdale. We
generally place purchase orders three months prior to production based on our
sales forecasts and inventory levels. The agreement with Five Rivers establishes
statistical defect tolerances and provides that the costs of quality defects
above the level of standards is to be borne by Five Rivers. We purchase products
from Five Rivers on open account with payment due thirty days after the product
was shipped. The initial term of this manufacturing agreement is three years and
is automatically renewed for one year periods unless we or Five Rivers provide
at least twelve months advance notice. The manufacturing agreement currently
extends to December 2000.
We use other independent manufacturers for other products under similar terms to
those in place with the manufacturers described above.
PATENTS, TRADEMARKS, AND PROPRIETARY RIGHTS
In August 1988, we obtained United States Patent No. 4,768,110 entitled
"Videocassette Recorder(s) Having Dual Decks For Selective Simultaneous
Functions". We have filed additional U.S. and foreign patent applications for
enhancements related to the Dual-Deck VCR since 1988. In general terms, our
patents cover a videocassette recorder system that has two decks contained in
one housing and has switching combinations which permit simultaneous and/or
auxiliary functions to occur, such as allowing one deck to record while the
other plays. In July 1992, we obtained U.S. Patent No. 5,124,807, entitled "Dual
Deck Videocassette Recorder System", featuring the further enhanced ability of a
Dual-Deck VCR system to duplicate high quality videocassette tapes with good
fidelity and avoidance of copy degradation.
During fiscal 1993, we were issued four new U.S. patents. The first patent
issued, No. 5,194,963, relates to a unique circuit that results in high-quality
duplication of a videocassette tape for in-home use. This circuit is identified
by the registered trademark "AmeriChrome". A second patent, No. 5,216,552,
relates to a unique Dual-Deck VCR video switching system with or without a
built-in tuner. The third patent, No. 5,216,499, relates to a Cable Select Box
Supplemental Splitter, identified by the trademark "Cable Ready Plus". The
fourth patent, No. 5,189,691, relates to a Dual-Deck VCR that includes answering
machine logic that allows the VCR to be used to answer a video telephone system.
During fiscal 1994, we were issued three new U.S. patents. The first patent
issued, No. 5,307,193, relates to a method of control over an infrared
controlled device such as a TV, VCR, or stereo without the use of an infrared
emitter. This method of control uses voltage-induced energy for direct control
of a device with or without a line of sight. A second patent, No. 5,177,618,
relates to additional AmeriChrome circuitry and identification and hardware
control in the presence of certain anti-copy encoding on a videocassette. A
third patent, No. 5,249,087, relates to a rotating scanning device for use with
magnetic storage media. Other U.S. and foreign patent applications are currently
pending. There is no assurance that any additional patents will be granted to
the Company or that the Company's patents will provide meaningful protection
from competition. The Company intends to vigorously enforce its proprietary
technology rights.
7
<PAGE>
We have registered or filed for registration of our trademarks "Sensory
Science", "Go-Video", "AmeriChrome", "California Audio Labs", and "RaveMP" with
the United States Patent and Trademark Office. We have also filed for
registration with the United States Patent and Trademark Office for various
other trademarks. We have developed and own the proprietary operating system
software used by most of our products including the Dual-Deck VCR. We believe
that patents, trademarks, trade names, and proprietary rights, once established,
are very important in the consumer electronics market, and the loss, denial, or
infringement of such patents, trademarks, trade names, and proprietary rights
could hurt our sales and profitability.
ENVIRONMENTAL MATTERS
Although we are subject to various federal, state, and local environmental laws
and regulations, we have not experienced any material cost in complying with
such laws and regulations.
YEAR 2000 COMPLIANCE
We recognize the problems associated with Year 2000 transactions and have
evaluated our management information systems and the possible effect of Year
2000 hardware and software issues. We believe all but one of our internal
management information systems are Year 2000 compliant. The one internal systems
that is not Year 2000 compliant is a customer contact management system that we
expect to replace by September 1999. We have communicated with our significant
suppliers, financial institutions, customers, and other parties that purchase
products or provide critical services or supplies to us to assess their
respective compliance with Year 2000 issues. We have 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 our larger customers are not Year 2000 compliant, payments to us
could be delayed and our cash flow would be affected. If our contract
manufacturers are not Year 2000 compliant, our receipt of inventory may be
disrupted which could affect our sales and cash flow. If our financial
institutions are not Year 2000 compliant, our operations could be disrupted as
vendors and employees await payment for goods and services provided and we await
collection of our accounts receivables.
We are in the process of designing a contingency plan which we expect to
complete by September 1999. However, we cannot provide assurances that our
significant suppliers, financial institutions, and customers will properly
address and resolve critical Year 2000 issues. We have incurred and expect to
continue to incur expenses to make all of our internal systems Year 2000
compliant. We currently estimate that these costs will total less than $200,000.
We have incurred relatively little costs to date specifically associated with
the Year 2000 issue since our rapid sales and employee growth over the last
three years has required that we upgrade our computer systems to support this
growth. The costs of Year 2000 compliance and the date on which we plan to be
completely Year 2000 compliant are based on our current estimates. These
estimates reflect our assumptions about future events, including the continued
availability of third party remediation plans. We cannot be sure that these
estimates will be achieved, and our actual results could differ materially from
our 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.
EMPLOYEES
As of June 24, 1999, we had 92 full-time employees. Our employees are not
represented by labor unions and we consider our relations with our employees to
be good.
8
<PAGE>
EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers are:
NAME AGE POSITIONS
- ---- --- ---------
Roger B. Hackett 48 Chief Executive Officer, President, and
Chief Operating Officer
Edward J. Brachocki 43 Senior Vice President, Corporate Development
Douglas P. Klein 38 Senior Vice President and Chief Financial
Officer, Secretary and Treasurer
Ralph F. Palaia 49 Senior Vice President, Marketing and Sales
Steven G.T. Maine 57 Senior Vice President and Chief Technology
Officer
ROGER B. HACKETT was first elected to our Board of Directors in December 1992
and joined Sensory Science as our President and Chief Operating Officer in
January 1993. In March 1994, Mr. Hackett was elected our Chief Executive Officer
and Chairman of the Board. Prior to joining Sensory Science, Mr. Hackett served
as an executive officer of Serving Software Inc., a Minneapolis, Minnesota-based
provider of computer software used in the health care industry. He also served
as a director of Serving Software from January 1993 until September 1994 when
Serving Software was acquired by HBO & Co. Mr. Hackett received a Bachelor of
Science Degree in Business Administration from Ohio State University.
EDWARD J. BRACHOCKI joined us in February 1993 as Vice President, Marketing, and
was named Vice President, Corporate Development, in August 1994 and Senior Vice
President, Corporate Development in October 1998. From July 1992 until joining
us, Mr. Brachocki was a Senior Associate for MTA/EMCI, a Washington, D.C.-based
consulting firm for the telecommunications and cable television industries,
where he advised clients on marketing issues for technology-based consumer
products. Mr. Brachocki received a Bachelor of Science Degree in Psychology from
Fairfield University in Connecticut.
DOUGLAS P. KLEIN joined us in April 1993 as Assistant Treasurer and was named
Treasurer and Vice President of Finance in October 1993, Corporate Secretary in
April 1994, Chief Financial Officer in September 1995, and Senior Vice President
in October 1998. Mr. Klein was employed from June 1983 through October 1992 by
Continental Bank N.A., Chicago (subsequently acquired by Bank of America), most
recently as Portfolio Manager for the Large Corporate Group. Mr. Klein serves on
the Board of Directors of Desert Schools Federal Credit Union, a
federally-charted credit union with $1.3 billion in assets. Mr. Klein received a
Bachelor of Science Degree in Management from Purdue University, and a Masters
Degree in Management from the J.L. Kellogg Graduate School of Management,
Northwestern University.
RALPH F. PALAIA has served as our Senior Vice President of Marketing and Sales
since December 1997. He also served on our Board of Directors from December 1994
until he joined the company. Prior to joining Sensory Science, Mr. Palaia was
co-owner of Innovative Marketing Group, a marketing and distribution firm
founded in April 1994, which performed marketing-related consultation and
services for consumer electronics and other related product clients. From
February 1991 to April 1994, Mr. Palaia held several sales and marketing
executive positions for Philips Consumer Electronics, a leading international
consumer electronics company, most recently as Senior Vice President of
Marketing and Sales for North America. He received a Bachelor of Arts Degree in
Economics from Duke University.
STEPHEN G.T. MAINE joined us in April 1998 as Senior Vice President and Chief
Technology Officer. Prior to joining us, Mr. Maine was Senior Director of New
Business Development for Broadcom Corporation, where he was responsible for
identifying new product opportunities for high performance mixed signal VLSI
products and technology for the broadband communications and networking markets.
Prior to joining Broadcom in August 1997, Mr. Maine was employed by General
Instruments from 1974 to July 1997 in a variety of positions, most recently as
Vice President of Business Development for Satellite & Data Networks. Mr. Maine
graduated from the University of Aston with a Bachelor of Science degree in
Electrical Engineering and the Birmingham College of Advanced Technology with a
Diploma in Technology (MSEE equivalent.) He holds numerous patents and has
published several articles on integrated circuit computer architectures. He was
one of thirty people selected by Electrical Engineering Times as a major
contributor to the Integrated Circuit Industry.
9
<PAGE>
ITEM 2. PROPERTIES
We lease 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 our option. We also lease a 7,800 square foot engineering and manufacturing
facility in Blue Lake, California, which is fully utilized and in good
condition. The least began in June 1997 and expires in May 2002. We are
currently evaluating our space requirements in relation to our business plan
which anticipates increased needs for personnel, office, and engineering space.
As a result, we expect we will need to lease additional space and to remodel our
existing space, both of which would increase our overall rental costs.
ITEM 3. LEGAL PROCEEDINGS
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were voted upon by our stockholders during the fourth
quarter of the fiscal year ended March 31, 1999.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY
HOLDER MATTERS
Our common stock trades on the American Stock Exchange under the symbol "VCR".
The following table shows the high and low sales prices for the common stock
during the period from April 1, 1997 through March 31, 1999, as reported to us
by the American Stock Exchange. These prices do not include commissions or other
adjustments to the selling price.
Fiscal Year Ended March 31, 1999 Fiscal Year Ended March 31, 1998
-------------------------------- --------------------------------
High Low High Low
---- --- ---- ---
First Quarter $3.5625 $2.3125 $1.9375 $1.2500
Second Quarter $4.6875 $2.5625 $2.6250 $1.3750
Third Quarter $3.5000 $2.6250 $2.8750 $2.0000
Fourth Quarter $4.0000 $2.1250 $2.6250 $1.7500
We had approximately 8,000 beneficial shareholders of our common stock,
including approximately 1,800 stockholders of record (certificate holders
registered directly rather than on account at various brokerages or trustees) as
of March 31, 1999.
We have not paid any cash dividends in the past and we do not intend to pay cash
dividends on our common stock in the future. Instead, we will continue to use
our available cash to support the planned growth of our business. Our credit
agreement does not allow us to pay cash dividends without the consent of our
lender.
ITEM 6. SELECTED FINANCIAL DATA
The following table shows our selected financial data for the last five fiscal
years. You should read this table in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and our financial
statements.
10
<PAGE>
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
Fiscal Year Ended March 31 Eight Months Fiscal Year
------------------------------------------------------ Ended March 31, Ended July 31,
1999 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Sales $63,550,812 $47,143,973 $39,024,306 $33,964,836 $27,602,708 $41,192,644
Net income (loss) from
continuing operations 1,664,368 3,379,631 2,411,509 (2,465,003) 117,801 105,741
Net (loss) from
discontinued operations (583,602) (296,281) (527,178) (406,167) -- --
Net income (loss) from
continuing operations
per share - basic 0.13 0.28 0.21 (0.22) 0.01 0.01
Net (loss) from
discontinued operations
per share - basic (0.05) (0.03) (0.04) (0.04) -- --
Weighted average
shares 13,227,493 12,248,724 11,407,553 11,304,261 11,194,200 11,090,549
BALANCE SHEET
Fiscal Year Ended March 31 Eight Months Fiscal Year
------------------------------------------------------ Ended March 31, Ended July 31,
1999 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ----
Current assets $25,225,608 $15,809,699 $12,503,287 $ 9,783,600 $10,035,234 $10,165,288
Current liabilities 16,864,512 6,684,399 5,361,277 6,236,720 3,184,011 3,608,489
Long-term assets (net) 5,404,421 2,850,572 1,252,444 1,414,386 464,963 541,940
Long-term liabilities 348,552 868,658 1,268,131 283,405 6,245 19,004
Total assets 30,630,029 18,660,271 13,755,731 11,197,986 10,500,197 10,707,228
Total liabilities 17,213,064 7,553,057 6,629,408 6,520,125 3,190,256 3,627,493
Stockholders' equity 13,416,965 11,107,214 7,126,323 4,677,861 7,309,941 7,079,735
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Sensory Science was incorporated in May 1984 and was engaged in
development-stage activities until the fiscal year ended July 31, 1990, when we
began our primary operations of developing, marketing and distributing consumer
electronic products. We experienced substantial losses from our formation
through the fiscal year ended July 31, 1992. We changed our fiscal year-end to
March 31 beginning with the eight month transition period ended March 31, 1995.
Since 1996, we have been able to reduce the manufacturing costs of our primary
product, the Dual-Deck VCR, which in turn has lead to reductions in the retail
price and corresponding increases in consumer demand. In April 1995 we acquired
the predecessor to our Security Products Division. In March 1999, we decided to
exit the video security products business to focus our efforts on development
and marketing of digital consumer electronic products. Beginning in the fiscal
year ended March 31, 1999, we added two major new product lines: digital
televisions and digital audio/video home theater products.
11
<PAGE>
RESULTS OF OPERATIONS
The following table shows the percentage of total revenues represented by the
key items that make up our statements of operations:
Year Ended March 31,
-------------------------------------
1999 1998 1997
---- ---- ----
Revenues:
Dual-Deck VCR's 91.6% 98.0% 98.3%
Digital Televisions 3.5% 0.0% 0.0%
Digital Audio/Video 2.9% 0.0% 0.0%
Other 2.0% 2.0% 1.7%
----- ----- -----
Net sales 100.0% 100.0% 100.0%
Gross profit 24.5% 24.9% 26.3%
Sales and marketing expense 9.7% 8.9% 8.0%
Research and development expense 3.6% 1.9% 2.9%
General and administrative expense 6.9% 6.5% 7.3%
Total operating expenses 20.1% 17.4% 18.1%
Operating income 4.4% 7.5% 8.2%
Other income (expense) (1.6%) (1.2%) (1.9%)
Pre-tax income 2.8% 6.3% 6.3%
Net income from continuing operations 2.6% 7.2% 6.2%
(Loss) from discontinued operations (0.9%) (0.6%) (1.4%)
Net income 1.7% 6.5% 4.8%
FISCAL 1999 COMPARED TO FISCAL 1998
Net sales increased by 35% to $63.6 million for the fiscal year ended March 31,
1999 ("fiscal 1999") from $47.1 million during the fiscal year ended March 31,
1998 ("fiscal 1998"). The increase in net sales was due to a 65% increase in
Dual-Deck VCR ("DDVCR") units sold by our Consumer Electronics Division during
fiscal 1999 compared to fiscal 1998, offset in part by a 22% decrease in the
average selling price per unit over the two periods. The increase in net DDVCR
units sold was due to the expansion of sales into warehouse clubs and home
shopping channels and increased consumer demand as a result of lower retail
prices. Sales by our Home Theater Division contributed approximately 6.4% of our
total net sales for fiscal 1999, up from 0% in prior years. These new sales by
our Home Theater Division resulted from our April 1998 acquisition of California
Audio Labs and the November 1998 commencement of sales of our line of digital
televisions. We anticipate that sales of new products including digital
televisions, MP3 players scheduled for introduction in July 1999, DVD players
with integrated multi-channel amplifiers scheduled for introduction in October
1999, and high-end home theater products including a surround sound processors
and five-channel amplifier scheduled for introduction in July 1999 will
contribute an increasing percentage of our total revenue for fiscal 2000, and
that overall revenue in fiscal 2000 will grow by a similar rate as it did in
fiscal 1999 subject to the successful introduction of these new products and
continued sales increases for DDVCR's.
Gross profit was $15.6 million and $11.7 million for fiscal 1999 and fiscal
1998, respectively, representing a 33% increase in gross profit dollars. The
increase in gross profit dollars was due to higher sales in fiscal 1999 compared
to fiscal 1998. Gross profit as a percentage of net sales ("gross margin")
decreased slightly to 24.5% for fiscal 1999 from 24.9% for fiscal 1998,
primarily as a result of the 22% decrease in the average DDVCR selling price
partially offset by a 20% decrease in the average manufacturing cost per unit.
We anticipate that we will maintain or slightly improve gross margin in fiscal
2000 as a result of scheduled manufacturing cost reductions in our DDVCR line.
However, the gross margin realized in fiscal 2000 will be heavily influenced by
the actual mix of high-fi and mono DDVCR units sold, the successful introduction
of our new products, and our ability to realize the scheduled reductions in
DDVCR manufacturing costs.
Sales and marketing expenses increased 46% to $6.1 million for fiscal 1999 from
$4.2 million for fiscal 1998. As a percentage of net sales, sales and marketing
expenses increased from 8.9% to 9.7% over the same period. The increase in sales
and marketing expense for fiscal 1999 was primarily due to higher sales levels
and a corresponding increase in sales commissions and other variable sales and
marketing costs. Increased expenses for marketing and sales personnel hired in
our Home Theater Division to market and sell the new television and digital
12
<PAGE>
audio/video product lines also contributed to the higher sales and marketing
expenses. We anticipate that sales and marketing expenses in fiscal 2000 will
remain consistent as a percentage of sales to fiscal 1999.
Research and development expenses increased by 149% to $2.3 million for fiscal
1999 from $0.9 million for fiscal 1998. The increase in research and development
expenses was due to a significant increase in the number of engineering and
product management personnel and includes the effect of the April 1998
acquisition of California Audio Labs and its research and development personnel.
As a percentage of sales, research and development expenses increased from 1.9%
to 3.6%. We expect that our growth strategy to develop and market innovative
consumer electronic products will continue to require increased research and
development expenditures in fiscal 2000 and beyond, both in dollars and as a
percentage of sales. We expect that research and development dollars that will
be incurred in fiscal 2000 will increase by a similar amount to the increase we
experienced in fiscal 1999.
General and administrative expenses increased by 42% to $4.4 million for fiscal
1999 from $3.1 million for fiscal 1998. The increase was primarily due to higher
depreciation and amortization expenses related to increased investments in
information systems hardware and software, higher compensation, recruitment and
training expenses, and increased expenses for office supplies and rent related
to the overall increase in the number of employees and the April 1998
acquisition of California Audio Labs. As a percentage of net sales, general and
administrative expenses increased to 6.9% for fiscal 1999 from 6.5% for fiscal
1998. While we anticipate that general and administrative expenses will increase
in fiscal 2000 in dollar amount, we also anticipate that general and
administrative expenses will decrease as a percentage of sales over the same
period.
As a result of the above, we recorded operating income of $2.8 million for
fiscal 1999 compared with operating income of $3.5 million for fiscal 1998. We
recorded net other expense of $1.0 million for fiscal 1999 compared with net
other expense of $0.6 million for fiscal 1998. The increase in net other expense
was due to increased interest expense resulting from an increase in the average
daily loan outstanding. The average daily loan outstanding during fiscal 1999
was $10.7 million compared to $3.8 million in the prior year. The average
interest rate declined in fiscal 1999 to 8.65% from 9.5% for the prior year due
to reductions in the prime lending rate and a 1/2% reduction in our interest
rate spread over the prime rate.
We reported income from continuing operations of $1.7 million for fiscal 1999,
down $1.7 million or 51% from income from continuing operations of $3.4 million
for fiscal 1998. Included in fiscal 1998 net income was a net income tax benefit
of $415,000 resulting from our determination that it is more likely than not
that $530,000 of deferred tax assets will be realized in future years.
In March 1999, we determined that our Security Products Division no longer fit
strategically into our long-term growth plans, and made plans to dispose of the
assets of the division. As a result, the financial results from the Security
Products Division as included as discontinued operations. For fiscal 1999, the
loss from discontinued operations was $0.6 million, which included a provision
of $0.3 million for the loss and disposal costs of exiting the security products
business. We plan to complete the disposal of the assets of the Security
Products Division by July 1999. In fiscal 1998, the discontinued operations
recorded a loss from operations of $0.3 million.
As a result of the above, we reported net income of $1.1 million for fiscal
1999, down $2.0 million or 65% from net income of $3.1 million for the prior
year.
FISCAL 1998 COMPARED TO FISCAL 1997
Net sales increased 21% to $47.1 million for the fiscal year ended March 31,
1998 ("fiscal 1998") from $39.0 million during the fiscal year ended March 31,
1997 ("fiscal 1997"). The increase in net sales was primarily due to a 30%
increase in Dual-Deck VCR ("DDVCR") units sold by our Consumer Electronics
Division during fiscal 1998 compared to fiscal 1997, offset in part by a 6.2%
decrease in the average selling price per unit over the two periods. The
increase in net DDVCR units sold was due to the expansion of sales into
warehouse clubs and increased consumer demand for most models of our current
model line of DDVCR's as a result of lower retail prices. There were no sales by
our Home Theater Division in fiscal 1998.
Gross profit was $11.7 million and $10.2 million for fiscal 1998 and fiscal
1997, respectively, representing a 14% increase in gross profit dollars. The
increase in gross profit dollars was primarily due to higher sales of DDVCR's in
13
<PAGE>
fiscal 1998 compared to fiscal 1997. Gross profit as a percentage of net sales
("gross margin") decreased to 24.9% for fiscal 1998 from 26.3% for fiscal 1997,
primarily as a result of the 6.2% decrease in the average DDVCR selling price
offset in part by a 5.7% decrease in the average manufacturing cost per unit.
Sales and marketing expenses increased by 35% to $4.2 million for fiscal 1998
from $3.1 million for fiscal 1997. As a percentage of net sales, sales and
marketing expenses increased from 8.0% to 8.9% over the same period. The
increase in sales and marketing expense for fiscal 1998 was primarily due to a
bad debt charge of $440,000 as a result of the December 1997 bankruptcy of
Nobody Beats The Wiz, a large retail customer of ours. Excluding the bad debt
charge, sales and marketing expenses were flat as a percentage of sales.
Research and development expenses decreased 18.5% to $0.9 million for fiscal
1998 from $1.1 million for fiscal 1997. The decrease in research and development
expenses was primarily due to an agreement reached effective January 1, 1997
with Loewe Opta GmbH in which Loewe agreed to develop and manufacture,
exclusively for us, a line of digital direct view televisions built to our
specifications. Prior to the agreement with Loewe, we had borne certain
development costs primarily related to software and hardware modifications of
the televisions to prepare them for sale in North America.
General and administrative expenses increased 8.6% to $3.1 million for fiscal
1998 from $2.8 million for fiscal 1997. The increase was primarily due to higher
depreciation and amortization expenses related to increased investments in
information systems hardware and software. Also contributing to the higher
general and administrative expenses were higher compensation, temporary labor,
recruitment, and training expenses. As a percentage of net sales, general and
administrative expenses decreased to 6.5% for fiscal 1998 from 7.3% for fiscal
1997.
As a result of the above, we recorded operating income of $3.5 million for
fiscal 1998 compared with operating income of $3.2 million for fiscal 1997. We
recorded net other expense of $0.6 million for fiscal 1998 compared with net
other expense of $0.7 million for fiscal 1997. The decrease in net other expense
was primarily due to lower interest expense resulting from a decrease in the
average effective interest rate on our line of credit, offset in part by an
increase in the average daily loan outstanding.
We reported income from continuing operations of $3.4 million for fiscal 1998,
up $1.0 million or 40% over income from continuing operations of $2.4 million
for the prior year. The loss from discontinued operations was $0.3 million for
fiscal 1998, reduced from the loss from discontinued operations of $0.5 million
for fiscal 1997. As a result, we reported net income of $3.1 million for fiscal
1998, up $1.2 million or 64% from net income of $1.9 million for fiscal 1997.
Included in fiscal 1998 net income was a net income tax benefit of $0.4 million
resulting from our determination that it is more likely than not that $0.5
million of deferred tax assets will be realized in future years, offset in part
by a provision for alternative minimum income tax and state income tax. We
recorded a provision for its alternative minimum income tax liability of $51,200
for fiscal 1997.
SEASONALITY
Our primary product lines compete within the consumer electronics industry,
which generally experience seasonality in sales. Accordingly, we expect to
experience peaks in our sales from September through January, which covers the
holiday selling season.
FUTURE RESULTS
Our expectations for results of operations and other forward-looking statements
contained in this Annual Report on Form 10K, in particular statements concerning
expected future growth in revenues and earnings, growth of market share, and the
entry into the home theater markets and Internet recording and playback devices,
involve a number of risks and uncertainties. Among the factors that could cause
actual results to differ materially from those expected are the following:
business conditions and general economic conditions; competitive factors, such
as pricing and marketing efforts of rival companies; timing of product
introductions and consumer acceptance of new products; ability of contract
manufacturers to meet product price objectives and delivery schedules;
legislative, regulatory and industry initiatives including the Digital
Millennium Copyright Act that may affect planned or actual product features and
marketing methods; and the pace and success of product research and development.
14
<PAGE>
CAPITAL RESOURCES AND LIQUIDITY
Net cash used by operating activities was $5.5 million for the fiscal year ended
March 31, 1999 ("fiscal 1999") compared with net cash provided by operating
activities of $2.9 million for the fiscal year ended March 31, 1998 ("fiscal
1998"). The $8.4 million increase in cash used by operating activities for
fiscal 1999 was primarily the result of an $8.4 million increase in inventories
and a $2.0 million decrease in net income, offset in part by a $1.9 million
increase in accounts payable. The increase in inventories resulted from a
combination of higher inventory to support higher sales levels, the addition of
digital televisions and California Audio Labs products, and slower inventory
turns of Dual-Deck VCR's. The increase in the accounts payable balance for
fiscal 1999 compared to fiscal 1998 was primarily due to our two primary
Dual-Deck VCR manufacturers agreeing to ship DDVCR's on open account with
payment due thirty days after shipment, a change from the purchase terms in
place one year prior when we paid for products as they shipped.
We had net working capital of $8.4 million and $9.1 million at March 31, 1999
and March 31, 1998, respectively. At March 31, 1999, our current ratio (current
assets divided by current liabilities) was 1.5 to 1, down from 2.4 at March 31,
1998.
We fund our 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, our sales seasonality generally require incremental working capital
for investment primarily in inventories and receivables, and we also used the
line in fiscal 1999 to fund our April 1998 acquisition of California Audio Labs.
Our primary source of funds for the fiscal year ended March 31, 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%. The lender is collateralized by all assets of Sensory
Science. The unused and available line of credit at March 31, 1999 was
approximately $6.4 million. All closing costs related to the origination and
amendment of the financing agreement had been fully amortized by March 31, 1999.
We believe that our current financial resources will be adequate to support
operations over the next twelve months.
In August 1996 we sold $1.5 million of convertible subordinated notes in a
private placement with institutional holders. Notes outstanding after August
1999 must be converted to common stock at our option. As of March 31, 1999,
notes with a principle amount of $1.3 million had been converted.
In 1997 we 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. We incurred fees
totaling $2.3 million for the exclusive right to market and distribute Loewe
Opta direct view televisions in North America which were capitalized. We began
amortizing the capitalized fee on a straight-line basis in November 1998 when we
began shipments of the first televisions.
On April 1, 1998, we acquired California Audio Labs, LLC ("Cal Audio"). Cal
Audio designs, develops, manufactures and distributes digital audio and video
products marketed to the high-performance home theater market under the
California Audio Labs and Cinevision brand names. The purchase price was
$775,000 in cash plus assumption of liabilities of $1.7 million. We have
incurred and expect to continue to incur increased expenses related to the
integration and development of the Cal Audio business and therefore do not
anticipate a meaningful contribution to operating income by Cal Audio during the
fiscal year ending March 31, 2000.
We lease 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 our option. We also lease a 7,800 square foot engineering and manufacturing
facility in Blue Lake, California, which is fully utilized and in good
condition. The least began in June 1997 and expires in May 2002. We are
currently evaluating our space requirements in relation to our business plan
which anticipates increased needs for personnel, office, and engineering space.
As a result, we expect we will need to lease additional space and to remodel our
existing space, both of which would increase our overall rental costs.
15
<PAGE>
INFLATION
Inflation has had no material effect on our operations or financial condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not utilize market risk sensitive instruments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Pages F-1 through F-19
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
16
<PAGE>
PART III
ITEM 10. DIRECTORS, AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding executive officers required by Item 10 is furnished
under "Executive Officers of the Registrant" in Part I of this Report. The other
information required by Item 10 is hereby incorporated by reference from our
definitive proxy statement relating to its Annual Meeting of Stockholders to be
held on August 19, 1999 (the "Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
Information on executive compensation is incorporated herein by reference from
the Registrant's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information on security ownership of certain beneficial owners and management is
incorporated herein by reference from the Registrant's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information on certain relationships and related transactions is incorporated
herein by reference from the Registrant's Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Page or
Method of Filing
----------------
(a) Financial Statements:
(1) Report of Deloitte & Touche LLP. Page F-1
(2) Consolidated Financial Statements and Notes Page F-2
to Consolidated Financial Statements of the
Company for the fiscal years ended March 31,
1999, 1998, and 1997.
(b) Reports on Form 8-K:
We filed one Report on Form 8-K during the fourth quarter of the
fiscal year ended March 31, 1999. The 8-K reported that we had filed
an amendment with the Secretary of the State of Delaware to change the
legal name of our company from Go-Video, Inc. to Sensory Science
Corporation.
17
<PAGE>
(c) Exhibits
The following exhibits are filed as part of this Report.
<TABLE>
<CAPTION>
Exhibit Page or
No. Description Method of Filing
--- ----------- ----------------
<S> <C> <C>
3.1 Certificate of Incorporation of the Incorporated by reference to Exhibit 3-A
Company of S-1 No. 33-17277
3.2 Amendment to Articles of Incorporation Incorporated by reference to the
Company's 8-K filing dated March 2, 1999
3.3 Bylaws of the Company Incorporated by reference to Exhibit 4-B
to S-2 No. 33-38445
4.1 Specimen Certificate representing Common Incorporated by reference to Exhibit 4-A
Stock to S-1 No. 33-17277
4.2 Form of Mandatory Convertible Incorporated by reference to Exhibit 4.3
Subordinated Note to the Company's S-2 Registration and
Filing No. 333-15731 filed November 7,
1996
10.2 Assignment of U.S. Patent Rights to Incorporated by reference to Exhibit
Sensory Science Corporation by R. Terren 10-B(1) to S-1 No. 33-17277
Dunlap and Richard A. Lang, dated October
11, 1985
10.3 Assignment of Japanese Patent Rights to Incorporated by reference to Exhibit
Sensory Science Corporation by R. Terren 10-B(2) to S-1 No. 33-17277
Dunlap and Richard A. Lang, dated August
5, 1987
10.4 Assignment of U.S. Patent Rights to Incorporated by reference to Exhibit
Sensory Science Corporation by R. Terren 10-B(3) to Annual Report on Form10K for
Dunlap, John Berkheimer, and Dwayne 1988 (the "1988
Woodmas, dated August 4, 1988 the fiscal
year ended July 31, 10K")
10.5 Assignment of U.S. Patent Rights to Incorporated by reference to Exhibit
Sensory Science Corporation by R. Terren 10-B(4) to the Company's 1988 10K.
Dunlap, John Berkheimer, and Richard
Otto, dated September 9, 1988
10.6* Form of 1987 Nonstatutory Stock Option Incorporated by reference to Exhibit 4-A
Plan, as amended to the Company's S-8 Registration and
Filing No. 33-18428
10.7* Form of 1989 Nonstatutory Stock Option Incorporated by reference to Exhibit
Plan, as amended 10-C (2) to the Company's S-2
Registration and Filing No. 33-33033
10.8* Form of 1991 Directors' Nonstatutory Incorporated by reference to Exhibit
Stock Option Plan, as amended 28.1 to the Company's S-8 Registration
and Filing No. 33-49924 and Exhibit A to
the Company's 1995 Proxy Statement.
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
10.9* Form of 1991 Employee Stock Option Plan Incorporated by reference to Exhibit
28.1 to the Company's S-8 Registration
and Filing No. 33-49926
10.11 Settlement Agreement, Manufacturing Incorporated by reference to Exhibit
Agreement, License and Technical 10-E(10) to S-1 No. 33-18433
Assistance Agreement and Mutual Release
between Sensory Science Corporation, and
Samsung Electronics Co. Ltd., dated
February 28, 1989.
10.14** Manufacturing Agreement between Sensory Incorporated by reference to Exhibit
Science Corporation and Samsung Corporation, 10.14 to the 1993 10K.
dated September 14, 1993.
10.16* Separation Agreement between Roger B. Incorporated by reference to Exhibit
Hackett and Sensory Science Corporation, 10.16 to the 1993 10K.
dated August 2, 1993.
10.17** License Agreement between Sensory Science Incorporated by reference to Exhibit
Corporation. and Goldstar U.S.A., Inc., 10.17 to the Company's Annual Report
dated July 11, 1994. Form 10K for fiscal year ended
July 31, 1994 (the "1994 10K").
10.22 Office Lease Agreement between Sensory Incorporated by reference to Exhibit
Science Corporation and 78 McClain, 10.22 to the Quarterly Report Form 10Q
L.L.C., for premises at 7835 East McClain for the quarter ended January 31, 1995.
Drive, Scottsdale, AZ, dated November 15,
1994.
10.24* Form of 1993 Employee Stock Option Plan Incorporated by reference to Exhibit
10.24 to the Transition Report 1995 10K.
10.26** Manufacturing Agreement between Sensory Incorporated by reference to Exhibit
Science Corporation and Shintom Co. Ltd. 10.26 to the Quarterly Report Form 10Q
and Talk Corporation, dated January 9, for the quarter ended December 31, 1995.
1996.
10.27** First Amendment to Manufacturing Incorporated by reference to Exhibit
Agreement between Sensory Science 10.27 to the 1996 10K.
Corporation and Samsung Corporation dated
April 1, 1996.
10.29 Amended and Restated Loan and Security Incorporated by reference to Exhibit to
Agreement between Sensory Science the Report Form dated 10Q for the
Corporation and Congress Financial, quarter ended September 30, 1998.
August 19, 1998
10.30 Development, Marketing, and Distribution Incorporated by reference to Exhibit
Agreement between Sensory Science 10.30 to the Quarterly dated January
Corporation and Loewe Opta GmbH 1, 1997 Report Form 10Q for the quarter ended
September 30, 1997
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
10.31 Acquisition Agreement By and Between Incorporated by reference to Exhibit
Sensory Science Corporation, Go-Video 10.31 to the Annual Report on Form 10K
Productions, Inc. and Pornthep Srichawla, for the fiscal year ended March 31, 1998
Akradej Srichawla, and Vorthep Srichawla
dated April 1, 1998
21 List of Subsidiaries Filed Herewith
23 Independent Auditor's Consent Filed Herewith
27 Financial Data Schedule Filed Herewith
</TABLE>
- ----------
* Management contract or compensatory plan
** Confidential treatment requested
(d) Financial Statement Schedules:
Schedules have been omitted because of the absence of conditions under
which they are required or because the required material information
is included in the Consolidated Financial Statements or Notes to the
Consolidated Financial Statements included herein.
20
<PAGE>
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.
SENSORY SCIENCE CORPORATION
By /s/ Roger B. Hackett
------------------------------------
Roger B. Hackett
Chairman of the Board of Directors,
Chief Executive Officer, President,
and Chief Operating Officer
Dated: June 25, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the date indicated.
Name and Signature Title Date
------------------ ----- ----
/s/ Roger B. Hackett Chairman of the Board of June 25, 1999
- ----------------------------- Directors, Chief Executive
Roger B. Hackett Officer, President, and Chief
Operating Officer
(principal executive officer)
/s/ Douglas P. Klein Chief Financial Officer, June 25, 1999
- ----------------------------- Senior Vice President,
Douglas P. Klein Secretary and Treasurer
(principal financial and
accounting officer)
/s/ Carmine F. Adimando Director June 25, 1999
- -----------------------------
Carmine F. Adimando
/s/ Thomas F. Hartley, Jr. Director June 25, 1999
- -----------------------------
Thomas F. Hartley, Jr.
/s/ Thomas E. Linnen Director June 25, 1999
- -----------------------------
Thomas E. Linnen
/s/ William T. Walker, Jr. Director June 25, 1999
- -----------------------------
William T. Walker, Jr.
S-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Sensory Science Corporation
Scottsdale, Arizona
We have audited the accompanying consolidated balance sheets of Sensory Science
Corporation (formerly Go-Video, Inc.) and subsidiaries (the "Company") as of
March 31, 1999 and 1998, and the related consolidated statements of income,
stockholders' equity and cash flows for each of the three years in the period
ended March 31, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on the
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company at March 31, 1999 and
1998, and the results of its operations and its cash flows for each of the three
years in the period ended March 31, 1999 in conformity with generally accepted
accounting principles.
/S/ DELOITTE & TOUCHE
Phoenix, Arizona
June 7, 1999
F-1
<PAGE>
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
(Formerly Go-Video, Inc.)
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
March 31,
-------------------------
ASSETS (Note 13) 1999 1998
CURRENT ASSETS:
Cash and cash equivalents $ 358,038 $ 445,925
Receivables - less allowance for doubtful accounts
of $98,500 and $100,000, respectively (Note 2) 10,526,335 9,019,697
Inventories (Note 6) 13,934,301 4,708,835
Prepaid expenses and other assets 191,519 47,146
Deferred income taxes (Note 10) 100,000 100,000
Net investment in discontinued operations (Note 4) 115,415 1,488,096
----------- -----------
Total current assets 25,225,608 15,809,699
----------- -----------
EQUIPMENT AND IMPROVEMENTS (Note 11):
Furniture, fixtures and equipment 875,270 585,096
Leasehold improvements 212,830 212,830
Office equipment 1,131,546 844,056
Tooling 1,587,602 1,353,360
----------- -----------
Total 3,807,248 2,995,342
Less accumulated depreciation and amortization 2,561,827 2,103,868
----------- -----------
Equipment and improvements - net 1,245,421 891,474
----------- -----------
DUAL-DECK VCR PATENTS - Net of amortization
of $65,930 and $54,410, respectively 149,381 121,607
GOODWILL - Net of amortization of $60,159 1,173,316
MARKET EXCLUSIVITY FEE - Net of amortization
of $237,000 (Note 3) 2,085,598 1,374,248
DEFERRED INCOME TAXES (Note 10) 470,000 430,000
INVESTMENT IN PREFERRED STOCK 250,000
OTHER ASSETS 30,705 33,243
----------- -----------
TOTAL $30,630,029 $18,660,271
=========== ===========
(Continued)
F-2
<PAGE>
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
(Formerly Go-Video, Inc.)
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
March 31,
--------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 1999 1998
----------- -----------
CURRENT LIABILITIES:
Accounts payable $ 4,147,579 $ 1,992,163
Accrued expenses 1,395,460 1,042,039
Current portion of capital lease
obligations (Note 11) 82,851 89,380
Other current liabilities (Note 7) 1,678,535 1,726,985
Warranty reserve - current 222,000 160,000
Income taxes payable (Note 10) 2,724 23,000
Line of credit (Note 13) 9,335,363 1,650,832
----------- -----------
Total current liabilities 16,864,512 6,684,399
DEFERRED RENT 42,533 37,152
CAPITAL LEASE OBLIGATIONS (Note 11) 8,844 90,673
WARRANTY RESERVES 85,500
MANDATORY CONVERTIBLE
SUBORDINATED DEBT (Note 8) 211,675 740,833
----------- -----------
Total liabilities 17,213,064 7,553,057
----------- -----------
COMMITMENTS AND CONTINGENCIES
(Notes 3 and 11)
STOCKHOLDERS' EQUITY (Note 9):
Common stock, $.001 par value - authorized,
50,000,000 shares; issued and outstanding,
13,658,052 and 12,643,297 shares, respectively 13,658 12,643
Additional capital 21,708,124 20,480,154
Accumulated deficit (8,304,817) (9,385,583)
----------- -----------
Total stockholders' equity 13,416,965 11,107,214
----------- -----------
TOTAL $30,630,029 $18,660,271
=========== ===========
See notes to consolidated financial statements. (Concluded)
F-3
<PAGE>
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
(Formerly Go-Video, Inc.)
CONSOLIDATED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years Ended March 31,
-----------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
SALES (Note 2) $63,550,812 $47,143,973 $39,024,306
COST OF SALES 47,991,792 35,423,691 28,777,854
----------- ----------- -----------
Gross profit 15,559,020 11,720,282 10,246,452
----------- ----------- -----------
OTHER OPERATING COSTS:
Sales and marketing 6,137,413 4,211,402 3,111,216
Research and development (Note 3) 2,261,912 906,638 1,112,675
General and administrative expenses 4,374,075 3,078,512 2,836,019
----------- ----------- -----------
Total other operating costs 12,773,400 8,196,552 7,059,910
----------- ----------- -----------
Operating income 2,785,620 3,523,730 3,186,542
----------- ----------- -----------
OTHER REVENUES (EXPENSES):
Interest income 21,449 11,206 16,846
Interest expense (1,047,441) (561,704) (667,149)
Other (2,210) (8,651) (73,530)
----------- ----------- -----------
Total other expenses - net (1,028,202) (559,149) (723,833)
----------- ----------- -----------
INCOME BEFORE PROVISION
(BENEFIT) FOR INCOME TAXES 1,757,418 2,964,581 2,462,709
PROVISION (BENEFIT) FOR INCOME
TAXES (Note 10) 93,050 (415,050) 51,200
----------- ----------- -----------
INCOME FROM CONTINUING OPERATIONS 1,664,368 3,379,631 2,411,509
DISCONTINUED OPERATIONS (Note 4):
Loss from operations - net tax benefits of
of $24,050, $11,950 and $11,200 (293,655) (296,281) (527,178)
Provision for loss on disposal (289,947)
----------- ----------- -----------
NET INCOME $ 1,080,766 $ 3,083,350 $ 1,884,331
=========== =========== ===========
DILUTED INCOME PER COMMON SHARE:
Continuing operations $ .12 $ .25 $ .20
Discontinued operations (.04) (.02) (.04)
----------- ----------- -----------
Diluted income per common share $ .08 $ .23 $ .16
=========== =========== ===========
BASIC INCOME PER COMMON SHARE:
Continuing operations $ .13 $ .28 $ .21
Discontinued operations (.05) (.03) (.04)
----------- ----------- -----------
Basic income per common share $ .08 $ .25 $ .17
=========== =========== ===========
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
(Formerly Go-Video, Inc.)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED MARCH 31, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Common Stock Unamortized
------------------- Additional Consulting Accumulated
Shares Amount Capital Services Deficit Total
------ ------ ------- -------- ------- -----
<S> <C> <C> <C> <C> <C> <C>
BALANCE, APRIL 1, 1996 (Note 9) 11,331,012 $ 11,331 $19,054,796 $(35,002) $(14,353,264) $ 4,677,861
Stock options exercised for cash 104,000 104 115,276 115,380
Stock grant 35,466 36 42,080 42,116
Private placement (Note 8) 60,000 60 27,306 27,366
Conversion of subordinated
debt (Note 8) 206,807 206 224,063 224,269
Exercise of warrants issued in
conjunction with private
placement (Note 8) 100,000 100 124,900 125,000
Amortization of consulting costs 30,000 30,000
Net income 1,884,331 1,884,331
---------- -------- ----------- ------ ------------ -----------
BALANCE, MARCH 31, 1997 (Note 9) 11,837,285 11,837 19,588,421 (5,002) (12,468,933) 7,126,323
Stock options exercised for cash 175,020 175 188,597 188,772
Payment of interest on subordinated
debt in stock 54,342 54 99,946 100,000
Conversion of subordinated debt
(Note 8) 341,400 342 339,059 339,401
Exercise of warrants issued in
conjunction with private placement
(Note 8) 224,000 224 279,767 279,991
Stock issued - private placement 11,250 11 (11)
Cash paid for conversion costs (Note 8) (15,625) (15,625)
Amortization of consulting costs 5,002 5,002
Net income 3,083,350 3,083,350
---------- -------- ----------- ------ ------------ -----------
BALANCE, MARCH 31, 1998 (Note 9) 12,643,297 12,643 20,480,154 (9,385,583) 11,107,214
Stock options exercised for cash 307,000 307 393,168 393,475
Payment of interest on subordinated
debt in stock 22,755 23 81,334 81,357
Conversion of subordinated debt
(Note 8) 500,000 500 528,653 529,153
Exercise of warrants issued in
conjunction with private placement
(Note 8) 180,000 180 224,820 225,000
Stock issued - private placement 5,000 5 (5)
Net income 1,080,766 1,080,766
---------- -------- ----------- ------ ------------ -----------
BALANCE, MARCH 31, 1999 (Note 9) 13,658,052 $ 13,658 $21,708,124 $ $ (8,304,817) $13,416,965
========== ======== =========== ====== ============ ===========
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
(Formerly Go-Video, Inc.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years Ended March 31,
---------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,080,766 $ 3,083,350 $ 1,884,331
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 830,944 583,571 623,407
Provision for losses on accounts receivable (1,500) (30,000)
Loss (gain) on sale of equipment 2,790 10,578 (834)
Provision for loss on disposal of
discontinued operations 289,947
Changes in operating assets and liabilities -
net of acquisition:
Receivables (1,248,286) (2,028,780) (2,900,774)
Inventories (8,419,299) 217,314 (38,684)
Prepaid expenses and other assets (144,373) (11,793) 6,668
Deferred income taxes (40,000) (530,000)
Patents (39,294) (62,497) 3,230
Other assets 2,538 17,699 73,308
Accounts payable 1,908,715 767,406 (1,287,837)
Accrued expenses 419,676 183,777 604,191
Other current liabilities (67,797) 746,907 357,191
Warranty reserve (22,500) (13,000) (18,000)
Income taxes payable (20,276) 3,000 20,000
Other long-term liabilities 5,381 7,413 14,219
----------- ----------- -----------
Net cash (used in) provided by operating
activities (5,462,568) 2,944,945 (659,584)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Equipment and improvement expenditures (727,568) (318,744) (464,867)
Investments in and advances to discontinued operations 1,065,688 (1,229,492) 184,664
Acquisitions - net of cash acquired from acquisition (773,904)
Investment in preferred stock (250,000)
Market exclusivity fee (948,350) (1,374,248)
----------- ----------- -----------
Net cash used in investing activities (1,634,134) (2,922,484) (280,203)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 618,475 468,763 295,098
Registration costs (15,625) (17,500)
Net borrowings (repayments) under line of credit 7,684,531 (249,636) (529,862)
Payment on capital lease obligations (88,358) (82,826) (108,943)
Net proceeds from issuance of mandatory
convertible debt 1,350,000
Payment of financing costs (60,134)
Payment of debt assumed in acquisition (1,205,833)
----------- ----------- -----------
Net cash provided by financing activities 7,008,815 120,676 928,659
----------- ----------- -----------
</TABLE>
(Continued)
F-6
<PAGE>
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
(Formerly Go-Video, Inc.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years Ended March 31,
--------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (87,887) 143,137 (11,128)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 445,925 302,788 313,916
----------- ----------- -----------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 358,038 $ 445,925 $ 302,788
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION:
Cash paid for income taxes $ 129,276 $ 100,000 $ 20,000
=========== =========== ===========
Cash paid for interest $ 1,042,369 $ 483,789 $ 391,625
=========== =========== ===========
Common shares issued for consulting services $ 75,000
===========
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Conversion of subordinated debt, accrued
interest and payment of interest to common
stock (Note 8) $ 610,510 $ 439,401 $ 224,269
=========== =========== ===========
In connection with the acquisition (Note 14):
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
acquired assets $ 1,233,475
===========
</TABLE>
See notes to consolidated financial statements. (Concluded)
F-7
<PAGE>
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
(FORMERLY GO-VIDEO, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 31, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Sensory Science Corporation (formerly Go-Video, Inc.) and subsidiaries (the
"Company") develop, design, engineer and market consumer electronic and
video security products (Note 4). The Company currently contracts with
independent electronics manufacturers to produce its products to its
specifications. The Company normally receives such products at its
Scottsdale, Arizona facility. Distribution of its products occurs upon
receipt of customer orders.
The following are the significant accounting and financial policies used in
the preparation of the consolidated financial statements of the Company.
a. THE CONSOLIDATED FINANCIAL STATEMENTS include the accounts of the
Company and its wholly-owned subsidiaries, Go-Video Productions, Inc.,
which has not initiated operations, and California Audio Labs, LLC
("Subsidiaries").
b. CASH AND CASH EQUIVALENTS consist of cash accounts and overnight
investment accounts. Cash and cash equivalents have initial maturity
dates of three months or less and are stated at cost, which
approximates market.
c. INVENTORIES are stated at the lower of cost (first-in, first-out) or
market.
d. EQUIPMENT AND IMPROVEMENTS are stated at cost. Depreciation is
calculated by the straight-line method over the estimated useful lives
of the assets of two to five years. Amortization, by the straight-line
method, of leased furniture and improvements to leased property is
based upon the term of the applicable lease or the estimated useful
lives of such assets, whichever is less. Tooling costs primarily
relate to Dual-Deck VCRs. Depreciation of tooling is calculated using
the number of new units sold (not to exceed two years) as the tooling
costs relate directly to the manufacturing of the new units.
e. DUAL-DECK VCR PATENTS represent professional fees and other costs
incurred in connection with obtaining patents for the Dual-Deck VCR.
The patent costs are amortized by the straight-line method over the
estimated life of the patents.
f. GOODWILL represents the excess of the cost of the acquired company
over the fair value of the net assets at the date of acquisition.
Goodwill is amortized using the straight-line method over a period of
20 years.
g. REVENUE RECOGNITION - Sales of products are recognized once the
product is shipped to the customer.
h. INCOME TAXES - The Company files a consolidated tax return. As of
August 1, 1993, the Company adopted the Financial Accounting Standards
Board's ("FASB") Statement of Financial Accounting Standard ("SFAS")
No. 109, ACCOUNTING FOR INCOME TAXES, which requires the use of the
liability method of accounting for deferred income taxes.
F-8
<PAGE>
i. EARNINGS PER SHARE - In accordance with SFAS No. 128, basic income
(loss) per common share is computed based on the weighted average
number of common shares outstanding during each period. Diluted income
(loss) per share is computed based on the weighted average number of
common and common equivalent shares outstanding during each year and
includes shares issuable upon exercise of stock options, except in
those circumstances where such options would be antidilutive.
j. ACCOUNTING FOR STOCK-BASED COMPENSATION - As permitted by SFAS No.
123, ACCOUNTING FOR STOCK BASED COMPENSATION, the Company uses the
intrinsic value method prescribed by Accounting Principles Board
Opinion No. 25 "Accounting for Stock Issued to Employees" for
measurement and recognition of employee stock based transactions. Pro
forma information reflecting the fair value method is presented in
Note 9.
k. NEW ACCOUNTING PRONOUNCEMENTS - In June of 1997, the FASB issued SFAS
No. 130, Reporting Comprehensive Income, the provisions of which are
effective for fiscal years beginning after December 15, 1997. The
Company had no transactions of a comprehensive income nature during
the periods presented.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133, which requires that
entities record all derivatives as assets or liabilities, measured at
fair value, with the change in fair value recognized in earnings or in
other comprehensive income, depending on the use of their derivative
and whether it qualifies for hedge accounting. SFAS No. 133, as
issued, is effective for all fiscal quarters of all fiscal years
beginning after June 15, 1999. Subsequent to the issuance of SFAS No.
133, the FASB issued an exposure draft which, if adopted, would defer
the implementation of SFAS No. 133 for one year. The Company is in the
process of evaluating the impact which will result upon adoption of
this standard.
l. USE OF ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles necessarily
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.
m. PRODUCT CONCENTRATION - The market for the Company's products is
characterized by changing technology and short product life cycles.
The Company has derived substantially all of its revenues from the
sale of Dual-Deck VCRs throughout the United States.
n. CERTAIN RECLASSIFICATIONS have been made to the prior year financial
statements to conform to the classifications used in the 1999
presentation.
2. COMPANY OPERATIONS
The Company was incorporated in May 1984 and was engaged in development
stage activities until late in the fiscal year ended July 31, 1990, when
the Company began its primary operations of distribution and marketing
Dual-Deck VCRs, which are being manufactured for the Company by Samsung
Electronics Company Ltd. ("Samsung") and Shintom Company Ltd., and Talk
Corporation ("Shintom & Talk"). The Company also distributes and markets a
line of digital televisions and digital audio/video home theater products.
F-9
<PAGE>
SALES AND MARKETING - The Company's current marketing strategy is to sell
its products with the support of independent sales representatives that
represent specific geographic territories throughout the United States and
who also represent many other brand name consumer electronic products. The
Company currently sells its product lines directly to retailers nationwide
and warehouse clubs including numerous national and regional chains,
catalog accounts, specialty stores, and Armed Services PXs.
During fiscal 1999, sales from continuing operations to the Company's three
major customers totaled $11,534,000, $7,489,000 and $6,350,000, which
represents approximately 18 percent, 12 percent and 10 percent,
respectively, of the Company's 1999 sales. Accounts receivable from these
customers totaled $1,404,000, $1,322,000 and $548,000, respectively, at
March 31, 1999.
During fiscal 1998, sales from continuing operations to the Company's two
major customers totaled $13,310,000 and $6,271,000, which represents
approximately 28 percent and 13 percent, respectively, of the Company's
1998 sales. Accounts receivable from these customers totaled $3,893,000 and
$1,164,000, respectively, at March 31, 1998.
During fiscal 1997, sales from continuing operations to the Company's three
major customers totaled $6,395,000, $4,377,000 and $4,137,000,
respectively. These amounts represent 16 percent, 11 percent and 11
percent, respectively, of the Company's 1997 sales. Accounts receivable
from these customers totaled $437,000, $2,441,000 and $1,484,000,
respectively, at March 31, 1997.
3. PRODUCT MANUFACTURING AND LICENSING
On February 28, 1989, the Company entered into an agreement with Samsung,
pursuant to which Samsung agreed to manufacture Dual-Deck VCRs to the
Company's design and specification ("Manufacturing Agreement"). As part of
its arrangement with Samsung, the Company has licensed to Samsung the use
of the Company's proprietary and patented technology: (1) the right to
manufacture Dual-Deck VCRs for the Company; (2) on an exclusive basis, the
right to manufacture, use and sell Dual-Deck VCRs in the Republic of Korea;
(3) on a non-exclusive basis, the right to manufacture, use and sell the
Dual-Deck VCRs in all markets except the United States and its territories;
and (4) on a non-exclusive basis, the right to sell Dual-Deck VCRs under
its own trademark and trade name in the United States and its territories.
Under the license agreement, the Company is entitled to receive royalties
calculated as a percentage of net sales of Dual-Deck VCRs by Samsung or its
sublicensees. The license agreement has a term of 15 years but may be
terminated by the Company if the Manufacturing Agreement is terminated for
any cause attributable to Samsung. The Company has received no royalties to
date from Samsung under this agreement.
Under the Manufacturing Agreement, Samsung manufactures Dual-Deck VCRs for
the Company pursuant to the Company's specifications. Quality control and
assurance is performed by Samsung at the manufacturing facility, and the
Company verifies product quality by sample testing in the United States.
The Manufacturing Agreement sets forth statistical defect tolerances, and
indicates that the costs of any quality defects above the level of
standards will be borne by Samsung. Generally, the Company purchases
Dual-Deck VCRs from Samsung FOB Korea. The Manufacturing Agreement is
automatically renewed for one year periods unless terminated by written
notice from either party and currently extends until at least February 28,
2000.
On January 9, 1996, the Company entered into an agreement with Shintom &
Talk pursuant to which Shintom & Talk have agreed to manufacture Dual-Deck
VCR's to the Company's design and specification. The agreement sets forth
statistical defect tolerances, and indicates that the costs of any quality
defects above the level of standards will be borne by Shintom & Talk.
F-10
<PAGE>
Generally, the Company will purchase Dual-Deck VCRs FOB Singapore. The
initial term of the Manufacturing Agreement was two years. The agreement is
automatically renewed for one year periods unless terminated by either
party and currently extends until at least January 2001.
The Company entered into an agreement with Loewe Opta GmbH ("Loewe") 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 $1.7 million and
Deutsche Marks 1,050,000 (approximately U.S. $623,000) for the exclusive
right to market and distribute Loewe Opta direct view televisions in North
America. Additionally, the agreement is structured so that Loewe Opta
reimburses development and marketing costs for the project. Through March
31, 1999, Loewe Opta had reimbursed $4,220,000, of which $372,000 remained
to be incurred as an expense. This amount is included in other current
liabilities (Note 7). The Company capitalized a total of $2.3 million
related to this market exclusivity fee and is amortizing the balance over
the remaining life of the agreement, beginning with the first shipment from
Loewe.
4. DISCONTINUED OPERATIONS
In fiscal 1999, the Company approved plans to dispose of its security
products business. The sale of the business is expected to occur in fiscal
year 2000. Revenues applicable to the operations of the discontinued
security products business totaled $3,977,000, $1,754,000 and $1,151,000 in
1999, 1998 and 1997, respectively.
Investments in discontinued operations consist of the following assets and
liabilities at March 31:
1999 1998
---- ----
Accounts receivable - net $ 815,257 $ 440,384
Inventory 722,960 1,303,187
Furniture and fixtures 16,600 9,539
Goodwill - net 119,324
Current liabilities (927,892) (174,677)
Borrowings on line of credit (511,510) (209,661)
--------- ----------
Net investment in discontinued operations $ 115,415 $1,488,096
========= ==========
F-11
<PAGE>
5. EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators of
basic and diluted per share computations for income from continuing
operations as required by SFAS No. 128:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Income from continuing operations $ 1,664,368 $ 3,379,631 $ 2,411,509
=========== =========== ===========
Average outstanding common shares 13,227,493 12,248,724 11,407,553
=========== =========== ===========
Basic income per share from
continuing operations $ 0.13 $ 0.28 $ 0.21
=========== =========== ===========
Diluted income from continuing
operations per common share - income
available to common stockholders, from
above $ 1,664,368 $ 3,379,631 $ 2,411,509
Add interest on presumed conversion of
convertible debt 41,250 89,077 76,951
----------- ----------- -----------
Income available to common stockholders
available for diluted earnings per share $ 1,705,618 $ 3,468,708 $ 2,488,460
=========== =========== ===========
Average outstanding common shares,
from above 13,227,493 12,248,724 11,407,553
Additional dilutive shares related to stock
options and warrants 1,113,701 685,555 258,467
Additional dilutive shares related to
subordinated notes 392,500 866,352 902,320
----------- ----------- -----------
Average outstanding and potentially dilutive
common shares 14,733,694 13,800,631 12,568,340
=========== =========== ===========
Diluted income per share from
continuing operations $ 0.12 $ 0.25 $ 0.20
=========== =========== ===========
</TABLE>
Options and warrants to purchase 18,300, 257,700 and 1,137,500 shares of
common stock at various prices during the years ended March 31, 1999, 1998
and 1997, respectively, were not included in the computation of diluted
earnings per share because the exercise of options and warrants was
determined to be antidilutive.
No events have occurred subsequent to March 31, 1999 which would have
changed materially the number of common shares or potential common shares
outstanding at March 31, 1999 had the events occurred prior to March 31,
1999.
F-12
<PAGE>
6. INVENTORIES
Inventories consisted of the following at March 31:
1999 1998
----------- ----------
Service replacement parts and raw materials $ 987,995 $ 561,896
Finished goods 12,946,306 4,146,939
----------- ----------
Total $13,934,301 $4,708,835
=========== ==========
7. OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following at March 31:
1999 1998
---------- ----------
Compensation and related benefits $ 889,075 $ 886,236
Sales returns reserve 408,847 244,334
Unexpended development and marketing
advance (Note 3) 372,350 590,124
Other 8,263 6,291
---------- ----------
Total $1,678,535 $1,726,985
========== ==========
8. MANDATORY CONVERTIBLE SUBORDINATED DEBT
The Company sold $1,500,000 of convertible subordinated notes (the "Notes")
in a Private Placement with institutional holders in August 1996. The
Private Placement included six Units, each consisting of one 10 percent
Convertible Subordinated Note in the principle amount of $250,000 and
warrants to purchase 100,000 shares of common stock at $1.25 per share
(Note 9). The Notes bear interest at 10 percent per annum, accrued
quarterly, paid annually in shares of common stock. At the Unit Holder's
election at any time, or the Company's election following the third
anniversary of the issuance of the Units, each Note will be convertible
into shares of common stock. The warrants have been valued at $230,000.
In connection with the Private Placement, the Company also issued 120,000
warrants to purchase common shares at $1.25 per share and 60,000 shares of
common stock to the placement agent with a fair value of $46,000 and
$75,000, respectively. In addition, professional fees in the amount of
approximately $236,000 were incurred by the Company in connection with the
Private Placement.
In 1997, Notes with a principle amount of $250,000 were converted. The
transaction, including interest, resulted in the issuance of 206,807 shares
of common stock to note holders. In addition, 100,000 warrants held by a
note holder were exercised to purchase 100,000 shares of common stock at a
price of $1.25 per share.
In 1998, Notes with a principal amount of $375,000 were converted. The
transactions, including interest on all Notes outstanding, resulted in the
issuance of 395,742 shares of common stock to note holders. In addition,
224,000 warrants issued to note holders and the placement agent in the
prior year were exercised to purchase stock at a price of $1.25 per share.
In 1999, Notes with a principal amount of $625,000 were converted. The
transaction, including interest on all Notes outstanding, resulted in the
issuance of 522,755 shares of common stock to noteholders. In addition,
180,000 warrants issued to noteholders and the placement agent in the prior
year were exercised to purchase stock at a price of $1.25 per share.
F-13
<PAGE>
9. STOCKHOLDERS' EQUITY
STOCK WARRANTS - During the year ended March 31, 1996, the Company entered
into four separate consulting agreements. In exchange for services, the
Company issued 110,000 warrants. Each warrant entitles the holder to
purchase one share of the Company's common stock. The warrants are
exercisable for four years, commencing one year after the date of grant.
The associated consulting costs for these agreements have been fully
amortized as of March 31, 1999.
A summary of warrant activity is as follows:
Warrants Warrant
Outstanding Price per Share
----------- ---------------
Balance, April 1, 1996 2,633,395 $1.563 - $8.250
Issued (Note 8) 720,000 1.250
Exercised (100,000) 1.250
Expired (2,146,951) 4.950 - 8.250
---------- ------ ------
Balance, March 31, 1997 1,106,444 1.250 - 3.125
Issued 22,500 1.250
Exercised (224,000) 1.250
Expired (76,444) 2.250 - 3.125
---------- ------ ------
Balance, March 31, 1998 828,500 $1.25 $1.688
Exercised (180,000) 1.250
---------- ------ ------
Balance, March 31, 1999 648,500 $1.250 - $1.688
==========
STOCK OPTION PLANS - Effective December 1986, the Company adopted a
Nonstatutory Stock Option plan. Pursuant to the terms of the plan, only
employees of the Company are eligible to participate. Eligibility is
determined by a committee (the "Committee") appointed by the Board of
Directors to administer the plan. The Company reserved 2,000,000 shares of
its common stock to be granted under the plan.
Effective November 1989, the Board of Directors approved the 1989
Nonstatutory Stock Option Plan. Pursuant to the terms of the plan, only
full-time employees and directors of the Company or any entity in which the
Company has at least 50 percent ownership are eligible to participate.
Eligibility is determined by the Committee which administers the plan. The
Company has reserved 500,000 shares of its common stock to be granted under
the 1989 plan.
Effective November 1991, the Company's stockholders approved the Go-Video,
Inc. 1991 Employee Stock Option Plan. This plan provides for the granting
of incentive and nonqualified stock options to eligible officers and
employees of the Company as determined by the plan Committee who
administers the plan. The Company reserved 500,000 shares of its common
stock to be granted under the plan.
Effective December 1993, the Company's stockholders approved the Go-Video,
Inc. 1993 Employee Stock Option Plan. The plan provides for the granting of
incentive and nonqualified stock options to officers and key employees of
the Company as determined by the 1993 plan committee who administers the
plan. The Company reserved 500,000 shares of its common stock to be granted
under the plan. During 1997, the Company reserved an additional 500,000
shares of its common stock to be granted under the Plan.
F-14
<PAGE>
Options granted under the above plans expire up to ten years after the date
of grant. The exercise price of such shares, as determined by the
committees on the date of grant, may be equal to or in excess of the fair
market value of the Company's registered common stock on the date of grant.
Options that expire or terminate prior to exercise are added to the shares
available for future grants.
Effective November 1991, the Company's stockholders approved a Nonstatutory
Directors' Stock Option Plan. The plan provides for the automatic annual
grant of stock options to the Chairman of the Board and directors of the
Company. The Company reserved 500,000 shares of its common stock to be
granted under the plan. During fiscal 1996, the Company reserved an
additional 250,000 shares to be granted under the plan. Options granted
under the plan expire ten years after the date of grant. The exercise price
of such shares is the fair market value on the date of grant. Participants
are entitled to exercise such options at any time six months after date of
grant. Options that expire or terminate prior to exercise are added to the
shares available for future grants.
A summary of changes in stock options is as follows:
Option Weighted Average
Shares Option Price
------ ------------
Balance, March 31, 1996 1,776,980 $1.93
Granted 453,253 1.11
Exercised (104,000) 1.11
Canceled (378,800) 1.62
---------- -----
Balance, March 31, 1997 1,747,433 1.83
Granted 400,000 1.69
Exercised (175,020) 1.08
Canceled (46,500) 2.43
---------- -----
Balance, March 31, 1998 1,925,913 1.86
Granted 481,500 2.64
Exercised (307,000) 1.28
Canceled (21,600) 3.36
---------- -----
Balance, March 31, 1999 2,078,813 $2.11
========== =====
The following information, aggregated by option price ranges, is applicable
to options outstanding at March 31, 1999:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Range of exercise prices $0.50 - $1.00 $1.25 - $3.13 $4.00 - $8.50
Shares outstanding in range 178,000 1,882,513 18,300
Weighted-average exercise price $.99 $2.20 $4.36
Weighted average remaining contractual life (years) 7.2 6.5 1.4
Shares currently exercisable 178,000 1,710,513 18,300
Weighted average exercise price of shares
currently exercisable $.99 $2.28 $4.36
</TABLE>
F-15
<PAGE>
The Company applies Accounting Principle Board Opinion No. 25 and related
Interpretations in accounting for its stock option plans. Accordingly, no
compensation cost has been recognized based on the fair value at the grant
dates for awards under those plans. Had compensation for the Company's
stock option plans been determined based upon the fair value at the grant
date for awards under the plans consistent with a methodology prescribed in
SFAS No. 123, the Company's income from continuing operations and income
from continuing operations per share for the years ended March 31, 1999,
1998 and 1997 would have been reduced to the pro forma amounts indicated
below:
1999 1998 1997
---------- ---------- ----------
Income from continuing operations -
as reported $1,664,368 $3,379,631 $2,411,509
========== ========== ==========
Income from continuing operations -
pro forma $ 986,063 $3,021,459 $2,166,694
========== ========== ==========
Basic income from continuing
operations per share - as reported $ 0 .13 $ 0 .28 $ 0 .21
========== ========== ==========
Basic income from continuing
operations per share - pro forma $ 0 .07 $ 0 .25 $ 0 .19
========== ========== ==========
Diluted income from continuing
per share - as reported $ 0 .12 $ 0 .25 $ 0 .20
========== ========== ==========
Diluted income from continuing
per share - pro forma $ 0 .07 $ 0 .23 $ 0 .18
========== ========== ==========
The fair value of each stock option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following
assumptions:
Expected dividend yield 0% 0% 0%
Expected volatility 62.9% 60.8% 52.8%
Risk-free interest rate 6% 7% 7%
Expected life 4 years 4 years 4 years
401(k) PLAN - Effective January 1, 1996, the Company established a 401(k)
plan for its employees. Employees may contribute between 1 percent and 16
percent of their total compensation to the Plan. The Company may make
matching contributions, on a discretionary basis, equal to a percentage of
an employee's covered compensation contributed to the Plan for the year. In
addition, the Company may make an annual profit sharing contribution to the
Plan. The Company's contribution to the Plan for the years ended March 31,
1999, 1998 and 1997 was $76,757, $50,121 and $35,724, respectively.
10. INCOME TAXES
1999 1998 1997
--------- --------- -------
Current $ 133,050 $ 114,950 $51,200
Deferred (40,000) (530,000)
--------- --------- -------
Total $ 93,050 $(415,050) $51,200
========= ========= =======
The provision (benefit) for income taxes is as follows:
F-16
<PAGE>
The following is a reconciliation of the reported effective income tax
rates to the statutory rates:
1999 1998 1997
---- ---- ----
Federal statutory income tax rate 34.0% 34.0% 34.0%
Utilization of net operating losses (34.0) (34.0) (34.0)
Reversal of valuation allowance (2.3) (17.9)
AMT and state income taxes 7.6 3.9 2.1
----- ----- -----
Effective rate 5.3% (14.0)% 2.1%
===== ===== =====
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 effect of significant items comprising the Company's net deferred
tax asset for the years ended March 31 is as follows:
1999 1998
----------- -----------
Current - reserves not currently deductible $ 1,104,000 $ 748,000
Noncurrent:
Difference between book and tax basis
of property 337,000 438,000
Operating loss carryforwards 4,316,000 6,687,000
Tax credit carryforwards 189,000 189,000
Other intangibles 77,000 77,000
----------- -----------
Net deferred tax asset 6,023,000 8,139,000
Valuation allowance (5,453,000) (7,609,000)
----------- -----------
Net deferred asset $ 570,000 $ 530,000
=========== ===========
During 1999 and 1998, the Company reduced the valuation allowance to
recognize a deferred tax asset at March 31, 1999 and 1998. The recognized
deferred tax asset is based upon expected utilization of net operating loss
carryforwards and reversal of certain temporary differences.
The Company has assessed its past earnings history and trends, sales
backlog, budgeted sales, and expiration dates of carryforwards and has
determined that it is more likely than not that approximately $570,000 of
deferred tax assets will be realized. The remaining valuation allowance of
approximately $5,453,000 is maintained against deferred tax assets which
the Company has not determined to be more likely than not realizable at
this time.
F-17
<PAGE>
At March 31, 1999, for income tax purposes, the Company had available the
following net operating loss and investment and research and development
tax credit carryforwards:
Net Investment Research and
Operating Tax Development
Date of Expiration Loss Credit Tax Credit
------------------ ---- ------ ----------
2000 $ 1,700
2001 $ 300
2002
2003 3,400
2004 $ 356,000 3,200
2005 7,336,000 22,400
2006 602,000 60,400
2007 1,513,000 97,600
2008 720,000
2009 484,000
2010 13,000
2011 1,626,000
2012 43,000
----------- ------- --------
Total $12,693,000 $ 1,700 $187,300
=========== ======= ========
11. COMMITMENTS AND CONTINGENCIES
The Company leases equipment, furniture and office space under capital and
operating lease agreements having initial periods ranging from two to seven
years. The Company currently has an operating lease for a 33,000 square
foot facility. The term of the lease is seven years and began on January
26, 1996. Monthly rentals are based on a fixed schedule which provides for
periodic rental adjustments during the lease term. Upon expiration of the
initial term of the lease, the Company has the option to extend the term
for an additional three years.
At March 31, 1999, future minimum payments required under noncancelable
operating leases and the present value of future minimum capital lease
payments with terms in excess of one year are as follows:
Future
Minimum
Operating
Capital Lease
Leases Payments
------ --------
2000 $ 85,938 $ 355,000
2001 9,843 357,000
2002 367,000
2003 274,000
-------- ----------
Total 95,781 $1,353,000
==========
Less imputed interest-rates ranging from 11% to 14% 4,086
--------
Present value of minimum capital lease obligations 91,695
Less current portion of capital lease obligations 82,851
--------
Long-term portion of capital lease obligations $ 8,844
========
F-18
<PAGE>
The Company's rental expense for the years ended March 31, 1999, 1998 and
1997 was $387,262, $302,725 and $306,528, respectively.
12. RELATED PARTY TRANSACTIONS
During the years ended March 31, 1999, 1998 and 1997, the Company paid its
directors $60,000, $91,157 and $124,346, respectively, for directors' fees,
legal services and consulting services rendered.
13. FINANCING AGREEMENT
In October 1992, the Company entered into a financing agreement which was
last amended and restated on August 19, 1998. The maximum line of credit is
$20,000,000, limited by a borrowing base determined by specific inventory
and receivable balances, and provides for cash loans, letters of credit and
acceptances. The agreement, as amended, has a term of three years. Interest
is charged at prime plus 1/2 percent (8.25% at March 31, 1999). The Company
pays a monthly fee on the unused balance of the line of credit of 0.25
percent per year. The line of credit is collateralized by all assets of the
Company. The line of credit is estimated to approximate fair value as the
actual rate is consistent with the rate estimated to be currently available
for debt of similar terms.
Certain information relative to the line of credit for the years ended
March 31 is as follows:
1999 1998
---- ----
Maximum amount of loans outstanding
during the period $17,752,147 $8,868,682
Average daily loans outstanding during
the period 10,702,873 3,760,731
Average effective interest rate 8.65% 9.5%
Amortization expense of costs incurred in connection with obtaining,
amending and renewing the financing agreement for the years ended March 31,
1999, 1998 and 1997, was $30,000, $0 and $65,833, respectively.
The Company had letters of credit of $1,590,200 outstanding at March 31,
1999. The unused and available line of credit at March 31, 1999 was
approximately $6,418,000.
14. BUSINESS COMBINATIONS
Effective April 1, 1998, the Company acquired California Audio Labs, LLC
("California Audio"). California Audio designs, develops, manufactures, and
distributes digital audio and video products marketed to the
high-performance home theater market under the California Audio Labs and
Cinevision brand names. The purchase price was $775,000 plus assumption of
liabilities. The transaction was accounted for using the purchase method.
The fair value of assets acquired and liabilities assumed was $1,232,000
and $1,690,000, respectively. The excess of cost over fair value of assets
acquired of $1,233,000 was recorded as goodwill. The goodwill is being
amortized on a straight-line basis over a 20-year period.
* * * * * *
F-19
<PAGE>
15. SELECTED QUARTERLY FINANCIAL DATA
Selected quarterly financial data for the years ended March 31, 1999 and
1998 is as follows:
<TABLE>
<CAPTION>
(000 omitted except for per share data)
June 30, September 30, December 31, March 31,
1998 1997 1998 1997 1998 1997 1999 1998
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues $10,795 $9,330 $17,074 $12,112 $20,642 $13,054 $15,040 $12,648
Gross profits 3,128 2,179 4,179 3,064 4,981 3,368 3,271 3,109
Income:
Continuing operations 476 268 1,099 817 396 934 (306) 1,361
Discontinued operations 62 51 (98) (125) (196) 139 (352) (361)
------- ------ ------- ------- ------- ------- ------- -------
Net income $ 538 $ 319 $ 1,001 $ 692 $ 200 $ 1,073 $ (658) $ 1,000
======= ====== ======= ======= ======= ======= ======= =======
Basic income per share ($'s):
Continuing operations $ 0.04 $ 0.02 $ 0.08 $ 0.07 $ 0.03 $ 0.08 $ (0.02) $ 0.11
Discontinued operations $ .00 $ 0.01 $ .00 $ (0.01) $ (0.01) $ 0.01 $ (0.03) $ (0.03)
------- ------ ------- ------- ------- ------- ------- -------
Basic net income per share $ 0.04 $ 0.03 $ 0.08 $ 0.06 $ 0.02 $ 0.09 $ (0.05 $ 0.08
======= ====== ======= ======= ======= ======= ======= =======
Diluted income per share ($'s):
Continuing operations $ 0.03 $ 0.02 $ 0.07 $ 0.06 $ 0.03 $ 0.07 $ (0.02) $ 0.10
Discontinued operations $ 0.01 $ 0.01 $ .00 $ (0.01) $ (0.02) $ 0.01 $ (0.03) $ (0.03)
------- ------ ------- ------- ------- ------- ------- -------
Diluted net income per share $ 0.04 $ 0.03 $ 0.07 $ 0.05 $ 0.01 $ 0.08 $ (0.05) $ 0.07
======= ====== ======= ======= ======= ======= ======= =======
</TABLE>
EXHIBIT 21
LIST OF SUBSIDIARIES
Legal Name State of Incorporation Ownership %
- ---------- ---------------------- -----------
Go-Video Productions, Inc. Delaware 100%
California Audio Labs, L.L.C. California 100%
INDEPENDENT AUDITORS' CONSENT
Board of Directors
Sensory Science Corporation
Scottsdale, Arizona
We consent to the incorporation by reference in Registration Statements No.
33-18428 on Form S-8, No. 33-39859 on Form S-8, No. 33-49924 on Form S-8, No.
33-49926 on Form S-8, No. 333-52329 on Form S-8, No. 33-58720 on Form S-3, and
No. 333-15731 on Form S-2 of our report dated June 7, 1999 appearing in this
Annual Report on Form 10-K of Sensory Science Corporation (formerly Go-Video,
Inc.) for the year ended March 31, 1999.
DELOITTE & TOUCHE LLP
Phoenix, Arizona
June 28, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FORM
10-K FOR THE YEAR ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> APR-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 358,038
<SECURITIES> 0
<RECEIVABLES> 10,624,835
<ALLOWANCES> (98,500)
<INVENTORY> 13,934,301
<CURRENT-ASSETS> 25,225,608
<PP&E> 3,807,248
<DEPRECIATION> 2,561,827
<TOTAL-ASSETS> 30,630,029
<CURRENT-LIABILITIES> 16,864,512
<BONDS> 211,675
0
0
<COMMON> 13,658
<OTHER-SE> 13,403,307
<TOTAL-LIABILITY-AND-EQUITY> 30,630,029
<SALES> 63,550,812
<TOTAL-REVENUES> 63,550,812
<CGS> 47,991,792
<TOTAL-COSTS> 12,773,400
<OTHER-EXPENSES> (19,239)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,047,441
<INCOME-PRETAX> 1,757,418
<INCOME-TAX> 93,050
<INCOME-CONTINUING> 1,664,368
<DISCONTINUED> (583,602)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,080,766
<EPS-BASIC> .08
<EPS-DILUTED> .08
</TABLE>
