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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, 2000
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 16, 2000, the aggregate market value of common stock held by non-
affiliates of the Registrant was approximately $34,105,000. See Item 5 of this
Form 10-K.
The number of shares of common stock outstanding as of June 16, 2000, was
14,359,978.
Documents Incorporated by Reference: Portions of the Registrant's Proxy
Statement relating to its Annual Meeting of Stockholders to be held September 7,
2000 are incorporated by reference in Part III of this Form 10-K.
Exhibit Index at page 39
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TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I
Item 1. Business............................................................................ 1
Executive Officers of the Registrant................................................ 8
Item 2. Properties.......................................................................... 9
Item 3. Legal Proceedings................................................................... 9
Item 4. Submission of Matters to a Vote of Security Holders................................. 9
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.......................... 15
Item 8. Financial Statements and Supplementary Data......................................... 15
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure........................................................................ 15
PART III
Item 10. Directors and Executive Officers of the Registrant.................................. 39
Item 11. Executive Compensation.............................................................. 39
Item 12. Security Ownership of Certain Beneficial Owners and Management...................... 39
Item 13. Certain Relationships and Related Transactions...................................... 39
PART IV
Item 14. Exhibits, Financial Statement, Schedules and Reports on Form 8-K.................... 39
Signatures.......................................................................... 42
</TABLE>
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 "MANAGEMENT'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.
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PART I
The terms "Company", "we", and "our" as used in this Report on Form 10-K refer
to Sensory Science Corporation and its consolidated subsidiaries unless the
context indicates otherwise.
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. Until last year, 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 ("Security 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. The legal transfer of
Security Products occurred during May 2000, yet the sale could not be recognized
as a divesture for accounting purposes at that time because we have continued
involvement through a guaranty of debt for up to one year and management
authority over the purchasing company through a seat on its Board of Directors.
In addition to the Dual-Deck VCR, our current products include digital
televisions, digital versatile disk (DVD) players, Internet audio (MP3) players
and CD players. We introduced the first in a line of Internet audio (MP3)
players in July 1999 and several new home theater products including a surround
sound processor, a video switcher, and a high-powered five-channel amplifier
in November 1999. 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, Internet
retailers, catalogs, distributors, custom installers, and specialty retailers
such as home shopping channels. We have also initiated the direct sale of our
refurbished and discontinued products, as well as selected new products, through
a company developed web site. We conduct our sales and marketing activities
through our Consumer Electronics and Home Theater departments.
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.
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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 Security Products to the senior management for cash. We completed a
legal transfer of the assets of Security Products during May 2000. However, we
have continued involvement with the senior management of the new company due to
our guaranty of the acquiror's debt for up to one year and a position on the
Board of Directors of the new company. Therefore, the sale was not recorded as a
divestiture for accounting purposes.
Our financial results have been restated to show the operations of Security
Products as a discontinued operation, and we recognized an estimated loss on the
sale in the quarter ended March 31, 1999. This estimated loss was consistent
with the actual loss.
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.
Because 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
<TABLE>
<CAPTION>
FY 2000 FY 1999 FY 1998
------- ------- -------
($ THOUSANDS) $ % $ % $ %
------------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Dual-Deck VCR's $58,662 81% $59,528 94% $47,144 100%
New Digital Products 13,487 19% 4,023 6%
------- ------- ------- ------- ------- -------
Total $72,149 100% $63,551 100% $47,144 100%
======= ======= ======= ======= ======= =======
</TABLE>
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
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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 Dual-Deck VCR's.
We have designed and marketed the Dual-Deck VCR for use as a full-featured
videocassette 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 required us to modify the operations of Dual-Deck VCR's sold after
April 2000 so that our VCR's recognize a type of anticopying signal and prevent
consumers from making a usable copy of videotapes encoded with that type of
anticopying signal. We modified Dual-Deck VCR models manufactured after May
1999 so that if they were purchased before April 2000 they continued to operate
as originally designed for the lifetime of the VCR, but if they were purchased
after April 2000 they 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 Electronics Co., Ltd. ("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, Inc. ("Goldstar") 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.
During April 2000, we announced that we have entered into an agreement with
Victor Company of Japan, Ltd. ("JVC") to license selected patents to JVC for
digital Dual-Deck(TM) VCR's, and to collaborate on the development and marketing
of a range of digital VCR products for the North American market. The agreement
paves the way for JVC to introduce a Dual-Deck VCR combining Mini-DV and Super
VHS technologies to create a Dual-Deck VCR ideally suited to the editing,
dubbing and recording needs of the growing digital TV market. As part of the
arrangement between the two companies, we will introduce our own version of the
product later this year, manufactured by JVC.
During March 2000, we announced the introduction of the Go-Video Professional
Duplication System, providing video duplicators with superior features and
picture-perfect copies using the Company's Go-Video Dual-Deck(TM) VCR's and
proprietary Go-Port(TM) serial interface. Designed for small groups,
institutions and government agencies that need to produce moderate numbers of
copies of VHS tapes such as churches, schools, law offices, police departments
and others, the Go-Video PDS provides an easy-to-use, low cost alternative to
outside tape duplication services and competing commercial systems.
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.
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
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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 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
largely 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 LLC ("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 introduced in November 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 introduced a line of Internet audio players, more commonly
known as MP3 players, during the second half of 1999 and added new models with
enhanced features early in calendar year 2000. These players can store computer
files downloaded from a personal computer and can store and playback music files
compressed using the MP3 format. We sell our Internet audio players through many
of the same retail stores as our Dual-Deck VCR's under the RaveMP brand and
market our products to several Internet retailers such as 800.com and
Mercata.com, which sophisticated consumers frequent. The competition for the
Internet audio player customer is very strong with respect to price and feature
content with product offerings from Diamond Rio, RCA LYRA and Audiovox competing
with our RaveMP brand. Several of our competitors have numerous competitive
advantages, including greater access to capital and better brand awareness.
LICENSING
We entered into a License Agreement with Samsung 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 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
Samsung terminates it earlier.
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We also have a Manufacturing Agreement with Samsung that is automatically
renewed in one-year increments unless either company gives at least six months'
notice of cancellation. The Manufacturing Agreement currently extends until at
least February 28, 2001 (see "PRODUCT DEVELOPMENT AND MANUFACTURING").
In March 2000, in an attempt to maximize the Dual-Deck(TM) VCR category in a
manner that is complementary to its existing business and distribution channels,
we announced an agreement with THOMSON multimedia, which will enable Thomson to
market and distribute RCA-branded monaural Dual-Deck VCR's in North America. In
return, we will receive a royalty for each monaural unit sold. We believe that
the introduction of these new units with the RCA brand will enhance the
Dual-Deck(TM) VCR category and create increased demand for the hi-fidelity
segment of the market which is our marketing direction.
In 1994, we licensed Goldstar 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 departments. Consumer Electronics 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, the RaveMP brand for our
new line of Internet audio (MP3) players. Home Theater, which performs sales and
marketing activities for Loewe televisions and Cal Audio product lines, is
pursuing distribution through regional and national audio/video specialty
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.
Consumer Electronics 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, baseball advertising, 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. Home Theater 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 that
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 and
Internet audio products, two year parts and labor on television products, and
one to two years on parts and labor for Cal Audio products. We have service
agreements for our products with independent service centers located throughout
the United States, and we provide service work at our Scottsdale, Arizona and
Blue Lake, California locations. We believe we have established adequate
reserves for our future warranty claims.
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SIGNIFICANT CUSTOMERS
The following table shows the customers who represented at least 10% of our
annual sales in each of the last three fiscal years:
<TABLE>
<CAPTION>
CUSTOMER FISCAL 2000 FISCAL 1999 FISCAL 1998
-------- ----------- ----------- -----------
<S> <C> <C> <C>
Sam's Club 13% 18% 28%
Circuit City 12% 12% 13%
QVC 11% 10% 1%
</TABLE>
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 March 31, 2000 or March 31, 1999.
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.
Independent companies manufacture most of our products. Our Dual-Deck VCR's
are manufactured by two independent manufacturers: Samsung and Shintom Co., Ltd.
("Shintom"). 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. Samsung performs quality control and
assurance 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 before 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 to sixty days after the product
has been shipped. The Manufacturing Agreement is automatically renewed for
one-year periods unless either Samsung or we provide at least six-months advance
notice in writing. The Manufacturing Agreement currently extends until at least
February 28, 2001.
We entered into a Dual-Deck VCR Manufacturing Agreement in January 1996 with
Shintom. 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. Shintom performs quality
control and assurance 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 before 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 Shintom or we provide at least twelve-months advance
notice, and currently extends to January 2001.
We use two manufacturers for our line of digital televisions: Loewe and Five
Rivers Electronic Innovations, LLC ("Five Rivers"). 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. Loewe performs quality control and
assurance 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 before 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
before shipment or by wire transfers at
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time of shipment. Payment by letter of credit 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 Loewe or we 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. The agreement provides that Five Rivers will assemble 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 before 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 Five Rivers or we 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 that 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. The registered
trademark "AmeriChrome" identifies this circuit. 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. We intend to vigorously enforce our proprietary technology
rights.
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.
7
<PAGE> 10
YEAR 2000 COMPLIANCE
Before December 31, 1999, we evaluated our management information systems and
the possible effect of Year 2000 hardware and software issues. We also
communicated with our significant suppliers, financial institutions, customers,
and other parties that purchase products or provide critical services or
supplies to assess their respective compliance with Year 2000 issues. We
estimated that we incurred expenses of approximately $100,000 to be Year 2000
compliant. Subsequent to December 31, 1999, we did not experience any
interruptions or other material adverse affects on our business because of the
beginning of the Year 2000. All systems are currently Year 2000 compliant and to
the best of our knowledge, all major suppliers and customers as well as the
financial institutions with which we conduct our business are Year 2000
compliant.
EMPLOYEES
As of March 31, 2000, we had 97 full-time employees. Our employees are not
represented by labor unions and we consider our relations with our employees to
be good.
EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers are:
<TABLE>
<CAPTION>
NAME AGE POSITIONS
---- --- ---------
<S> <C> <C>
Roger B. Hackett 49 Chief Executive Officer, President, and Chief Operating Officer
Edward J. Brachocki 44 Senior Vice President, Corporate Development
Thomas E. Linnen 54 Executive Vice President, Corporate Planning and Chief Financial
Officer, Secretary and Treasurer
Ralph F. Palaia 50 Senior Vice President, Marketing and Sales
Steven G.T. Maine 58 Senior Vice President and Chief Technology Officer
</TABLE>
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. Before 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.
THOMAS E. LINNEN was first elected to our Board of Directors in 1993 and joined
Sensory Science as Executive Vice President Corporate Planning and Chief
Financial Officer, Secretary and Treasurer in June 1999. Before joining us, Mr.
Linnen was the Senior Vice President, Corporate Development & Strategic Planning
at Hypercom Corporation from 1996 to 1999. Hypercom develops and sells
point-of-sale payment systems and as CFO Mr. Linnen led their IPO in November of
1997. For the nine years before joining Hypercom, Mr. Linnen served as Vice
President Finance, Secretary & Treasurer for Continental Circuits Corp., a
circuit board manufacturer. Mr. Linnen earned a Bachelor of Business
Administration Degree with a major in accounting at the University of Wisconsin
at Madison.
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. Before 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.
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<PAGE> 11
STEPHEN G.T. MAINE joined us in April 1998 as Senior Vice President and Chief
Technology Officer. Before 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.
Before 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.
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. In November 1999, we entered into a five-year lease for 13,000
square feet of additional office and warehouse storage space in the building
next door to the existing corporate office. The lease will expire in October
2004. When renovations are complete, this additional space will support the
current and planned business needs of our Research and Development department.
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 lease began
in June 1997 and expires in May 2002.
ITEM 3. LEGAL PROCEEDINGS
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We submitted no matters to be voted on by our stockholders voted upon no matters
during the fourth quarter of the fiscal year ended March 31, 2000.
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<PAGE> 12
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, 1998 through March 31, 2000, as reported to us
by the American Stock Exchange. These prices do not include commissions or other
adjustments to the selling price.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED MARCH 31, 2000 FISCAL YEAR ENDED MARCH 31, 1999
-------------------------------- --------------------------------
HIGH LOW HIGH LOW
---- --- ---- ---
<S> <C> <C> <C> <C>
First Quarter $3.7500 $2.0000 $3.5625 $2.3125
Second Quarter $3.8750 $2.1250 $4.6875 $2.5625
Third Quarter $2.2500 $1.5000 $3.5000 $2.6250
Fourth Quarter $4.2500 $1.7500 $4.0000 $2.1250
</TABLE>
We had approximately 7,000 beneficial shareholders of our common stock,
including approximately 2,716 stockholders of record (certificate holders
registered directly rather than on account at various brokerages or trustees) as
of March 31, 2000.
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.
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Sales $72,148,564 $63,550,812 $47,143,973 $39,024,306 $33,964,836
Net (loss) income from
continuing operations (566,167) 1,664,368 3,379,631 2,411,509 (2,465,003)
Net (loss) from
discontinued operations - (583,602) (296,281) (527,178) (406,167)
Net (loss) income from
continuing operations per
share-basic (0.04) 0.13 0.28 0.21 (0.22)
Net (loss) from
discontinued operations
per share-basic - (0.05) (0.03) (0.04) (0.04)
Weighted average shares 13,865,758 13,227,493 12,248,724 11,407,553 11,304,261
</TABLE>
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<PAGE> 13
BALANCE SHEET
<TABLE>
<CAPTION>
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Current assets $30,049,033 $25,225,608 $15,809,699 $12,503,287 $9,783,600
Current liabilities 21,743,333 16,578,912 6,684,399 5,361,277 6,236,720
Long-term assets (net) 5,875,624 5,404,421 2,850,572 1,252,444 1,414,386
Long-term liabilities 386,713 634,152 868,658 1,268,131 283,405
Total assets 35,924,657 30,630,029 18,660,271 13,755,731 11,197,986
Total liabilities 22,130,046 17,213,064 7,553,057 6,629,408 6,520,125
Stockholders' equity 13,794,611 13,416,965 11,107,214 7,126,323 4,677,861
</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 led to reductions in the retail
price and corresponding increases in consumer demand. In April 1995, we acquired
the predecessor to our Security Products business. 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. The legal transfer of the
video security products business was completed in May 2000. However, the sale
could not be recognized as a divesture for accounting purposes at that time
because we have continued involvement with the senior management of the new
company due to our guaranty of the acquiror's debt for up to one year and a
position on the Board of Directors of the new company. 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 and in the fiscal year
ended March 31, 2000 we added a line of Internet audio products.
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<PAGE> 14
RESULTS OF OPERATIONS
The following table shows the percentage of total revenues represented by the
key items that make up our statements of operations:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
--------------------
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Revenues:
Dual-Deck VCR's 81.3% 93.7% 100.0%
New Digital Products 18.7% 6.3% 0.0%
----- ---- ----
Net sales 100.0% 100.0% 100.0%
Gross profit 23.9% 24.5% 24.9%
Sales and marketing expense 11.1% 9.7% 8.9%
Research and development expense 4.0% 3.6% 1.9%
General and administrative expense 7.7% 6.9% 6.5%
Total operating expenses 22.8% 20.1% 17.4%
Operating income 1.1% 4.4% 7.5%
Other expenses 1.9% 1.6% 1.2%
Pre-tax (loss) income (0.8)% 2.8% 6.3%
Net (loss) income from continuing operations (0.8)% 2.6% 7.2%
(Loss) from discontinued operations 0.0% (0.9)% (0.6)%
Net (loss) income (0.8)% 1.7% 6.5%
</TABLE>
FISCAL 2000 COMPARED TO FISCAL 1999
Net sales increased by 14% to $72.1 million for the fiscal year ended March 31,
2000 ("fiscal 2000") from $63.6 million during the fiscal year ended March 31,
1999 ("fiscal 1999"). The increase in net sales was due to the combination of a
decline in revenues of Dual-Deck VCR's ("DDVCR") being offset by increases in
digital televisions, the new line of Internet audio players, and to a lesser
extent, an increase in digital audio and video players. The decrease in revenues
of DDVCR's was due to a 13% increase in units sold being offset by a decline in
the average selling price per unit from fiscal 1999 levels. The significant
increase in volume is due to continued sell through in mass merchandisers,
shopping channels and club stores as a result of lower retail sales prices. Net
sales of the digital televisions increased by approximately 300% during fiscal
2000 from prior year introductory levels due to the acceptance of digital
television products in additional retail outlets during fiscal 2000. In
addition, the average selling price of digital television and component sales
during fiscal 2000 was approximately the same as fiscal 1999. It is anticipated
that the average selling prices of digital televisions will decline in future
periods and volumes will increase in a corresponding manner. During fiscal 2000,
we added a new line of Internet audio players. The sales of Internet audio
players contributed to our total net sales for fiscal year 2000. We anticipate
an increase in the sales of these products during the new year due to line
extensions with enhanced features and we expect average sales prices to be about
the same. Combined net revenue from digital audio and video products was up
slightly from fiscal 1999 levels principally because of a new line of digital
video products introduced during fiscal 2000. The revenues from digital audio
products were lower than expected during fiscal 2000 as the transition to a new
product line was delayed longer than expected which left demand for product
offerings unfulfilled. These issues have been resolved and we expect that
revenues from the new line of digital audio products, bearing the California
Audio Labs name, will contribute higher revenues in the new year. We also expect
a new line of digital video products using the Dual-Deck technology is expected
to contribute to net sales in the new year.
Gross profit was $17.2 million for fiscal 2000 compared to $15.6 million in the
prior year, representing an approximate 11% increase over prior year levels. The
increase in gross profit dollars was due to higher sales in fiscal 2000 compared
to fiscal 1999. Gross profit as a percentage of net sales for fiscal 2000
decreased slightly from fiscal 1999 levels to 23.9% compared to 24.5% in fiscal
1999 primarily as a result of a decrease in the average selling price of
DDVCR's. The majority of this decline in average selling price was offset by a
17.0% decline in average manufacturing cost per unit. We anticipate that average
selling prices will continue to decline in fiscal 2001 and will be offset in
part by a decline in purchased manufacturing costs that will yield a gross
margin below fiscal 2000 levels. The gross margin anticipated in fiscal 2001
will be dependent upon our ability to realize planned reductions in purchased
manufacturing costs and improvement in the mix of products, particularly in the
high-fidelity line.
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<PAGE> 15
Sales and marketing expenses increased 30% to $8.0 million for fiscal 2000
compared to $6.1 million for fiscal 1999. As a percentage of net sales, sales
and marketing expenses increased from 9.7% to 11.1% over the same period. The
increase in sales and marketing expense for fiscal 2000 was primarily due to
higher sales levels and a corresponding increase in product promotional
activities and sales commissions in support of our existing and new product
initiatives, particularly digital video products. We anticipate that sales and
marketing expenses in fiscal 2001 will decline as a percentage of sales compared
to fiscal 2000.
Research and development expenses increased by 28% to $2.9 million for fiscal
2000 from $2.3 million for fiscal 1999. The increase in research and development
expenses was due to the continuing investment in engineering and product
management personnel in support of products added during fiscal 2000 and line
extension anticipated to be added during fiscal 2001. As a percentage of sales,
research and development expenses increased from 3.6% to 4.0%. 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 2001 and beyond.
General and administrative expenses increased by 27% to $5.6 million for fiscal
2000 from $4.4 million for fiscal 1999. The expenses for fiscal 2000 include a
$0.3 million write-off of a receivable from a Canadian customer who declared
bankruptcy subsequent to the end of fiscal 2000. The increase in general and
administrative expenses, exclusive of the receivable write-off, was primarily
due to higher expenses related to increased investments in information systems
personnel, hardware and expenses related to the overall increase in the number
of employees. As a percentage of net sales, general and administrative expenses
increased to 7.7% for fiscal 2000 from 6.9% for fiscal 1999. While we anticipate
that general and administrative expenses will increase slightly in fiscal 2001
in dollar amount, we also anticipate that general and administrative expenses
will decrease as a percentage of sales over the same period.
Because of the above, we recorded operating income of $0.8 million for fiscal
2000 compared with operating income of $2.8 million for fiscal 1999. We recorded
interest and other expenses of $1.3 million for fiscal 2000 compared with
interest and other expenses of $1.0 million for fiscal 1999. This was due to
increased interest expense resulting from an increase in the average daily loan
outstanding. The average daily loan outstanding during fiscal 2000 was $14.2
million compared to $10.7 million in the prior year. The average interest rate
in fiscal 2000 was 8.73%, approximately the same as the 8.65% rate for the prior
year.
We reported a loss from continuing operations of $0.6 million for fiscal 2000,
down $2.3 million from income from continuing operations of $1.7 million for
fiscal 1999.
FISCAL 1999 COMPARED TO FISCAL 1998
Net sales increased by 35% to $63.6 million for 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 DDVCR units sold by Consumer Electronics
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 department 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 department resulted from our April 1998 acquisition of
California Audio Labs and the November 1998 commencement of sales of our line of
digital televisions.
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 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.
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 department to market and sell the new television and digital
audio/video product lines also contributed to the higher sales and marketing
expenses.
Research and development expenses increased by 149% to $2.3 million for fiscal
1999 from $0.9 million for fiscal 1998.
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<PAGE> 16
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%.
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 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.
Because 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
In March 1999, we determined that Security Products 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 Security Products are 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. In fiscal
1998, the discontinued operations recorded a loss from operations of $0.3
million.
Because 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.
SEASONALITY
Our primary product lines compete within the consumer electronics industry,
which generally experiences seasonality in sales. Accordingly, we expect to
experience peaks in our sales from September through January, which covers the
holiday selling season. We expect this seasonality to be pronounced during the
first quarter of fiscal 2001 due to a shortfall in DDVCR revenues.
FUTURE RESULTS
Our expectations for results of operations and other forward-looking statements
contained in this Annual Report on Form 10-K, in particular statements
concerning expected future growth in revenues and earnings, growth of market
share, and development of the home theater markets and Internet recording and
playback devices markets, 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 that may affect
planned or actual product features and marketing methods; and the pace and
success of product research and development.
CAPITAL RESOURCES AND LIQUIDITY
Net cash used by operating activities was $2.4 million for fiscal 2000 compared
with net cash used by operating activities of $5.2 million for fiscal 1999. The
$2.4 million decrease in cash used by operating activities for fiscal 2000 was
due primarily to an increase in trade receivables partially offset by a decrease
in inventories. The decrease in inventories resulted from an increase in sales
activity and strong management attention to inventory levels. The increase in
trade receivables was primarily due to the timing of sales, in particular,
strong sales volume during the last weeks of fiscal 2000.
We had net working capital of $8.3 million and $8.6 million at March 31, 2000
and March 31, 1999, respectively. At March 31, 2000, our current ratio (current
assets divided by current liabilities) was 1.4 to 1, down slightly from 1.5 at
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<PAGE> 17
March 31, 1999.
We fund our cash requirements through a combination of cash flows from
operations and loans under a line of credit with Congress Financial Corporation
("Congress Financial"). During the fiscal year, our sales seasonality generally
requires incremental working capital for investments, primarily in inventories
and receivables. Our primary source of funds for financing during the fiscal
year ended March 31, 2000 was the line of credit. The financing agreement with
Congress Financial was first entered into in October 1992 and was last amended
in May 2000. The maximum line of credit available is $30.0 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, 2000 was approximately $2.7 million. We believe that our current financial
resources will be adequate to support operations over the next twelve months.
On April 1, 1998, we acquired 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 expenses related to the
integration and development of the Cal Audio business and it is expected to
provide a meaningful contribution to operating income during the fiscal year
ending March 31, 2001.
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. In November 1999, we entered into a five-year lease for 13,000
square feet of additional office and warehouse storage space in the building
next door to the existing corporate office. The lease will expire in October
2004. When renovations are complete, this additional space will be support the
current and planned business needs of our Research and Development department.
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 lease began
in June 1997 and expires in May 2002.
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 16 through 38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
15
<PAGE> 18
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 and subsidiaries (the "Company") as of March 31, 2000 and 1999, and
the related consolidated statements of operations, comprehensive (loss) income,
stockholders' equity and cash flows for each of the three years in the period
ended March 31, 2000. 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 auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company at March 31, 2000 and
1999, and the results of its operations and its cash flows for each of the three
years in the period ended March 31, 2000 in conformity with accounting
principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
Phoenix, Arizona
May 19, 2000
16
<PAGE> 19
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MARCH 31,
---------
ASSETS (Note 13) 2000 1999
---- ----
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 1,218,949 $ 358,038
Receivables - less allowance for doubtful accounts
of $116,000 and $98,500, respectively (Note 2) 15,670,572 10,526,335
Inventories (Note 6) 11,869,163 13,934,301
Prepaid expenses and other assets (Note 15) 975,923 191,519
Deferred income taxes (Note 10) 100,000 100,000
Net investment in discontinued operations (Note 4) 214,426 115,415
----------- -----------
Total current assets 30,049,033 25,225,608
----------- -----------
EQUIPMENT AND IMPROVEMENTS (Note 11):
Furniture, fixtures and equipment 856,787 875,270
Leasehold improvements 420,227 212,830
Office equipment 1,803,319 1,131,546
Tooling 1,377,523 1,587,602
----------- -----------
Total 4,457,856 3,807,248
Less accumulated depreciation and amortization 1,912,972 2,561,827
----------- -----------
Equipment and improvements - net 2,544,884 1,245,421
----------- -----------
DUAL-DECK VCR PATENTS - Net of amortization
of $79,047 and $65,930, respectively 136,264 149,381
GOODWILL - Net of amortization of $121,713 and $60,159,
respectively (Note 14) 1,111,763 1,173,316
MARKET EXCLUSIVITY FEE - Net of amortization
of $805,799 and $237,000, respectively (Note 3) 1,516,799 2,085,598
DEFERRED INCOME TAXES (Note 10) 317,500 470,000
OTHER ASSETS AND INVESTMENTS (Note 15) 248,414 280,705
----------- -----------
TOTAL $35,924,657 $30,630,029
=========== ===========
</TABLE>
(Continued)
17
<PAGE> 20
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MARCH 31,
---------
LIABILITIES AND STOCKHOLDERS' EQUITY 2000 1999
---- ----
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable $ 4,789,152 $ 4,147,579
Accrued expenses 938,866 1,109,860
Current portion of capital lease obligations (Note 11) 3,822 82,851
Other current liabilities (Note 7) 954,016 1,678,535
Warranty reserve - current 324,964 222,000
Income taxes payable (Note 10) 2,724
Line of credit (Note 13) 14,732,513 9,335,363
------------ ------------
Total current liabilities 21,743,333 16,578,912
DEFERRED RENT 37,389 42,533
CAPITAL LEASE OBLIGATIONS (Note 11) 8,844
SEVERANCE RESERVES 320,000 285,600
WARRANTY RESERVES 29,324 85,500
MANDATORY CONVERTIBLE
SUBORDINATED DEBT (Note 8) 211,675
------------ ------------
Total liabilities 22,130,046 17,213,064
------------ ------------
COMMITMENTS AND CONTINGENCIES
(Notes 3 and 11)
STOCKHOLDERS' EQUITY (Note 9):
Common stock, $.001 par value - authorized,
50,000,000 shares; issued and outstanding, 14,260,214
shares (2000) and 13,658,052 shares (1999) 14,260 13,658
Additional capital 22,422,587 21,708,124
Unrealized gain on investment - net of tax of
$152,500 (Note 15) 228,748
Accumulated deficit (8,870,984) (8,304,817)
------------ ------------
Total stockholders' equity 13,794,611 13,416,965
------------ ------------
TOTAL $ 35,924,657 $ 30,630,029
============ ============
</TABLE>
See notes to consolidated financial statements. (Concluded)
18
<PAGE> 21
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years Ended March 31,
---------------------
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
SALES (Note 2) $ 72,148,564 $ 63,550,812 $ 47,143,973
COST OF SALES 54,933,292 47,991,792 35,423,691
------------ ------------ ------------
Gross profit 17,215,272 15,559,020 11,720,282
------------ ------------ ------------
OTHER OPERATING COSTS:
Sales and marketing 7,997,810 6,137,413 4,211,402
Research and development (Note 3) 2,897,170 2,261,912 906,638
General and administrative expenses 5,556,653 4,374,075 3,078,512
------------ ------------ ------------
Total other operating costs 16,451,633 12,773,400 8,196,552
------------ ------------ ------------
Operating income 763,639 2,785,620 3,523,730
------------ ------------ ------------
OTHER REVENUES (EXPENSES):
Interest income 21,534 21,449 11,206
Interest expense (1,360,466) (1,047,441) (561,704)
Other income (expense) 9,126 (2,210) (8,651)
------------ ------------ ------------
Total other expenses - net (1,329,806) (1,028,202) (559,149)
------------ ------------ ------------
(LOSS) INCOME BEFORE PROVISION
(BENEFIT) FOR INCOME TAXES (566,167) 1,757,418 2,964,581
PROVISION (BENEFIT) FOR INCOME
TAXES (Note 10) 93,050 (415,050)
------------ ------------ ------------
(LOSS) INCOME FROM CONTINUING OPERATIONS (566,167) 1,664,368 3,379,631
DISCONTINUED OPERATIONS (Note 4):
Loss from operations - net tax benefits
of $0, $24,050 and $11,950 (293,655) (296,281)
Provision for loss on disposal (289,947)
------------ ------------ ------------
NET (LOSS) INCOME $ (566,167) $ 1,080,766 $ 3,083,350
============ ============ ============
DILUTED (LOSS) INCOME PER COMMON SHARE:
Continuing operations $ (.04) $ .12 $ .25
Discontinued operations (.04) (.02)
------------ ------------ ------------
Diluted (loss) income per common share $ (.04) $ .08 $ .23
============ ============ ============
BASIC (LOSS) INCOME PER COMMON SHARE:
Continuing operations $ (.04) $ .13 $ .28
Discontinued operations (.05) (.03)
------------ ------------ ------------
Basic (loss) income per common share $ (.04) $ .08 $ .25
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
19
<PAGE> 22
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
-------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years Ended March 31,
---------------------
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
NET (LOSS) INCOME $ (566,167) $1,080,766 $3,083,350
OTHER COMPREHENSIVE INCOME - Holding
gain arising during year - net of tax of $152,500 228,748
---------- ---------- ----------
COMPREHENSIVE (LOSS) INCOME $ (337,419) $1,080,766 $3,083,350
========== ========== ==========
</TABLE>
See notes to consolidated financial statements.
20
<PAGE> 23
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED MARCH 31, 2000, 1999, AND 1998
-------------------------------------------------------------------------------
<TABLE>
<CAPTION>
UNAMORTIZED
COMMON STOCK ADDITIONAL CONSULTING
SHARES AMOUNT CAPITAL SERVICES
------ ------ ------- --------
<S> <C> <C> <C> <C>
BALANCE, MARCH 31, 1997 (Note 9) 11,837,285 $11,837 $19,588,421 $ (5,002)
Stock options exercised for cash 175,020 175 188,597
Payment of interest on subordinated debt in stock 54,342 54 99,946
Conversion of subordinated debt (Note 8) 341,400 342 339,059
Exercise of warrants issued in conjunction with
private placement (Note 8) 224,000 224 279,767
Stock issued - private placement 11,250 11 (11)
Cash paid for conversion costs (Note 8) (15,625)
Amortization of consulting costs 5,002
Net income
---------- ---------- ---------- ----------
BALANCE, MARCH 31, 1998 (Note 9) 12,643,297 12,643 20,480,154
Stock options exercised for cash 307,000 307 393,168
Payment of interest on subordinated debt in stock 22,755 23 81,334
Conversion of subordinated debt (Note 8) 500,000 500 528,653
Exercise of warrants issued in conjunction with
private placement (Note 8) 180,000 180 224,820
Stock issued - private placement 5,000 5 (5)
Net income
---------- ---------- ---------- ----------
BALANCE, MARCH 31, 1999 (Note 9) 13,658,052 13,658 21,708,124
Stock options exercised for cash 149,200 149 342,459
Payment of interest on subordinated debt in stock 8,150 8 24,992
Conversion of subordinated debt (Note 8) 200,000 200 211,475
Exercise of warrants issued in conjunction with
private placement (Note 8) 244,812 245 135,537
Unrealized gain on investment (Note 15)
Net loss
---------- ---------- ---------- ----------
BALANCE, MARCH 31, 2000 (Note 9) 14,260,214 $14,260 $22,422,587 $ -
========== ========== ========== ==========
<CAPTION>
UNREALIZED
GAIN ON ACCUMULATED
INVESTMENT DEFICIT TOTAL
---------- ------- -----
<S> <C> <C> <C>
BALANCE, MARCH 31, 1997 (Note 9) $(12,468,933) $7,126,323
Stock options exercised for cash 188,772
Payment of interest on subordinated debt in stock 100,000
Conversion of subordinated debt (Note 8) 339,401
Exercise of warrants issued in conjunction with
private placement (Note 8) 279,991
Stock issued - private placement
Cash paid for conversion costs (Note 8) (15,625)
Amortization of consulting costs 5,002
Net income 3,083,350 3,083,350
---------- ----------
BALANCE, MARCH 31, 1998 (Note 9) (9,385,583) 11,107,214
Stock options exercised for cash 393,475
Payment of interest on subordinated debt in stock 81,357
Conversion of subordinated debt (Note 8) 529,153
Exercise of warrants issued in conjunction with
private placement (Note 8) 225,000
Stock issued - private placement
Net income 1,080,766 1,080,766
---------- ----------
BALANCE, MARCH 31, 1999 (Note 9) (8,304,817) 13,416,965
Stock options exercised for cash 342,608
Payment of interest on subordinated debt in stock 25,000
Conversion of subordinated debt (Note 8) 211,675
Exercise of warrants issued in conjunction with
private placement (Note 8) 135,782
Unrealized gain on investment (Note 15) $228,748 228,748
Net loss (566,167) (566,167)
----------- ---------- ----------
BALANCE, MARCH 31, 2000 (Note 9) $228,748 $(8,870,984) $13,794,611
=========== ========== ==========
</TABLE>
See notes to consolidated financial statements.
21
<PAGE> 24
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
---------------------
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (566,167) $ 1,080,766 $ 3,083,350
Adjustments to reconcile net (loss) income to net cash
(used in) provided by operating activities:
Depreciation and amortization 1,691,568 830,944 583,571
Provision for losses on accounts receivable 17,500 (1,500) (30,000)
Deferred income taxes (40,000) (530,000)
(Gain) loss on sale of equipment (5,788) 2,790 10,578
Loss from discontinued operations 583,602 296,281
Changes in operating assets and liabilities - net of acquisition:
Receivables (5,161,737) (1,248,286) (2,028,780)
Inventories 2,065,138 (8,419,299) 217,314
Prepaid expenses and other assets (153,156) (144,373) (11,793)
Patents (39,294) (62,497)
Other assets (56,707) 2,538 17,699
Accounts payable 641,573 1,908,715 767,406
Accrued expenses (247,034) 334,476 158,577
Other current liabilities (724,519) (67,797) 746,907
Warranty reserve 46,788 (22,500) (13,000)
Income taxes payable (2,724) (20,276) 3,000
Other long-term liabilities 29,256 90,581 32,613
----------- ----------- -----------
Net cash (used in) provided by operating activities (2,426,009) (5,168,913) 3,241,226
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Equipment and improvement expenditures (2,391,772) (727,568) (318,744)
Proceeds on the disposal of equipment 49,998
Investments in and advances to discontinued operations 2,029 772,033 (1,525,773)
Acquisitions - net of cash acquired from acquisition (773,904)
Purchase of investments (161,002) (250,000)
Market exclusivity fee (948,350) (1,374,248)
----------- ----------- -----------
Net cash used in investing activities (2,500,747) (1,927,789) (3,218,765)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 478,390 618,475 468,763
Registration costs (15,625)
Net borrowings (repayments) under line of credit 5,397,150 7,684,531 (249,636)
Payment on capital lease obligations (87,873) (88,358) (82,826)
Payment of debt assumed in acquisition (1,205,833)
----------- ----------- -----------
Net cash provided by financing activities 5,787,667 7,008,815 120,676
----------- ----------- -----------
</TABLE>
(Continued)
22
<PAGE> 25
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
---------------------
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 860,911 (87,887) 143,137
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 358,038 445,925 302,788
----------- ----------- -----------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 1,218,949 $ 358,038 $ 445,925
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION:
Cash paid for income taxes $ 2,724 $ 129,276 $ 100,000
=========== =========== ===========
Cash paid for interest $ 1,293,932 $ 1,042,369 $ 483,789
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Conversion of subordinated debt, accrued interest and
payment of interest to common stock (Note 8) $ 236,675 $ 610,510 $ 439,401
=========== =========== ===========
Unrealized gain on investment $ 381,248
===========
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)
23
<PAGE> 26
SENSORY SCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 31, 2000, 1999, AND 1998
--------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Sensory Science Corporation and subsidiaries (the "Company", "we", or "our")
develop, design, engineer and market consumer electronic and home theater
products. We currently contract with independent electronics manufacturers
to produce our products to our specifications. We normally receive such
products at our Scottsdale, Arizona facility. Distribution of our products
occurs upon receipt of customer orders.
The following are the significant accounting and financial policies used in
the preparation of our consolidated financial statements.
a. The consolidated financial statements include the accounts of Sensory
Science Corporation 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. Investments--We have certain investments in common stock of other
companies. For those investments with readily determinable market
value, we classify these investments as available for sale in
accordance with Statement of Financial Accounting Standards ("SFAS")
No. 115, Accounting for Certain Investments in Debt and Equity
Securities. For those investments for which a readily determinable
market value is not available and for which we do not have
significant influence, we use the cost method of accounting.
d. Inventories are stated at the lower of cost (first-in, first-out) or
market.
e. 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 VCR's and televisions.
Depreciation of tooling is calculated using the number of new units
sold as the tooling costs relate directly to the manufacturing of the
new units.
f. 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.
g. 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.
24
<PAGE> 27
h. Revenue Recognition--Sales of products are recognized once the product
is shipped to the customer.
i. Income Taxes--We file a consolidated tax return. As of August 1, 1993,
we adopted the Financial Accounting Standards Board's ("FASB") SFAS No.
109, Accounting for Income Taxes, which requires the use of the
liability method of accounting for deferred income taxes.
j. 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.
k. Accounting for Stock-Based Compensation--As permitted by SFAS No. 123,
Accounting for Stock Based Compensation, we use 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.
l. New Accounting Pronouncements--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, 2000. We are in
the process of evaluating the impact which will result upon adoption of
this standard.
In December 1999, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 101 ("SAB No. 101"), Revenue
Recognition in Financial Statements. SAB No. 101 summarizes staff's
views in applying accounting principles generally accepted in the
United States of America to revenue recognition in financial
statements. The adoption of SAB No. 101 did not have a material
effect on the our revenues or revenue recognition policy.
m. Use of Estimates--The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States of America 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.
n. Product Concentration--The market for our product is characterized by
changing technology and short product life cycles. Until last year, we
have derived substantially all of our revenues from the sale of
Dual-Deck VCR's throughout the United States.
o. Certain reclassifications have been made to the prior year financial
statements to conform to the classifications used in the 2000
presentation.
25
<PAGE> 28
2. COMPANY OPERATIONS
We were incorporated in May 1984 and were engaged in development stage
activities until late in the fiscal year ended July 31, 1990, when we began
our primary operation of distribution and marketing of Dual-Deck VCR's,
which are being manufactured for us by Samsung Electronics Company Ltd.
("Samsung") and Shintom Company Ltd., and Talk Corporation ("Shintom &
Talk"). We also distribute and market a line of digital televisions, digital
audio/video home theater products and Internet audio (MP3) players.
SALES AND MARKETING--Our current marketing strategy is to sell our 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. We currently
sell our product lines directly to retailers nationwide including numerous
national and regional chains, catalog accounts, specialty stores, warehouse
clubs, home shopping channels and Armed Services PXs.
During fiscal 2000, sales from continuing operations to our three major
customers totaled $9,577,000, $8,636,000 and $8,027,000, respectively. These
amounts represent 13 percent, 12 percent and 11 percent, respectively, of
our fiscal 2000 sales. Accounts receivable from these customers totaled
$2,276,000, $1,416,000 and $1,018,000, respectively, at March 31, 2000.
During fiscal 1999, sales from continuing operations to our 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 our
fiscal 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 our two major
customers totaled $13,310,000 and $6,271,000, which represents approximately
28 percent and 13 percent, respectively, of our fiscal 1998 sales. Accounts
receivable from these customers totaled $3,893,000 and $1,164,000,
respectively, at March 31, 1998.
3. PRODUCT MANUFACTURING AND LICENSING
On February 28, 1989, we entered into an agreement with Samsung, pursuant to
which Samsung agreed to manufacture Dual-Deck VCR's to our design and
specification ("Manufacturing Agreement"). As part of this arrangement with
Samsung, we have licensed to Samsung the use of our proprietary and patented
technology: (1) the right to manufacture Dual-Deck VCR's for us; (2) on an
exclusive basis, the right to manufacture, use and sell Dual-Deck VCR's in
the Republic of Korea; (3) on a non-exclusive basis, the right to
manufacture, use and sell the Dual-Deck VCR's in all markets except the
United States and its territories; and (4) on a non-exclusive basis, the
right to sell Dual-Deck VCR's under its own trademark and trade name in the
United States and its territories. Under the license agreement, we are
entitled to receive royalties calculated as a percentage of net sales of
Dual-Deck VCR's by Samsung or its sublicensees. The license agreement has a
term of 15 years but may be terminated by us if the Manufacturing Agreement
is terminated for any cause attributable to Samsung. We have received no
royalties to date from Samsung under this agreement.
Under the Manufacturing Agreement, Samsung manufactures Dual-Deck VCR's for
us pursuant to our specifications. Quality control and assurance is
performed by Samsung at the manufacturing facility, and we verify 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, we purchase Dual-Deck VCR's 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, 2001.
On January 9, 1996, we entered into an agreement with Shintom & Talk
pursuant to which Shintom & Talk have agreed to manufacture Dual-Deck VCR's
to our 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. Generally, we will
purchase Dual-Deck VCR's 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.
26
<PAGE> 29
We 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. We 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, 2000,
Loewe Opta had reimbursed $4,220,000, all of which was incurred as an
expense. We capitalized a total of $2.3 million related to this market
exclusivity fee and amortized the balance beginning with the first shipment
from Loewe. The balance was fully amortized at the conclusion of fiscal year
2000.
4. DISCONTINUED OPERATIONS
In fiscal 1999, we approved plans to dispose of our security products
business. A legal transfer of the assets occurred during May 2000, yet the
sale could not be recognized as a divestiture for accounting purposes at
that time because we have continued involvement through a guaranty of debt
for up to one year and management authority over the purchasing company
through a seat on its Board of Directors. Revenues applicable to the
operations of the discontinued security products business totaled
$5,587,000, $3,977,000 and $1,754,000 in 2000, 1999, and 1998, respectively.
Investments in discontinued operations consist of the following assets and
liabilities at March 31:
<TABLE>
<CAPTION>
2000 1999
----------- -----------
<S> <C> <C>
Accounts receivable-net $ 929,471 $ 815,257
Inventory 1,611,557 722,960
Furniture and fixtures 12,268 16,600
Current liabilities (1,940,415) (927,892)
Borrowings on line of credit (398,455) (511,510)
----------- -----------
Net investment in discontinued operations $ 214,426 $ 115,415
=========== ===========
</TABLE>
27
<PAGE> 30
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>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
(Loss) income from continuing operations $ (566,167) $ 1,664,368 $ 3,379,631
============ ============ ============
Average outstanding common shares 13,865,758 13,227,493 12,248,724
============ ============ ============
Basic (loss) income per share from
continuing operations $ (0.04) $ 0.13 $ 0.28
============ ============ ============
Diluted (loss) income from continuing
operations per common share - income
available to common stockholders, from
above $ (566,167) $ 1,664,368 $ 3,379,631
Add interest on presumed conversion of
convertible debt 41,250 89,077
------------ ------------ ------------
(Loss) income available to common stockholders
available for diluted earnings per share $ (566,167) $ 1,705,618 $ 3,468,708
============ ============ ============
Average outstanding common shares,
from above 13,865,758 13,227,493 12,248,724
Additional dilutive shares related to stock
options and warrants 1,113,701 685,555
Additional dilutive shares related to
subordinated notes 392,500 866,352
------------ ------------ ------------
Average outstanding and potentially dilutive
common shares 13,865,758 14,733,694 13,800,631
============ ============ ============
Diluted (loss) income per share from
continuing operations $ (0.04) $ 0.12 $ 0.25
============ ============ ============
</TABLE>
Options and warrants to purchase 793,361, 18,300 and 257,700 shares of
common stock at various prices during the years ended March 31, 2000, 1999,
and 1998, respectively, were not included in the computation of diluted
earnings per share because the exercise of options and warrants was
determined to be antidilutive. Additionally, for the year ended March 31,
2000, interest and shares related to convertible and subordinated notes were
not included in the computation of diluted earnings per share because these
items are antidilutive.
No events have occurred subsequent to March 31, 2000 which would have
changed materially the number of common shares or potential common shares
outstanding at March 31, 2000 had the events occurred before March 31, 2000.
28
<PAGE> 31
6. INVENTORIES
Inventories consisted of the following at March 31:
<TABLE>
<CAPTION>
2000 1999
----------- -----------
<S> <C> <C>
Service replacement parts and raw materials $ 1,759,637 $ 987,995
Finished goods 10,109,526 12,946,306
----------- -----------
Total $11,869,163 $13,934,301
=========== ===========
</TABLE>
7. OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following at March 31:
<TABLE>
<CAPTION>
2000 1999
---------- ----------
<S> <C> <C>
Compensation and related benefits $ 344,207 $ 889,075
Sales returns reserve 594,938 408,847
Unexpended development and marketing advance (Note 3) 372,350
Other 14,871 8,263
---------- ----------
Total $ 954,016 $1,678,535
========== ==========
</TABLE>
8. MANDATORY CONVERTIBLE SUBORDINATED DEBT
We 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 detachable
warrants to purchase 100,000 shares of common stock at $1.25 per share. 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 were valued at $230,000.
In connection with the Private Placement, we 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 us in connection with the Private Placement.
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 noteholders 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.
In 2000, Notes with a principal amount of $250,000 were converted. The
transaction, including interest, resulted in the issuance of 208,150 shares
of common stock to note holders. In addition, all remaining warrants
associated with the notes held by a note holder either expired or were
exercised to purchase stock at a price of $1.25 per share.
29
<PAGE> 32
9. STOCKHOLDERS' EQUITY
STOCK WARRANTS -- During the year ended March 31, 1996, we entered into four
separate consulting agreements. In exchange for services, we issued 110,000
warrants. Each warrant entitles the holder to purchase one share of our
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:
<TABLE>
<CAPTION>
WARRANTS WARRANT
OUTSTANDING PRICE PER SHARE
----------- ---------------
<S> <C> <C>
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 1.250 1.688
Exercised (180,000) 1.250
--------- ------ ------
Balance, March 31, 1999 648,500 1.250 -- 1.688
Exercised (436,000) 1.250 -- 1.688
Expired (100,000) 1.250
--------- ------ ------
Balance, March 31, 2000 112,500 1.250 -- 1.688
========= ====== ======
</TABLE>
STOCK OPTION PLANS - Effective December 1986, we adopted a Nonstatutory
Stock Option plan. Pursuant to the terms of the plan, only our employees are
eligible to participate. Eligibility is determined by a committee (the
"Committee") appointed by the Board of Directors to administer the plan. We
reserved 2,000,000 shares of our 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 our
full-time employees and directors 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. We reserved 500,000
shares of our common stock to be granted under the 1989 plan.
Effective November 1991, our 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 as
determined by the plan Committee who administers the plan. We reserved
500,000 shares of our common stock to be granted under the plan.
Effective December 1993, our 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 as determined
by the 1993 plan committee who administers the plan. We reserved 500,000
shares of our common stock to be granted under the plan. During 1997, we
reserved an additional 500,000 shares of our common stock to be granted
under the Plan.
30
<PAGE> 33
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 our registered common stock on the date of grant. Options that expire or
terminate before exercise are added to the shares available for future
grants.
Effective November 1991, our 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 our Company. We
reserved 500,000 shares of our common stock to be granted under the plan.
During fiscal 1996, we 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 before
exercise are added to the shares available for future grants.
A summary of changes in stock options is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTION OPTION
SHARES PRICE
------ -----
<S> <C> <C>
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
Granted 672,700 1.97
Exercised (149,200) 2.30
Canceled (17,300) 3.28
---------- -----
Balance, March 31, 2000 2,585,013 2.06
========== =====
</TABLE>
The following information, aggregated by option price ranges, is applicable to
options outstanding at March 31, 2000:
<TABLE>
<S> <C> <C> <C>
Range of exercise prices $0.50-$1.00 $1.25-$3.13 $4.00-$8.50
Shares outstanding in range 175,000 2,395,013 15,000
Weighted-average exercise price $ 0.94 $ 2.13 $ 4.00
Weighted average remaining contractual life (years) 6.3 6.7 0.5
Shares currently exercisable 175,000 1,763,763 15,000
Weighted average exercise price of shares
currently exercisable $ 0.94 $ 2.20 $ 4.00
</TABLE>
31
<PAGE> 34
We applied Accounting Principle Board Opinion No. 25 and related
Interpretations in accounting for our 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 our 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, our income from continuing operations and income from continuing
operations per share for the years ended March 31, 2000, 1999 and 1998
would have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
2000 1999 1998
------------ ------------ ------------
<S> <C> <C> <C>
(Loss) income from continuing operations --
as reported $ (566,167) $ 1,664,368 $ 3,379,631
============ ============ ============
(Loss) income from continuing operations --
pro forma $ (1,205,024) $ 986,063 $ 3,021,459
============ ============ ============
Basic (loss) income from continuing
operations per share -- as reported $ (0.04) $ 0 .13 $ 0 .28
============ ============ ============
Basic (loss) income from continuing
operations per share -- pro forma $ (0.09) $ 0 .07 $ 0 .25
============ ============ ============
Diluted (loss) income from continuing
per share -- as reported $ (0.04) $ 0 .12 $ 0 .25
============ ============ ============
Diluted (loss) income from continuing
per share -- pro forma $ (0.09) $ 0 .07 $ 0 .23
============ ============ ============
</TABLE>
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:
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Expected dividend yield 0% 0% 0%
Expected volatility 56.3% 62.9% 60.8%
Risk-free interest rate 6% 6% 7%
Expected life 4 years 4 years 4 years
</TABLE>
401(k) PLAN -- Effective January 1, 1996, we established a 401(k) plan (the
"Plan") for our employees. Employees may contribute between 1 percent and 16
percent of their total compensation to the Plan. We 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, we may make an annual profit sharing contribution to the Plan. Our
contribution to the Plan for the years ended March 31, 2000, 1999 and 1998
was $65,097, $76,757 and $50,121, respectively.
10. INCOME TAXES
The provision (benefit) for income taxes is as follows:
<TABLE>
<CAPTION>
2000 1999 1998
---- --------- ---------
<S> <C> <C> <C>
Current $ -- $ 133,050 $ 114,950
Deferred -- (40,000) (530,000)
---- --------- ---------
Total $ -- $ 93,050 $(415,050)
==== ========= =========
</TABLE>
32
<PAGE> 35
The following is a reconciliation of the reported effective income tax rates
to the statutory rates:
<TABLE>
<CAPTION>
2000 1999 1998
------ ------ ------
<S> <C> <C> <C>
Federal statutory income tax rate (35.0)% 35.0% 35.0%
Utilization of net operating losses 40.5 (35.0) (35.0)
Reversal of valuation allowance (2.3) (17.9)
AMT and state income taxes (5.5) 7.6 3.9
------ ------ ------
Effective rate 0.0 % 5.3% (14.0)%
====== ====== ======
</TABLE>
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 our net deferred tax asset
for the years ended March 31 is as follows:
<TABLE>
<CAPTION>
2000 1999
----------- -----------
<S> <C> <C>
Current:
Reserves not currently deductible $ 1,369,200 $ 1,104,000
Unrealized gain on available-for-sale securities (152,500)
Noncurrent:
Difference between book and tax basis
of property (279,500) 337,000
Operating loss carryforwards 4,630,900 4,316,000
Tax credit carryforwards 187,300 189,000
Other intangibles 77,000
----------- -----------
Net deferred tax asset 5,755,400 6,023,000
Valuation allowance (5,337,900) (5,453,000)
----------- -----------
Net deferred asset $ 417,500 $ 570,000
=========== ===========
</TABLE>
During 2000 and 1999, we reduced the valuation allowance to recognize a
deferred tax asset at March 31, 2000 and 1999. The recognized deferred tax
asset is based upon expected utilization of net operating loss carryforwards
and reversal of certain temporary differences.
We have assessed our past earnings history and trends, sales backlog,
budgeted sales, and expiration dates of carryforwards and have determined
that it is more likely than not that approximately $417,500 of deferred tax
assets will be realized. The remaining valuation allowance of $5,337,900 is
maintained against deferred tax assets which we have not determined to be
more likely than not realizable at this time.
33
<PAGE> 36
At March 31, 2000, for income tax purposes, we had available the following
net operating loss and investment and research and development tax credit
carryforwards:
<TABLE>
<CAPTION>
NET RESEARCH AND
OPERATING DEVELOPMENT
DATE OF EXPIRATION LOSS TAX CREDIT
<S> <C> <C>
2001 $ 300
2002
2003 3,400
2004 3,200
2005 $ 6,891,000 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
2013 22,000
2019 25,000
2020 1,116,000
----------- -----------
Total $13,055,000 $ 187,300
=========== ===========
</TABLE>
11. COMMITMENTS AND CONTINGENCIES
We lease equipment, furniture and office space under capital and operating
lease agreements having initial periods ranging from two to seven years. We
currently have 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, we have the option to extend the term for an additional three
years.
We have an operating lease for a 7,800 square foot facility. The term of the
lease is for five years and began on June 1, 1997. Monthly rentals increase
annually based upon increases in the Consumer Price Index, but not in excess
of 4 percent per year. We lease a 13,000 square foot facility under another
operating lease. The term of the lease is for five years and began on
November 11, 1999. 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 these leases, we have the option to extend
the term for an additional three and five years, respectively.
34
<PAGE> 37
At March 31, 2000, 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:
<TABLE>
<CAPTION>
FUTURE
MINIMUM
OPERATING
CAPITAL LEASE
LEASES PAYMENTS
------ --------
<S> <C> <C>
2001 $ 3,912 $ 506,000
2002 520,000
2003 430,000
2004 160,000
2005 101,000
---------- ----------
Total 3,912 $1,717,000
==========
Less 14% imputed interest 90
----------
Present value of minimum capital lease obligations 3,822
Less current portion of capital lease obligations 3,822
----------
Long-term portion of capital lease obligations $ --
==========
</TABLE>
Our rental expense for the years ended March 31, 2000, 1999 and 1998 was
$460,620, $387,262 and $302,725, respectively.
12. RELATED PARTY TRANSACTIONS
During the years ended March 31, 2000, 1999 and 1998, we paid our directors
$50,000, $60,000 and $91,157, respectively, for directors' fees, legal
services and consulting services rendered.
13. FINANCING AGREEMENT
In October 1992, we entered into a financing agreement which was last
amended and restated in May 2000. The maximum line of credit available is
$30,000,000, 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 (9.5% at March 31, 2000). We pay 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 of our assets. 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:
<TABLE>
<CAPTION>
2000 1999
----------- -----------
<S> <C> <C>
Maximum amount of loans outstanding during the period $21,021,246 $17,752,147
Average daily loans outstanding during the period 14,157,512 10,702,873
Average effective interest rate 8.73% 8.65%
</TABLE>
Amortization expense of costs incurred in connection with obtaining,
amending and renewing the financing agreement for the years ended March 31,
2000, 1999 and 1998, was $8,451, $5,612, and $0, respectively. The unused
and available line of credit at March 31, 2000 was approximately $2,677,000.
35
<PAGE> 38
14. BUSINESS COMBINATIONS
Effective April 1, 1998, we 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.
15. INVESTMENTS
During fiscal year 1999, we purchased an investment in Emusic.com, Inc.,
which was recorded on the cost basis of accounting due to certain
restrictions affecting marketability. This $250,000 restricted investment
was recorded in other assets and investments as of March 31, 1999. During
2000, the restriction on this investment expired and the investment was
reclassified as available for sale. This investment is recorded at March 31,
2000 at market value of $631,250 in prepaid expenses and other assets as we
intend to sell the investment during fiscal year 2001. Changes in the market
value may be significant from amounts reported at March 31, 2000 due to
market volatility.
During fiscal year 2000, we purchased an investment in Mpman.com, Inc., a
private Korean company, which was recorded on the cost basis of accounting
due to certain restrictions affecting marketability. This $161,002
restricted investment was recorded in other assets and investments as of
March 31, 2000.
16. SEGMENT INFORMATION
We have adopted SFAS No. 131, Disclosures about Segments of an Enterprise
and Related Information. SFAS No. 131 which requires enterprises to report
information about operating segments in annual financial statements and
selected information about reportable segments in interim financial reports
issued to stockholders. It also establishes standards for related
disclosures about products and services, geographic areas and major
customers.
We operate in one business segment but track revenue by two product
categories. Operating margins are not tracked separately by category. The
following represents the revenue by product category for the years ended
March 31:
<TABLE>
<CAPTION>
2000 1999 1998
----------------------- ---------------------- ----------------------
(IN THOUSANDS) $ % $ % $ %
-------------------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Dual-Deck VCR's $58,662 81% $59,528 94% $47,144 100%
New Digital Products 13,487 19% 4,023 6%
------- ------- ------- ------- ------- -------
Total $72,149 100% $63,551 100% $47,144 100%
======= ======= ======= ======= ======= =======
</TABLE>
Our assets are all located in the United States, and all sales were to
customers in the United States and Canada.
17. SHAREHOLDERS RIGHTS AGREEMENT
Effective April 13, 2000, we adopted a Shareholder Rights Agreement (the
"Rights Agreement"). Under the terms of the Rights Agreement, a dividend of
one common share purchase right (a "Right") was paid on April 23, 2000 to
holders of record for each outstanding share of our common stock. One Right
is also issued with each share of common stock issued thereafter until the
date on which outstanding Rights become exercisable or are otherwise
redeemed or expired. These Rights entitle the holder to purchase one share
of our common stock at an exercise price of $15. The Rights become
detachable and exercisable (a) 10 days after a public announcement that a
person or group has acquired shares representing 15% or more of the
outstanding shares of our common stock, or (b) 10 days following the
commencement of, or announcement of an intention to make, a tender offer or
exchange offer for 15% or more of the outstanding shares of our common
stock.
36
<PAGE> 39
We can redeem the Rights for $0.01 per Right at any time prior to their
becoming exercisable. The Rights expire on April 13, 2010, unless we redeem
them earlier or they are exchanged for common stock. Under certain
circumstances, if a person or group acquires 15% or more of our common
stock, each Right permits the holder to purchase one share of our common
stock for a price of 50% of the market price of the common stock at the time
of exercise. In addition, in the event of certain business combinations, the
Rights permit the holder to purchase $30 of the common stock of the acquiror
for the $15 Right exercise price. Rights held by the acquiror will become
null and void in both cases.
37
<PAGE> 40
18. SELECTED QUARTERLY FINANCIAL DATA
Selected quarterly financial data for the years ended March 31, 2000 and
1999 is as follows:
(000 OMITTED EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
June 30, September 30,
-------- -------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues $ 14,136 $ 10,795 $ 19,583 $ 17,074
========== ========== ========== ==========
Gross profits $ 2,972 $ 3,128 $ 4,292 $ 4,179
========== ========== ========== ==========
Income:
Continuing operations $ (437) $ 476 $ 26 $ 1,099
Discontinued operations 62 (98)
---------- ---------- ---------- ----------
Net (loss) income $ (437) $ 538 $ 26 $ 1,001
========== ========== ========== ==========
Basic (loss) income per share ($'s):
Continuing operations $ (0.03) $ 0.04 $ -- $ 0.08
Discontinued operations
---------- ---------- ---------- ----------
Basic net (loss) income
per share $ (0.03) $ 0.04 $ -- $ 0.08
========== ========== ========== ==========
Diluted (loss) income per share ($'s):
Continuing operations $ (0.03) $ 0.03 $ -- $ 0.07
Discontinued operations 0.01
---------- ---------- ---------- ----------
Diluted net (loss) income
per share $ (0.03) $ 0.04 $ -- $ 0.07
========== ========== ======== ========
<CAPTION>
December 31, March 31,
------------ ---------
1999 1998 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues $ 20,435 $ 20,642 $ 17,995 $ 15,040
========== ========== ========== ==========
Gross profits $ 4,887 $ 4,981 $ 5,064 $ 3,271
========== ========== ========== ==========
Income:
Continuing operations $ 400 $ 396 $ (555) $ (306)
Discontinued operations (196) (352)
---------- ---------- ---------- ----------
Net (loss) income $ 400 $ 200 $ (555) $ (658)
========== ========== ========== ==========
Basic (loss) income per share ($'s):
Continuing operations $ 0.03 $ 0.03 $ (0.04) $ (0.02)
Discontinued operations (0.01) (0.03)
---------- ---------- ---------- ----------
Basic net (loss) income
per share $ 0.03 $ 0.02 $ (0.04) $ (0.05)
========== ========== ========== ==========
Diluted (loss) income per share ($'s):
Continuing operations $ 0.03 $ 0.03 $ (0.04) $ (0.02)
Discontinued operations (0.02) (0.03)
---------- ---------- ---------- ----------
Diluted net (loss) income
per share $ 0.03 $ 0.01 $ (0.04) $ (0.05)
========== ========== ========== ==========
</TABLE>
38
<PAGE> 41
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 our Annual Meeting of Stockholders to be
held on September 7, 2000 (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
<TABLE>
<CAPTION>
PAGE OR
METHOD OF FILING
----------------
<S> <C>
(a) Financial Statements:
(1) Report of Deloitte & Touche LLP. Page 16
(2) Consolidated Financial Statements and Notes to Consolidated Financial
Statements of the Company for the fiscal years ended March 31, 2000,
1999 and 1998. Page 17
</TABLE>
(b) Reports on Form 8-K:
We filed one Report on Form 8-K dated April 13, 2000,
subsequent to the end of the fiscal year ended March 31,
2000. The Form 8-K reported that we have adopted a
Shareholder Rights Agreement and authorized and declared a
dividend of one common share purchase right for each
outstanding share of common stock.
39
<PAGE> 42
(c) Exhibits
The following exhibits are filed as part of this Report.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION PAGE OR METHOD OF FILING
----------- ----------- ------------------------
<S> <C> <C>
3.1 Certificate of Incorporation of the Company Incorporated by reference to Exhibit 3-A of
the Company's S-1 Registration Statement No.
33-17277
3.2 Amendment to Articles of Incorporation Incorporated by reference to the Company's
Form 8-K filing dated March 2, 1999
3.3 Bylaws of the Company Incorporated by reference to Exhibit 4-B to
the Company's S-2 Registration Statement No.
33-38445
4.1 Specimen Certificate representing Common Stock Incorporated by reference to Exhibit 4-A to
the Company's S-1 Registration Statement No.
33-17277
4.2 Form of Mandatory Convertible Subordinated Note Incorporated by reference to Exhibit 4.3 to
the Company's S-2 Registration Statement No.
333-15731 filed November 7, 1996
4.3 Shareholder Rights Agreement Incorporated by reference to Exhibit 4.1 to
the Company's report on Form 8-K dated April
13, 2000
10.2 Assignment of U.S. Patent Rights to Sensory Incorporated by reference to Exhibit 10-B(1)
Science Corporation by R. Terren Dunlap and to the Company's S-1 Registration Statement
Richard A. Lang, dated October 11, 1985 No. 33-17277
10.3 Assignment of Japanese Patent Rights to Sensory Incorporated by reference to Exhibit 10-B(2)
Science Corporation by R. Terren Dunlap and to the Company's S-1 Registration Statement
Richard A. Lang, dated August 5, 1987 No. 33-17277
10.4 Assignment of U.S. Patent Rights to Sensory Incorporated by reference to Exhibit 10-B(3)
Science Corporation by R. Terren Dunlap, John to the Company's Annual Report on Form 10-K
Berkheimer, and Dwayne Woodmas, dated August 4, for 1988 (the "1988 10-K")
1988
10.5 Assignment of U.S. Patent Rights to Sensory Incorporated by reference to Exhibit 10-B(4)
Science Corporation by R. Terren Dunlap, John to the Company's 1988 Annual Report on Form
Berkheimer, and Richard Otto, dated September 9, 10-K.
1988
10.6* Form of 1987 Nonstatutory Stock Option Plan, as Incorporated by reference to Exhibit 4-A to
amended the Company's S-8 Registration Statement No.
33-18428
10.7* Form of 1989 Nonstatutory Stock Option Plan, as Incorporated by reference to Exhibit 10-C
amended (2) to the Company's S-8 Registration
Statement No. 33-33033
10.8* Form of 1991 Directors' Nonstatutory Stock Option Incorporated by reference to Exhibit 28.1 to
Plan, as amended the Company's S-8 Registration Statement No.
33-49924 and Exhibit A to the Company's 1995
Proxy Statement.
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<TABLE>
<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 Statement No.
33-49926
10.11 Settlement Agreement, Manufacturing Agreement, Incorporated by reference to Exhibit 10-E(10)
License and Technical Assistance Agreement and of the Company's S-1 Registration
Mutual Release between Sensory Science Statement No. 33-18433
Corporation, and Samsung Electronics Co. Ltd.,
dated February 28, 1989.
10.14** Manufacturing Agreement between Sensory Science Incorporated by reference to Exhibit 10.14 to
Corporation and Samsung Corporation, dated the Company's 1993 Annual Report on Form 10-K.
September 14, 1993.
10.16* Separation Agreement between Roger B. Hackett and Incorporated by reference to Exhibit 10.16 to
Sensory Science Corporation, dated August 2, 1993. the Company's 1993 Annual Report on Form 10-K.
10.17** License Agreement between Sensory Science Incorporated by reference to Exhibit 10.17 to
Corporation and Goldstar U.S.A.,Inc., dated July the Company's Annual Report Form 10-K for 11,
1994. fiscal year ended July 31, 1994 (the "1994
10-K").
10.22 Office Lease Agreement between Sensory Science Incorporated by reference to Exhibit 10.22 to
Corporation and 78 McClain, L.L.C., for premises the Company's Quarterly Report Form 10-Q for
at 7835 East McClain Drive, Scottsdale, AZ, dated the quarter ended January 31, 1995.
November 15, 1994.
10.24* Form of 1993 Employee Stock Option Plan Incorporated by reference to Exhibit 10.24 to
the Company's Transition Report on Form 10-K
for 1995.
10.26** Manufacturing Agreement between Sensory Science Incorporated by reference to Exhibit 10.26 to
Corporation and Shintom Co. Ltd. and Talk the Company's Quarterly Report Form 10-Q for
Corporation, dated January 9, 1996. the quarter ended December 31, 1995.
10.27** First Amendment to Manufacturing Agreement between Incorporated by reference to Exhibit 10.27 to
Sensory Science Corporation and Samsung the Company's Annual Report on Form 10-K for
Corporation dated April 1, 1996. 1996.
10.29 Amended and Restated Loan and Security Agreement Incorporated by reference to Exhibit 10.31 to
between Sensory Science Corporation and Congress the Company's Report on Form 10-Q for the
Financial, August 19, 1998 quarter ended September 30, 1998.
10.30 Development, Marketing, and Distribution Agreement Incorporated by reference to Exhibit 10.30 to
between Sensory Science Corporation and Loewe Opta the Quarterly Report on Form 10-Q for the
GmbH 1, 1997 quarter ended September 30, 1997
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<TABLE>
<S> <C> <C>
10.31 Acquisition Agreement By and Between Sensory Incorporated by reference to Exhibit 10.31 to
Science Corporation, Go-Video Productions, Inc. the Company's Annual Report on Form 10-K for
and Pornthep Srichawla, Akradej Srichawla, and the fiscal year ended March 31, 1998
Vorthep Srichawla dated April 1, 1998
10.32 Amendment Number Four to Second Amended and Filed Herewith
Restated Loan and Security Agreement
21 List of Subsidiaries Filed Herewith
23 Independent Auditor's Consent Filed Herewith
27 Financial Data Schedule Filed Herewith
</TABLE>
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* 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.
42
<PAGE> 45
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 29, 2000
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.
<TABLE>
<CAPTION>
NAME AND SIGNATURE TITLE DATE
------------------ ----- ----
<S> <C> <C>
/s/ Roger B. Hackett Chairman of the Board of Directors, Chief June 29, 2000
------------------------------------ Executive Officer, President, and Chief
Roger B. Hackett Operating Officer (principal executive officer)
/s/ Thomas E. Linnen Executive Vice President Corporate Planning and June 29, 2000
-------------------------------------- Chief Financial Officer, Secretary and Treasurer
Thomas E. Linnen and Director (principal financial and accounting
officer)
/s/ Carmine F. Adimando Director June 29, 2000
--------------------------------------
Carmine F. Adimando
/s/ Thomas F. Hartley, Jr. Director June 29, 2000
--------------------------------------
Thomas F. Hartley, Jr.
/s/ William T. Walker, Jr. Director June 29, 2000
--------------------------------------
William T. Walker, Jr.
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<PAGE> 46
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
------ ----------------------
10.32 Amendment Number Four to Second Amended and
Restated Loan and Security Agreement
21 List of Subsidiaries
23 Independent Auditor's Consent
27 Financial Data Schedule