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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
FOR THE QUARTERLY PERIOD ENDED MARCH 29, 1998
Commission File Number 0-20684
AUREAL SEMICONDUCTOR INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3117385
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
4245 TECHNOLOGY DRIVE
FREMONT, CA 94538
(Address of principal executive offices)
Telephone: (510) 252-4245
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 whether the registrant has filed all documents required
to be filed by Section 12, 13 or 15 (d) of the Securities Exchange Act of 1934
subsequent to the distribution of securities under a plan confirmed by a court.
Yes X No
--- ---
At April 30, 1998, 42,137,414 shares of common stock, $0.001 par value, of the
registrant were outstanding.
This report on Form 10-Q contains 16 pages. The exhibit index is on page 16.
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AUREAL SEMICONDUCTOR INC.
FORM 10-Q
Table of Contents
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Page
PART I. FINANCIAL INFORMATION
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Item 1. Financial Statements...................................................... 3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................................... 15
Item 5. Other Information......................................................... 15
Item 6. Exhibits and Reports on Form 8-K.......................................... 15
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AUREAL SEMICONDUCTOR INC.
INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Interim Condensed Consolidated Financial Statements of Aureal
Semiconductor Inc. (the "Company") have been prepared by the Company, without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principals have been omitted pursuant to such rules and regulations. The
disclosures included in the Interim Condensed Consolidated Financial Statements
should be read in conjunction with the Company's audited financial statements at
December 28, 1997 and the notes thereto included in the Company's 1997 Annual
Report on Form 10-K.
The preparation of financial statements in conformity with generally
accepted accounting principles and pursuant to the rules and regulations of the
Securities and Exchange Commission 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.
The Interim Condensed Consolidated Financial Statements reflect, in the
opinion of management, all adjustments (which include only normal recurring
adjustments) necessary for a fair presentation of financial position, results of
operations and cash flows for such periods. The results of operations for the
fiscal quarter ended March 29, 1998 are not necessarily indicative of the
results that may be expected for any subsequent quarter or the entire fiscal
year ending December 27, 1998.
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AUREAL SEMICONDUCTOR INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
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<CAPTION>
March 29, December 28,
1998 1997
--------- ---------
(Unaudited)
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ASSETS:
Current assets:
Cash and cash equivalents $ 105 $ 135
Restricted cash 113 109
Accounts receivable 2,636 21
Inventories 5,745 511
Deferred fair value of debt related warrants 3,000 3,000
Prepaid loan fees and other current assets 611 462
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Total current assets 12,210 4,238
Property and equipment:
Machinery and equipment 3,185 3,785
Furniture, fixtures and improvements 608 599
--------- ---------
3,793 4,384
Accumulated depreciation and amortization (1,923) (3,170)
--------- ---------
Net property and equipment 1,870 1,214
Long-term portion of fair value of debt
related warrants, other assets 68 898
--------- ---------
Total assets $ 14,148 $ 6,350
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Current liabilities:
Accounts payable $ 7,705 $ 1,523
Accrued compensation and benefits 985 1,115
Other accrued liabilities 1,675 1,365
Current portion of pre-petition claims 873 880
--------- ---------
Total current liabilities 11,238 4,883
Line of Credit 25,000 21,975
Long-term portion of pre-petition claims and
deferred obligations 2,804 3,641
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Total liabilities 39,042 30,499
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Stockholders' equity (deficit):
Preferred Stock, $0.001 par value:
Authorized shares - 5,000,000; Issued and outstanding
shares - 500 in 1998 and none in 1997 -- --
Additional paid-in capital 4,592 --
Common stock, $0.001 par value:
Authorized shares - 100,000,000; Issued and outstanding
shares - 42,082,938 in 1998 and 41,850,205 in 1997 42 42
Additional paid-in capital 114,501 114,352
Accumulated deficit (144,029) (138,543)
--------- ---------
Total stockholders' equity (deficit) (24,894) (24,149)
--------- ---------
Total liabilities and stockholders' equity (deficit) $ 14,148 $ 6,350
========= =========
</TABLE>
See accompanying notes.
4
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AUREAL SEMICONDUCTOR INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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<CAPTION>
Quarter Ended
------------------------
March 29, March 30,
1998 1997
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(Unaudited)
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Net sales $ 3,582 $ 427
Cost of sales 2,793 20
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Gross Margin 789 407
Operating expenses:
Research and Development 2,618 1,438
Sales and Marketing 1,356 778
General and Administrative 860 584
Amortization of Reorganization Asset -- 625
-------- --------
Total operating expenses 4,834 3,425
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Operating loss (4,045) (3,018)
Amortization of debt related warrants (750) --
Interest expense (1,031) (519)
Other income (expense), net 340 53
-------- --------
Loss from operations before income taxes (5,486) (3,484)
Provision for income taxes -- --
-------- --------
Net loss $ (5,486) $ (3,484)
======== ========
Net loss per share: basic and diluted $ (0.13) $ (0.09)
-------- --------
Weighted average common shares
outstanding: basic and diluted 41,969 39,304
======== ========
</TABLE>
See accompanying notes.
5
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AUREAL SEMICONDUCTOR INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
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<CAPTION>
Quarter Ended
-------------------------
March 29, March 30,
1998 1997
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(Unaudited)
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OPERATING ACTIVITIES
Net loss from operations $(5,486) $(3,484)
Adjustments to reconcile net loss from operations
to net cash used in operating activities:
Depreciation and amortization 1,022 801
Changes in operating assets and liabilities:
Restricted cash (4) (100)
Accounts receivable (2,615) (88)
Inventories (5,234) (121)
Prepaid expenses and other current assets (149) 108
Other assets (15) --
Accounts payable 6,182 (125)
Accrued compensation and benefits, and
other accrued liabilities 183 (224)
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Net cash used in operating activities (6,116) (3,233)
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INVESTING ACTIVITIES
Acquisition of property and equipment (832) (129)
------- -------
Net cash used in investing activities (832) (129)
------- -------
FINANCING ACTIVITIES
Proceeds from Line of Credit 7,225 3,535
Repayment on Line of Credit (4,200) (100)
Principal payments on pre-petition claims (844) (261)
Proceeds from issuance of preferred stock, net of
issuance costs 4,592 --
Proceeds from issuance of common stock, net of
issuance costs 145 178
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Net cash provided by financing activities 6,918 3,352
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Net decrease in cash and cash equivalents (30) (10)
Cash and cash equivalents at beginning of period 135 18
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Cash and cash equivalents at end of period $ 105 $ 8
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid $ 749 $ 383
</TABLE>
See accompanying notes.
6
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AUREAL SEMICONDUCTOR INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. THE COMPANY AND RECENT EVENTS
Aureal Semiconductor Inc., together with its subsidiaries Crystal River
Engineering, Inc., and Aureal Semiconductor Limited (combined, the "Company")
specialize in the design and marketing of audio semiconductor technologies for
use in both the PC and consumer electronics markets. Crystal River Engineering,
Inc. ("CRE"), founded in 1987 and acquired by Aureal in the second quarter of
1996, has been a pioneer in the development of 3D audio technologies. Aureal
Semiconductor Limited, located in Hong Kong, was established in March of 1998 as
a sales, technical support and field engineering office. The Company's business
involves not only the development and sale of audio processing semiconductor
chips, but the licensing of technology which is designed to define and develop
advanced audio standards in the marketplace. The Company's stock symbol on the
OTC Bulletin Board is AURL.
On April 28, 1998 the Company announced the introduction of A3D 2.0, a
significant enhancement to the current version of A3D which was originally
introduced in September 1996. A3D 2.0 is backward compatible with A3D, which is
expected to be incorporated into over 100 new PC game titles and is included on
PC sound cards and brand name computer systems. This new generation of A3D
includes Aureal Wavetracing Technology (which enables real-time acoustic
reflections, reverb and occlusion rendering), more 3D sources, a higher sample
rate and larger Head-Related Transfer Function (HRTF) filters. Together, all of
these feature enhancements provide for improved three-dimensional rendering of
audio for interactive applications.
In March 1998, Aureal was granted another patent for advanced
three-dimensional audio technology. Specifically, the patent was for a method
and apparatus for measuring HRTF's. This patent further strengthens the
Company's intellectual property position in the area of advanced 3D audio
technology. Aureal's patent portfolio is now 18 issued U.S. patents with 35
additional patent applications on file in the field of audio.
Also in March, the Company completed the sale of $5 million of Aureal's
Series A Preferred Stock. The shares of preferred stock include conversion
rights to the Company's common stock at either a $2.50 fixed conversion rate or
a variable conversion pricing dependent upon the underlying price of the common
stock over the three-year term.
During the quarter, key design wins for the Vortex AU8820 were
announced, including Dell Computer Corporation, Turtle Beach Systems, Aztech
Systems Ltd. and TerraTec Electronic GmbH. These design wins, along with others,
enabled the Company to begin shipping the AU8820 chip in volume during the first
quarter of 1998. In addition to the potential for revenue generation, the design
wins are important in that these customers will promote the Company's A3D
technology. This may lead to design wins for additional product lines for these
customers, as well as new customers.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The Interim Condensed Consolidated Financial Statements of Aureal
Semiconductor Inc. have been prepared by the Company, without audit, pursuant to
the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in the financial
statements prepared in accordance with generally accepted accounting principles
have been omitted pursuant to such rules and regulations. The disclosures
included in the Interim Condensed Consolidated Financial Statements should be
read in conjunction with the Company's audited financial statements at December
28, 1997 and the notes thereto included in the Company's 1997 Annual Report on
Form 10-K.
The Interim Condensed Consolidated Financial Statements reflect, in the
opinion of management, all adjustments (which include only normal recurring
adjustments) necessary for a fair presentation of financial position, results of
operations and cash flows for such periods. The results of operations for the
fiscal quarter ended March 29, 1998 is not necessarily indicative of the results
that may be expected for any subsequent quarter or the entire fiscal year ending
December 27, 1998.
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Inventories
Inventories are stated at the lower-of-cost-or-market value on a
weighted-average costing method. The Company does not consider any inventory to
be raw material, since the Company's point of purchase is for fabricated silicon
wafers. Net inventories at March 29, 1998 and December 28, 1997 consist of the
following, in thousands:
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March 1998 Dec. 1997
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Work-In-Process . . . . . . . . . . . . . . . . . $4,877 $ 243
Finished Goods . . . . . . . . . . . . . . . . . . 868 268
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Total Inventories . . . . . . . . . . . . . $5,745 $ 511
====== ======
</TABLE>
Property and Equipment
Property and equipment are stated at cost and depreciated utilizing the
straight-line method over their estimated useful lives (one and one-half to five
years). Fixed assets with approximately $1.4 million in gross value and zero net
book value were retired during the quarter as they were determined to no longer
be in use.
Revenue Recognition
The Company's major sources of revenue consist of sales of proprietary
design, advanced audio semiconductor chips, and licensing of related audio
technologies. Revenue was recognized upon shipment for product sales. Licensing
revenues are recognized upon delivery of licensed product, and upon reported
sales of licensed units for royalties unless it is necessary to defer
recognition as a result of continuing obligations.
Concentration of Financial Instrument Risks and Credit Risks
Financial instruments which potentially subject the Company to
concentration of market risk consist primarily of the Company's line of credit.
Concentration of market risk on the line of credit is related to changes in the
prime lending rate, as the majority of the Company's debt bears interest rates
which fluctuate with changes in the prime lending rate.
Credit risk for the Company consists primarily of the trade receivables.
Most of the trade receivables are the result of sales to foreign companies.
Concentration of credit risk is limited by the use of bank letters of credit for
many of these international customers. Additionally, the Company has established
an allowance for doubtful accounts based on the credit risk of specific
customers.
Valuation of Warrants
In 1997, the Company recorded the estimated fair value for the warrants
issued in association with both the amendment to the line of credit ("Debt
Warrants"), and the sale of common stock ("Equity Warrants"). The fair values of
the Debt Warrants and the Equity Warrants were estimated to be $5.0 million and
$1.5 million respectively. Amortization of the $5.0 million asset, as additional
interest expense over the life of the loan, commenced in August 1997 at the rate
of $0.75 million per quarter.
Loss Per Share
The Financial Accounting Standards Board has issued SFAS No. 128, which
is effective for financial statements for periods ending after December 15,
1997. SFAS No. 128 requires that the calculation for basic EPS exclude the
dilutive effect of common stock equivalents in the calculation for basic net
income (loss) per share. Diluted EPS under SFAS No. 128, is calculated using the
weighted average number of common and common stock equivalent shares outstanding
during the period. Common equivalent shares are computed using the treasury
stock method for outstanding warrants and stock options. Common equivalent
shares are excluded from the diluted EPS computation only if their effect is
anti-dilutive. No common stock equivalents were included in the calculations for
any fiscal period presented as, due to the net loss position, any affect would
be anti-dilutive.
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In 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income,"
which was adopted by the Company in the first quarter of 1998. SFAS No. 130
requires companies to report a new, additional measure of income. The Company
adopted SFAS No. 130 in the current period; however, the Company has no material
items of other comprehensive income in any period presented.
Amortization of Intangibles
At December 31, 1994, the reorganization value of the Company in excess
of its net assets generated a $44.1 million intangible value that was classified
as a reorganization asset in the consolidated balance sheet of the Company
("Reorganization Asset"). The value of the Reorganization Asset was reduced in
the second quarter of 1995 as the Company exited the retail products business.
The net remaining Reorganization Asset was fully amortized as of December 28,
1997.
In conjunction with the acquisition of (CRE) made during the second
quarter of 1996, the allocation of the purchase price included an intangible
asset of $150,000. Amortization over the estimated useful life of eighteen
months commenced in mid-1996. As a result of further asset value allocations,
the intangible asset was reduced by $61,000 during 1996. As of December 28,
1997, the intangible asset was fully depreciated.
3. LINE OF CREDIT
The Company maintains a line of credit managed by TCW Special Credits,
an affiliate of the TCW Group, Inc. ("TCW"). The maturity date (originally March
1, 1995) and the total availability under the line (ranging from $10 million to
$31.5 million to date) have been negotiated periodically with TCW. In
conjunction with the private placement of equity, finalized in August 1997, the
line of credit was increased from $20.0 million to $31.5 million, and the
maturity date was extended to March 31, 1999. In addition, the Company has an
option to extend the due date an additional year, to March 31, 2000. Borrowings
under the facility are secured by substantially all the assets of the Company
and bear interest at the rate of prime (8.50% at March 29, 1998) plus five
percent. At April 30, 1998, $30.4 million was outstanding under the line.
In May 1998, subsequent to the quarterly results shown, the Company
secured a $5 million increase to the total availability under the existing line
of credit. The line of credit lenders include entities affiliated with TCW
Special Credits and DDJ Capital Management LLC. As of April 30, 1998 these
entities controlled approximately 42% and 16% of the Company's equity
securities, respectively.
4. EQUITY FUNDING
In March 1998, the Company completed the sale of $5 million of the
Company's Series A Preferred Stock. The shares of the preferred stock include
conversion rights to Aureal common stock at either a $2.50 fixed conversion rate
or a variable conversion pricing dependent upon the underlying price of the
common stock over the three-year term. The proceeds were used to pay down a
portion of the outstanding balance on the Company's line of credit.
5. INCOME TAXES
The Company was not required to provide for income taxes in the first
quarter of 1998 or 1997 due to its net operating losses. No tax benefit has been
recorded for the losses due to the uncertainty as to the realizability.
At December 28, 1997, the Company had available net operating loss
carryforwards ("NOL's") of approximately $285 million to reduce future taxable
income. The NOL's expire on various dates through 2012. In connection with the
adoption of fresh start accounting, any tax benefit resulting from the use of
the NOL's generated prior to the bankruptcy plan confirmation in 1994 will be
applied as a direct addition to stockholders' equity.
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ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS INCLUDED ELSEWHERE HEREIN
AND THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO AND
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE YEAR ENDED DECEMBER 28, 1997, CONTAINED IN FORM 10-K FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION.
FORWARD-LOOKING STATEMENTS IN THIS REPORT ARE MADE PURSUANT TO THE SAFE
HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
INVESTORS ARE CAUTIONED THAT SUCH FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND
UNCERTAINTIES, INCLUDING, BUT NOT LIMITED TO, DEPENDENCE ON THE PC AND CONSUMER
ELECTRONICS INDUSTRIES AND ON PRODUCT LINES BASED ON NEW TECHNOLOGIES; FOUNDRY
CAPACITY, AVAILABILITY AND RELIABILITY; COMPETITION AND PRICING PRESSURES,
AVAILABILITY OF ADEQUATE FINANCIAL RESOURCES, AND OTHER RISKS DETAILED BELOW AND
FROM TIME TO TIME IN THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE
COMMISSION.
OVERVIEW
The Company's objective is to be a leading supplier of high quality,
advanced audio solutions to both the consumer electronics and PC marketplaces.
The Company utilizes a strategy which combines the development and sale of audio
processing semiconductor chips, with the licensing of technology to strategic
partners in order to define and develop advanced audio standards in the
marketplace. For 1998 and the future, this strategy is expected to include the
following elements:
- - Create value in the Aureal logo - Aureal intends to establish an
association in consumers' minds between the Aureal A3D brand and
high-quality audio.
- - Offer low-cost PC audio acceleration - Aureal's goal is to continue to
sell and develop low-cost, high-feature audio accelerators for use in
the PC marketplace.
- - Provide integrated audio components to the consumer market - Aureal is
developing devices targeted to the consumer electronics marketplace
which provide lower system cost through integration of digital, analog
and other audio system functions.
- - Brand name used throughout all areas of digital audio - Aureal believes
it has core competencies in all areas of digital audio; input,
processing and output.
Thus far in 1998 the Company has made significant strides towards
achieving company growth as a result of some recent accomplishments. Aureal has
secured key design wins or agreements for its A3D technologies, either as a
semiconductor product or as a license to include A3D in the customer's product.
In this quarter, the Company's products have begun to be included in name brand
computer systems, retail sound cards and speaker components. Some of these
customers have started to take delivery of significant volumes and, although
there is no contractual commitment, are expected to continue to order the AU8820
in significant volumes for the remainder of the year.
Aureal's A3D technology is also gaining wide acceptance from PC game
developers, and is currently supported by major game developers such as
Activision, Lucas Arts, Interplay, GT Interactive, Broderbund, Electronic Arts,
Sierra On-Line and Ubi Soft. Many game developers, as well as the hardware
manufacturers previously mentioned are helping Aureal promote its technologies
and are including the Aureal logo on packaging and advertisements.
In the second quarter, the Company has announced the next generation of
the Company's A3D technology. Later this year, Aureal expects to introduce an
additional semiconductor product based on the Vortex architecture, secure
additional design wins and bring the Company's technology to the PC motherboard.
These objectives are important for the long-term success of the Company, yet the
accomplishment of any or all of these objectives may not impact the Company's
financial results in 1998.
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RESULTS OF OPERATIONS
Net Sales
Net sales for the first quarter of 1998 were $3.6 million, compared to
$0.4 million for the first quarter of 1997. The majority of the revenues
resulted from the sale of the Vortex AU8820 chip, a PCI-based AC'97 Digital
Audio Processor produced for the PC market. Less than 10% of the revenues
resulted from licensing transactions, royalties and the sale of the VSP901 chip.
Revenues from the sale of the AU8820 chip are expected to be the largest single
component of revenue during 1998. Most of the revenues were from sales to
foreign customers. The two largest customers, both foreign, accounted for 47%
and 16% of total revenues in the first quarter.
Net revenues of $0.4 million for the first quarter of 1997 consisted
primarily of revenues from licensing transactions. The Company has A3D audio
technology license agreements in place with a number of companies, some of which
are currently shipping products that include Aureal's A3D technology.
Gross Margin
Gross margin of $0.8 million for the first quarter of 1998 was 22% of
net sales. This compares to $0.4 million, or 95% of net sales for the first
quarter of 1997. The change in margin percentage is attributable to two factors.
There was a significant shift in the mix of total revenues from very high margin
(almost 100%) licensing transactions in the first quarter of 1997, to primarily
sales of audio chips in the first quarter of 1998. Secondly, the 1998 gross
margin reflected the lower yields, extensive testing and higher transportation
costs and other costs incurred in association with the initial manufacturing
cycles of the AU8820 chip.
Research and Development
Research and development expenditures for the quarter were $2.6 million,
compared to $2.6 million in the previous quarter and $1.4 million in the first
quarter of 1997. Although the expense levels were similar for the first quarter
of 1998 and the fourth quarter of 1997, engineering staff and consulting costs
were higher in 1998. Offsetting these increases in 1998 were lower expenses for
maintenance of design tools and a significant portion of the Company's
Manufacturing Operations Department expenses being charged to cost-of-sales.
These operating costs were classified as engineering costs in 1997, but changed
classification due to the transition of operations with the commencement of chip
sales in the first quarter of 1998.
The significant increase from the first quarter of 1997 to the first
quarter of 1998 reflects the Company's commitment to the development of new
technologies and new products. Increases in research and development costs are
primarily attributable to increased staff levels. The Company expects to
continue its emphasis on research and development, and thus dollar costs in the
area are expected to increase in future periods.
Sales and Marketing
Sales and marketing expenses increased to $1.4 million for the quarter,
from $1.1 million in the previous quarter and $0.8 million in the first quarter
of 1997. The increase in 1998 over prior quarters was due primarily to two
factors. First was an increase in employee and related costs from increased
staff levels in both sales and marketing. The second factor in the increase
consisted of costs directly associated with sales volume, including distributor
commissions, which were insignificant in 1997. In addition, the Company opened a
Hong Kong sales and customer support office in March 1998. Selling and marketing
expenses are expected to generally rise over the long term as travel, promotion
and marketing costs grow with Aureal's customer base, and sales commissions
increase with higher sales volumes.
General and Administrative
General and administrative expenses for the quarter ended March 29, 1998
were $0.9 million, an increase from $0.6 million in both the previous quarter
and the first quarter of the previous year. The increase was primarily due to
increases in recruiting and other employee related costs. Aureal's employee base
has increased approximately 50% from early 1997 to March 1998, which has
necessitated increased efforts in administration of the Company. Cost control
measures have been maintained and the Company will continue its efforts in this
area.
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Amortization of Reorganization Asset
The Reorganization Asset originated pursuant to the Company's valuation
upon its exit from bankruptcy protection on December 30, 1994 whereby the fair
value of the Company exceeded its net assets by $44.1 million Operating expenses
for the first quarter of 1997 were impacted by amortization of $625,000. As of
December 28, 1997, the remaining Reorganization Asset value was completely
amortized, so no such expenses were incurred in the first quarter of 1998.
Amortization of Debt Related Warrants
The fair value of the Debt Warrants was estimated to be $5.0 million.
The value of the Debt Warrants is included in both current and long-term assets
in the accompanying balance sheets. Amortization of the $5.0 million asset, as
additional interest expense over the life of the loan, commenced in August 1997
at a rate of $0.75 million per quarter.
Interest Expense
Interest expense in both quarters presented consisted primarily of
interest on the line of credit at the rate of prime plus 5%. Interest expense
for the quarter ended March 29, 1998 totaled $1.0 million, compared to $0.5
million for the first quarter of 1997. The higher interest expense for 1998 is
the result of a higher average outstanding balance on the line of credit.
Other Income (expense)
Other income for the first quarter of 1998 included various receipts and
credits resulting from favorable resolutions to previously recorded liabilities.
For the first quarter of 1997, other income and expenses were not significant.
Income Taxes
The Company was not required to provide income taxes in the first
quarter of either 1998 or 1997 due to its net operating losses. No tax benefit
has been recorded for the loss due to the uncertainty as to its realizability.
LIQUIDITY AND CAPITAL RESOURCES
As of March 29, 1998 the Company had working capital of $1.0 million and
a shareholder's deficit of $24.9 million. This compares to a working capital
deficit of $0.6 million and a shareholder's deficit of $24.1 million as of
December 28, 1997. The net cash flow requirements for the Company have been
running in excess of $2 million per month during the first quarter of 1998. The
$6.1 million net cash used in operations for the quarter was approximately $2.9
million more than the same period in 1997. The primary factors for the increase
in net cash used were an increase in inventories, an increase in account
receivable and an increase in net loss from operations. Offsetting these to some
extent was an increase to accounts payable. The increase in cash used was
financed by borrowings from the Company's line of credit. The Company expects to
increase the manufacturing of products (through outside foundries) and financing
of customer receivables. Working capital to enable this growth is expected to be
provided primarily from the Company's working capital line of credit. For a
company just commencing sales, the timing and uncertain amount of inventory
purchases and the collection of revenues make the forecasting of cash flows from
operations inherently difficult. There is no assurance the Company will generate
positive cash flows in the future.
Capital expenditures of $832,000 during the first quarter of 1998
consisted primarily of hardware and software tools utilized in the Company's
research and development activities. This compares to capital expenditures, for
similar purposes, of $129,000 during the first quarter of 1997. Capital
expenditures for the remainder of 1998 are anticipated to generally be higher
than the corresponding quarters for 1997, but the amount may fluctuate
significantly from quarter to quarter.
12
<PAGE> 13
The terms of the line of credit, as amended in August 1997, provide for
a maturity date of March 31, 1999. In addition, the Company has an option to
extend the due date an additional year, to March 31, 2000. Borrowings under the
line of credit are secured by substantially all assets of the Company, and bear
interest at the rate of prime plus 5% per annum. The maturity date (originally
March 1, 1995) and the total availability under the line (ranging from $10
million to $31.5 million to date) have been negotiated periodically with TCW. In
early May 1998 the Company secured a $5 million increase to the $31.5 million
line of credit, of which $1.1 million was available for borrowings as of April
30, 1998. The line of credit lenders include entities affiliated with TCW
Special Credits and DDJ Capital Management LLC. As of April 30, 1998 these
entities controlled approximately 42% and 16% of the Company's equity
securities, respectively.
In May 1998, subsequent to the quarterly results shown, the Company
secured a $5 million increase to the total availability under the existing line
of credit. The line of credit lenders include entities affiliated with TCW
Special Credits and DDJ Capital Management LLC.
The Company expects to complete additional financing transactions to
continue to allow for the Company's growth or to expand its business. It has no
commitments for any specific financing at this time and there can be no
assurance that any such financing can be obtained at terms acceptable to the
Company, or at all.
RISK FACTORS
In evaluating the Company's business, certain factors, including those
discussed below and those included in documents previously filed with the
Securities and Exchange Commission, should be considered in addition to the
other information in this Form 10-Q.
New Technologies and Products Developed With New Technologies
The Company's success depends on its ability to develop and market new
technologies aimed at advancing the level of audio quality in the PC and
consumer electronics devices. With respect to the PC market, audio technology is
shifting from utilization of the ISA bus to utilization of the more advanced PCI
bus. This change enables advanced digital audio functionality including
positional 3D audio, streaming audio and higher quality presentation. There can
be no assurance that the shift from ISA-based audio to PCI-based audio will
occur in a timeframe for the Company to benefit from its PCI-based products and
technologies. As new technologies are developed, there can be no assurance that
markets will develop for them, or that markets will develop on a timely basis
for the Company to benefit therefrom.
The success of new products depends on a number of factors, including
timely completion of product development, market acceptance of the Company's and
its customer's new products and the Company's ability to offer new products at
competitive prices. Incorporating the Company's new products into its OEM
customers' new product design requires the anticipation of market trends and
performance and functionality requirements of OEM's and the production of
products that can be available in a timely manner consistent with the OEM's
development and production schedule. A failure in any of these areas could have
a material adverse effect on the Company's results of operations.
Each successive generation of microprocessors has provided increased
performance, which could in the future result in a microprocessor capable of
performing advanced audio functions to an extent that the need or preference for
the Company's products could be diminished or eliminated. Conversely, each new
generation of technology, including digital audio technology, generally requires
increased processing power. At this time, a product with the processing power
required to execute high quality audio, video and graphics simultaneously and
all other functions which the host processor does has not been introduced. The
Company believes that advanced audio processing, done in conjunction with either
video or graphics processing is best performed with a separate accelerator chip
in addition to the host processor. There can be no assurance that the increased
capabilities of microprocessors will not adversely affect demand for the
Company's products.
Product Concentration
Substantially all of the Company's revenues are related to advanced
audio solutions for the PC and consumer electronics markets and the Company
expects this to continue for the foreseeable future. The failure of this market
to continue to grow, any reduction in demand as a result of increased
competition in this market, technological change, failure by the Company to
introduce new versions of products acceptable to the marketplace or other
similar factors would have a material adverse effect on the Company's results of
operations.
13
<PAGE> 14
Competition and Pricing Pressures
The semiconductor industry is extremely competitive, and is
characterized by rapid technological change, evolving industry standards,
changing market conditions and frequent new product introductions and
enhancements. The introduction of products embodying new technologies or
standards can render existing products or products under development obsolete or
unmarketable. Many of the Company's competitors have more extensive engineering,
manufacturing, marketing, financial and personnel resources than those of the
Company. The Company expects competition to increase in the future from existing
competitors and from other companies that may enter the markets with products
that may be less costly or provide higher performance or additional features. In
general, product prices in the semiconductor industry have decreased over the
life of a particular product. As the markets for the Company's products mature
and competition increases, the Company anticipates that prices for its products
will generally decline over time. If the Company is unable to reduce its cost
sufficiently to offset declines in product prices or is unable to introduce new,
higher performance products with higher product prices, the Company's results of
operations could be materially adversely affected.
Need for Foundry Access
The Company is a "fabless semiconductor firm" which depends on outside
manufacturing resources for production of all of its semiconductor products. The
foundries which the Company uses have indicated that they have the manufacturing
availability to provide for the Company's planned production of each product
through at least 1998; however the production relationships are based only upon
purchase orders and planned production forecasts. No long term production
contracts have been entered into by the Company, and there is no assurance that
the foundries will continue to provide adequate manufacturing capacity to the
Company, or maintain such capacity at acceptable costs.
Dependence on Key Personnel
The Company's success depends to a significant extent upon continued
services of key engineering, marketing, sales and management personnel. The
Company's employees may voluntarily terminate their employment with the Company
at any time. The Company recognizes the value of the contributions of each of
its employees and has developed compensation programs, including stock option
plans for the granting of options to all employees, designed to retain its
employees. Competition for such employees is intense and the loss of the
services of such employees could have a material adverse effect on the Company's
results of operations.
Proprietary Rights and Related Litigation
The Company's ability to compete successfully will depend, in part, on
its ability to protect its proprietary technology. The Company relies on a
combination of copyright and trade secret protection, nondisclosure agreements
and licensing arrangements to establish and protect its proprietary rights. In
addition, the Company has 18 patents issued and 35 patent applications pending
in the United States and in foreign countries and intends to file additional
applications as appropriate for patents covering its technologies and products.
There can also be no assurance that any patents that may be issued to the
Company will not be challenged, invalidated or circumvented, or that any rights
granted thereunder would provide proprietary protection to the Company. In
addition, the laws of certain foreign countries may not protect the Company's
proprietary rights to the same extent as do the laws of the United States.
Although the Company does not believe that its products infringe the
proprietary rights of any third parties, there can be no assurance that
infringement or invalidity claims (or claims for indemnification resulting from
infringement claims) will not be asserted against the Company or that any such
assertions will not materially adversely affect the Company's business,
financial condition or results of operations (See Item 1 in Part II of this
document). Irrespective of the validity or the successful assertion of such
claims, the Company could incur significant cost with respect to the defense
thereof which could have a material adverse effect on the Company's business,
financial condition or results of operations.
14
<PAGE> 15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In March 1998, Aureal was served with a suit for patent infringement
filed by Creative Technology Ltd., a Singapore corporation and its subsidiary,
E-MU Systems, Inc., a California corporation. The suit alleges that Aureal's
Vortex AU8820 AC'97 Digital Audio Processor infringes on a patent which
describes a specific implementation for an electronic musical instrument
designed by E-MU Systems, Inc. Aureal has reviewed the allegations in the
complaint and believes that the action is without merit. In April 1998, the
Company filed an answer and counterclaim against Creative Technology for, among
other items, unfair trade practices and fraud.
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit index at page 16.
(b) Reports on Form 8-K: The Company filed a report on Form 8-K on
March 16, 1998 with the Securities and Exchange Commission. The
filing was to report the completion of a private placement
transaction on March 11, 1998 for the sale of $5 million of the
Company's three year 8% Series A Convertible Preferred Stock,
par value $0.001 per share.
The Preferred Stock is convertible at the lesser of the fixed
conversion price ("Fixed Conversion Price") of $2.50 face value
of the Preferred Stock per share of the Company's Common Stock,
or at varying discounts from the then-current market price of
the Common Stock if the Common Stock is trading at prices below
$2.50 per share over certain periods of time ("Variable
Conversion Price"). Conversion of the Preferred Stock can
commence at a date four months after the final closing date
(March 11, 1998). Variable Conversion Price conversions can be
completed at the rate of 15% of the originally issued Preferred
Stock per month. No such limitations apply to Fixed Conversion
Price conversions.
Accretion at the 8% rate on the outstanding Preferred Stock is
terminated if at any time the Common Stock trades at a price in
excess of 150% of the fixed conversion price for twenty
consecutive trading days. At such time as accretion is
terminated, if ever, all restrictions as to conversion are
eliminated. If not converted earlier, all outstanding Preferred
Stock will be converted on the three-year anniversary of the
final closing.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act
of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
AUREAL SEMICONDUCTOR INC.
Date: May 8, 1998 By: /s/Kenneth A. Kokinakis
------------------------------------
Kenneth A. Kokinakis
President and Chief Executive Officer
Date: May 8, 1998 By: /s/David J. Domeier
------------------------------------
David J. Domeier
Vice President of Finance
Chief Financial Officer
15
<PAGE> 16
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description of Document
----------- -----------------------
<S> <C>
2.1 Agreement and Plan of Reorganization among the Company, Aureal
Acquisition Corporation, a wholly-owned subsidiary of the
Company and Crystal River Engineering, Inc., dated as of May 7,
1996 (1)
2.2 Second Amended Joint Plan of Reorganization dated November 10,
1994 (4)
3.1 Second Amended and Restated Certificate of Incorporation of the
Company dated May 8, 1996 (2)
3.2 Restated Bylaws of Aureal Semiconductor Inc. (6)
4.1 Common Stock Purchase Agreement by and among the Company and
certain beneficial owners of 5% or more of the Company's Common
Stock, as amended(3)
4.2 Common Stock Purchase Agreement by and among the Company and
certain entities and individuals dated June 10, 1996 (5)
4.3 Common Stock Purchase Agreement by and among the Company and
certain entities and individuals dated August 6, 1997 (8)
4.4 Preferred Stock Regulation D Subscription Agreement (10)
4.5 Certificate of Designation of Series A Preferred Stock of Aureal
Semiconductor Inc. (10)
4.6 Preferred Stock Registration Rights Agreement (10)
10.1 Second Amended and Restated Loan Agreement between TCW Special
Credits and the Company dated August 6, 1997 increasing the loan
commitment from $20 million to $31.5 million. (9)
10.2 1995 Stock Option Plan (3)
10.3 Form of incentive option agreement and non-statutory stock
option agreement used under 1995 Stock Option Plan (3)
10.4 1994 Stock Option Plan (4)
10.5 Form of incentive option agreement and non-statutory stock
option agreement used under 1994 Stock Option Plan (4)
10.6 Industrial Space Sublease with Chemical Waste Management, Inc.
dated September 13, 1995 (3)
10.7 Form of Indemnity Agreement for Directors and Officers (6)
10.8 1996 Outside Directors Stock Option Plan (7)
11.1 Computation of Earnings (Loss) Per Share (See Pages 5 and 9)
27.1 Financial Data Schedule (Edgar Only)
</TABLE>
- ------------------
(1) Incorporated by reference to the exhibits filed with Form 8-K dated May
22, 1996.
(2) Incorporated by reference to the exhibits filed with Form S-8
(Registration number 333-09531) filed August 2, 1996.
(3) Incorporated by reference to the exhibits filed with Form 10-K for the
year ended December 31, 1995.
(4) Incorporated by reference to the exhibits filed with Form 10-K for the
year ended December 31, 1994.
(5) Incorporated by reference to the exhibits filed with Form S-3
(Registration number 333-3870) filed June 26, 1996.
(6) Incorporated by reference to the exhibits filed with Form 10-Q for the
quarter ended September 29, 1996.
(7) Incorporated by reference to the exhibits filed with Form 10-K for the
year ended December 29, 1996.
(8) Incorporated by reference to the exhibits filed with Form S-3 (As
Post-Effective Amendment No. 1, Registration number 333-3870) filed
September 12, 1997.
(9) Incorporated by reference to the exhibits filed with Form 10-Q for the
quarter ended September 28, 1997.
(10) Incorporated by reference to the exhibits filed with Form 8-K dated
March 16, 1998.
16
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS FOR THE FISCAL QUARTER ENDED MARCH 29, 1998
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<PERIOD-START> DEC-29-1997
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