<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB
(Mark One)
[X] Quarterly report under Section 13 or 15 (d) of the Securities Exchange Act
of 1934
For the quarterly period ended March 31, 1998
[ ] Transition report under Section 13 or 15 (d) of the Exchange Act
For the transition period from __________ to __________
Commission file number 0-28604
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SOUND SOURCE INTERACTIVE, INC.
------------------------------
(Exact Name of Small Business Issuer as Specified in Its Charter)
DELAWARE 95-426046
-------- ---------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
26115 MUREAU ROAD, SUITE B, CALABASAS, CALIFORNIA 91302-3126
------------------------------------------------------------
(Address of Principal Executive Offices)
(818) 878-0505
--------------
(Issuer's Telephone Number, Including Area Code)
_______________________________________________________________________
(Former Name, Former Address and Former Fiscal Year, If Changed
Since Last Report)
Check whether the issuer: (1) filed all reports required to be file by
Section 13 or 15 (d) of the Exchange Act during the past 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
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The number of shares outstanding of the issuer's common stock as of April
30, 1998 was 4,548,474
---------
Transitional Small Business Disclosure Format (check one):
Yes No X
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<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997
INDEX
<TABLE>
<CAPTION>
PAGE NO.
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<S> <C>
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Balance Sheet - March 31, 1998 3
Condensed Consolidated Statements of Operations - Three month
periods ended March 31, 1998 and 1997, and the nine month
periods ended March 31, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows - Nine month
periods ended March 31, 1998 and 1997 6
Notes to the Condensed Consolidated Financial Statements 8
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Outlook 15
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 16
ITEM 4. Submission of a Matter to a Vote of Security Holders 17
ITEM 5. Other Information 18
ITEM 6. Exhibits and Reports on Form 8-K 18
Signature Page 19
Financial Data Schedule 20
</TABLE>
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
MARCH 31, 1998
<TABLE>
<CAPTION>
ASSETS
<S> <C>
Current Assets:
Cash and cash equivalents $ 1,075,783
Accounts receivable - net 721,818
Inventory - net 477,453
Prepaid royalties 1,956,579
Prepaid expenses 285,464
------------
Total current assets 4,517,097
------------
Property and equipment - net 442,694
------------
TOTAL ASSETS $ 4,959,791
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued expenses $ 860,401
Accrued compensation and related taxes 252,081
Accrued royalties 1,833,996
Current portion of capital lease obligations 5,250
------------
Total current liabilities 2,951,728
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Stockholder's Equity:
Common stock - $.001 par value, 20,000,000 shares
authorized, 4,548,474 shares issued and outstanding 4,548
Warrants 1,104,925
Additional paid-in capital 13,694,819
Accumulated deficit (12,796,229)
------------
Total stockholders' equity 2,008,063
------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 4,959,791
============
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31,
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Net revenues $1,189,470 $ 929,271
Cost of sales 336,881 470,878
---------- ----------
Gross profit 852,589 458,393
---------- ----------
Operating costs and expenses:
Marketing and sales 454,874 262,122
Compensation in connection with
common stock and common stock
options issued for services
rendered 88,095 89,304
Other general and administrative 334,144 480,692
Research and development 511,856 244,466
---------- ----------
Total operating costs and expenses 1,388,969 1,076,584
---------- ----------
Operating income (loss) (536,380) (618,191)
Other income (expense) 307,958 12,442
---------- ----------
Income (loss) before provision for income taxes (228,422) (605,749)
Provision for income taxes 800 (870)
---------- ----------
Net income (loss) $ (229,222) $ (604,879)
========== ==========
Basic earnings (loss) per share $ (0.05) $ (0.14)
========== ==========
Diluted earnings (loss) per share $ (0.05) $ (0.14)
========== ==========
Weighted average number of common
shares outstanding - Basic 4,506,949 4,403,040
========== ==========
Weighted average number of common
shares outstanding - Diluted 4,506,949 4,403,040
========== ==========
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Net revenues $5,262,439 $ 3,359,517
Cost of sales 1,801,372 1,423,880
---------- -----------
Gross profit 3,461,067 1,935,637
---------- -----------
Operating costs and expenses:
Marketing and sales 1,404,759 954,875
Compensation in connection with
common stock and common stock
options issued for services
rendered 264,285 267,911
Other general and administrative 538,533 1,495,546
Research and development 1,086,576 813,339
---------- -----------
Total operating costs and expenses 3,294,153 3,531,671
---------- -----------
Operating income (loss) 166,914 (1,596,034)
Other income (expense) 293,727 53,579
---------- -----------
Income (loss) before provision for income taxes 460,641 (1,542,455)
Provision for income taxes 800 4,060
---------- -----------
Net income (loss) $ 459,841 $(1,546,515)
========== ===========
Basic earnings (loss) per share $ 0.10 $ (0.36)
========== ===========
Diluted earnings (loss) per share $ 0.10 $ (0.36)
========== ===========
Weighted average number of common
shares outstanding - Basic 4,442,477 4,346,100
========== ===========
Weighted average number of common
shares outstanding - Diluted 4,555,263 4,346,100
========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTH PERIODS ENDED MARCH 31,
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 459,841 $(1,546,515)
Adjustments to reconcile net income (loss) to net
cash used by operating activities:
Depreciation and amortization 98,017 74,454
Allowance for sales returns (130,678) 144,420
Allowance for bad debts (703,421)
Common stock and common stock options
issued for services rendered 264,285 267,911
Changes in operating assets and liabilities:
Accounts receivable 1,473,400 (490,013)
Inventories (248,776) (180,873)
Prepaid royalties (338,016) (910,376)
Prepaid expenses and other (193,038) (103,732)
Accounts payable and accrued expenses (294,899) (302,618)
Accrued compensation and related taxes (20,677) 218,427
Accrued interest (367,695)
Accrued royalties 160,254 857,977
Deferred revenues (12,000) (67,704)
---------- -----------
Net cash used by operating activities 514,292 (2,406,337)
---------- -----------
Cash flows from investing activities-
Purchases of property and equipment (26,458) (340,397)
---------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock 6,053 7,969,618
Proceeds from issuance of warrant 341,575
Repayment of notes payable (4,987,500)
Deferred offering costs 620,904
Payments on capital lease obligations (8,563) (20,005)
Repayment of short term advance (400,000)
---------- -----------
Net cash (used in) provided by financing activities (2,510) 3,524,592
---------- -----------
Net change in cash and cash equivalents 485,324 777,858
Cash and cash equivalents, beginning of period 590,459 181,985
---------- -----------
Cash and cash equivalents, end of period $1,075,783 $ 959,843
========== ===========
</TABLE>
6
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
FOR THE NINE MONTH PERIODS ENDED MARCH 31,
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Supplement disclosure of cash flow information -
Cash paid during the period for:
Interest $21,773 $382,970
======= ========
Income taxes $ 800 $ 4,059
======= ========
Supplemental disclosure of noncash investing
and financing activities:
</TABLE>
During the nine-month period ended March 31, 1997, the Company issued 2,016,657
warrants in connection with the conversion of a note payable to related party in
the amount of $500,000 and accrued interest thereon in the amount of $4,164.
On February 17, 1998, the Company acquired all of the outstanding common stock
of BWT Labs, Inc. for the assumption of approximately $99,798 of liabilities.
The Company has accounted for such transaction under the purchase method of
accounting and ascribed the amount to property and equipment.
See notes to condensed consolidated financial statements.
7
<PAGE>
SOUND SOURCE INTERACTIVE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTH PERIODS ENDED MARCH 31, 1998 AND 1997
NOTE A - BASIS OF PRESENTATION
- ------------------------------
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with the instructions to Form 10-QSB and therefore do not
include all information and notes necessary for a fair presentation of financial
position, results of operations, and cash flows in conformity with generally
accepted accounting principles. The unaudited condensed consolidated financial
statements include the accounts of Sound Source Interactive, Inc. and its wholly
owned subsidiaries (collectively referred to as the Company). The operating
results for interim periods are unaudited and are not necessarily an indication
of the results to be expected for the full fiscal year, particularly given the
seasonal nature of the Company's business. In the opinion of management, the
results of operations as reported for the interim period reflect all adjustments
which are necessary for a fair presentation of operating results.
NOTE B - INITIAL PUBLIC OFFERING (IPO)
- --------------------------------------
On July 1, 1996, the Company issued 2,400,000 shares of common stock at $4.00
per share and 1,200,000 redeemable warrants at $.25 per warrant. Net proceeds
totaled $7,973,305, net of offering costs of $1,926,695. On August 14, 1996,
the underwriters exercised a portion of their "overallotment" option, pursuant
to the underwriting agreement, which resulted in the Company issuing an
additional 160,000 shares of common stock at $4.00 per share and 171,775
redeemable warrants at $.25 per warrant. Net proceeds totaled $594,161, net of
offering costs of $88,783.
NOTE C - NOTES PAYABLE AND NOTES PAYABLE TO RELATED PARTY
- ---------------------------------------------------------
On July 7, 1996, in connection with the IPO, the Company repaid notes payable
issued during fiscal 1996 aggregating $4,987,500 plus accrued interest of
$373,753.
On July 7, 1996, in connection with the IPO, the Company issued 2,016,657
warrants in connection with the conversion of a note payable to related party of
$500,000, plus accrued interest of $4,164.
NOTE D - ACCOUNTS RECEIVABLE AND SHORT TERM ADVANCE
- ---------------------------------------------------
In June 1995, the Company entered into a sales and distribution agreement with a
subsidiary of Acclaim Entertainment, Inc. (Acclaim). Under the terms of the
agreement, Acclaim was responsible for the distribution of the Company's
products on a worldwide basis to retail accounts. Effective April 1, 1996, such
agreement was terminated.
8
<PAGE>
In July 1996, Acclaim submitted certain information to the Company together with
payment of $256,067 and a promissory note with a principal amount of $256,067,
maturing August 26, 1996 and bearing interest at 10% per annum. Such
represented the balances of all amounts due to the Company under the
distribution agreement, as determined by Acclaim. Included in the information
provided by Acclaim, it was noted that the Company was not obligated to repay a
short-term advance totaling $400,000 previously made by Acclaim to the Company.
On August 28, 1996, the Company received $256,067 plus accrued interest of
$2,175 pursuant to the terms of the promissory note. On December 13, 1996, the
Company filed suit in Superior Court for the County of Los Angeles, California,
against Acclaim. On January 7, 1998, the Company and Acclaim settled the
lawsuit for the payment of $1,500,000 by Acclaim without any admission of
liability. The Company recorded an offset to bad debt expense in the amount of
$703,421 during the three-month period ended December 31, 1997 and other income
in the amount of $296,579 during the three-month period ended March 31, 1998.
As of March 31, 1998, $461,777 of the accounts receivable balance is due from
Simon & Schuster Interactive Distribution Services (SSIDS). SSIDS is the
consumer software distribution unit of Simon & Schuster, Inc., the publishing
operations of Viacom, Inc. Pursuant to a distribution agreement between the
Company and SSIDS, which expires on May 31, 1998, SSIDS provides sales,
distribution, warehousing and order fulfillment services for all of the
Company's products throughout the United States and Canada. The Company is
currently negotiating a new distribution agreement with SSIDS under the terms of
which the Company will be responsible for all sales and marketing activities and
SSIDS will be responsible for all distribution, fulfillment, invoicing and
accounts receivable collection activities. There can be no assurance that such
agreement will be consummated.
NOTE E - CASH AND CASH EQUIVALENTS
- ----------------------------------
The Company invests all excess cash in working capital asset management accounts
with Merrill Lynch and Company. The Company maintains balances within the
federally insured limits.
NOTE F DETERMINATION OF EARNINGS PER SHARE COMPUTATION
- -------------------------------------------------------
<TABLE>
<CAPTION>
First Second Third Nine Month
Quarter Quarter Quarter Period
------- ------- ------- ------
<S> <C> <C> <C> <C>
Basic EPS Computation
Numerator $ (584,215) $1,273,280 $ (229,222) $ 459,841
Denominator 4,409,849 4,412,099 4,507,415 4,442,630
Basic EPS $ (0.13) $ 0.29 $ (0.05) $ 0.10
</TABLE>
<TABLE>
<CAPTION>
First Second Third Nine Month
Quarter Quarter Quarter Period
------- ------- ------- ------
<S> <C> <C> <C> <C>
Diluted EPS Computation
Numerator $ (584,215) $1,273,280 $ (229,222) $ 459,841
Denominator
Common shares outstanding 4,409,849 4,412,099 4,507,415 4,507,415
Options 338,357 112,786
---------- ---------- ----------
4,409,849 4,750,456 4,507,415 4,620,201
Diluted EPS $ (0.13) $ 0.27 $ (0.05) $ 0.10
</TABLE>
9
<PAGE>
As of December 31, 1997, the Company has issued options to purchase a total of
873,773 shares of the Company's common stock. Of such amount, options to
purchase 584,923 shares of common stock are included in the above diluted
earnings per share computation for the three month period ended December 31,
1997. Of the remaining 288,850 outstanding options to purchase shares of common
stock, 268,850 options were excluded from the above diluted earnings per share
computation as they were not vested as of December 31, 1997, and 20,000 options
to purchase shares of common stock were excluded as inclusion would be anti-
dilutive. No options were included in the three month periods ended September
30, 1997 and March 31, 1998 as their inclusion would have be antidilutive.
As of March 31, 1998, the Company has issued warrants to purchase a total of
11,078,097 shares of the Company's common stock. All of such warrants have been
excluded from the above diluted earnings per share computation for the three-
month period ended and the nine month period ended March 31, 1998, as their
inclusion would be anti-dilutive. On April 27, 1998, the Company entered a
settlement agreement regarding certain outstanding lawsuits, which included
among other things, the conversion of 4,816,657 of the outstanding warrants into
1,100,000 shares of the Company's common stock.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Three Months Ended March 31, 1998 Compared to the Three Months Ended March 31,
1997
Net Sales. Net sales increased by 28.0 percent from $929,271 for the three
months ended March 31, 1997 to $1,189,470 for the three months ended March 31,
1998. This increase is primarily attributable to increased sales related to the
Company's children's products, which were partially offset by higher than
expected returns of certain other products.. Net sales of the Company's The
Land Before Time Series continues to exceed expectations. During March 1998,
the Company introduced the third product in this series and anticipates
introducing the fourth The Land Before Time product during the three month
period ended June 30, 1998. Product sales also were strong for the Company's
Casper product.
Several of the Company's competitors, which are larger and have greater capital
resources, appear to have entered into a contest for market share, which
essentially has led those companies to give away their products for free. The
Company is attempting to remain competitive in the children's product
marketplace with high quality products based on premier licenses from the major
motion picture studios. Product returns for the Company's children's products
continue to be below amounts established as reserves for returns and the Company
is pleased with the performance of its children's products in light of the
competitive marketplace.
During the three-month period ended March 31, 1998, the Company experienced
returns principally from three of its products that significantly exceeded
amounts reserved for product returns as of December 31, 1997. These products
consist of the Company's two interactive video games for the adult market; Final
Conflict and Star Trek, and The Lost World Jurassic Park entertainment utility.
Although the Company performed a detailed analysis as of January 31, 1998
regarding expected product returns based on sell through rates as of such date
and feedback from retailers, sales for those products significantly diminished
during February, March and April 1998. The Company has received or expects to
continue to receive returns greater than that reserved as of December 31, 1997
of approximately $350,000. The larger than expected returns have been accounted
for during the three month period ended March 31, 1998 as an offset to sales and
therefore significantly reduced net sales during the current three month period.
The Company believes that return reserves at March 31, 1998 are adequate.
10
<PAGE>
Cost of Sales. Cost of sales decreased by 28.5 percent from $470,878 for the
three months ended March 31, 1997 to $336,881 for the three months ended March
31, 1998. Cost of sales as a percentage of sales decreased from 50.7 percent to
28.3 percent during these respective periods. The decrease in cost of sales,
both in total dollar value and as a percentage of revenues is primarily due to
recording the value of inventory being returned from retailers. Previously the
Company had not ascribed any valuation to inventory expected to be returned as
the vast majority of the Company's returned inventory was not in salable
condition without significant rework. However, as noted above, the Company
received significant returns of three products, which were returned in salable
condition. Accordingly, the Company ascribed a valuation to such inventory at
the lower of cost or net realizable value, as the Company believes such
inventory will be sold in future periods at discounted prices. At the time the
Company no longer believes such inventory is salable, its valuation will be
reduced to zero. Product sales during the three months ended March 31, 1998,
were comprised principally of products selling at full price. The Company
anticipates that as some of the inventory is sold at reduced prices, there will
be an increase in cost of sales as a percentage of net sales in future periods.
Additionally, the Company received approximately $75,000 of royalty income from
its international distributors for which cost of goods sold is limited to
royalty expense as such international distributors are responsible for all
manufacturing costs. No such royalty income was earned during the same three-
month period in the prior fiscal year. During the three months ended March 31,
1997, significant portions of the Company's net sales were derived from one
product, Star Wars Limited Edition Entertainment Utility. Such product had very
high royalty percentages that were due to the licensor, actors, musicians and
voice talent thereby causing cost of sales as a percentage of net sales to be
unusually high. As such license terminated on June 30, 1997, the Company had no
sales for such product during the three months ended March 31, 1998.
Marketing and Sales. Marketing and sales expenses increased by 73.5 percent
from $262,122 for the three months ended March 31, 1997 to $454,874 for the
three months ended March 31, 1998, and increased as a percentage of sales from
28.2 percent to 38.2 percent, respectively. As noted above, net sales for the
three months ended March 31, 1998 have been reduced by approximately $350,000
for actual returns in excess of those amounts anticipated at December 31, 1997.
Had actual returns not exceeded the reserve for return amounts established at
December 31, 1997, marketing and sales expenses for the three months ended March
31, 1998 as a percentage of net sales would have been approximately 29.5
percent, a slight increase as compared to the same period in the prior year.
The Company's sales and distribution agreement with SSIDS expires on May 31,
1998. The Company is currently negotiating a new distribution agreement with
SSIDS under the terms of which the Company will be responsible for all sales and
marketing activities and SSIDS will be responsible for all distribution,
fulfillment, invoicing and accounts receivable collection activities. There can
be no assurance that such agreement will be consummated. Accordingly, the
Company hired an additional sales director in February 1998 to begin the
transition of having its own sales force. The Company believes the transition
to a dedicated sales force is essential to achieving its long term growth. The
Company anticipates that during the period from February 1998 through May 31,
1998, the Company will have an increase in sales costs as it will be incurring
its own sales expenses while still paying SSIDS a percentage of sales to perform
similar activities. Effective June 1, 1998, payments to SSIDS will be limited
to distribution, fulfillment, invoicing and accounts receivable collection
activities. The Company has also noted that marketing expenditures for in-store
marketing activities have increased substantially, as retailers are demanding
greater market development funds (MDF). Although the Company continues to be
cautious in determining where and when to expend such funds, market conditions
are dictating increased expenditures in order to maintain and expand market
share. Additionally, the Company has noted that products are returned by
retailers in a lesser number of days, thereby reducing sell through rates and
increasing marketing expenditures as a percentage of net sales. The Company is
committed to effectively marketing its products through in store promotions,
print advertising and cross-promotional activities intended to increase sell
through rates, market share and net sales. The Company believes that this
increase in marketing effort will create increased awareness of the Company's
products from both retailers and consumers.
11
<PAGE>
Research and Development. Research and Development costs increased 109.4
percent from $244,466 during the three months ended March 31, 1997 to $511,856
for the three months ended March 31, 1998, and increased as a percentage of
sales from 26.3 percent to 43.0 percent, respectively. The increase in costs is
due to a variety of factors, principally the acquisition of BWT Labs, Inc.,
increased development activities in both the entertainment and games divisions,
and the hiring of a new Senior Vice President of Product Development and the
hiring of a Vice President of Product Development for the Games Division. In
February 1998, the Company completed its acquisition of BWT Labs, Inc., a game
development company located in Berkeley, California. Effective February 17,
1998, the Company's payroll costs associated with its acquisition of BWT Labs
and the hiring of a Senior Vice President of Product Development increased
approximately $35,000 per month. The Senior Vice President of Product
Development was recruited to oversee the Company's product development
activities and to replace the existing executive in charge of product
development whose employment will be terminated due to health reasons.
During the three months ended March 31, 1998, the Company completed the
development of its The Land Before Time Math Adventure, Lost In Space Limited
Edition Entertainment Utility and An American Tail Animated MovieBook products.
Products under development and not yet completed during the three months
include: Lost In Space Learning Adventure, The Land Before Time Kindergarten
Adventure, and Casper Reading Adventure children's products and The Abyss:
Incident at Europa adventure game, God Complex strategy game and another as yet
untitled game being developed by BWT Labs. The Company also began preliminary
design work on three other children's products, which the Company anticipates
will be released during the upcoming holiday season. The Company has not only
increased the number of products that it will be releasing during calendar 1998,
but has also increased the depth and quality of such products, thereby
increasing development costs.
General and Administrative. General and administrative expenses decreased from
$480,692 during the three months ended March 31, 1997 to $334,144 for the three
months ended March 31, 1998. The most significant reduction in costs is reduced
legal fees. During the three months ended March 31, 1997, the Company expended
$89,031 related to the Acclaim litigation. No such expenses were incurred
during the three months ended March 31, 1998.
Compensation in Connection with Common Stock and Common Stock Options Issued for
Services Rendered. Expenses recorded by the Company in connection with common
stock and common stock options issued for services rendered amounted to $88,095
and $89,304 for the three months ended March 31, 1998 and 1997, respectively,
and relate to the vesting of common stock options issued during fiscal 1994.
Other Income. Included in other income during the three months ended March 31,
1998 is $296,579 related to the settlement of the Acclaim lawsuit.
Nine Months Ended March 31, 1998 Compared to the Nine Months Ended March 31,
1997
Net Sales. Net sales increased by 56.7 percent from $3,359,517 for the nine
months ended March 31, 1997 to $5,262,439 for the nine months ended March 31,
1998. This increase is primarily attributable to increased distribution by the
Company's North American distributor, Simon and Schuster Interactive
Distribution Services, Inc. (SSIDS) and other direct sales in North America.
Sales to international distributors for the nine months ended March 31, 1998
were approximately $503,413, as compared to 629,675 for the nine months ended
March 31, 1997. Sales to SSIDS for the nine-month period ended March 31, 1998
were approximately $4,063,813, as compared to $2,099,253 during the nine months
ended March 31, 1997.
12
<PAGE>
During the nine months ended March 31, 1998, the Company's net sales were
primarily comprised of sales of its The Land Before Time series and Casper
children's products, its Babylon 5 Limited Edition Entertainment Utility and its
Star Trek: The Game Show products. Other products contributing significantly to
net sales were An American Tail Animated MovieBook, Free Willy Activity Center,
and I Love Lucy, Lost In Space and The Lost World: Jurassic Park Limited Edition
Entertainment Utilities. Net sales during the nine months ended March 31, 1997
were largely comprised of the Star Wars Limited Edition Entertainment Utility
for which the Company's license to produce and sell the product terminated on
June 30, 1997, and The Land Before Time Animated MovieBook which was introduced
during August, 1996.
Cost of Sales. Cost of sales increased by 26.5 percent from $1,423,880 for the
nine months ended March 31, 1997 to $1,801,372 for the nine months ended March
31, 1998. Additionally, cost of sales as a percentage of sales decreased from
42.4 percent to 34.2 percent during these respective periods. The increase in
total cost of sales is due to the above noted 56.7 percent increase in net
revenues. The decrease in cost of sales as a percentage of revenues is
primarily due to changes in product mix to higher priced products, reductions in
manufacturing costs and reduced inventory and royalty guarantee write-downs, and
lower royalty rates of product mix. The Company does not believe that further
significant decreases in cost of sales as a percentage of net sales can be
achieved and believes that cost of goods sold as a percentage of sales during
the three month period ended June 30, 1998 will increase as the Company either
sells excess inventory at reduced prices or writes down nonsalable inventory.
Marketing and Sales. Marketing and sales expenses increased by 47.1 percent
from $954,875 for the nine months ended March 31, 1997 to $1,404,759 for the
nine months ended March 31, 1998, and decreased as a percentage of sales from
28.4 percent to 26.7 percent, respectively. The change in dollar amount is
principally related to increased marketing and sales efforts to support new
product releases during the nine-month period and increased salaries due to
additional sales personnel as noted above. The decrease as a percentage of
sales is due to the above noted 56.7 percent increase in sales. The Company
believes that marketing and sales expenses will continue to increase as the
Company continues to introduce new products, as the Company attempts to obtain
greater market share and brand loyalty and as the Company builds its own sales
force and undertakes all sales efforts. The Company also anticipates that costs
will increase as retailers are expected to significantly increase their in store
marketing costs, particularly in children's products as the marketplace is being
reduced to a small number of publishers.
Research and Development. Research and Development costs increased by 33.6
percent from $813,339 during the nine months ended March 31, 1997 to $1,086,576
for the nine months ended March 31, 1998, and decreased as a percentage of sales
from 24.2 percent to 20.6 percent, respectively. The increase in costs is
primarily associated with the increased quantity and quality of products under
development, the hiring of additional development personnel and the acquisition
of BWT Labs. The Company anticipates that Research and Development costs will
continue to increase as the Company hires additional personnel to support an
increase in the number of products and quality of products under development.
13
<PAGE>
General and Administrative. General and administrative expenses decreased by
64.0 percent from $1,495,546 during the nine months ended March 31, 1997 to
$538,533 for the nine months ended March 31, 1998, and decreased as a percentage
of sales from 44.5 percent to 10.2 percent, respectively. Included in general
and administrative expenses for the nine months ended March 31, 1998 is a one-
time recovery of $703,421 related to the collection of accounts receivable that
had been previously reserved in full. Included in general and administrative
expenses for the nine months ended March 31, 1997 is a one-time charge of
$329,644 related to the departure of the Company's former president/chief
operating officer. Excluding the two above noted events, general and
administrative expenses increased from $1,165,902 during the six months ended
March 31, 1997 to $1,241,954 during the nine months ended March 31, 1998,
primarily due to the Company recording management performance bonuses of
$100,000 and the Company incurring approximately $26,000 in consulting fees
related to the management of the Company's rapid growth. No such expenses were
incurred during the nine months ended March 31, 1997.
Compensation in Connection with Common Stock and Common Stock Options Issued for
Services Rendered. Expenses recorded by the Company in connection with common
stock and common stock options issued for services rendered amounted to $264,285
and $267,911 for the nine month periods ended March 31, 1998 and 1997,
respectively, and relate to the vesting of common stock options issued during
fiscal 1994.
Other Income. Included in other income during the nine months ended March 31,
1998 is $296,579 related to the settlement of the Acclaim lawsuit.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1998, the Company had working capital of $1,565,369 in
comparison with $851,290 at June 30, 1997, an increase of $714,079. Cash and
cash equivalents increased $485,324. Accounts receivable decreased $639,300 due
to the seasonality of product sales. The majority of net sales that the Company
received during the holiday season were collected prior to March 31, 1998.
Sales during the three month period ended March 31, 1998 were significantly
lower than those experienced during the three months ended June 30, 1997,
partially due to seasonality and partially due to the larger than expected
returns from sales recognized during the three month ended December 31, 1997.
During the nine months ended March 31, 1998, current liabilities decreased by
$10,372 from $2,962,100 at June 30, 1997 to $2,951,728 at March 31, 1998. This
change is not considered significant.
During September 1997, the Company entered into a factoring agreement with
Silicon Valley Financial Services, a division of Silicon Valley Bank. The
factoring agreement provides the Company with borrowing availability of up to
85% of the Company's qualified gross domestic accounts receivable, not to exceed
$1,500,000 in the aggregate, at a rate of 1.75% per month of the average gross
daily factoring account balance. The credit is secured by all the assets of the
Company and matures one year from the date of the agreement. As of March 31,
1998, the Company had no outstanding borrowings under the agreement.
The Company has experienced a significant increase in growth during the last
nine-month period, as compared to the same period of time in the prior fiscal
year. The Company continues to search for new opportunities to obtain licenses,
develop and sell products, and to purchase products that are at or near
completion of development. Additionally, the Company is seeking new and
innovative ways to deliver its products to consumers, some of which may require
large up-front cash resources. If the Company enters into agreements related to
such business opportunities in the future, the Company may require additional
financing to fund its growth.
14
<PAGE>
OUTLOOK
The statements contained in this report on Form 10-QSB that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, including statements regarding the Company's expectations, hopes,
intentions or strategies regarding the future. Forward-looking statements
include, but are not limited to: statements regarding the Company's sales and
future revenues, statements regarding future research and development costs and
products, and statements regarding the future flexibility of the Company's cash
reserves. All forward-looking statements included in this document are based on
information available to the Company on the date hereof, and the Company assumes
no obligation to update any such forward-looking statement. It is important to
note that the Company's actual results could differ materially from those in
such forward-looking statements. Among the factors that could cause actual
results to differ materially are the factors detailed below. Please consult the
risk factors listed from time to time in the Company's reports on Form 10-QSB
and 10-KSB and Annual Reports to Stockholders and reports filed by the Company
on Form 8-K.
Sound Source Interactive, Inc. does not provide forecasts of potential future
financial performance. While management of the Company is optimistic about the
Company's long-term prospects, the following issues and uncertainties among
others, should be considered in evaluating its growth outlook.
Sufficient Cash Flows. Although the Company has experienced significant growth
in terms of net sales, the Company will need to generate sufficient cash flows
from recurring revenues to meet its obligations to maintain its liquidity in the
future and to sustain its growth rate.
Acquisition of BWT Labs, Inc. The Company will need to properly integrate the
business and operations of this acquired entity into that of the remainder of
the Company.
Technological Developments. The personal computer software industry is
characterized by rapid technological advancement and the uncertainty of new
breakthroughs and developments in emerging areas such as the Internet and
DVD-ROM.
Distribution Channels. Traditional retail distribution channels are continuing
to experience a major restructuring and are fostering the development of
alternative distribution outlets such as direct to consumer and Internet/World
Wide Web. The Company intends to explore new and innovative distribution
methods, the success of which cannot be assured. In the traditional retail
distribution channel, there continues to be an excess of companies and products
competing for available retail shelf space. Additionally, particularly in the
children's product area, consolidation among competitors continues and as of
March 31, 1998, two of the Company's competitors control over 60% of the market.
Retailers are demanding an increase in in-store marketing to promote sell-
through of products. This in-store marketing is very expensive and does not
assure the success of any one or group of products. Accordingly, retail shelf
space is extremely difficult and expensive to obtain and maintain. Products
that do not immediately sell well are removed from the retail shelves and
returned to the publisher.
Licensed Properties. There is a risk factor inherent in any venture involving
licensed properties. Not every licensed product guarantees success; only the
software consumer can ultimately determine the outcome. Additionally, there is
no guarantee that the Company can obtain future licenses of either the quality
or the quantity necessary for the Company to reach its goals.
Product Ship Schedules. Delays in product ship schedules can cause problems
with product fulfillment, revenue recognition and retailer orders.
15
<PAGE>
Research and Development. Research and development costs can vary significantly
depending on the products currently in development and potential products the
Company may choose to develop.
Consumer Preferences. Consumers ultimately determine the success of software
products. Not every product will be a hit and residual inventory may exist
depending on actual sell through. Games, in particular, can have very wide
degrees of success or failure in terms of customer acceptance. The Company has
entered the Games market for the first time during the three-month period ended
December 31, 1997. Actual sell through of the games published by the Company
were below the Company's expectations and below the Company's estimates based on
initial sell through rates. The Company recorded a reserve for returns based
upon its prior experience in the consumer software industry and current market
conditions. The reserve established by the Company at December 31, 1997 was not
sufficient. There can be no assurance that future actual losses due to returns
will not exceed the reserved amounts as of March 31, 1998.
NASDAQ SmallCap Listing Requirements. In order to maintain its continued
listing on the NASDAQ SmallCap Market, the Company is required to maintain
minimum shareholders' equity of $2,000,000. As of March 31, 1998, the Company
had shareholders' equity of $2,008,063. The Company's ability to maintain the
minimum shareholders' equity required for continued listing will be largely
dependent upon its ability to operate profitably or to obtain additional equity
capital. Therefore there can be no assurance as to the Company's continuing
ability to maintain listing in the NASDAQ SmallCap Market.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and its officers and directors may be involved in suits and actions
incidental to the Company's business.
On December 13, 1996, the Company filed suit in Superior Court for the County of
Los Angeles, California, against its former distributor, Acclaim Entertainment,
Inc. On January 7, 1998, the Company and Acclaim settled the lawsuit for the
payment of $1,500,000 by Acclaim without any admission of liability. The
Company netted approximately $1,050,000 after payment for legal, accounting and
other costs associated with the lawsuit. The Company recorded an offset to bad
debt expense in the amount of $703,421 during the three-month period ended
December 31, 1997 and other income in the amount of $296,579 during the three-
month period ended March 31, 1998. All amounts due from Acclaim related to this
settlement have been received as of March 31, 1998
On April 27, 1998, the Company entered into a Settlement Agreement dated as of
April 24, 1998 with ASSI, Inc., NCD, Inc., The Boston Group, L.P., Vincent J.
Bitetti, Ulrich E. Gottschling, Mark A. James and Robert G. Kalik. Pursuant to
the Settlement Agreement, the Company has settled with prejudice two legal
proceedings which were pending against it, its Chairman and Chief Executive
Officer Vincent J. Bitetti, and its President and Chief Operating Officer Ulrich
E. Gottschling, in Los Angeles Superior Court which related to an attempted
expansion of the Company's Board of Directors and the election of four persons
to fill expansion seats. In connection with the settlement, the Company (a)
exchanged 1,100,000 shares of its common stock for the 4,816,657 common stock
purchase warrants held by ASSI, Inc. (b) amended and restated its Bylaws to
provide for a seven-member Board of Directors; (c) appointed Wayne Rogers, John
Wholihan, Samuel Poole and Richard Azevedo to fill vacancies on the Board of
Directors; and (d) entered into certain related agreements described below.
16
<PAGE>
Pursuant to the Settlement Agreement, the Company received the consent of ASSI,
Inc. to certain matters relating to the existing Voting Agreement among the
Company, ASSI, Inc., Vincent J. Bitetti and Eric H. Winston. Among other
things, the consent provides that as between the Company, ASSI, Inc., The Boston
Group, L.P., and Vincent J. Bitetti, the nominees for the seven-person Board of
Directors will be determined as follows: up to two persons may be nominated by
Bitetti as long as he holds 750,000 or more shares of the Company's common stock
(but only one person if Bitetti holds more than 500,000 and less than 750,000
shares, and no person if Bitetti holds 500,000 or fewer shares); one person may
be nominated by ASSI, Inc. as long as it holds 500,000 or more shares of the
Company's common stock (but no person if ASSI, Inc. holds fewer than 500,000
shares); up to two persons may be nominated by The Boston Group, L.P. (including
as assignee of the rights of Joseph Stevens & Company, L.P.) pursuant to the
Underwriting Agreement dated July 1, 1996 so long as it may be in effect in
pertinent part; one person (an "Expansion Member") may be nominated by
Mr. Bitetti (subject to approval of such person by ASSI, Inc. (unless a
renomination of a presently serving nominee)), and one person (another
"Expansion Member") may be nominated by ASSI, Inc. (subject to approval of such
person by Mr. Bitetti (unless a renomination of a presently serving nominee)).
Each Expansion Member must be independent of the Company and the person
nominating such Expansion Member, and must meet certain other requirements set
forth in the consent.
Pursuant to the Settlement Agreement, ASSI, Inc., NCD, Inc., Louis Habash and
the Company also entered into a Lock-Up Agreement. Such agreement provides that
during the year ending May 31, 1999, ASSI, Inc., NCD, Inc. and Louis Habash (who
is the beneficial owner of all the voting securities of ASSI, Inc. and NCD,
Inc.) may not sell shares of the Company's common stock beneficially owned by
them in an aggregate amount in excess of an amount determined by a formula,
which equates to the product of approximately 94,620 shares times the number of
full months commencing with the month of May 1998 elapsed since the settlement.
Pursuant to the Settlement Agreement, the Company also entered into a Third
Amended and Restated Employment Agreement with Vincent J. Bitetti. The new
employment agreement extends the term of Mr. Bitetti's existing agreement for
2-1/4 years until December 31, 2000 at a salary increase from $200,000 to
$240,000, grants Mr. Bitetti options to purchase an additional 50,000 shares of
the Company's common stock at prices of $2.50 and $5.00 per share and alters the
bonus structure applicable under the prior agreement.
Pursuant to the Settlement Agreement, the Company entered into an Employment
Memorandum with Ulrich E. Gottschling, which amends Mr. Gottschling's existing
employment agreement. The amendment extends the term of the existing agreement
for one year until January 31, 2000 at a salary increase from $150,000 to
$180,000, grants Mr. Gottschling options similar to those granted Mr. Bitetti to
purchase an additional 50,000 shares of the Company's common stock and alters
the bonus structure applicable under the existing agreement.
Certain aspects of the Settlement will be submitted for stockholder approval at
the next annual meeting.
17
<PAGE>
ITEM 4. SUBMISSION OF A MATTER TO A VOTE OF SECURITY HOLDERS
Pursuant to an Information Statement transmitted by the Company to its
stockholders on or about March 3, 1998, the Company solicited stockholder
consents for the election of four persons as directors. In response to such
consent solicitation, each of the four persons for whose election consents were
sought received the affirmative written consent of the holders of a majority of
the outstanding Common Stock, as follows:
<TABLE>
<CAPTION>
Abstentions and
Name Votes For Votes Against or Withheld
____ --------- -------------------------
<S> <C> <C>
Robert G. Kalik 2427508 0
Allan R. Lyons 2427508 0
Wayne M. Rogers 2426508 1000
John T. Wholihan 2427508 0
</TABLE>
Subsequent to the commencement of the consent solicitation, two separate
suits were filed against the Company, Vincent J. Bitetti and Ulrich E.
Gottschling in Los Angeles Superior Court challenging the legality of the
consent solicitation and seeking, among other things, to enjoin the impanelment
of the directors purported to have been elected pursuant to the consent
solicitation. On April 27, 1998 this litigation was settled pursuant to the
Settlement Agreement. Effective as of such date, all of the directors purported
to have been elected pursuant to the consent solicitation resigned. In addition,
also as of such date, four persons were appointed by the unanimous written
consent of the Company's three remaining directors to fill existing vacancies on
the Board. The persons so elected were Richard Azevedo, Samuel L. Poole, Wayne
M. Rogers and John T. Wholihan. Additional information concerning the terms of
the settlement is set forth above in response to Item 1, Legal Proceedings.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit
- ----------- ----------------------
<C> <S>
27 Financial Data Schedule, filed herewith
</TABLE>
(b) Reports on Form 8-K
On May 6, 1998, the Company filed a report on Form 8-K which related to the
settlement of certain litigation.
18
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Exchange Act, the
Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
SOUND SOURCE INTERACTIVE, INC.
By: /s/ Vincent J. Bitetti Date: May 14, 1998
---------------------- ------------
Vincent J. Bitetti
Chairman and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Ulrich E. Gottschling Date: May 14, 1998
------------------------- ------------
Ulrich E. Gottschling
President, Chief Operating Officer,
Chief Financial Officer, Treasurer and Corporate Secretary
(Chief Financial Officer)
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SOUND SOURCE
INTERACTIVE, INC. AND SUBSIDIARIES FOR THE PERIOD JULY 1, 1997 THROUGH MARCH 31,
1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 1,075,783
<SECURITIES> 0
<RECEIVABLES> 721,818
<ALLOWANCES> 0
<INVENTORY> 477,453
<CURRENT-ASSETS> 4,517,097
<PP&E> 697,191
<DEPRECIATION> (254,497)
<TOTAL-ASSETS> 4,959,791
<CURRENT-LIABILITIES> 2,951,728
<BONDS> 0
0
0
<COMMON> 4,548
<OTHER-SE> 2,003,515
<TOTAL-LIABILITY-AND-EQUITY> 4,959,791
<SALES> 1,189,470
<TOTAL-REVENUES> 1,189,470
<CGS> 336,881
<TOTAL-COSTS> 1,388,969
<OTHER-EXPENSES> (307,958)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,272
<INCOME-PRETAX> (228,422)
<INCOME-TAX> 800
<INCOME-CONTINUING> (229,222)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (229,222)
<EPS-PRIMARY> (0.05)
<EPS-DILUTED> (0.05)
</TABLE>
