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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the Fiscal Year Ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from to
Commission File Number 0-26516
EUPHONIX, INC.
(Exact name of Registrant as specified in its charter)
California 77-0189481
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
220 Portage Avenue, Palo Alto, California 94306
(Address of principal executive offices, including zip code)
(415) 855-0400
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 Par Value
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.[X]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based upon the closing sale price of the Common Stock on
February 28, 1997, as reported on the Nasdaq National Market, was approximately
$22,968,660. Shares of Common Stock held by each executive officer and director
and by each person who owns 5% or more of the outstanding Common Stock have
been excluded in that such persons may under certain circumstances be deemed to
be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
The number of shares of the Registrant's Common Stock outstanding as of
February 28, 1997 was 5,568,160.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Registrant's 1997 Annual Meeting
of Stockholders to be held on June 4, 1997 are incorporated by reference in
Part III of this Form 10-K.
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TABLE OF CONTENTS
Page
PART 1
Item 1. Business....................................................... 3
Item 2. Properties..................................................... 20
Item 3. Legal Proceedings.............................................. 20
Item 4. Submission of Matters to a Vote of Security Holders............ 20
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters........................................... 21
Item 6. Selected Financial Data........................................ 22
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 22
Item 8. Financial Statements and Supplementary Data.................... 28
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure....................................... 46
PART III
Item 10. Directors and Executive Officers of the Registrant.............. 47
Item 11. Executive Compensation.......................................... 47
Item 12. Security Ownership of Certain Beneficial Owners and Management.. 47
Item 13. Certain Relationships and Related Transactions.................. 47
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. 48
SIGNATURES................................................................ 52
page 2 of 52
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PART I
------
The Business section and other parts of this Report contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
may differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed in the section entitled "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Factors
Affecting Future Operating Results."
Item 1. Business.
Euphonix, Inc.'s core business is the development, manufacture and
marketing of digitally controlled audio mixing consoles for use in the
production of audio content for the music, post production (film and
television), broadcast, live sound reinforcement (live concerts and theater)
and multimedia segments of the professional audio market. The Company is an
industry leader in providing software-driven functionality that serves to
automate and streamline tedious and repetitive tasks during the audio
production process, while providing high quality audio and extended function-
ality relative to the current industry standards. Euphonix systems have
played a role in the production of major music, motion picture and television
projects, including Bruce Springstein, Herbie Hancock and Babyface music
productions; The Lion King, Waiting to Exhale and Crimson Tide movies; and
X-Men and Entertainment Tonight television productions.
Mixing is one of three major functions in the audio production process;
the other major functions are editing and recording. It is Euphonix's busi-
ness strategy to produce products for mixing, editing and recording for high
end professional use which will have the capability to be used in an integrated
manner to further automate the audio production process. As part of this
business strategy, Euphonix acquired Spectral Incorporated in February 1996.
Spectral develops and markets PC based digital audio workstations.
In March 1997, Euphonix began production deliveries of its new CS3000
mixing consoles. The CS3000 provides new features and performance to antici-
pate the increase in demand for multi-channel surround sound mixing, (i.e.
DVD and SDDS formats), and the use of sophisticated automation. See "--
Products." Orders for the CS3000 were received from, among others, A&M
Studios in Los Angeles and Emmy and Oscar winning composer Hans Zimmer.
The Company was incorporated in California in July 1988. The Company's
principal executive offices are located at 220 Portage Avenue, Palo Alto,
California 94306, and its telephone number is (415) 855-0400.
Industry Overview
Audio content for the entertainment industry is produced by professionals
in four primary market segments: music (CD's, tapes, music for film and
television), post production (sound for film and television), broadcast (sound
for broadcast television), and live sound reinforcement (sound for live con-
certs and theater). An emerging market requiring audio production for multi-
media consumer products, such as interactive CD-ROM and games, is forming and,
the Company believes, may grow in the future.
Mixing consoles serve as the central component of most professional audio
production studios, and are used by all segments of the professional audio
market throughout the production process, which process includes recording,
editing and mixing. A mixing console electronically blends, routes and enhances
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sound from musical instruments, voices, sound effects and pre-recorded
material. Mixing consoles used in each market segment during the different
stages of production share a high degree of common functionality. Professional
mixing consoles are used to process, combine, and reduce a large number of
individual audio inputs (typically 20-100) to produce a smaller number of
outputs (typically 2-8) for the audio engineer to hear or record.
Mixing consoles provide at least one fader (sliding potentiometer) to control
the individual volume of each input. In addition, consoles provide processing
for each input that may require anywhere from 1-40 variable controls (knobs)
and 1-100 switching controls (buttons). Such controls include those for
adjusting the tonal qualities of an individual channel to enhance nuances and
filter out noise or correct other problems ("EQ"), enhancing, inducing or
correcting volume fluctuations on individual channels ("Dynamics"), adding
special effects to an individual channel such as reverberation, delay or pitch
shifting ("Aux Sends") and locating each individual channel on the sound field
of the final output ("Panning"). Mixing consoles used for professional appli-
cations often require up to 100 faders, 4,000 knobs, and 10,000 buttons. The
Company expects that as the complexity of audio production increases in all
market segments, due to industry demand for higher quality and more captivating
sound, the need for more and larger-scale mixing consoles will increase.
In order to prepare for a recording, editing or mixing session, the
controls on a mixing console must be configured in such a way as to duplicate
the setup from an earlier session or such controls must be reset for a new
session. It is common for the duplication process to take anywhere from 10
to 30 minutes on traditional consoles because each control must be manually
set by the operator. During the mixing phase of a production, it is also
common for the console operator to perform many adjustments to controls so
that the characteristics of each input (including voices, sound effects and
musical instruments) may change over time. When the operator is required to
perform multiple changes over time, or to update changes that have already
been performed, it becomes highly advantageous to provide computer automation
in order to capture and replay the operator's performance. However, while
high-end consoles have been available with computer automated faders as an
optional retrofit, the thousands of other controls on the mixing console
(high-end and otherwise) traditionally have been operated manually.
In addition, traditional mixing consoles have required large surfaces in
order to accommodate the multitude of faders, knobs and buttons. Moreover,
all audio electronics necessary for operation of the console have typically
been located under the large control surface because the faders, knobs and
switches are mechanically coupled to the audio processing hardware. It is
not uncommon to find large mixing consoles that are over 12 feet long and
weigh over 1,000 pounds. Operators often have difficulty operating these
traditional systems because of their size, and frequently more than one
operator is required to operate the system. The size and weight of these
traditional-architecture mixing consoles and their lack of modularity and
upgradeability have placed restrictions on the installation, location and
portability of the hardware required to record, edit and mix audio. Moreover,
these traditional systems have typically been purchased with a fixed size and
feature set and often require total replacement to expand the customer's
capabilities.
To date the predominant mode of audio processing and transmission to and
from a mixing console has been analog due to its simplicity, cost-effectiveness,
high sound quality and the extensive analog infrastructure which currently
exists in the professional audio market. Digital control/digital processing
mixing consoles have been available in the marketplace for a number of years,
although the Company believes that their rate of acceptance in the marketplace
has been restricted due to the disadvantages generally associated with digital
processing (higher complexity, higher cost, audible processing delays, and
the relative lack of digital audio infrastructure products including cabling,
patching, and interconnecting devices).
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Euphonix Solution
Euphonix has developed a digitally controlled mixing console that the
Company believes represents an industry breakthrough in automation of controls
and processing functions, together with lower cost, upgradeable features and
smaller size. The Company believes that its system provides audio performance
and processing features that are equal to or better than traditional archi-
tectures at a substantial reduction in price. The Euphonix system provides
the benefits of digital control to the professional audio industry with the
sound quality, simplicity and cost-effectiveness of analog signal processing
and transmission, without requiring the industry to abandon its existing
investment in analog transmission and processing infrastructure. The Company
has also provided new features to mixing consoles that enable operators to
perform functions that to date have been difficult to perform, as well as a
dynamic hardware and software upgrade path for all of its systems that allows
users to utilize new features and functions as they are released. Moreover,
because the Euphonix system is modular and scaleable, it allows customers to
configure the systems to meet their professional needs and financial resources,
and to upgrade their systems as their needs change. In addition, the Euphonix
architecture is capable of providing digital control of audio processing
regardless of whether the transmission method is analog or digital. As a
result, as the audio production industry increasingly adopts digital processing
in the future, the Company believes that its system will be upgradeable to
incorporate such technology with further product development.*
Strategy
The Company's goal is to become the leading provider of digitally control-
led audio mixing consoles for the music, post production for film and tele-
vision, broadcast, live sound reinforcement and multimedia segments of the
professional audio market. The Company's strategy includes the following key
elements:
Capitalize on Leading Edge Technology
Since its inception in 1988, the Company has dedicated itself to bringing
cost-effective digital and software technology to professional audio mixing.
In 1991, the Company brought to market the first digitally controlled audio
mixing console with performance the Company believes rivaled high-end products
from other manufacturers at a significantly lower price. The Company's
product architecture and technology have been designed to enable the profes-
sional user to express more easily creative talents while reducing labor and
time-intensive operations, at a more favorable price-performance ratio than
existing mixing systems. Furthermore, the Company believes that its
digital technology and software-based systems provide a strong foundation
into which the new emerging technologies can be incorporated to meet the needs
of its target market segments.
Provide Complete Scaleable Solutions
The Company offers modular systems that provide customers a range of
functionality and flexibility, allowing them to configure the Company's
systems to meet their professional needs and financial resources. A key
focus of the Company's product development efforts is to maintain the soft-
ware and hardware compatibility of its new products and features with its cur-
rent products, enabling customers to make an initial investment in a Euphonix
system, and then upgrade their system as their needs and finances permit.
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* This paragraph contains forward-looking statements reflecting current
expectations. There can be no assurance that the Company's actual
future performance will meet the Company's current expectations.
Investors are strongly encouraged to review the section entitled "Factors
Affecting Future Operating Results" commencing on page 26 for a discus-
sion of factors that could affect future performance
page 5 of 52
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Leverage Brand Name Recognition
The Company seeks to enhance its reputation for technical innovation, high
quality and superior price-performance. To date, as a result of the Company's
product architecture, customer satisfaction, excellent price-performance and
significant industry visibility, the Company believes it has generated brand
name recognition and loyalty, which will benefit the Company as it seeks to
increase its share of its target market segments.
Increase Penetration into Other Market Segments
The Company seeks to leverage its success in the music market to continue
to expand into complementary market segments of the professional audio market,
including post production, broadcast, live sound reinforcement and multimedia.
The Company believes that the key features of the Euphonix system, including
its time-based automation, SnapShot Recall, flexible architecture and compact
design, are well-suited to meet the needs of such complementary market seg-
ments. The Company is increasing marketing efforts to aggressively target
these market segments. *
Build Global Presence
The Company's sales strategy is to build a worldwide presence in order to
address fully its target markets and to serve customers that operate on an
international basis. The Company's sales outside the United States as a
percentage of its net revenues were approximately 52.2%, 48.5% and 29.8%, in
fiscal years 1996, 1995 and 1994, respectively. In addition to its New York,
Los Angeles, Nashville and Palo Alto offices in the United States, the
Company has offices in London and Tokyo and a network of distributors outside
of the United States.
Expand Product Offerings
The Company's goal is to leverage its reputation and substantial invest-
ment in software, digital control technology, digital signal processing and
distributed computer processing to develop and market new products for
the professional audio market, as well as to continue focusing its product
development on the modularity and upgradeability of its current products.
In the long term, the Company intends to develop, internally or through
acquisitions or licensing, a range of compatible audio production products
that will enable the Euphonix system to become the control center for automa-
ting and streamlining significant portions of the audio production process.*
Products
The Company's products include its base system mixing consoles, the CS3000
and CS2000, system options and system packages configured for specific market
segments, as described below.
CS3000D & CS2000D Base Systems
The Euphonix CS3000 and CS2000 (the "Systems") have been designed for
operational speed, high sound quality and flexible configuration control and
processing. System options may be factory installed or added in the
field, allowing customers to tailor the product to their exact requirements
and then to subsequently modify and upgrade their Systems as their needs
change. The Company offers specific software features developed for indivi-
dual market segments to all customers in order to ensure compatibility between
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* This paragraph contains forward-looking statements reflecting current
expectations. There can be no assurance that the Company's actual
future performance will meet the Company's current expectations. Investors
are strongly encouraged to review the section entitled " Factors Affecting
Future Operating Results" commencing on page 26 for a discussion of factors
that could affect future performance.
page 6 of 52
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Systems and to provide customers with the ability to change applications
across market segments. The Systems can use the same version of software for
various applications. The base Systems may currently be specified with hard-
ware variations to accommodate differences in application of the product by
the music ("D" & "M" Sytems), post production ("P" & "F" Systems), and broad-
cast ("B" Systems) market segments.
The key features and advantages of the Systems include:
Centralized Control Panel. Mixing consoles for professional applications
often require up to 100 faders, 4,000 knobs and 10,000 buttons. The Systems
use a proprietary central control panel which eliminates a significant portion
of these knobs and buttons by assigning multiple tasks to individual controls.
The operator can therefore control a large amount of processing without moving
away from the "sweet spot" (the optimal listening position).
Centralized Graphical User Interface. The Systems incorporate a built-in,
flat screen interactive color graphics monitor allowing the operator to visual-
ize, set up and meter the effects that control settings have on the audio as
it is being processed. A graphical representation of the assignable rotary
controls for channel control, EQ, Dynamics and Aux Sends are centrally located
for easy viewing capability.
Fast Reconfiguration and Recall. Utilizing the Company's "SnapShot
Recall," a user can reconfigure the Euphonix mixing console in less than one
video frame (1/30th of a second) at the push of a button. This feature enables
the user to save and recall console setups at any time and to move quickly
between sessions or multiple projects, thereby saving significant labor time
and enhancing creative potential.
Software-Based. Because the Euphonix system is software-based, the Systems
are generally easier to upgrade as compared to hardware-based systems. A
Euphonix System can be upgraded by simply loading new software onto existing
Euphonix hardware at the customer's location, thereby enabling installation at
reduced time, cost and effort than is generally possible with hardware upgrades.
Modularity. The modular architecture of the Company's products enables
the customer to upgrade its existing System and to implement product enhance-
ments. Furthermore, the Company believes that the modularity of its products
enables the Company to be more efficient in manufacturing and servicing its
products, as well as in designing and developing incremental improvements to
its products.
Compact Design. The console's compact design allows for easier access by
users to the controls, eliminating the potential need for multiple operators.
In addition, the compact design is attractive for studios with space and other
environmental constraints, as well as for mobile applications, such as live
concerts and sports events.
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CS3000 & CS2000 Options
The modular form of the Euphonix CS3000 and CS2000 Systems provide
customers with a range of functionality and flexibility that allows them to
configure their System to meet their professional needs and financial
resources and to upgrade their Systems as their needs change. Euphonix offers
two primary options to increase the amount of audio processing provided by
the overall System -- the Audio Cube and the Dynamics processors. The Company
plans to continue developing a range of options to allow the Systems to meet
the changing needs in its market segments.*
Audio Cube. The Audio Cube is a hardware and software-based option that
provides additional output capability to the base Systems. The flexible nature
of the System software allows the customer to determine the feature set provided
by the Audio Cube. Music applications typically require the Audio Cube to
expand the base system's Aux Send capability (allowing more special effects).
Post production applications require the Audio Cube to be configured as a
panning and stemming device (allowing users to separate music, effects and
dialog mixes with 4 or 6 channel surround sound outputs). Broadcast customers
can use the Audio Cube to provide remote "mix minus" feeds to reporters and
commentators through telecom or satellite links. The Audio Cube is both modular
and scaleable so that it may be specified or upgraded according to the number
of channels required (4-48) and the number of outputs desired for each channel
(4-48).
Dynamic Processors. This option adds Dynamics to the base System in
sections of 8 channels at a time, up to 120 additional channels. Traditional
high-end consoles have been marketed with Dynamics built into every channel
as a standard feature. This practice has served to increase the price of a
standard console and forces the customer to pay for a feature that is typically
not used on every channel at the same time. By providing Dynamics as a modular
option, Euphonix has helped to provide customers with a basic high-end System
at a lower price with the ability to upgrade as needed.
CS3000 & CS2000 Packages
The Company also offers System packages configured for particular market
segments, including the following:
"M" Systems. The Company created the "M" (Music) System package to
provide commercial music customers the ability to offer a consistent feature
set to their clients when moving projects between different Euphonix equipped
studios. The "M" System combines a base System with a package of options,
including an Audio Cube configured for 12 Aux Sends, and sufficient Dynamics
processors to provide one channel of processing for every channel on the base
System and a digital studio control. The customer may specify that its System
package include from 32 to 104 faders in 8 fader increments.
"P" Systems. The Company created the "P" (Post Production) System
package to provide the TV audio post production customer a totally automated
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* This paragraph contains forward-looking statements reflecting current
expectations. There can be no assurance that the Company's actual
future performance will meet the Company's current expectations.
Investors are strongly encouraged to review the section entitled "Factors
Affecting Future Operating Results" commencing on page 26 for a discus-
sion of factors that could affect future performance.
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mixing System which is easily locked to video sources. Post production facil-
ities take advantage of the speed and flexibility of the "P" system's digital
control technology to maximize their throughput without compromising creativity
or sonic quality.
"F" Systems. The Company has designed the "F" (Film) System package to
provide multiple operator functionality as required for film dubbing applica-
tions. The "F" System is designed as one, two or three "P" Systems which can
be physically joined together to allow for usage by one, two or three opera-
tors, with each base System component fitted with the Audio Cube option con-
figured to provide 12 output channels of panning and stemming.
"B" Systems. The Company added the "B" (Broadcast) System package to
provide broadcast customers the ability to increase the quality of on-air and
taped programming audio. With Euphonix digital control technology, broadcast
facilities can meet the demands of multiple studios from a single audio
control room. In Remote broadcasting, the compact lightweight digital control
surface provides increased control in less space. Broadcast specific options
such as the MX464 add GPI (programmable relay closures), listenback, multiple
studio monitoring, and an input routing matrix to the base system. Redundant
power supplies are available to meet the demands of live on-air broadcasting.
Proposed Products
In 1997, the Company intends to announce products with planned initial ship-
ments in 1998 and 1999, to integrate the recording, editing and mixing func-
tions of sound production as well as digital audio processing and networking
systems. The Company anticipates that these new products will help streng-
then its position in the mixing and editing markets and its entrance into the
random access recording market. The Company expects that its software for
these products will utilize technology not widely used by the audio industry,
but successfully employed by the computer industry, to allow a high degree
of connectivity and integration among multiple users. The Company's planned
products are also being designed to enable upgrading from the Company's
present product line to allow hybrid digital and analog processing, a feature
that Euphonix believes will mirror customer's requirements for sound quality as
well as provide minimal conversion from one format to another. It is intended
that these new digital products will also have file compatibility between
editing and mixing functions, as well as high speed digital routing for simple
networking of multiple systems.
Technology
The Company's proprietary technology is central to its product offering
and its business strategy. The key elements of its technology are described
below.
Digital Control of Analog Audio Processing
The Company utilizes an architecture that physically separates the mixing
control surface from the audio processing hardware. The Company has replaced
manual (mechanically coupled) control methods with digital control technology
so that the audio processing hardware may be controlled remotely over a digi-
tal link by the separated control surface. Because of this separation, it is
possible to insert a computer in the link between the controller and the
processing circuit so that audio may be manipulated either by the operator or
the computer. A high degree of computer automation can then be provided with
the appropriate software. The elimination of bulky and expensive mechanical
controls, the ability to share digital controls for different functions and
the relocation of the audio processing hardware to a separate enclosure has
allowed a substantial reduction in size, weight, heat generation and cost of
the console surface.
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Traditionally, the predominant mode of audio processing and transmission
has been analog due to its simplicity, cost-effectiveness, high sound quality
and the extensive analog infrastructure which currently exists in the profes-
sional audio market. Euphonix is a market leader in providing digital control
in conjunction with analog processing and transmission. Euphonix believes
that its hybrid digital control/analog processing technology has allowed the
acceptance of digital control because it is compatible with potential custo-
mers' existing studio design and peripheral equipment. The Euphonix archi-
tecture is capable of providing digital control of audio processing regard-
less of whether the transmission method is analog or digital. As a result,
as the audio production industry increasingly adopts digital audio processing
in the future, the Company believes that its system will be upgradeable
to incorporate such technology with further product development.*
Scaleable, Distributed Computer Processing
The computer power required to instantly reconfigure and automate a
mixing console is proportional to the console's size (number of controls per
channel times the number of channels). Two approaches may be taken in
order to provide adequate computer power to reset and automate a large-scale
mixing console. The first is to use a large, fast and powerful central compu-
ter that has sufficient capacity to manipulate all of the console's controls
in the required period of time for the largest possible console. The second
is to distribute the processing load over multiple processors that have suffi-
cient capacity to handle their share of the processing load. Euphonix has
chosen the distributed processing method because it has the added benefit to
being scaleable. The Euphonix system may be configured in and upgraded to a
range of sizes. Euphonix customers benefit because they only pay for computer
power that is proportional to the size of their systems, yet more computer
power can be added as their systems are upgraded. Because of the lighter
demand placed on each individual microprocessor in a distributed system, the
use of low-cost components is possible to further leverage price performance.
Another benefit of the Company's distributed processing architecture is its
systemwide SnapShot Recall performance within one video frame (1/30 of a
second) which the Company believes is superior to competitive commercial offer-
ings.
Multi-Processor Communications and Real-time Operating Systems
Euphonix has developed proprietary software and real-time operating system
technologies for interfacing the multiple microprocessors required to support
its large distributed processing system. A typical large Euphonix console will
contain as many as 125 independent microprocessors of different varieties and
functions all working together as one system. In addition, the Euphonix sys-
tem provides interfaces to microprocessors in third-party peripheral studio
equipment. This seamless networking of internal processors (Euphonix compo-
nents) and external equipment (third-party digital audio workstations, tape
machines and MIDI devices) provides a powerful foundation to encourage new
product development by both Euphonix and third-party manufacturers.
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Digital Signal Processing
The Company's products employ state-of-the-art digital signal processing
techniques in their digital control subsystems. The Company intends to conti-
nue to develop digital signal processing technology in order to improve fidel-
ity, simplify interfaces and reduce costs involved with digital audio trans-
mission and processing. *
Advanced User Interface Methods for Audio Processing
Euphonix's digitally controlled system gives the user real-time feedback
of the system's performance, thereby enabling the user to evaluate and improve
the audio mix more effectively and efficiently. Euphonix has developed several
software-based user interface methods for the professional audio market that
are designed to simplify and improve the user's understanding of how the mixing
console is affecting the sound. The Company's interface techniques are desig-
ned to allow the operator to harness the power of digital control in a user-
friendly manner. For example, graphical user interfaces are used extensively
to show views of settings and parameters, enabling a "what you see is what you
hear" display. Such graphical comparisons and various archival, marking and
retrieval methods allow for greater operator efficiency.
- -----------------
* This paragraph contains forward-looking statements reflecting current
expectations. There can be no assurance that the Company's actual
performance will meet the Company's current expectations. Investors
are strongly encouraged to review the section entitled "Factors Affecting
Future Operating Results" commencing on page 26 for a discussion of
factors that could affect future performance.
page 11 of 52
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Customers
The Euphonix product line has been adopted by many professional audio
facilities worldwide, with more than 300 Euphonix consoles currently instal-
led. The following table sets forth a partial list of Euphonix customers:
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CUSTOMER LOCATION SAMPLE PROJECT/OTHER
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Music
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A&M Recording Los Angeles Leading record label in USA
(new customer)
Babyface Los Angeles Grammy Award "Producer of the
Year" in 1997. Various pro-
jects.
Bruce Springstein Los Angeles 1997 Grammy Award The Ghost
of Joad
Carter Burwell New York Film score for Rob Roy
Curb Records Nashville Second largest Country Music
record label in the USA
Glen Ballard Los Angeles Jagged Little Pill by Alanis
Morrisette
Hans Zimmer/Media Ventures Los Angeles Film scores for The Rock,
Crimson Tide
Herbie Hancock Los Angeles Album Manhattan 1997 Grammy
La Chapelle Belgium Ende Neu: Einstuerzeude
Neubauten
Maruni Japan Various Japanese album
projects
Sony Music New York Mariah Carey's TV special
Fantasy
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Post Production
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Buzz Nashville TV commercials for Pizza Hut
& Budweiser
Cinar Montreal Film mixing for children's
cartoons
Crawford Post Atlanta TV and Film post projects
KSS Japan Various Japanese TV projects
Soundtrack New York/Boston Various TV commercials
National Sound New York TV series Spin City
Omnibus Japan Various TV/Film post projects
Warner Hollywood Los Angeles Audio Post (Foley) on var-
ious Films
Waves Sound Recorders Los Angeles Various TV commercials
Saban Entertainment Burbank TV series X-Men & Power
Rangers
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Broadcast
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CBS Sports USA Various live sporting events
China Television People's Republic Various TV productions
of China
Fox 32/WFLD-TV Chicago TV show Fox Thing in the
Morning
NHK Japan 1998 Winter Olympics in Nagano
NRK Norway Music recording for radio
Paramount Television Los Angeles TV show Entertainment Tonight
RTBF Belgium National Broadcast Centers
Seven Network Australia TV Broadcast of 1992 Barce-
lona Olympics
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Live Sound Reinforcement
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Lyon Opera House France Live sound reinforcement
San Francisco Opera San Francisco Live sound reinforcement
for the entire 1996 season
page 12 of 52
<PAGE>
- -------------------------------------------------------------------------------
The Gothenburg Opera House Sweden Live sound reinforcement
West Point Academy West Point Live sound reinforcement
and recording
- -------------------------------------------------------------------------------
Multimedia
- -------------------------------------------------------------------------------
Electronic Arts Canada Sound for multimedia games
Sega America San Francisco Sound for multimedia games
7th Level Los Angeles Sound for multimedia games
Square Tokyo Sound for multimedia games
- -------------------------------------------------------------------------------
Other
- ------------------------------------------------------------------------------
Cal Arts Los Angeles Sound recording education
China Music Conservatory People's Republic Music and recording education
of China
University of Arkansas Little Rock Sound recording education
Westwood One Los Angeles Mobile recording
- -------------------------------------------------------------------------------
Marketing
The Company's marketing strategy has been to create awareness of its
products and to differentiate its products from its competitors' products in
terms of performance and cost-effectiveness. The Company participates
in trade shows, direct-mail advertising and selective advertisements in
industry publications. The Company believes that its high quality products,
technical innovation, support and service result in significant industry
awareness of its products, and numerous word of mouth referrals for its pro-
ducts. The Company differentiates its products through one-on-one sessions
with the key decision makers of its current and prospective customers during
which the Company's trained engineers and distributors perform product demon-
strations.
The Company has historically focused its marketing efforts primarily on
the music market segment. In this segment, most of the Company's sales, to
date, have been individual recording artists, composers, producers and
independent record companies who purchase the Company's systems for their own
professional or personal use. While the Company believes that there is contin-
ued substantial opportunity growth of the Company's sales in the music segment
of the market, the Company's strategy is to continue to expand into comple-
mentary market segments, including post production, broadcast, live sound
reinforcement and mulitmedia. The Company believes that the Euphonix system,
with its flexible architecture, is well-suited to meet the needs of these
customers who also seek high performance and quality at an affordable price.
To address these complementary market segments, the Company has begun to pro-
duce market specific product literature, and is broadening the base of publi-
cations in which it advertises, attending trade shows associated with such
complementary market segments and expanding its direct mail communications. *
- ------------------
* This paragraph contain forward-looking statements reflecting current
expectations. There can be no assurance that the Company's actual
future performance will meet the Company's current expectations. Investors
are strongly encouraged to review the section entitled "Factors Affecting
Future Operating Results" commencing on page 26 for a discussion of factors
that could affect future performance.
page 13 of 52
<PAGE>
Sales and Distribution
Euphonix sells its consoles through its direct sales organization in the
United States, the United Kingdom and Japan, and manages a network of interna-
tional distributors and representatives for sales in other countries. The
Company conducts it direct sales activity in the United States primarily from
its sales office in Los Angeles. The Company has also established sales
offices in the major domestic entertainment centers of New York and Nashville.
The Company's international distributors typically cover an exclusive
geographic region. Distributors generally order and purchase systems from
the Company based on orders they receive for Euphonix systems. Certain of the
Company's distributors provide direct customer support and installation, while
the other distributors receive customer support and installation from the
Company's international sales offices. Electori (a distributor) no longer
accounts for 11.0% of the Company's net revenues in fiscal 1996. There were
no customers who accounted for 10.0% or more of the Company's net revenues in
fiscal 1996.
A key element of the Company's strategy is to continue to build a world-
wide presence through its international sales presence and its network of
distributors in order to address fully its target markets and to serve cust-
omers that operate on an international basis. The Company believes that
revenues from customers outside the United States will continue to account
for a substantial portion of its revenues, and that it is well-positioned to
expand sales of the Company's console in international markets through its
international sales presence and its network of international distributors.
Customer Service and Support
Providing excellent customer service and support is a key element of the
Company's strategy to maintain and build its reputation for high quality and
enhance brand name loyalty. The Company provides service, support and
training to its customers and distributors through a wide range of support
services, including on-site and telephone support and training in the use of
the Company's consoles. *
The Company's customer service organization provides the following services:
Systems Installation and Training. The Company's systems installation
personnel assist customers in the configuration, installation and testing of
Euphonix systems at the customer's site. The systems can usually be installed
in less than one day, which the Company believes to be considerably less time
than required for other manufacturers' large format consoles. The Company
provides demonstration equipment for use by customers as well as prospective
purchasers at each of the Company's sales offices (and those of certain distri-
butors). The Company may also provide on-site training following installa-
tion of its system, as well as advanced operations documentation regarding
the Euphonix system.
Technical Support. The Company's technical support personnel provide
telephone assistance to customers and distributors. These personnel assist
customers in the use of their systems, and diagnose and solve technical
software, hardware and application problems with the aid of self-diagnostic
programs within the Euphonix system. The Company provides a one-year warranty
on the Euphonix system covering defects in materials and workmanship. Such
policy provides that the Company may, at its option, repair, replace or refund
- ------------------
* This paragraph contains forward-looking statements reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations. Investors are
strongly encouraged to review the section entitled "Factors Affecting
Future Operating Results" commencing on page 26 for a discussion of factors
that could affect future performance.
page 14 of 52
<PAGE>
the full purchase price of any defective products sold to the customers.
Technical support personnel maintain a supply of similar or spare modules
to deliver to customers if necessary for repair, and in more complicated
situations will dispatch an on-site technician to assist the customer. The
Company also offers an on-line 24-hour computer bulletin board to maintain
communications with its customers.
Research and Development
The Company's research and development strategy is to develop high-quality
enhancements to its products, focusing on modularity and upgradeability of
such products, as well as new products for its target market segments. The
Company's research and development and engineering staff consists of 36 soft-
ware, hardware engineers and technicians with technical backgrounds in computer
software design, digital signal processing, analog audio processing and high
speed audio communications.
The Company's research and development and engineering expenses for the
years ended December 31, 1996, 1995 and 1994 were $2.8 million, $1.7 million,
and $1.2 million, respectively.
Proprietary Rights
The Company generally relies on a combination of trade secrets, copyright
law and trademark law, contracts and technical measures to establish and pro-
tect its proprietary rights in its products and technologies. However, the
Company believes that such measures provide only limited protection of its
proprietary information, and there is no assurance that such measures will be
adequate to prevent misappropriation. The Company currently has two United
States registered trademarks, two issued United States patents and several
applications for United States patents pending with respect to certain ele-
ments of its hardware and software. The Company has no foreign patents nor
has it filed any applications for any foreign patents.
The Company believes that, due to the rapid proliferation of new technolo-
gies in the audio, video and general software industries, intellectual proper-
ty protection of the Company's proprietary technology will be less influential
on the Company's ability to compete in its target markets than the ability of
the Company's research and development personnel to design products that con-
tinue to address evolving customer requirements, the ability of the Company
to enter new markets and the ability of Euphonix to service its customers. *
Manufacturing and Suppliers
The Company focuses its manufacturing efforts on producing high quality
products in a cost-effective manner. The Company's manufacturing operations
for mixing consoles, located in Palo Alto, consist primarily of materials
and procurement management, testing and final assembly of products, quality
assurance and shipping. The Company subcontracts other functions, including
the production of printed circuit boards, specialized metal finishing and
other subassemblies, which currently are not cost-effective for the Company
to perform. The Company's systems undergo complete testing and quality inspec-
tion at the board level and final assembly stages of production.
The Company and its manufacturing vendors are dependent upon single or
limited source suppliers, such as Analog Devices, Inc. and Maxim Integrated
Products, Inc., for numerous components and parts used in the Company's
products. Currently, the Company uses many sole or limited source suppliers,
- ------------------
* This paragraph contains forward-looking statements reflecting current
expectations. There can be no assurance that the Company's actual
future performance will meet the Company's current expectations. Investors
are strongly encouraged to review the section entitled "Factors Affecting
Future Operating Results" commencing on page 26 for a discussion of
factors that could affect future performance.
page 15 of 52
<PAGE>
certain of which are critical to the Company's continued uninterrupted produc-
tion because they supply key components, such as integrated circuits, included
in the Company's base system. Major delays or terminations in supplies of such
components could significantly adversely affect the Company's timely shipment
of its products, which in turn would adversely affect the Company's business
and results of operations. There can be no assurance that these suppliers
will continue to be able and willing to meet the Company's requirements for
any sole-sourced components. The Company generally purchases these single or
limited source components pursuant to purchase orders and has no guaranteed
supply arrangements with such suppliers. In addition, the availability of
many components to the Company's subcontractors is dependent in part on the
Company's ability to provide its subcontractors, and in turn the subcontrac-
tor's ability to provide their suppliers, with accurate forecasts of their
future requirements. The process of qualifying suppliers or designing out
certain parts could be lengthy, and no assurance can be given that any addi-
tional sources or product redesign would be available to the Company or imple-
mented on a timely basis. In the past, the Company has experienced interrup-
tions in the supply of certain key components from suppliers which delayed
product shipments and there can be no assurance that the Company will not
experience significant shortages for these components in the future. The
Company does not maintain an extensive inventory of such components and any
extended interruption or reduction in the future supply or increases in prices
of any key components currently obtained from a single limited source sup-
plier could have a material adverse effect on the Company's business and
results of operations for any given period. *
The manufacturing for Spectral products, which are digital audio worksta-
tions for the audio recording market, is currently in the process of being
transferred to the Company's headquarters in Palo Alto.
Competition
The markets for the Company's mixing products are intensely competitive
and characterized by significant price competition. The markets for mixing
consoles can be classified based on price, as follows: (1) low-end range
products with prices up to $30,000; (2) mid-range products with prices from
$30,000 to $100,000; and (3) high end range products with prices over $100,000.
Prices for mixing consoles generally vary based on the number of channels and
the processing power per channel, which directly affects the quality of the
sound output of the particular mixing consoles. The Company's products compete
primarily with other mixing consoles in the high end price range of the Com-
pany's targeted market segments, although they may also compete with lower
priced products with fewer features. Competing companies in the high-end
price range include, among others, Solid State Logic, Ltd. (a wholly-owned
subsidiary of Carlton Communications Ltd.), AMS Neve, GLW a.k.a. Harrison,
Amek Technology Group, plc, Sony Corporation, Calrac Ltd., and Otari Corpora-
tion. In addition, the Company believes that, as technology in the profes-
sional audio industry advances, prices for mixing consoles and other audio
equipment, including the Company's products, will decrease, and as a result
the Company's products may increasingly compete against lower priced products,
as well as products in the high-end price range. There are numerous companies,
in addition to those listed above, that compete in the low-end and mid-range
of the professional audio market. Many of the Company's competitors are larger
and have greater financial, technical, manufacturing and marketing resources,
broader product offerings, more extensive distribution networks and larger in-
stalled bases than the Company. A number of the Company's competitors cur-
rently offer all digital mixing consoles, as well as analog control/analog
- -----------------
* This paragraph contains forward-looking statements reflecting current
expectations. There can be no assurance that the Company's actual
future performance will meet the Company's current expectations. Investors
are strongly encouraged to review the section entitled "Factors Affecting
Future Operating Results" commencing on page 26 for a discussion of factors
that could affect future performance.
page 16 of 52
<PAGE>
processing mixing consoles, at least two competitors (Harrison & Calrac) cur-
rently offers a hybrid digital control/analog processing mixing console, and
all such competitors are likely to have additional products under development.
The Company believes that companies with large installed bases, in particular,
may have a competitive advantage since many potential customers in the Company's
targeted markets are often reluctant to commit significant resources to replace
their current products and to retrain operators to use new products despite
technological advantages of such new alternative products. Certain of the
Company's competitors also offer customers leasing or refinancing packages in
connection with the purchase of their mixing consoles, which financing alterna-
tives the Company does not generally offer. Furthermore, the Company competes
with resellers of used mixing consoles and equipment who are able to sell high-
end price range products at generally lower prices.*
The Company believes that its ability to compete depends on elements both
within and outside its control, including the success and timing of new product
development and introduction by the Company and its competitors, product per-
formance and price, distribution, availability of lease or other financing
alternatives, resale of used systems and customer support. There can be no
assurance that the Company will be able to compete successfully with respect
to these factors. In addition, there can be no assurance that the Company will
successfully differentiate its products from the products of its competitors
or that the marketplace will consider the Company's products to be superior
to competing products. Moreover, the Company's competitors may introduce
additional products that are competitive with those of the Company, and there
can be no assurance that the Company's products would compete effectively with
such products. Although the Company believes that its audio mixing console has
certain technological advantages over its competitors, maintaining such advan-
tages will require continued investment by the Company in research and develop-
ment, sales and marketing and customer service and support. There can be no
assurance that the Company will have sufficient resources to be able to main-
tain such competitive advantages. *
- ------------------
* This paragraph contains forward-looking statements reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations. Investors are
strongly encouraged to review the section entitled "Factors Affecting
Future Operating Results" commencing on page 26 for a discussion of factors
that could affect future performance.
page 17 of 52
<PAGE>
Backlog
An order is booked into a backlog when a deposit or a purchase order is
received from the customer or leasing agent. The Company's products are typic-
ally delivered to customers two to three months after receipt of an order.
However, because shipment of the product is dependent upon other customer re-
quirements or changing situations, the product may not be delivered for more
than a year after the receipt of the order. All orders are subject to cancella-
tion or rescheduling by the customer. The Company does not believe that its
backlog at any particular point in time is indicative of future sales levels.
Employees
As of December 31, 1996, the Company had 107 full-time employees, 7 part-
time and temporary employees and 11 consultants. Of such personnel, 36 were
employed in research and development and engineering, 33 in sales, marketing
and customer service, 43 in manufacturing and 13 in general management, admin-
istration and finance. The Company currently intends to hire additional person-
nel during the next 12 months in all of these areas. None of the Company's
employees is represented by a labor union and the Company has never experienced
a work stoppage, slowdown or strike. The Company considers its employee rela-
tions to be good.
Acquisition
On February 7, 1996, the Company acquired Spectral, Incorporated, a Wash-
ington-based company that develops and markets PC-based digital audio worksta-
tions. The purchase price of the acquisition was approximately $2.3 million,
which consisted of the purchase of Spectral's stock for $1.5 million and debt
reduction of $778,000.
page 18 of 52
<PAGE>
MANAGEMENT
Executive Officers
The executive and other officers of the Company and their ages as of
December 31, 1996 are as follows:
Name Age Position
---- --- --------
James Dobbie 66 Chief Executive Officer and Chairman of
the Board
Scott W. Silfvast 34 President and Director
Jeffrey A. Chew 47 Vice President of Finance and Chief
Financial Officer
John A. Carey 44 Vice President of Marketing
Eric Plushner 44 Vice President of Sales-Americas
Steve Milne 39 Vice President of Engineering
James Dobbie has served as Chief Executive Officer and Chairman of the
Board of the Company since March 1991. From 1988 to February 1991, Mr. Dobbie
was a self-employed consultant and consulted for Euphonix from November 1990
to February 1991. From 1984 to 1987, Mr. Dobbie was Chairman of the Board of
Akashic Memories, a privately held supplier of high density computer disks.
From 1979 to 1983, Mr. Dobbie was President of Avantek, an electronics compo-
nent company.
Scott W. Silfvast founded the Company in July 1988. He has been a director
of the Company since its inception and has served as President since March
1990. Mr. Silfvast also served as Chairman of the Board from July 1988 until
February 1991. From 1983 to July 1988, he was an engineer for SRS, a measure-
ment instrumentation company.
Jeffrey A. Chew joined the Company in June 1991 as Finance Director and
has been Chief Financial Officer since January 1992 and the Vice President of
Finance since December 1993. From 1987 to June 1991, he was a self-employed
consultant. From 1983 to 1987, Mr. Chew served as Corporate Controller for
Akashic Memories.
John A. Carey joined the Company as Vice President of Marketing in June
1995. From December 1993 to June 1995, he was employed by E-mu Systems Inc.,
a professional audio equipment company, most recently as Vice President, Market-
ing and Sales, and from October 1981 to December 1993, Mr. Carey was employed
by Otari Corporation, a professional audio company, most recently as Vice Presi-
dent, General Manager, Audio Products Division. Prior to that time, he was
employed by Westlake Audio as Sales and Design Executive from 1980 to 1981
and by Express Sound Company as Sales Manager from 1978 to 1980, both profes-
sional audio equipment dealers.
Eric Plushner joined the Company in February 1993 as Vice President of
Sales-Americas. From 1986 to February 1993, Mr. Plushner was General Manager
of Siemens Audio, representing AMS/Neve Technology, a leading supplier of audio
production equipment. From 1979 to 1985, he was employed by Sony Pro Audio, a
supplier of audio production equipment, most recently as National Sales Manager
for the Digital Audio Products Division.
Steve Milne joined the Company in April 1996 as Vice President of Engineer-
ing. From 1992 to 1996, he was employed at Taligent, Inc., a software joint
venture owned by International Business Machines Corporation, Hewlett-Packard
Company, and Apple Computers Inc., most recently as Director, Media Software
page 19 of 52
<PAGE>
Development. From 1986 to 1992, Mr. Milne was an engineer and manager working
on audio for Apple Computer Inc. Prior to that Mr. Milne was employed by
Sydis, Inc. and Wang Laboratories, working on voice recording products.
Item 2. Properties.
The Company leases approximately 30,000 square-feet space at its head-
quarters located on Portage Avenue in Palo Alto, California, under leases
expiring in September 2004. Activities at this facility include engineering,
manufacturing, management information systems, customer service, distribution
and general administration. Euphonix also leases space for its sales and
service offices in Los Angeles, New York, Nashville and London, and its subsid-
iaries in Seattle and Tokyo.
Item 3. Legal Proceedings.
The Company is not currently involved in any material legal proceedings.
Item 4. Submission of Matters to Vote of Security Holders.
Not applicable.
page 20 of 52
<PAGE>
PART II
-------
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters.
The Company effected the initial public offering of its Common Stock on
August 22, 1995, at a price to the public of $8.00 per share. The following
table sets forth, for the periods indicated, the high and low closing prices
for the Company's common stock:
<TABLE>
<CAPTION>
<S>
Fiscal 1995 <C>High Low
- ----------- ---- ---
Third quarter (beginning August 22, 1995)........ $ 10.00 $ 7.88
Fourth quarter................................... 9.75 7.88
Fiscal 1996
- -----------
First quarter.................................... 12.25 8.13
Second quarter................................... 10.75 8.00
Third quarter.................................... 8.13 4.57
Fourth quarter................................... 6.13 3.50
</TABLE>
As of March 10, 1997, there were approximately 99 holders of record of the
Company's Common Stock. The Company's Common Stock is listed for quotation in
the Nasdaq National Market under the Symbol "EUPH".
The Company has not paid any cash dividends on its Common Stock and cur-
rently intends to retain any future earnings for use in its business. Accord-
ingly, the Company does not anticipate that any cash dividends will be declared
or paid on the Common Stock in the foreseeable future. *
- ------------------
* This paragraph contains forward-looking statements reflecting current
expectations. There can be no assurance that the Company's actual
performance will meet the Company's current expectations. Investors are
strongly encouraged to review the section entitled "Factors Affecting
Future Operating Results" commencing on page 26 for a discussion of factors
that could affect future performance.
page 21 of 52
<PAGE>
Item 6. Selected Financial Data.
The following selected financial data for the five-year period ended
December 31, 1996, should be read in conjunction with the Company's Financial
Statements and notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operation" included in Item 7 of this report.
<TABLE>
<CAPTION> Year Ended December 31,
-----------------------------------------------------
<S> <C> 1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(In thousands, except per share data)
Statement of Operations Data:
Net revenues................. $ 18,237 $ 14,681 $ 8,133 $ 6,331 $ 5,185
Gross profit................. 9,396 7,482 4,246 3,322 2,635
Operating income (loss)...... (1,836) 1,436 416 104 154
Net income (loss) ........... $(1,398) $ 1,346 $ 472 $ 163 $ 222
Net income (loss) per share(1) $ (0.25) $ 0.27 $ 0.12
Shares used in per share cal-
culations................... 5,515 4,922 4,085
December 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(In thousands)
Balance Sheet Data:
Working capital............... $11,035 $12,937 $2,588 $2,256 $2,317
Total assets.................. 15,466 18,279 4,999 4,288 3,318
Redeemable convertible
preferred stock.............. ---- ---- 2,185 2,185 2,185
Shareholders' equity.......... 12,338 13,602 964 486 322
</TABLE>
(1) Prior to 1994, statements of operations data omit the historical net
income per share as it was not presented in the initial public offering
registration statement. Pro forma net income per share is presented for 1994.
See Note 1 of Notes to Financial Statements.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Overview
The Company develops, manufactures and markets digitally controlled audio
mixing consoles for the use in the production of audio content for the music,
post production (film and television), broadcast, live sound reinforcement
(live concerts and theater) and multimedia segments of the professional audio
market. From its inception in July 1988 through 1990, the Company was princi-
pally engaged in product research and development. In late 1991, the Company
began shipping its first commercial product in the United States and interna-
tionally. The Company has funded its growth primarily through sales of equity
securities in 1991, 1995 and 1996 , and cash generated from operations in 1994
and 1995. In 1996, $2.8 million was used in the Company's operating activities.
As of December 31, 1996, the Company has shipped approximately 300 of its
mixing consoles worldwide.
The price of the Company's mixing consoles generally ranges from $100,000
to $400,000, and is often the most expensive piece of equipment in the studio.
Products are typically delivered two to three months after receipt of an order.
Prior to shipping a product, the Company generally requires payment of a sub-
stantial portion of the purchase price, an irrevocable letter of credit or a
purchase order from a third-party lessor. The Company usually relies on new
orders in the same quarter to achieve its net revenues. The Company recognizes
its revenues on shipment.
page 22 of 52
<PAGE>
Annual Results of Operations
The following table sets forth certain operating data as a percentage of
net revenues for the periods indicated:
<TABLE>
<CAPTION> Year Ended December 31,
-----------------------
<S> <C> 1996 1995 1994
---- ---- ----
Net revenues............................... 100.0% 100.0% 100.0%
Cost of revenues........................... 48.5 49.0 47.8
----- ----- -----
Gross margin............................... 51.5 51.0 52.2
Operating expenses:
Research and development................ 15.5 11.3 15.0
Sales and marketing..................... 25.0 20.2 23.6
General and administrative.............. 10.7 9.7 8.5
In-process technology................... 7.9 --- ---
Write off of intangibles and goodwill .. 2.4 --- ---
----- ----- -----
Total operating expenses............ 61.5 41.2 47.1
----- ----- -----
Operating (loss) income ................... (10.0) 9.8 5.1
Interest income, net....................... 2.6 2.1 0.8
----- ----- -----
(Loss) income before income taxes ......... (7.4) 11.9 5.9
Provision for income taxes ................ 0.3 2.7 0.1
----- ----- -----
Net (loss) income ......................... (7.7)% 9.2% 5.8%
----- ----- -----
</TABLE>
Net Revenues
Net revenues increased to $18.2 million in 1996, from $14.7 million in
1995 and $8.1 million in 1994, representing increases of 24.2% and 80.5%,
respectively. The Company's annual increases in net revenues have resulted
primarily from increased sales efforts, increased market acceptance and
enhanced product capabilities of the Company's mixing consoles. In addition
during 1996 the Company acquired Spectral which contributed $1.2 million or
6.6% of net revenue from the date of acquisition through December 31, 1996.
Sales of the Company's products in the United States were $8.7 million,
$7.6 million and $5.7 million, comprising approximately 47.3%, 51.5% and
70.2% of the Company's net revenues for 1996, 1995 and 1994, respectively.
Export sales were $9.5 million, $7.1 million and $2.4 million, comprising
approximately 52.7%, 48.5% and 29.8% of the Company's net revenues for 1996,
1995 and 1994, respectively. In 1996 compared with 1995 new markets were
entered with first time sales in Korea, Netherlands, New Zealand, Denmark,
Sweden, Brazil, Argentina and South Africa. The Company believes that export
sales as a percent of net revenues were low in 1994 due in part to poor econom-
ic conditions in Japan and certain major European countries, as well as the
lack of a significant international market presence of the Company until late
1994 and the Company's focus on the United States market. Substantially all
sales are denominated in United States dollars to reduce the effect of
fluctuations in foreign currency exchange rates.
The Company continues to make progress in the sales of audio mixing
systems; however, there were a number of significant factors which the Company
believes impacted the third and fourth quarter 1996 results and may adversely
impact the Company's 1997 results. These factors included a slower than antici-
pated product penetration into the post production and broadcast markets, new
competitive product offerings, and a slow down in domestic and European indus-
try markets.
page 23 of 52
<PAGE>
Gross Margin
The Company's gross margin increased to 51.5% in 1996, up from 51.0% in
1995 and down from 52.2% in 1994. The decrease in 1995 from 1994 reflected an
increase in export sales, which includes greater discounts to distributors.
The increase in 1996 from 1995 was primarily attributable to lower material
procurement and manufacturing support costs, as a percentage of net revenues
for the same period. In addition during 1996 the Company acquired Spectral
whose products have a higher gross margin percentage than the consoles.
Research and Development
Research and development expenses increased to $2.8 million in 1996, up
from $1.7 million in 1995, and $1.2 million in 1994, representing an increase
of 70.9% in 1996, and an increase of 35.4% in 1995. Research and
development expenses as a percentage of net revenues increased to 15.5% in
1996, up from 11.3% in 1995, and 15.0% in 1994. The increase in research and
development expenses from 1994 was primarily due to the development of a number
of product enhancements and in 1996 from 1995 was primarily due to the addi-
tion of Spectral, Incorporated engineering personnel.
Sales and Marketing
Sales and marketing expenses increased to $4.6 million in 1996, from $3.0
million in 1995, and $1.9 million in 1994, representing increases of 53.9%
and 54.6%, respectively. Sales and marketing expenses also increased as a
percentage of net revenues to 25.0% in 1996 from 20.2% in 1995, and from 23.6%
in 1994. The increase in sales and marketing expenses as a percentage of net
revenues in 1996 was primarily attributable to the addition of Spectral Incorp-
orated sales and marketing personnel.
General and Administrative
General and administrative expenses increased to $2.0 million in 1996 from
$1.4 million in 1995, and $689,000 in 1994, representing increases of 37.0%
and 106.6%, respectively. General and administrative expenses as a percent of
net revenues increased to 10.7% in 1996 from 9.7% in 1995, and from 8.5% in
1994, respectively. The increases in 1996 and 1995 are primarily due to
increases in number of personnel and staffing costs and the addition of report-
ing, legal and accounting requirements of a publicly traded company.
In-process Technology & Write off of Intangibles and Goodwill
In connection with the acquisition of Spectral, Euphonix recorded a charge
for in-process technology that had not yet reached technological feasibility
and did not have alternative future uses. This one-time charge amounted to
$1.4 million during the first quarter of 1996. In the fourth quarter of 1996
the unamortized capitalized technology and goodwill was charged to expense, due
to new products being planned and developed which will address the high end
digital audio workstation (DAW) and recorder markets that do not include
Spectral's existing technology. In addition Spectral's existing technology has
no alternative future uses.
Provision for Income Taxes
The Company's effective tax rate in 1996 was 31.0%, excluding the effects
of a one time in-process technology write-off for which no tax benefit is avail-
able. The Company's effective tax rates in 1995 and 1994 were 22.7% and 2.3%,
respectively. The effective tax rate for 1996, 1995 and 1994 differs from the
federal statutory rate of 34% primarily due to utilization of tax loss carry-
forwards and the recognition of certain deferred tax assets previously subject
to valuation allowance. The Company expects that its effective tax rate will
be higher in future years as the amount of unrecognized deferred tax assets
is reduced.
page 24 of 52
<PAGE>
Liquidity and Capital Resources
The Company has funded its operations to date primarily through cash
flows from operations, the private sale of equity securities, and the initial
public offering of Common Stock completed in September 1995. For the year
ended December 31, 1996, cash, cash equivalents and short-term investments
decreased by $5.8 million to approximately $7.0 million. Also during this
period, working capital decreased by $1.9 million to approximately $11.0
million.
The Company's operating activities used cash of approximately $2.8 million
in 1996 and generated cash of $2.0 million in 1995 and $463,000 in 1994. Cash
used in operating activities for 1996 was comprised primarily of net loss, a
decrease in customer deposits, an increase in inventory, an increase in prepaid
expenses and other current assets and other assets, offset partially by an
increase in non cash items including acquired in-process research and write-
off of intangibles and goodwill, and higher depreciation and amortization
expense. The Company expects that its accounts receivable and inventory will
continue to grow and such increases are likely to increase the Company's
requirements for working capital. * Cash provided by operating activities for
1995 was comprised primarily of net income, an increase in accounts payable,
accrued liabilities and customer deposits offset by increases in accounts
receivable and inventory.
On February 7, 1996 the Company used cash to acquire Spectral, Incorp-
orated, a Washington based company, that develops and markets PC-based digi-
tal audio workstations. The cost of the acquisition was approximately
$2,300,000, which included the purchase of Spectral's stock for $1,500,000
and debt reduction of $778,000.
As of December 31, 1996, the Company's sources of liquidity included cash,
cash equivalents and short-term investments totaling approximately $7.0 mil-
lion, and an unsecured bank line of credit of up to $500,000. As of December
31, 1996, no borrowings were outstanding under such line of credit. The Company
believes that its existing sources of liquidity, together with anticipated
funds provided from operations, will be sufficient to finance its operations
for at least the next 12 months.*
- ------------------
* This paragraph contains forward-looking statements reflecting current
expectations. There can be no assurance that the Company's actual
future performance will meet the Company's current expectations. Inves-
tors are strongly encouraged to review the section entitled "Factors
Affecting Future Operating Results" commencing on page 26 for a discus-
sion of factors that could affect future performance.
page 25 of 52
<PAGE>
Factors Affecting Future Operating Results
The Company has derived virtually all of its revenues from sales of its
digitally controlled audio mixing console system, which system is based upon
its proprietary software and hardware platform. The Company believes that
sales of this system, along with enhancements thereof, will continue to
constitute virtually all of the Company's revenues for the foreseeable future,
with only limited sales of digital audio workstations by Spectral. Accordingly,
any factor adversely affecting the Company's base system, whether technical,
competitive or otherwise, could have a material adverse effect on the Company's
business and results of operations.
A limited number of the Company's system sales typically account for a
substantial percentage of the Company's quarterly revenue because of the
relatively high average sales price of such systems. Moreover, the Company's
expense levels are based in part on its expectations of future revenue. There-
fore, if revenue is below expectations, the Company's operating results are
likely to be adversely affected. In addition, the timing of revenue is
influenced by a number of other factors, including the timing of individual
orders and shipments, industry trade shows, seasonal customer buying patterns,
changes in product development and sales and marketing expenditures, custom
financing arrangements, production limitations and international sales activ-
ity. Because the Company's operating expenses are based on anticipated reve-
nue levels and a high percentage of the Company's expenses are relatively
fixed in the short term, variations in the timing of recognition of revenue
could cause significant fluctuations in operating results from quarter to
quarter and may result in unanticipated quarterly earnings shortfalls or
losses.
The markets for the Company's system are characterized by changing tech-
nologies and new product introductions. The Company's future success will
depend in part upon its continued ability to enhance its base system with
features including new software and hardware add-ons and to develop or ac-
quire and introduce new products and features which meet new market demands
and changing customer requirements on a timely basis. The Company is currently
designing and developing new products, primarily in the areas of recording,
editing and mixing functions of sound production as well as digital audio
processing and networking systems. The substantial investment in these new
developments will result in higher research and development expenses to be
incurred over the next twelve months and therefore reduce operating profits.
In addition, there can be no assurance that products or technologies dev-
eloped by others will not render the Company's products or technologies non-
competitive or obsolete. See "Business".
To date, the Company's primary market success has been in the music segment
of the professional audio market. In order for the Company to grow, the Company
believes that it must continue to gain market share in the music market segment,
as well as in its other targeted market segments. There can be no assurance
that the Company will be able to compete favorably in any other market seg-
ments. The Company's inability to compete favorably could have a material
adverse effect on its business and results of operations. The markets for the
Company's products are intensely competitive and characterized by significant
price competition. The Company believes that its ability to compete depends
on elements both within and outside its control, including the success and
timing of new product development (including development on a timely basis of
a hybrid digital product, of which there can be no assurance) and introduction
by the Company and its competitors, product performance and price, distribu-
tion, availability of lease or other financing alternatives, resale of used
systems and customer support. See "Business--Competition".
Currently, the Company uses many sole or limited source suppliers, certain
of which are critical to the integrated circuits included in the Company's base
system. Major delays or terminations in supplies of such components could have
a significant adverse effect on the Company's timely shipment of its products,
which in turn would adversely affect the Company's business and results of oper-
ations. The Company also relies on single vendors to manufacture major subassem-
blies for its products. Any extended interruption in the future supply or in-
crease in the cost of subassemblies manufactured by its primary or other third
party vendors could have a material adverse effect on the Company's business
page 26 of 52
<PAGE>
and results of operations. See "Business--Manufacturing and Suppliers".
In addition, as different electrical, radiation or other standards
applicable to the Company's products are adopted in countries, including the
United States, or groups of countries in which the Company sells its products,
the failure of the Company to modify its products, if necessary, to comply
with such standards would likely have an adverse effect on the Company's
business and results of operations. See "Business--Sales and Distribution".
The Company generally relies on a combination of trade secret, copyright
law and trademark law, contracts and technical measures to establish and
protect its proprietary rights in its products and technologies. However, the
Company believes that such measures provide only limited protection of its
proprietary information, and there is no assurance that such measures will be
adequate to prevent misappropriation. In addition, significant and protracted
litigation may be necessary to protect the Company's intellectual property
rights, to determine the scope of the proprietary rights of others or to defend
against claims of infringement. There can be no assurance that third-party
claims alleging infringement will not be asserted against the Company in the
future. Any such claims could have a material adverse effect on the Company's
business and results of operations. See "Business--Proprietary Rights".
The Company's success depends, in part, on its ability to retain key
management and technical employees and its continued ability to attract and
retain highly skilled personnel. In addition, the Company's ability to manage
any growth will require it to continue to improve and expand its management,
operational and financial systems and controls. If the Company's management
is unable to manage growth effectively, its business and results of operations
will be adversely affected.
The Company acquired Spectral in February 1996. Sale of Spectral products
for 1996 were significantly below plan and below 1995 sales levels. The year
over year decrease in sales was primarily attributed to increased competition,
product development delays and revamping of their distributor channels of the
current digital audio workstation product line. Spectral's pre-tax operating
losses for 1996 also increased significantly due primarily to lower sales
volumes and increased engineering staffing costs. In 1997, sales are expected
to remain near 1996 levels. In 1996, Spectral engineering, marketing and
sales activities were integrated into the respective Euphonix organizations.
In 1997, the Company plans to further integrate Spectral activities by the
transfer of their manufacturing to Euphonix headquarters in Palo Alto, Calif-
ornia.
As a result of these and other factors, the Company has experienced signifi-
cant quarterly fluctuations in operating results and anticipates that these
fluctuations will continue in future periods. There can be no assurance that
the Company will be successful in maintaining or improving its profitability
or avoiding losses in any future period. Further, it is likely that in some
future period the Company's net revenues or operating results will be below
the expectations of public market securities analysts and investors. In such
event, the price of the Company's Common Stock would likely be materially
adversely affected. See "Future Operating Results."
page 27 of 52
<PAGE>
Item 8. Financial Statements and Supplementary Data
Index to Financial Statements
Page
Report of Ernst & Young LLP, Independent Auditors ................... 29
Consolidated Balance Sheets as of December 31, 1996, and 1995 ....... 30
Consolidated Statements of Operations for the years ended December
31, 1996, 1995, and 1994 ........................................... 31
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1996, 1995 and 1994.................................... 32
Consolidated Statements of Cash Flows for the years ended December
31, 1996, 1995 and 1994............................................. 33
Notes to Consolidated Financial Statements........................... 34
page 28 of 52
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Euphonix, Inc.
We have audited the accompanying consolidated balance sheets of Euphonix, Inc.
as of December 31, 1996 and 1995, and the related consolidated statements of
operations, shareholders' equity, and cash flows for each of the three years
in the period ended December 31, 1996. Our audits also included the financial
statement schedule listed in the Index at Item 14(a). These financial state-
ments and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing stan-
dards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant esti-
mates made by management, as well as evaluating the overall financial state-
ment presentation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Euph-
onix, Inc. at December 31, 1996 and 1995, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
ERNST & YOUNG LLP
San Jose, California
February 12, 1997
page 29 of 52
<PAGE>
EUPHONIX, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION> December 31,
<S> -----------------------------------
ASSETS <C> 1996 1995
CURRENT ASSETS:
Cash and cash equivalents............... $ 1,428,095 $ 860,527
Short-term investments.................. 5,591,272 11,947,046
Accounts receivable (net of allowance
for doubtful accounts: 1996, $119,739;
1995, $84,820).......................... 1,626,756 1,358,672
Inventories.............................. 4,674,082 3,251,629
Prepaid expenses and other current assets 697,064 187,840
------------- -------------
Total current assets........... 14,017,269 17,605,714
PROPERTY AND EQUIPMENT:
Furniture and fixtures................... 217,680 243,513
Computer equipment and software.......... 1,443,291 464,474
Leasehold improvements................... 177,353 163,477
Demo equipment........................... 238,443 81,524
------------- -------------
2,076,767 952,988
Accumulated depreciation and amortization 828,834 375,136
------------- -------------
1,247,933 577,852
Deposits and other assets................. 200,561 95,486
------------- -------------
Total assets...................$ 15,465,763 $ 18,279,052
------------- -------------
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.........................$ 736,939 $ 471,321
Accrued payroll and related liabilities,
including deferred salary............... 515,786 484,497
Accrued warranty......................... 382,715 156,398
Accrued commissions...................... 251,958 246,568
Income taxes payable..................... 50,892 366,339
Other accrued liabilities................ 515,680 434,899
Customer deposits........................ 484,960 2,508,460
Short term portion capital leases ....... 43,679 ---
------------- ------------
Total current liabilities...... 2,982,609 4,668,482
LONG-TERM OBLIGATIONS:
Long term portion capital leases ........... 65,948 ---
Deferred rent ....... ...................... 5,284 8,632
Deferred income taxes ...................... 74,000 ---
COMMITMENTS
SHAREHOLDERS' EQUITY:
Common stock, $0.001 par value: 20,000,000
authorized shares, 5,565,288 and 5,410,284
shares issued and outstanding in 1996 and
1995, respectively ....................... 5,566 5,410
Additional paid-in capital ................ 13,719,069 13,675,329
Retained earnings (deficit) ............... (1,157,213) 240,699
Deferred compensation ..................... (229,500) (319,500)
------------ -------------
Total shareholders' equity..... 12,337,922 13,601,938
------------ -------------
Total liabilities and share-
holders' equity ..............$ 15,465,763 $ 18,279,052
------------ -------------
------------ -------------
</TABLE>
See accompanying notes.
page 30 of 52
<PAGE>
EUPHONIX, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION> Years Ended December 31,
-----------------------------------------------
<S> <C> 1996 1995 1994
---- ---- ----
Net revenues..................$ 18,237,149 $ 14,681,416 $ 8,132,844
Cost of revenues.............. 8,841,122 7,199,688 3,886,724
-------------- -------------- -------------
Gross profit.................. 9,396,027 7,481,728 4,246,120
Costs and expenses:
Research and development.... 2,831,861 1,656,798 1,223,219
Sales and marketing......... 4,563,542 2,964,539 1,917,800
General and administrative.. 1,951,450 1,424,731 689,466
In-process technology ...... 1,445,839 --- ---
Write off of intangibles and
goodwill .................. 439,027 --- ---
-------------- -------------- -------------
11,231,719 6,046,068 3,830,485
-------------- -------------- -------------
Operating income (loss)....... (1,835,692) 1,435,660 415,635
Interest income............... 487,723 306,483 67,930
Other income (expense)........ --- --- (589)
-------------- -------------- -------------
487,723 306,483 67,341
-------------- -------------- -------------
Income (loss) before income
taxes ....................... (1,347,969) 1,742,143 482,976
Provision for income taxes.... 49,943 395,949 11,000
-------------- -------------- -------------
Net income (loss).............$ (1,397,912) $ 1,346,194 $ 471,976
-------------- -------------- -------------
Net income (loss) per share ..$ (0.25) $ 0.27
-------------- --------------
Number of shares used in
computing per share amounts
(in thousands)............... 5,515 4,922
-------------- --------------
Pro forma net income per share $ 0.12
-------------
Number of shares used in
computing pro forma per share
amounts (in thousands)....... 4,085
-------------
</TABLE>
See accompanying notes.
page 31 of 52
<PAGE>
EUPHONIX, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
<S> Convertible Preferred Stock
--------------------------------------- (Cont.)
Series A Series B
-------------------- -----------------
Shares Amount Shares Amount
------ ------ ------ ------
<C>
Balance at December 31, 1993.. 1,033,908 $ 1,034 590,232 $590
Exercise of stock options... --- --- --- ---
Net income.................. --- --- --- ---
--------- ------- -------- ------
Balance at December 31, 1994.. 1,033,908 1,034 590,232 590
Conversion of preferred stock
to common stock............(1,033,908) (1,034) (590,232) (590)
Sale of common stock, net of
issuance costs............. --- --- --- ---
Exercise of stock purchase
rights..................... --- --- --- ---
Deferred compensation related
to stock options........... --- --- --- ---
Amortization of deferred
compensation............... --- --- --- ---
Net income ................. --- --- --- ---
---------- ------- -------- -----
Balance at December 31, 1995.. --- --- --- ---
Exercise of stock options... --- --- --- ---
Amortization of deferred
compensation............... --- --- --- ---
Net loss.................... --- --- --- ---
---------- ------- --------- ------
Balance at December 31, 1996.. --- $--- --- $---
---------- ------- --------- ------ (Cont.)
---------- ------- --------- ------
(Continued) Additional Retained Total
Common Stock Paid-In Earnings Deferred Shareholders'
Shares Amount Capital (Deficit) Compensation Equity
<S> <C> ------ ------ ------ --------- ------------ --------
Balance at Dec. 31,
1993................. 863,953 $864 $2,060,915 $(1,577,471) $--- $485,932
Exercise of stock
options............. 59,900 60 6,150 --- --- 6,210
Net income........... --- --- --- 471,976 --- 471,976
--------- ---- --------- ----------- ---- --------
Balance at Dec. 31,
1994................. 923,853 924 2,067,065 (1,105,495) --- 964,118
Conversion of preferred
stock to common stock 2,647,397 2,647 2,184,326 --- --- 2,185,349
Sale of common stock
net of issuance cost 1,288,604 1,289 8,994,970 --- --- 8,996,259
Exercise of stock
options.............. 520,430 520 53,998 --- --- 54,518
Exercise of stock
purchase rights...... 30,000 30 2,970 --- --- 3,000
Deferred compensation
related to stock options --- --- 372,000 --- (372,000) ---
Amortization of deferred
compensation --- --- --- --- 52,500 52,500
Net income............. --- --- --- 1,346,194 --- 1,346,194
--------- ----- -------- ---------- ------ ---------
Balance at December 31,
1995.............. 5,410,284 5,410 13,675,239 240,699 (319,500) 13,601,938
Exercise of stock
options.......... 155,004 156 43,740 --- --- 43,896
Amortization of
deferred compen-
sation........... --- --- --- --- 90,000 90,000
Net loss.......... --- --- --- (1,397,912) --- (1,397,912)
----------- ----- ---------- ----------- ------- ----------
Balance at December 31,
1996............ 5,565,288 $5,566 $13,719,069 $(1,157,213)$(229,500)$12,337,922
---------- ------ ----------- ----------- --------- -----------
---------- ------ ----------- ----------- --------- -----------
</TABLE>
See accompanying notes.
page 32 of 52
<PAGE>
EUPHONIX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE> Years Ended December 31,
-----------------------------------
<CAPTION> 1996 1995 1994
---- ---- ----
<S> <C>
Operating activities
Net (loss) income......................... $(1,397,912) $1,346,194 $471,976
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Depreciation.......................... 306,964 153,205 101,794
Amortization of technology and goodwill 180,783 --- ---
Amortization of organization expense.. 8,552 --- ---
Amortization of patents and trademarks 7,015 6,233 ---
Deferred compensation amortization..... 90,000 52,500 ---
Acquired research and development...... 1,445,839 --- ---
Write off of intangibles and goodwill.. 439,027 --- ---
Changes in operating assets and
liabilities:
Prepaid expenses, other current assets
and other assets..................... (614,884) (120,685) (61,026)
Accounts receivable................... 176,236 (899,476) 217,199
Inventory............................. (1,033,785) (1,361,944) (499,372)
Accounts payable, accrued liabilities,
and deferred rent................... (380,573) 1,154,712 (88,724)
Customer deposits..................... (2,023,500) 1,672,923 321,163
------------ ---------- --------
Total adjustments.......................... (1,398,326) 657,468 (8,966)
------------ ---------- --------
Net cash provided by (used in) operating
activities............................... (2,796,238) 2,003,662 463,010
Investing activities
Purchase of Spectral, Inc. net of cash
acquired................................. (2,283,327) --- ---
Proceeds from sales of short-term
investments.............................. 6,355,774 12,279,310 678,022
Purchases of short-term investments........ --- (23,900,398) ---
Purchase of property and equipment......... (716,300) (294,787) (204,341)
------------ ------------ ---------
Net cash provided by (used in) investing
activities............................... 3,356,147 (11,915,875) 473,681
Financing activities
Principal payments under capital lease
obligations.............................. (36,237) --- ---
Proceeds from short-term borrowings........ 287,000 --- 50,000
Repayment of short-term borrowings......... (287,000) --- (50,000)
Proceeds from sale of common stock and
exercise of stock options................ 43,896 9,053,777 6,210
------------- ----------- ----------
Net cash provided by financing activities.. 7,659 9,053,777 6,210
------------- ----------- ----------
Net increase (decrease) in cash and cash
equivalents.............................. 567,568 (858,436) 942,901
Cash and cash equivalents at beginning of
year..................................... 860,527 1,718,963 776,062
------------- ----------- ----------
Cash and cash equivalents at end of year... $1,428,095 $860,527 $1,718,963
============= =========== ==========
Supplemental disclosures of cash flow
information
Cash paid for income taxes................. $894,000 $66,800 $800
Supplemental schedules of noncash investing
and financing activities
Conversion of preferred stock to
common stock............................. $ --- $4,236,347 $ ---
</TABLE>
See accompanying notes.
page 33 of 52
<PAGE>
EUPHONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business Activities and Summary of Significant Accounting Policies
Business Activities
Euphonix, Inc. (the "Company") was incorporated on July 6, 1988. The
Company's core business is the development, manufacture and marketing of
digitally controlled audio mixing consoles and accessories for use in the
production of audio content for music, post production for film and televi-
sion, broadcast, live sound reinforcement and multimedia world-wide markets.
On February 7, 1996, Euphonix acquired 100% of the stock of Spectral Incorp-
orated. Spectral, a wholly owned subsidiary, develops and markets PC-based
digital audio workstations.
Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary. All significant intercompany accounts
and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and assump-
tions that affect the amounts reported in the financial statements and accom-
panying notes. Actual results could differ from those estimates.
Cash, Cash Equivalents, and Short-Term Investments
Cash equivalents consist of short-term financial instruments that are
readily convertible into cash with original maturities of less then ninety
days from the date of acquisition. The carrying amount reported in the balance
sheets for cash and cash equivalents approximates fair value. The fair values
for short-term investments are based on quoted market prices.
At December 31, 1996 and 1995, the Company has classified its short term
investments, which are substantially money market funds, that invest in govern-
ment obligations and corporate securities, as available-for-sale, and has
included them in short-term investments. Available-for-sale securities are
carried at fair value with unrealized gains and losses, net of tax, and are
reported in a separate component of shareholders' equity. The amortized cost
of debt securities in this category is adjusted for the amortization of
premiums and the accretion of discounts to maturity. Such amortization is
included in investment income. Realized gains and losses and declines in value
judged to be other-than-temporary on available-for-sale securities are included
in investment income (loss). The cost of securities sold is based on the
specific identification method. Interest and dividends on securities classi-
fied as available-for-sale are included in investment income.
page 34 of 52
<PAGE>
EUPHONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
At December 31, 1996 and 1995, estimated fair value approximated cost.
Realized gains for the year ended December 31, 1996 and 1995 were $28,000 and
$0, respectively. Sales of short-term investments classified as available-
for-sale securities for the years ended December 31, 1996 and 1995 totaled
approximately $6.3 million and $12.3 million in 1996 and 1995, respectively.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market (net realizable value). Inventories consist of the following:
<TABLE>
<CAPTION> December 31,
-------------------------------
<S> <C> 1996 1995
---- ----
Raw materials....................... $ 1,983,382 $ 940,765
Work-in-process..................... 935,211 1,475,107
Finished goods...................... 1,755,489 835,757
------------ -----------
$ 4,674,082 $ 3,251,629
============ ===========
</TABLE>
Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation
and amortization. Depreciation and amortization are provided on a straight-
line basis over the estimated useful life of the respective assets, generally
five years or, in the case of property under capital leases, over the lesser
of the useful life of the assets or lease term.
Revenue Recognition
Revenues are recognized upon the shipment. Revenues on rental units, which
have not been material, are recognized upon the invoicing of the monthly rental
charges. Depreciation on rental units is charged to cost of revenues.
Warranty Accrual
The Company provides a one-year parts and labor warranty on its products.
The Company accrues for estimated warranty costs upon shipment.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense
was approximately $293,000, $216,000 and $188,000 in 1996, 1995 and 1994,
respectively.
Net Income (Loss) Per Share
Net loss per share for 1996 is computed using the weighted average number
of shares of common stock outstanding. Net income per share for 1995 is
computed using the weighted average number of shares of common stock and
common equivalent shares, when dilutive, from convertible preferred stock
page 35 of 52
<PAGE>
EUPHONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(using the if-converted method) and from stock options and warrants (using
the treasury stock method). Pursuant to the Securities and Exchange Commission
(the "SEC") Staff Accounting Bulletins, common and common equivalent shares
issued by the Company at prices below the initial public offering price
during the twelve-month period prior to the August 1995 initial public offering
have been included in the calculation as if they were outstanding for all
periods presented (using the treasury stock method and the initial public
offering price).
Pro Forma Net Income Per Share
Pro forma net income per share was computed as described above and also
gave effect to common equivalent shares from convertible preferred stock that
automatically converted upon the closing of the Company's initial public
offering (using the as-if-converted method). Pro forma net income per share
is presented for 1994.
Concentration of Credit Risk
The Company sells mainly to end-users and distributors. The Company
performs ongoing credit evaluations of its customers and, prior to shipping a
product, required payment of a substantial portion of the purchase price, an
irrevocable letter of credit, or a purchase order from a third-party lessor
on the majority of orders. The Company maintains reserves for potential credit
losses, and such losses have been within management's expectations.
2. Line of Credit
The Company has a line of credit with a bank that provides for borrowings
not to exceed $500,000. The agreement contains covenants that require the
Company to maintain certain financial ratios, yearly profitability, and levels
of net worth. Borrowings against the line of credit bear interest at the
bank's prime rate. There were no borrowings against the line of credit at
December 31, 1996. The line of credit terminates upon a thirty-day written
notification by either party.
3. Commitments
The Company leases its main facility, located in Palo Alto, California,
under a noncancelable operating lease that expires in 2004. The lease contains
provisions for rental adjustments and requires the Company to pay property
page 36 of 52
<PAGE>
EUPHONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
taxes, insurance, property and normal maintenance costs. The Company has an
option to continue to lease on a month-to-month basis upon the expiration of
the noncancelable lease.
The Company also leases space for its sales office in Los Angeles, Nash-
ville, New York, and London under noncancelable operating leases that expire
September 30, 1998, August 31, 1998, August 31, 1999, and August 31, 1999,
respectively.
The future minimum lease payments under operating leases are as follows:
<TABLE>
<CAPTION> December 31,
1996
----
<S> <C>
1997............................. $ 439,218
1998............................. 423,830
1999............................. 432,136
2000............................. 608,712
2001............................. 608,712
Thereafter....................... 1,826,136
----------
Total minimum payments........... $4,338,744
==========
</TABLE>
Rental expense was approximately $410,000, $282,000 and $218,000 in 1996,
1995 and 1994, respectively.
4. Obligations Under Capital Leases
In conjunction with the acquisition of Spectral, the Company assumed
certain capital lease obligations of its wholly owned subsidiary. Obligations
under capital leases represent the present value of future payments under the
equipment lease agreements.
<TABLE>
<CAPTION> December 31,
1996
<S> <C> ----
Property, plant and equipment under capital leases ... $ 202,606
Accumulated Amortization ............................. (116,521)
----------
Net property, plant and equipment under capital leases $ 86,085
==========
</TABLE>
page 37 of 52
<PAGE>
EUPHONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Future minimum payments under capital leases consist of the following at
December 31, 1996:
<TABLE>
<CAPTION> Fiscal year ending December 31:
<S> <C>
1997 ....................................... $ 57,207
1998 ....................................... 42,271
1999 ....................................... 31,664
2000 ....................................... 2,362
----------
Total minimum lease payments .................. 133,504
Amount representing interest .................. 23,877
----------
Present value of net minimum lease payments ... 109,627
Less current portion .......................... 43,679
----------
Long-term portion ............................. $ 65,948
</TABLE> ==========
5. Shareholders' Equity
Public Offering
In August and September 1995, the Company sold a total of 1,288,604
shares of common stock at $8.00 per share through its initial public offering.
The net proceeds (after underwriters' commissions and fees and other costs
associated with the offering) totaled approximately $8,996,000. In connection
with the offering, all convertible preferred stock totaling 2,647,397 shares
with an aggregate paid-in value of approximately $4,036,000 were converted into
2,647,397 shares of common stock of the Company.
Stock Based Compensation
The Company has elected to follow Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under
FASB Statement No. 123, "Accounting for Stock-Based Compensation," ("FAS 123")
requires use of option valuation models that were not developed for use in
valuing employee stock options. Under APB 25, when the exercise price of the
Company's employee stock options equals the market price of the underlying
Stock on the date of grant, no compensation is recognized.
1990 Stock Plan
The 1990 Stock Plan (the "1990 Plan") provides for the grant of incen-
tive stock options to employees of the Company and nonstatutory stock options
and stock purchase rights to employees and consultants of the Company.
page 38 of 52
<PAGE>
EUPHONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company has authorized 2,042,281 shares of common stock for issuance under
the 1990 Plan. Options issued under the 1990 Plan are exercisable upon vesting,
which generally occurs at the rate of one-fifth of the shares one year follow-
ing the date of grant or hire, with one-sixtieth of the shares vesting each
month thereafter.
1995 Performance Based Stock Option Plan
The 1995 Performance Based Stock Option Plan (the "1995 Plan") provides
for the grant of incentive stock options to employees of the Company and
nonstatutory options to employees and consultants of the Company. A total of
50,000 shares of common stock has been reserved for issuance under the 1995
Plan. To date, each option granted under the 1995 Plan vests at the rate of
one-third of the shares one year following the vesting commencement date,
with one thirty-sixth of the shares vesting each month thereafter.
1995 New Director Option Plan
The 1995 New Director Option Plan (the "Directors' Plan") authorizes
the Company to issue nonstatutory stock options to purchase up to 50,000
shares of the Company's common stock at an exercise price equal to the fair
market value of the common stock on the grant date. The Directors' Plan
provides that each person who becomes a member of the Board of Directors after
the effective date of the Directors' Plan shall be automatically granted an
option to purchase 10,000 shares. Additionally, each such outside director
shall be automatically granted an option to purchase 2,000 shares on the date
of each annual shareholders' meeting provided he is an outside director as of
the date of such meeting and is reelected to the Board of Directors at such
meeting. One-fourth of the shares of Common Stock subject to the First
Option and each Annual Option shall vest one year after the date of grant,
with one-fourth vesting each anniversary thereafter.
On October 27, 1996, the Company was authorized to exchange stock options
granted under these plans and having an exercise price greater than $5.375 for
options with an exercise price of $5.375 (the fair market value of the Company's
stock on October 27, 1996). A total of 382,732 stock option shares were
repriced.
page 39 of 52
<PAGE>
EUPHONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of the Company's stock option activity, is as follows:
<TABLE>
<CAPTION> Weighted
<S> Number of Average
Shares Exercise
<C> Outstanding Price
-------------------------------------------------------------
Balance at December 31, 1993 760,000 $0.11
Granted ................... 79,000 0.20
Exercised ................. (59,900) 0.10
Canceled .................. (13,600) 0.17
---------
Balance at December 31, 1994 765,500 0.12
Granted ................... 221,850 2.90
Exercised ................. (520,430) 0.10
Canceled .................. (29,450) 2.95
---------
Balance at December 31, 1995 437,470 1.49
Granted ................... 540,750 5.37
Exercised ................. (155,004) 0.33
Canceled .................. (168,874) 4.54
---------
Balance at December 31, 1996 654,342 $4.08
=========
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
<S> Options Outstanding Options Exercisable
---------------------------------------------------------------
Number of Weighted Number of
Range of Exercise Shares Average Weighted Shares Weighted
Prices Outstanding Remaining Average Outstanding Average
Contractual Exercise Exercise
Life Price Price
----------------------------------------------------------------
<C>
$0.10-$0.15 48,703 6.0 $0.14 25,576 $0.13
$0.20-$1.25 49,657 7.7 $0.35 9,674 $0.43
$3.00-$4.00 149,500 8.4 $3.05 34,585 $3.06
$4.687-$5.375 406,482 9.2 $5.37 83,592 $5.37
----------- -------
Total 654,342 $4.08 153,427 $3.66
=========== =======
</TABLE>
page 40 of 52
<PAGE>
EUPHONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pro forma information regarding net income (loss) and net income (loss)
per share is required by FAS 123, which also requires that the information be
determined as if the Company has accounted for its employee stock options
granted subsequent to December 31, 1994 under the fair value method. The fair
value for options granted prior to the initial public offering was estimated at
the date of grant using the minimum value method. The fair value for options
granted subsequent to the initial public offering was estimated at the date
of grant using the Black-Scholes option pricing model. The minimum value method
differs from the Black-Scholes option pricing model because it does not consider
the effect of expected volatility. The following weighted average assumptions
were used for 1996 and 1995, respectively: risk-free interest rates of 6.17%
and 6.26%; a dividend yield of 0%; volatility factors of the expected market
price of the Company's common stock of 65.0%; and a weighted average expected
life of the option of 6 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restric-
tions and are fully transferable. In addition, option valuation models require
the input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value estimate,
in management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Com-
pany's pro forma information follows:
<TABLE>
<CAPTION> 1996 1995
<S> <C> ---- ----
Pro forma net income (loss)....... $ (1,587,035) $ 1,346,194
Pro forma net income (loss) per
share............................ $ (0.29) $ 0.27
</TABLE>
The weighted-average grant-date fair value of options granted during the
year ended December 31, 1996 and 1995 were $3.36 and $1.10, respectively.
Because Statement 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until
1998. The effects on pro forma disclosures of applying FAS 123 are not like-
ly to be representative of the effects on pro forma disclosures in future
years.
page 41 of 52
<PAGE>
EUPHONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Deferred Compensation
For certain options granted, the Company recognized $372,000 as deferred
compensation for the excess of the deemed value at the grant date for account-
ing purposes of the common stock issuable upon exercise of such options over
the aggregate exercise price of such options. The deemed value for accounting
purposes represents fair value at the date of grant. The deferred compensation
expense is amortized ratably over the vesting period of the options into
expense. For the year ended December 31, 1996, $90,000 was charged to opera-
tions.
6. Income Taxes
The provision for income taxes consists of the following:
<TABLE>
<CAPTION> Years Ended December 31,
<S> <C> -----------------------------
1996 1995 1994
---- ---- ----
Federal:
Current.................. $226,943 $450,949 $ 2,000
Deferred................. (183,000) (105,000) ---
--------- --------- -------
43,943 345,949 2,000
--------- --------- -------
State:
Current.................. 7,000 50,000 9,000
Deferred................. (1,000) --- ---
--------- --------- -------
6,000 50,000 9,000
--------- --------- -------
Total...................... $49,943 $395,949 $ 11,000
========= ========= ========
</TABLE>
page 42 of 52
<PAGE>
EUPHONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A reconciliation of the provision for income taxes at the federal statu-
tory rate to the provision for income taxes at the effective tax rate is as
follows:
<TABLE>
<CAPTION> Years Ended December 31,
---------------------------------------------
<S> <C> 1996 1995 1994
---- ---- ----
Income taxes computed at the
federal statutory rate....... $(458,000) $593,000 $ 164,000
Operating losses, utilized..... --- (117,000) (166,000)
In process R&D charge ......... 492,000 --- ---
Valuation of temporary
differences.................. (31,000) (215,000) ---
State taxes, net of federal
benefit...................... 4,000 33,000 9,000
Other individually immaterial
items........................ 42,943 101,949 4,000
----------- -------- ---------
Provision for income taxes..... $ 49,943 $395,949 $ 11,000
=========== ======== =========
</TABLE>
Significant components of the Company's deferred tax assets are as follows:
<TABLE>
<CAPTION> December 31,
------------------------
<S> <C> 1996 1995
Deferred tax assets: ---- ----
Net operating loss carryforwards............ $ --- $ ---
Research and development credit carry-
forwards.................................. --- 25,000
Accruals and reserves not deductible for
tax....................................... 385,000 347,000
Capitalized research and development costs.. --- 27,000
--------- --------
Total deferred tax assets..................... $ 385,000 $ 399,000
Valuation allowance for deferred tax asset.... (63,000) (294,000)
--------- ---------
Net deferred tax assets....................... $ 322,000 $ 105,000
========= ===========
</TABLE>
The valuation allowance decreased by $332,000 in 1995.
7. Industry and Geographic Information
The Company operates in a single industry segment. The Company markets its
products in the United States and in foreign countries through its sales organ-
izations and through distributors. Export sales represented 52.7%, 48.5%, and
29.8% of net revenues for the years ended December 31, 1996, 1995, and 1994,
respectively.
8. Concentration of Other Risks
Products
The Company has derived substantially all of its revenues to date from
sales of its digitally controlled audio mixing console system. The Company
expects that its ability to maintain or expand its current levels of revenues
and profits in the future will depend upon, among other things, its success
in enhancing its base system with features including new software and hardware
add-ons and developing and marketing new products and features which meet new
market demands and changing customer requirements on a timely basis.
page 43 of 52
<PAGE>
EUPHONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Markets
The markets for the Company's products are characterized by rapidly chang-
ing technologies, significant price competition and frequent new product intro-
ductions. The Company believes that it must continue to gain market share in
the music market. If, in the future, there should be a downturn in the music
market, the Company's business could be materially and adversely affected.
Inventories
The Company makes inventory provisions for potentially excess and obsolete
inventory based on backlog and forecasted demand. Actual demand will inevit-
ably differ from such anticipated demand, and such differences may have a mater-
ial effect on the financial statements.
Customers
The Company markets and sells its products primarily to a broad base of
customers comprised of end-users and distributors. No one end-user or distri-
butor constituted 10% or more of net revenues in 1996.
Export Sales
The Company derives more than half of its net revenues from export sales.
None of the Company's export sales were denominated in foreign currencies.
Materials
Currently, the Company uses many sole or limited source suppliers, cer-
tain of which are critical to integrated circuits included in the Company's
base system. If there were to be major delays or terminations in supplies of
such components, the Company could experience a delay in the shipment of its
products, which could have a materially adverse affect on its financial state-
ments.
9. Benefit Plans
Defined Contribution Plan
The Company has an employee 410(k) salary deferral plan (the "Plan")
that allows voluntary contributions by all full-time U.S. employees. Eligible
employees may contribute from 1% to 20% of their respective compensation. The
Company does not contribute to the Plan.
Bonus Plans
Bonus expense incurred was $194,000, $317,000 and $56,000 for 1996,
1995, and 1994, respectively.
10. Acquisition
On February 7, 1996 the Company acquired Spectral, Incorporated, who de-
velops and markets PC-based digital audio workstations. The cost of the acquis-
ition was approximately $2.3 million, which included the purchase of Spectral's
stock for $1,500,000 and debt reduction of $778,000. In 1995, Spectral's net
revenues and net loss were approximately $2.3 million and $435,000, respec-
tively.
page 44 of 52
<PAGE>
EUPHONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Legal, accounting and appraisal costs related to the transaction were
approximately $50,000. The acquisition was accounted for as a purchase in
accordance with Accounting Principles Board Opinion No. 16. The excess of
the total acquisition cost over the fair value of assets acquired was approx-
imately $758,000 and was allocated, based on values determined by an indepen-
dent appraisal, to existing technology which had reached technological
feasibility and in process research and development.
To determine the value of the technology in the development stage, the
Company considered, among other factors, the stage of development of each
project, the time and resources needed to complete each project, expected
income and associated risks. Associated risks included the inherent difficul-
ties and uncertainties in completing the project and thereby achieving technolo-
gical feasibility, and risks related to the viability of and potential changes
to future target markets. This analysis resulted in a value of approximately
$1,446,000 being assigned to technology in the development stage that had not
yet reached technological feasibility and did not have alternative future uses.
Therefore, in accordance with generally accepted accounting principles, the
$1,446,000 of technology in the development stage was expensed.
To determine the value of the existing technology, the expected future
cash flows of each existing technology product were discounted taking into
account risks related to the characteristics and applications of each product,
existing and future markets, and assessments of the life cycle stage of each
product. Based on this analysis the existing technology, which had reached
technological feasibility, was assigned a value of approximately $435,000,
and capitalized. The unamortized capitalized technology and goodwill was
charged to expense in the fourth quarter of 1996, due to new products being
planned and developed which will address the high end digital audio worksta-
tion (DAW) and recorder markets that do not include Spectral's existing tech-
nology. In addition Spectral's existing technology has no alternative future
uses.
In processs research and development valued at approximately $1,446,000 as
of the acquisition date was charged to expense in the first quarter 1996, and
$439,000, net of $116,000 of taxes was charged to expense in the fourth
quarter, but are excluded from the pro forma net income for the year ended
December 31, 1996 and 1995 as such amounts represent non-recurring charges.
The unaudited pro forma combined results of operations that follow assume
that the acquisition had occurred at January 1, 1995. In addition to combining
the historical results of operations of the two companies, the pro forma
calculations exclude the in-process technology charge and the write-off of
intangibles and goodwill and include adjustments for the estimated effect on
the Company's historical results of operations for the loss of interest income
as a result of making the acquisition. The following pro forma information is
not necessarily indicative of the results that would have occurred had the
transaction been completed at the beginning of the period indicated, nor is it
indicative of future operating results:
<TABLE>
<CAPTION> Year Ended December 31, 1996 1995
<S> -----------------------------------------------------------
<C>
Revenues........................$ 18,348,149 $ 16,965,074
Net income ..................... 371,088 796,554
Net income per share........... 0.07 0.15
------------------------------------------------------------
</TABLE>
page 45 of 52
<PAGE>
EUPHONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
page 46 of 52
<PAGE>
PART III
Certain information by Part III is omitted from this Report on Form 10-K
in that the Registrant will file its definitive Proxy Statement for its Annual
Meeting of Stockholders to be held on May 8, 1997, pursuant to Regulation 14A
of the Securities Exchange Act of 1934, as amended (the "Proxy Statement"),
not later than 120 days after the end of the fiscal year covered by this
Report, and certain information included in the Proxy Statement is incorpo-
rated herein by reference.
Item 10. Directors and Executive Officers of the Registrant.
(a) Executive Officers -- See the section entitled "Management--
Executive Officers" in Part I, Item 1 hereof.
(b) Directors -- The information required by this Item is incorporated
by reference to the section entitled "Election of Directors" in the
Proxy Statement.
Item 11. Executive Compensation.
The information required by this Item is incorporated by reference to the
sections entitled "Compensation of Executive Officers" and "Compensation of
Directors" in the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information requested by this Item is incorporated by reference to
the section entitled "Principal Share Ownership" and "Security Ownership of
Management" in the Proxy Statement.
Item 13. Certain Relationships and Related Transactions.
The information requested by this Item is incorporated by reference to
the section entitled "Certain Transactions" in the Proxy Statement.
page 47 of 52
<PAGE>
PART IV
-------
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 10-K.
(a) 1. List of Financial Statement Schedules
The following financial statements of Euphonix, Inc., are included
in Item 8:
Consolidated Balance Sheets as of December 31, 1996 and 1995
Consolidated Statements of Operations for the three years in the
period ended December 31, 1996
Consolidated Statements of Shareholders' Equity for the three
years in the period ended December 31, 1996
Consolidated Statements of Cash Flows for the three years in the
period ended December 31, 1996
Notes to Consolidated Financial Statements
2. Supplemental Schedules
The following financial statement schedule of Euphonix, Inc. is
filed as part of this annual report, and should be read in conjunc-
tion with the financial statements of Euphonix, Inc.:
Schedule II Valuation and qualifying accounts
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the finan-
cial statements or notes thereto.
page 48 of 52
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION> Charged
<S> Balance at to Costs Balance
Beginning and at End of
Descriptions <C> of Period Expenses Deduction(1) Period
------------ --------- -------- ------------ ---------
Year Ended December 31, 1994
Allowance for Doubtful
Accounts................. $ 45,670 $ --- $ (19,670) $ 26,000
Year Ended December 31, 1995
Allowance for Doubtful
Accounts ................ $ 26,000 $ 61,436 $ (2,616) $ 84,820
Year Ended December 31, 1996
Allowance for Doubtful
Accounts ................ $ 84,820 $ 34,919 $ ---- $ 119,739
____________________
(1) Charges for uncollectible accounts, net of recoveries
</TABLE>
page 49 of 52
<PAGE>
3. Exhibits.
Exhibit
Number Description of Document
- ------ -----------------------
3.1(1) Amended and Restated Articles of Incorporation of the Registrant.
3.2(1) Bylaws of the Registrant.
10.1(1) Form of indemnification Agreement between the Registrant and each of
its directors and officers.
10.2(1) 1990 Stock Plan and forms of stock option agreement thereunder.
10.3(1) 1995 Performance Based Stock Option Plan and form of stock option
agreement thereunder.
10.4(1) 1995 New Director Option Plan and form of stock option agreement there-
under.
10.5(1) Modification Agreement dated November 6, 1991, among the Registrant
and certain shareholders of the Registrant.
10.6(1) Credit Agreement dated September 30, 1994 between the Registrant and
Bank of the West, as amended.
10.7(1) Lease Agreement dated December 31, 1990, as amended May 14, 1993, by
and between the Registrant and El Camino Center.
10.8(1) Memorandum dated February 9, 1995 from the Compensation committee of
the Board of Directors of the Registrant to James Dobbie, the Regis-
trant's Chief Executive Officer and Chairman of the Board, describing
the 1995 Bonus Plan for Mr. Dobbie.
10.9(1) Memorandum dated February 9, 1995 from James Dobbie to Scott Silfvast,
the Registrant's President, describing the 1995 Bonus Plan for Mr.
Silfvast.
10.10(1) Memorandum dated February 9, 1995 from James Dobbie to Jeff Chew, the
Registrant's Vice President of Finance, Chief Financial Officer and
Director of Operations, describing the 1995 Bonus Plan for Mr. Chew.
10.11(2) Agreement and Plan of Reorganization dated January 15, 1996 by and
among the registrant, Spectral, Incorporated, Euphonix Acquisition
Corporation and certain shareholders of Spectral, Incorporated.
11.1 Calculation of Earnings Per Share
23.1 Consent of Ernst & Young LLP, Independent Auditors
23.2 Consent of Counsel
24.1 Power of Attorney
27.1 Financial Data Schedule
________________________________
(1) Incorporated by reference to the exhibit filed with the Company's Registra-
tion Statement on Form SB-2 (File No. 33-94898-LA), effective August 21, 1995,
and the Company's Registration Statement on Form S-8, effective December 9,
1996.
(b) Reports on Form 8-K.
None.
(c) Exhibits.
See (a) above.
(d) Financial Statement Schedules.
See (a) above.
(2) Incorporated by reference to the exhibit filed with the Company's current
report on Form 8-K dated February 7, 1996.
page 49 of 52
<PAGE>
EUPHONIX, INC.
Exhibit 11.1 Statement re: Computation of Per Share Earnings
<TABLE>
<CAPTION> Years Ended December 31,
<S> 1996 1995 1994(1)
---- ---- -------
<C>(in thousands, except per share
data)
Primary
Weighted average common shares outstanding.. 5,515 2,702 914
Common equivalent shares attributable to
convertible preferred stock................ --- 1,705 2,647
Common equivalent shares attributable to the
net effect of dilutive stock options based
on the treasury stock method using
average market price....................... --- 420 334
Shares related to SAB No. 55, 64 and 83...... --- 95 190
------- ------ ------
Number of shares used in computing
per share amounts........................... 5,515 4,922 4,085
======= ======= =======
Net (loss) income............................ $(1,398) $ 1,346 $ 472
======= ======= ======
Net (loss) earnings per share................ $(0.25) $ 0.27 $ 0.12
======= ======= ======
Fully Diluted
Weighted average common shares outstanding.. 5,515 2,702 914
Common equivalent shares attributable to
convertible preferred stock................ --- 1,705 2,647
Common equivalent shares attributable to the
net effect of dilutive stock options based
on the treasury stock method using the
year-end market price, if higher than
average market price....................... --- 461 334
Shares related to SAB No. 55, 64 and 83..... --- 95 190
------- ------- ------
Number of shares used in computing
per share amounts.......................... 5,515 4,963 4,085
======= ======= ======
Net (loss) income........................... $(1,398) $ 1,346 $ 472
======= ======= ======
Net (loss) earnings per share............... $(0.25) $ 0.27 $ 0.12
======= ======= ======
(1) Pro forma net income per share is presented for 1994.
</TABLE>
page 51 of 52
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report on Form 10-K
to be signed on its behalf by the undersigned, thereunto duly authorized, in
the City of Palo Alto, State of California, on the 28th day of March, 1997.
EUPHONIX, INC.
By /s/ JAMES DOBBIE
-------------------------------
James Dobbie
Chief Executive Officer and Chairman
POWER OF ATTORNEY
KNOW ALL PERSON BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints James Dobbie and Jeffrey A. Chew, and
each of them acting individually, as his attorney-in-fact, each with full
power of substitution, for him in any and all capacities, to sign any and all
amendments to this Report on Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming our signatures as they
may be signed by our said attorney to any and all amendments to said Report.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Registration Statement has been signed by the following persons in the capaci-
ties and on the date indicated:
Signature Title Date
--------- ----- ----
/s/ JAMES DOBBIE Director, Chief Executive Officer March 28, 1997
- ---------------------------- (Principal Executive Officer)
James Dobbie
/s/ JEFFREY A. CHEW Chief Financial Officer (Principal
- ---------------------------- Financial and Accounting Officer) March 28, 1997
Jeffrey A. Chew
/s/ SCOTT W. SILFVAST Director, President March 28, 1997
- ----------------------------
Scott W. Silfvast
/s/ MILTON M.T. CHANG Director March 28, 1997
- ----------------------------
Milton M.T. Chang, Ph.D.
/s/ ROBERT F. KUHLING Director March 28, 1997
- ----------------------------
Robert F. Kuhling
/s/ GUY PAUL NOHRA Director March 28, 1997
- ----------------------------
Guy Paul Nohra
/s/ YESHWANT KAMATH Director March 28, 1997
- ----------------------------
Yeshwant Kamath
page 52 of 52
<PAGE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 1,428,095
<SECURITIES> 5,591,272
<RECEIVABLES> 1,626,756
<ALLOWANCES> 0
<INVENTORY> 4,674,082
<CURRENT-ASSETS> 14,017,269<F1>
<PP&E> 1,247,933
<DEPRECIATION> 0
<TOTAL-ASSETS> 15,465,763
<CURRENT-LIABILITIES> 2,982,609
<BONDS> 0
<COMMON> 5,566
0
0
<OTHER-SE> 12,332,356<F2>
<TOTAL-LIABILITY-AND-EQUITY> 15,465,763
<SALES> 18,237,149
<TOTAL-REVENUES> 18,237,149
<CGS> 8,841,122
<TOTAL-COSTS> 11,231,719
<OTHER-EXPENSES> 487,723
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (1,347,969)
<INCOME-TAX> 49,943
<INCOME-CONTINUING> (1,397,912)
<EPS-PRIMARY> (0.25)
<EPS-DILUTED> (0.25)
<FN>
<F1> Includes Currents Assets $13,320,205; Prepaid expenses and other
current assets $697,064.
<F2> Includes Paid in Capital $13,719,069; Accumulated Deficit $<1,157,213>;
and deferred compensation $<229,500>.
</FN>
</TABLE>
