FORM 10-Q
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________________________________
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 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: 0-18280
DIGITAL SOUND CORPORATION
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(Exact name of Registrant as specified in its charter)
California 95-3222624
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6307 Carpinteria Avenue, Carpinteria, California 93013
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(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code (805) 566-2000
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Not Applicable
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(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months or for such shorter period that the
Registrant was required to file such reports, and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
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The number of shares outstanding of Registrant's common stock as of
October 31, 1996 was 20,093,241
DIGITAL SOUND CORPORATION
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TABLE OF CONTENTS
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Page Number
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Balance Sheets as of September 30, 1996
and December 31, 1995 3
Statements of Operations for the
Three Months and Nine Months ended
September 30, 1996 and September 30, 1995 4
Statements of Cash Flows for the
Nine Months ended September 30, 1996
and September 30, 1995 5
Notes to Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 7
PART II. OTHER INFORMATION
Item 1. Legal proceedings 11
Item 6. Exhibits and Reports on Form 8-K 11
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PART I - FINANCIAL INFORMATION
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DIGITAL SOUND CORPORATION
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BALANCE SHEETS
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(In thousands, except share data)
September 30, December 31,
1996 1995
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(Unaudited)
ASSETS
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Current assets:
Cash and equivalents $ 18,839 $ 25,503
Accounts receivable, less allowance for
doubtful accounts of $600 at both
September 30, 1996 and December 31, 1995 6,158 3,407
Inventories 3,272 4,098
Other current assets 281 434
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Total current assets 28,550 31,442
Property and equipment, at cost:
Computers and other equipment 11,372 11,207
Furniture and fixtures 982 977
Leasehold improvements 855 769
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13,209 12,953
Less accumulated depreciation and amortization (11,455) (11,184)
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1,754 1,769
Other assets
Investment securities - 1,400
Other assets 3,477 4,303
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Total other assets 3,477 5,703
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$ 33,781 $ 38,914
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LIABILITIES AND SHAREHOLDERS' EQUITY
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Current liabilities:
Accounts payable $ 1,873 $ 2,712
Accrued payroll and related 2,323 1,613
Other accrued liabilities 2,283 2,032
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Total current liabilities 6,479 6,357
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value, 15,000,000 shares
authorized, 2,631,579 issued and outstanding at
September 30, 1996 and December 31, 1995 respectively 5,000 5,000
Common stock, no par value, 50,000,000 shares
authorized; 20,093,241 and 20,000,954 shares issued
and outstanding at September 30, 1996 and
December 31, 1995 respectively 68,812 68,704
Accumulated deficit (46,510) (41,147)
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Total shareholders' equity 27,302 32,557
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$ 33,781 $ 38,914
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See accompanying notes
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DIGITAL SOUND CORPORATION
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CONSOLIDATED STATEMENT OF OPERATIONS
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(In thousands, except per share data)
Three Months Ended Nine Months Ended
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September 30, September 30, September 30, September 30,
1996 1995 1996 1995
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(Unaudited)
Net sales $ 6,369 $ 4,111 $ 16,174 $ 18,440
Cost of sales 2,458 1,685 5,873 6,949
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Gross margin 3,911 2,426 10,301 11,491
Selling, general and administrative 3,295 2,780 9,741 8,747
Engineering and development 2,298 1,832 6,808 5,328
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5,593 4,612 16,549 14,075
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Loss from operations (1,682) (2,186) (6,248) (2,584)
Interest and other income 248 371 884 1,168
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Loss before provision for income
taxes (1,434) (1,815) (5,364) (1,416)
Provision for income taxes: - - - (56)
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Net Loss $ (1,434) $ (1,815) $ (5,364) $ (1,472)
======== ======== ======== ========
Net Loss per common and common
equivalent share $ (.07) $ (.08) $ (.27) $ (.06)
======== ======== ======== ========
Weighted average common and common
equivalent shares outstanding 20,093 23,176 20,055 23,190
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See accompanying notes
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DIGITAL SOUND CORPORATION
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STATEMENT OF CASH FLOWS
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(In thousands)
Nine Months Ended
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September 30, September 30,
1996 1995
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(Unaudited)
Cash flows from operating activities
Net income $ (5,364) $ (1,472)
Adjustments to reconcile net income to
net cash provided (used) by operations:
Depreciation and amortization 271 964
Changes in operating assets and liabilities:
Accounts receivable (2,751) 2,682
Inventories 826 (1,805)
Other current assets 153 (84)
Other assets 2,226 (2,175)
Accounts payable (839) (271)
Accrued payroll and related 710 689
Other accrued liabilities 251 540
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Net cash provided (used) by
operations (4,517) (932)
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Cash flows from investing activities:
(Additions to) disposition of
property and equipment (255) (731)
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Cash flows from financing activities:
Net proceeds from issuance of common stock 108 278
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Net increase in cash and equivalents (4,664) (1,385)
Cash and equivalents at beginning of period 23,503 26,838
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Cash and equivalents at end of period $ 18,839 $ 25,453
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See accompanying notes
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DIGITAL SOUND CORPORATION
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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SEPTEMBER 30, 1996
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(Unaudited)
NOTE 1. General
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All interim financial data is unaudited, but, in the opinion of the Company,
such unaudited statements include all adjustments, consisting of normal
recurring accruals, necessary for a fair presentation of the results for the
interim periods. Certain information and footnote disclosures normally included
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission. Nevertheless, the
Company believes that the disclosures in these financial statements are adequate
to make the information presented not misleading.
The results of operations for current interim periods are not necessarily
indicative of results to be expected for the current year.
These financial statements should be read in conjunction with the financial
statements and the notes thereto, included in the Company's 1995 Form 10-K, as
filed with the Securities and Exchange Commission.
NOTE 2. Principles of Consolidation
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The consolidated financial statements include the accounts of Digital Sound
Corporation (the Company) and its wholly owned subsidiary Digital Sound
International. All significant intercompany transactions and balances have been
eliminated.
NOTE 3. Inventories
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Inventories are stated at the lower of standard cost (which approximates the
first-in, first-out method) or market:
September 30, December 31,
1996 1995
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(Unaudited)
Raw materials and purchased parts $ 1,446 $ 885
Work in process 1,699 2,263
Finished goods 127 950
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$ 3,272 $ 4,098
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NOTE 4. Per Share Information
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Earnings (loss) per common and common equivalent share are computed based
upon the weighted average number of outstanding shares of common stock and
common stock equivalents. Antidilutive common stock equivalents were excluded
from this calculation for the periods in which a loss was incurred.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
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FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Results of Operations
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Three Months Ended September 30, 1996 Compared to Three Months Ended September
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30, 1995
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Net sales increased 55% from $4.1 million in 1995 to $6.4 million in 1996,
as the Company continued to focus on those sales opportunities that were aligned
with the corporate long-term strategy for both domestic and international
markets. Compared to the third quarter of 1995, sales into the VIS market
increased by $2.6 million and sales into the CPE market decreased by $0.3
million. Combined sales of the VoiceServer 1110, VoiceServer 2110 and
VoiceServer 3110 increased from those of the prior period by $3.4 million while
sales of system upgrades and enhancements and services decreased $1.1 million.
Significant international shipments of the Company's VoiceServer 3110 product
accounted for the large increase.
Gross margin as a percentage of net sales increased to 61.4% in the 1996
period as compared to 59.0% for the same period in 1995. System margins were up
slightly from 48.9% in the 1995 period to 58.1% in the third quarter of 1996 and
system upgrades, enhancements and service margins were up from 60.3% in the
third quarter of 1995 compared to 66.3% in the comparable period in 1996.
System upgrades and enhancements and services were 89.0% of total sales in the
third quarter of 1995 and 39.7% in the comparable period in 1996. International
revenue accounted for 43.5% in the third quarter of 1996 compared to 2.9% for
the same period in 1995.
Selling, general and administrative expenses increased $0.5 million in the
third quarter of 1996 as compared to the third quarter of 1995, reflecting an
increase in spending for marketing programs. As a result of the higher volume
in net sales, selling, general and administrative expenses were lower as a
percentage of sales (51.7%) in 1996 as compared to the 1995 period (67.6%).
Engineering and development expenses increased $0.5 million in the third
quarter of 1996 as compared to the third quarter of 1995. For the 1996 period,
engineering and development expenses reflect the Company's strategy of continued
investment in new product development and product enhancements. As a result of
the higher volume in net sales, engineering and development expenses were lower
as a percentage of sales in 1996 (36.1%) as compared to the 1995 period (44.6%).
There was no provision for income taxes in the third quarter of 1996 due to
the loss from operations, nor was a tax benefit recorded because it was fully
offset by a valuation allowance resulting in no net benefit. There was no
provision for income taxes in the third quarter of 1995 due to the loss from
operations.
As a result of the above, the Company's net loss for the nine months ended
September 30, 1996 was $1.4 million as compared to a net loss of $1.8 million
for the comparable period last year.
Nine Months Ended September 30, 1996 Compared to Nine Months Ended September 30,
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1995
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Net sales decreased 12.3% from $18.4 million in 1995 to $16.2 million in
1996, as the Company continued to focus on those sales opportunities that were
aligned with the corporate long-term strategy for both domestic and
international markets. Compared to 1995, sales into the VIS market decreased by
$0.9 million and sales into the CPE market decreased by $1.3 million. Combined
sales of the VoiceServer 1110, VoiceServer 2110 and VoiceServer 3110 increased
from those of the prior period by $1.3 million while sales of system upgrades
and enhancements and services decreased $3.5 million.
Gross margin as a percentage of net sales increased to 63.7% in the 1996
period as compared to 62.3% for the same period in 1995. System margins were
down from 52.6% in the 1995 period to 48.3% in 1996 and system upgrades,
enhancements and service margins were up from 66.1% in 1995 compared to 73.9% in
the comparable period in 1996. System upgrades and enhancements and services
were 72.0% of total sales in 1995 and 60.3% in the comparable period in 1996.
International revenue accounted for 24.6% of total sales in the 1996 period as
compared to 2% in 1995.
Selling, general and administrative expenses increased $1.0 million in 1996
as compared to the 1995 period, reflecting an increase in spending for marketing
programs in line with the Company's strategy. As a result of the increased
spending, selling, general and administrative expenses were higher as a
percentage of sales (60.2%) in 1996 as compared to the 1995 period (47.4%).
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Engineering and development expenses increased $1.5 million in 1996 as
compared to the 1995 period. For the 1996 period, engineering and development
expenses reflect the Company's strategy of continued investment in new product
development and product enhancements. As a result of the increase in spending,
engineering and development expenses were higher as a percentage of sales in
1996 (42.1%) as compared to the 1995 period (28.9%).
There was no provision for income taxes in the third quarter of 1996 due to
the loss from operations, nor was a tax benefit recorded because it was fully
offset by a valuation allowance resulting in no net benefit. There was no
provision for income taxes in the third quarter of 1995 due to the loss from
operations.
As a result of the above, the Company's net loss for the nine months ended
September 30, 1996 was $5.4 million as compared to a net loss of $1.5 million
for the comparable period last year.
Factors That May Affect Future Results
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Various paragraphs of this Item 2 (Management's Discussion and Analysis of
Financial Condition and Results of Operations) contain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Actual results could differ materially from those projected in the forward-
looking statements as a result of the factors set forth below and elsewhere in
this document.
Digital Sound operates in a rapidly changing environment that involves a number
of risks, some of which are beyond the Company's control. The following
discussion highlights some of these risks.
The voice processing and messaging industry is highly competitive, with rapid
technological advances and constantly improving price/performance. As the
markets in which the Company operates continue to grow, the Company is
experiencing an increase in competition, and it expects this trend to continue.
The Company is one of the smaller providers of voice processing and messaging
equipment in the industry. Many of the Company's competitors have substantially
greater technical, marketing and financial resources and, in some markets, a
larger installed base of customers and a wider range of available applications
software.
The voice processing and messaging industry has experienced a continuing
evolution of product offerings and alternatives for delivery of services. These
trends have affected and may be expected to have a significant continuing
influence on conditions in the industry, although the impact on the industry
generally and on the Company's position in the industry cannot be predicted with
assurance. The Company and the industry are in general heavily dependent on the
domestic telephone companies for a large percentage of revenue. The suppliers
to the telephone company market, which is primarily comprised of 7 regional Bell
operating companies and GTE, has largely been decided for first generation voice
processing requirements. While the Company continues to pursue opportunities,
any incumbency will be difficult to displace.
The market for voice processing and messaging systems is in a period of
transition. Budgetary constraints, uncertainties resulting from the
introduction of new technologies in the telecommunications environment and
changes in the government regulations have increased uncertainties in the
market. Significant changes in the industry as a result of the 1995
Telecommunications act make planning decisions more difficult and increase the
risk inherent in the planning process.
The Company's operating results may fluctuate for a number of reasons. The
Company has short delivery cycles and as a result does not have a large order
backlog, which makes the forecasting of revenue inherently uncertain. This
uncertainty is compounded because each quarter's revenue results predominantly
from orders booked and shipped during the third month of the quarter. Because
the Company plans its operating expenses, many of which are relatively fixed in
the short term, on the basis of its anticipated revenues even a relatively small
revenue shortfall may cause a period's results to be substantially below
expectations. Such a revenue shortfall could arise from any number of factors,
including lower than expected demand, supply constraints, delays in the
availability of new products, overall economic conditions or natural disasters.
The International portion of the Company's business, which represented 24.6% of
revenues for nine months ending September 1996, is subject to a number of
inherent risks, including difficulties in building and managing international
operations and international reseller networks, international service and
support of the Company's products, difficulties or delays in translating
products into foreign languages, fluctuations in the value of foreign
currencies, import/export duties and quotas, and unexpected regulatory, economic
or political changes in international markets. Due to the competitive
environment in the international marketplace, certain international customers
may require longer payment terms; as a result, days sales outstanding may
periodically extend beyond ninety days on amounts due from these customers.
-8-
The development of new technologies and products is increasingly complex and
uncertain, which increases the risk of delays. The introduction of new systems
requires close collaboration and continued technological advancement involving
multiple hardware and software design and manufacturing teams within the Company
as well as teams at outside suppliers of key components. The failure of any one
of these elements could cause the Company's new products to fail to meet
specifications or to miss the aggressive timetables that the Company
establishes. In 1996 the Company is concentrating on, among other things,
Unified Messaging. The initiative relates to the marketing of InfoMail Express
2.0 commonly known as unified or mixed media messaging. This product was
announced in Spring of 1995 and went to market trial during the 3/rd/ quarter of
1996. The Company believes that the market reception for this product will be
positive, but the market reception for new products is inherently uncertain. As
the variety and complexity of the Company's product families increase, the
process of planning production and inventory levels also becomes more difficult.
The Company believes that its production capacity should be sufficient to
support anticipated unit volumes for the foreseeable future. The Company is
primarily engaged in final assembly and test of the hardware equipment. The
Company currently buys the majority of its subassembly inventory from a single
supplier. The failure of this supplier to provide such subassemblies on a
timely basis and within specifications could have a materially adverse effect on
the Company's business. If the Company is unable to obtain certain key
components, or to effectively forecast customer demand or manage its inventory,
increased inventory obsolescence or reduced utilization of production capacity
could adversely impact the Company's gross margins and results of operations.
The Company has historically derived a significant portion of its revenue and
operating profit from a relatively small number of customers. In 1995, the
Company derived 47% of its revenue from a single customer. International
proposals for large system installations typically involve a lengthy and complex
bidding and selection process, and the ability of the Company to obtain a
particular proposal award is inherently difficult to predict. The Company
believes that the opportunities for these installations will continue to grow
and intends to continue to expand its research and development, manufacturing,
sales and marketing and product support capabilities in anticipation of such
growth. However, the timing and scope of these opportunities and the pricing
and margins associated with any eventual proposal award are difficult to
forecast, and may vary substantially from transaction to transaction. The
Company's future operating results may accordingly exhibit a higher degree of
volatility than the operating results of other companies in its industry that
have adopted different strategies. Although the Company is actively pursuing a
number of opportunities in the United States and internationally, both the
timing of any eventual opportunities and the probability of the Company's
receipts of significant purchase orders are uncertain. The degree of dependence
by the Company on large orders, and the investment required to enable the
Company to perform such orders, without assurance of continuing order flow from
the same customers and predictability of gross margins on any future orders,
increase the risk associated with its business.
The Company's stock price, like that of other technology companies, is subject
to significant volatility. If revenues or earnings in any quarter fail to meet
the investment community's expectations, there could be an immediate impact on
the Company's stock price. The stock price may also be affected by broader
market trends unrelated to the Company's performance.
The Company routinely receives communications from third parties asserting
patent or other rights covering the Company's products and technologies. Based
upon the Company's evaluation, it may take no action or it may seek to obtain a
license. In any given case there is a risk that a license will not be available
with terms that the Company considers reasonable, or that litigation will ensue.
The Company expects that, as the number of hardware and software patents issued
continues to increase, and as the Company's business grows, the volume of these
third party communications will also increase.
The Company's corporate headquarters facility, at which the majority of its
research and development activities are conducted, is located near major
earthquake faults which have experienced earthquakes in the past. While the
Company does carry insurance at levels management believes to be prudent, in the
event of a major earthquake or other disaster affecting one or more of the
Company's facilities, it is likely that insurance proceeds would not cover all
of the costs incurred and, therefore, the operations and operating results of
the Company could be adversely affected.
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Due to the factors noted above and elsewhere in management's discussion and
analysis of financial condition and results of operations, the Company's future
earnings and Common Stock price may be subject to significant volatility,
particularly on a quarterly basis. Past financial performance should not be
considered a reliable indicator of future performance and investors should not
use historical trends to anticipate results or trends in future periods. Any
shortfall in revenue or earnings from the levels anticipated by securities
analysts could have an immediate and significant adverse effect on the trading
price of the Company's Common Stock in any given period. Additionally, the
Company may not learn of such shortfalls until late in a fiscal quarter, which
could result in an even more immediate and adverse effect on the trading price
of the Company's Common Stock. Finally, the Company participates in a highly
dynamic industry which often results in volatility of the Company's Common Stock
price.
Liquidity and Capital Resources
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For the nine months ended September 30, 1996, working capital decreased
$3.0 million to $22.1 million as compared to December 31, 1995. The level of
working capital reflects a decrease in cash of $4.7 million which is a use of
gross cash of $6.1 million, offset by a reclassification of $1.4 million in cash
equivalents from other assets to current assets, an increase in receivables of
$2.8 million due to sales and shipments late in the quarter plus a decrease in
inventory of $0.8 million. Current liabilities reflected a decrease in accounts
payable of $0.8 million and a increase in other current accrued liabilities of
$1.0 million.
At September 30, 1996, the Company had cash of $18.8 million and no debt.
During the nine-month period, net cash used by operations was $4.5 million, net
of $0.9 million of interest earned on cash balances. Capital expenditures for
the nine-month period were $0.3 million. The Company believes that current cash
balances will be sufficient to meet its working capital requirements for the
next 12 months.
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PART II - OTHER INFORMATION
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DIGITAL SOUND CORPORATION
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Item 1. Legal Proceedings
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As reported in Note 10 to the Company's financial statements included in
the Company's 1995 Annual Report to Shareholders and incorporated by reference
in the Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1995, the Company is involved in patent litigation with Theis Research, Inc.
No material developments have occurred in 1996.
Item 2. Exhibits and Reports on Form 8-K
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(a) Exhibits
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10.44 Lease Agreement by and between the Registrant and Bluffs
Group III dated October 1, 1996
27 Financial Data Schedule-Article 5
(b) Reports on Form 8-K
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No reports on Form 8-K have been filed during the quarter for
which this report is filed.
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SIGNATURES
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on November 11, 1996.
DIGITAL SOUND CORPORATION
By /s/ Mark C. Ozur
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Mark C. Ozur
President, Chief Executive Officer
By /s/ B. Robert Suh
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B. Robert Suh
Vice President, Finance and
Chief Financial Officer
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