FORM 10-Q
---------
UNITED STATES
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 March 31, 1997
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
---------------------------------------------------------
(Exact name of Registrant as specified in its charter)
California 95-3222624
- ------------------------------- ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6307 Carpinteria Avenue, Carpinteria, California 93013
- ----------------------------------------------------------------------------
(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code (805) 566-2000
-------------------------
Not Applicable
- ----------------------------------------------------------------------------
(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
----- ------
The number of shares outstanding of Registrant's common stock as of
April 28, 1997 was 20,228,915.
DIGITAL SOUND CORPORATION
-------------------------
TABLE OF CONTENTS
-----------------
Page Number
-----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Balance Sheets as of March 31, 1997
and December 31, 1996 3
Statements of Operations for the
Three Months ended March 31, 1997
and March 31, 1996 4
Statements of Cash Flows for the
Three Months ended March 31, 1997
and March 31, 1996 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 9
Item 2. Exhibits and Reports on Form 8-K 9
2
PART I - FINANCIAL INFORMATION
------------------------------
DIGITAL SOUND CORPORATION
-------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
(In thousands, except share data)
March 31, December 31,
1997 1996
--------- ------------
(Unaudited)
ASSETS
- ------
Current assets:
Cash and equivalents $ 12,472 $ 18,187
Accounts receivable, less allowance for
doubtful accounts of $581 and $600 at March
31, 1997 and December 31, 1996, respectively. 6,238 5,695
Inventories 3,383 3,470
Other current assets 327 299
-------- --------
Total current assets 22,420 27,651
Property and equipment, at cost:
Computers and other equipment 12,472 11,077
Furniture and fixtures 984 982
Leasehold improvements 1,124 1,130
-------- --------
14,580 13,189
Less accumulated depreciation and amortization (10,742) (10,733)
-------- --------
3,838 2,456
Other assets
Investment securities 1,000 -
Other assets 3,033 3,226
-------- --------
Total other assets 4,033 3,226
-------- --------
$ 30,291 $ 33,333
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable $ 4,439 $ 3,639
Accrued payroll and related 2,213 1,986
Other accrued liabilities 2,233 1,681
-------- --------
Total current liabilities 8,885 7,306
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value, 15,000,000 shares
authorized, 2,631,579 issued and outstanding at
March 31, 1997 and December 31, 1996 respectively 5,000 5,000
Common stock, no par value, 50,000,000 shares
authorized; 20,228,915 and 20,224,540 shares issued
and outstanding at March 31, 1997 and
December 31, 1996 respectively 68,982 68,975
Accumulated deficit (52,576) (47,948)
-------- --------
Total shareholders' equity 21,406 26,027
-------- --------
$ 30,291 $ 33,333
======== ========
See accompanying notes
3
DIGITAL SOUND CORPORATION
--------------------------
STATEMENT OF OPERATIONS
-----------------------
(In thousands, except per share data)
Three Months Ended
-----------------------------------------
March 31, March 31,
1997 1996
--------- ---------
(Unaudited)
Net sales $ 3,359 $ 4,769
Cost of sales 1,915 1,890
-------- --------
Gross margin 1,444 2,879
Selling, general and administrative 3,899 3,049
Engineering and development 2,323 2,070
-------- --------
6,222 5,119
-------- --------
Income (loss) from operations (4,778) (2,240)
Interest and other income 150 344
-------- --------
Income (loss) before provision for income taxes (4,628) (1,896)
Provision for income taxes: - -
Net income (loss) $ (4,628) $ (1,896)
======== ========
Net income (loss) per common and common
equivalent share $ (.23) $ (.09)
======== ========
Weighted average common and common
equivalent shares outstanding 20,227 20,008
======== ========
See accompanying notes
4
DIGITAL SOUND CORPORATION
-------------------------
STATEMENT OF CASH FLOWS
-----------------------
(In thousands)
Three Months Ended
-----------------------------------------
March 31, March 31,
1997 1996
--------- ---------
(Unaudited)
Cash flows from operating activities
Net income $ (4,628) $ (1,896)
Adjustments to reconcile net income to
net cash provided (used) by operations:
Depreciation and amortization 171 199
Changes in operating assets and liabilities:
Accounts receivable (543) (682)
Inventories 88 (221)
Other current assets (28) 102
Investment securities (1,000) 0
Other assets 30 1,700
Accounts payable 800 (648)
Accrued payroll and related 227 4
Other accrued liabilities 552 196
--------- ---------
Net cash provided (used) by
operations (4,331) (1,246)
--------- ---------
Cash flows from investing activities:
(Additions to) disposition of
property and equipment (1,391) (52)
--------- ---------
Cash flows from financing activities:
Net proceeds from issuance of common stock 7 12
--------- ---------
Net increase (decrease) in cash and equivalents (5,715) (1,286)
Cash and equivalents at beginning of period 18,187 23,503
--------- ---------
Cash and equivalents at end of period $ 12,472 $ 22,217
========= =========
See accompanying notes
5
DIGITAL SOUND CORPORATION
-------------------------
NOTES TO FINANCIAL STATEMENTS
-----------------------------
March 31, 1997
--------------
(Unaudited)
NOTE 1. General
- -----------------
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 the current interim period are not
necessarily indicative of results to be expected for the current year.
Principles of consolidation 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.
Short term investments The Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS 115"). The Company adopted the
provisions of SFAS 115 for investments held as of December 31, 1995. The
adoption had no effect on the financial statements. Short term investments
(principally commercial paper and discount notes with maturity dates generally
within 90 days and considered cash equivalents) are classified as "held to
maturity" based on the Company's positive intent and ability to hold the
securities until maturity. The securities are presented at amortized cost which
approximates fair value. Amortization and interest on securities classified as
"held to maturity" is included in investment income.
Cash, cash equivalents and pledged cash The Company considers as cash
equivalents only those investments that are short-term, highly liquid, readily
convertible to cash, and so near their maturity that they present insignificant
risk of changes in value because of changes in interest rates. The Company
classifies as cash equivalents only those investments with maturities of three
months or less. The Company pledged $1.0 million to facilitate a construction
loan for the landlord to build new office space in its existing building. The
Company anticipates these pledged funds to become available for general use in
the second quarter of 1997.
Operating Lease Agreements. Effective January 1997, the Company entered
into master lease agreements with BancBoston Leasing Inc and Mellon US Leasing.
The purpose of the lease agreements is to provide sale/lease-back financing
for capital acquisitions for 1997. The lease agreements are for up to a combined
$4.0 million in equipment purchases and the term of the lease is for 4 years.
The lease agreements requires a cash collateral equal to the limit of the credit
line which will be pledged in a certificate of deposit account in $1.0 million
increments as required.
These financial statements should be read in conjunction with the financial
statements and the notes thereto included in the Company's Form 10-K for the
fiscal year ended December 31, 1996, as filed with the Securities and Exchange
Commission.
6
NOTE 2. Inventories
- --------------------
Inventories are stated at the lower of standard cost (which approximates
the first-in, first-out method) or market:
March 31, December 31,
1997 1996
---------- ------------
(Unaudited)
Raw materials and purchased parts $ 1,614 $ 1,528
Work in process 1,645 1,815
Finished goods 124 127
--------- ---------
$ 3,383 $ 3,470
--------- ---------
NOTE 3. Per Share Information
- ------------------------------
Earnings (loss) per common and common equivalent share is 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
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
Results of Operations
- ---------------------
Three Months Ended March 31, 1997 Compared to Three Months Ended March 31, 1996
- -------------------------------------------------------------------------------
Net sales decreased 29.6% from $4.8 million in 1996 to $3.4 million in
1997. Compared to the first quarter of 1996, sales into the VIS market
decreased by $1.1 million and sales into the CPE market decreased by $0.3
million. Combined sales of the VoiceServer 1110, VoiceServer 2110 and
VoiceServer 3110 decreased from those of the prior period by $0.3 million while
sales of system upgrades and enhancements and services decreased $1.1 million.
Gross margin as a percentage of net sales decreased to 42.9% in the 1997
period as compared to 60.4% for the same period in 1996. System margins were
down from 65.3% in the 1996 period to 41.6% in the first quarter of 1997 and
system upgrades, enhancements and service margins were down from 58.5% in the
first quarter of 1996 to 43.3% in the comparable period in 1997. Margins were
affected by additional costs incurred due to a large international system
installation and lower than planned manufacturing volume. System upgrades and
enhancements and services were 78.0% of total sales in the first quarter of 1996
and 77.0% in the comparable period in 1997.
Selling, general and administrative expenses increased from $3.0 million in
1996 to $3.9 million in 1997 as the Company invested in upgrading its personnel
and capabilities primarily in Sales and Marketing. As a result of the increased
investment and the lower volume in net sales, selling, general and
administrative expenses were higher as a percentage of sales (116.0%) in 1997 as
compared to 1996 (64.0%).
Engineering and development expenses increased from $2.1 million in 1996
to $2.3 million in 1997. For 1997, 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 for engineering
development in 1997 and the lower volume in net sales, engineering and
development expenses were higher as a percentage of sales in 1997 (69.0%) as
compared to 1996 (43.4%).
There was no provision for income taxes in the first quarter of 1997 due to
the loss from operations. There was no provision for income taxes in the first
quarter of 1996 due to the loss from operations.
7
As a result of the above, the Company's net loss for the three months ended
March 31, 1997 was $4.6 million as compared to a net loss of $1.9 million for
the comparable period last year.
Factors That May Affect Future Results
- --------------------------------------
Digital Sound operates in a rapidly changing environment that involves a number
of risks, some of which are beyond the Company's control. These risks are
discussed in the Company's 1996 Annual Report To Shareholders and incorporated
by reference in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31,1996.
Liquidity and Capital Resources
- -------------------------------
For the three months ended March 31, 1997, net working capital was $13.5
million compared to $20.3 million at December 31, 1996. The level of net working
capital resulted principally from a reduction in cash of $4.7 million, a
reclassification of $1.0 million from current assets to investment securities
pledged in connection with the lease agreement with BancBoston Leasing, an
increase in accounts receivable of $0.5 million, an increase in accounts payable
of $0.8 million and an increase in accrued payroll and other accrued liabilities
of $0.8 million. The decrease in cash reflects the level of the Company's sales
combined with the Company's continued commitment to investment in certain
strategic long-term initiatives focusing on the development of new products, the
enhancement of existing products and the strengthening of the Company' marketing
and sales capabilities. The Company's goal is for these initiatives to begin
showing concrete results by no later than the end of 1997. The level of sales
achieved by the Company during the first quarter of 1997 and before has been
insufficient to provide the Company with net cash from operations, and the
Company does not expect to generate net cash from operations in 1997.
At March 31, 1997, the Company had cash and investments of $13.5 million
and no long term debt. During 1997, net cash used by operations was $4.3
million, which was offset by $0.2 million of interest earned on cash balances.
Through March 31, 1997 capital expenditures were $1.4 million. Most of the
capital expenditures are identified as qualifying for the sale/lease-back
agreements described earlier in Note 1 to the financial statements under the
heading "Operating Lease Agreements." The Company has never paid any cash
dividends on its stock and anticipates that, for the foreseeable future, it will
continue to retain any earnings for use in the operation of its business.
8
PART II - OTHER INFORMATION
----------------------------
DIGITAL SOUND CORPORATION
-------------------------
Item 1. Legal Proceedings
-----------------
As reported in Note 10 to the Company's financial statements included in
the Company's 1996 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, 1996, the Company is involved in patent litigation with Theis Research, Inc.
There were no material developments in this litigation during the quarter ended
March 31, 1997.
Item 2. Exhibits and Reports on Form 8-K
--------------------------------
a) Exhibits
--------
10.45 - Lease Agreement by and between the Registrant and BancBoston
Leasing, Inc. dated January 8, 1997.
b) Reports on Form 8-K
-------------------
No reports on Form 8-K have been filed during the quarter for which
this report is filed.
9
SIGNATURES
----------
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 May 9, 1997.
DIGITAL SOUND CORPORATION
By /s/ Mark C. Ozur
---------------------------------------
Mark C. Ozur
President, Chief Executive Officer
By /s/ B. Robert Suh
---------------------------------------
B. Robert Suh
Vice President, Chief Financial Officer
10