1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 Quarter Ended September 30, 1997 Commission File No. 0-10385 VOICE CONTROL SYSTEMS, INC. (Name of small business issuer in its charter) DELAWARE 75-1707970 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 14140 MIDWAY ROAD DALLAS, TEXAS 75244 (972) 726-1200 (Address of principal executive (Registrant's telephone offices) number, including area code) ----------------------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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. X Yes No ---- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 11,298,959 SHARES of Common Stock, $.01 par value outstanding at September 30, 1997. 2 VOICE CONTROL SYSTEMS, INC. FORM 10-QSB QUARTERLY REPORT PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS 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 S.E.C. rules and regulations although the Company believes the disclosures made are adequate to make the information presented not misleading, and in the opinion of management, all adjustments have been reflected which are necessary for a fair statement of the information shown. 2 3 VOICE CONTROL SYSTEMS, INC. BALANCE SHEET (UNAUDITED) =================================================================================================================== ASSETS Sept 30, 1997 -------------- CURRENT ASSETS: Cash and cash equivalents $ 13,848,343 Accounts receivable (net of $130,000 allowance for doubtful accounts) (Note 7) 3,033,828 Inventory 492,673 Prepaid expenses 178,927 -------------- TOTAL CURRENT ASSETS 17,553,771 NET PROPERTY AND EQUIPMENT 1,367,864 OTHER ASSETS 155,023 -------------- $ 19,076,658 ============== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT: Accounts payable and accrued expenses (Note 5) $ 1,016,106 Deferred revenue 705,570 TOTAL CURRENT LIABILITIES 1,721,676 -------------- LONG TERM DEBT -- -------------- TOTAL LIABILITIES 1,721,676 -------------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Preferred stock; $1.00 par value; 300,000 shares authorized; none issued and outstanding -- Common stock, $.01 par value: 20,000,000 shares authorized; 11,298,959 issued and outstanding 112,990 Paid-in capital 37,318,505 Receivable from shareholders (70,010) Deficit (20,006,503) -------------- TOTAL STOCKHOLDERS' EQUITY 17,354,982 -------------- $ 19,076,658 ============== See accompanying notes to financial statements 3 4 VOICE CONTROL SYSTEMS, INC. STATEMENTS OF OPERATIONS (UNAUDITED) =================================================================================================================== Three Months Nine Months Ended Sept 30, Ended Sept 30, 1997 1996 1997 1996 ------------ -------------- ------------ -------------- SALES (NOTE 7) $ 2,021,095 4,078,731 10,285,977 10,866,277 COST OF SALES 450,197 764,126 2,146,296 2,216,511 ------------ ------------ ------------ -------------- GROSS PROFIT 1,570,898 3,314,605 8,139,681 8,649,766 COSTS AND EXPENSES: Research and development 1,323,401 1,559,806 3,918,516 4,856,662 Selling, general and administrative 1,737,193 1,684,254 5,230,499 4,814,886 Other interest expense (Income), net (189,045) (198,405) (570,703) (467,275) Interest, to affiliates 0 30,016 0 89,645 ------------ ------------ ------------ -------------- TOTAL COSTS AND EXPENSES 2,871,549 3,075,671 8,578,312 9,293,918 ------------ ------------ ------------ -------------- NET INCOME (LOSS) BEFORE TAXES (1,300,651) 238,934 (438,631) (644,152) INCOME TAXES (NOTE 6) 0 0 10,750 0 ------------ ------------ ------------ -------------- NET INCOME (LOSS) $ (1,300,651) $ 238,934 $ (449,381) $ (644,152) ============ ============ ============ ============== NET INCOME PER SHARE: Primary $ (0.10) $ 0.02 $ (0.04) $ (0.06) ============ ============ ============ ============== Fully diluted $ (0.10) $ 0.02 $ (0.04) $ (0.06) ============ ============ ============ ============== WEIGHTED AVERAGE OUTSTANDING SHARES: Primary 12,641,141 11,464,948 12,720,217 11,148,234 ============ ============ ============ ============== Fully diluted 12,641,141 11,464,948 12,720,217 11,144,980 ============ ============ ============ ============== See accompanying notes to financial statements 4 5 VOICE CONTROL SYSTEMS, INC. STATEMENTS OF CASH FLOWS (UNAUDITED) ========================================================================================= Nine months Ended Sept 30, ---------------------------- 1997 1996 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (449,381) $ (644,152) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 379,942 335,970 Changes in operating assets and liabilities: Accounts receivable (526,065) (1,854,798) Inventory (39,995) 159,654 Prepaid expenses (83,725) 1,031 Other assets (103,161) (56,582) Accounts payable and accrued expenses 35,688 529,088 Deferred revenue (720,193) 39,788 ------------ ------------ Net cash used in operating activities (1,506,890) (1,490,001) ------------ ------------ NET CASH USED IN INVESTING ACTIVITIES: CAPITAL EXPENDITURES (277,665) (489,017) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of principal on notes payable -- (1,982) Proceeds from note receivable 48,745 35,627 Proceeds from note payable -- 500,000 Net proceeds from common stock issuance (Note 4) -- 13,446,261 Proceeds from exercise of stock options 357,329 1,268,813 ------------ ------------ Net cash provided by financing activities 406,074 15,248,719 ------------ ------------ Net increase (decrease) in cash and cash equivalents (1,378,481) 13,269,701 Cash and cash equivalents at beginning of year 15,226,824 2,556,717 ------------ ------------ Cash and cash equivalents at September 30 $ 13,848,343 $ 15,826,418 ============ ============ Supplemental disclosures of cash flow information Interest paid $ 302 $ 89,645 Conversion of debt and interest by an affiliate to 1,300,694 shares of stock 1,195,078 -- See accompanying notes to financial statements 5 6 VOICE CONTROL SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS (UNAUDITED) ================================================================================ 1. BUSINESS Voice Control Systems, Inc. (the "Company" or "VCS") engages in the design of voice recognition systems that allow for the voice control of electronic machines and/or devices. Operating results for the nine months ending September 30, 1997 are not necessarily indicative of the expected results for the year. The unaudited financial statements include all adjustments, consisting primarily of normal recurring accruals, which management considers necessary for a fair presentation of such information. 2. BUSINESS ACQUISITION The Company and Voice Processing Corporation ("VPC") entered into an Agreement and Plan of Merger, approved on October 29, 1996 by each Company's stockholders of record, pursuant to which VPC was merged into the Company. Effective November 4, 1996, all of VPC's common stock was converted into and exchanged for 0.87091 shares of VCS common stock in a transaction accounted for using the pooling-of-interest method of accounting. In addition, all options and warrants to purchase VPC shares were exchanged for options and warrants to purchase VCS shares at the 0.87091 exchange rate. The stock conversion referred to above has been retroactively reflected in the financial statements for all periods presented. Separate results of operation for the periods prior to the merger with VPC are provided below. NINE MONTHS ENDED SEPT 30, 1996 REVENUES: VCS 6,448,786 VPC 4,417,491 ---------- COMBINED 10,866,277 NET INCOME (LOSS): VCS 694,945 VPC (1,339,097) ---------- COMBINED ( 644,152) 6 7 VOICE CONTROL SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS (UNAUDITED) ================================================================================ 3. PER SHARE INFORMATION Earnings per common and common equivalent share are computed based upon the weighted average number of outstanding shares of common stock and common stock equivalents. 4. STOCK OFFERING On February 14, 1996, the Company completed the sale of 1,269,402 shares of common stock. In March 1996, the underwriters exercised their overallotment option for an additional 220,500 shares of common stock. Net proceeds to the Company from the stock offering and from stock options excerised in conjunction with the offering totaled $14,432,000. 5. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consist of the following at September 30, 1997: Accounts payable $ 436,033 Accrued expenses 580,073 ----------- $ 1,016,106 =========== 6. INCOME TAXES The combined net operating loss (NOL) carryforwards of the merged Company expire from 1997 to 2011 and total approximately $24,256,000 as of September 30, 1997. The Company has provided an allowance against its entire deferred tax asset relating primarily to NOL carryforwards of approximately $8,247,000. In connection with the acquisition of VCS Industries, Inc., effective as of August 11, 1994, the Company had an ownership change as defined by Internal Revenue Code Section 382 (IRC 382). The effect of such change limited the use of the Company's NOL in future years to approximately $1,355,000 annually. In connection with the merger with VPC, VPC had an ownership change as defined by IRC 382. The effect of such change limits the use of VPC's NOL in future years to approximately $850,000 annually. On a combined basis, the NOL of the Company is limited in its use against future earnings, if any, to approximately $2,205,000 annually. The Company has provided an allowance for its entire deferred tax asset as its realization is dependent upon future generation of taxable income, which is not assured. Until such realization can be reasonably determined based on established sources of earnings sufficient to utilize the NOL carryforward, management will continue to provide an allowance for the entire deferred tax asset. 7 8 The following reconciles income tax expense at the federal statutory rate to the actual tax expense for the nine months ended September 30: 1997 1996 --------------- --------------- Income taxes at the statutory rate $ - $ - State taxes based on income - - Effect on taxes resulting from: Utilization of NOL carry forwards - - Federal Alternative Minimum Taxes 10,750 - -------------- ---------------- $ 10,750 $ - ============== =============== 7. MAJOR CUSTOMERS Three customers accounted for 29%, 15% and 10% of total sales revenue for the nine months ended September 30, 1997. Two customers accounted for 22% and 12% of total sales revenue for the nine months ended September 30, 1996. The Company's largest customer was also the holder of its short-term convertible debt. The promissory note and accrued interest was converted to 1,300,694 shares of common stock on January 1, 1997. Accounts receivable from the three largest customers were 8%, 12% and 14% of the total receivable balance at September 30, 1997. 8. NEW ACCOUNTING PRONOUNCEMENT On March 3, 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". This statement simplifies the standards for computing and presenting earnings per share ("EPS") and makes them comparable to international EPS standards. SFAS 128 replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures. While early adoption is not permitted, disclosure of the effect of the adoption of the standard is required. If SFAS 128 was applied to the nine months ended September 30, 1997 and 1996, the earnings per share would be as follows: Nine Months Ended September 30, 1997 1996 -------- -------- Basic earnings per common share $ (.04) $ (.06) Diluted earnings per common share $ (.04) $ (.06) 8 9 PART I - FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS Nine Months Ended September 30, 1997 vs. September 30, 1996 Sales decreased 5% from $10,866,000 during the nine months ending September 30, 1996 to $10,286,000 during the nine months ending September 30, 1997. Three customers, Dialogic Corporation, Glenayre and OKI Telecom, Inc., accounted for 29%, 15% and 10%, respectively, of total sales for the nine months ending September 30, 1997. Dialogic Corporation and Periphonics Corporation accounted for 22% and 12%, respectively, of total sales for the nine months ending September 30, 1996. Royalty, development and license fees, which decreased 1% over the nine months ending September 30, 1996, were 32% of total revenues for the nine months ending September 30, 1997. Hardware sales, which decreased 8% over the nine months ending September 30, 1996, were 63% of revenues in the nine months ending September 30, 1997. Cost of sales includes the cost of components and subcontracted manufacturing related to hardware products. Gross profit as a percent of sales was flat at 79% for the nine months ending September 30, 1996 and 1997. Research and development expenses decreased 19% from $4,857,000 for the nine months ending September 30, 1996 to $3,918,000 for the nine months ending September 30, 1997. This decrease reflects cost reductions as a result of the merger with VPC. Selling, general, and administrative expenses increased 9% from $4,815,000 for the nine months ending September 30, 1996 to $5,231,000 for the nine months ending September 30, 1997. The increase is due to the introduction of the new Ready Receptionist product and additions to the selling and marketing areas to support the growing customer base. 9 10 The combined net operating loss ("NOL") carryforwards of the merged Company expire from 1997 to 2011 and total approximately $24,256,000 as of September 30, 1997. The Company has provided an allowance against its entire deferred tax asset relating primarily to NOL carry- forwards of approximately $8,247,000. Effective August 11, 1994, the Company had an ownership change as defined by the Internal Revenue Code Section 382 (IRC 382). The effect of the change limited the use of the Company's NOL in future years to approximately $1,355,000 annually. In connection with the merger with VPC, VPC had an ownership change as defined by IRC 382. The effect of such change limits the use of VPC's NOL in future years to $850,000 annually. On a combined basis, the NOL of the Company is limited in its use against future earnings, if any, to approximately $2,205,000 annually. Federal income taxes and state franchise taxes based on income have been offset by net operating loss carryforwards thus far in 1997. The Company has incurred a tax based on the federal alternative minimum tax of $10,750 for the nine months ended September 30, 1997. Three Months Ended September 30, 1997 vs. September 30, 1996 Sales decreased 50% from $4,079,000 during the three months ending September 30, 1996 to $2,021,000 during the three months ending September 30, 1997. Three customers, OKI Teclecom, Inc., Glenayre, and Dialogic Corporation, accounted for 24% and 18%, and 14% respectively, of total sales for the three months ending September 30, 1997. Dialogic Corporation, Periphonics Corporation and Natural Micro Systems Corp. accounted for 17%, 16% and 15%, respectively, of total sales for the three months ending September 30, 1996. Royalty, development and license fees, which decreased 38% over the three months ending September 30, 1996, were 38% of total revenues for the three months ending September 30, 1997. Hardware sales, which decreased 52% over the three months ending September 30, 1996, were 56% of revenues for the three months ending September 30, 1997. The sales decrease was due to a significant decrease in sales of older generation speech recognition hardware products. The decrease in hardware sales has not yet been replaced by volume deployments of customer applications using VCS software designed for open architecture platforms. Cost of sales includes the cost of components and subcontracted manufacturing related to hardware products. Gross profit as a percent of sales decreased from 81% for the three months ending September 30, 1996 to 78% for the comparable 1997 period as a result of product mix. Research and development expenses decreased 15% from $1,560,000 for the three months ending September 30, 1996 to $1,323,000 for the three months ending September 30, 1997. This decrease reflects cost reductions as a result of the merger with VPC. Selling, general, and administrative expenses increased 6% from $1,684,000 for the three months ending September 30, 1996 to $1,737,000 for the three months ending September 30, 1997. The increase is due to the introduction of the new Ready Receptionist product. 10 11 LIQUIDITY AND CAPITAL RESOURCES The Company's principal cash requirements to date have been to fund working capital and capital expenditures in order to support its sales growth. Net working capital at September 30, 1997 was $15,653,000. In the past, the Company's working capital needs were financed primarily through cash flow from operations and proceeds from the exercise of warrants and stock options. A stock offering was completed during the first quarter of 1996 that provided net proceeds of $13,446,000 to the Company. At September 30, 1997, the Company held $13,848,000 in cash and cash equivalents. Cash and cash equivalents are invested in institutional cash investment accounts with preservation of capital being the primary consideration. All investments currently have overnight liquidity. Historically, the Company's primary source of liquidity has been the timely collection of its accounts receivable. The average day's sales in accounts receivable was 80 days as of September 30, 1997. The Company's inventory as of September 30, 1997 was $493,000 of which non-telecom products were approximately 48% of the inventory. The Company maintained no debt obligations as of September 30, 1997. The Company's capital expenditures were $278,000 for the nine months ended September 30, 1997. The expenditures were primarily for computer equipment. VCS believes that its existing sources of liquidity, funds generated by operations and the funds received from the stock offering will be sufficient to provide the capital resources necessary to support increased operating needs and finance continued growth in the foreseeable future. 11 12 PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27 - Financial Data Schedule (b) Reports on Form 8-K No reports on Form 8-K were filed by the Company during the quarter covered by this report. 12 13 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. VOICE CONTROL SYSTEMS, INC. Dated: November 13, 1997 By: /s/ Peter J. Foster ------------------------------------- Peter J. Foster Chief Executive Officer and President /s/ Kim S. Terry ------------------------------------- Kim S. Terry Principal Financial and Accounting Officer 13 14 Exhibit Index Exhibit Number Description - ------- ----------- 27 Financial Data Schedule