-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, N13AV/qBnO2Jq4AYie7cXQMC4YktYQM7KQx96H1P6UhH+I1MF2HX91TFXpGThf2m mazRf11psO9OCFy49Q5wtA== 0000891618-98-002282.txt : 19980513 0000891618-98-002282.hdr.sgml : 19980513 ACCESSION NUMBER: 0000891618-98-002282 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980329 FILED AS OF DATE: 19980512 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: AUREAL SEMICONDUCTOR INC CENTRAL INDEX KEY: 0000892433 STANDARD INDUSTRIAL CLASSIFICATION: PRINTED CIRCUIT BOARDS [3672] IRS NUMBER: 943117385 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-22626 FILM NUMBER: 98616429 BUSINESS ADDRESS: STREET 1: 4245 TECHNOLOGY DR CITY: FREMONT STATE: CA ZIP: 94538-6339 BUSINESS PHONE: 5102524245 MAIL ADDRESS: STREET 1: 4245 TECHNOLOGY DR CITY: FREMONT STATE: CA ZIP: 94538-6339 FORMER COMPANY: FORMER CONFORMED NAME: MEDIA VISION TECHNOLOGY INC DATE OF NAME CHANGE: 19931210 10-Q 1 FORM 10-Q FOR QUARTERLY PERIOD ENDED 03/29/98 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. FOR THE QUARTERLY PERIOD ENDED MARCH 29, 1998 Commission File Number 0-20684 AUREAL SEMICONDUCTOR INC. (Exact name of registrant as specified in its charter) DELAWARE 94-3117385 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 4245 TECHNOLOGY DRIVE FREMONT, CA 94538 (Address of principal executive offices) Telephone: (510) 252-4245 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 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 whether the registrant has filed all documents required to be filed by Section 12, 13 or 15 (d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes X No --- --- At April 30, 1998, 42,137,414 shares of common stock, $0.001 par value, of the registrant were outstanding. This report on Form 10-Q contains 16 pages. The exhibit index is on page 16. 2 AUREAL SEMICONDUCTOR INC. FORM 10-Q Table of Contents
Page PART I. FINANCIAL INFORMATION Item 1. Financial Statements...................................................... 3 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................... 10 PART II. OTHER INFORMATION Item 1. Legal Proceedings......................................................... 15 Item 5. Other Information......................................................... 15 Item 6. Exhibits and Reports on Form 8-K.......................................... 15
2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS AUREAL SEMICONDUCTOR INC. INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) The Interim Condensed Consolidated Financial Statements of Aureal Semiconductor Inc. (the "Company") have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principals have been omitted pursuant to such rules and regulations. The disclosures included in the Interim Condensed Consolidated Financial Statements should be read in conjunction with the Company's audited financial statements at December 28, 1997 and the notes thereto included in the Company's 1997 Annual Report on Form 10-K. The preparation of financial statements in conformity with generally accepted accounting principles and pursuant to the rules and regulations of the Securities and Exchange Commission requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Interim Condensed Consolidated Financial Statements reflect, in the opinion of management, all adjustments (which include only normal recurring adjustments) necessary for a fair presentation of financial position, results of operations and cash flows for such periods. The results of operations for the fiscal quarter ended March 29, 1998 are not necessarily indicative of the results that may be expected for any subsequent quarter or the entire fiscal year ending December 27, 1998. 3 4 AUREAL SEMICONDUCTOR INC. CONDENSED CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
March 29, December 28, 1998 1997 --------- --------- (Unaudited) ASSETS: Current assets: Cash and cash equivalents $ 105 $ 135 Restricted cash 113 109 Accounts receivable 2,636 21 Inventories 5,745 511 Deferred fair value of debt related warrants 3,000 3,000 Prepaid loan fees and other current assets 611 462 --------- --------- Total current assets 12,210 4,238 Property and equipment: Machinery and equipment 3,185 3,785 Furniture, fixtures and improvements 608 599 --------- --------- 3,793 4,384 Accumulated depreciation and amortization (1,923) (3,170) --------- --------- Net property and equipment 1,870 1,214 Long-term portion of fair value of debt related warrants, other assets 68 898 --------- --------- Total assets $ 14,148 $ 6,350 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT): Current liabilities: Accounts payable $ 7,705 $ 1,523 Accrued compensation and benefits 985 1,115 Other accrued liabilities 1,675 1,365 Current portion of pre-petition claims 873 880 --------- --------- Total current liabilities 11,238 4,883 Line of Credit 25,000 21,975 Long-term portion of pre-petition claims and deferred obligations 2,804 3,641 --------- --------- Total liabilities 39,042 30,499 --------- --------- Stockholders' equity (deficit): Preferred Stock, $0.001 par value: Authorized shares - 5,000,000; Issued and outstanding shares - 500 in 1998 and none in 1997 -- -- Additional paid-in capital 4,592 -- Common stock, $0.001 par value: Authorized shares - 100,000,000; Issued and outstanding shares - 42,082,938 in 1998 and 41,850,205 in 1997 42 42 Additional paid-in capital 114,501 114,352 Accumulated deficit (144,029) (138,543) --------- --------- Total stockholders' equity (deficit) (24,894) (24,149) --------- --------- Total liabilities and stockholders' equity (deficit) $ 14,148 $ 6,350 ========= =========
See accompanying notes. 4 5 AUREAL SEMICONDUCTOR INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Quarter Ended ------------------------ March 29, March 30, 1998 1997 -------- -------- (Unaudited) Net sales $ 3,582 $ 427 Cost of sales 2,793 20 -------- -------- Gross Margin 789 407 Operating expenses: Research and Development 2,618 1,438 Sales and Marketing 1,356 778 General and Administrative 860 584 Amortization of Reorganization Asset -- 625 -------- -------- Total operating expenses 4,834 3,425 -------- -------- Operating loss (4,045) (3,018) Amortization of debt related warrants (750) -- Interest expense (1,031) (519) Other income (expense), net 340 53 -------- -------- Loss from operations before income taxes (5,486) (3,484) Provision for income taxes -- -- -------- -------- Net loss $ (5,486) $ (3,484) ======== ======== Net loss per share: basic and diluted $ (0.13) $ (0.09) -------- -------- Weighted average common shares outstanding: basic and diluted 41,969 39,304 ======== ========
See accompanying notes. 5 6 AUREAL SEMICONDUCTOR INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
Quarter Ended ------------------------- March 29, March 30, 1998 1997 --------- --------- (Unaudited) OPERATING ACTIVITIES Net loss from operations $(5,486) $(3,484) Adjustments to reconcile net loss from operations to net cash used in operating activities: Depreciation and amortization 1,022 801 Changes in operating assets and liabilities: Restricted cash (4) (100) Accounts receivable (2,615) (88) Inventories (5,234) (121) Prepaid expenses and other current assets (149) 108 Other assets (15) -- Accounts payable 6,182 (125) Accrued compensation and benefits, and other accrued liabilities 183 (224) ------- ------- Net cash used in operating activities (6,116) (3,233) ------- ------- INVESTING ACTIVITIES Acquisition of property and equipment (832) (129) ------- ------- Net cash used in investing activities (832) (129) ------- ------- FINANCING ACTIVITIES Proceeds from Line of Credit 7,225 3,535 Repayment on Line of Credit (4,200) (100) Principal payments on pre-petition claims (844) (261) Proceeds from issuance of preferred stock, net of issuance costs 4,592 -- Proceeds from issuance of common stock, net of issuance costs 145 178 ------- ------- Net cash provided by financing activities 6,918 3,352 ------- ------- Net decrease in cash and cash equivalents (30) (10) Cash and cash equivalents at beginning of period 135 18 ------- ------- Cash and cash equivalents at end of period $ 105 $ 8 ======= ======= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid $ 749 $ 383
See accompanying notes. 6 7 AUREAL SEMICONDUCTOR INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. THE COMPANY AND RECENT EVENTS Aureal Semiconductor Inc., together with its subsidiaries Crystal River Engineering, Inc., and Aureal Semiconductor Limited (combined, the "Company") specialize in the design and marketing of audio semiconductor technologies for use in both the PC and consumer electronics markets. Crystal River Engineering, Inc. ("CRE"), founded in 1987 and acquired by Aureal in the second quarter of 1996, has been a pioneer in the development of 3D audio technologies. Aureal Semiconductor Limited, located in Hong Kong, was established in March of 1998 as a sales, technical support and field engineering office. The Company's business involves not only the development and sale of audio processing semiconductor chips, but the licensing of technology which is designed to define and develop advanced audio standards in the marketplace. The Company's stock symbol on the OTC Bulletin Board is AURL. On April 28, 1998 the Company announced the introduction of A3D 2.0, a significant enhancement to the current version of A3D which was originally introduced in September 1996. A3D 2.0 is backward compatible with A3D, which is expected to be incorporated into over 100 new PC game titles and is included on PC sound cards and brand name computer systems. This new generation of A3D includes Aureal Wavetracing Technology (which enables real-time acoustic reflections, reverb and occlusion rendering), more 3D sources, a higher sample rate and larger Head-Related Transfer Function (HRTF) filters. Together, all of these feature enhancements provide for improved three-dimensional rendering of audio for interactive applications. In March 1998, Aureal was granted another patent for advanced three-dimensional audio technology. Specifically, the patent was for a method and apparatus for measuring HRTF's. This patent further strengthens the Company's intellectual property position in the area of advanced 3D audio technology. Aureal's patent portfolio is now 18 issued U.S. patents with 35 additional patent applications on file in the field of audio. Also in March, the Company completed the sale of $5 million of Aureal's Series A Preferred Stock. The shares of preferred stock include conversion rights to the Company's common stock at either a $2.50 fixed conversion rate or a variable conversion pricing dependent upon the underlying price of the common stock over the three-year term. During the quarter, key design wins for the Vortex AU8820 were announced, including Dell Computer Corporation, Turtle Beach Systems, Aztech Systems Ltd. and TerraTec Electronic GmbH. These design wins, along with others, enabled the Company to begin shipping the AU8820 chip in volume during the first quarter of 1998. In addition to the potential for revenue generation, the design wins are important in that these customers will promote the Company's A3D technology. This may lead to design wins for additional product lines for these customers, as well as new customers. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The Interim Condensed Consolidated Financial Statements of Aureal Semiconductor Inc. have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations. The disclosures included in the Interim Condensed Consolidated Financial Statements should be read in conjunction with the Company's audited financial statements at December 28, 1997 and the notes thereto included in the Company's 1997 Annual Report on Form 10-K. The Interim Condensed Consolidated Financial Statements reflect, in the opinion of management, all adjustments (which include only normal recurring adjustments) necessary for a fair presentation of financial position, results of operations and cash flows for such periods. The results of operations for the fiscal quarter ended March 29, 1998 is not necessarily indicative of the results that may be expected for any subsequent quarter or the entire fiscal year ending December 27, 1998. 7 8 Inventories Inventories are stated at the lower-of-cost-or-market value on a weighted-average costing method. The Company does not consider any inventory to be raw material, since the Company's point of purchase is for fabricated silicon wafers. Net inventories at March 29, 1998 and December 28, 1997 consist of the following, in thousands:
March 1998 Dec. 1997 ---------- --------- Work-In-Process . . . . . . . . . . . . . . . . . $4,877 $ 243 Finished Goods . . . . . . . . . . . . . . . . . . 868 268 ------ ------ Total Inventories . . . . . . . . . . . . . $5,745 $ 511 ====== ======
Property and Equipment Property and equipment are stated at cost and depreciated utilizing the straight-line method over their estimated useful lives (one and one-half to five years). Fixed assets with approximately $1.4 million in gross value and zero net book value were retired during the quarter as they were determined to no longer be in use. Revenue Recognition The Company's major sources of revenue consist of sales of proprietary design, advanced audio semiconductor chips, and licensing of related audio technologies. Revenue was recognized upon shipment for product sales. Licensing revenues are recognized upon delivery of licensed product, and upon reported sales of licensed units for royalties unless it is necessary to defer recognition as a result of continuing obligations. Concentration of Financial Instrument Risks and Credit Risks Financial instruments which potentially subject the Company to concentration of market risk consist primarily of the Company's line of credit. Concentration of market risk on the line of credit is related to changes in the prime lending rate, as the majority of the Company's debt bears interest rates which fluctuate with changes in the prime lending rate. Credit risk for the Company consists primarily of the trade receivables. Most of the trade receivables are the result of sales to foreign companies. Concentration of credit risk is limited by the use of bank letters of credit for many of these international customers. Additionally, the Company has established an allowance for doubtful accounts based on the credit risk of specific customers. Valuation of Warrants In 1997, the Company recorded the estimated fair value for the warrants issued in association with both the amendment to the line of credit ("Debt Warrants"), and the sale of common stock ("Equity Warrants"). The fair values of the Debt Warrants and the Equity Warrants were estimated to be $5.0 million and $1.5 million respectively. Amortization of the $5.0 million asset, as additional interest expense over the life of the loan, commenced in August 1997 at the rate of $0.75 million per quarter. Loss Per Share The Financial Accounting Standards Board has issued SFAS No. 128, which is effective for financial statements for periods ending after December 15, 1997. SFAS No. 128 requires that the calculation for basic EPS exclude the dilutive effect of common stock equivalents in the calculation for basic net income (loss) per share. Diluted EPS under SFAS No. 128, is calculated using the weighted average number of common and common stock equivalent shares outstanding during the period. Common equivalent shares are computed using the treasury stock method for outstanding warrants and stock options. Common equivalent shares are excluded from the diluted EPS computation only if their effect is anti-dilutive. No common stock equivalents were included in the calculations for any fiscal period presented as, due to the net loss position, any affect would be anti-dilutive. 8 9 In 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income," which was adopted by the Company in the first quarter of 1998. SFAS No. 130 requires companies to report a new, additional measure of income. The Company adopted SFAS No. 130 in the current period; however, the Company has no material items of other comprehensive income in any period presented. Amortization of Intangibles At December 31, 1994, the reorganization value of the Company in excess of its net assets generated a $44.1 million intangible value that was classified as a reorganization asset in the consolidated balance sheet of the Company ("Reorganization Asset"). The value of the Reorganization Asset was reduced in the second quarter of 1995 as the Company exited the retail products business. The net remaining Reorganization Asset was fully amortized as of December 28, 1997. In conjunction with the acquisition of (CRE) made during the second quarter of 1996, the allocation of the purchase price included an intangible asset of $150,000. Amortization over the estimated useful life of eighteen months commenced in mid-1996. As a result of further asset value allocations, the intangible asset was reduced by $61,000 during 1996. As of December 28, 1997, the intangible asset was fully depreciated. 3. LINE OF CREDIT The Company maintains a line of credit managed by TCW Special Credits, an affiliate of the TCW Group, Inc. ("TCW"). The maturity date (originally March 1, 1995) and the total availability under the line (ranging from $10 million to $31.5 million to date) have been negotiated periodically with TCW. In conjunction with the private placement of equity, finalized in August 1997, the line of credit was increased from $20.0 million to $31.5 million, and the maturity date was extended to March 31, 1999. In addition, the Company has an option to extend the due date an additional year, to March 31, 2000. Borrowings under the facility are secured by substantially all the assets of the Company and bear interest at the rate of prime (8.50% at March 29, 1998) plus five percent. At April 30, 1998, $30.4 million was outstanding under the line. In May 1998, subsequent to the quarterly results shown, the Company secured a $5 million increase to the total availability under the existing line of credit. The line of credit lenders include entities affiliated with TCW Special Credits and DDJ Capital Management LLC. As of April 30, 1998 these entities controlled approximately 42% and 16% of the Company's equity securities, respectively. 4. EQUITY FUNDING In March 1998, the Company completed the sale of $5 million of the Company's Series A Preferred Stock. The shares of the preferred stock include conversion rights to Aureal common stock at either a $2.50 fixed conversion rate or a variable conversion pricing dependent upon the underlying price of the common stock over the three-year term. The proceeds were used to pay down a portion of the outstanding balance on the Company's line of credit. 5. INCOME TAXES The Company was not required to provide for income taxes in the first quarter of 1998 or 1997 due to its net operating losses. No tax benefit has been recorded for the losses due to the uncertainty as to the realizability. At December 28, 1997, the Company had available net operating loss carryforwards ("NOL's") of approximately $285 million to reduce future taxable income. The NOL's expire on various dates through 2012. In connection with the adoption of fresh start accounting, any tax benefit resulting from the use of the NOL's generated prior to the bankruptcy plan confirmation in 1994 will be applied as a direct addition to stockholders' equity. 9 10 ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS INCLUDED ELSEWHERE HEREIN AND THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 28, 1997, CONTAINED IN FORM 10-K FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. FORWARD-LOOKING STATEMENTS IN THIS REPORT ARE MADE PURSUANT TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. INVESTORS ARE CAUTIONED THAT SUCH FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, INCLUDING, BUT NOT LIMITED TO, DEPENDENCE ON THE PC AND CONSUMER ELECTRONICS INDUSTRIES AND ON PRODUCT LINES BASED ON NEW TECHNOLOGIES; FOUNDRY CAPACITY, AVAILABILITY AND RELIABILITY; COMPETITION AND PRICING PRESSURES, AVAILABILITY OF ADEQUATE FINANCIAL RESOURCES, AND OTHER RISKS DETAILED BELOW AND FROM TIME TO TIME IN THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION. OVERVIEW The Company's objective is to be a leading supplier of high quality, advanced audio solutions to both the consumer electronics and PC marketplaces. The Company utilizes a strategy which combines the development and sale of audio processing semiconductor chips, with the licensing of technology to strategic partners in order to define and develop advanced audio standards in the marketplace. For 1998 and the future, this strategy is expected to include the following elements: - - Create value in the Aureal logo - Aureal intends to establish an association in consumers' minds between the Aureal A3D brand and high-quality audio. - - Offer low-cost PC audio acceleration - Aureal's goal is to continue to sell and develop low-cost, high-feature audio accelerators for use in the PC marketplace. - - Provide integrated audio components to the consumer market - Aureal is developing devices targeted to the consumer electronics marketplace which provide lower system cost through integration of digital, analog and other audio system functions. - - Brand name used throughout all areas of digital audio - Aureal believes it has core competencies in all areas of digital audio; input, processing and output. Thus far in 1998 the Company has made significant strides towards achieving company growth as a result of some recent accomplishments. Aureal has secured key design wins or agreements for its A3D technologies, either as a semiconductor product or as a license to include A3D in the customer's product. In this quarter, the Company's products have begun to be included in name brand computer systems, retail sound cards and speaker components. Some of these customers have started to take delivery of significant volumes and, although there is no contractual commitment, are expected to continue to order the AU8820 in significant volumes for the remainder of the year. Aureal's A3D technology is also gaining wide acceptance from PC game developers, and is currently supported by major game developers such as Activision, Lucas Arts, Interplay, GT Interactive, Broderbund, Electronic Arts, Sierra On-Line and Ubi Soft. Many game developers, as well as the hardware manufacturers previously mentioned are helping Aureal promote its technologies and are including the Aureal logo on packaging and advertisements. In the second quarter, the Company has announced the next generation of the Company's A3D technology. Later this year, Aureal expects to introduce an additional semiconductor product based on the Vortex architecture, secure additional design wins and bring the Company's technology to the PC motherboard. These objectives are important for the long-term success of the Company, yet the accomplishment of any or all of these objectives may not impact the Company's financial results in 1998. 10 11 RESULTS OF OPERATIONS Net Sales Net sales for the first quarter of 1998 were $3.6 million, compared to $0.4 million for the first quarter of 1997. The majority of the revenues resulted from the sale of the Vortex AU8820 chip, a PCI-based AC'97 Digital Audio Processor produced for the PC market. Less than 10% of the revenues resulted from licensing transactions, royalties and the sale of the VSP901 chip. Revenues from the sale of the AU8820 chip are expected to be the largest single component of revenue during 1998. Most of the revenues were from sales to foreign customers. The two largest customers, both foreign, accounted for 47% and 16% of total revenues in the first quarter. Net revenues of $0.4 million for the first quarter of 1997 consisted primarily of revenues from licensing transactions. The Company has A3D audio technology license agreements in place with a number of companies, some of which are currently shipping products that include Aureal's A3D technology. Gross Margin Gross margin of $0.8 million for the first quarter of 1998 was 22% of net sales. This compares to $0.4 million, or 95% of net sales for the first quarter of 1997. The change in margin percentage is attributable to two factors. There was a significant shift in the mix of total revenues from very high margin (almost 100%) licensing transactions in the first quarter of 1997, to primarily sales of audio chips in the first quarter of 1998. Secondly, the 1998 gross margin reflected the lower yields, extensive testing and higher transportation costs and other costs incurred in association with the initial manufacturing cycles of the AU8820 chip. Research and Development Research and development expenditures for the quarter were $2.6 million, compared to $2.6 million in the previous quarter and $1.4 million in the first quarter of 1997. Although the expense levels were similar for the first quarter of 1998 and the fourth quarter of 1997, engineering staff and consulting costs were higher in 1998. Offsetting these increases in 1998 were lower expenses for maintenance of design tools and a significant portion of the Company's Manufacturing Operations Department expenses being charged to cost-of-sales. These operating costs were classified as engineering costs in 1997, but changed classification due to the transition of operations with the commencement of chip sales in the first quarter of 1998. The significant increase from the first quarter of 1997 to the first quarter of 1998 reflects the Company's commitment to the development of new technologies and new products. Increases in research and development costs are primarily attributable to increased staff levels. The Company expects to continue its emphasis on research and development, and thus dollar costs in the area are expected to increase in future periods. Sales and Marketing Sales and marketing expenses increased to $1.4 million for the quarter, from $1.1 million in the previous quarter and $0.8 million in the first quarter of 1997. The increase in 1998 over prior quarters was due primarily to two factors. First was an increase in employee and related costs from increased staff levels in both sales and marketing. The second factor in the increase consisted of costs directly associated with sales volume, including distributor commissions, which were insignificant in 1997. In addition, the Company opened a Hong Kong sales and customer support office in March 1998. Selling and marketing expenses are expected to generally rise over the long term as travel, promotion and marketing costs grow with Aureal's customer base, and sales commissions increase with higher sales volumes. General and Administrative General and administrative expenses for the quarter ended March 29, 1998 were $0.9 million, an increase from $0.6 million in both the previous quarter and the first quarter of the previous year. The increase was primarily due to increases in recruiting and other employee related costs. Aureal's employee base has increased approximately 50% from early 1997 to March 1998, which has necessitated increased efforts in administration of the Company. Cost control measures have been maintained and the Company will continue its efforts in this area. 11 12 Amortization of Reorganization Asset The Reorganization Asset originated pursuant to the Company's valuation upon its exit from bankruptcy protection on December 30, 1994 whereby the fair value of the Company exceeded its net assets by $44.1 million Operating expenses for the first quarter of 1997 were impacted by amortization of $625,000. As of December 28, 1997, the remaining Reorganization Asset value was completely amortized, so no such expenses were incurred in the first quarter of 1998. Amortization of Debt Related Warrants The fair value of the Debt Warrants was estimated to be $5.0 million. The value of the Debt Warrants is included in both current and long-term assets in the accompanying balance sheets. Amortization of the $5.0 million asset, as additional interest expense over the life of the loan, commenced in August 1997 at a rate of $0.75 million per quarter. Interest Expense Interest expense in both quarters presented consisted primarily of interest on the line of credit at the rate of prime plus 5%. Interest expense for the quarter ended March 29, 1998 totaled $1.0 million, compared to $0.5 million for the first quarter of 1997. The higher interest expense for 1998 is the result of a higher average outstanding balance on the line of credit. Other Income (expense) Other income for the first quarter of 1998 included various receipts and credits resulting from favorable resolutions to previously recorded liabilities. For the first quarter of 1997, other income and expenses were not significant. Income Taxes The Company was not required to provide income taxes in the first quarter of either 1998 or 1997 due to its net operating losses. No tax benefit has been recorded for the loss due to the uncertainty as to its realizability. LIQUIDITY AND CAPITAL RESOURCES As of March 29, 1998 the Company had working capital of $1.0 million and a shareholder's deficit of $24.9 million. This compares to a working capital deficit of $0.6 million and a shareholder's deficit of $24.1 million as of December 28, 1997. The net cash flow requirements for the Company have been running in excess of $2 million per month during the first quarter of 1998. The $6.1 million net cash used in operations for the quarter was approximately $2.9 million more than the same period in 1997. The primary factors for the increase in net cash used were an increase in inventories, an increase in account receivable and an increase in net loss from operations. Offsetting these to some extent was an increase to accounts payable. The increase in cash used was financed by borrowings from the Company's line of credit. The Company expects to increase the manufacturing of products (through outside foundries) and financing of customer receivables. Working capital to enable this growth is expected to be provided primarily from the Company's working capital line of credit. For a company just commencing sales, the timing and uncertain amount of inventory purchases and the collection of revenues make the forecasting of cash flows from operations inherently difficult. There is no assurance the Company will generate positive cash flows in the future. Capital expenditures of $832,000 during the first quarter of 1998 consisted primarily of hardware and software tools utilized in the Company's research and development activities. This compares to capital expenditures, for similar purposes, of $129,000 during the first quarter of 1997. Capital expenditures for the remainder of 1998 are anticipated to generally be higher than the corresponding quarters for 1997, but the amount may fluctuate significantly from quarter to quarter. 12 13 The terms of the line of credit, as amended in August 1997, provide for a maturity date of March 31, 1999. In addition, the Company has an option to extend the due date an additional year, to March 31, 2000. Borrowings under the line of credit are secured by substantially all assets of the Company, and bear interest at the rate of prime plus 5% per annum. The maturity date (originally March 1, 1995) and the total availability under the line (ranging from $10 million to $31.5 million to date) have been negotiated periodically with TCW. In early May 1998 the Company secured a $5 million increase to the $31.5 million line of credit, of which $1.1 million was available for borrowings as of April 30, 1998. The line of credit lenders include entities affiliated with TCW Special Credits and DDJ Capital Management LLC. As of April 30, 1998 these entities controlled approximately 42% and 16% of the Company's equity securities, respectively. In May 1998, subsequent to the quarterly results shown, the Company secured a $5 million increase to the total availability under the existing line of credit. The line of credit lenders include entities affiliated with TCW Special Credits and DDJ Capital Management LLC. The Company expects to complete additional financing transactions to continue to allow for the Company's growth or to expand its business. It has no commitments for any specific financing at this time and there can be no assurance that any such financing can be obtained at terms acceptable to the Company, or at all. RISK FACTORS In evaluating the Company's business, certain factors, including those discussed below and those included in documents previously filed with the Securities and Exchange Commission, should be considered in addition to the other information in this Form 10-Q. New Technologies and Products Developed With New Technologies The Company's success depends on its ability to develop and market new technologies aimed at advancing the level of audio quality in the PC and consumer electronics devices. With respect to the PC market, audio technology is shifting from utilization of the ISA bus to utilization of the more advanced PCI bus. This change enables advanced digital audio functionality including positional 3D audio, streaming audio and higher quality presentation. There can be no assurance that the shift from ISA-based audio to PCI-based audio will occur in a timeframe for the Company to benefit from its PCI-based products and technologies. As new technologies are developed, there can be no assurance that markets will develop for them, or that markets will develop on a timely basis for the Company to benefit therefrom. The success of new products depends on a number of factors, including timely completion of product development, market acceptance of the Company's and its customer's new products and the Company's ability to offer new products at competitive prices. Incorporating the Company's new products into its OEM customers' new product design requires the anticipation of market trends and performance and functionality requirements of OEM's and the production of products that can be available in a timely manner consistent with the OEM's development and production schedule. A failure in any of these areas could have a material adverse effect on the Company's results of operations. Each successive generation of microprocessors has provided increased performance, which could in the future result in a microprocessor capable of performing advanced audio functions to an extent that the need or preference for the Company's products could be diminished or eliminated. Conversely, each new generation of technology, including digital audio technology, generally requires increased processing power. At this time, a product with the processing power required to execute high quality audio, video and graphics simultaneously and all other functions which the host processor does has not been introduced. The Company believes that advanced audio processing, done in conjunction with either video or graphics processing is best performed with a separate accelerator chip in addition to the host processor. There can be no assurance that the increased capabilities of microprocessors will not adversely affect demand for the Company's products. Product Concentration Substantially all of the Company's revenues are related to advanced audio solutions for the PC and consumer electronics markets and the Company expects this to continue for the foreseeable future. The failure of this market to continue to grow, any reduction in demand as a result of increased competition in this market, technological change, failure by the Company to introduce new versions of products acceptable to the marketplace or other similar factors would have a material adverse effect on the Company's results of operations. 13 14 Competition and Pricing Pressures The semiconductor industry is extremely competitive, and is characterized by rapid technological change, evolving industry standards, changing market conditions and frequent new product introductions and enhancements. The introduction of products embodying new technologies or standards can render existing products or products under development obsolete or unmarketable. Many of the Company's competitors have more extensive engineering, manufacturing, marketing, financial and personnel resources than those of the Company. The Company expects competition to increase in the future from existing competitors and from other companies that may enter the markets with products that may be less costly or provide higher performance or additional features. In general, product prices in the semiconductor industry have decreased over the life of a particular product. As the markets for the Company's products mature and competition increases, the Company anticipates that prices for its products will generally decline over time. If the Company is unable to reduce its cost sufficiently to offset declines in product prices or is unable to introduce new, higher performance products with higher product prices, the Company's results of operations could be materially adversely affected. Need for Foundry Access The Company is a "fabless semiconductor firm" which depends on outside manufacturing resources for production of all of its semiconductor products. The foundries which the Company uses have indicated that they have the manufacturing availability to provide for the Company's planned production of each product through at least 1998; however the production relationships are based only upon purchase orders and planned production forecasts. No long term production contracts have been entered into by the Company, and there is no assurance that the foundries will continue to provide adequate manufacturing capacity to the Company, or maintain such capacity at acceptable costs. Dependence on Key Personnel The Company's success depends to a significant extent upon continued services of key engineering, marketing, sales and management personnel. The Company's employees may voluntarily terminate their employment with the Company at any time. The Company recognizes the value of the contributions of each of its employees and has developed compensation programs, including stock option plans for the granting of options to all employees, designed to retain its employees. Competition for such employees is intense and the loss of the services of such employees could have a material adverse effect on the Company's results of operations. Proprietary Rights and Related Litigation The Company's ability to compete successfully will depend, in part, on its ability to protect its proprietary technology. The Company relies on a combination of copyright and trade secret protection, nondisclosure agreements and licensing arrangements to establish and protect its proprietary rights. In addition, the Company has 18 patents issued and 35 patent applications pending in the United States and in foreign countries and intends to file additional applications as appropriate for patents covering its technologies and products. There can also be no assurance that any patents that may be issued to the Company will not be challenged, invalidated or circumvented, or that any rights granted thereunder would provide proprietary protection to the Company. In addition, the laws of certain foreign countries may not protect the Company's proprietary rights to the same extent as do the laws of the United States. Although the Company does not believe that its products infringe the proprietary rights of any third parties, there can be no assurance that infringement or invalidity claims (or claims for indemnification resulting from infringement claims) will not be asserted against the Company or that any such assertions will not materially adversely affect the Company's business, financial condition or results of operations (See Item 1 in Part II of this document). Irrespective of the validity or the successful assertion of such claims, the Company could incur significant cost with respect to the defense thereof which could have a material adverse effect on the Company's business, financial condition or results of operations. 14 15 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In March 1998, Aureal was served with a suit for patent infringement filed by Creative Technology Ltd., a Singapore corporation and its subsidiary, E-MU Systems, Inc., a California corporation. The suit alleges that Aureal's Vortex AU8820 AC'97 Digital Audio Processor infringes on a patent which describes a specific implementation for an electronic musical instrument designed by E-MU Systems, Inc. Aureal has reviewed the allegations in the complaint and believes that the action is without merit. In April 1998, the Company filed an answer and counterclaim against Creative Technology for, among other items, unfair trade practices and fraud. ITEM 5. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibit index at page 16. (b) Reports on Form 8-K: The Company filed a report on Form 8-K on March 16, 1998 with the Securities and Exchange Commission. The filing was to report the completion of a private placement transaction on March 11, 1998 for the sale of $5 million of the Company's three year 8% Series A Convertible Preferred Stock, par value $0.001 per share. The Preferred Stock is convertible at the lesser of the fixed conversion price ("Fixed Conversion Price") of $2.50 face value of the Preferred Stock per share of the Company's Common Stock, or at varying discounts from the then-current market price of the Common Stock if the Common Stock is trading at prices below $2.50 per share over certain periods of time ("Variable Conversion Price"). Conversion of the Preferred Stock can commence at a date four months after the final closing date (March 11, 1998). Variable Conversion Price conversions can be completed at the rate of 15% of the originally issued Preferred Stock per month. No such limitations apply to Fixed Conversion Price conversions. Accretion at the 8% rate on the outstanding Preferred Stock is terminated if at any time the Common Stock trades at a price in excess of 150% of the fixed conversion price for twenty consecutive trading days. At such time as accretion is terminated, if ever, all restrictions as to conversion are eliminated. If not converted earlier, all outstanding Preferred Stock will be converted on the three-year anniversary of the final closing. SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AUREAL SEMICONDUCTOR INC. Date: May 8, 1998 By: /s/Kenneth A. Kokinakis ------------------------------------ Kenneth A. Kokinakis President and Chief Executive Officer Date: May 8, 1998 By: /s/David J. Domeier ------------------------------------ David J. Domeier Vice President of Finance Chief Financial Officer 15 16 EXHIBIT INDEX
Exhibit No. Description of Document ----------- ----------------------- 2.1 Agreement and Plan of Reorganization among the Company, Aureal Acquisition Corporation, a wholly-owned subsidiary of the Company and Crystal River Engineering, Inc., dated as of May 7, 1996 (1) 2.2 Second Amended Joint Plan of Reorganization dated November 10, 1994 (4) 3.1 Second Amended and Restated Certificate of Incorporation of the Company dated May 8, 1996 (2) 3.2 Restated Bylaws of Aureal Semiconductor Inc. (6) 4.1 Common Stock Purchase Agreement by and among the Company and certain beneficial owners of 5% or more of the Company's Common Stock, as amended(3) 4.2 Common Stock Purchase Agreement by and among the Company and certain entities and individuals dated June 10, 1996 (5) 4.3 Common Stock Purchase Agreement by and among the Company and certain entities and individuals dated August 6, 1997 (8) 4.4 Preferred Stock Regulation D Subscription Agreement (10) 4.5 Certificate of Designation of Series A Preferred Stock of Aureal Semiconductor Inc. (10) 4.6 Preferred Stock Registration Rights Agreement (10) 10.1 Second Amended and Restated Loan Agreement between TCW Special Credits and the Company dated August 6, 1997 increasing the loan commitment from $20 million to $31.5 million. (9) 10.2 1995 Stock Option Plan (3) 10.3 Form of incentive option agreement and non-statutory stock option agreement used under 1995 Stock Option Plan (3) 10.4 1994 Stock Option Plan (4) 10.5 Form of incentive option agreement and non-statutory stock option agreement used under 1994 Stock Option Plan (4) 10.6 Industrial Space Sublease with Chemical Waste Management, Inc. dated September 13, 1995 (3) 10.7 Form of Indemnity Agreement for Directors and Officers (6) 10.8 1996 Outside Directors Stock Option Plan (7) 11.1 Computation of Earnings (Loss) Per Share (See Pages 5 and 9) 27.1 Financial Data Schedule (Edgar Only)
- ------------------ (1) Incorporated by reference to the exhibits filed with Form 8-K dated May 22, 1996. (2) Incorporated by reference to the exhibits filed with Form S-8 (Registration number 333-09531) filed August 2, 1996. (3) Incorporated by reference to the exhibits filed with Form 10-K for the year ended December 31, 1995. (4) Incorporated by reference to the exhibits filed with Form 10-K for the year ended December 31, 1994. (5) Incorporated by reference to the exhibits filed with Form S-3 (Registration number 333-3870) filed June 26, 1996. (6) Incorporated by reference to the exhibits filed with Form 10-Q for the quarter ended September 29, 1996. (7) Incorporated by reference to the exhibits filed with Form 10-K for the year ended December 29, 1996. (8) Incorporated by reference to the exhibits filed with Form S-3 (As Post-Effective Amendment No. 1, Registration number 333-3870) filed September 12, 1997. (9) Incorporated by reference to the exhibits filed with Form 10-Q for the quarter ended September 28, 1997. (10) Incorporated by reference to the exhibits filed with Form 8-K dated March 16, 1998. 16 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE FISCAL QUARTER ENDED MARCH 29, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-27-1998 DEC-29-1997 MAR-29-1998 218 0 2,647 11 5,745 12,210 3,793 1,923 14,148 11,238 0 0 0 42 (24,936) 14,148 3,582 3,582 2,793 2,793 4,834 0 1,781 (5,486) 0 (5,486) 0 0 0 (5,486) (0.13) (0.13)
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