================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(AMENDMENT NO.1)
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
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: 0-24248
AMERICAN TECHNOLOGY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 87-03261799
-------- -----------
(State or other jurisdiction of (I.R.S. Empl. Ident. No.)
incorporation or organization)
13114 Evening Creek Drive South, San Diego, California 92128
------------------------------------------------------ -----
(Address of principal executive offices) (Zip Code)
(858) 679-2114
(Registrant's telephone 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 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. [X] YES NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X].
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of August 8, 2003.
Common Stock, $0.00001 par value 18,845,292
-------------------------------- ----------
(Class) (Number of Shares)
Explanatory Note:
This quarterly report on Form 10-Q/A is being filed to reflect the restatement
of the Registrant's financial results for the three and nine month periods ended
June 30, 2003 (the "Restatement"). The Restatement primarily reflects an accrual
for an agreement in principle dated August 11, 2003 to settle litigation between
the Company and Horizon Sports Technologies, Inc. d/b/a HST. Based on SFAS No. 5
and EITF D-86, the Company has determined that because the liability was
incurred at June 30, 2003, and because prior to the issuance of the financial
statements for the quarter ended June 30, 2003 the Company entered into the
agreement in principle to settle the litigation, the Company should have accrued
an estimate of the liability as of June 30, 2003. Accordingly, the Company has
accrued $950,000 at June 30, 2003 as an estimate of the liability associated
with the litigation brought by HST.
As a result of the Restatement, the net loss available to common stockholders
increased from $2,061,097 and $6,612,339 for the three and nine months ended
June 30, 2003, respectively, to $3,011,097 and $7,562,339, respectively. The
loss per share of common stock increased from $0.13 and $0.44 for the three and
nine months ended June 30, 2003, respectively, to $0.19 and $0.51. Current
liabilities increased from $1,167,749 as of June 30, 2003 to $2,117,749. Further
information concerning the settlement agreement with HST is provided in Note 10
to the Financial Statements included herewith.
Except for (i) the Restatement and changes to Management's Discussion and
Analysis reflecting the Restatement, (ii) additional disclosure added to Note 10
to the Financial Statements concerning certain legal matters disclosed in Part
II, Item 1 of the original filing, (iii) certain updates concerning those legal
matters; and (iv) updates to the disclosure in Part I, Item 4 concerning
disclosure controls and procedures, this report does not attempt to update the
information included herein beyond the original filing date.
AMERICAN TECHNOLOGY CORPORATION
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Balance Sheets as of June 30, 2003 (unaudited)
and September 30, 2002 3
Statements of Operations for the three and nine months ended
June 30, 2003 and 2002 (unaudited) 4
Statements of Cash Flows for the nine months ended
June 30, 2003 and 2002 (unaudited) 5
Notes to Interim Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk 25
Item 4. Controls and Procedures 25
PART II. OTHER INFORMATION 25
Item 1. Legal Proceedings 25
Item 2. Changes in Securities and Use of Proceeds 26
Item 3. Defaults upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 27
SIGNATURES 28
American Technology Corporation
BALANCE SHEETS
(Unaudited)
Restated
June 30, September 30,
2003 2002
-----------------------------------------------------------------------------------------------------------
ASSETS
Current Assets:
Cash $ 1,109,293 $ 1,807,720
Trade accounts receivable, less allowance of
$19,451 and $20,191 for doubtful accounts 15,613 111,486
Inventories 356,324 136,881
Prepaid expenses and other 35,236 20,130
-----------------------------------------------------------------------------------------------------------
Total current assets 1,516,466 2,076,217
Equipment, net 131,987 363,448
Patents, net of accumulated amortization of $199,397 and $141,314 1,007,027 1,034,333
Purchased technology, net of accumulated amortization of $1,262,500
and $946,864 -- 315,636
-----------------------------------------------------------------------------------------------------------
Total assets $ 2,655,480 $ 3,789,634
-----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Accounts payable $ 283,498 $ 733,531
Accrued liabilities:
Accrued expense 950,000 --
Payroll and related 151,165 202,432
Deferred revenue 274,170 276,667
Warranty and other 112,301 59,632
Interest on notes 19,497 240,279
Capital lease short-term portion 8,963 8,963
8% Senior Secured Promissory Notes 318,155 --
-----------------------------------------------------------------------------------------------------------
Total current liabilities 2,117,749 1,521,504
Long-Term Liabilities:
12% Convertible Promissory Notes net of $0 and $345,000 debt discount -- 1,380,000
Related party 12% Convertible Promissory Notes,
net of $0 and $60,000 debt discount -- 240,000
8% Senior Secured Promissory Notes -- 1,500,000
Capital lease long-term portion 25,760 33,012
-----------------------------------------------------------------------------------------------------------
Total liabilities 2,143,509 4,674,516
-----------------------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' Equity
Series C Preferred stock 300,000 shares designated: 0 and 10,000
issued and outstanding respectively. Liquidation preference
of $0 and $230,510, respectively -- --
Series D Preferred stock 235,400 shares designated: 55,000 and 235,400
issued and outstanding, respectively. Liquidation preference
of $588,244 and $2,412,046, respectively 1 2
Series E Preferred stock 350,000 shares designated: 338,250 and 0
issued and outstanding, respectively. Liquidation preference
of $3,450,169 and $0, respectively 3 --
Common stock, $0.00001 par value; 50,000,000 shares authorized
16,796,614 and 14,351,476 shares issued and outstanding 168 144
Additional paid-in capital 34,620,446 27,255,016
Accumulated deficit (34,108,647) (28,140,044)
-----------------------------------------------------------------------------------------------------------
Total stockholders' equity 511,971 (884,882)
-----------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 2,655,480 $ 3,789,634
-----------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements.
3
American Technology Corporation
STATEMENTS OF OPERATIONS
(Unaudited)
For the three months ended For the nine months ended
June 30, June 30,
Restated Restated
2003 2002 2003 2002
-----------------------------------------------------------------------------------------------------------------------------
Revenues:
Product sales $ 274,718 $ 165,365 $ 808,296 $ 489,475
Related party sales -- 32,323 -- 32,323
Contract and license 38,894 38,003 166,557 169,947
-----------------------------------------------------------------------------------------------------------------------------
Total revenues 313,612 235,691 974,853 691,745
Cost of revenues 186,101 158,998 858,520 397,843
-----------------------------------------------------------------------------------------------------------------------------
Gross profit 127,511 76,693 116,333 293,902
-----------------------------------------------------------------------------------------------------------------------------
Operating expenses:
Selling, general and administrative 1,728,296 760,967 3,393,605 1,864,087
Research and development 714,376 1,002,980 2,023,095 2,883,977
-----------------------------------------------------------------------------------------------------------------------------
Total operating expenses 2,442,672 1,763,947 5,416,700 4,748,064
-----------------------------------------------------------------------------------------------------------------------------
Loss from operations (2,315,161) (1,687,254) (5,300,367) (4,454,162)
-----------------------------------------------------------------------------------------------------------------------------
Other income (expense):
Interest income 1,348 772 5,000 13,328
Interest expense (68,039) (465,584) (670,769) (1,395,058)
Other (800) -- (2,467) (800)
-----------------------------------------------------------------------------------------------------------------------------
Total other income (expense) (67,491) (464,812) (668,236) (1,382,530)
-----------------------------------------------------------------------------------------------------------------------------
Net loss $ (2,382,652) $ (2,152,066) $ (5,968,603) $ (5,836,692)
-----------------------------------------------------------------------------------------------------------------------------
Imputed dividends on convertible preferred stock 628,445 101,198 1,593,736 124,113
Net loss available to common stockholders $ (3,011,097) $ (2,253,264) $ (7,562,339) $ (5,960,805)
-----------------------------------------------------------------------------------------------------------------------------
Net loss per share of common stock - basic and diluted $ (0.19) $ (0.16) $ (0.51) $ (0.42)
-----------------------------------------------------------------------------------------------------------------------------
Average weighted number of common shares outstanding 15,447,015 14,291,087 14,902,786 14,147,027
-----------------------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements.
4
American Technology Corporation
STATEMENTS OF CASH FLOWS
(Unaudited)
For the nine months ended
June 30,
Restated
2003 2002
-------------------------------------------------------------------------------------------------------
Increase (Decrease) in Cash
Operating Activities:
Net loss $(5,968,603) $(5,836,692)
Adjustments to reconcile net loss to net cash
used in operations:
Depreciation and amortization 497,880 545,292
Allowance for doubtful accounts (1,140) --
Warranty reserves 63,568 --
Common stock issued for services and compensation 410,816 106,469
Write-down on patents 40,321 --
Options and warrants granted for services 179,995 272,539
Settlement on litigation 950,000 --
Amortization of debt discount 405,000 1,215,000
Changes in assets and liabilities:
Trade accounts receivable 97,013 (15,954)
Inventories (219,443) (4,591)
Prepaid expenses and other (15,106) 38,900
Accounts payable (333,033) 166,575
Accrued liabilities 124,587 195,883
-------------------------------------------------------------------------------------------------------
Net cash used in operating activities (3,768,145) (3,316,579)
-------------------------------------------------------------------------------------------------------
Investing Activities:
Purchase of equipment (9,700) (31,647)
Patent costs paid (71,098) (146,824)
-------------------------------------------------------------------------------------------------------
Net cash used in investing activities (80,798) (178,471)
-------------------------------------------------------------------------------------------------------
Financing Activities:
Payments on capital lease (7,252) --
Proceeds from senior secured promissory notes 500,000 --
Proceeds from issuance of convertible promissory notes -- 1,225,000
Proceeds from the issuance of preferred stock 2,432,500 2,354,000
Cash paid for offering costs (176,222) (78,750)
Proceeds from exercise of warrants 24,375 --
Proceeds from exercise of stock options 377,115 --
-------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 3,150,516 3,500,250
-------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash (698,427) 5,200
Cash, beginning of year 1,807,720 1,354,072
-------------------------------------------------------------------------------------------------------
Cash, end of year $ 1,109,293 $ 1,359,272
-------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash information:
Cash paid during the period for:
Interest $ 72,521 $ --
Supplemental disclosure of noncash investing and financing activities:
Increase in additional paid in capital for the beneficial conversion
feature of convertible debt $ -- $ 600,250
Issuance of stock warrants in connection with convertible debt $ -- $ 624,750
Common stock issued on conversion of Series B preferred stock $ -- $ 2,102,412
Common stock issued on conversion of Series C preferred stock $ 236,494 $ --
Common stock issued on conversion of Series D preferred stock $ 1,881,910 $ --
Common stock issued on conversion of Series E preferred stock $ 50,992 $ --
Common stock issued on repayment of 8% promissory note $ 681,845 $ --
Sale of equipment for accounts payable $ 117,000 $ --
Senior Notes converted to Series E Preferred Stock $ 1,000,000 $ --
Subordinated Notes and accrued interest paid in common stock $ 2,435,032 $ --
See accompanying notes to financial statements.
5
AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)
1. OPERATIONS
American Technology Corporation is engaged in design, development and
commercialization of sound, acoustic and other technologies. The Company's
primary focus is on marketing four proprietary sound reproduction technologies
and supplying components based on these technologies to customers.
2. STATEMENT PRESENTATION
The accompanying unaudited interim financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information. In the opinion of management, the
interim financial statements reflect all adjustments of a normal recurring
nature necessary for a fair presentation of the results for interim periods.
Operating results for the three and nine month periods are not necessarily
indicative of the results that may be expected for the year. The interim
financial statements and notes thereto should be read in conjunction with the
Company's audited financial statements and notes thereto for the year ended
September 30, 2002 included in the Company's annual report on Form 10-K.
The Company's financial statements are presented on a going concern basis, which
contemplates the realization of assets and the satisfaction of liabilities in
the normal course of business. The ability of the Company to continue as a going
concern is contingent upon it obtaining sufficient financing to sustain its
operations and its ability to ultimately generate profits and positive cash flow
from operations. The Company has funded its operations primarily through the
issuance of securities and debt financings. Other than cash of $1,109,293 the
Company had no other material unused sources of liquidity at June 30, 2003.
Subsequent to the quarter ended June 30, 2003, the Company obtained gross
proceeds of $10 million from the sale to institutional investors of 1,818,180
shares of common stock and warrants to purchase 454,547 shares of common stock.
Management believes that existing resources and this new financing will allow it
to meet cash requirements for the next twelve months.
Based on current plans and assumptions, management believes increased product
sales will provide additional operating funds during the next twelve months.
Management has significant flexibility to adjust the level of research and
development and selling and administrative expenses based on the availability of
resources.
Management expects to incur additional operating losses as a result of
expenditures for research and development and marketing costs for sound products
and technologies. The timing and amounts of these expenditures and the extent of
the Company's operating losses will depend on many factors, some of which are
beyond management's control. Management anticipates that the commercialization
of the Company's technologies may require increased operating costs, however
management cannot currently estimate the amounts of these costs.
3. NET LOSS PER SHARE
The Company applies Statement of Financial Accounting Standards ("SFAS") No.
128, "Earnings Per Share." SFAS No. 128 provides for the calculation of "Basic"
and "Diluted" earnings per share ("EPS"). Basic EPS includes no dilution and is
computed by dividing income available to common stockholders by the weighted
average number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution of securities that could share in the earnings of an
entity. The Company's net losses for the periods presented cause the inclusion
of potential common stock instruments outstanding to be antidilutive and,
therefore, in accordance with SFAS No. 128, the Company is not required to
present a diluted EPS. Convertible preferred stock, convertible promissory
notes, stock options and warrants convertible or exercisable into approximately
5,280,466 and 5,127,879 shares of common stock were outstanding at June 30, 2003
and 2002, respectively. These securities were not included in the computation of
diluted EPS because of the net losses but could potentially dilute EPS in future
periods.
The Series C Preferred Stock provided for an accretion in the conversion value
of 6% or $1.20 per share per annum. The Series D and Series E Preferred Stock
provides for an accretion in the conversion value of 6% or $0.60 per share per
annum. The accrued accretion increases the net loss available to common
stockholders. Net loss available to common stockholders is computed as follows:
6
AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)
Three months ended Nine months ended
June 30, June 30,
2003 2002 2003 2002
------------------------------------------------------------------------------------------------------------------------
Net Loss $(2,382,652) $(2,152,066) $(5,968,603) $(5,836,692)
Series D Preferred Stock imputed deemed dividends
based on discount at issuance (47,223) (40,385) (725,670) (40,385)
Imputed deemed dividends on warrants issued with
Series D Preferred Stock (100,350) (35,377) (215,111) (35,377)
Series E Preferred Stock imputed deemed dividends
based on discount at issuance (209,452) -- (270,597) --
Imputed deemed dividends on warrants issued with
Series E Preferred Stock (209,695) -- (226,951) --
Accretion on Series C, D and E Preferred
Stock at stated rate (61,725) (25,436) (155,407) (48,351)
------------------------------------------------------------------------------------------------------------------------
Net loss available to common stockholders $(3,011,097) $(2,253,264) $(7,562,339) $(5,960,805)
------------------------------------------------------------------------------------------------------------------------
4. RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 requires
the fair value of a liability for an asset retirement obligation to be
recognized in the period in which it is incurred if a reasonable estimate of
fair value can be made. The associated asset retirement costs are capitalized as
part of the carrying amount of the long-lived asset. SFAS No. 143 is effective
for the Company for the fiscal year ending September 30, 2003. The Company
adopted this statement effective October 1, 2002. The adoption of this statement
did not have a material impact on its financial statements.
In October 2001, FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lives Assets." SFAS 144 requires that those long-lived assets
be measured at the lower of carrying amount or fair value, less cost to sell,
whether reported in continuing operations or in discontinued operations.
Therefore, discontinued operations will no longer be measured at net realizable
value or include amounts for operating losses that have not yet occurred. SFAS
144 is effective for financial statements issued for fiscal years beginning
after December 15, 2001 and, generally, is to be applied prospectively. The
adoption of this statement did not have a material impact on its financial
statements.
In April 2002, FASB issued SFAS No. 145, Rescission of FASB No. 4, 44 and 64,
Amendment of FASB No.13, and Technical Corrections. SFAS rescinds FASB No. 4
Reporting Gains and Losses from Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements. This statement also rescinds SFAS No.44 Accounting
for Intangible Assets of Motor Carriers and amends SFAS No.13, Accounting for
Leases, to eliminate an inconsistency between the required accounting for
sale-leaseback transactions and the required accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. This Statement also amends other existing authoritative
pronouncements to make various technical corrections, clarify meanings, or
describe their applicability under changed conditions. This statement is
effective for fiscal years beginning after May 15, 2002. The adoption of this
statement did not have a material impact on its financial statements.
In June 2002, FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. SFAS No. 146 addresses accounting and reporting for
costs associated with exit or disposal activities and nullifies Emerging Issues
Task Force Issue No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (Including Certain
Costs Incurred in a Restructuring). SFAS No. 146 requires that a liability for a
cost associated with an exit or disposal activity be recognized and measured
initially at fair value when the liability is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after June 30,
2003, with early application encouraged. The Company does not expect the
adoption of this statement to have a material effect on its financial
statements.
In December 2002, FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure -- an Amendment of FASB Statement No.
123." This statement amends SFAS No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about
7
AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)
the method of accounting for stock-based employee compensation and the effect of
the method used on reported results. The Company adopted the disclosure
requirements effective October 1, 2002, in its financial statements.
In May 2003, FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150
provides guidance on how an entity classifies and measures certain financial
instruments with characteristics of both liabilities and equity. Many of these
instruments were previously classified as equity. This statement is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. The statement requires cumulative effect transition for
financial instruments existing at the adoption date. The Company does not expect
the adoption of this statement to have a material effect on its financial
statements.
In November 2002, FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 clarifies that a
guarantor is required to recognize, at the inception of a guarantee, a liability
for the fair value of the obligation undertaken in issuing the guarantee. The
initial recognition and initial measurement provisions of FIN 45 are applicable
on a prospective basis to guarantees issued or modified after December 31, 2002.
The disclosure requirements of FIN 45 are applicable for financial statements of
interim periods ending after December 15, 2002. The Company adopted the
disclosure requirements of FIN 45 in the 1st quarter of 2002 and has included
the new disclosure requirements in the Notes to the Financial Statements (see
Note 6).
5. INVENTORIES
Inventories are valued at the lower of cost or market. Cost is determined using
the first-in, first-out (FIFO) method. Inventories consist of the following:
June 30, 2003 September 30, 2002
-----------------------------------------------------------------------------
Finished goods $188,242 $78,361
Raw materials 188,082 78,520
Reserve for obsolete inventory (20,000) (20,000)
-----------------------------------------------------------------------------
$356,324 $136,881
-----------------------------------------------------------------------------
6. PRODUCT WARRANTY COST
At the time revenue is recognized, the Company provides for estimated cost of
product warranties as provided under contractual arrangements. Warranty
obligations are affected by product failure rates and service delivery costs
incurred in correcting a product failure. Should such failure rates or costs
differ from these estimates, accrued warranty costs would be adjusted in the
period that such events or costs become known.
Changes in the warranty reserves during the nine months ended June 30, 2003 were
as follows:
------------------------------------------------------------------------------
Balance at October 1, 2002 $ 6,313
Accruals for warranty during the nine months
ended June 30, 2003 63,568
------------------------------------------------------------------------------
Balance at June 30, 2003 $69,881
------------------------------------------------------------------------------
7. PURCHASED TECHNOLOGY
In April 2000, the Company acquired all rights to certain loudspeaker technology
owned by David Graebener ("Graebener"), Stephen M. Williams ("Williams") and
Hucon Limited, a Washington corporation ("Hucon"). The purchase price consisted
of $300,000 cash plus 200,000 shares of common stock. The 200,000 shares of
common stock were issued in June 2000 and were valued at $962,500. The Company
agreed to pay up to an additional 159,843 shares of common stock to Williams and
Graebener contingent upon the achievement of certain performance milestones
relating to gross revenues received by the Company from the purchased
technology. Contingent shares are recorded as compensation expense when earned.
During fiscal 2002, a total of 50,000 contingent shares were issued. In fiscal
2003, the Company issued the balance of 109,844 contingent shares and recorded
$410,816 in compensation expense. The Company agreed to employ Mr. Williams and
Mr. Graebener for a term of three years subject to certain terms and conditions.
The employment agreements terminated on February 15, 2003.
8
AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)
8. SENIOR SECURED AND CONVERTIBLE SUBORDINATED PROMISSORY NOTES
8% Senior Secured Promissory Notes
----------------------------------
On September 30, 2002, the Company issued to accredited investors 8% Senior
Secured Promissory Notes ("Senior Notes") for cash proceeds of $1,500,000. The
Senior Notes bear interest at a rate of eight percent (8%) per annum on the
principal outstanding until the earlier to occur of (i) December 31, 2003 or
(ii) when declared due and payable by the Holder upon the occurrence of an Event
of Default (the "Maturity Date"). Interest is payable on a quarterly basis with
the first payment due January 2, 2003. The Senior Notes are secured by accounts
receivable, certain equipment and inventory. The Senior Notes are convertible at
the option of the Company. In January 2003, the Company received an additional
$500,000 in cash proceeds from the issuance of a Senior Note to one accredited
investor. The terms of this note are the same as the 8% Senior Secured Notes
discussed above. In connection with the Series E Financing, the Company amended
its Senior Notes (i) to allow the holders of the Notes to convert all or a
portion of the principal balance of the Senior Notes into Series E Preferred
Stock and (ii) to extend the due date of the unconverted balance of the Senior
Notes from December 31, 2003 to December 31, 2004. On February 28, 2003, an
aggregate of $1,000,000 of Senior Note principal was converted into Series E
Preferred. All accrued but unpaid interest on the converted principal balances
plus a redemption premium of $13,333, equal to two months interest on the
converted principal balances, was paid in cash on the day of conversion. On June
27, 2003, $681,845 of Senior Note principal was applied to the exercise of
259,500 warrants leaving a remaining note balance of $318,155 at June 30, 2003.
Subsequent to June 30, 2003 the remaining balance of $318,155 plus interest was
redeemed for cash pursuant to the redemption terms of the Senior Notes.
12% Convertible Subordinated Promissory Notes
---------------------------------------------
In September and October 2001, the Company sold for cash in a private offering
an aggregate of $2,025,000 of unsecured 12% Convertible Subordinated Promissory
Notes ("Notes") to accredited investors and related parties. The Notes were
originally due December 31, 2002, but the maturity date was extended to December
31, 2003 by amendment dated November 19, 2002. The principal and interest amount
of each Note was convertible, at the election of the Note holder one or more
times into fully paid and nonassessable shares of common stock, at a price of
$2.00 per share. The Notes were callable by the Company for mandatory conversion
if the market price of the Company's common stock exceeded $5.00 per share for
five days and certain conditions were met. Each purchaser was granted a warrant
to purchase one common share of the Company at $2.00 per share until September
30, 2006 (the "Warrant") for each $2.00 of Notes (aggregate Warrants exercisable
into 1,012,500 shares).
On June 2, 2003, the Company exercised its right to call the Notes for mandatory
conversion into shares of common stock of the Company. The principal balance of
the Notes of $2,025,000 and accrued interest of $410,032 was converted on June
13, 2003 into 1,217,516 shares of common stock.
The Warrants have antidilution rights reducing the exercise price for certain
issuances of equity securities by the Company at an effective price below the
applicable exercise price. In connection with the Notes and Warrants, the
Company recorded a $2,025,000 discount to the notes to reflect the value of the
beneficial conversion feature of the Notes and the value of the Warrants. The
Warrants were valued using the Black-Scholes model with a dividend yield of zero
percent; expected volatility of 89 to 90 percent; risk free interest rate of 4
percent; and an expected life of five years. The value was reflected as a
discount to the debt. This debt discount was being amortized as non-cash
interest expense over the original term of the Notes. For the nine month period
ending June 30, 2003, $405,000 was amortized as non-cash interest expense.
9. STOCKHOLDERS' EQUITY
On March 31, 2003, the 10,000 shares of Series C Preferred Stock outstanding
were automatically converted into 41,130 shares of Common stock.
In May 2002, the Company sold 235,400 shares of Series D Convertible Preferred
Stock ("Series D Stock"), at $10.00 per share for gross cash proceeds of
$2,354,000. A total of 250,000 shares of Series D Stock have been authorized.
The dollar amount of Series D Stock, increased by $0.60 per share accretion per
annum and other adjustments, is convertible one or more times into fully paid
shares of common stock at a conversion price which is the lower of (i) $4.50 per
share or (ii) 90% of the volume weighted average market price for the five days
prior to conversion, but in no event less than $2.00 per share, subject to
adjustment, provided however, that no such conversion could be made prior to
January 1, 2003 at a conversion price of less than $4.50 per share. The shares
of Series D Stock may be called by the Company for conversion if the market
price of the common stock exceeds $9.50 per share for ten days and certain
conditions are met. The Series D Stock is subject to automatic conversion on
June 30, 2006. The purchasers of the Series D Stock were
9
AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)
granted warrants to purchase an aggregate of 517,880 common shares of the
Company at $4.50 per share until June 30, 2007 ("D Warrants"). The Series D
Stock and the D Warrants have antidilution rights reducing the floor conversion
and warrant exercise price for certain issuances of equity securities by the
Company at an effective price below the applicable floor conversion or warrant
exercise price. In connection with the Series D Stock financing, the Company
incurred closing costs of $78,752.
During the nine months ending June 30, 2003, 180,400 shares of Series D Stock
were converted into 683,344 shares of common stock. As of June 30, 2003, the
55,000 remaining outstanding shares of Series D Stock were convertible into
130,738 shares of common stock.
In connection with the Series D Stock and D Warrants, the Company recorded
$994,310 and $871,000 as the value of the discount at issuance of the Series D
Stock and the value of the D Warrants, respectively. The D Warrants were valued
using the Black-Scholes model with a dividend yield of zero percent; expected
volatility of 78 percent; risk free interest rate of 4.94 percent; and an
expected life of five years. The Series E Financing resulted in a repricing of
the 517,880 outstanding D Warrants from $4.50 per share to $3.01 per share in
accordance with repricing provisions of such warrants. In connection with the
repricing the Company recorded $158,519 in additional warrant value. For the
nine months ended June 30, 2003, $725,670 and $215,111 were amortized as a
deemed dividend related to the value of the discount at issuance and the value
of the D Warrants.
Subsequent to June 30, 2003, 5,000 shares of Series D Stock were converted into
11,922 shares of common stock.
In March 2003, the Company sold 343,250 shares of Series E Preferred Stock, par
value $.00001, at $10.00 per share (the "Series E Stock" or the "Series E
Financing"). In connection with the Series E Financing, the Company amended its
8% Senior Secured Promissory Notes (the "Senior Notes") (i) to allow the holders
of the Senior Notes to convert all or a portion of the principal balance of such
notes into Series E Stock and (ii) to extend the due date of the unconverted
balance of the Senior Notes from December 31, 2003 to December 31, 2004. The
Company raised an aggregate of $2,432,500 in new cash and converted Senior Notes
with an aggregate value of $1,000,000.
The dollar amount of Series E Stock, increased by $0.60 per share accretion per
annum and other adjustments, is convertible one or more times into fully paid
shares of common stock at a conversion price which is the lower of (i) $3.25 per
share or (ii) 90% of the volume weighted average market price for the five days
prior to conversion, but in no event less than $2.00 per share, subject to
adjustment, provided however, that no such conversion can be made prior to
September 30, 2003 at a conversion price of less than $3.25 per share. The
shares of Series E Stock may be called by the Company for conversion if the
market price of the common stock exceeds $9.50 per share for ten days and
certain conditions are met. The Series E Stock is subject to automatic
conversion on December 31, 2006. Each purchaser of Series E Stock was also
granted a warrant to purchase 1.5 shares of common stock for each share of
Series E Preferred Stock purchased, exercisable until December 31, 2007 at a
price of $3.25 per share. In connection with the Series E Financing, we issued
warrants exercisable for an aggregate of 514,875 shares ("E Warrants"). In
connection with the Series E Financing, the Company incurred closing costs of
$176,222.
During the nine months ending June 30, 2003, 5,000 shares of Series E Stock were
converted into 15,679 shares of common stock. As of June 30, 2003 the 338,250
remaining outstanding shares of Series E Stock (based on a 360 day year) were
convertible into 1,061,932 shares of common stock.
In connection with the Series E Stock and E Warrants, the Company recorded
$2,677,000 and $755,500 as the value of the discount at issuance of the Series E
Stock and the value of the warrants, respectively. The warrants were valued
using the Black-Scholes model with a dividend yield of zero percent; expected
volatility of 76.5 percent; risk free interest rate of 4.0 percent; and an
expected life of five years. For the nine months ended June 30, 2003, $270,597
and $226,951 were amortized as a deemed dividend related to the value of the
discount at issuance and the value of the E Warrants.
The cash proceeds of the preferred stock were allocated prorata between the
relative fair values of the preferred stock and warrants at issuance using the
Black Scholes valuation model for valuing the warrants. After allocating the
proceeds between the preferred stock and warrant, an effective conversion price
was calculated for the convertible preferred stock to determine the beneficial
conversion discount for each share. The value of the beneficial conversion
discount is recorded as a deemed
10
AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)
dividend. The resultant combined discount to the preferred stock is accreted as
an deemed dividend over the conversion period of the preferred stock. The
following is a summary of the components of the discount recorded upon issuance
of the preferred stock and warrants:
Components of
Deemed Dividend
-------------------------------------------
Preferred Number of
Issuance Stock Purchase Preferred Number of Beneficial
Date Series Price Shares Warrants Conversion Warrants Total
---------------------------------------------------------------------------- -------------------------------------------
May 2002 Series D $ 2,354,000 235,400 517,880 $ 994,310 $ 871,000 $ 1,865,310
March 2003 Series E $ 3,432,500 343,250 514,875 $ 2,677,000 $ 755,500 $ 3,432,500
The following table summarizes information about the Series D Preferred Stock
and deemed dividend activity during the nine months ended June 30, 2003:
Series D
-----------------------------------------------
Preferred
Deemed Shares Warrants
Dividend Outstanding Outstanding
--------------------------------------------------------------------------------------------------------------------
Deemed dividend for warrants and beneficial conversion May 2002 $ 1,865,310 235,400 517,880
Accretion of deemed dividend (195,936) -- --
--------------------------------------------------------------------------------------------------------------------
Balance as of September 30, 2002 1,669,374 235,400 517,880
Deemed dividend accreted on preferred stock converted (681,420) (180,400) --
Deemed dividend accreted on warrants exercised (39,822) -- (22,000)
Additional deemed dividend for Series D warrant repricing 158,519 -- --
Accretion of deemed dividend (219,539) -- --
--------------------------------------------------------------------------------------------------------------------
Balance as of June 30, 2003 $ 887,112 55,000 495,880
--------------------------------------------------------------------------------------------------------------------
The following table summarizes information about the Series E Preferred Stock
and deemed dividend activity during the nine months ended June 30, 2003:
Series E
-----------------------------------------------
Preferred
Deemed Shares Warrants
Dividend Outstanding Outstanding
-------------------------------------------------------------------------------------------------------------------------
Deemed dividend for warrants and beneficial conversion March, 2003 $ 3,432,500 343,250 514,875
Deemed dividend accreted on preferred stock converted (38,995) (5,000) --
Deemed dividend accreted on warrants exercised (176,082) -- (120,000)
Accretion of deemed dividend (282,472) -- --
-------------------------------------------------------------------------------------------------------------------------
Deemed dividend for warrants and beneficial conversion June 30, 2003 $ 2,934,951 338,250 394,875
-------------------------------------------------------------------------------------------------------------------------
11
AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)
The following table summarizes changes in equity components from transactions
during the nine months ended June 30, 2003:
Additional
Preferred Stock Common Stock Paid-In Accumulated
Shares Amount Shares Amount Capital Deficit
----------------------------------------------------------------------------------------------------------------------------------
Balance as of October 1, 2002 245,400 $ 2 14,351,476 $ 144 $ 27,255,016 $(28,140,044)
Stock issued upon exercise of
stock options -- -- 110,625 1 377,115 --
Stock issued upon exercise of
Warrants -- -- 267,000 3 706,219 --
Stock issued for services -- -- 109,844 1 410,815 --
Stock issued on conversion of
Series E Preferred Stock (5,000) -- 15,679 -- -- --
Stock issued on conversion of
Series D Preferred Stock (180,400) (1) 683,344 7 (6) --
Stock issued on conversion of Series
C Preferred Stock (10,000) -- 41,130 -- -- --
Stock issued on conversion of Notes -- -- 1,217,516 12 2,435,020 --
Issuance of Series E Preferred Stock,
net of offering costs of $176,222 343,250 3 -- -- 3,256,272 --
Issuance of options and warrants
for services -- -- -- -- 179,995 --
Net loss -- -- -- -- -- (5,968,603)
----------------------------------------------------------------------------------------------------------------------------------
Balance as of June 30, 2003 393,250 $ 4 16,796,614 $ 168 $ 34,620,446 $(34,108,647)
==================================================================================================================================
The following table summarizes information about stock option activity during
the nine months ended June 30, 2003:
Number of Weighted Average
Options exercise price
-------------------------------------------------------------------------------
Outstanding October 1, 2002 1,459,175 $3.97
Canceled/expired (97,650) $4.19
Exercised (110,625) $3.41
Granted 784,000 $3.35
-------------------------------------------------------------------------------
Outstanding June 30, 2003 2,034,900 $2.80
-------------------------------------------------------------------------------
Exercisable at June 30, 2003 1,367,722 $3.48
-------------------------------------------------------------------------------
During the nine months ended June 30, 2003, the Company recorded non-cash
compensation expense of $25,597 for the granting of 13,000 options under its
stock options plans to non-employees.
In October 2001, the Company granted a total of 110,000 stock options to a
consultant in conjunction with related development and manufacturing agreements.
Options to purchase 65,000 shares of common stock vest depending on the
consultant's completion of various project milestones as well as the Company's
acceptance of the specified work. The Company estimates the period required to
complete the specified milestones each reporting period and records consulting
expense based on the current market price of the Company's stock and the
estimated percentage of the work completed. Consulting expense is adjusted each
reporting period until vesting occurs. The Company has recorded consulting
expense of $47,782 for the Black Scholes value of 10,000 milestone options
vested at June 30, 2003.
On April 8, 2003 the Company granted a warrant exercisable for 50,000 common
shares at $3.63 per share to a consultant for consulting services. The Company
recorded non-cash consulting expense of $106,616 for the value of these
warrants.
Options outstanding are exercisable at prices ranging from $2.50 to $9.03 and
expire over the period from 2003 to 2008 with an average life of 2 years.
12
AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)
Subsequent to June 30, 2003, the Company received cash proceeds of $946,681 from
the exercise of 218,576 stock options.
The following table summarizes information about warrant activity during the
nine months ended June 30, 2003:
Weighted
Average
Number of Exercise
Warrants Price
------------------------------------------------------------------------------
Outstanding October 1, 2002 2,105,380 $ 4.85
Canceled/expired (350,000) 11.71
Exercised (267,000) 2.65
Granted 564,875 3.28
------------------------------------------------------------------------------
Outstanding June 30, 2003 2,053,255 $ 3.16
------------------------------------------------------------------------------
At June 30, 2003, the Company had the following warrants outstanding arising
from offerings and other transactions, each exercisable into one common share:
Number Exercise Price Expiration Date
----------------------------------------------------------------------------
50,000 $10.00 January 5, 2004
75,000 $11.00 March 31, 2005
887,500 $2.00 September 30, 2006
495,880 $3.01 March 31, 2007
100,000 $4.25 September 30, 2007
394,875 $3.25 December 31, 2007
50,000 $3.63 April 8, 2008
----------------------------------------------------------------------------
2,053,255 $3.16
----------------------------------------------------------------------------
At June 30, 2003, the Company had two stock-based employee compensation plans.
The Company accounts for the plans under the recognition and measurement
principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees, and
related Interpretations". No stock-based employee compensation cost is reflected
in net loss available to common shareholders, as all options granted under those
plans had an exercise price equal to or greater than the market value of the
underlying common stock on the date of grant. The following table illustrates
the effect on net loss available to common shareholders and basic and diluted
loss per common share if the Company had applied the fair value recognition
provisions of SFAS No.123:
For the three months ended For the nine months ended
June 30, June 30,
2003 2002 2003 2002
----------------------------------------------------------------------------------------------------------------------
Net loss available to common shareholders
Net loss as reported $(3,011,097) $(2,253,264) $(7,562,339) $(5,960,806)
Deduct:
Total stock-based employee compensation
determined under fair value based method for all
awards, net of related tax effects 342,040 414,310 722,267 711,746
----------------------------------------------------------------------------------------------------------------------
Pro forma net loss $(3,353,137) $(2,667,574) $(8,284,606) $(6,672,552)
----------------------------------------------------------------------------------------------------------------------
Net loss per common share
As reported $ (0.19) $ (0.16) $ (0.51) $ (0.42)
----------------------------------------------------------------------------------------------------------------------
Pro forma $ (0.22) $ (0.19) $ (0.56) $ (0.47)
----------------------------------------------------------------------------------------------------------------------
10. LEGAL PROCEEDINGS
On May 27, 2003, Horizon Sports Technologies, Inc. d/b/a HST filed a complaint
in the Superior Court of California, County of San Diego, alleging breach of
contract and fraud in connection with the various agreements between the Company
and HST. HST sought damages of approximately $811,000, plus other unspecified
damages. The Company answered the complaint with a general denial on June 26,
2003. The Company and HST reached an agreement in principle to settle the
litigation on August 11, 2003,. The Company has accrued at June 30, 2003
$950,000 as an estimate of the liability associated with such settlement.
13
AMERICAN TECHNOLOGY CORPORATION
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)
11. INCOME TAXES
At September 30, 2002, a valuation allowance has been provided to offset the net
deferred tax asset as management has determined that it is more likely than not
that the deferred tax asset will not be realized. The Company has for federal
income tax purposes net operating loss carryforwards of approximately
$23,259,000 which expire through 2022 of which certain amounts are subject to
limitations under the Internal Revenue Code of 1986, as amended.
12. SUBSEQUENT EVENTS
On July 11, 2003, the Company sold 1,818,180 shares of its common stock at a
purchase price of $5.50 per share. The Company also issued warrants to the
investors to purchase 454,547 shares of common stock with an exercise price of
$6.75 per share subject to certain antidilution adjustments. The warrants are
exercisable until July 10, 2007.
The gross proceeds received from this financing were $10 million. The Company
incurred financing and closing costs of approximately $550,000. Net proceeds of
the financing were used to redeem the $318,155 principal balance of the Senior
Notes and accrued interest, and for working capital purposes.
14
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO OUR
FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE
CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF
FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, "BUSINESS
RISKS." ALSO SEE OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED SEPTEMBER 30,
2002.
Overview
We are a consumer electronics company that develops and markets proprietary
sound reproduction products, components and technologies. Our primary sound
technologies are:
o HSS(R), HyperSonic(R) Sound Technology
o LRAD(TM) and HIDA(TM)
o NeoPlanar(TM) Technology
o PureBass(TM), Woofer Technology
HyperSonic Sound (HSS) technology is a new method of sound reproduction. Sound
is generated in an air column using ultrasonic frequencies, those above the
normal range of hearing. Our proprietary electronic process generates an
ultrasonic beam to interact in mid-air producing wide spectrum audio along the
beam. The sound beam has a very high degree of directionality and maintains
sound volume over longer distances than traditional methods of sound
reproduction. We believe HyperSonic Sound has unique features useful in new
sound applications.
Our Long Range Acoustic Device (LRAD) technology is based in part on our HSS
technology but is subject to additional pending patents and distinct marketing
efforts. LRAD employs proprietary techniques to produce variable intensity
directional acoustical sound intended for use primarily in long-range delivery
of directional sound information, effectively a supercharged megaphone. LRAD is
employed as a long-range hailing and warning system with minimal distraction to
others not in the directed beam. One version of this technology, our High
Intensity Directional Acoustics (HIDA) technology, has potential application as
a scaleable nonlethal weapon. Our high intensity directional technology has been
developed in part from sponsored research and development fees obtained from
Bath Iron Works, a General Dynamics company.
NeoPlanar technology is a thin film magnetic speaker that can be produced as
thin as 1/8". We believe the novel films and magnetic materials employed results
in superior sound quality, reduced distortion and greater sound volume for a
given size than traditional planar (flat or thin) magnetic speaker devices. Our
NeoPlanar speaker technology is targeted at the automotive, multimedia, home,
professional and marine speaker markets.
Our PureBass extended range woofer was designed to complement our high
performance NeoPlanar technology as well as other loudspeakers including those
used in professional and consumer applications. PureBass employs unique cabinet
construction and vent configurations along with multiple acoustic filters, which
we believe produces improved performance. We believe PureBass minimizes
distortion, provides high output for its size, and results in lower system costs
when compared to conventional woofer systems. It provides a high frequency
interface with upper range satellite speaker systems. This technology is a
complement to our NeoPlanar and other flat speaker technologies.
During the third quarter of 2003, we changed contract manufacturers for our HSS,
NeoPlanar and PureBass components. Until high volume contract manufacturing is
successfully established we are also producing these components at our
facilities. We have also been preparing to introduce an improved second
generation HSS emitter component. These factors resulted in a delay in order
procurement and fulfillment in the third quarter for HSS products. We have been
shipping HSS units to customers worldwide for evaluation in markets including
retailing, point-of-purchase displays, museums, trade show booths, law
enforcement, television, expositions, transportation, government and military.
We expect growth in HSS shipments in the fourth fiscal quarter.
Commercial deliveries of LRAD/HIDA products commenced in May 2003 and accounted
for a majority of third quarter revenues. LRAD/HIDA products are currently
produced by us. LRAD/HIDA technology-based devices have been successfully
demonstrated to various military, government and commercial parties. We expect
continued growth in LRAD/HIDA shipments in the fourth fiscal quarter.
15
We have produced and sold NeoPlanar speaker components for installation in
outside entertainment, luxury yacht and military ship applications. We expect
growth in NeoPlanar shipments as new contract production is successfully
established.
The net loss of $5,968,603 for the nine months ended June 30, 2003 included
$405,000 of debt amortization expense, $590,811 of expenses paid with common
stock and options and $601,769 of depreciation, amortization and other reserves
and write downs. We have substantial research and development and selling,
general and administrative expenses, and our revenues from our sound
technologies have not yet been sufficient to offset these costs. We also invest
significant funds in patent applications. We expect to incur additional
operating losses during the balance of fiscal 2003 but we expect a reduction in
our non-cash expense outlays. See "Liquidity and Capital Resources" below.
As a result of our past needs for capital and our net losses to date, our
independent auditors noted in their audit report on our financial statements for
the fiscal year ended September 30, 2002 substantial doubt about our ability to
continue as a going concern. Since that time to the date of this report, we have
obtained equity proceeds of approximately $14,092,000 from the issuance of
preferred and common stock and from the exercise of options and warrants, with
some proceeds applied to reduce debt. As of the date of this report, we have no
long-term debt other than approximately $25,000 of capital lease obligations.
Although we will need to generate additional revenue to achieve profitability
and generate positive cash flow from operations in future periods, we believe we
have sufficient resources to meet our operating requirements for the next twelve
months.
Our primary marketing focus is on providing sound reproduction products and
components to customers and licensing our technologies for customer
applications. When we supply systems or components used in other products to
customers, distributors or OEMs, we include our intellectual property fees in
the selling prices of the systems or components. We currently produce HSS
systems and NeoPlanar panels which are installed as a component of a sound
system. When we license a sound technology, we typically receive a flat fee
up-front, with the balance of payments based upon a percentage of net revenues
of the products in which our technology is incorporated. Revenues from up-front
license fees are recognized ratably over the specified term of the particular
license. Contract fees are recorded as services are performed.
There can be no assurance our technologies will achieve market acceptance
sufficient to sustain operations or achieve future profits. See "Business Risks"
below.
Effective in October 2002, we discontinued our portable consumer product line in
order to focus financial, personnel and facility resources on our sound
technologies, which we expect to provide substantially all of our fiscal 2003
revenues. For the nine months ended June 30, 2003 and for fiscal 2002 we
recorded revenues of $83,360 and $274,245, respectively for portable consumer
products. These revenues represented products sourced by us, private labeled
under our name and resold to sporting good stores and other retailers.
Historically, portable consumer product revenues accounted for the majority of
our revenues.
Demand for our sound technologies and products is subject to significant month
to month variability resulting from seasonal demand fluctuations and the limited
number of customers and market penetration achieved by us to date. Further, we
expect future sales may be concentrated with a limited number of customers. We
are also reliant on outside suppliers for components of our products and outside
manufacturers for assembly and there can be no assurance of future supply. The
markets for our products and future products and technologies are subject to
rapidly changing customer tastes and a high level of competition. Demographic
trends in society, marketing and advertising expenditures, and product
positioning in retail outlets, technological developments, seasonal variations
and general economic conditions influence demand for our products. Because these
factors can change rapidly, customer demand can also shift quickly. We may not
be able to respond to changes in customer demand because of the time required to
change or introduce products, production limitations and/or limited financial
resources.
Recent Developments
On July 11, 2003, we entered into a Securities Purchase Agreement with certain
institutional investors pursuant to which we issued and sold 1,818,180 shares of
common stock at a purchase price of $5.50 per share. In connection with such
financing, we also issued warrants to the investors to purchase 454,547 shares
of common stock with an exercise price of $6.75 per share, subject to adjustment
if we sell securities in the future for less than an effective price of $6.75
per share. The warrants are exercisable until July 10, 2007. We agreed to give
each investor in the offering the first right to participate in any proposed
sale of equity securities by us until July 11, 2004. This right does not apply
to the issuance of securities upon exercise or conversion of previously
outstanding securities, to the grant of options under company plans, to certain
strategic transactions, or to a firm commitment underwriting that results in net
proceeds to us of at least $10 million.
16
The gross proceeds received from this financing were $10 million. We paid a
placement fee of 5% of the gross proceeds of the financing to Olympus
Securities, LLC. Net proceeds of approximately $9.45 million were used in part
to discharge the remaining $318,155 principal balance of our 8% Senior Secured
Promissory Notes and accrued interest, and the balance is expected to be used
for working capital purposes.
In connection with this financing, we and the investors entered into a
Registration Rights Agreement, pursuant to which we agreed to prepare and file,
within 30 days following the issuance of the securities, a registration
statement covering the resale of the common stock sold and issuable upon the
exercise of the warrants. We filed such registration statement on August 4,
2003, but it has not yet been declared effective. We agreed to use our best
efforts to have such registration statement declared effective as soon as
possible and in any event within 90 days following the date of the issuance of
the securities. Once the registration statement is effective, we have agreed to
use our best efforts to keep it effective for five years after the date the
registration statement is declared effective, or the earlier date when all of
the shares covered by the registration statement have been sold or may be sold
without volume restrictions in accordance with Rule 144(k) under the Securities
Act of 1933. If we do not comply with our registration obligations, we have
agreed to pay to each investor liquidated damages of up to 0.05% of its
investment amount per day that we are out of compliance with our registration
obligations. We have also agreed to pay liquidated damages in that amount during
any time that the exercisability of the warrants is suspended.
Critical Accounting Policies
We have identified the policies below as critical to our business operations and
the understandings of our results of operations. The impact and any associated
risks related to these policies on our business operations is discussed
throughout Management's Discussion and Analysis of Financial Condition and
Results of Operations when such policies affect our reported and expected
financial results.
In the ordinary course of business, we have made a number of estimates and
assumptions relating to the reporting of results of operations and financial
condition in the preparation of our financial statements in conformity with
accounting principles generally accepted in the United States of America. Actual
results could differ significantly from those estimates under different
assumptions and conditions. We believe that the following discussion addresses
our most critical accounting policies, which are those that are most important
to the portrayal of our financial condition and results of operations and
require our most difficult, subjective, and complex judgments, often as a result
of the need to make estimates about the effect of matters that are inherently
uncertain.
We do not have off-balance sheet arrangements, financings, or other
relationships with unconsolidated entities or other persons, also known as
"special purpose entities" (SPEs).
Revenue Recognition
We derive our revenue primarily from two sources: (i) component and product sale
revenues and (ii) contract and license fee revenue. Component and product sale
revenues are recognized in the periods that products are shipped to customers,
FOB shipping point, if a signed contract exists, the fee is fixed and
determinable, collection of resulting receivables is probable and there are no
resulting obligations. Revenues from ongoing per unit license fees are earned
based on units shipped incorporating our patented proprietary technologies and
are recognized in the period when the manufacturers' units shipped information
is available to us and collectibility is reasonably assured. Revenues from
up-front license and other fees and annual license fees are recognized ratably
over the specified term of the particular license or agreement.
Research and Development Expenses
Research and development expenses are salaries and related expenses associated
with the development of our proprietary sound technologies and include
compensation paid to engineering personnel and fees to outside contractors and
consultants.
Deferred Tax Asset
We have provided a full valuation reserve related to our substantial deferred
tax assets. In the future, if sufficient evidence of our ability to generate
sufficient future taxable income in certain tax jurisdictions becomes apparent,
we may be required to reduce our valuation allowances, resulting in income tax
benefits in our consolidated statement of operations. We evaluate the
realizability of the deferred tax assets and assess the need for valuation
allowance quarterly. The utilization of the net operating loss carryforwards
could be substantially limited due to restrictions imposed under federal and
state laws upon a change in ownership.
17
Results of Operations
Total revenues for the nine month period ended June 30, 2003 and 2002 were
$974,853 and $691,745, respectively. Total revenues for the three month period
ended June 30, 2003 and 2002 were $313,612 and $235,691, respectively. Product
revenues for the nine months ended June 30, 2003 were $808,296, a 55% increase
from the comparable nine month total of $521,798 for the prior year. For the
nine months ended June 30, 2003 product sales included $83,360 of consumer
portable product sales and $724,936 from the sale of NeoPlanar, LRAD/HIDA and
HSS products. For the nine months ended June 30, 2002 product sales included
$274,245 of consumer portable product sales and $247,553 from the sale of
NeoPlanar, LRAD/HIDA and HSS products. Product revenues for the third quarter
ended June 30, 2003 and 2002 were $274,718 and $197,688, respectively with the
majority of 2003 revenues from LRAD/HIDA shipments. We experienced manufacturing
quality control problems with some of our initial commercial HSS units, which
negatively impacted product sales during the third quarter of fiscal 2003. We
have established a new contract manufacturing relationship and are working to
resolve manufacturing issues, but because our HSS emitters are a new and unique
product, we may continue to experience manufacturing problems that could
adversely affect product sales in future periods. Since we have discontinued our
portable consumer products line, fiscal 2003 revenues for these products will be
substantially below those for fiscal 2002, and will be limited to sales of
inventory on hand. Sales of sound products are expected to be volatile as a
result of manufacturing startup requirements and the need to recruit new
customers for products not previously available in the marketplace.
Contract and license revenues for the quarters ended June 30, 2003 and 2002 were
$166,557 and $169,947, respectively. We recognize upfront fees and advance
revenues over the term of respective license agreements. At June 30, 2003 and
September 30, 2002 we had $274,170 and $276,667, respectively, collected and
recorded as unrecognized revenue for existing contracts and licenses.
At June 30, 2003, we received purchase orders for approximately $558,000 for
product expected to ship during our fiscal fourth quarter ending September 30,
2003. Anticipated shipments are subject to change due to a variety of factors,
many outside our control. Our customers may modify or cancel orders and delay or
change schedules. Shipments may also be delayed due to production delays,
component shortages and other production related issues.
Cost of revenues for the nine months ended June 30, 2003 was $858,520 resulting
in a gross profit of $116,333 or 12%. This compares to a gross profit of
$293,902 or 42% for the comparable period of the prior year. It is difficult to
compare historical gross profit percentages due to changes in contract and
license revenues as a percentage of total revenues and changes in the product
mix in each year. Cost of revenues for the three months ended June 30, 2003 and
2002 were $186,101 and $158,998 resulting in a gross profit of 41% and a gross
profit of 32%, respectively. The lower gross profit percentage in the nine
months ended June 30, 2003 resulted from lower margins on consumer product
sales, warranty reserves and startup production costs for HSS, LRAD/HIDA and
NeoPlanar products. Gross profit percentage is highly dependent on product mix,
sales prices, volumes, purchasing costs and overhead allocations. Overall gross
margins will also be impacted by future contract and licensing revenues and the
types of products sold to customers. Margins may vary significantly from period
to period.
Selling, general and administrative expenses for the nine months ended June 30,
2003 and 2002 were $3,393,605 and $1,864,087, respectively. The $1,529,518
increase resulted from an accrual of $950,000 in the 2003 period for estimated
liability related to the HST litigation described under the heading "Legal
Proceedings" below, an increase in legal costs and fees of $257,111, an increase
in professional services of $61,508, an increase in personnel and related costs
of $221,604 and an increase of $39,505 for accounting and shareholder costs. The
increase in personnel costs included five new hires. Selling, general and
administrative expense for the three month period ending June 30, 2003 increased
by $967,329 from the comparable prior year period. This increase is the result
of the $950,000 accrual for estimated liability related to the HST litigation.
We may expend additional resources on marketing our sound technologies in future
quarters, which may increase selling, general and administrative expenses in
future periods.
Research and development expenses for the nine months ended June 30, 2003 were
$2,023,095 compared to $2,883,977 for the comparable nine months of the prior
year. The $860,882 decrease resulted from a reduction of $436,148 for supplies
and materials used in the development of our sound technologies and a decrease
of $433,409 for consulting services, a $43,585 decrease in depreciation and a
$37,642 decrease in travel expenditures offset by an increase in personnel and
related costs of $115,926. The increase in personnel and related costs primarily
represent the addition of an engineer administrative assistant and three lab
technicians. Research and development costs for the three months ended June 30,
2003 decreased by $288,604 or 29% from the comparable prior year period.
Research and development costs vary quarter by quarter due to the timing of
projects, the availability of funds for research and development and the timing
and extent of use of outside consulting, design and development firms. We expect
that fiscal 2003 research and development costs may be at lower levels than the
prior year based on current staffing and budgeting as we focus resources on
sales of products from developed technologies.
18
We recorded in selling, general and administrative expenses $3,600 for the nine
months ended June 30, 2002 for services paid through the issuance of 1,425
shares of common stock.
We experienced a loss from operations of $5,300,367 during the nine months ended
June 30, 2003, compared to a loss from operations of $4,454,162 for the
comparable nine months ended June 30, 2002. The $846,205 increase is primarily
due to the increase in selling, general and administrative expenses accompanied
with a decrease in our gross profit on product sales reflecting production start
up costs offset by a decrease in research and development costs.
Interest expense of $670,769 for the nine months ended June 30, 2003 included
$405,000 of noncash amortization of debt discount, $169,753 of accrued interest
on convertible subordinated promissory notes and $91,802 of paid interest on
senior secured promissory notes.
The net loss available to common stockholders for the nine months ended June 30,
2003 of $7,562,339 included $155,407 of accretion on the Series C, D and E
Preferred Stock and also included $725,670 and $270,597 on Series D and Series E
Preferred Stock imputed deemed dividends based on discount at issuance,
respectively, and $215,111 and $226,951 on imputed deemed dividends on warrants
issued in connection with the Series D and Series E Preferred Stock,
respectively. The net loss available to common stockholders for the three months
ended June 30, 2003 of $3,011,097 included $61,725 of accretion on the Series C,
D and E Preferred Stock also included $47,223 and $209,452 on Series D and
Series E Preferred Stock imputed deemed dividends based on discount at issuance,
respectively, and $100,350 and $209,695 on imputed deemed dividends on warrants
issued in connection with the Series D and Series E Preferred Stock,
respectively
The net loss available to common stockholders for the nine months ended June 30,
2002 of $5,960,805 included $40,385 on Series D imputed deemed dividends based
on discount at issuance, $35,377 on imputed deemed dividends on warrants issued
in connection with the Series D Preferred Stock and $48,351 of accretion on the
Series C and D Preferred Stock. The net loss available to common stockholders
for the three months ended June 30, 2002 of $2,253,264 included $25,436 of
accretion on the Series C and D Preferred Stock.
We have federal net loss carryforwards of approximately $23,259,000 for federal
tax purposes expiring through 2022. The amount and timing of the utilization of
our net loss carryforwards may be limited under Section 382 of the Internal
Revenue Code. A valuation allowance has been recorded to offset the related net
deferred tax asset as management was unable to determine that it is more likely
than not that the deferred tax asset will be realized.
Future operations are subject to significant variability as a result of
licensing activities, product sales and margins, timing of new product
offerings, the success and timing of new technology exploitation, decisions
regarding future research and development and variability in other expenditures.
Liquidity and Capital Resources
We have experienced significant negative cash flow from operating activities
including developing and introducing our sound technologies. Our negative cash
flow from operating activities was $3,768,145 for the nine months ended June 30,
2003. As of June 30, 2003, the net loss of $5,968,603 included certain expenses
not requiring the use of cash totaling $2,546,440. In addition, cash was used in
operating activities through an increase of $219,443 in inventories, an increase
of $15,106 in prepaid expenses and other and a decrease of $333,033 in accounts
payable. Cash provided by operating activities included a $97,013 decrease in
accounts receivable and a $124,587 increase in accrued liabilities.
At June 30, 2003, we had accounts receivable of $35,064 as compared to $131,677
at September 30, 2002. This represented approximately 4 days of sales. Terms
with individual customers vary greatly. We typically require pre-payment or a
maximum of thirty day terms for our sound technology components and products.
Our receivables can vary dramatically due to overall sales volumes and due to
quarterly and seasonal variations in sales and timing of shipments to and
receipts from large customers.
For the nine months ended June 30, 2003, we used approximately $9,700 for the
purchase of laboratory and computer equipment and made a $71,098 investment in
patents and new patent applications. We anticipate a continued investment in
patents in fiscal 2003. Dollar amounts to be invested on these patents are not
currently estimable by management.
At June 30, 2003, we had a working capital deficit of $601,283 compared to
working capital of $554,713 at September 30, 2002.
19
We have financed our operations primarily through the sale of stock, exercises
of stock options, sale of convertible and non-convertible notes and margins from
product sales. At June 30, 2003, we had cash of $1,109,293, representing a
decrease of $698,427 from cash at September 30, 2002. The decrease resulted from
cash used in operating activities offset by proceeds from our Series E Preferred
Stock financing, exercise of stock options and warrants and an 8% Senior Note
funding, in aggregate an amount of $3,333,990.
During the quarter ended June 30, 2003, we obtained $24,375 from the exercise of
warrants issued in connection with our 12% Convertible Subordinated Notes and
our Series D Preferred Stock, and $377,115 from the exercise of stock options.
In July 2003, we raised net proceeds of $9.45 million from the sale of common
stock and warrants. See "Recent Developments" above.
Based on our current cash position and assuming (a) currently planned
expenditures and level of operations, (b) continuation of product sales and (c)
expected royalty and licensing proceeds we believe we have sufficient cash for
operations for the next twelve months. We believe increased sales of HSS,
LRAD/HIDA and NeoPlanar products may also contribute cash. We have significant
flexibility to adjust the level of research and development and selling and
administrative expenses based on the availability of resources. However
reductions in expenditures could delay development and adversely affect our
ability to generate future revenues.
Other than cash and cash equivalents, we have no unused sources of liquidity at
this time. We expect to incur additional operating losses as a result of
expenditures for research and development and marketing costs for our sound
products and technologies. The timing and amounts of these expenditures and the
extent of our operating losses will depend on many factors, some of which are
beyond our control. Accordingly, there can be no assurance that our current
expectations regarding required financial resources will prove to be accurate.
We anticipate that the commercialization of our technologies may require
increased operating costs; however, we cannot currently estimate the amounts of
these costs.
Contractual Commitments and Commercial Commitments
The following table summarizes our contractual obligations, including purchase
commitments at June 30, 2003, and the effect such obligations are expected to
have on our liquidity and cash flow in future periods:
Payments Due by Period
Less than 1
Contractual Obligations Year 1-3 Year 4-5 Years After 5 Years
-------------------------------------------------------------------------------------------------------------
Capital leases $8,963 $25,760 $- $-
Operating lease 15,991 - - -
Employment agreements 470,000 550,000 - -
Senior secured promissory notes
due December 31, 2004 338,698(1) - - -
-------------------------------------------------------------------------------------------------------------
Total contractual cash obligations $833,652 $575,760 $- $-
-------------------------------------------------------------------------------------------------------------
1. Subsequent to June 30, 2003, we redeemed these notes for cash.
2. Table excludes cash obligations related to the Legal Settlement discussed
in Note 10.
New Accounting Pronouncements
A number of new pronouncements have been issued for future implementation as
discussed in the footnotes to our interim financial statements (see page 7, Note
4). As discussed in the notes to the interim financial statements, the
implementation of these new pronouncements is not expected to have a material
effect on our financial statements.
Business Risks
You should consider each of the following factors as well as the other
information in this Quarterly Report in evaluating our business and our
prospects. The risks and uncertainties described below are not the only ones we
face. Additional risks and uncertainties not presently known to us or that we
currently consider immaterial may also impair our business operations. If any of
the following risks actually occur, our business and financial results could be
harmed. In that case the trading price of our common stock could decline. You
should also refer to the other information set forth in this Quarterly Report
and in our Annual Report on Form 10-K for the fiscal year ended September 30,
2002, including our financial statements and the related notes.
20
We have a history of net losses. We expect to continue to incur net losses and
we may not achieve or maintain profitability. Our independent auditors have
raised substantial doubt about our ability to continue as a going concern.
We have incurred significant operating losses and anticipate continued
losses in fiscal 2003. At June 30, 2003, we had an accumulated deficit of
$34,108,647. Due to our net losses and our prior need for additional capital to
sustain operations, our independent auditors noted in their November 19, 2002
report on our financial statements for the fiscal year ended September 30, 2002
a substantial doubt about our ability to continue as a going concern. We need to
generate additional revenue to be profitable in future periods. Failure to
achieve profitability, or maintain profitability if achieved, may cause our
stock price to decline.
In July 2003, we raised net proceeds of $9.45 million from the sale of common
stock and warrants.
We are an early stage company introducing new products and technologies. If
commercially successful products do not result from our efforts, we may be
unprofitable or forced to cease operations.
Our HSS, NeoPlanar, PureBass and LRAD/HIDA technologies have only
recently been introduced to market and are still being improved. Commercially
viable sound technology systems may not be successfully and timely produced by
original equipment manufacturers (OEMs) due to the inherent risks of technology
development, new product introduction, limitations on financing, manufacturing
problems, competition, obsolescence, loss of key technical personnel and other
factors. Our revenues from our sound technology have been limited to date, and
we cannot guarantee significant revenues in the future. The development and
introduction of our sound technology has taken longer than anticipated by
management and could be subject to additional delays. We have also experienced
manufacturing quality control problems with some of our initial commercial HSS
units, and we may not be able to resolve future manufacturing problems in a
timely and cost effective manner. Products employing our sound technology may
not achieve market acceptance. Our various sound projects are high risk in
nature, and unanticipated technical obstacles can arise at any time and result
in lengthy and costly delays or result in a determination that further
exploitation is unfeasible. If we do not successfully exploit our technology,
our financial condition and results of operations and business prospects would
be adversely affected.
Portable consumer products were the primary source of our historical revenues.
You cannot rely on period-to-period comparisons of our results of operations as
an indication of future performance.
We derived most of our historical revenues from the sale of portable
consumer electronics products. We expect future revenues will primarily be
generated from our proprietary sound reproduction and other electronic
technologies, but there can be no assurance we will achieve substantial revenues
from these technologies. If we do not achieve substantial revenues from these
technologies, you may not be able to rely on period-to-period comparisons of our
results of operations as an indication of future performance.
We do not have the ability to predict future operating results. Our quarterly
and annual revenues will likely be subject to fluctuations caused by many
factors, any of which could result in our failure to achieve our revenue
expectations.
Our historical revenues derived almost exclusively from portable
consumer products, and we expect a majority of future revenues to be generated
from our sound reproduction technologies. Revenues from our sound reproduction
technologies are expected to vary significantly due to a number of factors. Many
of these factors are beyond our control. Any one or more of the factors listed
below or other factors could cause us to fail to achieve our revenue
expectations. These factors include:
o our ability to develop and license our sound reproduction
technologies or our ability to supply components to customers,
distributors or OEMs;
o market acceptance of and changes in demand for products of our
customers;
o gains or losses of significant customers, distributors or
strategic relationships;
o unpredictable volume and timing of customer orders;
o the availability, pricing and timeliness of delivery of
components for our products and OEM products;
o fluctuations in the availability of manufacturing capacity or
manufacturing yields and related manufacturing costs;
21
o the timing of new technological advances, product
announcements or introductions by us, by our licensees and by
our competitors;
o product obsolescence and the management of product transitions
and inventory;
o production delays by customers, distributors, OEMs or by us or
our suppliers;
o seasonal fluctuations in sales;
o the conditions of other industries, such as military and
commercial industries, into which our technologies may be
licensed;
o general consumer electronics industry conditions, including
changes in demand and associated effects on inventory and
inventory practices; and
o general economic conditions that could affect the timing of
customer orders and capital spending and result in order
cancellations or rescheduling.
Some or all of these factors could adversely affect demand for OEM
products incorporating our sound reproduction technologies, and therefore
adversely affect our future operating results.
Most of our operating expenses are relatively fixed in the short term.
We may be unable to rapidly adjust spending to compensate for any unexpected
sales or license revenue shortfalls, which could harm our quarterly operating
results. We do not have the ability to predict future operating results with any
certainty.
Our expenses may vary from period to period, which could affect quarterly
results and our stock price.
If we incur additional expenses in a quarter in which we do not
experience increased revenue, our results of operations would be adversely
affected and we may incur larger losses than anticipated for that quarter.
Factors that could cause our expenses to fluctuate from period to period
include:
o the timing and extent of our research and development efforts;
o the extent of marketing and sales efforts to promote our
products and technologies; and
o the timing of personnel and consultant hiring.
Sound reproduction markets are subject to rapid technological change, so our
success will depend on our ability to develop and introduce new technologies.
Technology and standards in the sound reproduction markets evolve
rapidly, making timely and cost-effective product innovation essential to
success in the marketplace. The introduction of products with improved
technologies or features may render our technologies obsolete and unmarketable.
If we cannot develop products in a timely manner in response to industry
changes, or if our technologies do not perform well, our business and financial
condition will be adversely affected. The life cycles of our technologies are
difficult to estimate, particularly those such as HSS and LRAD/HIDA for which
there are no established markets. As a result, our technologies, even if
successful, may become obsolete before we recoup our investment.
Our HSS technology is subject to government regulation, which could lead to
unanticipated expense or litigation.
Our HyperSonic Sound technology emits ultrasonic vibrations, and as
such is regulated by the Food and Drug Administration. In the event of certain
unanticipated defects in an HSS product, a customer or we may be required to
comply with FDA requirements to remedy the defect and/or notify consumers of the
problem. This could lead to unanticipated expense, and possible product
liability litigation against a customer or us. Any regulatory impediment to full
commercialization of our HSS technology, or any of our other technologies, could
adversely affect our results of operations. For a further discussion of the
regulation of our HSS technology, see Part I, Item 1 of our Annual Report on
Form 10-K, under the heading "Government Regulation."
We may not be successful in obtaining the necessary licenses required for us to
sell some of our products abroad.
Licenses for the export of certain of our products may be required from
government agencies in accordance with various statutory authorities, including
the Export Administration Act of 1979, the International Emergency Economic
Powers Act, the Trading with the Enemy Act of 1917 and the Arms Export Control
Act of 1976. We may not be able to obtain the necessary licenses in order to
conduct business abroad. In the case of certain sales of defense equipment and
services to foreign governments, the U.S. Department of State must notify
Congress at least 15 to 30 days, depending on
22
the size and location of the sale, prior to authorizing these sales. During that
time, Congress may take action to block the proposed sale. Failure to receive
required licenses or authorization would hinder our ability to sell our products
outside the United States.
Many potential competitors who have greater resources and experience than we do
may develop products and technologies that make ours obsolete.
Technological competition from other and longer established electronic
and loudspeaker manufacturers is significant and expected to increase. Most of
the companies with which we expect to compete have substantially greater capital
resources, research and development staffs, marketing and distribution programs
and facilities, and many of them have substantially greater experience in the
production and marketing of products. In addition, one or more of our
competitors may have developed or may succeed in developing technologies and
products that are more effective than any of ours, rendering our technology and
products obsolete or noncompetitive.
Commercialization of our sound technologies depends on collaborations with other
companies. If we are not able to maintain or find collaborators and strategic
alliance relationships in the future, we may not be able to develop our sound
technologies and products.
As we do not have the production, marketing and selling resources to
commercialize our products on our own, our strategy is to establish business
relationships with leading participants in various segments of the electronics
and sound reproduction markets to assist us in producing, marketing and selling
products that include our sound technologies.
Our success will therefore depend on our ability to maintain or enter
into new strategic arrangements with partners on commercially reasonable terms.
If we fail to enter into such strategic arrangements with third parties, our
financial condition, results of operations, cash flows and business prospects
will be adversely affected. Any future relationships may require us to share
control over our development, manufacturing and marketing programs or to
relinquish rights to certain versions of our sound and other technologies.
We are dependent on outside suppliers and manufacturers. Our relationships with
two key manufacturers have recently terminated, and our new manufacturer has not
yet produced our products in quantity. Disruptions in supply could adversely
affect us.
We recently terminated our manufacturing relationship with HST, Inc.,
formerly our sub-contract manufacturer of our HSS and NeoPlanar products. In
addition, Amtec Manufacturing, the sole manufacturer of our PureBass subwoofer
units, recently went out of business. We have contracted with Magnotek
Manufacturing to manufacture all three of these products, but Magnotek has not
yet commenced large scale production of our products. Magnotek's production
start-up requirements may cause longer lead times, particularly for larger
orders, which could have a negative impact on our ability to introduce these
technologies in volume. The agreement with Magnotek is non-exclusive and either
party may terminate the agreement on 90 days advance notice. Any loss or
disruption of supply could reduce future revenues, adversely affecting financial
condition and results of operations.
Any inability to adequately protect our proprietary technologies could harm our
competitive position.
We are heavily dependent on patent protection to secure the economic
value of our technologies. We have both issued and pending patents on our sound
reproduction technologies and we are considering additional patent applications.
Patents may not be issued for some or all of our pending applications. Claims
allowed from existing or pending patents may not be of sufficient scope or
strength to protect the economic value of our technologies. Issued patents may
be challenged or invalidated. Further, we may not receive patents in all
countries where our products can be sold or licensed. Our competitors may also
be able to design around our patents. The electronics industry is characterized
by vigorous protection and pursuit of intellectual property rights or positions,
which have resulted in significant and often protracted and expensive
litigation. There is currently no pending litigation against us that questions
our intellectual property rights. Third parties may charge that our technologies
or products infringe their patents or proprietary rights. Problems with patents
or other rights could potentially increase the cost of our products, or delay or
preclude our new product development and commercialization. If infringement
claims against us are deemed valid, we may be forced to obtain licenses, which
might not be available on acceptable terms or at all. Litigation could be costly
and time-consuming but may be necessary to protect our future patent and/or
technology license positions, or to defend against infringement claims. A
successful challenge to our sound technology could have a negative effect on our
business prospects.
23
If our key employees do not continue to work for us, our business will be harmed
because competition for replacements is intense.
Our performance is substantially dependent on the performance of our
executive officers and key technical employees, including Elwood G. Norris, our
Chairman, and James M. Irish, our CEO. We are dependent on our ability to retain
and motivate high quality personnel, especially highly skilled technical
personnel. Our future success and growth also depend on our continuing ability
to identify, hire, train and retain other highly qualified technical, managerial
and sales personnel. Competition for such personnel is intense, and we may not
be able to attract, assimilate or retain other highly qualified technical,
managerial or sales personnel in the future. The inability to attract and retain
the necessary technical, managerial or sales personnel could cause our business,
operating results or financial condition to suffer.
We may issue preferred stock in the future, and the terms of the preferred stock
may reduce the value of your common stock.
We are authorized to issue up to 5,000,000 shares of preferred stock in
one or more series. Our board of directors may determine the terms of future
preferred stock without further action by our stockholders. If we issue
additional preferred stock, it could affect your rights or reduce the value of
your common stock. In particular, specific rights granted to future holders of
preferred stock could be used to restrict our ability to merge with or sell our
assets to a third party. These terms may include voting rights, preferences as
to dividends and liquidation, conversion and redemption rights, and sinking fund
provisions.
Our Series D and Series E Preferred Stock financings may result in dilution to
our common stockholders. The holders of Series D and Series E Preferred Stock
will receive more common shares on conversion if the market price of our common
stock declines.
Dilution of the per share value of our common shares could result from
the conversion of the outstanding Series D and Series E Preferred Stock. In May
2002, we issued a total of 235,400 shares of our Series D Preferred Stock.
185,400 of these shares have been converted into 695,266 common shares, and
50,000 shares of Series D Preferred Stock remain outstanding as of July 28,
2003. In March 2003, we issued 343,250 shares of Series E Preferred Stock. 5,000
of these shares have been converted into 15,679 common shares and 338,250 shares
of Series E Preferred Stock remain outstanding as of July 28, 2003.
The holders of our outstanding shares of Series D Preferred Stock may
convert these shares into shares of our common stock at a conversion price equal
to the lower of $4.50 or 90% of volume-weighted average price of our common
stock for the five trading days prior to conversion. The conversion rate cannot
however be lower than lower than $2.00. The $2.00 floor price may however be
adjusted downward if we sell securities for less than an effective price of
$2.00 per share. As of July 28, 2003, the outstanding 50,000 shares of Series D
Preferred Stock are convertible into an aggregate of 119,348 common shares. In
addition, the Series D Preferred Stock purchasers received warrants to purchase
2.2 common shares for each share of Series D Preferred Stock purchased. The
exercise price of the warrants was initially $4.50 per share, but was reduced to
$3.01 per share as a result of anti-dilution provisions in the warrants. The
exercise price will be subject to further reduction if we sell securities for
less than an effective price of $3.01 per share.
The holders of our outstanding shares of Series E Preferred Stock may
convert these shares into shares of our common stock at a conversion price equal
to the lower of $3.25 or 90% of volume-weighted average price of our common
stock for the five trading days prior to conversion. The conversion rate cannot
however be lower than $3.25 before September 30, 2003, or lower than $2.00 after
such date. As of July 28, 2003, the 338,250 outstanding shares of Series E
Preferred Stock are convertible into an aggregate of 1,066,785 common shares. In
addition, the Series E Preferred Stock purchasers received warrants to purchase
1.5 common shares for each share of Series E Preferred Stock purchased at an
exercise price of $3.25 per share.
Holders of our common stock could experience substantial dilution from
the conversion of the Series D and Series E Preferred Stock and exercise of the
related warrants. As a result of the floating conversion price, the holders of
Series D and Series E Preferred Stock will receive more common shares on
conversion if the price of our common shares declines. To the extent that the
Series D or Series E stockholders convert and then sell their common shares, the
common stock price may decrease due to the additional shares in the market. This
could allow the Series D or Series E stockholders to receive greater amounts of
common stock, the sales of which would further depress the stock price.
Furthermore, the significant downward pressure on the trading price of our
common stock as Series D and Series E Preferred Stock and related warrant
holders convert or exercise these securities and sell the common shares received
24
could encourage short sales by the holders of Series D and Series E Preferred
Stock and the related warrants, or other stockholders. This would place further
downward pressure on the trading price of our common stock. Even the mere
perception of eventual sales of common shares issued on the conversion of the
Series D and Series E Preferred Stock or exercise of the related warrants could
lead to a decline in the trading price of our common stock.
Our stock price is volatile and may continue to be volatile in the future.
Our common stock trades on the Nasdaq SmallCap Market. The market price
of our common stock has fluctuated significantly to date. In the future, the
market price of our common stock could be subject to significant fluctuations
due to general market conditions and in response to quarter-to-quarter
variations in:
o our anticipated or actual operating results;
o developments concerning our sound reproduction technologies;
o technological innovations or setbacks by us or our
competitors;
o conditions in the consumer electronics market;
o announcements of merger or acquisition transactions; and
o other events or factors and general economic and market
conditions.
The stock market in recent years has experienced extreme price and
volume fluctuations that have affected the market price of many technology
companies, and that have often been unrelated or disproportionate to the
operating performance of companies.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk represents the risk of loss that may impact our financial position,
results of operations or cash due to adverse changes in market prices, including
interest rate risk and other relevant market rate or price risks.
We are exposed to some market risk through interest rates, related to our
investment of our cash of $1,109,293 at June 30, 2003. Based on this balance, a
change of one percent in interest rate would cause a change in interest income
of $11,093. We do not consider this risk to be material, and we manage the risk
by continuing to evaluate the best investment rates available for short-term
high quality investments.
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. Based on their
evaluation as of the end of the period covered by this report, our
principal executive officer and principal financial officer have
concluded that our disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934) are effective to ensure that information required to be disclosed
by us in reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms.
Notwithstanding the foregoing, and in connection with the Restatement
described in the Explanatory Note to this report, the principal
executive officer and the principal financial officer have concluded
that the manner in which information brought to the attention of senior
management is evaluated for proper recording in the financial
statements should be improved, and the principal executive officer and
the principal financial officer intend to develop new disclosure
controls and procedures toward this end. The principal executive
officer and the principal financial officer will continue to evaluate
the effectiveness of its disclosure controls and procedures on an
ongoing basis, and will take further action as appropriate.
(b) Changes in internal controls. There were no significant changes in
our internal controls over financial reporting identified in connection
with the evaluation described above which occurred during the period
covered by this report which have affected or are reasonably likely to
affect our internal controls over financial reporting
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On May 27, 2003, Horizon Sports Technologies, Inc. d/b/a HST filed a complaint
in the Superior Court of California, County of San Diego, alleging breach of
contract and fraud in connection with the various agreements between us and HST.
HST sought damages of approximately $811,000, plus other unspecified damages. We
answered the complaint
25
with a general denial on June 26, 2003. We and HST reached an agreement in
principle to settle the litigation on August 11, 2003. Accordingly, the Company
has accrued $950,000 at June 30, 2003 as an estimate of the liability associated
with the litigation brought by HST.
On May 23, 2003, we gave notice to eSOUNDideas, Inc. (ESI) of termination of the
license agreement between us and ESI for our HSS technology. The ESI agreement
granted ESI an exclusive right to distribute HSS products specifically targeted
for the point of sale, kiosk, display, event, trade show and exhibit markets in
North America. We based our termination on our belief that ESI has failed to
fulfill certain covenants contained in the license agreement related to efforts
and resources required to maximize the distribution and sales of HSS products in
its product categories. Under the terms of the license agreement, the
termination was effective immediately, but ESI had sixty days to cure conditions
giving rise to termination and reinstate the agreement. ESI did not tender a
cure within such sixty day period, and we consider the agreement to be
permanently terminated.
ESI has retained legal counsel and disputed the grounds for termination, and has
further disputed the termination in October 2002 of stock options to purchase
10,000 shares of common stock granted to each of ESI's two principals for
consulting services that terminated in July 2002. We have agreed to non-binding
mediation of the dispute, which is scheduled to occur on August 28, 2003. No
litigation has been filed in this matter.
Related to the April 2000 purchase of certain loudspeaker technology (NeoPlanar
technology) from Hucon Limited ("Hucon"), we are in dispute with a predecessor
owner of the technology regarding a minimum film royalty for 2002 of
approximately $228,000. The technology purchase agreement provided for a minimum
royalty in 2002 to maintain exclusive film supply. We believe film exclusivity
was terminated and therefore the minimum royalty for 2002 is not due. We have
elected to rely on our intellectual property rights to protect this technology
rather than exclusive supply. Royalties are due on film purchases. Binding
arbitration has been suspended as the parties attempt to settle this matter. No
litigation has been filed in this matter.
From time to time we are involved in routine litigation incidental to the
conduct of our business. Expect as set forth above, there are currently no
material pending legal proceedings to which we are a party or to which any of
our property is subject.
Item 2. Changes in Securities
During the quarter ended June 30, 2003, we issued 267,000 shares upon the
exercise of outstanding common stock purchase warrants, for total proceeds of
$706,220. These securities were offered and sold without registration under the
Securities Act to a limited number of accredited investors in reliance upon the
exemption provided by Rule 506 of Regulation D thereunder, and may not be
offered or sold in the United States in the absence of an effective registration
statement or exemption from the registration requirements under the Securities
Act. An appropriate legend was placed on the shares issued. The shares issued
are included in a currently effective registration statement for their resale.
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's fiscal 2003 Annual Meeting of Stockholders held on May 29,
2003, the following individuals, constituting all of the members of the Board of
Director were elected: Elwood G. Norris, James M. Irish, Terry Conrad, Richard
M. Wagner, David J. Carter and Daniel Hunter. For each elected director, the
results of the voting were:
Affirmative Votes Negative Votes Votes Withheld
----------------- -------------- --------------
Elwood G. Norris 13,660,468 -0- 103,743
James M. Irish 13,661,073 -0- 103,138
Terry Conrad 13,664,443 -0- 99,768
Richard M. Wagner 13,668,968 -0- 95,243
David J. Carter 13,672,643 -0- 91,568
Daniel Hunter 13,672,293 -0- 91,918
Our stockholders also voted to ratify the selection of BDO Seidman, LLP as our
independent auditors for the fiscal year ended September 30, 2003. The results
of the voting on this proposal were:
Affirmative Votes Negative Votes Votes Withheld
-----------------------------------------------------------
13,651,212 68,931 44,068
The foregoing proposal was approved and accordingly ratified.
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Item 5. Other Information
Not applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
31 Certifications of Principal Executive Officer and
Principal Financial Officer as required pursuant to
Section 302 of the Sarbanes-Oxley Act of 2003. *
32 Certification of Chairman and Chief Financial Officer
as required pursuant to Section 906 of the
Sarbanes-Oxley Act of 2003. *
* Filed concurrently herewith.
Reports on Form 8-K
On May 28, 2003, we filed a Form 8-K containing disclosure in Item 5.
On June 6, 2003, we filed a Form 8-K containing disclosure in Item 5
and Item 7.
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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.
AMERICAN TECHNOLOGY CORPORATION
Date: October 1, 2003 By: /s/ RENEE' WARDEN
---------------------
Renee' Warden, Chief Accounting
Officer, Treasurer and Corporate
Secretary (Principal Financial
and Accounting Officer and duly
authorized to sign on behalf
of the Registrant)
27