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| ARUZ.OB > SEC Filings for ARUZ.OB > Form 10-Q on 6-Nov-2009 | All Recent SEC Filings |
6-Nov-2009
Quarterly Report
This report contains forward-looking statements. In addition, from time to time, we or our representatives may make forward-looking statements orally or in writing. We base these forward-looking statements on our expectations and projections about future events, which we derive from the information currently available to us. Such forward-looking statements relate to future events or our future performance. You can identify forward-looking statements because they are not historical in nature. In particular, those statements that use terminology such as "may," "should," "expects," "anticipates," "contemplates," "estimates," "believes," "intends," "plans," "projected," "predicts," "potential" or "continue" or the negative of these or similar terms are forward-looking statements. In evaluating these forward-looking statements, you should consider various factors, including those described in this report. These and other factors may cause our actual results to differ materially from any forward-looking statements.
The following is a listing of important risks, uncertainties and contingencies that could cause our actual results, performances or achievements to be materially different from the forward-looking statements included in this report.
· Our ability to finance our operations on acceptable terms;
· Our ability to retain members of our management team and our employees;
· The success of our research and development activities, the development of viable commercial products, and the speed with which product launches and sales contracts may be achieved;
· Our ability to develop and expand our sales, marketing and distribution capabilities;
· Our ability to adapt to or upgrade our technologies and products as the markets in which we compete evolve;
· Our ability to offer pricing for products which is acceptable to customers; and
· Competition that exists presently or may arise in the future.
Except to the extent required by applicable laws or rules, we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.
Overview
We are a southern California based developer, manufacturer and marketer of premium audio products. Since our business began in 1987, we have focused on the development of innovative and revolutionary magnetic speaker motor designs to deliver high-end audio products to the OEM, home and professional audio markets. We have developed a proprietary portfolio of unique audio speaker technologies as a result of this emphasis on research and development, which we believe has led to strong brand recognition among audiophiles, sound engineers, electronics manufacturers and premium audio manufacturers.
From a product development standpoint, our company has focused its research and development efforts during the last two years on the development of new product lines for the micro-audio market. Specifically, we have developed miniaturized speakers that our tests indicate will deliver sound quality to devices such as laptop computers, flat-panel TVs, display screens, and mobile phones which we believe to be superior to the speakers currently utilized by such devices. Our micro-audio products have been tested and approved by NEC, Quanta, Hewlett Packard and Acer. NEC and Quanta have included our speakers into certain of their new product design specifications. We believe that the market for micro-audio products is significant and we expect continued rapid growth as the consumer appetite for devices such as mobile telephones, computers, televisions and personal digital assistants continues to grow. As of the date of this report, we had a backlog of approximately $750,000 in orders.
Our sales are made primarily on an OEM basis to manufacturers of high end speakers and sound systems. Historically, approximately 51% of our net sales were made to customers outside the United States. We believe that international sales will continue to represent a significant portion of our revenues.
Problems with our Suppliers
We originally utilized Grandford Holdings Ltd. ("Grandford") as the primary manufacturer of our audio products. This relationship was established over 5 years ago. It was based upon the ability of the general manager of Grandford, David Liu, who is the son of Arthur Liu, our Chief Executive Officer, a director and a major shareholder, to provide quality products and timely deliveries to our customers. Historically, Grandford successfully supplied approximately 96% of our finished products without significant problems. As part of our plan for significant expansion and the introduction of microaudio products, we decided to continue using Grandford as our supplier.
Our OEM business is based upon verbal commitments which are subject to our ability to continue to meet customer/product specifications, quality standards and delivery schedules. The customers initiate periodic (usually monthly) purchase orders in increments designed to meet their production schedules. Prior to June 2007, the annual sales volumes of products manufactured by Grandford ranged between $2 million to $3 million. However, we had obtained verbal commitments from major OEM customers such as Amtran ($5.8 million), Softbank ($9.6 million), NEC ($4.5 million) and Quanta ($12.5 million) among others, which far exceeded Grandford's historical monthly production volumes. In June 2007 we obtained the financing necessary to begin initial production of our microaudio products and to expand production of our other products. Grandford assured us that it could ramp-up operations to meet our requirements.
In order to ramp-up production at Grandford's manufacturing facility, we established a temporary prepayment practice which was intended to transition to thirty day terms over a six month period. We made significant advance payments totaling $4,228,038 to Grandford for tools, jigs, molds and raw materials that were needed to produce our products. However, by September 2007 we had received significant complaints regarding late deliveries and it became apparent to us that Grandford did not have the infrastructure to support the required level of production. We attempted to resolve these issues, but we were ultimately unsuccessful and terminated that entity as our primary supplier. During this period, we also established alternative vendors, one of which was Zylux Acoustic Corporation ("Zylux"). Zylux began producing our microaudio products during October 2007.
Zylux made significant commitments to our Chief Executive Officer regarding its manufacturing processes and quality control procedures and had sufficient capacity to meet our customer demands. Accordingly, with appropriate controls and procedures in place, we began directing all of our production to Zylux. However, after only two months we alerted Zylux to the following problems:
· Delivery schedules were not being met, with some models being months late. In one case, only 15,000 pieces of a 40,000 piece order were delivered. In another case, the customer prepaid for 10,500 pieces and received 2,000 pieces. These delivery problems caused a material disruption in the production schedules of our customers. In an attempt to bridge these delays and pacify our customers, we paid to air freight shipments from the manufacturing facility.
· Commercially acceptable quality was never achieved and Zylux was unable to timely correct the deficiencies in the manufacturing process. Reject rates as high as 40% were experienced by our customers with an overall reject rate of about 30%.
The adverse impact on our reputation was significant. Furthermore, at least one of our customers had to add employees to sort through delivered products and perform quality checks on each piece. This caused an additional disruption in the production schedules which had already been disrupted by the late deliveries. As a result of the delivery and quality issues:
· One customer excluded us from bidding on a newly designed speaker with expected volumes in excess of 50 million pieces
· Another customer billed us $18,000 for additional employee costs incurred and put our company on probation whereby any future quality problems would result in termination of our supplier status.
· Actual orders from impacted customers were significantly reduced from the number of orders that were promised while customers wait to see if we can supply microspeakers of acceptable quality.
· Amtran and Softbank terminated their relationship with us completely and Quanta and NEC significantly reduced the volume of their orders and deferred designing our products into the early 2008 models pending our ability to prove we could deliver quality products in a timely manner. In addition, various other customers deferred certification of our products relating to early 2008 models pending our ability to prove we could fulfill their requirements. The approval window for many consumer products is June, July and August. The products are then manufactured in September and October and delivered to retail stores in November and December. If our samples are not delivered, tested and approved during the approval window, we will not be approved as a supplier for the new models. Some industries, such as notebook computers and cell phones, introduce new models on more random cycles but the result is the same - if our samples are not delivered, tested and approved during the window period, we will not be approved as a supplier for that model. When we were experiencing problems with Grandford and Zylux, we missed many approval windows.
Most of the customers who experienced quality problems requested that the defective product be replaced with quality products which met their inspection criteria. Accordingly, we replaced about $640,000 of product at no-charge, the accounting for which resulted in no change to revenue but an additional cost for the replacement product. Only about $14,000 of product was returned for credit. This amount was low because customers need the speakers which are designed into their finished product.
In order to save the company, we were required to search out another manufacturer, again pay the cost of certification, again delay deliveries and walk through starting up new production lines at a new facility.
Our Chief Executive Officer contacted Guoguang Electric Co. Ltd ("GGEC"), a company that was already producing speakers for Bose and Harmin Kardin among others, in an effort to place future production with a supplier with an established record of producing quality speakers for major OEM customers. GGEC has been able to satisfactorily meet the requirements of our customers and we are attempting to rebuild the relationships we lost.
General
Net sales are comprised of gross sales less returns and cash discounts. Our operating results are seasonal, with a greater percentage of net sales being earned in the third and fourth quarters of our fiscal year due to the fall and winter selling seasons.
Cost of goods sold consists primarily of material costs, direct labor, direct overhead, inbound freight and duty costs, warranty costs, sales commission and a reserve for inventory obsolescence.
Research and development costs consist primarily of costs related to new product commercialization including product research, development and testing.
Our selling, general and administrative expenses consist primarily of non-marketing payroll and related costs and corporate infrastructure costs.
Critical Accounting Policies and Estimates
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The reported financial results and disclosures were determined using the significant accounting policies, practices and estimates described in Note 2 to our consolidated financial statements.
Three Months Ended September 30, 2009 compared to the Three Months Ended September 30, 2008
REVENUE
Revenue increased by $1,067,271 or 504% compared to the same prior year period, from $211,629 to $1,278,900. The increase in sales for the current period has been the result of efforts by the Company and GGEC to re-establish relationships damaged by the problems incurred by the Company during 2007 and 2008 with two previous suppliers, Grandford Holdings and Zylux. Please see our discussion above titled "Problems with our Suppliers". While the prior year results reflected the problems of the time, the current period results reflect significant progress in re-establishing the Company with prior customers and responding to new opportunities with new customers. The largest increase has come in applications which utilize our newly redesigned mini-speakers such as notebook computer manufacturers. Speakers which utilize our NRT Technology have also experienced a significant increase in demand due to a focused marketing effort and our ability to provide quality products on a timely basis with our current supplier, GGEC.
GROSS PROFIT (LOSS)
Cost of sales for the three months ended September 30, 2009 was $1,211,353 as compared to cost of sales of $194,155 for the three months ended September 30, 2008, which resulted in a gross profit for the current quarter of $67,547, compared to $17,474 during the prior year period. With the emphasis on re-establishing credibility with our OEM customers, additional time and cost has been incurred to insure that quality standards are met. The result has been to defer significant profitability improvements while insuring the establishment of a disciplined and consistent quality assurance program and timely deliveries of finished products to our customers. A significant reduction in the reject rates and improved vendor acceptance of our products has resulted in an improved backlog which has increased to approximately $750,000 as of September 30, 2009.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses for the quarter ended September 30, 2009 totaled $125,828, a reduction of $163,267 or 56% from the $289,095 incurred for the same prior year period. This reduction is the result of a cost reduction program which resulted in a reduction of salaries and related expenses. Research and development costs consist primarily of salaries and related expenses associated with designing and testing new speaker designs for new applications and redesigning old speaker designs for new customers and applications. While a short-term cost reduction program was deemed appropriate under the circumstances, development of new and customer specific products is the life line of the Company and as such the Company expects to continue to incur research and development costs for the foreseeable future.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses for the quarter ended September 30, 2009 decreased by $27,068 or 6% to $429,783 as compared to $456,851 for the quarter ended September 30, 2008. Affecting the current year period was a reduction in legal expenses and the cost reduction program implemented during the period which resulted in the reduction of about 40% of the work force in the US and a reduction of about 20% in the workforce in Taiwan and China. We expect our costs of administration will continue to be significant due to the costs of regulatory compliance as a public company, in addition to the expected incremental costs related to volumetric increases in the manufacturing and sale of audio speakers and other equipment.
INTEREST EXPENSE
Net interest expense totaled $44,096 in the quarter ended September 30, 2009 compared with net interest expense of $38,981 for the quarter ended September 30, 2008. Current interest charges relate primarily to the loans from GGEC which totaled $1,253,558 as of September 30, 2009 and to notes payable to InSeat Solutions LLC, a company owned by our President and Chief Executive Officer, which amounted to $1,264,527 as of September 30, 2009.
INCOME TAXES
We have significant income tax net operating loss carry forwards; however, due to the uncertainty of the realizability of the deferred tax asset, a reserve equal to the amount of deferred tax benefit has been established as of September 30, 2009 and September 30, 2008. Accordingly, no income tax benefit has been reflected for either period.
NET LOSS
As a result of the above, there was a net loss for the three month period ended September 30, 2009 of $532,160 compared to a net loss of $767,453 during the same period in the prior year.
As of September 30, 2009, our current liabilities exceeded our current assets by
$4,893,700 compared to a deficit of $4,364,480 as of June 30, 2009. As
previously discussed, during the current year we have worked closely with GGEC
in focusing our efforts on transitioning relationships with existing customers
and establishing relationships with new customers in addition to insuring a
disciplined quality assurance program both of which we believe are necessary for
us to grow as a company and meet the demands of our customers. Progress in
gaining re-acceptance has been gaining momentum as reflected in the increased
sales revenue and a backlog which has improved to about $750,000 as of September
30, 2009. The JIT inventory program for Quanta has been successful for both
Quanta and the Company by providing longer runs and more efficient production
scheduling while not resulting in a significant increase in inventory.
Production for the 2010 models is expected to begin during late 2009 and the
beginning of 2010. Indications are that the Company has made significant gains
in acceptance and trust with key customers. We expect to see a continuing
increase in our backlog and believe that we have now established a solid
foundation for the expected growth of the Company.
Net cash used in operating activities during the three months ended September 30, 2009 was $70,046 as compared to net cash used of $49,464 during the same period in the prior year. This was due primarily to an increase in accounts receivable and the net loss from operations mostly offset by an increase in accounts payable (mainly to GGEC), an increase in accrued expenses (mainly interest)and an increase in the amounts due to an affiliate.
Cash used in investing activities for the three months ending September 30, 2009 was $1,212. Cash used in the period was primarily used for the purchase of various tools, jigs and dies for use in the production of customer products. There was no cash used in investing activities during the same prior year period.
There was no cash provided by financing activities for the three month period ended September 30, 2009. Cash provided by financing activities during the period ended September 30, 2008 was $155,607. The net cash provided during the prior year period was primarily the result of advances from GGEC of $150,421. Also reflected in the prior year period was the repayment of the credit facility with the proceeds of the restricted cash deposit.
We had net operating loss carry-forwards of approximately $26,933,781 as of September 30, 2009, which will expire in various amounts through the year 2029. Based upon historical operating results, management has determined that it cannot conclude that it is more likely than not that the deferred tax is realizable. Accordingly, a 100% valuation reserve allowance has been provided against the deferred tax benefit asset.
In September 2007, we executed a $10.0 million one-year accounts receivable credit facility and a one year $2.0 million fixed deposit credit facility with Bank SinoPac in order to insure resource availability. On September 25, 2008, we repaid our credit facility in full. We are currently in discussions with Bank SinoPac for the establishment of a new credit facility. On October 8, 2008, GGEC entered into a non-binding letter of intent directed at a possible transaction whereby GGEC would acquire a 55% interest in AuraSound, Inc. During the evaluation period, GGEC agreed to fund up to $150,000 per month for current operating costs until the transaction is either consummated or terminated. As of September 30, 2009, GGEC had advanced $1,253,558 under the terms of that agreement. While we believe that our long-term prognosis with GGEC as a financial partner is very positive, there can be no guarantees that the transaction with GGEC will be consummated or that the Company will be able to attract another financial partner or arrange for alternative financing in the absence of a transaction with GGEC. If the Company is unable to obtain financing for its working capital requirements, it may have to curtail its business sharply or cease business altogether.
Management believes that production and expansion of product lines during the next twelve months will need to be funded by third party financing, such as through loans, the sale of our securities or some combination of both.
INFLATION
Management believes that inflation generally causes an increase in sales prices with an offsetting unfavorable effect on the cost of products sold and other operating expenses. Accordingly, with the possible impact on interest rates, management believes that inflation will have no significant effect on our results of operations or financial condition.
OFF-BALANCE SHEET ARRANGEMENTS
We currently do not have any off-balance sheet arrangements or financing activities with special purpose entities.
GOING CONCERN STATUS
The accompanying financial statements have been prepared on a going concern basis which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. During the three month period ended September 30, 2009, the Company incurred losses of $532,160. The Company had an accumulated deficit of $36,132,002 as of September 30, 2009. The Company has never been profitable and there can be no assurances that it will ever be profitable or that it will survive as a public company.
If the Company is unable to generate profits and unable to continue to obtain financing for its working capital requirements, it may have to curtail its business sharply or cease business altogether.
The financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to retain its current short term financing and ultimately to generate sufficient cash flow to meet its obligations on a timely basis in order to obtain additional financing, and ultimately to attain profitability.
On October 8, 2008, the Company entered into a non-binding letter of intent with GGEC pursuant to which GGEC may acquire a 55% interest in AuraSound, Inc. During the evaluation period, GGEC agreed to fund up to $150,000 per month for current operating costs until the transaction is either consummated or terminated. The process of obtaining regulatory approval from the government of China was completed and approval has been received. GGEC is in the final stages of its due diligence investigation however if for any reason GGEC determines not to proceed with the contemplated transaction, the Company would not have sufficient funding to continue in business and would be forced to curtail operations or find alternative funding.
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