-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Fa4fWpWPaJoS3g5Lxxvr0HHl55R0KrZP/4Z9qcW48WuR2H9vdDxmlE3rfJ554ytF 0Bf7rzck0+8dFLruXi89iA== 0000944209-98-000432.txt : 19980226 0000944209-98-000432.hdr.sgml : 19980226 ACCESSION NUMBER: 0000944209-98-000432 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980225 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIGITAL SOUND CORP CENTRAL INDEX KEY: 0000718576 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 953222624 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-18280 FILM NUMBER: 98549277 BUSINESS ADDRESS: STREET 1: 6307 CARPINTERIA AVE CITY: CARPINTERIA STATE: CA ZIP: 93013 BUSINESS PHONE: 8055662255X2154 MAIL ADDRESS: STREET 1: 6307 CARPINTERIA AVE CITY: CARPINTERIA STATE: CA ZIP: 93013 10-K405 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) (X) Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 [FEE REQUIRED] For the fiscal year ended December 31, 1997. OR ( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 [FEE REQUIRED] For the transition period from __________________ to _________________ Commission File Number: 0-18280 ------- DIGITAL SOUND CORPORATION ----------------------------------------- (Exact name of Registrant as specified in its charter) California 95-3222624 - ------------------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer) incorporation or organization) Identification No.) 6307 Carpinteria Avenue, Carpinteria, California 93013 - ------------------------------------------------ ---------------- (Address of principal executive offices) (Zip Code) (805) 566-2000 --------------------------------------------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None ---- Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value -------------------------- (Title of class) Indicate by check mark whether Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --------------- --------------- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] The aggregate market value of Registrant's voting stock held by non-affiliates of the Registrant as of January 22, 1998 was approximately $28,967,294 The number of shares outstanding of Registrant's common stock as of January 22, 1998: 20,561,593. Documents Incorporated by Reference: - ------------------------------------ Part of the following document is incorporated by reference to Part III of the Form 10-K Report: Proxy Statement for Registrant's 1998 Annual Meeting of Stockholders (the "1998 Proxy Statement"). DIGITAL SOUND CORPORATION Annual Report on Form 10-K December 31, 1997 TABLE OF CONTENTS
PART I Page ---- Item 1. Business.............................................................................. 1 Item 2. Properties............................................................................ 7 Item 3. Legal Proceedings..................................................................... 7 Item 4. Submission of Matters to a Vote of Security Holders................................... 8 Executive Officers of the Registrant.................................................. 9 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................. 10 Item 6. Selected Financial Data............................................................... 11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................................................. 12 Item 8. Financial Statements and Supplementary Data........................................... 17 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................................................. 28 PART III Item 10. Directors and Executive Officers of the Registrant.................................... 29 Item 11. Executive Compensation................................................................ 29 Item 12. Security Ownership of Certain Beneficial Owners and Management........................ 29 Item 13. Certain Relationships and Related Transactions........................................ 29 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................ 29 Signatures ............................................................................................ 31
- -------------------- Trademarks - Digital Sound(R), VoiceServer(R), VoiceForms(R), MessageNet(R), UNIVOX(R), InfoMail(R) are registered trademarks of the Company. UNIX(R) is a registered trademark of Novell Inc. Ethernet(TM) is a trademark of Xerox Corporation. MediaCom(TM) is a trademark of Bellcore. Windows NT(R) is a registered trademark of Microsoft Corporation. VoiceView(R) is a registered trademark of Radish Communications Systems, Inc. PART I IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN THE SECTION ENTITLED "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- FACTORS THAT MAY AFFECT FUTURE RESULTS." READERS SHOULD CAREFULLY REVIEW THE RISK FACTORS DESCRIBED IN OTHER DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE COMMISSION, INCLUDING THE QUARTERLY REPORTS ON FORM 10-Q AND ANY CURRENT REPORTS ON FORM 8-K. ITEM 1. BUSINESS -------- Digital Sound Corporation, a California corporation, designs, manufactures and markets high-capacity, network-based enhanced services solutions. The Company has two product lines, the new product line and the existing product line. The new product line is the PulsePoint(TM) Enhanced Application Platform and Communication-Management Suite of Applications and is sold to telecommunications network service providers, worldwide. The existing product line is the VoiceServer(R) Family of Multimedia Messaging Products and is sold to telecommunications network service providers and large corporations, worldwide. Both the PulsePoint Enhanced Application Platform and Applications and VoiceServer(R) products integrate voice, fax and e-mail messaging applications on a single platform for implementation with telephony and data networks to enable Unified Messaging. Unified Messaging enables senders to send and receive messages using telephones, cellular phones, fax machines or screen-based devices, such as desktop or portable personal computers. The PulsePoint Enhanced Application Platform functions in a traditional voice/fax, data and computer/telephony environment. The VoiceServer(R) platform functions in a traditional voice/fax environment. The Company sells its products primarily into the public service provider market and secondarily into the customer premises equipment (CPE) market through a variety of channels. These channels include direct and indirect sales. Complementing a direct sales effort, the public enhanced services markets are served by indirect channels, including original equipment manufacturers (OEMs) and value added resellers (VARs). Indirect distributor channels serve the CPE market. The public service provider market includes a broad array of established and emerging carriers that provide voice and data services to business and residential customers. These providers offer enhanced application services to increase adoption, to reduce churn of their customer base and to provide strategic differentiation of their basic services. These enhanced services are comprised of communication-management applications, which include voice, fax and e-mail messaging, and are provided using enhanced services solutions located at or connected to the telephone company's central switching offices or voice/data access servers. The CPE market encompasses communication-management applications, which include voice and fax messaging, in which the voice messaging system is installed on the customer's premises and is integrated with the customer's private branch exchange systems. On December 19, 1997, the Company consummated a private placement of the Company's convertible securities with certain investors (collectively, the "Investors") for an aggregate of approximately $20 million pursuant to a Preferred Stock Purchase Agreement (the "Purchase Agreement"). Pursuant to the Purchase Agreement, the Company (i) sold for cash (A) 1,785,000 shares of the Company's Series B Convertible Preferred Stock and (B) $6,612,502.50 aggregate principal amount of the Company's Convertible Promissory Notes (the "Notes" and together with the Series B Convertible Preferred Stock, the "Securities") and (ii) exchanged the 2,631,579 shares of Series A Convertible Preferred Stock held by affiliates of Oak Investment Partners ("Oak") for 666,667 shares of the Series B Convertible Preferred Stock. Each share of Series B Convertible Preferred Stock is convertible into 10 shares of Common Stock, subject to certain antidilution adjustments. The Notes were issued because the Company did not have an adequate number of shares of the underlying Common Stock authorized to permit the conversion of the entire $20 million of Series B Convertible Preferred Stock. The Company sold the Securities at a price of $0.75 per share of Common Stock on an as-converted basis. The Notes automatically convert into the Series B Convertible Preferred Stock if the Company's shareholders approve an amendment to the Company's Ninth Amended and Restated Articles of Incorporation authorizing a sufficient number of shares of Common Stock to permit conversion of all of the Series B Convertible Preferred Stock issuable upon conversion of the Notes ("Shareholder Approval"). Such amendment is being submitted to the Company's shareholders for approval at the Company's 1998 annual meeting. One of the Investors was Microsoft Corporation, which purchased an aggregate of $5 million of the Securities. Affiliates of Oak also purchased an aggregate of $5 million of the Securities. PRODUCTS The Company's products use a common architecture, design and technology and common hardware and software. The PulsePoint Enhanced Application Platform is based on Microsoft(R)'s Windows NT(R) Server operating system, other Microsoft technologies, products from Dialogic Corporation and a variety of other technology providers. The platform is a highly-available, scalable, open-system platform with an application development environment using state-of-the-art computer industry solutions to enable rapid creation of integrated services. Accompanying the platform is a Communication-Management Suite of Applications that help end users communicate more effectively during real-time and non-real-time communications. The VoiceServer(R) is a single-unit, multimedia, and multiple-application platform. Its single-system design allows multiple applications to share resources, including ports, storage and digital signal processors. This fully integrated design enables new applications to be added efficiently, while reducing system costs. Since the VoiceServer(R) is completely self-contained, downtime is reduced, reliability is increased, and ease of service is enhanced. Hardware Products The Company's PulsePoint Enhanced Application Platform is comprised of third party, open-system hardware and software components, which are combined with the company's proprietary middleware software. This platform is designed for the messaging needs of small- to large-sized public service providers and resellers. Its architecture supports a wide variety of port capacities from tens to thousands of ports. The Company's VoiceServer(R) family of products includes the following hardware platforms: VoiceServer(R) 2110 - Designed for the messaging needs of medium- to large-sized organizations and the voice and fax messaging needs of small- to medium-sized independent telephone companies ("telcos") and service bureaus. It supports up to 25,000 mailboxes and provides from 8 to 120 voice ports. VoiceServer(R) 3110 - Designed specifically for the unified messaging needs of large-sized telco central offices, it supports up to 50,000 mailboxes and provides up to 240 voice ports. Software Products and Applications The Company's new software products offer a spectrum of features, including voice and fax messaging, call processing and call delivery. These applications are written to run on Microsoft's Windows NT Server operating system using Microsoft's Visual Studio integrated with Digital Sound's application creation tools. The Company currently has the following software applications available: PulsePoint Messaging Application -- PulsePoint Messaging Application provides messaging services for public enhanced services markets such as Competitive Local Exchange Carriers and Internet Service Providers. A completely new implementation, it includes flexible administration, a high-performance object-oriented database for subscriber data and D/COM interfaces. It is a highly flexible implementation that will allow the Company to meet the requirements of service providers as they address the needs of their customers. The Company's existing software products offer a spectrum of features, including voice, fax and e-mail messaging, call processing, call delivery and audiotex services. In addition, the Company offers enhanced speech technology products, such as name-to-speech and speaker-independent recognition. These applications are written for the UNIX System V operating system with proprietary extensions (together called UNIVOX(R)) which provides voice, fax and e-mail processing, multi-tasking capabilities and real-time processing extensions in a single package. InfoMail(R) 4.0 -- InfoMail is the Company's full-featured voice/fax messaging product for CPE and public enhanced services markets. It includes advanced voice mail features and offers flexible administration. InfoMail serves as a platform for storing and retrieving voice and fax messages. InfoMail offers integrated fax messaging, on-line tutorial, guest mailboxes, scheduled future delivery of messages up to one year in advance, non-delivery notification, name delivery, a personal reminder interface for users, user programming of calls to other extensions and group distribution lists. Fax Mail -- Integrated with the InfoMail application, fax mail lets users access a single mailbox for receiving and forwarding fax messages, allowing the user to control when, where and how faxes are received. Voice comments can be "attached" as a "voice cover sheet" and deposited as a single mixed-media message in the subscriber's mailbox. Fax Overflow -- Integrated with the InfoMail application, this application allows VoiceServer(R) to intercept incoming faxes when the receiving fax machine is busy or out of service, storing them until the machine becomes available, and then delivering to the fax machine. Hands-Free Operation -- The Hands-free feature is provided as an InfoMail software option. It allows users to save or delete new messages through the use of spoken commands. It is especially convenient for cellular users. Spoken Password -- Spoken password is an InfoMail feature that allows subscribers to access their voice mailboxes by speaking passwords rather than using touch-tone key presses. InfoMail Express(TM) -- InfoMail Express integrates Internet e-mail with the InfoMail multimedia platform to provide full unified messaging for the public enhanced services market, and extends the unified messaging services of InfoMail to personal computers. With InfoMail Express, users of personal computers running Microsoft's Windows 95 and Internet Explorer can visually access mailboxes on InfoMail Express to review voice, fax and e-mail messages. MessageNet(R) -- The MessageNet option of InfoMail is the first high-speed digital networking software for voice mail that is based on X.400, the industry standard for message exchange. X.400 was selected because it supports the transmission of voice, fax and e-mail. MessageNet provides the complete InfoMail feature set, including real-time address confirmation of up to one million users. Inter-Vendor Networking -- These options provide the industry-standard protocols for digital and analog transmission of messages among voice messaging systems from different vendors. Audio Messaging Interchange Specification (AMIS) networking allows for message exchange between remote VoiceServer(R)s and any manufacturer's voice messaging system that utilizes the AMIS protocol. CallController(TM) -- CallController provides call-processing capabilities, which allow callers to route their calls to a specific destination by listening to voice menus and entering responses on a telephone keypad. When integrated with InfoMail, the caller can leave a voice message when encountering a busy line or no answer when dialing an extension. As a flexible call processing and audiotex application, CallController enables companies to program various greetings. VoiceForms(R) -- VoiceForms is an option to InfoMail that permits customers to create and complete forms using the telephone. Like written forms, the VoiceForms option asks specific questions and provides "electronic space" for either voice or touch-tone key press responses. VoiceForms prompts callers to leave necessary information, such as purchasing data and sales contact reports. Completed VoiceForms are stored as voice messages for later transcription and compilation. VoiceForms can also be used to provide information to callers, such as job openings on a "voice" bulletin board. Audiotex/Bulletin Boards -- This application allows companies to combine InfoMail, CallController and VoiceForms to create voice information lines that provide information, such as hours of operation, job postings, and directions, among others. The following application enablers are available as a part of the Company's VoiceServer(R): Voice Development Server (VDS) -- VDS is a software tool-kit designed to aid VARs and OEMs in the development of customized voice and fax applications. VDS is well suited for developers because it allows them to take advantage of the flexible UNIX operating environment to build voice and fax applications in a high-level programming language. Speaker-Dependent Speech Recognition -- This application enables developers to create applications that use spoken input instead of touch-tone key press. Used in applications that require security, it is used in InfoMail to allow users to speak a password to access their voice/fax mailbox. It can be used for voice-controlled transcription of VoiceForms in which users direct the system with verbal commands rather than by touch-tone key presses, leaving hands free for word processing. This capability simplifies the transcription task and increases user productivity. Speaker Verification -- Speaker Verification is a form of speaker-dependent recognition that confirms the identity of a speaker. The spoken password of a caller is analyzed using complex algorithms within the system, which validate or reject the password, offering an additional level of security in voice messaging and call processing applications. Speaker-Independent Speech Recognition -- This enables developers to create applications that allow users to respond to prompts with spoken "yes/no" commands instead of touch-tone key presses. It is used with InfoMail's Hands-Free interface for cellular phone users. It is used in Directory Assistance (411) applications that offer "call completion" when they respond "yes" or "no". Continuous Speaker-Independent Recognition of Digits 0-9 -- This enables developers to create applications that use spoken input instead of touch-tone key presses. It is used for applications such as voice-activated dialing and credit card and personal identification number collection. It does not require speakers to pause between spoken numbers. Name-to-Speech -- This converts text names into computer-synthesized speech. Digital Sound has developed special algorithms to optimize the pronunciation of proper names across a wide range of ethnic backgrounds. Name-to-speech technology is used in InfoMail Express to speak the name of an e-mail sender over the telephone. It can be used to provide spoken name confirmation to a voice mail subscriber sending a message to a subscriber on a remote, networked system. MessageExpress(TM) -- This sophisticated protocol is designed to run over various wireline and wireless protocols, such as TCP/IP, ISDN, VoiceView, and X.25. Client software that resides on a personal computer, which communicates with InfoMail Express server using the MessageExpress protocol. SmartAnswer(TM) -- Digital Sound's patent-pending digital signal processing (DSP) technology automatically determines whether an incoming call is from a telephone, fax machine or computer and provides the appropriate response--voice prompts, fax tone or remote log-in, respectively. This capability is used for one-number deposit and retrieval of unified messages. Datacom Interfaces The Company provides the data communications interfaces listed below for the PulsePoint Enhanced Application Platform and Communication-Management Suite of Applications. These interfaces enable the PulsePoint Platform to work in conjunction with a variety of data packet and circuit-switched networks. . TCP/IP -- A communications protocol for internetwork routing and reliable message delivery. . SNMP -- An open-network management surveillance protocol. . Protocols supported by Dialogic's DM3(TM) Quad Voice Span products The Company provides the data communications interfaces listed below for the VoiceServer(R) product family. These interfaces enable the VoiceServer(R) to work in conjunction with a variety of data processing and office automation systems. . RS232 -- An industry-standard mechanical and electrical interface for computers and communications line and devices. . Ethernet -- A standard for high-speed data communications over a local area network. . X.400 -- An industry standard for electronic message exchange, which the Company has adapted for voice mail networking. . TCP/IP -- A communications protocol for internetwork routing and reliable message delivery. . SMTP -- A standard protocol for transferring electronic mail messages from one computer or network to another. Simple Mail Transfer Protocol specifies how two mail systems interact and the control message format they use to transfer mail. SWITCH INTEGRATIONS The Company's existing systems have been integrated with most major telephone switching systems, including systems offered by Lucent Technologies Inc., Ericsson Inc., GTE Corporation, NEC Corporation, Northern Telecom Limited, Intecom, ROLM, a division of Siemens AG (ROLM), and Siemens AG, Public Communication Networks Group. The Company's systems are also compatible with most major central office switches, including those manufactured by Lucent Technologies Inc., Ericsson, Inc., GTE Corporation, Motorola, Inc. and Northern Telecom Limited. 1997 PRODUCT DEVELOPMENT To further strengthen its product line, the Company continued to incorporate new hardware and software technologies into the VoiceServer(R) product line. During 1997 the Company continued development of an entirely new enhanced application platform and applications for public enhanced services markets. The Company continued to invest in upgrading the skills of the engineering organization. The Company's engineering and development group included 54 employees at December 31, 1997. During the years ended December 31, 1995, 1996 and 1997 the Company spent approximately $7.2 million, $8.9 million and $12.2 million, respectively, on engineering and development. To date, all of the Company's engineering and development expenses, including software development costs, have been charged to operations as incurred. 1998 PRODUCT DEVELOPMENT OUTLOOK In 1998, the Company will focus development activities on adding to its new product offerings. Specific focus will be on leveraging the rapid application tools to round out the applications in its Communication-Management Suite of Applications. QUALITY ASSURANCE AND MANUFACTURING Digital Sound satisfies the requirements of one of the most rigorous international quality standards, ISO 9001, as indicated by the 1995 registration to ISO 9001 of its company-wide quality management system. The ISO 9000 series of standards represents an international consensus on the essential features of a quality system to ensure the effective operation of any business, and more than 90 countries have adopted the ISO 9001 series as national standards. There have also been two large regional adoptions, CEN (European Committee for Standardization) and COPANT (the Pan-American Standards Commission). The Company believes its certification to the most stringent level of the series (9001) provides significant competitive advantage, and the quality management system implemented in support of the certification effort ensures that procedures are implemented and responsibilities defined to provide all employees with the ability to pursue continuous quality improvement in meeting customer requirements. Quality First, the Company's Total Quality Management program, was initiated in 1991 and has continued to provide improved performance and enhancement of the quality levels of the Company's products and services. The program has been extended to include major customers through the Partnering for Quality Program. The Company's manufacturing operations consist principally of final assembly and testing of subassemblies and systems. The Company uses independent manufacturers to perform printed circuit board assembly, building of cabinets and subassemblies and sheet metal fabrication. These suppliers all satisfy the strictest quality standards such as ISO or MIL-SPEC. Although the Company generally uses standard parts and components in manufacturing its products, certain components, primarily power supplies, disk drives, interface cards and certain semiconductors are presently available only from a single source or from limited sources. To date, the Company has been able to obtain adequate supplies of these components in a timely manner from existing sources. However, delay or lack of supply from existing sources or the inability to develop alternative sources, if and as required in the future, could adversely affect the Company's operating results. At December 31, 1997, the Company's quality assurance and manufacturing group included 19 employees. CUSTOMER SUPPORT, SALES AND MARKETING The Company sells its products into the public enhanced services market and the CPE market. The enhanced services market consists of local exchange carriers, including the Regional Bell Operating Companies ("RBOCs"), Post Telephone and Telegraphs ("PTT's", providers of telephone and telecommunications services in most foreign countries), independent telephone companies, service bureaus, inter-exchange carriers, cellular service providers and internet service providers. The Company has distribution agreements with Siemens, AG of Germany, GPT Limited of Coventry, England, and Consultronix Systems Corporation of the Philippines, PT Galva of Indonesia, Intecom and Volt-Delta. The CPE market consists of major corporations, such as Southern Pacific/Union Pacific Railroad, Baxter Health Care, the Discovery Channel, Gordon Foods, The Boston Herald, Polaroid and Motorola. It also consists of state and local governments, such as the County of Los Angeles, County of Riverside and the State of Oregon and universities such as the University of California campuses at Berkeley, San Diego and Santa Barbara. To date, over 1,895 systems have been sold to customers in the United States, Canada, the United Kingdom, France, the Dominican Republic, Indonesia, Mexico, Malaysia, Russia, and the Philippines. Customer service and support are of great importance to the Company. The Company believes that customer satisfaction is achieved through continued high levels of quality service and support. The Company's customer support group includes field engineers, applications specialists, implementation specialists and third party maintenance providers and is supported by a training staff and the Company's entire technical staff when necessary. The Company maintains a 24-hour service and support center at its Carpinteria facility. The Company has an extensive field service organization with offices strategically located throughout the United States to provide on-site emergency assistance should the need arise. Most customers' problems are resolved over the telephone by remote diagnostic and corrective actions. The Company maintains a training center at its Carpinteria facility to support the needs of its customers for instructional, administrative and technical training. Additionally, the Company maintains a staff of highly qualified trainers available to support customers' requests for on-site training at all levels. Prior to equipment delivery, training and implementation, personnel are made available to the customer to ensure a smooth installation, with follow-up visits performed to reinforce previous training and answer new questions. The training organization also offers technical software, system maintenance, customer support and administrative courses. The Company's customer support, sales and marketing group included 66 employees at December 31, 1997. During the year ended December 31, 1995, GTE and Pacific Bell Information Services Group accounted for 46.8% and 12.6%, respectively, of the net sales for the Company. During the year ended December 31, 1996, GTE; PT Galva, Indonesia and GPT, England accounted for 39.8%, 13.3% and 10.5%, respectively, of the net sales for the Company. During the year ended December 31, 1997, GTE accounted for 58.3% of the net sales for the Company. Export sales, principally to Canada, Europe and Indonesia, during the years ended December 31, 1995, 1996 and 1997 accounted for 1.6%, 26.0% and 5.3%, respectively, of the Company's net sales. The percentage decrease in export sales for 1997 was principally a result of the uncertainties surrounding the Asian economies. These sales depend on the Company's continued ability to meet agreed milestones, specifications, requirements and conditions of sales contracts in a timely manner. The Company's goal is to meet these requirements as agreed with each customer, however, forward-planning involves risk; there can be no assurance that it will do so or realize the corresponding revenue. The Company currently maintains support and sales offices and/or has sales or technical support representatives in the following locations: Phoenix, Arizona; Irvine, California; Carpinteria, California; San Francisco, California; San Diego, California; Roswell, Georgia; Chicago, Illinois; Tyngsboro, Massachusetts; Irving, Texas; Coventry, England; Munich, Germany; and Kualu Lumpur, Malaysia. The Company provides a system product warranty for parts and labor for a 12-month period after commencement of operations or 13 months from date of shipment, whichever occurs first. The Company offers several options for maintenance and support services of its products on a contractual basis after the limited product warranty has expired. Additionally, the Company offers a performance guarantee for the VoiceServer(R), which guarantees the system performance will not deteriorate under maximum load conditions. Otherwise, the Company will re-configure the system or replace it at no cost to the customer. BACKLOG The Company's backlog at December 31, 1997 was $1.5 million compared to $1.6 million at December 31, 1996. The Company includes in backlog orders for products or services to be shipped or performed within 180 days. Quarterly revenues and operating results will depend on the volume and timing of new orders received during a quarter, which are difficult to forecast. Because of the possibility of customer changes in delivery schedules or cancellation of orders, the Company's backlog as of any particular date may not result in actual sales for any future period. COMPETITION The messaging industry is highly competitive and the Company believes that competition will intensify as the industry grows, matures and consolidates. The Company competes with different companies in the different customer markets it serves and the principal competitive factors vary depending on the customer market. Digital Sound focuses primarily on selling its products in the domestic and international public enhanced services markets. Principal competitive factors are reliability, scalability and the ability to offer a rich suite of integrated multimedia applications on one platform. In the public enhanced services market, the Company's principal competitors include Lucent Technologies Inc., Comverse Technology Inc., Brite Voice Systems Inc., InterVoice, Inc., Glenayre Technologies Inc, Unisys and Centigram Communications Corporation. The Company continues to develop enhancements to its products and to develop new products in order to address what the Company believes are the emerging requirements of the telephone companies and other telecommunication service providers. However, there can be no assurance that product requirements will not change as this market develops or that other companies will not be faster or more successful in bringing comparable products to market. In the CPE market, the Company competes primarily with two types of companies: PBX manufacturers, including Lucent, Nortel Limited and Siemens Rolm Communications, Inc.; and independent voice processing manufacturers, such as Centigram, Active Voice Corp. and Applied Voice Technology, Inc. In the CPE market, the Company has indirect competition from a wide variety of products, including stand alone voice mail systems, products offering call processing services with voice mail features. In addition, the Company has indirect competition from products integrated with other voice mail systems, such as personal computer modems and software designed to furnish voice processing and voice messaging features. Competitive factors include system performance and reliability, service and support and the capability to integrate systems with a variety of central office and cellular switches and other communications systems. The Company believes that its competitive strengths include carrier-class reliability and scalability, a modular and integrated suite of communication-management applications, a rapid application creation environment, state-of-the-art digital networking, software-embedded signaling technology, easy-to-use interfaces, and the ability to integrate with the switches of multiple manufacturers. In the public enhanced services and CPE markets, these competitors and other new entrants may introduce and deliver new products with expanded capabilities that could adversely affect the competitive position of the Company. The Company believes competition for the sale of voice processing systems in its markets will continue to evolve as customers' applications and technology become more sophisticated. Some of the Company's competitors have substantially greater development, marketing and capital resources than the Company. PATENTS, COPYRIGHTS AND TECHNOLOGY LICENSES The Company policy on intellectual property is to develop, utilize and protect its patents, trademarks, copyrights and trade secrets in order to maximize the value of the Company's technological expertise and innovation. The Company holds four United States patents and has three patent applications pending. The Company also has one foreign patent and ten foreign patent applications pending. The Company has registered a number of trademarks in the United States and has a number of trademark applications pending both in the United States and in foreign countries. The Company's software is protected by copyright and trade secrecy laws. However, such protection does not ensure that the Company's competitors will not develop similar technology. The Company periodically acquires technology from third parties to supplement its development efforts. These acquisitions may require prepaid license fees and/or the payment of royalties. The Company holds a perpetual license from AT&T for the UNIX operating system. EMPLOYEES At December 31, 1997, the Company had 155 employees, including 66 in sales, marketing and customer support, 54 in engineering and development, 19 in quality assurance and manufacturing and 16 in corporate administration and finance. Many of the Company's employees are highly skilled, and the Company's success will depend in part on its ability to attract and retain such employees. The Company has never had a work stoppage. No employees are represented by a labor organization and the Company considers its employee relations to be good. ITEM 2. PROPERTIES ---------- The Company's corporate offices, engineering and development facilities and manufacturing facilities are located in Carpinteria, California, in a total of approximately 53,000 square feet. In December of 1996, the Company entered into a new lease and consolidated into half of the facility that it currently occupies. The move resulted in a savings of approximately 45.0% of the previous annual lease payments. The facility is leased for a period of ten years beginning in December 1996, with two five-year renewal options. Annual rental on the facility was approximately $0.7 million in 1997, with the rent subject to annual increases. The Company currently maintains support and sales offices and/or has sales or technical support representatives in the following locations: Phoenix, Arizona; Irvine, California; Carpinteria, California; San Diego, California; San Francisco, California; Roswell, Georgia; Chicago, Illinois; Tyngsboro, Massachusetts; Irving, Texas; Coventry, England; Munich, Germany; and Kualu Lumpur, Malaysia. The Company believes that its current facilities are well maintained and sufficient to satisfy its operations for the next several years. ITEM 3. LEGAL PROCEEDINGS ----------------- In 1992, Octel Communications Corporation (Octel, now Lucent Technologies, Inc), a competitor of the Company, filed suit in the United States District Court for the Northern District of California against Theis Research, Inc. (Theis) for a declaratory judgment that Octel's products do not infringe certain patents held by Theis and that those patents are invalid. In 1993, the court consolidated several actions and Theis filed a counterclaim for infringement, a judgment of patent validity and various claims for injunctive and monetary relief against, among others, Pacific Telesis Group, Pacific Bell and other Pacific Bell entities (Pacific Telesis). Pacific Telesis tendered defense of this action to various of its vendors, including the Company, which resulted in counterclaims by Theis against the Company, Octel, Boston Technology (now Comverse Technology Inc), Northern Telecom and most other manufacturers of voice mail products. In 1993, the court severed trial of the counterclaims against all counter defendants except Octel, Comverse and Northern Telecom. In 1994, a jury concluded that the patents held by Theis Research, Inc. were either invalid or not infringed upon by Octel, and the counterclaims against Pacific Telesis in which Digital Sound has intervened are currently stayed. Theis Research appealed the findings of invalidity and noninfringement to the U.S. Court of Appeals and on November 6, 1997 the U.S. Court of Appeals affirmed the District Court's decision in its entirety. Theis Research has until March 30, 1998 to seek to have the matter heard before the U.S. Supreme Court. If Theis Research is granted a hearing before the U.S. Supreme Court and the U.S. Supreme Court reverses the judgment, Theis Research may assert claims of infringement against Pacific Telesis and Digital Sound on these patents. However, if the U.S. Supreme Court refuses to hear the matter or affirms the holding, the potential for any successful counterclaim against Pacific Telesis and Digital Sound as a supplier to Pacific Telesis is significantly reduced. Management believes, based on information currently available, including consultations with patent counsel, that the Company is not infringing upon any valid patents of Theis. The Company will vigorously defend the patent infringement claims and related claims for damages. While litigation is inherently uncertain, Management believes in view of the jury verdict in the Octel case that the ultimate resolution of these matters will not have a material adverse effect on the financial condition or results of operations of the Company. Should the outcome of this litigation be unfavorable to the Company, however, the Company would be required to fulfill its indemnification obligations to its customers, including Pacific Telesis, by either replacing or modifying its products to avoid infringement or by procuring a license to use the technology, either of which could have a materially adverse effect on the financial condition or results of operations of the Company. Additionally, the Company is subject to pending claims and litigation primarily related to contractual, product and employee issues. Management, after review and consultation with the Company's counsel, believes that the liability, if any, from the disposition of such claims and litigation would not have a materially adverse effect on the financial condition or results of operations of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. EXECUTIVE OFFICERS OF THE REGISTRANT ------------------------------------ Pursuant to the Instructions to Paragraph (b) of Item 401 of Regulation S- K, the current executive officers of the Company, their ages and respective positions with the Company are set forth in the following table. Biographical information on each of the executive officers is set forth following the table. There are no family relationships between any director or executive officer and any other director or executive officer of the Company. Executive officers serve at the discretion of the Board of Directors.
Served as Officer Name Age Position Since - ----------------------------------------------------------------------------------------------------------------- Mark C. Ozur 41 President 1993 Chief Executive Officer Keith M. Beckwith 42 Vice President, Sales 1994 Americas and Europe James C. Eby 51 Vice President, Chief Quality and Operations 1983 Officer, Assistant Secretary Stanford D. Milnes 49 Vice President, Sales 1997 Asia/Pacific Rim Benn Schreiber 45 Vice President, Engineering 1997 B. Robert Suh 38 Vice President, Finance, 1995 Chief Financial Officer and Corporate Secretary Pamela J. Thompson 39 Vice President, Marketing 1997
Mr. Ozur has been President and Chief Executive Officer of the Company since December 1994. From April 1993 to November 1994 he served as Vice President -Chief Technical Officer. From 1990 to 1992 he was Vice President of Precision Visuals, a software development company, and from 1978 to 1982 and 1986 to 1990 he was at Digital Equipment Corporation, a computer hardware and software company, developing software. During 1982, he founded Omtool Corporation, a compiler and software publishing company. Mr. Beckwith has been Vice President, Sales since September 1994. From January 1991 to August 1994 he was Director, Voice Information Services. From August 1988 to December 1990 he was National Sales Manager. From August 1986 to July 1988 he was Regional Sales Manager. Mr. Eby has been Vice President, Chief Quality and Opera tions Officer since September 1994. From January 1992 to August 1994 he was Vice President - Quality Assurance and Manufacturing of the Company. From October 1983 to December 1991 he was Vice President, Manufacturing. Mr. Milnes has been Vice President for Asia/Pacific Rim since January 1997. From January 1994 to January 1997 he was Vice President and Managing Director for Brite Voice Systems, Asia Pacific. From November 1988 to December 1993 he was Area Vice President for international marketing for Boston Technology. Mr. Schreiber was appointed Vice President, Engineering in August 1997. Previously, he worked at Digital Equipment Corporation (DEC) where he was the director of Windows NT Systems Software. Previously, Mr. Schreiber held several other engineering management positions at DEC. Mr. Suh has been Vice President and Chief Financial Officer since November 1995. From September 1992 to October 1995 he was Chief Financial Officer for the Bank of Boston's European Division. From February 1988 to August 1992 he was Director of Finance for the Bank of Boston's retail franchise throughout New England. From July 1985 to January 1988 he was a Manager in corporate development at MCI Communications Corporation. Ms. Thompson has been Vice President, Marketing since October 1997. Thompson comes to Digital Sound after eight years at Motorola, Inc. where she was most recently the Director of Strategic Businesses, responsible for developing and implementing wireless content solutions for paging carriers around the globe. Prior to this, Thompson was Managing Director for Motorola Air Communications, Ltd. Previously, Thompson held other senior management positions at Motorola, including Vice President and Director of Asia Pacific Wireless Data Network Operations and Manager of Corporate Strategy. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS --------------------------------------------------------------------- In 1997, the Company's common stock traded in the over-the-counter market under the NASDAQ National Market System under the symbol DGSD. (Effective February 2, 1998, the symbol was changed to PLPT.) The following tables set forth the following range of the high and low closing prices in each quarter during 1996 and 1997 as reported by the NASDAQ National Market System. 1996 High Low ----------------------------------------------------- 1st Quarter $ 1.88 $ 1.13 2nd Quarter 2.63 1.19 3rd Quarter 2.25 1.38 4th Quarter 2.28 1.38 ----------------------------------------------------- 1997 High Low ----------------------------------------------------- 1st Quarter $ 1.72 $ 1.28 2nd Quarter 1.47 0.69 3rd Quarter 1.84 0.88 4th Quarter 1.63 0.94 ----------------------------------------------------- The Company has never paid any cash dividends on its stock and anticipates that, for the foreseeable future, it will continue to retain any earnings for use in the operation of its business. At January 23, 1998, there were approximately 750 holders of record of the Company's common stock. ITEM 6. SELECTED FINANCIAL DATA ----------------------- Consolidated Selected Financial Data Digital Sound Corporation (In thousands, except per share data)
Year Ended December 31, - ------------------------------------------------------------------------------------------------------------------------------------ 1993 1994 1995 1996 1997 - ------------------------------------------------------------------------------------------------------------------------------------ Statement of Operations Data: Net sales $ 23,264 $ 31,687 $ 23,201 $ 22,332 $ 20,644 Cost of sales 8,917 13,295 10,858 8,312 10,523 -------------------------------------------------------------------------- Gross Margin 14,347 18,392 12,343 14,020 10,121 -------------------------------------------------------------------------- Selling, general and administrative 11,572 10,165 11,781 12,846 17,122 Engineering and development 7,557 6,328 7,209 8,903 12,181 Reduction in workforce 1,250 - - - - -------------------------------------------------------------------------- Total operating expense 20,379 16,493 18,990 21,749 29,303 -------------------------------------------------------------------------- Income (loss) from operations (6,032) 1,899 (6,647) (7,729) (19,182) Interest and other income, net 313 669 1,473 950 273 -------------------------------------------------------------------------- Income (loss) before provision for income taxes (5,719) 2,568 (5,174) (6,779) (18,909) Provision for income taxes - (80) (14) (22) (15) -------------------------------------------------------------------------- Net income (loss) (5,719) 2,488 (5,188) (6,801) (18,924) -------------------------------------------------------------------------- Earnings (loss) per common share $ (.30) $ .13 $ (.26) $ (.34) $ (.93) Earnings (loss) per common share - assuming dilution $ (.30) $ .12 $ (.26) $ (.34) $ (.93) Weighted average common and common equivalent shares outstanding 18,830 21,183 19,881 20,086 20,363 - ------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, - ------------------------------------------------------------------------------------------------------------------------------------ 1993 1994 1995 1996 1997 - ------------------------------------------------------------------------------------------------------------------------------------ Balance Sheet Data: Working capital $ 23,370 $ 31,695 $ 25,085 $ 20,345 $ 12,131 Total assets 36,452 43,960 38,914 33,333 37,441 Long-term obligations, excluding current portion 615 127 - - - Shareholders' equity 29,193 37,327 32,557 26,027 20,443 - ------------------------------------------------------------------------------------------------------------------------------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ----------------------------------------------------------- AND RESULTS OF OPERATIONS ------------------------- 1997 Compared to 1996. Net sales decreased 7.6% from $22.3 million in 1996 to $20.6 million in 1997, a decrease of $1.7 million. Sales to domestic U.S. customers increased by $2.9 million, while sales to International customers declined by $4.6 million. Due to uncertainties regarding the economic condition in Asia, foreign sales fell sharply. In 1997, net sales from Europe and Asia accounted for 5% of the Company's total revenue as compared to 26% coming from outside the U.S. in 1996. Compared to the prior year, sales in the Voice Information Services (VIS) market decreased $1.7 million while sales in the Customer Premises Equipment (CPE) showed no change. New systems sales for the VoiceServer(R) 1110, VoiceServer 2110 and VoiceServer 3110 family of products decreased by $3.5 million in 1997 while sales of system upgrades and enhancements increased by $1.8 million. Gross margin as a percentage of net sales decreased from 62.8% in 1996 to 49.0% in 1997, primarily as a result of the decrease in international sales and as a result of a one-time charge to cost of sales of approximately $1.5 million in connection with a review of the Company's operations, cost structure and balance sheet. Excluding the one-time charge, the gross margin was 55% in 1997. Margins on the sale of new systems decreased from 50.0% in 1996 to 46.2% in 1997. In addition, the margin on the sale of system upgrades and enhancements and service decreased from 70.5% in 1996 to 49.9% in 1997. This decrease in margins for system upgrades, enhancements and service is reflective of a smaller percentage of software upgrades, principally upgrades to the Company's latest version of voice messaging software, InfoMail 4.0, performed in 1997. Selling, general and administrative expenses increased from $12.8 million in 1996 to $17.1 million in 1997 as the Company invested in upgrading its personnel and capabilities, primarily in Sales and Marketing. As a result of the increased investment and decreased sales levels, selling, general and administrative expenses were higher as a percentage of sales in 1997 (83.0%) as compared to 1996 (52.5%). Engineering and development expenses increased from $8.9 million in 1996 to $12.2 million in 1997. For 1997, engineering and development expenses reflect the Company's strategy of continued investment in new product development and product enhancements. As a result of the increase in spending for engineering development in 1997 and decreased sales levels, engineering and development expenses were higher as a percentage of sales in 1997 (59.0%) as compared to 1996 (39.9%). Interest and other income decreased from $1.0 million in 1996 to $0.3 million 1997, principally as the result of a lower average cash balance. The provision for income taxes in 1997 was $15,000. As a result of the above, the Company incurred a net loss of $18.9 million as of December 31, 1997 compared to a net loss of $6.8 million in 1996. The extent and timing of new orders for the Company's existing products from VIS providers has a substantial effect on the company's net sales. Such orders are usually significant in size and can materially affect sales in any quarter. The Company's operations are not subject to a particular seasonality, however, historically first quarter sales have been less than fourth quarter sales. It is difficult to predict receipt of new orders reliably and quarterly revenues and operating results will depend on volume and timing of new orders received during a quarter. 1996 Compared to 1995. Net sales decreased 3.7% from $23.2 million in 1995 to $22.3 million in 1996 as sales to domestic U.S. customers were below planned levels. In 1996, net sales from Europe and Asia accounted for 26% of the Company's total revenue as compared to less than 2% coming from outside the U.S. in 1995. Compared to the prior year, sales in the Voice Information Services (VIS) market were unchanged while sales in the Customer Premises Equipment (CPE) market decreased by $0.8 million. New systems sales for the VoiceServer(R) 1110, VoiceServer 2110 and VoiceServer 3110 family of products increased by $2.3 million in 1996 while sales of system upgrades and enhancements decreased by $3.1 million. Gross margin as a percentage of net sales increased from 53.2% in 1995 to 62.8% in 1996, primarily as a result of the change in the product mix and the benefit obtained from lower valued overall inventory carried over from the prior year. The increase in sales outside the U.S. helped margins on the sale of new systems rise from 49.4% in 1995 to 50.0% in 1996. In addition, the margin on the sale of system upgrades and enhancements and service increased from 54.6% in 1995 to 70.5% in 1996. This increase in margins for system upgrades, enhancements and service is reflective of a greater percentage of software upgrades, principally upgrades to the Company's latest version of voice messaging software, InfoMail 4.0, performed in 1996. Selling, general and administrative expenses increased from $11.8 million in 1995 to $12.8 million in 1996 as the Company invested in upgrading its personnel and capabilities primarily in Sales and Marketing. As a result of the increased investment, selling, general and administrative expenses were higher as a percentage of sales (52.5%) in 1996 as compared to 1995 (50.8%). Engineering and development expenses increased from $7.2 million in 1995 to $8.9 million in 1996. For 1996, engineering and development expenses reflected the Company's strategy of continued investment in new product development and product enhancements. As a result of the increase in spending for engineering development in 1996, engineering and development expenses were higher as a percentage of sales in 1996 (39.9%) as compared to 1995 (31.0%). Interest and other income decreased from $1.5 million in 1995 to $1.0 million in 1996, principally the result of a lower average cash balance. The provision for income taxes in 1996 was $22,000, which is adequate to cover corporate tax liability. As a result of the above, the Company incurred a net loss of $6.8 million as of December 31, 1996 compared to a net loss of $5.2 million in 1995. FACTORS THAT MAY AFFECT FUTURE RESULTS This Annual Report to Shareholders contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21S of the Securities Exchange Act of 1934, as amended. Actual results could differ materially from those projected in such forward-looking statements as a result of the factors set forth below and elsewhere in this document. Digital Sound operates in a rapidly changing environment that involves a number of risks, some of which are beyond the Company's control. The following discussion highlights some of these risks. As discussed in "Part I - Item 1. Business, "the Notes automatically convert into the Series B Convertible Preferred Stock upon Shareholder Approval. Without such Shareholder Approval, each holder of a Note may declare the principal and all accrued interest immediately due and payable. The Company would be obligated to repay immediately $6,612,502.50 in aggregate principal amount of the Notes plus 7% interest from the date of issue. There can be no assurance that the Company will have available cash resources to repay the Notes or that it would be able to repay the Notes in compliance with applicable law. In addition, the Company's obligations to repay the Notes will create a default under certain of its other agreements. In the event Shareholder Approval is not obtained, repayment of the Notes would have a material adverse effect on the Company's financial condition and ability to implement its business strategy. The Company has developed and introduced its new product line, the PulsePoint Enhanced Application Platform and Communication-Management Suite of Applications. The new platform and applications are designed to increase the Company's market share and boost its position in the industry. See "Part I - Item 1. Business." The successful introduction of these and other new products is dependent on a number of factors, some of which are beyond the Company's control, including product acceptance in the marketplace, introduction of competitive products by existing or new competitors, changes in technology, price competition and other factors. Any failure of such products to achieve acceptance in the marketplace could significantly reduce future expected revenues or result in the need for additional expenses to bring the product to market. Furthermore, there can be no assurance that the Company will be successful in introducing new products or that such products will generate significant revenues or profits. The Company's inability to successfully generate revenues from the introduction of these new products would have a material adverse effect on the Company's financial condition and ability to implement its business strategy. The Company has not been operating profitably. The Company's strategy has been to develop new technology and to expand its marketing capabilities, with the goal of creating successful new products and marketing them effectively, thereby returning the Company to profitability. The Company's on-going investments in technology and marketing require funds, and although the Company presently has a significant positive cash balance as a result of the consummation of a private placement in December 1997 (see "Part I - Item 1. Business."), the Company's financial resources are not unlimited, and the Company's funds eventually will be exhausted if the Company's strategy does not succeed in returning the Company to profitability or otherwise enable it to raise additional working capital. The Company is in the process of identifying operating and application software challenges related to the "Year 2000" issue. The Year 2000 problem is the result of computer programs being written using two digits (rather than four) to define the applicable year. Software programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the Year 2000. This could result in a major system failure or miscalculations. During 1997, the Company completed the conversion of its primary in-house accounting, inventory, and manufacturing control systems to a Year 2000 compliant system. The total cost of the Year 2000 project is estimated to be $0.5 million. To date the Company has incurred approximately $0.4 million related to the assessment of the impact of Year 2000 on the Company and the purchase of new systems and system modifications. The project is estimated to be completed not later than December 31, 1998, which is prior to any anticipated impact on its operating systems. The Company believes that with conversion to new software and modifications to existing software, the Year 2000 Issue will not pose significant operational problems for its computer systems. The costs of the project and the date on which the Company believes it will complete the Year 2000 modifications are based on management's best estimates. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. If such modifications and conversions are not made, or not completely timely, the Year 2000 issue could have a material impact on the Company's business and consolidated results of operations. The voice processing and messaging industry is highly competitive, with rapid technological advances and constantly improving price/performance. As the markets in which the Company operates continue to grow, the Company is experiencing an increase in competition, and it expects this trend to continue. The Company is not one of the largest providers of voice processing and messaging equipment in the industry. Some of the Company's competitors have substantially greater technical, marketing and financial resources and, in some markets, a larger installed base of customers and a wider range of available applications software. The voice processing and messaging industry has experienced a continuing evolution of product offerings and alternatives for delivery of services. These trends have affected and may be expected to have a significant continuing influence on conditions in the industry, although the impact on the industry generally and on the Company's position in the industry cannot be predicted with assurance. The Company and the industry are, in general, dependent on the U.S. domestic telephone companies for a large percentage of revenue. The suppliers to the telephone company market, which is primarily comprised of 7 regional Bell operating companies and GTE, have largely been decided for first generation voice processing requirements. The market for voice processing and messaging systems is in a period of transition. Budgetary constraints, uncertainties resulting from the introduction of new technologies in the telecommunications environment and changes in the government regulations have increased uncertainties in the market. Significant changes in the domestic U.S. industry as a result of the 1996 Telecommunications Act make planning decisions more difficult and increase the risk inherent in the planning process. The Company's operating results may fluctuate for a number of reasons. The Company has short delivery cycles and as a result does not have a large order backlog, which makes the forecasting of revenue inherently uncertain. This uncertainty is compounded because each quarter's revenue results predominantly from orders booked and shipped during the third month of the quarter. Because the Company plans its operating expenses, many of which are relatively fixed in the short term, on the basis of its anticipated revenues, even a relatively small revenue shortfall may cause a period's results to be substantially below expectations. Such a revenue shortfall could arise from any number of factors, including lower than expected demand, supply constraints, delays in the availability of new products, overall economic conditions or natural disasters. The international portion of the Company's business, which represented 5.3% of revenues for the year ending December 31, 1997, is subject to a number of inherent risks, including difficulties in building and managing international operations and international reseller networks and international service and support of the Company's products, difficulties or delays in translating products into foreign languages, fluctuations in the value of foreign currencies, import/export duties and quotas, and unexpected regulatory, economic or political changes in international markets. Disruption in the Asian economies was the principal cause of a decrease in the Company's foreign sales, from 26.0% of total sales in 1996 to 5.3% of total sales in 1997. Although the majority of international transactions are performed through confirmed letters of credit, due to the competitive environment in the international marketplace, certain international customers may require longer payment terms; and as a result, days sales outstanding may periodically extend beyond ninety days on amounts due from these customers. The development of new technologies and products is increasingly complex and uncertain, which increases the risk of delays. The introduction of new systems requires close collaboration and continued technological advancement involving multiple hardware and software design, manufacturing, marketing and sales teams within the Company as well as teams at outside suppliers of key components. The failure of any one of these elements could cause the Company's new products to fail to meet specifications or to miss the aggressive timetables that the Company establishes. As the variety and complexity of the Company's product families increase, the process of planning production and inventory levels also becomes more difficult. The Company expects to continue investing heavily in supporting the development effort required to bring new technologies and products to the market. To support this, substantial financial resources will be expended. The Company believes that its production capacity should be sufficient to support anticipated unit volumes for the foreseeable future. The Company is primarily engaged in the final assembly and testing of the hardware equipment. The Company currently buys the majority of its subassembly inventory from a limited number of suppliers. The failure of these suppliers to provide such subassemblies on a timely basis and within specifications could have a materially adverse effect on the Company's business. If the Company is unable to obtain certain key components, or to effectively forecast customer demand or manage its inventory, increased inventory obsolescence or reduced utilization of production capacity could adversely impact the Company's gross margins and results of operations. The Company has historically derived a significant portion of its revenue and operating profit from a relatively small number of customers. In 1997, the Company derived 58% of its revenue from a single customer (GTE). Should sales to this customer be significantly reduced, the Company's operating results could be materially adversely affected. International proposals for large system installations typically involve a lengthy and complex bidding and selection process, and the ability of the Company to obtain a particular proposal award is inherently difficult to predict. The Company believes that the opportunities for these installations will continue to grow and intends to continue to expand its research and development, manufacturing, sales and marketing and product support capabilities in anticipation of such growth. However, the timing and scope of these opportunities and the pricing and margins associated with any eventual proposal award are difficult to forecast, and may vary substantially from transaction to transaction. The Company's future operating results may, accordingly, exhibit a higher degree of volatility than the operating results of other companies in its industry that have adopted different strategies. Although the Company is actively pursuing a number of opportunities both in and out of the United States, both the timing of any eventual opportunities and the probability of the Company's receipts of significant purchase orders are uncertain. The degree of dependence by the Company on large orders, and the investment required to enable the Company to perform such orders, without assurance of continuing order flow from the same customers and predictability of gross margins on any future orders, increase the risk associated with its business. The Company's stock price, like that of other technology companies, is subject to significant volatility. If revenues or earnings in any quarter fail to meet the investment community's expectations, there could be an immediate impact on the Company's stock price. The stock price may also be affected by broader market trends unrelated to the Company's performance. The Company routinely receives communications from third parties asserting patent or other rights covering the Company's products and technologies. Based upon the Company's evaluation, it may take no action or it may seek to obtain a license. In any given case there is a risk that a license will not be available with terms that the Company considers reasonable, or that litigation will ensue. The Company expects that, as the number of hardware and software patents issued continues to increase, and as the Company's business grows, the volume of these third party communications will also increase. The Company's corporate headquarters facility, at which the majority of its research and development activities are conducted, is located near major earthquake faults which have experienced earthquakes in the past. While the Company does carry insurance at levels management believes to be prudent, in the event of a major earthquake or other disaster affecting one or more of the Company's facilities, it is likely that insurance proceeds would not cover all of the costs incurred and, therefore, the operations and operating results of the Company could be adversely affected. Due to the factors noted above and elsewhere in management's discussion and analysis of financial condition and results of operations, the Company's future earnings and Common Stock price may be subject to significant volatility, particularly on a quarterly basis. Past financial performance should not be considered a reliable indicator of future performance and investors should not use historical trends to anticipate results or trends in future periods. Any shortfall in revenue or earnings from the levels anticipated by securities analysts could have an immediate and significant adverse effect on the trading price of the Company's Common Stock in any given period. Additionally, the Company may not learn of such shortfalls until late in a fiscal quarter, which could result in an even more immediate and adverse effect on the trading price of the Company's Common Stock. Furthermore, the Company participates in a highly dynamic industry which often results in volatility of the Company's Common Stock price. LIQUIDITY AND CAPITAL RESOURCES For the year ended December 31, 1997, net working capital decreased by $8.2 million to $12.1 million compared to $20.3 million at December 31, 1996. In 1997 the decrease in working capital resulted principally from a reduction in accounts receivable of $1.6 million, an increase in amounts borrowed under the Company's credit line of $1.6 million, and an increase in shareholder notes payable of $6.6 million. The increase in shareholder notes payable is the result of the Company's December 1997 private placement of convertible securities; see Notes 8 and 9 to the Consolidated Financial Statements. At December 31, 1997, the Company had cash of $21.0 million and no long term debt. During 1997, net cash used by operations was $13.6 million. The 1997 capital expenditures were $4.1 million, while budgeted expenditures for 1998 are $1.6 million, principally hardware and software for test equipment. The Company has never paid any cash dividends on its stock and anticipates that, for the foreseeable future, it will continue to retain any earnings for use in the operation of its business. For the year ended December 31, 1996, net working capital decreased by $4.8 million to $20.3 million compared to $25.1 million at December 31, 1995. In 1996 the decrease in working capital resulted principally from a reduction in cash of $5.3 million, an increase in accounts receivable of $2.3 million, a decrease in inventory of $0.6 million, an increase in accounts payable of $0.9 million and an increase in accrued payroll and other accrued liabilities of $0.3 million. The decrease in cash reflects the Company's strategy of continued investment in new product development, product enhancements and strengthening of its marketing and sales capabilities. At December 31, 1996, the Company had cash of $18.2 million and no long term debt. During 1996, net cash used by operations was $4.6 million, which was offset by $1.0 million of interest earned on cash balances. The 1996 capital expenditures were $2.0 million. For the year ended December 31, 1995, working capital decreased by $6.6 million to $25.1 million compared to $31.7 million at December 31, 1994. In 1995 the reduction in working capital resulted principally from a decrease in accounts receivable of $3.7 million caused by substantially lower sales, a reclassification of $1.4 million to other assets as a result of long term investments which exceed the company's definition of cash and equivalents, a settlement of $2.5 million as described in note 10 of Notes to Financial Statements in the 1995 Annual Report, and a decrease in other accrued liabilities related to sales tax payable and accrued license fees totaling $1.0 million. At December 31, 1995, the Company had cash of $23.5 million and no long term debt. During 1995, net cash used by operations was $4.3 million, which was offset by $1.5 million of interest earned on cash balances. REPORT OF INDEPENDENT AUDITOR - ----------------------------- The Board of Directors and Shareholders Digital Sound Corporation We have audited the accompanying balance sheets of Digital Sound Corporation as of December 31, 1997 and 1996, and the related statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Digital Sound Corporation at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ Ernst & Young L.L.P. -------------------- ERNST & YOUNG LLP Woodland Hills, CA January 22, 1998 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ------------------------------------------- Consolidated Balance Sheets Digital Sound Corporation (In thousands, except share data)
Year Ended December 31, ----------------------- 1996 1997 ----------------------- ASSETS ----------------------- Current assets: Cash, cash equivalents and pledged cash $18,187 $20,973 Accounts receivable, less allowance for doubtful accounts of $600 and $527 at December 31, 1996 and 1997, respectively 5,695 4,111 Inventories, net 3,470 3,876 Other current assets 299 169 ----------------------- Total Current assets 27,651 29,129 Property and equipment, at cost: Computers and other equipment 11,077 9,504 Furniture and fixtures 982 999 Leasehold improvements 1,130 1,357 ----------------------- 13,189 11,860 Less accumulated depreciation and amortization (10,733) (6,776) ----------------------- 2,456 5,084 Other assets: Investment securities -- 1,030 Other assets 3,226 2,198 ----------------------- Total other assets 3,226 3,228 ----------------------- Total assets $33,333 $37,441 ======================= LIABILITIES & SHAREHOLDERS' EQUITY ----------------------- Current liabilities: Credit Line $ -- $ 1,581 Shareholder notes payable -- 6,613 Accounts payable 3,639 3,532 Accrued payroll and related 1,986 3,102 Other accrued liabilities 1,681 2,170 ----------------------- Total current liabilities 7,306 16,998 Commitments and contingencies Shareholders' equity: Preferred stock 15,000,000 shares authorized Series A, no par value, 2,631,579 shares issued and outstanding at December 31, 1996 5,000 Series B, no par value, 2,451,667 shares issued and outstanding at December 31, 1997 18,110 Common stock, no par value - 50,000,000 shares authorized, 20,224,540 and 20,561,593 shares issued and outstanding at December 31, 1996 and 1997, respectively 68,975 69,205 Accumulated Deficit (47,948) (66,872) ----------------------- Total shareholders' equity 26,027 20,443 ----------------------- Total liabilities & shareholders' equity 33,333 37,441 -----------------------
See accompanying notes. Consolidated Statements of Operations Digital Sound Corporation (In thousands, except per share data)
Year Ended December 31, - ----------------------------------------------------------------------------------------- 1995 1996 1997 ========================================================================================= Net sales $23,201 $22,332 $ 20,644 Cost of sales 10,858 8,312 10,523 ------- ------- -------- Gross margin 12,343 14,020 10,121 ------- ------- -------- Selling, general and administrative 11,781 12,846 17,122 Engineering and development 7,209 8,903 12,181 ------- ------- -------- Total operating expense 18,990 21,749 29,303 ------- ------- -------- Income (loss) from operations (6,647) (7,729) (19,182) Interest and other income, net 1,473 950 273 ------- ------- -------- Income (loss) before provision for income taxes (5,174) (6,779) (18,909) Provision for income taxes (14) (22) (15) ------- ------- -------- Net income (loss) $(5,188) $(6,801) $(18,924) ======= ======= ======== Earnings (loss) per common share $ (.26) $ (.34) $ (.93) ======= ======= ======== Weighted average common shares outstanding 19,881 20,086 20,363 ======= ======= ========
See accompanying notes. Consolidated Statements of Shareholders' Equity Digital Sound Corporation (In thousands, except share data)
Convertible Convertible Preferred Total Preferred Stock Stock Series B Common Stock Accumulated Shareholders' - ------------------------------------------------------------------------------------------------------------------------------------ Shares Amount Shares Amount Shares Amount Deficit Equity ==================================================================================================================================== Balance, December 31, 1994 2,631,579 $ 5,000 19,733,060 $68,286 $(35,959) $ 37,327 Exercise of stock options - - 109,050 166 166 Shares issued under employee stock purchase plan 158,844 252 252 Net loss - - - - (5,188) (5,188) ---------- ------- --------- ------- ---------- ------- -------- -------- Balance, December 31, 1995 2,631,579 $ 5,000 20,000,954 $68,704 $(41,147) $ 32,557 Exercise of stock options - - 31,625 47 47 Shares issued under employee stock purchase plan 191,961 224 224 Net loss (6,801) (6,801) ---------- ------- --------- ------- ---------- ------- -------- -------- Balance, December 31, 1996 2,631,579 $ 5,000 20,224,540 $68,975 $(47,948) $ 26,027 Exercise of stock options 4,375 7 7 Shares issued under employee stock purchase plan 332,678 223 223 Conversion of Series A to Series B (2,631,579) (5,000) 666,667 5,000 - Shares issued under private placement of convertible securities 1,785,000 13,110 13,110 Net loss - - - - (18,924) (18,924) ---------- ------- --------- ------- ---------- ------- -------- -------- Balance, December 31, 1997 - - 2,451,667 $18,110 20,561,593 $69,205 $(66,872) $ 20,443 ========== ======= ========= ======= ========== ======= ======== ========
See accompanying notes.
Consolidated Statements of Cash Flows Digital Sound Corporation Year Ended December 31, (In thousands) -------------------------------------------------------- 1995 1996 1997 ================================================== ============= ============ =========== Cash flows from operating activities: Net income (loss) $ (5,188) $ (6,801) $ (18,924) Adjustments to reconcile net income (loss) to net cash provided (used) by operations: Depreciation and amortization 2,463 2,349 2,979 Provision for losses on accounts receivable (100) -- (73) Gain on disposal of fixed assets 492 3 -- Changes in operating assets and liabilities: Accounts receivable 3,845 (2,288) 1,657 Inventories (137) 628 (406) Other current assets (179) 135 130 Other assets (3,732) 1,412 (504) Accounts payable 524 927 (107) Accrued payroll and related 234 373 1,116 Other accrued liabilities (1,034) (351) 489 - -------------------------------------------------- ------------- ------------ ----------- Net cash provided (used) by operations (2,812) (3,613) (13,643) ================================================== ============= ============ =========== Cash flows from investing activities: Increase in investment securities (1,030) Additions to property and equipment (936) (1,974) (4,075) - -------------------------------------------------- ------------- ------------ ----------- Net cash used in investing activities (936) (1,974) (5,105) ================================================== ============= ============ =========== Cash flows from financing activities: Proceeds from issuance of preferred stock -- -- 13,110 Proceeds from issuance of notes payable -- -- 6,613 Proceeds from issuance of common stock 418 271 230 Proceeds from line of credit -- -- 1,581 - -------------------------------------------------- ------------- ------------ ----------- Net cash provided by financing activities 418 271 21,534 ================================================== ============= ============ =========== Net increase (decrease) in cash and equivalents (3,330) (5,316) 2,786 Cash and equivalents at beginning of period 26,833 23,503 18,187 - -------------------------------------------------- ------------- ------------ ----------- Cash and equivalents at end of period $ 23,503 $ 18,187 $ 20,973 ================================================== ============= ============ =========== Supplemental disclosures Cash paid for interest $ -- $ -- $ 6 Cash paid for taxes $ 35 $ 21 $ 23 ================================================== ============= ============ ===========
See accompanying notes. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies Nature of business. Digital Sound Corporation (the Company) designs, manufactures and markets information processing systems which enable unified messaging. Principles of consolidation. The consolidated financial statements include the accounts of Digital Sound Corporation (the Company) and its wholly owned subsidiaries Digital Sound International Corporation and DGSD Malaysia Corporation. All significant intercompany transactions and balances have been eliminated. Revenue recognition. Generally sales are recognized when products are shipped or when services are performed. Warranty costs are accrued at time of sale. Revenue from sales of extended warranties is accounted for as deferred revenues and recognized into income over the warranty or maintenance period. Short term investments. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). The Company adopted the provisions of SFAS 115 for investments held as of December 31, 1995. The adoption had no effect on the financial statements. Short term investments (principally commercial paper and discount notes with maturity dates generally within 90 days and considered cash equivalents) are classified as "held to maturity" based on the Company's positive intent and ability to hold the securities until maturity. The securities are presented at amortized cost which approximates fair value. Amortization and interest on securities classified as "held to maturity" is included in investment income. Engineering and development. Statement of Financial Accounting Standards No. 86, "Accounting for the Cost of Computer Software to Be Sold, Leased or Otherwise Marketed," requires that development costs incurred in connection with research and development of software products and enhancements to existing software products be expensed and incurred until technological feasibility has been established. Costs incurred subsequent to the establishment of technological feasibility must be capitalized until the product is released for sale. The Company considers technological feasibility to be demonstrated when a fully functional working model has been produced. To date, all costs associated with the development of new software products or enhancements to existing software products have been expensed as incurred. The costs incurred beyond the working model stage are not significant. Other engineering and development costs are also expensed as incurred. Inventories. Inventories are stated at the lower of standard cost (which approximates the first-in first-out method) or market. Property and equipment. Property and equipment are depreciated using the straight-line method over the respective estimated useful lives, which range from two to five years. Leasehold improvements are amortized over the period of the lease or the estimated useful life, whichever is shorter. Earnings (loss) per common share. During 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128). Pursuant to SFAS No. 128, earnings (loss) per common share are computed based upon the weighted average number of common shares outstanding for the period. Diluted earnings per common share reflects the potential dilution that could occur if securities were exercised or converted into common stock. The adoption of SFAS No. 128 did not result in a restatement of earnings (loss) per common share for the periods presented in the financial statements. Antidilutive common stock equivalents were 28,728,380 in 1997, 2,651,526 in 1996, and 2,309,526 in 1995 and were excluded from this calculation. Stock-Based Compensation. During 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123). Pursuant to SFAS No. 123, a company may elect to continue expense recognition under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB No. 25) or to recognize compensation expense for grants of stock, stock options, and other equity instruments to employees based on the fair value methodology outlined in SFAS No. 123. SFAS No. 123 further specifies that companies electing to continue expense recognition under APB No. 25 are required to disclose pro forma net income and pro forma earning per share as if fair value based accounting prescribed by SFAS No. 123 has been applied. The Company has elected to continue expense recognition pursuant to APB No. 25. SFAS No. 123 is effective for fiscal years beginning after December 15, 1995. CASH, CASH EQUIVALENTS AND PLEDGED CASH. The Company considers as cash equivalents only those investments that are short-term, highly liquid, readily convertible to cash, and so near their maturity that they present insignificant risk of changes in value because of changes in interest rates. The Company classifies as cash equivalents only those investments with maturities of three months or less. The Company pledged $1.0 million to facilitate a construction loan for the landlord to build new office space in its' existing building. These funds became available to the Company in February 1998. INCOME TAXES. The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards 109, "Accounting for Income Taxes". The standard prescribes a liability method for calculating the provision for income taxes, replacing the deferred method previously used by the Company. DEFERRED LICENSE FEES. The company has entered into license agreements for which the fees are amortized based on sales of product technology over the estimated useful life of the technology, which is generally four years. ESTIMATES AND ASSUMPTIONS. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at December 31, 1997 and the reported amounts of revenues and expenses during the year then ended. Actual results could differ from those estimates. 2. INVENTORIES Inventories at December 31, consist of the following:
- -------------------------------- (in thousands) 1996 1997 ================================ ======== ======== Raw material and purchased parts $1,528 $2,077 Work-in-progress 1,815 1,521 Finished goods 127 278 - -------------------------------- -------- -------- $3,470 $3,876 ========= ========
3. CERTAIN ONE TIME CHARGES In the fourth quarter of 1995, the Company recorded a one-time charge of approximately $2.1 million in connection with a comprehensive and systematic review of its operations, cost structure and balance sheet in light of expected new product introductions. The one time charge included $0.3 million in property and equipment write-offs, related to obsolescence of test fixtures and other equipment used in the production of the current product line, and $1.6 million in inventory write-downs resulting from obsolescence of current inventory that is unable to be used in the new product line due to technological changes and enhancements. An additional $0.2 million of miscellaneous operational charges were written-off. Due to a longer than expected development period for the Company's new product line, the Company continued to market the old product line through 1997. In light of imminent new product introductions in early 1998, in the fourth quarter of 1997 the Company recorded additional charges of approximately $1.5 million in connection with a review of its operations, cost structure and balance sheet. The charges included $0.5 million in property and equipment write-offs related to obsolescence of test fixtures and other equipment used in the production of the current product line, and $1.0 million in inventory write-downs, resulting from obsolescence of current inventory and licenses that are unable to be used in the new product line due to technological changes and enhancements. 4. OTHER ASSETS Other assets at December 31 consist of the following:
- -------------------------------------------------------------------------------- (In thousands) 1996 1997 ================================================================================ Deferred license fees, net of accumulated amortization of $4,237 and $5,769 at December 31, 1996 and 1997, respectively $2,938 $1,933 Other 288 265 - -------------------------------------------------------------------------------- $3,226 $2,198 ================================================================================
5. LEASES In December 1996, the Company entered into a new ten year lease for the corporate headquarters in Carpinteria, California. The lease is subject to an annual adjustment based on total sales. In December of 1996 the company consolidated into half of the building that it currently occupies. The new lease coupled with the consolidation of space resulted in a reduction in monthly lease expenses of approximately 45%. The Company also leases office equipment as well as regional office space under one to five year operating lease agreements. Effective January 1997, the Company entered into master lease agreements with BancBoston Leasing Inc. and Mellon US Leasing ("the Lease Agreements"). The BancBoston lease agreement is for a maximum of $3.0 million in equipment cost and the term of the lease is 48 months. The BancBoston lease agreement requires cash collateral equal to the acquisition cost of the equipment leased. The Company has utilized $1.25 million of the BancBoston lease agreement as of December 31, 1997. The Mellon US Leasing lease agreement is for a maximum of $1.0 million in equipment cost and the term of the lease is for 30 months. The Mellon lease agreement requires collateralization via a letter of credit equal to 50% of the acquisition cost of the equipment leased. During 1997, a bank had provided the Company with this letter of credit, which was in turn collateralized by the Company's certificate of deposit. Beginning in January 1998, the Company collateralized the letter of credit with available borrowing under its credit line. The Company has fully utilized the Mellon US Leasing lease agreement as of December 31, 1997. Minimum future lease payments as of December 31, 1997 are as follows:
- --------------------------------------------------- (In thousands) =================================================== 1998 $ 1,446 1999 1,322 2000 1,287 2001 1,661 2002 996 2003 and beyond 3,985 - --------------------------------------------------- $10,697 ===================================================
Rent expense, including rent under noncancelable operating lease obligations, was approximately $1.7 million, $1.5 million, and $1.6 million for the years ended December 31, 1995, 1996 and 1997, respectively. 6. OTHER ACCRUED LIABILITIES Other accrued liabilities at December 31 consist of the following:
- ---------------------------------------------------------------- (In thousands) 1996 1997 ================================================================ Sales taxes payable $ 180 $ 202 Customer deposits 322 262 Deferred revenue 92 317 Accrued warranty reserve 360 429 Other 727 1,222 - ---------------------------------------------------------------- $1,681 $2,432 ================================================================
7. Income Taxes The provision for income taxes included in the Consolidated Statements of Operations consists of:
- -------------- ---- ---- ---- (In thousands) 1995 1996 1997 ============== ==== ==== ==== Current Federal $ -- $ -- $ -- State 14 22 15 - -------------- ---- ---- ---- $ 14 $ 22 $ 15 ============== ==== ==== ====
The provision for income taxes is at a rate different than the U.S. federal statutory tax rate for the following reasons:
- ----------------------------------- --------- --------- --------- (In thousands) 1995 1996 1997 =================================== ========= ========= ========= Computed tax at statutory rate $ (1,811) $ (2,380) $ (6,523) State taxes, net of federal benefit 9 14 10 Loss not benefited 1,854 2,336 6,519 Other (38) 52 9 - ----------------------------------- --------- --------- --------- $ 14 $ 22 $ 15 =================================== ========= ========= =========
Deferred income taxes reflect the tax impact of temporary differences between the amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. The components of deferred tax assets as of December 31, 1996 and 1997 are as follows:
- -------------------------------------------- --------- --------- (In thousands) 1996 1997 ============================================ ========= ========= Net operating loss carryforwards $ 15,003 $ 21,323 General business credit carryforwards 1,468 3,140 Alternative minimum tax credit carryforwards 190 190 Inventory accounting methods 1,813 1,833 Allowance for doubtful accounts 252 220 Accrued vacation 147 278 Warranty service 152 179 Excess of book over tax depreciation 415 296 Research expenditures accounting method 865 821 Other 58 641 ============================================ ========= ========= Deferred tax assets, net 20,363 28,921 Valuation allowance (20,363) (28,921) - -------------------------------------------- --------- --------- Net deferred tax asset $ -- $ -- ============================================ ========= =========
Management determined that a valuation allowance of approximately $28.9 million, primarily related to net operating loss and general business credit carryforwards, was required. The valuation allowance increased approximately $8.6 million during 1997, primarily reflecting the current year net operating loss. At December 31, 1997, the Company has net operating loss carryforward for federal income tax purposes of approximately $58.4 million which expire from 2000 through 2012. The Company has net operating loss carryforwards for California tax purposes of approximately $13.2 million at December 31, 1997 which expire from 1998 through 2002. The Company's ability to utilize the above net operating loss carryforward may be limited due to the application of statutory provisions. At December 31, 1997, the Company has general business credits of approximately $1.3 million for federal income tax purposes which expire from 1998 through 2006. 8. Debt Shareholder Notes Payable. The $6.6 million in shareholder notes payable arose in connection with the December 1997 $20 million private placement (see Note 9). Credit Line. On July 28, 1997, the Company entered into a Security and Loan Agreement ("the Credit Line") with a bank for the purpose of obtaining a $5 million credit line. The credit line was secured by substantially all of the assets of the Company, and allowed for borrowings of up to the lesser of $2 million or an amount equal to 50% of eligible domestic accounts receivable. Interest under the Credit Line was at the prime rate plus one-half percent. The Credit Line also allowed for borrowing up to the lesser of $3 million or an amount equal to 90% of eligible foreign accounts receivable and inventory. Borrowings under the Credit Line were subject to certain financial covenants and restrictions on receivables, financial guarantees, and other related items. On October 30, 1997, the Company was in violation of certain of the financial covenants of the Credit Line. There were no borrowings under the Credit Line at that time. On October 31, 1997, the Company entered into an amendment to the Credit Line providing for a relaxation of certain financial covenants. The amendments also allowed for borrowing up to $5 million or an amount equal to 65% of eligible accounts receivable, foreign or domestic. The interested charged under the Credit Line was increased to prime plus 2.0% (two percent). In connection with the agreement, the Company issued a warrant to the bank (the "Warrant") for the purchase of 300,000 shares of the Company's Common Stock at an exercise price of $1.00 per share. The terms of the warrant provide for "full ratchet" antidilution for 180 days after its issuance and for "weighted average" antidilution thereafter. In December 1997, the Company completed a $20 million private placement of convertible securities. The "full ratchet" antidilution provision of the Warrant effected an increase in the number of shares of common stock issuable under the Warrant from 300,000 to 400,000 and a decrease in the exercise price from $1.00 to $0.75. In December 1997, due to the Company's achievement of certain milestone events, the interest rate applicable to the Credit Line was decreased from Prime plus two percent to Prime plus one-half percent (9% at December 31, 1997). At December 31, 1997, the Credit Line was extended to June 30, 1998 and the amount borrowed was approximately $1.6 million. Also at December 31, 1997, the Company was in violation of one of the covenants of the Credit Line and received a one-time waiver of the covenant violation. The Company maintains a lease agreement with Mellon US Leasing. This lease agreement is collateralized by a $500,000 standby letter of credit issued under the Company's Credit Line. (See Note 5). 9. Shareholders' Equity and Related Items The Company's amended Articles of Incorporation authorize 50,000,000 shares of common stock and 15,000,000 shares of preferred stock (of which 3,373,334 have been designated Series B), no par value, which may be issued by the Board of Directors without further approval by the shareholders. In December 1997, the Company created the Series B preferred stock. The holders of the Series B convertible Preferred Stock are entitled to dividends at the applicable dividend rate for each share of the underlying Common Stock into which the Series B Convertible Preferred Stock is convertible. Dividends on the Series B Convertible Preferred Stock are not mandatory or cumulative. Upon liquidation, the holders of the Series B Convertible Preferred Stock are entitled to $7.50 per share plus all accrued and unpaid dividends to the extent funds are available and subject to all amounts payable in respect of any other shares of preferred stock of the Company that rank pari passu with the Series B Convertible Preferred Stock. Each share of Series B Convertible Preferred Stock is entitled to a number of votes equal to the number of shares of Common Stock into which such share of Series B Convertible Preferred Stock could be converted. The Series B Convertible Preferred Stock and the Common Stock vote together. The Series B Convertible Preferred Stock is convertible at any time at the option of the holder into Common Stock, initially at a conversion price (the "Series B Preferred Conversion Price") of $0.75 per share of Common Stock. In addition to customary antidilution provisions, the Series B Preferred Conversion Price is subject to adjustment for certain issuances of the Company's Common Stock if the consideration per share of such issuance is less than the Series B Preferred Conversion Price. The Series B Convertible Preferred Stock is also subject to automatic conversion upon the earliest to occur of an event that would cause the Series B Convertible Preferred Stock to be required to be registered pursuant to the Securities Exchange Act of 1934, or upon the filing with the Secretary of the Company of the written approval of the holders of more than 50% of the outstanding shares of the Series B Convertible Preferred Stock. In December 1997, the Company consummated a private placement of convertible securities for an aggregate of approximately $20 million (the "Transaction"). The Company (i) exchanged the Series A convertible preferred stock initially issued for an aggregate consideration of $5 million into 666,667 shares of Series B convertible preferred stock at a price of $7.50 per share; (ii) issued 1,785,000 shares of Series B convertible preferred stock at a price of $7.50 per share for $13,387,500 of the funds raised in the Transaction; and (iii) issued Notes (the "Notes") for the balance of the $20 million raised in the Transaction, or $6,612,502.50. At the time of the Transaction, the Company had adequate Common Stock authorized to allow for the ultimate conversion into common stock of the Series B convertible preferred stock issued under the terms of the Transaction and issued from the exchange of the Series A preferred stock. The Notes will automatically convert to Series B Convertible Preferred Stock if the Company's shareholders approve an amendment to the Ninth Amended and Restated Articles of Incorporation authorizing a sufficient number of shares of common stock to permit conversion to common stock of all of the Series B Convertible preferred stock issuable upon conversion of the Notes. If the Company's shareholders approve this amendment, the Notes will convert into an additional 881,667 shares of Series B convertible Preferred Stock, which would in turn be convertible into 8,881,670 shares of Common Stock. If the Company's shareholders do not approve this amendment, the Notes will become immediately due and payable. Pursuant to the terms of the Transaction, the Company must hold its annual meeting of shareholders no later than April 15, 1998, subject to certain exceptions. 1983 Stock Option Plan. The Company maintains a stock option plan which provides for the issuance of incentive stock options (ISOs) and nonqualified stock options (NSOs) to officers, employees, independent contractors, consultants and advisors of the Company. In July of 1997 the Company filed a Form S-8 to register the issuance and sales of an additional 800,000 shares reserved under the plan. The Company has reserved 6,500,000 shares of common stock for issuance thereunder. The Plan terminates October 31, 2003. At December 31, 1997, options to purchase 3,911,110 shares were outstanding of which 1,403,010 were exercisable at prices ranging from $1.25 to $3.31. Directors' Stock Option Plan. The Company maintains a stock option plan which provides for NSOs as equity incentives to assist the Company in recruiting and retaining outside directors. In August of 1996 the Company filed a Form S-8 to register the issuance and sales of an additional 200,000 shares reserved under the plan. The director's stock option plan allows for the Company to issue options covering up to 500,000 shares. At December 31, 1997, options to purchase 270,600 shares were outstanding, of which 151,850 were exercisable at prices ranging from $1.25 to $3.31 and 185,000 were available for future grant of options under the plan. The Company has reserved 500,000 shares of common stock for issuance thereunder. A summary of option transactions under the two option plans is as follows:
Number of Shares Option Price ---------------- --------------------- Outstanding at December 31, 1994 2,153,688 $ 1.00 - 5.06 Granted 454,972 1.62 - 3.31 Exercised (109,050) 1.19 - 2.25 Canceled or expired (148,242) 1.25 - 2.75 --------- --------------------- Outstanding at December 31, 1995 2,351,368 1.00 - 3.31 Granted 1,434,460 1.25 - 1.97 Exercised (31,625) 1.19 - 1.63 Canceled or expired (1,089,331) 1.00 - 5.06 --------- --------------------- Outstanding at December 31, 1996 2,664,872 1.25 - 3.31 Granted 1,666,850 .69 - 1.56 Exercised (4,375) 1.50 Canceled or expired (415,637) .93 - 3.13 --------- --------------------- Outstanding at December 31, 1997 3,911,710 .69 - 3.31 ========= =====================
1990 EMPLOYEE STOCK PURCHASE PLAN. The Company maintains a stock purchase plan to provide employees of the Company with a convenient means to acquire an equity interest in the Company through payroll deductions, and to provide an incentive for continued employment. The employee stock purchase plan reserves 2,000,000 shares of common stock for issuance under the plan. The plan qualifies as an "employee stock purchase plan" under Section 423 of the Internal Revenue Code. All full-time employees are eligible to participate through payroll deductions up to 10% of their compensation; participants may, at their option, purchase shares from the Company at the lower of 85% of the fair market value of the common stock at either the beginning or end of each six- months option period. In the event the market price at the end of any option period is less than 50% of the market price at the beginning of the period, employee purchases are limited to twice the shares that could have been purchased using the beginning market price. During 1997, 332,678 shares were purchased at a price of $0.64. During 1996, 191,961 shares were purchased at a price of $1.17. During 1995, 158,844 shares were purchased at prices ranging from $1.33 to $2.18. At December 31, 1997, 324,411 shares were available for future issuance under the plan. FAIR VALUE DISCLOSURES. Stock option grants are set at the closing price of the Company's common stock on the date of grant and the related number of shares granted are fixed at that point in time. Therefore under the principles of APB Opinion No. 25, the Company does not recognize compensation expense associated with the grant of stock options. SFAS No. 123, "Accounting for Stock-Based Compensation," requires the use of option valuation models to provide supplemental information regarding options granted after 1994. Pro forma information regarding net income and earnings per share shown below was determined as if the Company had accounted for its employee stock options and shares sold under its stock purchase plan under the fair value method of the Statement. The fair value of the options was estimated at the date of grant using a Black- Scholes option pricing model with the following weighted-average assumptions for 1997, 1996, and 1995, respectively: risk-free interest rates of 6.25%, 6.25% and 5.40%; dividend yields for the 3 periods of 0%; volatility factors of the expected target price of the Company's common stock of 62.8% for the 3 periods; and expected life of the options of 5.0 for the 3 periods. These assumptions resulted in weighted-average fair values of $1.40, $1.47 and $2.32 per share for stock options granted in 1997, 1996 and 1995, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options. The Company's employee stock options have characteristics significantly different from those of traded options such as vesting restrictions and extremely limited transferability. In addition, the assumptions used in option valuation models (see above) are highly uncertain, particularly the expected stock price volatility of the underlying stock. Because changes in these uncertain input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized over the option vesting periods. The pro forma effect on net income for 1997, 1996 and 1995 is not representative of the pro forma effect on net income in future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1995. Pro forma information in future years will reflect the amortization of a larger number of stock options granted in several succeeding years. The Company's pro forma information is as follows (in thousands, except per share information):
Year ended December 31, ------------------------------------------------------------ (in thousands) 1997 1996 1995 ------------ ------------ ------------ Net loss - as reported $ (18,924) $ (6,801) $ (5,188) Net loss - pro forma (19,428) (7,097) (5,232) Loss per share - as reported $ (.93) $ (.34) $ (.26) Loss per share - pro forma $ (.95) $ (.35) $ (.26) ============ ============ ============
Information regarding outstanding stock options and warrants as of December 31, 1997 is as follows:
Options Outstanding Options Exercisable ----------------------------------------------------------------- --------------------------------------- Weighted Average Weighted-Average Remaining Weighted-Average Price Range Shares Exercise Price Contractual Life Shares Exercise Price - ------------ ------------- --------------------- --------------------- ------------ ---------------------- $0.69-$1.53 2,471,485 $1.38 4.84 478,102 $1.13 $1.56-$2.00 1,406,000 $1.69 2.65 797,748 $1.72 $2.38-$3.31 334,225 $2.77 1.78 227,473 $2.80 ============ ============= ===================== ===================== ============ ======================
10. Employee Benefit Plan In 1994, the Company established a 401(k) plan the (the "Plan") covering substantially all of its employees. The Plan allows eligible employees to contribute up to 15% of their compensation. Company contributions are voluntary and at the discretion of the Board of Directors. Contributions made by the Company for the year ended December 31, 1997 and 1996 and 1995 totaled $23,224, $31,440, and $32,615, respectively. 11. Contingencies In 1992, Octel Communications Corporation (Octel, now Lucent Technologies Inc.) a competitor of the Company, filed suit in the United States District Court for the Northern District of California against Theis Research, Inc. (Theis) for a declaratory judgment that Octel's products do not infringe certain patents held by Theis and that those patents are invalid. In 1993, the court consolidated several actions and Theis filed a counterclaim for infringement, a judgment of patent validity and various claims for injunctive and monetary relief against, among others, Pacific Telesis Group, Pacific Bell and other Pacific Bell entities (Pacific Telesis). Pacific Telesis tendered defense of this action to various of its vendors, including the Company, which resulted in counterclaims by Theis against the Company, Octel, Boston Technology (now Comverse Technology Inc), Northern Telecom and most other manufacturers of voice mail products. In 1993, the court severed trial of the counterclaims against all counter defendants except Octel, Boston Technology and Northern Telecom. In 1994, a jury concluded that the patents held by Theis Research, Inc. were either invalid or not infringed upon by Octel, and the counterclaims against Pacific Telesis in which Digital Sound has intervened are currently stayed. Theis Research appealed the findings of invalidity and noninfringement to the U.S. Court of Appeals and on November 6, 1997 the U.S. Court of Appeals affirmed the District Court's decision in its entirety. Theis Research has until March 30, 1998 to seek to have the matter heard before the U.S. Supreme Court. If Theis Research is granted a hearing before the U.S. Supreme Court and the U.S. Supreme Court reverses the judgment, Theis Research may assert claims of infringement against Pacific Telesis and Digital Sound on these patents. However, if the U.S. Supreme Court refuses to hear the matter or affirms the holding, the potential for any successful counterclaim against Pacific Telesis and Digital Sound as a supplier to Pacific Telesis is significantly reduced. Management believes, based on information currently available, including consultations with patent counsel, that the Company is not infringing upon any valid patents of Theis. The Company will vigorously defend the patent infringement claims and related claims for damages. While litigation is inherently uncertain, Management believes in view of the jury verdict in the Octel case that the ultimate resolution of these matters will not have a material adverse effect on the financial condition or results of operations of the Company. Should the outcome of this litigation be unfavorable to the Company, however, the Company would be required to fulfill its indemnification obligations to its customers, including Pacific Telesis, by either replacing or modifying its products to avoid infringement or by procuring a license to use the technology, either of which could have a materially adverse effect on the financial condition or results of operations of the Company. Additionally, the Company is subject to pending claims and litigation primarily related to contractual, product and employee issues. Management, after review and consultation with the Company's counsel, believes that the liability, if any, from the disposition of such claims and litigation would not have a materially adverse effect on the financial condition or results of operations of the Company. 12. Significant Customers During the year ended December 31, 1997, one customer accounted for 58% of the Company's net sales. During the year ended December 31, 1996, three customers accounted for 40%, 13% and 11% of the Company's net sales. During the year ended December 31, 1995, two customers accounted for 47% and 13% of the Company's net sales. No other customer accounted for sales of 10% or more. A majority of the Company's sales are made to telecommunications companies. The Company performs ongoing credit evaluations of its customers' financial condition and, generally, requires no collateral from its customers. In 1997 export sales accounted for 5% of the Company's net sales as compared to 26% in 1996. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE -------------------- None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT -------------------------------------------------- The information concerning Directors required by this item is incorporated by reference to Page 8-9 of the 1998 Proxy Statement. Information concerning Executive Officers required by this item appears after Part I, Item 4 of this report. ITEM 11. EXECUTIVE COMPENSATION ---------------------- The information required by this item is incorporated by reference to Pages 10-11 of the 1998 Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT -------------------------------------------------------------- The information required by this item is incorporated by reference to Page 5-7 of the 1998 Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ---------------------------------------------- None. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K ---------------------------------------------------------------- (a) Financial Statements, Financial Statement Schedules and Exhibits (1) The following exhibits are filed herewith:
Exhibit Number Title ------- ----- 10.40 Description of Registrant's Executive Bonus Plan for 1998. 11.01 Computation of Earnings (Loss) per Common Share. 23.00 Consent of Ernst & Young, LLP, independent auditors. 10.57 Purchase Agreement between GTE Communication Systems Corporation and Digital Sound Corporation (Contract Number 120900-92-01), dated January 13, 1993, and Amendments Nos. 1 through 9 thereto. 27 Financial Data Schedule
The following exhibits to the Company's Registration Statement under the Securities Act of 1933, as amended (filed January 19, 1990, Registration No. 33-33066), and the amendments thereto, are incorporated herein by reference:
Exhibit Number Title ------- ----- 3.01 Registrant's Articles of Incorporation, as amended to date. 3.02 Registrant's By-Laws, as amended to date. 10.12 Form of Indemnity Agreement with Directors.
The following exhibits to the Company's Form 10-K for 1996 or subsequently filed Form 10-Qs for 1997 are incorporated herein by reference: Exhibit Number Title ------- ----- 10.08 *The Amended and Restated Stock Option Plan for Independent Directors of Digital Sound Corporation, (The Directors' Plan). 10.10 *Registrant's Preferred Stock Purchase Agreement 10.35 *Letter agreement between Registrant and Mark C. Ozur. 10.38 *Registrant's 1983 Stock Option Plan. 10.39 *Registrant's Employee Stock Purchase Plan 10.43 *Amendment dated March 26, 1993 to the Registrant's 1983 Stock Option Plan. 10.44 Lease Agreement by and between the Registrant and Bluffs Group III dated October 1, 1996. EXHIBIT NUMBER TITLE - ------- ----- 10.45 Lease Agreement by and between the Registrant and BancBoston Leasing, Inc., dated January 8, 1997. 10.46 Amendment dated April 4, 1997 to the Registrant's 1983 Stock Option Plan. 10.47 Amendment dated March 26, 1993 to the Registrant's Employee Stock Purchase Plan. 10.48 Amendment dated April 4, 1997 to the Registrant's Employee Stock Purchase Plan. 10.49 Line of Credit Agreement between Registrant and Imperial Bank dated July 28, 1997. 10.50 Security and Loan Agreement Domestic Facility by and between Registrant and Imperial Bank dated July 28, 1997. 10.52 First Amendment and Waiver to Digital Sound Corporation Credit Terms and Conditions by and between Registrant and Imperial Bank dated October 30, 1997. 10.53 First Amendment to Security and Loan Agreement, Domestic Credit by and between Registrant and Imperial Bank dated October 30, 1997. 10.54 Warrant Purchase Agreement by and between Registrant and Imperial Bank dated October 30, 1997 10.55 Antidilution Agreement by and between Registrant and Imperial Bank dated October 30, 1997. 10.56 Registration Rights Agreement by and between Registrant and Imperial Bank dated October 30, 1997 The following exhibits to the Company's Form 8-K dated December 23, 1997, are incorporated by herein by reference: 3.03 Certificate of Determination. 10.1 Preferred Stock Purchase Agreement dated December 19, 1997. 10.2 Form of Convertible Promissory Note. 10.3 Registration Rights Agreement dated December 19, 1997 (b) In December 1997, the Registrant filed the following report on a Form 8K: Preferred Stock Purchase Agreement dated December 19, 1997. Certificate of Determination. Form of Convertible Promissory Note. Registration Rights Agreement dated December 19, 1997. - ------ *Management contract or compensatory plan or arrangement required to be filed as an Exhibit to the Form 10-K Report pursuant to Item 14(c).
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on February 25, 1997. DIGITAL SOUND CORPORATION By: /s/ B. Robert Suh --------------------- B. Robert Suh Vice President, Finance and Chief Financial Officer Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated. Name Title Date ---- ----- ---- Chief Executive Officer: President, /s/ Mark C. Ozur Chief Executive Officer, February 25, 1998 - ------------------------ and Director Mark C. Ozur Chief Financial Officer: /s/ B. Robert Suh Vice President, Finance February 25, 1998 - ----------------------- Chief Financial Officer B. Robert Suh Directors: /s/ John D. Beletic Director February 25, 1998 - ----------------------- John D. Beletic /s/ Bandel L. Carano Director February 25, 1998 - ----------------------- Bandel L. Carano /s/ J. David Hann Director February 25, 1998 - ----------------------- J. David Hann /s/ Frederick J. Warren Director February 25, 1998 - ----------------------- Frederick J. Warren DIGITAL SOUND CORPORATION SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 (Amount in thousands)
Balance at Addition Deductions Balance beginning charged to from at end of period earnings allowance of period ================================================================================================ December 31, 1995 Allowance for doubtful receivables $ 700 $ 34 $(134) $ 600 Accrued warranty reserve $ 375 $ 232 $(232) $ 375 - ------------------------------------------------------------------------------------------------ December 31, 1996 Allowance for doubtful receivables $ 600 $ 60 $ (60) $ 600 Accrued warranty reserve $ 375 $ 217 $(232) $ 360 - ------------------------------------------------------------------------------------------------ December 31, 1997 Allowance for doubtful receivables $ 600 $ 393 $(466) $ 527 Accrued warranty reserve $ 360 $ 589 $(520) $ 429 ================================================================================================
EX-10.40 2 DESCRIPTION OF REGISTRANT'S EXECUTIVE BONUS PLAN Exhibit 10.40 DIGITAL SOUND CORPORATION DESCRIPTION OF REGISTRANT'S EXECUTIVE OFFICER BONUS PLAN FOR 1998 The Company's 1998 Executive Officer Bonus Plan (the "Plan") is based solely on achieving the Company's 1998 revenue target. The Plan provides that if 100% of the revenue target is attained, a cash bonus equivalent to 20% of base salary will be earned. If revenue exceeds the annual target by 50%, then the maximum bonus of 75% of base salary will be earned. If revenue exceeds the annual target but by less than 50%, the percentage earned will be linearly prorated. There will be no bonus if the target is not reached. EX-10.57 3 PURCHASE AGREEMENT BETWEEN GTE COMMUNICATION EXHIBIT 10.57 CONTRACT NUMBER: 120900-92-01 PURCHASE AGREEMENT BETWEEN GTE COMMUNICATION SYSTEMS CORPORATION AND DIGITAL SOUND CORPORATION TABLE OF CONTENTS 1. TERM............................................................... 49 2. PURCHASE AND DISTRIBUTION OF PRODUCT(S)............................ 49 3. PRICE.............................................................. 50 4. TERMS OF PAYMENT................................................... 50 5. PRICE REVISIONS.................................................... 50 6. PURCHASING FORECAST................................................ 50 7. THIRD PARTY PURCHASES.............................................. 51 8. REPORTS............................................................ 51 9. BAR CODING......................................................... 51 10. PRECEDENCE OF DOCUMENTS........................................... 51 11. PURCHASE ORDER INFORMATION........................................ 51 12. DELIVERY.......................................................... 52 13. PACKAGING......................................................... 54 14. BILLING........................................................... 54 15. BILL OF SALE...................................................... 54 16. INSPECTION AND ACCEPTANCE......................................... 54 17. PRODUCT(S) STANDARDIZATION........................................ 55 18. TECHNOLOGICAL OR SPECIFICATION CHANGE/PRODUCT(S) DELETION/SUBSTITUTION.................................................. 56 19. UNSATISFACTORY CONDITION SITUATIONS............................... 57 20. PRODUCT(S) CHANGES................................................ 57 21. QUALITY ASSURANCE REPORTING....................................... 59 22. PRODUCT(S) SERVICES AND SUPPORT................................... 59 23. TRADEMARK LICENSE................................................. 59 24. INFRINGEMENT...................................................... 59 25. USE OF CONFIDENTIAL INFORMATION................................... 61 26. PROPRIETARY RIGHTS................................................ 61 27. PUBLICITY......................................................... 62 28. COMPLIANCE WITH LAWS.............................................. 62 29. FORCE MAJEURE..................................................... 63 30. ASSIGNMENT........................................................ 63 31. TAXES............................................................. 64 32. RECORDS........................................................... 64 33. RIGHT OF ACCESS................................................... 64 34. PLANT AND WORK RULES.............................................. 65 35. LIABILITY......................................................... 65 36. TOXIC SUBSTANCES AND HAZARDOUS PRODUCT(S)......................... 66 37. CANCELLATION 0F PURCHASE ORDERS; REVOCATION OF ACKNOWLEDGEMENTS... 66 38. TERMINATION....................................................... 67 39. NOTICES........................................................... 68 40. REGISTRATION...................................................... 70 41. NONWAIVER......................................................... 70 42. SEVERABILITY...................................................... 70 43. SECTION HEADINGS.................................................. 70 44. SURVIVAL OF OBLIGATIONS........................................... 71 45. CHOICE OF LAW..................................................... 71 46. ENTIRE AGREEMENT.................................................. 71 EXHIBIT A: GTE AFFILIATED ENTITIES.................................... 72 EXHIBIT B: SUPPLIER PRODUCT(S)......................................... 72 EXHIBIT C: SUPPLIER PRODUCT(S) PRICING................................ 72 EXHIBIT D: GTE BAR CODING............................................. 72 EXHIBIT E: GTE SHIPPING AND CARRIER ROUTING INSTRUCTIONS.............. 72 EXHIBIT F: SUPPLIER PRODUCT(S) DELIVERY INTERVAL...................... 72 EXHIBIT G: GTE PACKAGING CONFIGURATION DEFINITIONS.................... 72 EXHIBIT H: GTE STANDARDIZA'NON POLICY................................. 72 EXHIBIT I: GTE QUALITY ASSURANCE REPORTING............................ 72 EXHIBIT J: GTE PRODUCT(S) SERVICES AND SUPPORT REQUIREMENTS........... 72 EXHIBIT K: SUPPLIER'S ADDITIONAL SOFTWARE LICENSING TERMS............. 72
PURCHASE AGREEMENT THIS AGREEMENT is made by and between Digital Sound Corporation, a State of California Corporation with principal offices at 6307 Carpinteria Avenue, Carpinteria, California 93013 (hereinafter referred to as "SELLER") and GTE Communication Systems Corporation, a Delaware Corporation, acting by and through the GTE Supply Division with principal offices located at GTE Place, West Airfield Drive, DFW Airport, Texas 75261 (hereinafter referred to as "CUSTOMER"), for the benefit of itself and the GTE Affiliated Entities (hereinafter referred to as "Affiliates") listed in Exhibit A. WHEREAS, the parties agree and understand that CUSTOMER and/or Affiliates may purchase products from SELLER on the same terms and conditions as CUSTOMER hereunder. In such event, the Affiliate shall also be a "CUSTOMER" hereunder. It is the intent of the parties that CUSTOMER and/or Affiliates may make purchases according to the terms and conditions hereunder. WHEREAS, the parties hereto desire to enter into an agreement on a non-exclusive basis to govern the purchase for use or distribution of SELLER'S product(s) listed in Exhibit B, attached to this Agreement (hereinafter called "PRODUCT(S)"), to CUSTOMER. THEREFORE, in consideration of the mutual promises and covenants contained herein, the parties agree as follows: 1. TERM This Agreement shall be effective on the date of signing of this Agreement, and shall continue in effect thereafter for a period of two (2) years unless terminated or modified by either party in accordance with the provisions of this Agreement. This Agreement shall be automatically terminated unless renewed by CUSTOMER for a period not greater than one (1) year by written notice to SELLER not less than thirty (30) days prior to the expiration date. At the end of each twelve month period either party shall have the option to review Agreement terms and adjust such terms as mutually agreed upon by the parties. 2. PURCHASE AND DISTRIBUTION OF PRODUCT(S) (a) This Agreement covers the terms and conditions for the purchase and sale of SELLER'S PRODUCT(S) listed in Exhibit B. (b) Pursuant to the terms of this Agreement, SELLER hereby agrees to sell to CUSTOMER, and CUSTOMER may purchase from SELLER, if it submits purchase orders for them, (1) the PRODUCT(S) listed in Exhibit B and (2) other goods for which SELLER accepts a purchase order hereunder at the price as quoted to CUSTOMER in writing with respect to each such transaction. (c) The parties agree that CUSTOMER may purchase the PRODUCT(S) for its own use, for resale to end users and/or for distribution to other parties. (d) This Agreement is non-exclusive and shall not be construed (1) to require CUSTOMER to purchase any specific amount of PRODUCT(S) from SELLER or (2) to require CUSTOMER to sell any, all or a portion of PRODUCT(S) it orders, or restrict the purchase, resale and/or distribution of PRODUCT(S) to any geographic area. 3. PRICE (a) The prices for all PRODUCT(S) to be paid by CUSTOMER are those prices specified in Exhibit B as discounted per Exhibit C. Installation charges listed in Exhibit B are the maximum allowable unless installation is beyond the committed installation date and due to fault of CUSTOMER. (b) SELLER represents that the prices for the purchase of any PRODUCT(S) hereunder are no less favorable than those offered to other purchasers in comparable transactions. 4. TERMS OF PAYMENT Payment shall be due thirty (30) days from the date of receipt of goods or receipt of SELLER'S invoice, whichever occurs later. 5. PRICE REVISIONS (a) SELLER may propose price increases annually but only after the anniversary date of this Agreement by giving ninety (90) days written notice to CUSTOMER. SELLER shall honor all prices for PRODUCT(S) for which purchase orders have been issued prior to the effective date of such increases. (b) Price decreases shall be effective immediately upon announcement by SELLER and shall apply to all purchase orders which have not been delivered prior to the announcement date. 6. PURCHASING FORECAST CUSTOMER estimates that it may purchase from SELLER in the aggregate amount, eleven million four hundred thousand dollars ($11,400,000) of SELLER'S PRODUCT(S) during the first twelve (12) months of this Agreement. The purchase forecast is only a projection or estimate and is not to be construed as a commitment to purchase that or any amount. In no case shall CUSTOMER be responsible for any billback or related nonconformance charges should CUSTOMER'S purchases fail to meet projected levels, nor shall failure to purchase the estimated amount of SELLER'S PRODUCT(S), or any of SELLER'S PRODUCT(S), be a breach of this Agreement by CUSTOMER. 7. THIRD PARTY PURCHASES SELLER agrees to consider CUSTOMER's Supply Division as a possible furnisher of goods or services which SELLER may acquire from a third party. Accordingly CUSTOMER shall provide SELLER with a listing of goods and services which it may be able to provide. SELLER shall, however be the sole authority for procurement selections from third party suppliers. 8. REPORTS When requested by CUSTOMER, SELLER shall, for purchase orders placed directly with the SELLER by an Affiliate other than GTE Supply, provide CUSTOMER, at each address as referenced in Section 39, a quarterly purchase report by ordering location, listing PRODUCT(S) purchased under this Agreement, description, part number, quantities shipped and associated net prices. 9. BAR CODING SELLER agrees to comply with GTE standards in the development of a Bar Coding Program as outlined in Exhibit D, as mutually agreed by both parties and based on SELLER'S capability. 10. PRECEDENCE OF DOCUMENTS All purchase orders shall be subject to and governed by the provisions contained herein. Additional conditions appearing on the face or reverse side of any CUSTOMER'S purchase order which do not conflict with the terms and conditions of this Agreement shall be a part of this Agreement with respect to such purchase order if accepted by SELLER'S order acknowledgment. The terms and conditions of this written Agreement shall control over any conflicting or inconsistent terms and conditions contained in any purchase order. Upon receipt of CUSTOMER'S purchase order, SELLER shall acknowledge receipt, verification of information, and required ship date. SELLER'S acknowledgment is to be forwarded to CUSTOMER within ten (10) days of receipt of purchase order. Unless CUSTOMER specifically agrees in a separate writing, no additional or different terms and conditions appearing on the face or reverse side of any SELLER'S acknowledgment or invoice shall become part of such purchase order. 11. PURCHASE ORDER INFORMATION (a) Unless otherwise mutually agreed in writing by the parties, the following information shall normally be contained in the purchase order: (1) Description of PRODUCT(S), including any numerical alphabetical identification, including SELLER'S part number, referenced in the price list herein; (2) Requested delivery date; (3) Applicable price; (4) Location to which the PRODUCT(S) is to be shipped; (5) Location to which invoices shall be rendered for payment; (6) CUSTOMER'S purchase order number; (7) Configurations (if applicable); (8) Delivery requirements; (9) A reference to any applicable quotation given by SELLER to CUSTOMER; and (10) Quantity to be shipped. (b) All purchase orders, acknowledgments and subsequent invoicing may be communicated between CUSTOMER and SELLER by way of postal services, facsimile transmission and electronic data interchange according to industrial standards as developed to meet both parties' needs or as otherwise mutually agreed to by both parties. (c) SELLER may enforce each purchase order only against the entity which has submitted the purchase order. (d) Unless otherwise agreed to in writing, any written purchase order placed by CUSTOMER for PRODUCT(S) or services specified herein shall be subject to the terms and conditions of this Agreement. 12. DELIVERY (a) Shipments of PRODUCT(S) shall be made FOB Origin freight collect or prepaid and added to the invoice as may be specified on individual purchase orders. When CUSTOMER requests SELLER to arrange the transportation of the PRODUCT(S), SELLER shall ship all PRODUCT(S) freight collect in accordance with the GTE Shipping and Carrier Routing Instructions, Exhibit E, unless otherwise specified on the CUSTOMER'S purchase order. In the absence of shipping instructions, SELLER shall select the carrier listed in the GTE Shipping and Carrier Routing Instructions on behalf of CUSTOMER, but SELLER shall not assume any liability for shipment nor shall the carrier be construed as an agent of SELLER. If SELLER is instructed by CUSTOMER to ship prepaid & add, SELLER shall select a carrier based on best rate as negotiated by SELLER. In such instance, CUSTOMER shall only pay SELLER'S net transportation costs, inclusive of all applicable discounts, allowances and refunds. (b) Failure of SELLER to ship PRODUCT(S) in accordance with CUSTOMER'S freight routing instructions shall result in charge-backs to the SELLER for excess freight charges. (c) Unless instructed otherwise by CUSTOMER, SELLER shall, for purchase orders placed hereunder, (1) ship PRODUCT(S) in accordance with specific shipping instructions; (2) see that all subordinate documents bear CUSTOMER'S purchase order number; (3) enclose a packing list with each shipment and when more than one package is shipped, identify the one containing the packing list; (4) mark CUSTOMER'S purchase order number on all packages and shipping papers; (5) render invoices showing CUSTOMER'S purchase order number; (6) render separate invoices for each shipment or purchase order; (7) forward shipping notices with invoices; (8) invoice CUSTOMER by mailing or otherwise transmitting invoices, bills, and notices to the billing address on the purchase order; and (9) make available Bill of Lading upon request. (d) Standard delivery for PRODUCT(S) shall be as specified in Exhibit F and may be amended only by written document signed by both parties hereto. FOB delivery times shall be from the date of receipt of CUSTOMER'S purchase order. (e) SELLER shall ship PRODUCT(S) to CUSTOMER within the time period stated in Exhibit F with a minimum ninety-six percent (96%) service level. Service level shall be calculated as total line items shipped complete, as compared to the total number of line items ordered that have been purchased for delivery within SELLER'S stated delivery interval. SELLER shall provide CUSTOMER, on a quarterly basis at the addresses as referenced in Section 39, shipping reports delineating the following information: (1) CUSTOMER'S purchase order number; (2) Date CUSTOMER'S purchase order received by SELLER; (3) Date purchase order shipped complete from SELLER; (4) Total number of line items scheduled for shipment in the period; (5) Total number of line items shipped complete in the period; (6) Percent (%) of line items shipped complete in the period; (7) Total number of units scheduled for shipment in the period; (8) Total number of units shipped in the period; and (9) Percentage (%) of units shipped complete in the period (fill rate). 13. PACKAGING PRODUCT(S) shall be packaged and packed at no additional charge for shipment in suitable containers which shall provide protection against damage during the domestic shipment, handling and storage in reasonably dry, unheated quarters. Refer to Exhibit G for packaging configuration definitions. Corrugated shipping containers shall comply with requirements of Item 222 of the National Motor Freight Code, Series NMFC 100-P. Containers of any type that are too heavy or too large to be palletized shall be skidded to facilitate fork truck and/or mechanized handling. 14. BILLING SELLER shall render invoices to CUSTOMER, for each shipment made, unless otherwise specified, at the address listed on CUSTOMER'S purchase order. Invoices shall include, but not be limited to (1) purchase order number; (2) purchase order line number; (3) PRODUCT(S) identification number; (4) ship to address; (5) quantity shipped and billed; (6) net invoice amount; (7) net unit cost; and (8) any special instructions as requested by CUSTOMER. 15. BILL OF SALE SELLER agrees, upon request by CUSTOMER, to execute and deliver to CUSTOMER a bill of sale evidencing conveyance of PRODUCT(S), free and clear of all liens, security interests and encumbrances, together with such other documents as may be necessary by CUSTOMER. 16. INSPECTION AND ACCEPTANCE (a) All PRODUCT(S) ordered pursuant to this Agreement shall be subject to inspection by CUSTOMER after delivery to determine its conformity with CUSTOMER'S purchase order. If the PRODUCT(S) delivered does not conform with CUSTOMER'S purchase order, CUSTOMER shall have the right to reject such PRODUCT(S). PRODUCT(S) which has been delivered and rejected, in whole or in part, shall be returned to SELLER at SELLER'S risk and expense. CUSTOMER shall have a period of thirty (30) days following arrival of PRODUCT(S) at the delivery destination specified by CUSTOMER within which to inspect the PRODUCT(S) for conformity with CUSTOMER'S purchase order and SELLER'S advertised and published specifications and to provide SELLER with written notice of any discrepancy or rejection. If CUSTOMER does not provide SELLER with such written notice of a discrepancy or rejection within such thirty (30) day period, the PRODUCT(S) shall be deemed accepted by CUSTOMER, unless otherwise agreed by the parties in writing. CUSTOMER shall notify SELLER and arrange for the return of PRODUCT(S) as required. (b) Inspection or failure to inspect on any occasion shall not affect CUSTOMER'S rights under the "WARRANTY" provisions of Exhibit J herein or any other rights or remedies available to CUSTOMER whether at law or in equity. 17. PRODUCT(S) STANDARDIZATION (a) During the term of this Agreement, SELLER shall comply with GTE's PRODUCT(S) Standardization Policy as set forth in Exhibit H. (b) Hardware/software problems identified during CUSTOMER's Standardization Management testing of new hardware/software releases are to be corrected in accordance with the following priority schedule: Priority One (1) - must be corrected prior to on-line implementation. Priority Two (2) - must be corrected prior to commercial release. Priority Three (3) - must be corrected in the first product update. Priority Four (4) - possible design request or future feature enhancement. Priority Five (5) - monitor on-line performance or verify commercial release documentation. The Priority assigned to a particular hardware/software problem shall be determined by CUSTOMER's Standardization Management. (c) CUSTOMER reserves the right to test new releases or feature enhancements prior to CUSTOMER's distribution. SELLER will not distribute commercially available system version releases to CUSTOMER without written approval from CUSTOMER. Software corrections (Patches and/or Point releases) will be provided at no charge for ninety (90) days from the date of written approval of the new release by CUSTOMER. (d) SELLER will work in good faith with CUSTOMER to follow guidelines to ensure the necessary tracking, reporting and processing of Product Design Requests submitted by CUSTOMER. (e) At the commencement of this Agreement, SELLER will provide a best efforts Product enhancement/availability schedule for the next two (2) years and update such schedule each quarter. Software (load) enhancements must be made available, and the cost of each software (load) enhancement must not exceed ****** (***) percent of the initial software (load) expense. 18. TECHNOLOGICAL OR SPECIFICATION CHANGE/PRODUCT(S) DELETION/SUBSTITUTION (a) SELLER is required to give CUSTOMER notice one hundred twenty (120) days in advance of any technological or specification change, software/firmware revision, PRODUCT(S) deletion or manufacturer discontinuance that shall significantly impact PRODUCT(S) operation, interchangeability with existing PRODUCT(S), appearance, warranty, life cycle or GTE engineering/quality approvals of any PRODUCT(S). SELLER shall, at the time of notification, provide CUSTOMER with (1) a PRODUCT(S) change number; (2) a description of such change; (3) reason for change; (4) a description of the impact of such change upon (i) reliability, (ii) PRODUCT(S) specifications, (iii) form, fit or function; (5) proposed price impact (if any); and (6) proposed effective date for such change and recommended implementation schedule therefore. Notwithstanding the foregoing, if SELLER makes any change with material impact to the PRODUCT(S) which SELLER in its reasonable discretion decides must be released on less than one hundred twenty (120) days notice (e.g., a bug fix or change for safety reasons), SELLER will give CUSTOMER the foregoing notification as soon as commercially practicable. (b) In the event that SELLER and CUSTOMER shall fail to reach agreement on any such change in PRODUCT(S) to be made by SELLER, then, in addition to all other rights and remedies at law or in equity or otherwise, CUSTOMER shall, at no cost or liability, have the right to terminate this Agreement and any and all pending purchase orders for PRODUCT(S) affected by such change. (c) SELLER agrees if the required one hundred twenty (120) days notice is not provided, SELLER shall accept at CUSTOMER'S option, a PRODUCT(S) exchange or return for all unsold PRODUCT(S) in CUSTOMER'S inventory which were received or shipped prior to the date of such notice. Such option must be made by CUSTOMER within one hundred twenty (120) days after SELLER'S notification. Any PRODUCT(S) returned must be unused, undamaged and in the original carton and may, at CUSTOMER'S option, be returned for one hundred percent (100%) credit of the price paid or an equal dollar value exchange for any other PRODUCT(S) offered under this Agreement. 19. UNSATISFACTORY CONDITION SITUATIONS If at any time during normal operation the CUSTOMER encounters an unsatisfactory condition in the PRODUCT(S), SELLER agrees to meet the following time frames for resolving the condition: (a) Conditions which affect public or employee safety or the ability to track and collect revenue, or which cause major degradation of service, SELLER shall acknowledge within ****** (**) days of notification and must provide a permanent resolution within ****** (**) days of notification. (b) Conditions which affect service, but have a temporary solution to reduce the impact, or which have potential for major service degradation, SELLER shall acknowledge within ****** (**) days of notification and must provide a permanent resolution within ******* (**) days of notification. (c) Conditions which are not service or safety affecting but which have potential to adversely affect normal maintenance and/or administration of telephone service, SELLER shall acknowledge within **** (**) days and provide a permanent resolution within **************** (**) days of notification. (d) CUSTOMER and SELLER may agree to action dates other than those stated above that shall correct unsatisfactory conditions due to upgrades, technological changes, etc. If an exception to the above corrective action time frames occurs, the SELLER is bound by the newly agreed upon date. 20. PRODUCT(S) CHANGES (a) After PRODUCT(S) has shipped to CUSTOMER, if SELLER issues changes affecting such PRODUCT(S) and a change is identified as necessary for the PRODUCT(S) to continue to meet SELLER'S published specifications, design criteria or is an identified correction of deficiency as a result of an Unsatisfactory Condition Report (refer to Section 19), SELLER shall provide prompt notification of required changes to GTE Standardization Management. SELLER shall, at its expense, furnish and install the parts necessary to implement any such changes made within a ten (10) year period from the date of shipment of PRODUCT(S) by SELLER to CUSTOMER. Upgrades and enhancements are not covered in this subsection or in the other subsections of this Product Changes provision. (b) If CUSTOMER and SELLER ascertain that PRODUCT(S) or part thereof subject to such change is readily returnable, CUSTOMER shall remove and shall return such PRODUCT(S) or part to SELLER'S facility and SELLER, at its expense, shall implement such changes at its facility and return such changed PRODUCT(S) or part to CUSTOMER'S designated location. If removed PRODUCT(S) returned to SELLER for modification creates an out-of-service condition, SELLER shall make suitable arrangements to provide replacement PRODUCT(S) such that no out-of-service condition shall occur. (c) Any PRODUCT(S) maintained in CUSTOMER'S inventory subject to such change shall be returned to SELLER'S facility to implement changes and return to CUSTOMER'S stocking location at SELLER'S expense. If such changes create an adverse impact on the PRODUCT(S) warranty or CUSTOMER'S ability to sell the PRODUCT(S) as new, then SELLER shall accept at CUSTOMER'S option, a PRODUCT(S) exchange or return for all unchanged PRODUCT(S) in CUSTOMER'S inventory. (d) All change notifications provided by SELLER to CUSTOMER shall contain the following information: (1) description of change; (2) reason for change; (3) impact on customer service (i.e., outages, system downtime); (4) price impact, if known; (5) effective date of changes; and (6) implementation schedule of change. (e) CUSTOMER may request SELLER to make changes to SELLER'S PRODUCT(S). Upon receipt of a written document describing in detail the changes requested by CUSTOMER, SELLER shall respond in writing to CUSTOMER within thirty (30) days. If SELLER agrees to undertake such modifications for CUSTOMER, the response shall quote a proposed implementation schedule and a cost for such changes to PRODUCT(S). 21. QUALITY ASSURANCE REPORTING (a) Unless specified otherwise, quality and reliability reporting requirements shall be as defined in GTE Standardization Management's Quality and Reliability Document, known as the TO-15 Process, as set forth in Exhibit I. SELLER shall submit Form TQ-15 and related documents to CUSTOMER for performance verification, as required, on a quarterly basis. Verification may include on-site audits of documentation, process reviews and product quality discussions. (b) CUSTOMER has the right to rate SELLER'S performance in accordance with CUSTOMER'S internal rating algorithm. Upon request, CUSTOMER agrees to provide rating information to SELLER without charge. (c) SELLER agrees to have a field reliability and delivery performance tracking system in place as mutually agreed between CUSTOMER and SELLER and shall continue the tracking system for as long as this Agreement is in effect. The tracking system shall provide timely internal data collection enabling SELLER to arrive at solutions to delivery, quality and reliability problems related to assembly, subassembly or other repairable module deficiencies as measured against CUSTOMER'S requirements. 22. PRODUCT(S) SERVICES AND SUPPORT During the term of this Agreement, SELLER shall provide PRODUCT(S) services and support as set forth in Exhibit J. 23. TRADEMARK LICENSE SELLER hereby grants to CUSTOMER the non-exclusive right to use SELLER'S trade name and trademark. The SELLER'S trade name and trademark are registered in the United States. SELLER reserves the right to prior review and approval of CUSTOMER'S use of the SELLER'S trade name, trademark, and all relevant advertising material and SELLER agrees not to unreasonably withhold or delay such approval. In the event of termination of this Agreement, SELLER has the right to withdraw this consent with respect to uses by CUSTOMER following termination. 24. INFRINGEMENT (a) SELLER shall defend at its own expense all third party claims, proceedings and/or suits alleging infringement or misappropriation of any patent, trademark, copyright, trade secret or violation of any other intellectual property or proprietary rights by reason of the use or sale of any PRODUCT(S) furnished to CUSTOMER under this Agreement, or the use of any licensed PRODUCT(S) within the scope of the licenses granted under this Agreement, and shall defend, indemnify, protect and save CUSTOMER harmless from all claims, actions, suits, costs, expenses, damages, including reasonable attorney's fees and payments, as a result of such claim of infringement or misappropriation; and if the use or resale shall be enjoined, SELLER shall, at its option, replace the enjoined PRODUCT(S), licensed PRODUCT(S) or service with a suitable substitute free of the infringement or misappropriation; or shall procure for CUSTOMER'S benefit a license or other right to use or resell the same, or shall remove the enjoined PRODUCT(S) and refund to CUSTOMER the amount paid to SELLER therefor, plus CUSTOMER'S direct, incidental and/or consequential damages for such infringing or misappropriated PRODUCT(S). CUSTOMER agrees that any such recovery of consequential damages shall have an upper limit of two hundred fifty thousand dollars ($250,000) per claim or occurrence. SELLER shall have total control over the defense, negotiation and settlement of each case, provided, however, that CUSTOMER shall be permitted to participate in such defenses, negotiation, or settlement by counsel of its own choosing and expense. (b) CUSTOMER shall give SELLER prompt notice of any claims of such infringement or misappropriation and of all suits and, except as otherwise indicated herein, full opportunity and authority to assume the sole defense thereof, where SELLER is obligated to indemnify CUSTOMER hereunder, including appeals, and to settle such suits, and shall furnish upon SELLER'S request and at SELLER'S expense all disclosable information and reasonable assistance available to CUSTOMER. This Section 24 states SELLER's entire liability and obligations with respect to claims of infringement of proprietary rights of any kind and is CUSTOMER's sole and exclusive remedy for any breach of Exhibit J Section 1 (a)(i) with respect to infringement of proprietary rights. (c) No undertaking of SELLER in this Section shall apply to any infringement misappropriation or any claim of infringement or misappropriation which arises solely from SELLER's adherence to CUSTOMER's written instructions or directions or which arise solely from the use of PRODUCT(S) with equipment, devices, or software not supplied by SELLER other than (1) commercial merchandise which is available on the open market with which PRODUCT(S) is designed to operate or (2) items of SELLER origin, design or selection. Each party shall defend or settle, at its own expense, any action or suit against the other for which ft is responsible. 25. USE OF CONFIDENTIAL INFORMATION (a) Any specifications, drawings, sketches, models, samples, tools, computer programs, technical information, or confidential business information or data, written, oral or otherwise (hereinafter called "Information") furnished by the parties to one another hereunder shall remain the property of the supplier of such Information. All copies of such Information in written, graphic or other tangible form shall be returned to the supplier upon request except for a single archival copy. (b) If clearly marked as confidential, and unless such Information was previously known to the recipient to be free from any obligation to keep it confidential or until It has been or is subsequently made public by the supplier or a third party, without breach of any obligation of confidentiality, it shall be treated as confidential by the recipient, and shall be used by the recipient only in connection with fulfilling the obligations of the recipient which arise pursuant to this Agreement, unless the prior written consent of the supplying party is obtained. Orally disclosed confidential Information shall be reduced to writing within twenty (20) days of disclosure and marked as confidential. Such Information shall only be distributed to those employees who have a need to know. (c) Each party shall treat the other's Information in accordance with a standard of care reasonably calculated to prevent inadvertent or accidental disclosure. Nothing herein shall be construed as waiving the right of any party to require the other party to execute a written nondisclosure agreement, containing reasonable additional terms and conditions, prior to the supplying of particular confidential Information from time to time. Such additional terms and conditions shall not be inconsistent, with the terms and conditions of this Agreement. 26. PROPRIETARY RIGHTS (a) Nothing herein shall be construed as affecting SELLER's (and its licensor') ownership, and CUSTOMER acknowledges and agrees that SELLER (and its licensor') retains all ownership of any and all patent rights, patent applications, rights to apply for patents, copyrights, trademarks, trade secrets and all other proprietary rights in and to the PRODUCT(S), including without limitation, the software portions of the PRODUCT(S) in all formats and mediums including ROMS, EPROMS and all other firmware devices. (b) CUSTOMER will take all steps reasonably necessary and advisable to preserve and protect SELLER's confidential information and proprietary rights in connection with any proposal, bid or contract between CUSTOMER and any part of any foreign, federal, state or local government, including without limitation the use of appropriate confidentiality legends and restricted rights notices in the name of SELLER on any written material submitted by CUSTOMER in connection with any such proposal, bid or contract. (c) SELLER hereby licenses the "Software," as defined in Exhibit K to CUSTOMER for use with the hardware portions of the PRODUCT(S) pursuant to the terms and conditions of this Agreement, including the Additional Software Terms attached as Exhibit K. 27. PUBLICITY The parties agree to submit to one another for written approval all advertising, sales promotion, press releases and other publicity matters relating to the PRODUCT(S) furnished or the services performed by them pursuant to this Agreement whereby their respective names or marks are mentioned or language from which the connection of said names or marks therewith may be inferred or implied, and the parties further agree not to publish or use such advertising, sales promotions, press releases, or publicity matters without such prior written approval. Such approval shall not be unreasonably withheld or delayed by either party. 28. COMPLIANCE WITH LAWS (a) The parties hereto shall comply with the provisions of all applicable federal, state, county and local laws, ordinances, regulations and codes (including procurement of required permits or certificates) in their respective performance hereunder including, but not limited to the standards promulgated by the Occupational Safety and Health Act, Executive Order 11246, as amended, relative to Equal Employment Opportunity, Section 503 of the Rehabilitation Act of 1973 and Section 402 of the Vietnam Veterans Readjustment Assistance Act of 1974 and all applicable laws, orders and regulations concerning immigrants and non- discrimination in the employment of minorities, females, veterans and the handicapped. Irrespective of whether a specification is furnished, if PRODUCT(S) or containers furnished are required to be constructed, packaged, labeled or registered in a prescribed manner, the SELLER shall comply with federal law and, in addition, with applicable state or local law. Each party agrees to indemnify the other, and defend the other party against, any claims, loss or damage sustained because of its noncompliance hereunder. (b) Without prejudice to the generality of the foregoing, CUSTOMER agrees to comply strictly and fully with all export controls imposed on the PRODUCT(S) by any country or organization of nations within whose jurisdiction CUSTOMER operates or does business. CUSTOMER agrees not to export or permit exportation of any part of the PRODUCT(S) or any related technical data or any direct product of any related technical data, outside of the United States without first (a) obtaining any required written permission to do so from the United States Office of Export Administration and other appropriate governmental agencies of the United States; or, (b) complying fully and strictly with all requirements of any general license exempting the exportation from the requirement for that permission. These restrictions also apply to re-exportation from the United States of imported items. 29. FORCE MAJEURE (a) Neither SELLER nor CUSTOMER shall be responsible for any delay or failure in performance of any part of this Agreement to the extent that such delay or failure is caused by fire, flood, explosion, war, strike, embargo, government requirement, civil or military authority, acts of God, inability to obtain raw materials or supplies of PRODUCT(S), acts or omissions of carriers and other similar causes beyond its control (hereinafter called "Condition(s)"). If any such Condition(s) occurs, the party delayed or unable to perform shall promptly give notice to the other party and, if such Condition(s) remains at the end of thirty (30) days thereafter, the party affected by the other's delay or inability to perform may elect to (1) terminate such purchase order or part thereof, or (2) suspend such purchase order for the duration of the Condition(s), and at the option of the suspending party, buy elsewhere comparable material to be bought or sold under such purchase order, and apply to any commitment the value of such purchase, and resume performance of such purchase order once the Condition(s) ceases, with an option in the affected party to extend the period of this Agreement up to the length of time the Condition(s) endured. (b) Unless written notice is given within thirty (30) days after the affected party is notified of the Condition(s), (a)(2) above shall be deemed selected. 30. ASSIGNMENT (a) Except as otherwise provided herein, the rights and obligations of the parties hereunder shall neither be assigned nor delegated without the prior written consent of the other party, which shall not be unreasonably withheld, provided that any party may assign or delegate their respective rights and obligations hereunder, in whole or in part, to any parent or subsidiary or affiliate of CUSTOMER or SELLER in existence at the time of execution of this Agreement, upon prior written notice to the other. Such assignment shall not diminish any rights or duties that SELLER or CUSTOMER may have had prior to the effective date of assignment. (b) The limitation on assignment does not apply to an assignment confined solely to monies due or to become due under this Agreement, provided CUSTOMER or SELLER is given thirty (30) days prior written notice of such assignment. Assignment of monies shall be void to the extent that it attempts to impose upon CUSTOMER or SELLER obligations to the assignee additional to the payment of such monies, or to preclude CUSTOMER or SELLER from dealing solely and directly with the other in all matters pertaining hereto, including negotiation of amendments or settlement of amounts due. In the event CUSTOMER or SELLER makes such an assignment it is and shall remain responsible for payment hereunder. 31. TAXES CUSTOMER shall be liable for and shall reimburse SELLER for payments of Federal Manufacturers' and Retailers' Excise Taxes, state and local sales taxes and use taxes, as applicable, with respect to transactions under this Agreement. Taxes payable by CUSTOMER shall be separately stated in SELLER'S invoices and shall not be included in SELLER'S prices. CUSTOMER shall not be liable for any tax for which a valid exemption certificate acceptable to the applicable, state taxing authorities is furnished by CUSTOMER to SELLER. 32. RECORDS SELLER shall maintain complete and accurate records of all amounts billable to and payments made by CUSTOMER hereunder in accordance with generally accepted accounting practices. SELLER shall retain such records for a period of three (3) years from the date of final shipment for PRODUCT(S) or services covered by this Agreement. SELLER agrees to provide supporting documentation concerning any disputed amount of invoice to CUSTOMER within thirty (30) days after CUSTOMER provides written notification of the dispute to SELLER. SELLER shall retain such records for three (3) years from date of invoice. 33. RIGHT OF ACCESS SELLER and CUSTOMER shall permit reasonable access during normal working hours to its facilities in connection with work hereunder. No charge shall be made for such visits. It is agreed that reasonable prior notification shall be given when access is required. CUSTOMER may inspect any material that CUSTOMER has ordered. 34. PLANT AND WORK RULES The respective agents and employees of the parties shall, while on premises of the other, comply with all plant rules, regulations and reasonable company standards for security, including (where required by Government Regulations) submission of satisfactory clearance from U.S. Department of Defense and other federal authorities concerned. 35. LIABILITY (a) Notwithstanding anything to be contrary herein, SELLER shall indemnify and save harmless CUSTOMER from any loss or damages (including reasonable attorney's fees) incurred by CUSTOMER because of claims, suits, or demands of any kind including personal injury or property damage to the extent such loss or damage is caused by or results from defective PRODUCT(S) manufactured by SELLER or the negligent acts or omissions of SELLER or its employees or agents provided (1) CUSTOMER promptly notifies SELLER in writing of any suits, claims, or demands against CUSTOMER for which SELLER is responsible under this indemnity; (2) CUSTOMER gives SELLER full opportunity and authority to assume the sole defense of and settlement of such suits; and (3) CUSTOMER furnishes to SELLER upon request all information and reasonable assistance available to CUSTOMER for defense against any such suit, claim, or demand. (b) All work performed under this Agreement by any party shall be performed as an independent contractor and not as an agent of any other party. Persons furnished by the respective parties shall be solely the employees or agents of such parties, respectively, and shall be under the sole and exclusive direction and control of such parties. They shall not be considered employees of the other party for any purpose. Each party shall be responsible for compliance with all laws, rules and regulations involving their respective employees or agents, including (but not limited to) employment of labor, hours of labor, health and safety, working conditions and payment of wages. Each party shall also be responsible, respectively, for payment of taxes, including federal, state, and municipal taxes, chargeable or assessed with respect to its employees or agents, such as social security, unemployment, worker's compensation, disability insurance and federal and state income tax withholding. (c) SELLER agrees to maintain during the term hereof all insurance and/or bonds required by law or this Agreement, including, but not limited to (1) Worker's Compensation and related insurance as prescribed by the law of the state in which SELLER'S services are performed; (2) employer's liability insurance with limits of at least $500,000 for each occurrence, and (3) comprehensive general liability insurance including PRODUCT(S) liability, and, if the use of motor vehicles is required, comprehensive motor vehicle liability insurance, each with limits of at least $2,000,000 for combined single limit for bodily injury, including death and/or property damage. SELLER shall, if requested by CUSTOMER, prior to rendering such services, furnish certificates or adequate proof of the foregoing insurance. Notwithstanding the above, SELLER and CUSTOMER shall each have the option, where permitted by law, to self-insure any or all of the foregoing risks. (d) The parties expressly agree and understand that Seller's liability shall in no event exceed ************* dollars ($*********) for any one occurrence, whether the claim arises under this Agreement, in contract, tort or otherwise. 36. TOXIC SUBSTANCES AND HAZARDOUS PRODUCT(S) (a) SELLER warrants to CUSTOMER that each PRODUCT(S) furnished by SELLER hereunder or in performance of purchase orders placed hereunder is safe for normal use, is nontoxic, presents no abnormal hazards to persons or the environment, and may be disposed of as normal refuse. (b) All system cards shall be clearly labeled with the letters "ESD" (Electro Static Discharge) for proper printed wire card handling. 37. CANCELLATION 0F PURCHASE ORDERS; REVOCATION OF ACKNOWLEDGEMENTS (a) In the event that SELLER shall be in material breach or default of any of the terms, conditions or covenants of this Agreement, including, but not limited to, SELLER'S failure to tender delivery of the PRODUCT(S) on or before the delivery date stated on SELLER'S acknowledgement, then, in addition to all other rights and remedies of law or equity or otherwise, CUSTOMER shall have the right to immediately cancel all applicable purchase orders without any obligation or liability to SELLER for said cancellation. (b) In the event that CUSTOMER shall be in material breach or default of any of the terms, conditions or covenants of this Agreement, including, but not limited to, timely payment for PRODUCT(S) purchased and such breach shall continue for a period of thirty (30) days after CUSTOMER'S receipt of SELLER'S written notice thereof, then, in addition to all other rights and remedies of law or equity or otherwise, SELLER shall have the right to suspend delivery of PRODUCT(S) on outstanding purchase orders or revoke existing acceptances. Default by an Affiliate shall not affect any other Affiliate party to this Agreement. (c) SELLER will defer or cancel shipment of items subject to purchase orders upon CUSTOMER's written request, if that request is received by SELLER a reasonable time prior to the scheduled shipment date. All deferments and cancellations will be subject to certain charges as a percentage of the discounted prices of the items to be deferred or canceled. That percentage will depend upon the number of days prior to the scheduled shipment date that SELLER receives a written request for deferment, or cancellation as follows:
Percentage Percentage Days Deferment Cancellation Notice Charge Charge Beyond **% of **% **% Delivery Lead Time Interval **% or less of **% **% Delivery Lead Time Interval
If equipment canceled is sold by SELLER within ****** (**) days of requested delivery date, then no cancellation charges will apply. If equipment canceled is sold by SELLER but not within ****** (**) days of requested delivery date, then a ** percent (*%) charge will apply. CUSTOMER will have no right to defer shipment of any item developed, made or modified to CUSTOMER's special order. Any request for deferment of any item for more than ***** (**) days, and the third (3rd) request for any deferment of shipment of any item, will be treated as a cancellation of the deferred shipment and a new order. 38. TERMINATION (a) CUSTOMER may terminate this Agreement without cause, effective immediately, upon written notice to the other party. (b) Upon termination of this Agreement, without cause pursuant to this Section, CUSTOMER shall not be liable to SELLER, either for compensation or for damages of any kind or character whatsoever, whether on account of the loss by SELLER of present or prospective profits on sales or anticipated sales, or expenditures, investments or commitments made in connection therewith or in connection with the establishment, development or maintenance of SELLER'S business, or on account of any other cause or thing whatsoever, provided that termination shall not prejudice or otherwise affect the rights or liabilities of SELLER with respect to PRODUCT(S) theretofore ordered hereunder, or any indebtedness then owing by either party to the other. (c) Either party may terminate this Agreement, effective immediately, without liability for said termination, upon written notice to the other party, if any of the following events occur: (1) The other files a voluntary petition in bankruptcy; (2) The other is adjudged bankrupt; (3) A court assumes jurisdiction of the assets of the other under a federal reorganization act; (4) A trustee or receiver is appointed by a court for all or a substantial portion of the assets of the other; (5) The other becomes insolvent of suspends its business; (6) The other makes an assignment of its assets for the benefit of its creditors except as required in the ordinary course of business; or (7) The identity of the other's business is materially changed by sale of its business, transfer of control of its outstanding stock, merger or otherwise. (d) Either party may immediately terminate this Agreement for a material breach or default of any of the terms, conditions or covenants of this Agreement by the other, provided that such termination may be made only following the expiration of a thirty (30) day period during which the other party has failed to cure such breach after having been given written notice of such breach. This paragraph shall not apply to CUSTOMER'S cancellations or SELLER'S revocations under Section 37. 39. NOTICES Any notice or demand given under the terms of this Agreement or pursuant to statute shall be in writing and shall be given or made by telegram, telecopy or similar communication or by certified or registered mail return receipt requested, proper postage paid and addressed to the respective parties as follows: To CUSTOMER: GTE Supply 700 Hidden Ridge Irving, Texas 75038 Attention: Director - Central Procurement (HQW02B28) and GTE Service Corporation 700 Hidden Ridge Irving, Texas 75038 Attention: Director - CPS Standardization (HQW01N60) and GTE Supply GTE Place, West Airfield Drive DFW Airport, Texas 75261 Attention: Director - Materials Management/Purchasing (D03B58) and GTE Service Corporation 700 Hidden Ridge Irving, Texas 75038 Attention: Director - Consumer Network Services (HQE02B60) To SELLER: Digital Sound Corporation 6307 Carpinteria Avenue Carpinteria, California 93013 Attention: Vice President, Sales Such notice or demand shall be deemed to have been given or made when received or seventy-two (72) hours after being sent whichever occurs first, or upon electronic confirmation of receipt, if sent by telegraph or telecopy. The above may be changed at any time by giving thirty (30) days prior written notice as above provided. 40. REGISTRATION PRODUCT(S) furnished hereunder shall comply, to the extent applicable, with the requirements of the Federal Communications Commission's Rules and Regulations, as may be amended, including those sections concerning the labeling of such PRODUCT(S) and the suppression of radiation to specified levels. If the PRODUCT(S) generates interference harmful to radio communications, and such PRODUCT(S) was installed in accordance with such Rules and Regulations, then SELLER shall provide to CUSTOMER methods for suppressing the interference. If the interference cannot be reasonably suppressed, SELLER shall, at CUSTOMER'S option, accept return of the PRODUCT(S), refund to CUSTOMER the price paid for the PRODUCT(S) and bear all expenses for removal and shipment of such PRODUCT(S). Nothing herein shall be deemed to diminish or otherwise limit SELLER'S obligations under respective "WARRANTY" provisions herein. 41. NONWAIVER Either party's failure to enforce any of the provisions of this Agreement and/or any purchase order or to exercise any option hereunder shall in no way be construed as a waiver of such provisions, rights, or options or in any way be deemed to affect the validity of this Agreement or any purchase order. 42. SEVERABILITY If any of the provisions of this Agreement shall be invalid or unenforceable, such invalidity or unenforceability shall not invalidate or render unenforceable the entire Agreement, but rather the entire Agreement shall be construed as if not containing the particular invalid or unenforceable provision or provisions, and the rights and obligations of SELLER and CUSTOMER shall be construed and enforced accordingly. 43. SECTION HEADINGS The headings of the sections herein are inserted for convenience only and are not intended to affect the meaning or interpretation of this Agreement. 44. SURVIVAL OF OBLIGATIONS The respective obligations of SELLER and CUSTOMER under this Agreement which by their nature would continue beyond the termination, cancellation or expiration hereof, shall survive termination, cancellation or expiration hereof. 45. CHOICE OF LAW The construction, interpretation and performance of this Agreement shall be governed by and construed in accordance with the domestic laws of the state of Texas. 46. ENTIRE AGREEMENT This Agreement and the exhibits hereto constitute the entire agreement between SELLER and CUSTOMER. No modifications shall be made to this Agreement unless in writing and signed by appropriate representatives of the parties. IN WITNESS WHEREOF, the parties hereto have executed this Agreement through their authorized corporate representatives. DIGITAL SOUND CORPORATION GTE COMMUNICATION SYSTEMS CORPORATION /s/ Harry Bruner /s/ C. W. Barlow - ------------------- ------------------- Harry Bruner C. W. Barlow Vice President, Sales President Dated: December 21, 1992 Dated: January 13, 1993 Approved as to form and legality /s/ Connie E. Nicholos ------------------------- Attorney, GTE Telephone Operations Dated: December 15, 1992 EXHIBIT A: Revised List of GTE Affiliated Entities that are entitled to purchase under the Purchase Agreement. EXHIBIT B: DGSD Domestic Version Price/Product List EXHIBIT C: DGSD Product Pricing Discount for GTE EXHIBIT D: GTE Bar Coding EXHIBIT E: GTE Shipping and Carrier Routing Instructions EXHIBIT F: DGSD Product(S) Delivery Interval EXHIBIT G: GTE Packaging Configuration Definitions EXHIBIT H: GTE Standardization Policy EXHIBIT I: GTE Quality Assurance Reporting EXHIBIT J: GTE Product(S) Services And Support Requirements Exhibit J ATTACHMENT A: DGSD Product(S) Warranty Exhibit J ATTACHMENT B: DGSD Product Repair Rates Exhibit J ATTACHMENT C: DGSD Repair Parts Pricing Exhibit J ATTACHMENT D: DGSD Working Hour Schedule & Contact Information & Escalation Matrix Exhibit J ATTACHMENT E: DGSD Training Rates Exhibit J ATTACHMENT F: GTE Training Standards EXHIBIT K: DGSD'S Additional Software Licensing Terms AMENDMENT NO. 1 TO PURCHASE AGREEMENT NO. 120900-92-01 BETWEEN GTE COMMUNICATION SYSTEMS CORPORATION AND DIGITAL SOUND CORPORATION This Amendment No. 1 to the Purchase Agreement - No. 120900-92-01 (the "Agreement"), by and between GTE Communication Systems Corporation ("CUSTOMER") for the benefit of itself and the GTE Affiliated Entities (as defined in the Agreement) and Digital Sound Corporation ("SELLER"), shall be effective as of September 30, 1993. WHEREAS CUSTOMER and SELLER desire to amend Exhibit A to the Agreement, GTE Affiliated Entities; and WHEREAS CUSTOMER and SELLER desire to amend Exhibit J, Section 6, Product(s) Maintenance; and WHEREAS CUSTOMER and SELLER desire to amend Exhibit J, Attachment E, Comprehensive Hardware and Software Maintenance For Non-Warranty Products; and WHEREAS CUSTOMER and SELLER desire to amend Agreement to include Section 47, DISPUTE RESOLUTION. NOW, THEREFORE, the parties agree that the Agreement is hereby amended as follows: 1. Exhibit A to the Agreement, GTE Affiliated Entities, is hereby deleted in its entirety and replaced with a new Exhibit A, GTE Affiliated Entities, attached hereto. 2. In Exhibit J, Section 6 to the Agreement, Product(s) Maintenance, the words "shall be in accordance with the terms and conditions as set forth in Attachment E" shall be replaced with "pursuant to issuance of CUSTOMER'S purchase order shall be in accordance with the terms and conditions as set forth in Attachment E for services provided for 1993. Services provided by SELLER to CUSTOMER beginning January 1, 1994, pursuant to issuance of CUSTOMER'S purchase order, shall be mutually agreed upon by year end 1993." 3. Exhibit J, Attachment E to the Agreement, Comprehensive Hardware and Software Maintenance For Non-Warranty Products is hereby deleted and replaced in its entirety with a new Attachment E, Comprehensive Hardware and Software Maintenance For Non-Warranty Products, attached-hereto. 4. The Agreement shall be amended to include Section 47, Dispute Resolution, as follows: 47. DISPUTE RESOLUTION (a) The parties desire to resolve disputes arising out of this Agreement without litigation. Accordingly, except for action seeking a temporary restraining order or injunction related to the purposes of this Agreement, or suit to compel compliance with this dispute resolution process, the parties agree to use the following alternative dispute resolution procedure as their sole remedy with respect to any controversy or claim arising out of or relating to this Agreement or its breach. (b) At the written request of a party, each party shall appoint a knowledgeable, responsible representative to meet and negotiate in good faith to resolve any dispute arising under this Agreement. The parties intend that these negotiations be conducted by non-lawyer, business representatives. The discussions shall be left to the discretion of the representatives. Upon agreement, the representatives may utilize other alternative dispute resolution procedures such as mediation to assist in the negotiations. Discussions and correspondence among the representatives for purposes of these negotiations shall be treated as confidential information developed for purposes of settlement, exempt from discovery and production, which shall not be admissible in the arbitration described below or in any lawsuit without the concurrence of all parties. Documents identified in or provided with such communications, which are not prepared for purposes of the negotiations, are not so exempted and may, if otherwise admissible, be admitted in evidence in the arbitration or lawsuit. (c) If the negotiations do not resolve the dispute within sixty (60) days of the initial written request, the dispute shall be submitted to binding arbitration by a single arbitrator pursuant to the Commercial Arbitration Rules of the American Arbitration Association. A party may demand such arbitration in accordance with the procedures set out in those rules. Discovery shall be controlled by the arbitrator and shall be permitted to the extent set out in this Section. Each party may submit in writing to a party, and that party shall so respond, to a maximum of any combination of thirty-five (35) (none of which may have subparts) of the following: interrogatories, demands to produce documents and requests for admission. Each party is also entitled to take the oral deposition of one (1) individual of another party. Additional discovery may be permitted upon mutual agreement of the parties. The arbitration hearing shall be commenced within sixty (60) days of the demand for arbitration and the arbitration shall be held in Dallas, Texas. The arbitrator shall control the scheduling so as to process the matter expeditiously. The parties may submit written briefs. The arbitrator shall rule on the dispute by issuing a written opinion within thirty (30) days after the close of hearings. The times specified in this Section may be extended upon mutual agreement of the parties or by the arbitrator upon a showing of good cause. Judgement, upon the award rendered by the arbitrator may be entered in any court having jurisdiction. (d) Each party shall bear its own cost of these procedures. A party seeking discovery shall reimburse the responding party the cost of production of documents (to include search time and reproduction time costs). The parties shall equally share the fees of the arbitration and the arbitrator. 5. All other terms and conditions of the Agreement shall remain in full force and effect. IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 1 to the Agreement to be executed by their duly authorized representatives. DIGITAL SOUND CORPORATION GTE COMMUNICATION SYSTEMS CORPORATION /s/ E. Hovanek /s/ Larry K. Henry - ---------------- -------------------- E. Hovanek Larry K. Henry Vice President, Finance Vice President - General Manager Dated: October 27, 1993 Dated: October 8, 1993 APPROVED AS TO FORM AND LEGALITY /s/ (illegible) ------------------ Attorney GTE Telephone Operations 10/6/93 ATTACHMENTS TO AMENDMENT NO. 1 EXHIBIT A: Revised List of GTE Affiliated Entities that are entitled to purchase under the Purchase Agreement. Exhibit J ATTACHMENT E: Terms for Comprehensive Hardware And Software Maintenance For Non-Warranty Products January 7, 1993 GTE Communication Systems Corporation GTE Supply Division GTE Place West Airfield Drive DFW Airport, TX 75261 RE: Amendment 2 [Software Escrow Deposit] to Purchase Agreement Gentlemen: GTE Communication Systems Corporation ("GTE") and Digital Sound Corporation ("DGSD") are parties to Purchase Agreement No. 120900-92-01 executed on January 13, 1993 ("the Agreement"). The parties wish to amend the subject Agreement to provide for a software escrow deposit for the benefit of GTE. In furtherance of this premise, GTE agrees to execute the Licensee of Record Acceptance document attached hereto and incorporated herein by this reference. Upon execution by GTE, GTE will become a Licensee of Record on DGSD's Escrow No. 490-9 at Brambles NSD, Inc. located in San Jose, CA 95131. This document and its attachments shall become Amendment 2 to the Agreement. In all other respects the Agreement is ratified and confirmed and shall continue in full force and effect according to its terms and conditions. Very truly yours, AGREED AND ACCEPTED /s/ Keith Beckwith for GTE COMMUNICATION SYSTEMS - --------------------- Keith Beckwith Director, VIS Sales by: /s/ Michelle Monger ----------------------- Michelle Monger Approved as to Form /s/ Joe A. Garza ------------------ Law Dept. 2/1/94 ATTACHMENTS TO AMENDMENT NO. 2 Licensee Of Record Acceptance Relating To Software Deposit Agreement Software Deposit Agreement Between Digital Sound Corporation And National Safe Depository National Safe Depository Inventory List InfoMail And Univox Source Q3 1993 AMENDMENT NO. 3 TO PURCHASE AGREEMENT NO. 120900-92-01 BETWEEN GTE COMMUNICATION SYSTEMS CORPORATION AND DIGITAL SOUND CORPORATION This Amendment No. 3 to the Purchase Agreement No. 120900-92-01 (the "Agreement"), by and between GTE Communication Systems Corporation ("CUSTOMER") for the benefit of itself and the GTE Affiliated Entities (as defined in the Agreement) and Digital Sound Corporation ("SELLER"), shall be effective as of January 1, 1994. WHEREAS CUSTOMER and SELLER desire to amend Exhibit J, Attachment E, to include Attachment E-1 to the Agreement, Comprehensive Hardware and Software Maintenance for Non-Warranty PRODUCT(S). NOW, THEREFORE, the parties agree that the Agreement is hereby amended as follows: 1. Exhibit J, Attachment E, to the Agreement, is hereby amended to include Attachment E-1 that is attached hereto and incorporated herein by this reference. 2. All other terms and conditions of the Agreement shall remain in full force and effect. IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 3 to the Agreement to be executed by their duly authorized representatives. DIGITAL SOUND CORPORATION GTE COMMUNICATION SYSTEMS CORPORATION /s/ Jim Eby /s/ Larry K. Henry - ------------------------- ------------------------------- Jim Eby Larry K. Henry Vice President, Chief Quality Vice President - General Manager and Operations Officer Dated: March 31, 1994 Dated: April 8, 1994 APPROVED AS TO FORM /s/ Joe A. Garza ---------------- Law Dept. 3/25/94 ATTACHMENT TO AMENDMENT NO. 3 Exhibit J ATTACHMENT E-1: Comprehensive Hardware And Software Maintenance For Non-Warranty Products AMENDMENT NO. 4 TO PURCHASE AGREEMENT NO. 120900-92-01 BETWEEN GTE COMMUNICATION SYSTEMS CORPORATION AND DIGITAL SOUND CORPORATION This Amendment No. 4 to Purchase Agreement No. 120900-92-01 (the "Agreement"), by and between GTE Communication Systems Corporation ("CUSTOMER") for the benefit of itself and the GTE Affiliated Entities (as defined in the Agreement) and Digital Sound Corporation ("SELLER"), shall be effective as of June 15, 1994. WHEREAS CUSTOMER and SELLER desire to set out certain terms and conditions applicable to purchases by CUSTOMER of SELLER'S PRODUCT(S) for VoiceServer Systems with fax capability during 1994 and 1995. NOW, THEREFORE, the parties agree that the Agreement is hereby amended as follows: 1. EXHIBIT B is hereby amended to include EXHIBIT B-1 ("VOICESERVER SYSTEMS WITH FAX CAPABILITIES PRODUCTS & PRICING") which is attached hereto and incorporated herein by this reference. 2. The following paragraph (d) is hereby added to Section 21, QUALITY ASSURANCE REPORTING as follows: (d) SELLER agrees to utilize its Quality First TQM Program to provide for continuous improvement in quality levels of PRODUCT(S). The parties agree to jointly develop a process for the ongoing monitoring of PRODUCT reliability, system availability, and progress reporting. 3. In Section 35, LIABILITY, paragraph (c) is hereby deleted in its entirety and replaced with the following: (c) SELLER agrees to maintain during the term hereof all insurance and/or bonds required by law or this Agreement, including, but not limited to (i) Workers' Compensation and related insurance as prescribed by the law of the state in which SELLER'S services are performed; (ii) employer's liability insurance with limits of at least five hundred thousand dollars ($500,000) for each occurrence, and (iii) comprehensive general liability insurance including products liability, and, if the use of motor vehicles is required, comprehensive motor vehicle liability insurance, each with limits of at least two million dollars ($2,000,000) for combined single limit for bodily injury, including death, and/or property damage. SELLER shall cause CUSTOMER to be included as an Additional Insured under said policies (as "GTE Corporation and its affiliates and subsidiaries") and CUSTOMER'S coverage under such policies shall be primary. SELLER shall, prior to rendering such services, furnish certificates or evidence of the foregoing insurance indicating the amount and nature of such coverage, the expiration date of each policy, and stating that no material change which affects CUSTOMER'S coverage and rights to collect under any such policy or cancellation of any such policy shall be effective unless thirty (30) days' prior written notice is given to CUSTOMER. Notwithstanding the above, SELLER and CUSTOMER shall each have the option, when permitted by law, to self-insure any or all of the foregoing risks. CUSTOMER shall provide SELLER with written notification prior to the filing of any claim against any such policy. 4. The following paragraph (o) is hereby added to Section 11, TRAINING of EXHIBIT J, GTE PRODUCT(S) SERVICES AND SUPPORT REQUIREMENTS: (o) For each VoiceServer System with fax capabilities purchased by CUSTOMER in 1994 and 1995, SELLER shall provide, at no cost to CUSTOMER, ****** training slots in a Fax Administration training class. CUSTOMER employees attending these training sessions must have previously completed either SELLER'S InfoMail Software Administration training class or SELLER'S Installation and Maintenance training classes, costs of which shall be in accordance with paragraph (f) above. If, at the request of CUSTOMER, such Fax Administration training class(es) are conducted at a location other than SELLER'S principal place of business, CUSTOMER shall be responsible for payment to SELLER for instructor's reasonable travel and living expenses. In no event shall CUSTOMER be responsible for such expenses which exceed what CUSTOMER would reasonably reimburse its own employees for such travel and living taken at the request and behalf of CUSTOMER. 5. The following subparagraph (1) is hereby added to paragraph (a) of Section 1, WARRANTY of EXHIBIT J, GTE PRODUCT(S) SERVICES AND SUPPORT REQUIREMENTS: (1) Notwithstanding the provisions of Paragraph (a) above, the warranty period for all VoiceServer Systems with fax capability purchased hereunder in 1994 shall be the longer of one (1) year from the date the PRODUCT(S) are placed in service, such date not to be later than ninety (90) days after delivery to CUSTOMER, or through December 31, 1995, whichever date occurs later. All other terms and conditions of this Section 1, WARRANTY shall apply to all VoiceServer Systems with fax capabilities for the duration of this warranty period. The warranty period for VoiceServer Systems with fax capabilities purchased by CUSTOMER in 1995 shall be as described in Paragraph (a) above. 6. All other terms and conditions of the Agreement shall remain in full force and effect. IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 4 to the Agreement to be executed by their duly authorized representatives. DIGITAL SOUND CORPORATION GTE COMMUNICATION SYSTEMS CORPORATION /s/ Keith M. Beckwith /s/ Larry K. Henry - -------------------------- ------------------------------- Keith M. Beckwith Larry K. Henry Vice President, Sales Vice President - General Manager Dated: October 21, 1994 Dated: October 10, 1994 APPROVED AS TO FORM /s/ Joe A. Garza ------------------ Law Dept. 10/04/94 ATTACHMENT TO AMENDMENT NO. 4 EXHIBIT B-1 Product Description & Pricing Information for VoiceServer Systems With Fax Capabilities AMENDMENT NO. 5 TO PURCHASE AGREEMENT NO. 120900-92-01 BETWEEN GTE COMMUNICATION SYSTEMS CORPORATION AND DIGITAL SOUND CORPORATION This Amendment No. 5 to Purchase Agreement No. 120900-92-01 (the "Agreement"), by and between GTE Communication Systems Corporation ("CUSTOMER") for the benefit of itself and the GTE Affiliated Entities (as defined in the Agreement) and Digital Sound Corporation ("SELLER"), shall be effective as of December 31, 1994. WHEREAS, the Agreement bears a termination date of January 12, 1995; and WHEREAS CUSTOMER and SELLER desire to extend the term of the Agreement. NOW, THEREFORE, the parties agree that the Agreement is further amended as follows: 1. Section 1, TERM is hereby amended to extend the term of the Agreement until February 28, 1995. 2. All other terms and conditions of the Agreement shall remain in full force and effect. IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 5 to the Agreement to be executed by their duly authorized representatives. DIGITAL SOUND CORPORATION GTE COMMUNICATION SYSTEMS CORPORATION /s/ Mark C. Ozur /s/ signed on behalf of M. R. Redmond - ------------------ --------------------------------------- Mark C. Ozur M. R. Redmond President and CEO Director - Contract Management Dated: December 31, 1994 Dated: 12/27/94 APPROVED AS TO FORM /s/ Joe A. Garza ------------------ Law Dept. 12/19/94 AMENDMENT NO. 6 TO CONTRACT NUMBER 120900-92-01 BETWEEN GTE COMMUNICATION SYSTEMS CORPORATION AND DIGITAL SOUND CORPORATION This Amendment No. 6 to Contract Number 120900-92-01 (the "Agreement"), by and between GTE Communication Systems Corporation ("CUSTOMER") for the benefit of itself and the GTE Affiliated Entities (as defined in the Agreement) and Digital Sound Corporation ("SELLER"), shall be effective as of January 1, 1995. WHEREAS, the Agreement bears a termination date of January 12, 1995; and WHEREAS, Amendment No. 5 to the Agreement extended the termination date to February 28, 1995; and WHEREAS CUSTOMER and SELLER desire to extend the term of the Agreement; and WHEREAS CUSTOMER and SELLER desire to amend Exhibit A, GTE Affiliated Entities, Exhibit B, Supplier Product(s), Exhibit C, Supplier Product(s) Pricing, Exhibit E, GTE Shipping and Carrier Routing Instructions, EXHIBIT H, GTE Standardization Policy, and certain attachments to EXHIBIT J, GTE Product(s) Services and Support Requirements; and WHEREAS CUSTOMER and SELLER desire to make other modifications to the terms and conditions of the Agreement. NOW, THEREFORE, the parties agree that the Agreement is hereby amended as follows: 1. In Section 1, TERM, the first sentence is hereby deleted in its entirety and replaced with the following: This Agreement shall be effective on the date of signing of this Agreement, and shall continue in effect through December 31, 1996 unless terminated or modified by either party in accordance with the provisions of this Agreement. 2. In Section 13, PACKAGING, the third sentence is hereby deleted in its entirety and replaced with the following: Corrugated shipping containers shall comply with the requirements of Item 222 of the National Motor Freight Code, Series NMFC 100-S, which may be amended from time to time. 3. Section 18, TECHNOLOGICAL OR SPECIFICATION CHANGE/PRODUCT(S) DELETION/SUBSTITUTION, of the Agreement is hereby deleted in its entirety. 4. Section 19, UNSATISFACTORY CONDITION SITUATIONS, of the Agreement is hereby deleted in its entirety. 5. Section 20, PRODUCT(S) CHANGES, of the Agreement is hereby deleted in its entirety. 6. Section 21, QUALITY ASSURANCE REPORTING, of the Agreement is hereby deleted in its entirety. 7. The following paragraph (c) is hereby added to Section 30, ASSIGNMENT: (c) If CUSTOMER sells, exchanges or otherwise disposes of all or a portion of the assets of, or CUSTOMER's interest in, any business unit in which PRODUCT are used, then CUSTOMER shall have the right, upon written notice to SELLER, to assign to such third party all licenses and rights granted under this Agreement with respect to such PRODUCT; provided that the third party agrees to be bound by all obligations of CUSTOMER to SELLER that pertain to the PRODUCT. 8. In Section 39, NOTICES, the address for the Director-Materials Management/Purchasing is hereby amended as follows: GTE Supply 5615 High Point Drive PO Box 169001 Irving, Texas 75016-9001 Attention: Director - Materials Management/Purchasing (HQA02JO2) 9. EXHIBIT A to the Agreement, "GTE AFFILIATED ENTITIES" is hereby amended to substitute the GTE Affiliated Entities listed on the attached Exhibit A(1). 10. EXHIBIT B to the Agreement, "SUPPLIER PRODUCT(S)", and EXHIBIT B-1 to the Agreement, "VOICESERVER SYSTEMS WITH FAX CAPABILITIES PRODUCT(S) & PRICING" as amended in Amendment No. 4 to the Agreement, is hereby amended to substitute the Supplier Product(s) listed on the attached Exhibit B(1). 11. EXHIBIT C to the Agreement, "SUPPLIER PRODUCT(S) PRICING" is hereby amended to substitute the Supplier Product(s) Pricing listed on the attached Exhibit C(1). 12. EXHIBIT E to the Agreement, "GTE SHIPPING AND CARRIER ROUTING INSTRUCTIONS" is hereby amended to substitute the GTE Shipping and Carrier Routing Instruction (May 1994) listed on the attached Exhibit E(1). 13. EXHIBIT G to the Agreement, "GTE PACKAGING CONFIGURATION DEFINITIONS" is hereby amended to substitute the GTE Packaging Configuration Definitions listed on the attached Exhibit G(1). 14. EXHIBIT H to the Agreement, "GTE STANDARDIZATION POLICY" is hereby amended to substitute the Standardization Policies, Procedures and Terms listed on the attached Exhibit H(1). 15. Section 6, PRODUCT(S) MAINTENANCE of Exhibit J, GTE PRODUCT(S) SERVICES AND SUPPORT REQUIREMENTS, as amended in Amendment No. 1 to the Agreement, is deleted in its entirety and replaced with the following: Hardware and software maintenance for each year of this Agreement pursuant to issuance of CUSTOMER's purchase orders shall be in accordance with the terms and conditions set forth in Attachment E, which may be changed each year as mutually agreed to by the parties. 16. ATTACHMENT C, "SUPPLIER REPAIR PARTS PRICING" of EXHIBIT J, GTE PRODUCT(S) SERVICES AND SUPPORT REQUIREMENTS, is hereby amended to substitute the Supplier Repair Parts Pricing listed in the attached Attachment C(1). 17. ATTACHMENT D, "SELLER WORKING HOUR SCHEDULE AND CONTACT INFORMATION" of EXHIBIT J, GTE PRODUCT(S) SERVICES AND SUPPORT REQUIREMENTS, is hereby amended to substitute the Seller Working Hour Schedule and Contact Information & Escalation Matrix listed in the attached Attachment D(1). 18. ATTACHMENT E(1), "COMPREHENSIVE HARDWARE AND SOFTWARE MAINTENANCE FOR NON-WARRANTY PRODUCTS" of EXHIBIT J, GTE PRODUCT(S) SERVICES AND SUPPORT REQUIREMENTS, is hereby amended to substitute the Hardware and Software Maintenance listed in the attached Attachment E(1). 19. ATTACHMENT G, "SELLER TRAINING RATES" of EXHIBIT J, GTE PRODUCT(S) SERVICES AND SUPPORT REQUIREMENTS, is hereby amended to substitute the Supplier Training Rates listed in the attached Attachment G(1). 20. All other terms and conditions of the Agreement shall remain in full force and effect. IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 1 to the Agreement to be executed by their duly authorized representatives. DIGITAL SOUND CORPORATION GTE COMMUNICATION SYSTEMS CORPORATION /s/ Keith M. Beckwith /s/ Larry K. Henry - ----------------------- -------------------- Keith M. Beckwith Larry K. Henry Vice President, Sales Vice President-General Manager Dated: March 9, 1995 Dated: March 6, 1995 APPROVED AS TO FORM /s/ Joe A. Garza ------------------ Law Dept. 03/01/95 Attachments To Amendment No. 6 Exhibit A(1): Revised List Of GTE Affiliated Entities That Are Entitled To Purchase Under The Purchase Agreement. Exhibit B(1): DGSD Domestic Version Price/Product List Exhibit C(1): DGSD Product Pricing Discount For GTE Exhibit E(1): GTE Packaging, Shipping And Carrier Routing Instruction Exhibit E(1) Attachment A: Detail Of 42 X 42 Inch Pallet To Be Used In Shipping Exhibit E(1) Attachment B: GTE Area Routing Instructions And Carrier Contacts Exhibit E(1) Attachment C: Carrier Routing Instruction For GTE Supply/GTE Telephone Operations Exhibit G(1): GTE Packaging Configuration Definitions Exhibit H(1): GTE Standardization Policies, Procedures And Terms Exhibit J Attachment C(1): DGSD Repair And Exchange Pricing For GTE Exhibit J Attachment D(1): DGSD Contact Information And Escalation Matrix In The Event Of Product Degradation Exhibit J Attachment E(1): Hardware And Software Maintenance Terms Exhibit J Attachment G(1): DGSD Training Rates For GTE And Process Description For Training Courses Available AMENDMENT NUMBER 7 TO PRODUCT PURCHASE AGREEMENT NUMBER 120900-92-01 BETWEEN GTE COMMUNICATION SYSTEMS CORPORATION AND DIGITAL SOUND CORPORATION 1. PARTIES This Amendment Number 7 to Product Purchase Agreement Number 120900-92-01 (Agreement) between Digital Sound Corporation, a California corporation, with offices at 6307 Carpinteria Avenue, Carpinteria, California 93013 (SELLER) and GTE Communication Systems Corporation, a Delaware corporation, acting through its GTE Supply Division on behalf of itself and its Affiliates, with offices at 700 Hidden Ridge, Irving, Texas 75038 (CUSTOMER). 2. EFFECTIVE DATE This Amendment Number 7 shall be effective January 1, 1996. 3. CHANGES TO TERMS (a) Exhibit A(1), GTE AFFILIATED ENTITIES, as amended in Amendment Number 6 dated January 1, 1995, is deleted in its entirety and replaced with a new Exhibit A(2), GTE AFFILIATED ENTITIES, included as Attachment I to this Amendment. (b) Exhibit B(1), SUPPLIER PRODUCT(S), as amended in Amendment Number 6, is deleted in its entirety and replaced with a new Exhibit B(2), SUPPLIER PRODUCT(S), included as Attachment II to this Amendment. (c) The first sentence of subsection 3(b) of Exhibit J, GTE PRODUCT(S) SERVICES AND SUPPORT REQUIREMENTS, is deleted in its entirety and replaced with the following: "SELLER agrees to sell to CUSTOMER the replacement parts or proprietary components for said repairs at prices as set forth in the column identified as "LIST PRICE" of Attachment C(2), SUPPLIER REPAIR PARTS PRICING." (d) Subsection 5(a) of Exhibit J, GTE PRODUCT(S) SERVICES AND SUPPORT REQUIREMENTS, is deleted in its entirety and replaced with the following: "(a) SELLER agrees, in the event of a failure that causes a customer service impairment caused by PRODUCT(S) furnished under this Agreement, to ship replacement parts at the most expedient means available within twenty four (24) hours of verbal notification by CUSTOMER. There shall be no charge for the expedited service. (1) If the defective part is under warranty, there shall be no charge for the replacement part, providing, however, that CUSTOMER returns such defective part within sixty (60) days after SELLER's shipment of the replacement part. If SELLER has not received such defective part within such sixty (60) day period, SELLER may invoice CUSTOMER for such replacement part at the price as set forth in the column identified as "LIST PRICE" of Attachment C(2), SUPPLIER REPAIR PARTS PRICING." (2) If the defective part is not under warranty, SELLER shall invoice CUSTOMER for such replacement part at the price as set forth in the column identified as "30 DAYS R/E PRICE" of Attachment C(2) of this Exhibit J. If CUSTOMER does not return such defective part to SELLER within sixty (60) days after SELLER's shipment of the replacement part, SELLER may invoice CUSTOMER for the difference between the "30 DAYS R/E PRICE" and the "LIST PRICE" for such replacement part as set forth in Attachment C(2)." (e) Attachment C(1), SUPPLIER REPAIR PARTS PRICING, of Exhibit J, GTE PRODUCT(S) SERVICES AND SUPPORT REQUIREMENTS, as amended in Amendment Number 6, is deleted in its entirety and replaced with a new Attachment C(2), SUPPLIER REPAIR PARTS PRICING, included as Attachment III to this Amendment. (f) Attachment E(1), HARDWARE AND SOFTWARE MAINTENANCE, of Exhibit J, GTE PRODUCT(S) SERVICES AND SUPPORT REQUIREMENTS, as amended in Amendment Number 6, is deleted in its entirety and replaced with a new Attachment E(2), HARDWARE AND SOFTWARE MAINTENANCE, included as Attachment IV to this Amendment. 4. ALL OTHER TERMS All other terms and conditions of the Agreement shall remain in full force and effect. Each party represents that it has executed this Agreement through its authorized corporate representative: DIGITAL SOUND CORPORATION GTE COMMUNICATION SYSTEMS CORPORATION /s/ Keith M. Beckwith /s/ Gary D. Klingsporn - ----------------------- ------------------------ Keith M. Beckwith Gary D. Klingsporn Vice President, Sales Contract Manager Dated: January 18, 1996 Dated: January 16, 1996 APPROVED AS TO FORM /s/ Joe A. Garza ------------------ Law Dept. 01/15/96 ATTACHMENTS to AMENDMENT NO. 7 EXHIBIT A(2): Revised List of GTE Affiliated Entities that are entitled to purchase under the Purchase Agreement. EXHIBIT B(2): DGSD Domestic Version Price/Product List Exhibit J ATTACHMENT C(2): DGSD'S Repair And Exchange Pricing For GTE Exhibit J ATTACHMENT E(2): Terms for Comprehensive Hardware And Software Maintenance For Non-Warranty Products AMENDMENT NUMBER 8 TO PRODUCT PURCHASE AGREEMENT NUMBER 120900-92-01 BETWEEN GTE COMMUNICATION SYSTEMS CORPORATION AND DIGITAL SOUND CORPORATION 1. PARTIES This Amendment Number 8 to Product Purchase Agreement Number 120900-92-01 (Agreement) between Digital Sound Corporation, a California corporation, with offices at 6307 Carpinteria Avenue, Carpinteria, California 93013 (SELLER) and GTE Communication Systems Corporation, a Delaware corporation, acting through its GTE Supply Division on behalf of itself and its Affiliates, with offices at 700 Hidden Ridge, Irving, Texas 75038 (CUSTOMER). 2. EFFECTIVE DATE This Amendment Number 8 shall be effective January 1, 1997. 3. CHANGES TO TERMS (a) Section 1, TERM, is amended as follows The words . . . "continue in effect through December 31, 1996" . . . shall be deleted and replaced with . . . "shall continue in effect until December 31, 1998". (b) Subsection 24(b), of Section 24, INFRINGEMENT is deleted in its entirety and replaced with the following: 24. INFRINGEMENT (b) Except for the negligence provisions, the procedures set forth in subsection (b) of Section 35, INDEMNIFICATION AND INSURANCE shall apply in the case of any claims of infringement, misappropriation or violation of intellectual property rights for which indemnification will be sought. (c) Section 35, LIABILITY and Amendment No. 4 item number 3 are deleted in its entirety and replaced with the following: 35. INDEMNIFICATION AND INSURANCE (a) SELLER shall indemnify, defend, and hold harmless CUSTOMER and its affiliates, officers, agents, and employees, from all claims, suits, actions, demands, damages, liabilities, expenses (including fees and disbursements of counsel), judgements, settlements and penalties of every kind based on (i) personal injury, death, or property damage to the extent any of the foregoing is proximately caused by either any defective PRODUCT provided by SELLER, its officers, employees, subcontractors or agents, or by the negligent or willful acts or omissions of SELLER, its officers, employees, subcontractors or agents, or (ii) strict liability in tort or product liability of any other kind in connection with any PRODUCT provided by SELLER, its officers, employees, subcontractors or agents or the use, resale or distribution of any such PRODUCT by CUSTOMER. The foregoing indemnity, to the extent permitted by law, shall apply in the case of all claims that arise from the negligence, misconduct or other fault of CUSTOMER, provided, however, that if a claim is the result of the joint negligence, joint misconduct, or joint fault of SELLER and CUSTOMER, the amount of the claim for which CUSTOMER is entitled to indemnification shall be limited to that portion of such claim that is attributable to the negligence, misconduct or other fault of SELLER. The obligations of this provision are in addition to SELLER obligation to provide insurance and shall not be limited by any limitation on the amount or type of damages, compensation or benefits payable by SELLER under the Worker's Compensation Acts, Longshoremen and Harborworker's Act, Disability Benefits Act or any other employee benefit act. (b) CUSTOMER shall promptly notify SELLER in writing of any suits, claims or demands covered by this indemnity. Promptly after receipt of such notice, SELLER shall assume the defense of such claim with counsel reasonably satisfactory to CUSTOMER. If SELLER fails, within a reasonable time after receipt of such notice, to assume the defense with counsel reasonably satisfactory to CUSTOMER, or if, in the reasonable judgement of CUSTOMER, a direct or indirect conflict of interest exists between the parties with respect to the claim, then CUSTOMER shall have the right to undertake the defense, compromise and settlement of such claim for the account and at the expense of SELLER. Notwithstanding the above, if CUSTOMER in its sole discretion so elects, CUSTOMER may also participate in the defense of such actions by employing counsel at its own expense, without waiving SELLER's obligations to indemnify or defend. SELLER shall not settle or compromise any claim or consent to the entry of any judgement without the prior written consent of CUSTOMER and without an unconditional release of all liability by each claimant or plaintiff to CUSTOMER. Such consent shall be timely given and shall not be reasonably withheld. (c) SELLER agrees to maintain during the term all insurance or bonds required by law or this Agreement, including, but not limited to (i) Workers Compensation and related insurance as prescribed by the law of the state in which SELLER's services are performed or PRODUCT are delivered; (ii) employer's liability insurance with limits of at least five hundred thousand dollars ($500,000) for each occurrence, and (iii) comprehensive general liability insurance including Services liability, and, if the use of motor vehicles is required, comprehensive motor vehicle liability insurance, each with limits of at least two million dollars ($2,000,000) for combined single limit for bodily injury, including death, and/or property damage. SELLER shall cause CUSTOMER to be included as an additional insured under said policies (as "GTE Corporation and its affiliates and subsidiaries") and CUSTOMER's coverage under such policies shall be primary. SELLER shall waive its rights of subrogation against CUSTOMER for Workers' Compensation claims. SELLER shall, prior to rendering such SERVICES, furnish certificates or evidence of the foregoing insurance indicating the amount and nature of such coverage, the expiration date of each policy, and stating that no material change or cancellation of any such policy shall be effective unless thirty (30) days' prior written notice is given to CUSTOMER. (d) All work performed under this Agreement by any party shall be performed as an independent contractor and not as an agent of any other party. Persons furnished by the respective parties shall be solely the employees or agents of such parties, respectively, and shall be under the sole and exclusive direction and control of such parties. They shall not be considered employees of the other party for any purpose. Each party shall be responsible for compliance with all laws, rules and regulations involving their respective employees or agents, including (but not limited to) employment of labor, hours of labor, health and safety, working conditions and payment of wages. Each party shall also be responsible, respectively, for payment of taxes, including federal, state, and municipal taxes, chargeable or assessed with respect to its employees or agents, such as social security, unemployment, worker's compensation, disability insurance and federal and state income tax withholding. (e) The parties expressly agree and understand that SELLER's liability shall in no event exceed ********** dollars ($*********) for any one (1) occurrence, whether the claim arises under this Agreement, in contract, tort or otherwise. Such limitation does not apply to loss or claims arising from death, personal injury or damage to real or tangible personal property or to claims of infringement. (d) The Agreement is hereby amended to include Section 48, CENTURY COMPLIANCE. "SELLER agrees to the terms and conditions as listed in Exhibit L, CENTURY COMPLIANCE". (e) Exhibit A(2), GTE AFFILIATED ENTITIES, as amended in Amendment Number 7 dated January 1, 1996, is deleted in its entirety and replaced with a new Exhibit A(3), GTE AFFILIATED ENTITIES, included as Attachment I to this Amendment. (f) Exhibit B(3), SUPPLIER PRODUCT(S), as amended in Amendment Number 7, is deleted in its entirety and replaced with a new Exhibit B(3), SUPPLIER PRODUCT(S), included as Attachment 11 to this Amendment. (g) This Agreement is hereby amended to add Exhibit L, CENTURY COMPLIANCE, included as Attachment III to this Amendment. (h) Attachment E(2), HARDWARE AND SOFTWARE MAINTENANCE (1996), of Exhibit J, GTE PRODUCT(S) SERVICES AND SUPPORT REQUIREMENTS, as amended in Amendment Number 7 dated January 1, 1996, is deleted in its entirety and replaced with a new Attachment E(3), HARDWARE AND SOFTWARE MAINTENANCE (1997), included as Attachment IV to this Amendment: 4. ALL OTHER TERMS All other terms and conditions of the Agreement shall remain in full force and effect. Each party represents that it has executed this Agreement through its authorized corporate representative: DIGITAL SOUND CORPORATION GTE COMMUNICATION SYSTEMS CORPORATION /s/ B. Robert Suh /s/ Richard E. Potter - ------------------- ----------------------- B. Robert Suh Richard E. Potter Vice President and CFO Manager-Contract/Management Dated: February 18, 1997 Dated: February 12, 1997 APPROVED AS TO FORM AND LEGALITY /s/ J. R. Seastrom -------------------- Attorney, GTE Telephone Operations Date: 2/11/97 ATTACHMENTS TO AMENDMENT NO. 8 EXHIBIT A(3): Revised List of GTE Affiliated Entities that are entitled to purchase under the Purchase Agreement. EXHIBIT B(2): DGSD Domestic Version Price/Product List EXHIBIT L: Details Of Century Compliance Obligation For Procured Systems Exhibit J ATTACHMENT E(2): Terms for Comprehensive Hardware And Software Maintenance For Non-Warranty Products EXHIBIT 10.57 AMENDMENT NUMBER 9 TO PRODUCT PURCHASE AGREEMENT NUMBER 120900-92-01 - ---------------------------------------------- BETWEEN GTE COMMUNICATION SYSTEMS CORPORATION AND DIGITAL SOUND CORPORATION 1. PARTIES This Amendment Number 9 to Product Purchase Agreement Number 12090092-01 (Agreement) is made between Digital Sound Corporation, a California corporation, with offices at 6307 Carpinteria Avenue, Carpinteria, California 93013 (SELLER) and GTE Communication Systems Corporation, a Delaware corporation, acting through Its GTE Supply Division with offices at 700 Hidden Ridge, Irving, Texas 75038 (CUSTOMER). 2. EFFECTIVE DATE This Amendment Number 9 shall be effective October 1, 1997. 3. PURPOSE The principal purpose of this Amendment is to provide for the commercial availability to CUSTOMER of SELLER's Open Enhanced Application Platform, System Software, and OnPoint Messaging, in accordance with the milestones, specifications and other requirements set out in Attachment A to this Amendment. The Amendment also provides for continued purchase of SELLER's products, extension of the term of the Agreement, and other matters as set out below. 4. PURCHASE COMMITMENT (a) SELLER agrees to make commercially available to CUSTOMER SELLER's Open Enhanced Application Platform, System Software, and OnPoint Messaging, in accordance with the milestones, specifications and other requirements set out in Attachment A to this Amendment. CUSTOMER agrees to purchase from SELLER in the aggregate amount of fifty million dollars ($50,000,000.00) of SELLER's PRODUCT(S) and/or related services during the period from October 1, 1997 through the remaining term of this Agreement (the "Purchase Commitment"). (b) If SELLER does not accomplish the development substantially in accordance with the milestones set out in Attachment A, and does not meet the milestones on time, with the commercial availability to CUSTOMER of the platform, software and OnPoint Messaging that meets CUSTOMER's acceptance and standardization criteria, by the final milestone date set out in Attachment A, CUSTOMER may exercise the option not to be bound by the Purchase Commitment. If SELLER does not meet an interim milestone, no later than five (5) business days after the failed milestone date, CUSTOMER shall give SELLER written notice setting out the nature of the failure, or the milestone shall be deemed to have been met. SELLER shall have ten business (10) days from receipt of the notice to cure the failure. If the failure is not cured within this time, CUSTOMER may terminate the Purchase Commitment by giving SELLER written notice. If the failure is cured within this time, CUSTOMER shall give SELLER written notice confirming the cure. Unless otherwise agreed in writing, the days consumed to cure a failure shall not result in changes to subsequent milestone dates, which shall remain in effect as stated in Attachment A. (c) SELLER's timely performance of the final milestone for commercial availability of the Open Enhanced Application Platform, System Software, and OnPoint Messaging, as set out in Attachment A, is a condition precedent to Customers Purchase Commitment, unless waived in writing by CUSTOMER. If SELLER does not meet this final milestone, CUSTOMER may terminate the Purchase Commitment, including the minimum purchase commitment in Section 4(d) of this Amendment (if any), by giving SELLER written notice within thirty (30) days of the date for performance of the final milestone. (d) If SELLER meets all of the milestones in Attachment A specified to be completed by the end of 1998, CUSTOMER agrees to purchase a minimum of Fifteen Million Dollars ($15,000,000) in SELLER's products and/or related services from SELLER during the period beginning October 1, 1997, through and including December 31, 1998, and said purchase shall be applied towards the Fifty Million Dollar ($50,000,000) aggregate Purchase Commitment. (e) The milestones can only be changed by mutual written agreement between SELLER and CUSTOMER. CUSTOMER may request modifications to deliverables set out in Attachment A. Such request must be made in writing. Upon receipt of such request, SELLER shall notify CUSTOMER in writing prior to starting work on the requested modification that SELLER is capable of performing the modification and that additional time may be required to complete said modification. If the parties mutually agree in writing to the delay the date(s) set out in Attachment A for SELLER's delivery of the deliverable to make CUSTOMER's requested modification, then SELLER shall be excused for the time period set out in the mutual agreement and CUSTOMER will otherwise honor its Purchase Commitment. (f) SELLER agrees that, except for the specific functions assigned to CUSTOMER in Attachment A, SELLER is not relying on participation by CUSTOMER in order for SELLER to meet the milestones set out in Attachment A. Nevertheless, if SELLER's performance of the requirements set out in Attachment A is dependent upon CUSTOMER or a CUSTOMER contractor or supplier, and if CUSTOMER or CUSTOMER's contractor or supplier fails to perform and such failure proximately causes SELLER to fail to timely deliver, then SELLER shall be excused for the time period of the delay and CUSTOMER will otherwise honor its purchase obligations. SELLER commits that it has sufficient control over all of SELLER's subcontractors to meet the milestones, and agrees that a failure of a subcontractor of SELLER to perform shall not excuse SELLER from meeting the milestones. (g) If CUSTOMER terminates the Purchase Commitment, SELLER nevertheless agrees to use Its best efforts to support all of the platform acquired and implemented by CUSTOMER. Termination of the Purchase Commitment does not alter CUSTOMER's rights to purchase the platform and related products under this Agreement. 5. RELATED AGREEMENTS SELLER and CUSTOMER, acting through GTE Service Corporation, are contemporaneously entering into the following related agreements: (a) Software Professional Services Agreement; (b) Joint Software Development Agreement; (c) Letter of Agreement Concerning Accelerated Development of Software; and (d) Master Source Code and Technology Escrow Agreement (the 'Related Agreements"). The Master Source Code and Technology Escrow Agreement is made part of this Agreement and is attached as Attachment E to this Amendment. In case of conflict between terms of any of these Related Agreements and this Amendment or this Agreement, the terms of the Related Agreements shall govern. 6. CHANGES TO TERMS (a) Section 1, TERM, is amended as follows: The words: 'shall continue in effect until December 31, 1998" shall be deleted and replaced with the words: "shall continue in effect until March 31, 2001." (b) Section 6, PURCHASING FORECAST, is deleted in its entirety and replaced with a new Section 6, PURCHASING FORECAST, as follows: "Customer estimates that ft may purchase from Seller, in the aggregate amount, the purchase forecast quantities set out in Attachment B. Attachment B may be amended from time to time by the mutual agreement of the parties. The purchase forecast is only an estimate or projection and is not be to construed as a commitment to purchase that or any amount. In no case shall Customer be responsible for any bill back or related nonconformance charges should Customer's purchase fail to meet the projected levels in Attachment B, nor shall failure to purchase the estimated amount of Seller's Products in Attachment B, or any of Seller's Products be a breach of this Agreement by customer." (c) Section 25, USE OF CONFIDENTIAL INFORMATION, is amended by adding the following subsection (d): "(d) Attachment A and A-1 through A-7 are designated as confidential business information of the party supplying the material, and are to be treated as Information under the Agreement. The parties shall not use this Information, or any portion thereof or any derivations therefrom, for any purpose not related to this Agreement, nor disclose this Information or portions thereof or derivations therefrom to third parties." (d) Section 38 (a) is deleted in its entirety. (e) Section 38 (b) is amended as follows: In the first line after the beginning words, 'Upon termination of this Agreement insert the words "pursuant to Section 38(e) or termination of the Purchase Commitment pursuant to the provisions of Amendment 9," and delete the words "without cause pursuant to this Section." (f) Section 38(c)(7) is deleted in its entirety. (g) A new Section 38 (e) is added to the Agreement as follows: "In addition to any other rights afforded to CUSTOMER under this Agreement, if SELLER or any of its subsidiaries shall sell, transfer, assign or otherwise dispose of all or substantially all of the assets of SELLER, if SELLER agrees to do any of the foregoing, or if a Change of Control of SELLER shall occur, then CUSTOMER may terminate, at CUSTOMER'S sole option, Customer's Purchase Commitment, by giving SELLER thirty (30)days written notice, which shall be provided within thirty (30) days of receipt by CUSTOMER of written notice from SELLER of an applicable event triggering the application of this provision." "A 'Change in Control' shall mean the direct or indirect acquisition of the beneficial ownership of twenty percent (20%) or more of the outstanding voting securities of SELLER, whether in a single transaction or a series of transactions, by any person, group, corporation, or other entity who is engaged, directly or through any of its affiliates, in any business engaged in by GTE Corporation or any of its Affiliates (a 'Communications Company"), or the announcement by any person, group, corporation, other entity or Communications Company of its intent to acquire twenty percent (20%) or more of the outstanding voting securities of SELLER." (h) Section 44, SURVIVAL OF OBLIGATIONS, is amended as follows: After the words: "beyond the termination, cancellation or expiration hereof insert the words: 'including but not limited to, any obligation to defend and indemnify, any warranty obligation, any obligation to escrow software code and technology pursuant to any software and technology agreement, any confidentiality or non-disclosure obligations and any obligations under the dispute resolution clause of this Agreement." (i) Exhibit A(3), GTE AFFILIATED ENTITIES, as amended in Amendment Number 8, dated January 1, 1997, is deleted in its entirety and replaced with a new Exhibit A(4), GTE AFFILIATED ENTITIES, included as Attachment C to this Amendment. A new Exhibit B, Attachment A, PULSEPOINT PRODUCTS, is added and included as Attachment D to this Amendment. (k) Exhibit C(l), SUPPLIER PRODUCT(S) PRICING, is deleted in its entirety and replaced with the following: EXHIBIT C(2) SUPPLIER PRODUCT(S) PRICING CUSTOMER shall receive a **** percent (**%) discount from the list prices as set forth in Exhibit B, with the exception that no discount shall apply to those items identified as "non-discountable'. Such discount shall apply to all system components, including hardware and software, except as otherwise provided for in this Exhibit C(2). CUSTOMER shall receive a ****** percent (**%) discount from the list prices as set forth in Exhibit B for hard disk drives, whether purchased individually or as a part of a configured "3110" system. CUSTOMER shall receive a **** percent (**%) discount from the list prices as set forth in Exhibit B, Attachment A, PULSEPOINT PRODUCTS, with the exception that no discounts shall apply to those items identified as "nondiscountable." (l) Attachment E(3), HARDWARE AND SOFTWARE MAINTENANCE (1997), Section C, APPLICABILITY, is hereby amended to add the following: "The hardware and software maintenance services described in this Attachment shall also apply to CUSTOMER's entire installed base of PulsePoint PRODUCT(S) as of October 1, 1997. 7. ALL OTHER TERMS All other terms and conditions of the Agreement shall remain in full force and effect. Each party represents that it has executed this Agreement through its authorized corporate representative: DIGITAL SOUND CORPORATION GTE COMMUNICATIONS SYSTEMS CORPORATION /s/ Keith M. Beckwith /s/ Larry K. Henry - ------------------------ --------------------- Keith M. Beckwith Larry K. Henry Vice President Sales, Vice President - General Manager Americas and Europe Date: November 17, 1997 Date: November 17, 1997 APPROVED AS TO FORM AND LEGALITY /s/ (signature illegible) --------------------------- Attorney GTE Telephone Operations 11/14/97 ATTACHMENTS TO AMENDMENT NO. 9 Attachment A: Software Applications & Features Specifications and Related Milestone Dates Attachment A lists milestones and other requirements that apply to the development and commercial availability to GTE of DGSD's Open Enhanced Application Platform, System Software, and OnPoint Messaging. The requirements stated in this Attachment incorporate the specifications and other standards and references set out in Attachments A-1 through A-7, which are part of this Attachment A. The milestones set forth in this Attachment A must be completed for the Purchase Commitment to remain in effect as set forth in Paragraph 4 of Amendment No. 9. Attachment A-1: Technical Specifications and Description of GTE networking plans Attachment A-2: Architectural Specifications for GTE's Centralized Voicemail Attachment A-3: Architectural Specifications for Digital Sound Corporation's Messaging Platform Attachment A-4: Definitions and Requirements for Messaging Standards Attachment A-5: Technical Summary of Digital Sound Corporation's Proprietary Rapid Application Creation Environment Attachment A-6: Product Requirements' Specification for Voice Messaging Application Attachment A-7: GTE Sample/Mock Marketing Literature: Voice Mail User Guide Attachment B: Digital Sound Corporation Product Milestone Chart and Correlated Non-binding GTE Forecast Attachment C: Revised List of GTE Affiliated Entities that are entitled to purchase under the Purchase Agreement. Attachment D: Digital Sound Corporation PulsePoint Product Description and Price List Attachment E: Master Source Code and Technology Escrow Agreement (to be attached at a later date). EX-11.01 4 COMPUTATION OF EARNINGS (LOSS) PER COMMON SHARE EXHIBIT 11.01 DIGITAL SOUND CORPORATION COMPUTATION OF EARNINGS (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE (in thousands, except share and per share)
Year Ended December 31, ----------------------- 1993 1994 1995 1996 1997 ----------- ----------- ----------- ----------- ----------- Net Income (loss) $ (5,719) $ 2,488 $ (5,188) $ (6,801) $ (18,924) ----------- ----------- ----------- ----------- ----------- Applicable common and common stock equivalent shares: Weighted average shares common stock 18,830,141 19,474,315 19,880,879 20,085,551 20,362,525 Assumed conversion of convertible preferred stock on date of issuance - 821,918 - - - Shares available upon exercise of other options and warrants outstanding based on an average market price of $3.32, $2.04, $1.63 and $1.29 for 1994, 1995, 1996 and 1997, respectively, using the "treasury stock" method. Because of the antidilutive effect the "treasury stock" method was not used in 1993, 1995, 1996 or 1997. - 495,345 - - - =========== =========== =========== =========== =========== Total 18,830,141 20,791,578 19,880,879 20,085,551 20,362,525 =========== =========== =========== =========== =========== Earnings (loss) per common share $ (.30) $ 0.13 $ (0.26) $ (0.34) $ (0.93) Earnings (loss) per common share -- assuming dilution $ (.30) $ 0.12 $ (0.26) $ (0.34) $ (0.93) =========== =========== =========== =========== ===========
EX-23 5 CONSENT OF ERNST & YOUNG, LLP EXHIBIT 23.0 Consent of Ernst & Young LLP Independent Auditors We consent to the use of our report dated January 22, 1998 included in the Annual Report on Form 10-K of Digital Sound Corporation for the year ended December 31, 1997 with respect to the consolidated financial statements included in this form 10-K. Our audits also included the financial statement schedule of Digital Sound Corporation listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statements (Form S-8 No. 333-09755, Form S-8 No. 33-35019, Form S-8 No. 33-42184, Form S-8 No. 33-50376, Form S-8 No. 33-67000, Form S-8 No. 84730, and Form S-8 No. 333- 31783) pertaining to the 1983 Employee Stock Option Plan, the Directors' Stock Option Plan and the Employee Stock Purchase Plan of Digital Sound Corporation or our report dated January 22, 1998, with respect to the financial statements and schedule of Digital Sound Corporation included in this Annual Report on Form 10- K for the year ended December 31, 1997. By /s/ Ernst & Young L.L.P. - --------------------------- Ernst & Young L.L.P. EX-27 6 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 20,973 0 4,638 527 3,876 29,129 11,860 (6,776) 37,441 16,998 0 0 18,110 69,205 0 37,441 20,644 20,644 10,523 29,303 0 0 273 (18,909) (15) (18,924) 0 0 0 (18,924) (0.93) (0.93)
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