-----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, T3x6QfJdTlr57YL83EI35dLy5EvKSgpQiiSHoaP8HEwXJPPWmFOM5+mAQpaC85vh bQXxSzifFNNDBB9moZqwdg== 0000950150-97-000467.txt : 19970401 0000950150-97-000467.hdr.sgml : 19970401 ACCESSION NUMBER: 0000950150-97-000467 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SPATIALIZER AUDIO LABORATORIES INC CENTRAL INDEX KEY: 0000890821 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 954484725 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-26460 FILM NUMBER: 97570361 BUSINESS ADDRESS: STREET 1: 20700 VENTURA BOULEVARD SUITE 134 STREET 2: STE 1100 CITY: WOODLAND HILLS STATE: CA ZIP: 91364 BUSINESS PHONE: 3102682700 10-K405 1 FORM 10-K FOR PERIOD ENDED DECEMBER 31, 1996 1 ================================================================================ 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 FOR THE PERIOD ENDED: DECEMBER 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 33-90532 SPATIALIZER AUDIO LABORATORIES, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-4484725 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
20700 VENTURA BOULEVARD, SUITE 134 WOODLAND HILLS, CALIFORNIA 91364-2357 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) TELEPHONE NUMBER: (818) 227-3370 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: YES [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the 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 the voting stock held by non-affiliates of the registrant at March 13, 1997 was approximately $27,399,000. As of March 13, 1997, there were 20,795,929 shares of the Registrant's Common Stock outstanding. ================================================================================ 2 PART I ITEM 1. BUSINESS OVERVIEW Spatializer Audio Laboratories, Inc. (the "Company") is a leading developer, licenser and marketer of next generation technologies for the consumer electronics, personal computing and entertainment industries. The Company has two operating business units (100% wholly owned subsidiaries), Desper Products, Inc. ("DPI") and MultiDisc Technologies, Inc. ("MDT"), both of which are in the business of technology development and licensing. DPI has developed a full complement of patented and proprietary 3-D audio signal processing technologies directed to the consumer electronics and multimedia PC markets. New product offerings introduced in the fall of 1996 include technologies for next generation consumer products like Digital Versatile Disc (DVD) for personal computers and home entertainment; and interactive positional audio for PC gaming on the Windows 95/97(TM) platforms. DPI's 3-D audio signal processing technologies have been incorporated in nearly 200 products offered by global brand leaders including Texas Instruments, Compaq, Hewlett-Packard, Panasonic, JVC, Hitachi and Sharp, among others. In addition to continuing the Company's objective of broadening recognition for the Spatializer brand name through association with these and other globally recognized consumer electronics and multimedia computer brand leaders, the Company has also placed a high priority on broadening its technology base to position itself for continued growth. MultiDisc Technologies, Inc. was formed in June 1996 when the Company acquired development stage optical disc storage and robotics assets and technologies from Home Theater Products International, Inc. ("HTP"), a debtor in possession (the "MultiDisc Transaction"). MDT is currently a development stage enterprise creating a new product category of 12 cm CD/DVD based scaleable optical disc storage devices uniquely designed to combine the speed and performance of CD server arrays, the flexibility and capacity of CD Jukebox designs and next generation high speed, high volume robotics (the "MultiDisc(TM) Technology"). The target markets for the MDT technology currently include business networking and the Internet, backup/ archiving, and specialized vertical market applications including medical information technology, data warehousing and video-on-demand. The Company's executive offices are located at 20700 Ventura Boulevard, Suite 134, Woodland Hills, California 91364, Telephone (818) 227-3370. World Wide WEB site (http://www.spatializer.com). DESPER PRODUCTS, INC. -- 3-D AUDIO SIGNAL PROCESSING TECHNOLOGIES DPI has developed a suite of proprietary advanced audio signal processing technologies for the entire spectrum of applications falling under the general category of "3-D" audio. The objective in each product category is to create or simulate the effect of a multi-speaker sonic environment using two ordinary speakers for playback. The market for 3-D audio is segmented into three broad categories of technology as identified in the chart below. Each of these technologies utilizes different underlying scientific principles in accomplishing its design objectives is targeted to a specific class of consumer electronics or multimedia product depending on the intended product use and functional capability of the product. 1 3 - --------------------------------------------------------------------------------
CATEGORY OF TECHNOLOGY PRODUCT CATEGORIES 3-D AUDIO ENHANCEMENT - --------------------------------------------------------------------------------------------------- 3-D Stereo Consumer electronics products Surround Sound enhancement from (Spatializer(R) 3-D Stereo) providing stereo playback -- DVD an ordinary stereo signal. Players, Stereo TV's, VCR's, Stereo Components and Systems, Car Audio, Laptop and Desktop Multimedia Computers, Set-top Boxes. - --------------------------------------------------------------------------------------------------- Positional Audio Interactive Gaming for Simulation of immersive, (Spatializer 3-D MAP(TM)) Multimedia Computers under interactive sonic environments (Spatializer enCompass(TM)) Windows '95/'97, Virtual Reality including sound objects that Applications. move in real time with related graphics objects or changes in game player position or perspective. - --------------------------------------------------------------------------------------------------- Two-Speaker Virtualization Products incorporating multi- Creation of spatially accurate (Spatializer N-2-2(TM)) channel audio sources like Dolby multi-speaker cinematic audio Digital Virtual Surround Digital(R) (AC-3), Dolby experience from two speakers, ProLogic(R) or MPEG-2. Home utilizing discrete multi-channel Theater, DVD-Video, Multimedia audio information. Computers utilizing DVD/MPEG and decoding. - ---------------------------------------------------------------------------------------------------
LICENSED PRODUCTS The Company's current technology product applications are directed to (1) stereo enhancement in consumer electronics products and multimedia PCs, (2) interactive positional audio for PC gaming, and (3) two-speaker virtualization of multi-channel audio for DVD based multimedia computer and home theater applications. 1. SPATIALIZER(R) 3D STEREO. Based upon proprietary and patented methods of stereo signal processing, the Company's Spatializer(R) 3-D Stereo technology is designed to create a vivid and expansive three-dimensional surround sound listening experience from any stereo source input using only two ordinary speakers. Along with professional audio quality and coherent stable sonic imaging, the technology includes the Company's unique DDP(TM) (Double Detect and Protect(TM)) algorithm which continuously monitors the underlying stereo signal and dynamically optimizes spatial processing avoiding deleterious sonic artifacts common in other systems and "set and forget" ease of use for consumers. First introduced in July, 1994, in the form of a 20 pin analog integrated circuit (IC) from Matsushita Electronics Corporation ("MEC"), the technology is now incorporated into low-cost, standard process ICs by three chip foundries (Matsushita, ESS Technologies, Inc., and OnChip Systems) for easy and inexpensive implementation in any consumer electronics or computer product utilizing stereo audio. A fourth IC Foundry, Lux Sonor, Inc., has recently been licensed. Matsushita and ESS are readying new Spatializer IC designs for introduction in 1997. In addition, the Company has developed cost reduced and improved performance analog and DSP software designs which it introduced during the first quarter of 1997. 2. SPATIALIZER(R) 3-D MAP(TM) AND SPATIALIZER(R) ENCOMPASS(TM). In 1996, the Company introduced Spatializer 3-D MAP(TM) (Multimedia Audio Positioning) , the first in its family of positional audio enhancements for PC gaming applications on the Windows 95(TM) platform which work in conjunction with DirectSound 2.0 and Spatializer 3-D Stereo hardware or software. There are currently 13 PC game developers licensed to use 3-D MAP. In February 1997, the Company introduced Spatializer(R) enCOMPASS(TM), a real-time software-only positional 3-D audio engine based upon the Company's proprietary implementation of HRTF (head related transfer functions) algorithms, and Interaural Intensity and Interaural Time differences. Spatializer enCOMPASS permits PC game developers to 2 4 easily create immersive and interactive audio environments under the Windows '95 DirectSound 3-D audio API where sound objects move in real time in response to changes in the location or the perspective of the player in the game. The system supports playback over speakers or through headphones. Microsoft recently announced its support for 3-D audio and will provide an industry standard open API in DirectSound 5.0 scheduled for release summer 1997. 3. SPATIALIZER(R) N-2-2(TM) DIGITAL VIRTUAL SURROUND. In September 1996, DPI introduced Spatializer N-2-2(TM) which the Company considers a "core" and "enabling" technology for DVD based personal computer and home theater products. DVD is considered by many to be the single most important and potentially most widely adopted consumer audio/computer technology to ever be introduced. The audio standards for DVD (based upon geographic region) are multi-channel audio formats (Dolby Digital(R) (AC-3) and MPEG-2) which carry six (or more) discrete (independent) channels of audio -- the front left and right channels, a center channel (for vocal tracks), two rear surround channels and a Low Frequency Effects (LFE or "sub-woofer") channel for sound effects. The Spatializer N-2-2 software-based algorithms permit spatially accurate reproduction of this multi-channel audio over any ordinary stereo system using two rather than the five or six speakers normally required in traditional home theater setups. Spatializer N-2-2 runs in real-time on general purpose DSP hardware platforms like those offered by Motorola and Zoran, may be integrated with host based software-only MPEG-2 or DVD decoders (like those offered by CompCore Multimedia and Mediamatics for the Intel(R) Pentium(R) microprocessor), and can be ported to any of the principal audio codecs or media processor/accelerator platforms performing Dolby Digital (AC-3) or MPEG-2 audio decoding. N-2-2 has been approved by Dolby Laboratories and qualifies Spatializer Licensees to use the newly created Dolby Digital VIRTUAL(TM) trademark on products incorporating the technology. The Company believes its Spatializer N-2-2 process will serve to widen and accelerate the market for DVD acceptance, because it delivers the full cinematic audio experience to ordinary consumers without the additional expense and complication of multi-speaker home theater playback systems. LICENSING ACTIVITIES The Company has traditionally licensed its technologies through semiconductor manufacturing and distribution licenses ("Foundry Licenses") with semiconductor foundries ("Foundries"). In turn, these Foundries manufacture and distribute integrated circuits (ICs) incorporating Spatializer technology to manufacturers of consumer electronics, and multimedia computer products ("OEMs"). The terms of the Foundry Licenses are negotiated on an individual basis requiring the payment of a per unit running royalty according to sliding scales based upon cumulative volume. In addition, certain of the licenses call for the payment of an up-front license issuance fee in addition to the running royalty. Royalties are payable in the quarter following shipment from the Foundry to the OEM. OEMs who desire to incorporate these ICs into their products are required to enter into a license ("OEM Licenses") with the Company before they may purchase the ICs in quantity. Foundry Licenses generally have limited the sale of Spatializer ICs to OEMs who have entered into an OEM License with the Company. OEM licenses generally provide for the payment of a further per unit royalty by the OEM for OEM products incorporating a Spatializer IC ("Licensed Products") payable in the quarter following shipment by the OEM of its Licensed Products. In mid-1996, the Company modified its licensing program to ease the licensing process and accelerate cash flow by offering Foundries an alternative "Bundled Royalty" arrangement which permits the IC foundry to make a traditional component IC sale to an OEM without requiring the OEM to negotiate a separate royalty bearing license agreement with the Company. In these situations, the IC Foundry is authorized to sell Spatializer ICs to OEMs which enter into a simplified Logo Usage Agreement ("LUA") in consideration for a higher ("bundled") per unit royalty from the IC Foundry. This new alternative license structure has relieved much of the licensing burden from the IC foundries and has resulted in an increase in License signings. 3 5 Because the Spatializer N-2-2 technology may be fully implemented in software to run in host based (Intel Pentium) or general purpose DSP (Motorola and Zoran) environments no IC Foundry may be involved. In these situations, the Company will enter into royalty bearing licenses directly with the OEM. The Company is currently negotiating new IC Foundry and OEM licenses for its N-2-2, enCOMPASS, and 3-D stereo technologies. IC Foundry Licenses As of December 31, 1996, the Company has entered into three non-exclusive Foundry Licenses for its 3-D Stereo technology with Matsushita Electronics Corporation ("MEC"), ESS Technology, Inc. ("ESS"), and OnChip Systems, Inc. ("OnChip"). Foundry Licenses require the payment of per unit running royalties based upon a sliding scale computed on the number of Spatializer ICs sold. MEC currently manufactures and sells three 3-D Stereo IC's incorporating Spatializer audio signal processing and has several more ICs in design. ESS currently manufactures and sells the ES938 Spatializer(R) IC, which is primarily for multimedia and notebook applications, and has designed Spatializer 3-D stereo technology in two of its highest volume multifunction AudioDrive(R) ICs for introduction in early 1997. OnChip currently manufacturers two versions of the 3-D Stereo Spatializer(R) IC. As of December 31, 1996, more than 5.5 million ICs incorporating Spatializer 3-D Stereo audio signal processing technology had been manufactured and sold. OEM Licenses As of December 31, 1996, the Company had entered into 48 separate OEM Licenses on various economic and business terms. Some of these OEM Licenses required a license issuance fee and/or a separate per unit royalty, while others were licensed under the LUA under bundled royalty licenses with the IC foundries. The OEMs license a wide range of products, which include direct view TVs, wide screen and projection TVs, VCRs, powered speakers, portable audio systems ("Boomboxes"), HiFi stereo systems and components, computer sound cards and graphics accelerator cards, multimedia desktop personal computers, notebook computers, LCD projectors, multimedia computer monitors, car stereo systems, and arcade pinball and video games. The following table is a list of the OEMs as of December 31, 1996 with whom the Company has entered into OEM and/or LUA agreements: OEM OEM LISTING -- CONTINUED - -------------------------------------------------- --------------------------------------------------- 4D Sound, Corp. Matsushita Communications Industrial Ad Lib Multimedia, Inc. Matsushita Kotobuki Electronics, Inc. Anam Electronics Co., Ltd. MediaForte Bung Enterprises Ltd. Multimedia Labs, Inc. Canopus Corporation Multiwave Innovation, Inc. Compaq Computer Corp. Orchid Technology CrystaLake Multimedia Panasonic (Matsushita Electric Industrial Co., Digital Equipment Corp. LTD) Digital Technology Systems Of California, Inc. Proside Corp. Everex Systems, Inc. Proton Electronic Industrial Co., Ltd. Grandtec Electronic Corp. Samsung Information Systems, America Hewlett-Packard Seiko Epson Corp. Hitachi, Ltd. Sharp Corp. Iiyama Electric Co., Ltd. Sigma Electronics Design International Jensen Inc. Sound Vision Product, Inc. JK Micro (S) Pte., Ltd. Sowah JVC STB Systems, Inc. Kyushu Matsushita Electric Tae Kwang Industrial Kodi Chengdu Taisei Electric, Inc. Konami Co., Ltd. Taiyo Electric Company, Ltd. Labtec Enterprises, Inc. Texas Instruments Lotte Electronics Tiva Microcomputer Corp. Mag Monitors TXC Corporation Maseco Vikosing Pte., Ltd. Winner Products (USA), Inc.
4 6 HARDWARE PRODUCTS Sales of the Company's professional and consumer hardware products to date have not generated significant revenues and the Company does not plan to manufacture these products in the future. The Company is focusing its attention on licensing these product designs to third parties and concentrating on software-only products and "plug-ins" for the principal of digital audio workstation ("DAW") providers on both the MacIntosh(TM) and PC platforms. Professional Recording, Film and Broadcast Products The Company's PRO Spatializer(R), is a microprocessor-based audio production system designed for professional recording, film and broadcast applications. It offers a multi-track real-time processor that permits spatial expansion, 360 degree dynamic sound movement, and localization of monophonic and stereo sources utilizing conventional two-speaker stereo playback. It may be used in any phase of the recording process and is fully compatible with all standard stereo playback systems. The PRO Spatializer(R) is an expandable system which offers from sixteen to twenty-four channels with a Manufacturer's Suggested Retail Price ("MSRP") of $7,500. The Company also markets Spatializer-8(TM), a non-expandable version of the PRO Spatializer(R) which limits operator control to eight simultaneous recording channels with an MSRP of $6,000; and DIGITAL Spatializer(R), a product designed for two-channel professional record mastering providing full control over all spatial audio parameters entirely within the digital domain. In December 1996, the Company introduced Spatializer(R) RETRO(TM), a rack mount two-channel analog 3-D audio processor for project studios and live performance with an MSRP of $649. The Company does not intend to further manufacture of this product and is currently negotiating for the license of its design. The Company's professional products have, however, served as a proving ground and established credibility of the Company's technologies, gained a strong measure of acceptance, and created strong brand recognition for the Spatializer name in the professional recording, film and broadcast markets as reflected by the following partial list of credits: - Soundtrack for the motion picture "EVITA" featuring Madonna - Live Broadcast of the 1996 SUMMER OLYMPICS in Atlanta - Twentieth Century Fox's film "BROKEN ARROW" - Paramount's "CRIMSON TIDE" - Disney's "THE LION KING" - The Eagles "HELL FREEZES OVER" CD - Bonnie Raitt's Grammy Award winning "LONGING IN THEIR HEARTS" - Barbra Streisand's live concert album "BARBRA -- THE CONCERT" - Michael Jackson's "HISTORY" CD - Warner Bros. animated TV series, including "ANIMANIACS"; "BATMAN: THE ANIMATED SERIES"; "TAZMANIA"; and "TINY TOON ADVENTURES" - GRAMMY(R) AWARDS live telecasts for the past four years. Capitalizing upon that name recognition, the Company has sought to expand the market for its technology and products into computer games and multimedia title production environments, particularly well suited to "3-D" sound enhancement. Consumer Audio Products In January 1996, the Company introduced its first Spatializer(R) brand product for consumers, the HTMS 2510(TM) Stereo Surround Sound System. The device is an easy to install add-on, about the size of a VCR, that 5 7 converts any two speaker or multiple speaker home stereo into a state-of-the-art home theater system. The suggested retail price for the HTMS 2510 is $249. At the Winter Consumer Electronics Show in January, 1996, the HTMS 2510 won a prestigious "Innovations Awards" for excellence in product design and innovation, as did eight other products which feature Spatializer(R) audio technology from Panasonic, Proton and Labtec. The product received several favorable reviews in respected consumer audio industry publications Audio Magazine (June, 1996), Audio Adventure (June, 1996) and Sound on Sound (October, 1996). Consistent with its plans to concentrate on licensing and software-only products, the Company does not intend to manufacture additional units, but is considering licensing of the product designs and trademarks for manufacture and distribution in selected geographic regions throughout the world. SOFTWARE PRODUCTS Focusing on high margin, lower risk software products, and leveraging its reputation and brand name recognition in the professional recording industry, the Company introduced Spatializer(R) PT3D(TM), a software plug-in for the industry leader Digidesign(R) digital audio workstation platform in November 1996. Priced at an MSRP of $399, PT3D provides Spatializer(R) 3-D sound imaging and enhancement for the editing and production of audio for music, films and computer games. The product is currently distributed through PRO Audio dealers around the country. PT3D(TM) has received favorable reviews in leading industry publications including Recording magazine (December 1996). The Company is currently developing additional software "plug-ins" for the principal vendors of DAW software on both the MacIntosh and PC platform which it expects to introduce in 1997. MULTIDISC TECHNOLOGIES, INC. -- NETWORK BASED MODULAR, SCALEABLE COMPACT DISC/DVD SERVERS As its first effort to broaden the Company's technology portfolio and capitalize on the Company's strong relationships with manufacturers of consumer electronics and personal computer peripheral products, the Company acquired certain technologies and assets from HTP for $1,062,000 in June 1996 to form its subsidiary, MultiDisc Technologies, Inc. The transaction, which was implemented through a court-approved sale in the HTP bankruptcy proceeding, included an array of development stage compact disc server robotics and software technologies. The transaction was undertaken to position the Company for long term growth in a significant new market. The MultiDisc Transaction brings to the Company a unique combination of proprietary electromechanical designs, robotics, operating software, firmware, intellectual property, and engineering talent. The core intellectual property is reflected in five patent applications acquired by the Company in the asset acquisition. When completed, the technology is expected to feature a flexible modular design, which will allow extremely high-density and expandable disc storage, and support all current and future 12cm CD and DVD formats. Since the MultiDisc Technology is expected to be fully configurable, scaleable, and drive independent, any new improvements in 12cm CD or DVD drive speed, format, optics or media capacity can be easily accommodated. The net result is expected to be a new class of devices significantly faster, smaller and more capable than existing solutions at a fraction of their current cost. Devices built on the technology are expected to have applications in numerous global markets where on-line, near real-time data access, storage, archiving and retrieval are required. Since the incorporation of MDT, the Company has concentrated on finalizing the principal proof of concept designs and initial prototypes which it expects to complete by the end of the second quarter of 1997. In addition, eight new patent applications have been submitted to the United States Patent and Trademark Office bringing the total patent applications to thirteen. An additional seventeen patents applications have been identified, which are currently in process and are expected to be filed in the near future. The principal competitive advantages of the MultiDisc technology are extremely high disc storage density, passive expandability, and unlimited scaleability of the system -- all at very small incremental hardware costs. As a result, MDT CD/DVD servers could allow easy accessibility to hundreds or even thousands of CDs into a single low cost device -- literally permitting terabytes of data storage on a desktop. 6 8 The chief design goal behind the MultiDisc Technology is "on-line" accessibility at "off-line" costs. With the forecasted growth in business networking, Internet and Intranet servers, and on-line access to an ever growing data storage market, the demand for network-capable scaleable compact disc-based storage and archiving technologies is expected to rise markedly beyond the turn of the century. MDT devices should have application in on-line or networked applications on the Internet particularly as more audio, graphic and full motion video data types become more prominent as these data-rich applications require tremendous storage capacity. Within the wide range of possible markets, the Company plans to focus its initial efforts on the development of general purpose, modular, scaleable systems which have the widest possible vertical and horizontal commercial application. Large vertical applications include patient medical records management and medical image storage and retrieval (PACS -- Picture Archival and Compression Systems). In health care, the trend to on-line systems is expected to continue as pressures on medical cost reduction and quality assurance increase. In these health information systems environments, an MDT data server can provide storage for thousands of digital diagnostic images and patient information for access and distribution within a hospital or medical center or for access by consulting professionals at remote sites. There are numerous other vertical market applications, including video-on-demand systems for hotels or cable systems, check image storage in banks, on-line resources and retrieval in libraries and similar archives, on-line instruction in schools and industry, real estate and banking, and in government and industry where large volumes of paper are being reduced to digital data. The major development milestones leading to MDT's market viability will be: 1. Proof of concept for principal electro-mechanical designs 2. Initial prototyping 3. Software integration of user interface, motion control and data transfer functions 4. Completion of the principal patent applications, and 5. Formation of key strategic manufacturing, distribution and licensing relationships The Company expects to complete the principal proof of concept designs, initial prototyping and filing of all key patents by the end of the second quarter of 1997. Operating software and user interface designs are currently underway initially targeting the Windows NT(R) and NOVELL(R) network platforms. The Company is currently in discussions with potential manufacturing and distribution partners as well as principal software providers for the CD Jukebox/Changer marketplace. REVENUES AND EXPENSES The Company generates revenues from royalties pursuant to its Foundry, OEM, and other licenses, and from the sale and distribution of its consumer and professional hardware products. The Company's revenues, which totaled $2,024,000 in 1996, were derived substantially from Foundry and OEM License royalties. The Company limits its inventory, capital cost, personnel and overhead cost exposure in connection with its hardware products by entering into third-party manufacturing and distribution arrangements. The Company is seeking to maximize return on its intellectual property base by concentrating its efforts in very high margin licensing and software products and eliminating its hardware product operations. Licensing operations have been managed internally by Company personnel. Sales of professional audio products are accomplished through a worldwide network of professional audio dealers and managed by Company personnel. The Company had four major customers in 1996, each of whom accounted for greater than 10% of the Company's 1996 revenues. One OEM accounted for 24% of the Company's total licensing revenues during 1996. All other OEM's accounted for less than 10% individually. Royalties from each of the three Foundry Licensees accounted for 25%, 14%, and 12% of total licensing revenues, respectively. 7 9 In June 1996, the Company acquired the MultiDisc development stage CD/DVD server technologies in a transaction for $1,062,000 in an effort to significantly broaden the Company's technology portfolio and capitalize on its strong manufacturing and OEM relationships. In August 1996, the Company prevailed in a 22-month legal battle over its 3-D Stereo intellectual property when the U.S. District Court granted the Company's motion for summary judgment against a competitor's assertions of patent infringement (See ITEM 3 -- LEGAL PROCEEDINGS, Page 11, for further detail). Following the ruling in its favor, the Company signed 17 new OEM licensees in the third and fourth quarters, including such global market leaders as JVC and Texas Instruments. The uncertainties caused by the patent litigation severely hindered the performance of the Company for the last two years, particularly since licensing revenue depends upon OEM unit shipments, which follow three to four quarter production cycles. During 1996, the Company recorded three one-time (non recurring) expenses aggregating $21,147,000 or ($1.67) per share which represented approximately 83% of the operating loss reported for the year. These charges were: a) The Company recorded a one-time non-cash financial statement charge to earnings of $20,218,000 in the fourth quarter upon final consent by the British Columbia Securities Commission ("BCSC") and the Company's acceptance to the modification of the Company's performance share escrow arrangement as approved by the Company's shareholders in August, 1996. Under the revised arrangement the Company's 5,776,700 "Performance Shares" (representing approximately 24 percent of fully diluted shares outstanding at December 31, 1996) became subject to a new escrow arrangement under which the shares will be released over a six year period of time. b) The Company recorded a one-time charge to earnings in June 1996, in the amount of $680,000 as "In Process Research & Development" in connection with its MultiDisc Technologies CD/DVD robotics system technology acquisition. c) In connection with the liquidation of its Canadian predecessor, the Company incurred and paid Canadian income taxes in the amount of $249,000. During the last quarter of 1996, the Company completed the first phase of re-organization of its Desper Products, Inc. audio signal processing business by relocating the East Coast engineering facilities from Boston, Massachusetts to Mountain View, California. The Company also closed its Southern California research facility. In addition, the Company has implemented other cost cutting measures during the first quarter of 1997 in an effort to reduce 1997 operating costs from 1996 levels. COMPETITION 3-D AUDIO SIGNAL PROCESSING MARKETPLACE The Company competes with a number of entities that produce various audio enhancement processes, technologies and products, some utilizing traditional two-speaker playback, others utilizing multiple speakers, and others restricted to headphone listening. These include the consumer versions of multiple speaker, matrix and discrete digital technologies developed for theatrical motion picture exhibition (like Dolby Digital(R), Dolby ProLogic(R), and DTS(R)), as well as other technologies designed to create an enhanced stereo image from two or more speakers. The Company's principal competitors in the field of 3-D audio are QSound Labs, Inc. ("QSound"), SRS Labs, Inc., Aureal Semi-conductor, Inc. and Harman International. Only QSound competes with the Company in all three 3-D audio market segments. In the future, the Company's products and technologies also may compete with audio technologies and product applications developed by other companies including entities that have business relationships with the Company. The Company believes that it will favorably compete in this market because it offers a single source, complete suite of patented and proprietary technologies, and because of its superior engineering and OEM support, the strength of its IC Foundry and OEM relationships, and the Spatializer brand name recognition in the industry. 8 10 COMPACT DISC SERVER/JUKEBOX MARKETPLACE The multiple disc server and CD-ROM changer industry is emerging and is currently characterized by a single market leader NSM, a German based entity which is adapting its audio "jukebox" expertise to CD-ROM applications and by a number of small companies and specialty groups in large and established enterprises which are seeking to enter the market. NSM sells products under its own label and as an OEM for other manufactures such as Kodak. NSM offers only hardware and is dependent on third parties for control and interface software, and on system integrators and value added resellers (VARs) to implement the hardware for individual solutions. The other entities generally offer either large capacity free-standing disc changers (like the NSM products) for network environments or small capacity changers (for ten or fewer discs) for personal computer markets. The NSM products require a substantial end-user investment of approximately $20,000 for a fully configured solution. Large capacity systems are currently offered by DISC, Kubik, Dynatek, Boffin, Denon and Kodak: small capacity systems are available from Mountain Data Systems (Nakamichi), NEC, Sanyo, TeleVideo and JVC. Only Pioneer and Smart & Friendly offer both larger and small capacity changers. The Company believes that if the MultiDisc technology is proven and reaches market, it will compete in both large and small capacity markets principally because of its flexible and configurable technology and its ability to integrate the technology in turnkey solutions for the end-user. Currently, the Company intends to enter the market through licensing, OEM relationships and other strategic arrangements rather than as a direct manufacturer. PATENTS, TRADEMARKS AND COPYRIGHTS The Company's core Spatializer audio signal processing technology is covered by its U.S. patent 5,412,731, issued May 2, 1995. In addition, the Company has acquired two related audio signal processing patents covering its technology. Additional patent applications for the Company's reduced cost/higher performance 3-D Stereo designs, and for its enCompass and N-2-2 technologies are currently in process. Much of the Company's intellectual property consists of trade secrets. The Company possesses copyright protection for its principal software applications and has U.S. and foreign trademark protection for its key product names and logo marks. As of December 31, 1996, MDT had five core patent applications on file with the USPTO. To date an additional eight patent applications have been filed covering software, mechanical techniques, implementations and mixed technology designs bringing the total to thirteen. An additional seventeen patent applications have been identified and are currently in process. The Company has applied for U.S. trademark protection for its principal product names and logo marks. EMPLOYEES The Company began 1996 with twenty-nine full-time and two part-time employees and grew to thirty-nine full-time and one part-time employees by December 31, 1996. At year end, there were sixteen employees engaged in research and development with seven of those employees involved with the development effort at the Company's new subsidiary MDT. The Company's sales and marketing department ended the year with nine full-time employees and the finance and administrative department ended the year with fourteen full-time and one part-time employees. From time to time the Company also employs the services of outside professional consultants. None of the Company's employees is represented by a labor union or is subject to a collective bargaining agreement. The Company considers its relations with its employees and consultants to be excellent. In February 1997 the Company reduced its workforce by seven full-time employees. This restructure reduced the staff count to thirty-two full-time employees and one part-time employee. The Company now has fifteen full-time employees in research and development, six full-time employees in sales and marketing, and eleven full-time and one part-time employee in finance and administrative. 9 11 PART II ITEM 2. PROPERTIES In 1996, the Company's executive office was located in Woodland Hills, California where it occupies approximately 4,340 square feet at an annual rent of approximately $83,000. The Company's regional offices in Natick, Massachusetts, Mountain View, California, and Newbury Park, California are also in leased premises. The Natick lease covered approximately 2,200 square feet and had an annual rent of approximately $26,200 in 1996. The Natick facility staff were relocated to the Mountain View facility in January 1997 and the Natick premises were closed on January 31, 1997. In the first quarter of 1996 the Company relocated its Mountain View location to a larger facility in Mountain View. The facility occupies approximately 4,200 square feet and the annual rent for these premises is approximately $50,400. In 1996 the Company rented a sound lab and technical support facility in Tujunga, California on a month-to-month basis at a rent of approximately $14,100 per year. In the Company's effort to consolidate, the technical support facility was also closed in January 1997. The Company incurred no lease termination costs in connection with the closing of various offices. The Company leases its space at rental rates and on terms which management believes are consistent with those available for similar space in the applicable local area. The Company's properties are well maintained, considered adequate and are being utilized for their intended purposes. ITEM 3. LEGAL PROCEEDINGS In the Fall of 1994, QSound Labs, Inc. ("QSound") advised MEC that, in its view, the Spatializer(R) technology infringed certain U.S. patents held by QSound. Based on its belief that its technology does not infringe QSound's patents, in October 1994 DPI initiated Desper Products, Inc. and Spatializer Audio Laboratories, Inc. v. QSound Labs, Inc., Case No. 94-7276WDK(Bx). On August 29, 1996 the Court granted the Company's summary judgment motion of non-infringment in its entirety and denied the motion by QSound in the pending patent infringement litigation between the Company and QSound. In granting the Company's summary judgment motion, the Court found that the Company's IC (Integrated Circuit) does not infringe the QSound patent and denied QSound's motion with respect to infringement. The Company's claim that the QSound patent is invalid was not decided and, since the issues which the Court would need to consider on the patent invalidity claim are similar to certain issues considered in the infringement claim, QSound was granted the right to immediately appeal the denial of its motion and trial on the invalidity issue was deferred until after that appeal. In substance, the Court's finding confirms the Company's position that there is no infringement by the Company's IC of any patent held by QSound and that the claims by QSound were without merit. If the appeal is denied and the Court's decision is confirmed on appeal, the Company intends to pursue the remaining claims for damages and for a decision that the QSound patent is invalid. If the appeal is granted and the Court's decision on the motion is overruled, a trial on the merits would follow at which time the Company will again assert its current position, which already was adopted in the grant of the Company's summary judgment motion, and will assert its remaining claims against QSound. QSound has appealed and the appeal is pending. The Company expects that it will ultimately prevail in this case, and therefore, the disposition of this matter is not expected to have a material effect on the financial position or results of operations of the Company. However, the outcome of all litigation is to some extent unpredictable. The Company is not currently a party to any other legal actions and is not aware of any other pending claims. The Company anticipates, however, that from time to time it may be named as a party to legal actions in the ordinary course of business. 10 12 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of the security holders of the Company either through solicitation of proxies or otherwise in the fourth quarter of the fiscal year ended December 31, 1996. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock was listed and commenced trading on the small capital market of NASDAQ on August 21, 1995 under the symbol "SPAZ". From July 14, 1992 to October 10, 1995, the Company's Common Stock traded on the Vancouver Stock Exchange ("VSE") in Canadian dollars under the symbol "SLB.V". Beginning October 10, 1995, the stock traded on the VSE in U.S. dollars under the symbol "SLB.U". On February 12, 1997 the Company delisted from the VSE and subsequent to such date has been trading only on NASDAQ. The following table sets forth the high and low sales price of the Company's Common Stock on its principal market for fiscal years 1995 and 1996:
HIGH (CDN. $)(1) LOW (CDN. $)(1) ---------------- --------------- PERIOD: 1995 First Quarter...................................... $4.15 $2.65 Second Quarter..................................... $5.63 $3.60 Third Quarter(2)................................... $7.25 $4.80 HIGH (U.S. $) LOW (U.S. $) ------------ ------------ Third Quarter(3)................................... $6.16 $4.31 Fourth Quarter..................................... $5.50 $3.38 1996 HIGH (U.S. $) LOW (U.S. $) ------------ ------------ First Quarter...................................... $5.00 $3.75 Second Quarter..................................... $5.41 $4.00 Third Quarter...................................... $5.06 $3.19 Fourth Quarter..................................... $3.88 $2.88
- --------------- (1) Trading is in shares of the Company as listed on the Vancouver Stock Exchange ("VSE") expressed in Canadian dollars. (2) The Company became active on NASDAQ on August 21, 1995. Prior to that date, shares were still traded on the VSE and expressed in Canadian dollars (July 1, 1995 to August 18, 1995). (3) August 21, 1995 to September 30, 1995 are expressed in US Dollars as traded on NASDAQ. On March 13, 1997, the closing price reported by NASDAQ was U.S. $2.13. Stockholders are urged to obtain current market prices for the Company's Common Stock. Montreal Trust Company of Canada, Vancouver, B.C., was the transfer agent and registrar for the Company's Common Stock for the 1996 fiscal year. Beginning April 1, 1997, Harris Trust Company of California will become the new transfer agent. RECORD HOLDERS To the Company's knowledge there were approximately 150 holders of record of the stock of the Company as of March 13, 1997. However, the Company's transfer agent has indicated that beneficial ownership is in excess of 1,600 shareholders. DIVIDENDS The Company has not paid any cash dividends on its Common Stock and has no present intention of paying any dividends. The current policy of the Company is to retain earnings, if any, for use in operations and in the development of its business. The future dividend policy of the Company will be determined from time to time by the Board of Directors. 11 13 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data should be read in conjunction with the Company's Consolidated Financial Statements and related Notes and with "Management's Discussion and Analysis of Financial Condition and Results of Operations", included in Item 7. The selected data presented below under the headings "Consolidated Statement of Operations Data" and "Consolidated Balance Sheet Data" as of and for the years ended December 31, 1996 and 1995, as of and for four-month period ended December 31, 1994, and the years ended August 31, 1994, are derived from the consolidated financial statements of Spatializer Audio Laboratories, Inc. and subsidiaries, which consolidated financial statements have been audited by KPMG Peat Marwick LLP, independent certified public accountants. The consolidated financial statements as of December 31, 1996 and 1995, and the related consolidated statements of operations, shareholders' equity, and cash flows for the years ended December 31, 1996 and 1995, the four-month period ended December 31, 1994, and the year ended August 31, 1994, and the report thereon, are included elsewhere in this Report.
FISCAL YEAR FOUR MONTH ENDED FISCAL YEAR ENDED AUGUST 31, PERIOD ENDED --------------------------- --------------------------------- DECEMBER 31, DECEMBER 31, DECEMBER 31, 1992 1993 1994(1) 1994(1 & 2) 1995(1) 1996 --------- --------- --------- ------------ ------------ ------------ (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenues..................................... $ -- $ 97 $ 140 $ 187 $ 1,230 $ 2,024 Cost Of Revenues............................. -- (55) (61) (25) (79) (186) --------- --------- --------- --------- ---------- ---------- Gross Profit................................. -- 42 79 162 1,151 1,838 Total Operating Expenses..................... (1,039) (2,120) (1,808) (1,339) (4,403) (27,042)(3) Interest Income (Expense), Net............... (29) (25) (79) (16) 74 119 Income taxes................................. -- -- -- -- (63) (310)(4) --------- --------- --------- --------- ---------- ---------- Loss For The Period.......................... $ (1,068) $ (2,103) $ (1,808) $ (1,193) $ (3,241) $ (25,395) --------- --------- --------- --------- ---------- ---------- Loss Per Common Share........................ $ (0.42) $ (0.37) $ (0.26) $ (0.14) $ (0.32) $ (2.01) ========= ========= ========= ========= ========== ========== Weighted Average Common Shares(5)............ 2,518,373 5,740,298 6,891,546 8,552,535 10,156,816 12,644,751 ========= ========= ========= ========= ========== ========== CONSOLIDATED BALANCE SHEET DATA: Cash and Cash Equivalents.................... $ 669 $ 500 $ 1,779 $ 1,540 $ 3,113 $ 1,587 Working Capital.............................. 278 (66) 6 982 3,159 2,092 Total Assets................................. 764 932 2,676 2,318 4,420 4,141 Advances From Related Parties................ 332 433 539 517 325 113 Shareholders's Note Payable.................. -- 292 -- -- -- -- Total Shareholders' Equity................... $ 361 $ 69 $ 288 $ 1,367 $ 3,697 $ 3,268
- --------------- (1) A Plan of Arrangement was completed on July 27, 1994 whereby the situs of the Company was moved to Delaware. Spatializer Audio Laboratories, Inc., a Delaware corporation, became the parent company for Spatializer-Yukon and DPI. The financial statements for this fiscal year reflect the consolidation of all three entities. (2) Not comparative. (3) Includes two one-time significant items. The first significant item is a Compensation Expense of $20,218,450 associated with the transfer of the Company's performance shares from Canadian Escrow into a new escrow arrangement which will provide for the release of the performance shares over the next six years. Based on the revised escrow arrangement, which primarily converts the escrow shares release from performance criteria to time-based criteria, the Company recorded compensation expense on the date the new escrow arrangement terms were accepted by the Company. The second significant item is an In-Process Research & Development ("IPR&D") expense of $680,000 related to the allocation of costs incurred as a result of the MultiDisc Technologies, Inc. ("MDT") subsidiary's asset acquisition in June 1996. (4) The Company incurred and paid Canadian income taxes in the amount of $249,000 during the year associated with the liquidation of Spatializer-Yukon, the Company's Canadian predecessor. (5) Loss per share has been calculated based on the weighted average number of common shares outstanding including escrowed performance shares, which are factored into the calculation as of December 30, 1996, the date on which the British Columbia Securities Commission ("BCSC") issued its consent to the Company's revised escrow arrangement. Common stock equivalents have not been included in the calculation of primary loss per share for all periods as the effect of including such securities would be antidilutive. 12 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1996, COMPARED TO THE YEAR ENDED DECEMBER 31, 1995 The following discussion and analysis relates to the financial condition and results of operations of Spatializer Audio Laboratories, Inc. (the "Company") for the year ended December 31, 1996, compared with the year ended December 31, 1995, the year ended December 31, 1995, compared with the year ended December 31, 1994 and for the four-month period ended December 31, 1994 compared with the four-month period ended December 31, 1993. RESULTS OF OPERATIONS REVENUES The Company reported increased revenues of 65% or $794,000, reaching $2,024,000 for the year ended December 31, 1996, compared to $1,230,000 for the year ended December 31, 1995. Revenues include sales of professional recording systems, consumer products, license issuance fees and royalties pertaining to the Spatializer(R) analog integrated circuit ("IC"). The growth in revenues reflect the Company's transition to recurring running royalties. In 1995 the majority of the Company's licensing revenues were derived from one-time, up-front license issuance fees. In contrast, a substantial portion of the licensing revenues for 1996 are derived primarily from running royalties based on usage and include revenues from four major customers. In 1996 these major customers represent 25%, 24%, 14% and 12%, respectively. The full impact of the increase in recurring royalties was not felt during 1996, as a portion of the revenue stream was offset by non-refundable advanced royalties reported in 1995. As of December 31, 1996, the majority of these advance royalties had been offset, resulting in the future recognition of revenue on a basis concurrent with unit shipments. During the year, the Company offered a new streamlined "bundled" royalty agreement with its foundries. The bundled royalty agreement is designed to accelerate revenues and to simplify the selling process of the Spatializer(R) IC. Foundries will continue to pay a royalty as the IC is manufactured and shipped to Original Equipment Manufacturers (OEM's), however, the new agreement makes it easier for foundries to sell the ICs to OEMs by eliminating the need to negotiate a separate royalty with the OEMs. In this new bundled agreement the OEM royalty is "bundled" in the chip price and paid directly by the IC Foundry thus accelerating the receipt of such royalties to the Company. OEMs sign a simplified Logo Usage Agreement 13 15 ("LUA") in order to promote the usage of the Spatializer(R) IC. Twenty-four new licensees were added during the year, bringing the total to fifty-one Foundry and OEM licensees. The new licensees were a result of a combination of the new "bundled" licensing agreement, introduction of the Company's N22(TM) -- Digital Virtual Surround(TM) technologies for multi-channel discrete digital audio systems for DVD/DVD-ROM, Spatializer 3-D Map(TM) positional audio enhancement software for Windows(R) 95 ("PT-3D(TM)"), and a favorable ruling by the Court in the intellectual property litigation with QSound Labs, Inc. The Company increased product sales through sales of its first consumer product, the HTMS-2510(TM). Product sales for the year ended December 31, 1996, represent approximately 17% of revenues compared with only 5% for the same period in 1995. Due to unsatisfactory sales performance, the Company plans to move away from such hardware products and to concentrate on the higher-margin software products such as PT-3D(TM). The Company expects the majority of revenues to continue to come from licensing activities. Gross profit for the year ended December 31, 1996, was approximately 91% as compared with 94% for same period in 1995. Profit margins are high as the majority of revenues are derived from licensing activities which carry low direct costs. The reduction in gross profit is due to the above referenced increase in product sales during 1996 since the margin on product sales is lower than licensing margins. OPERATING EXPENSES The Operating expenses for the year ended December 31, 1996 reflect two significant non-recurring items which occurred in 1996. The first significant item is for a Compensation expense of $20,218,450 associated with the transfer of the Company's performance shares from Canadian Escrow into a new escrow arrangement which will provide for the release of the performance shares for a period up to six years. The second significant item is for In-Process Research & Development ("IPR&D") of $680,000 related to the allocation of costs incurred as a result of the MultiDisc Technologies, Inc. ("MDT") subsidiary's asset acquisition in June 1996. After adjusting for the two one-time items listed above, operating expenses for the year ended December 31, 1996, increased by approximately 40% or $1,740,000, for a total of $6,144,000 compared to $4,404,000 for the same year in 1995. This increase can be attributed primarily to the added costs of operations related to the Company's new MDT subsidiary, increased efforts of Sales and Marketing including the launch of an aggressive advertising campaign for the HTMS-2510, as well as the effects of a fully staffed operation at the Desper Products, Inc. ("DPI"). GENERAL AND ADMINISTRATIVE General and administrative costs remained relatively flat with a minor decrease of approximately 2% or $51,000, to $2,329,000 for the year ended December 31, 1996 as compared with $2,380,000 for the same period in 1995. The change is primarily the result of increased payroll and payroll related costs and financial reporting costs, offset by savings in travel, external accounting fees, and consulting and temporary help. Payroll and Payroll Related Payroll and payroll related costs increased approximately 22%, or $151,000, to $831,000 for the year ended December 31, 1996 as compared with $680,000 for the same period in 1995. The increase is attributed to the increase in staff from ten full-time staff in 1995 to eleven full-time staff and one part-time staff in 1996. The increase in staff count is related primarily to additional workloads due to regulatory reporting requirements, the support of pursuing new product launches, and the support requirements of the Company's newest subsidiary, MDT. The increase is also reflective of a transition from temporary staff and consultants to permanent employees. Financial Reporting Financial reporting costs relate to regulatory filing requirements of the SEC and NASDAQ as well as printing of such materials for investor relations, financial analysts, and sales and marketing purposes. 14 16 The costs for the Company's first Annual Report and Form 10-K along with quarterly Form 10-Q financial reportings were $150,000 for the year ended December 31, 1996. No similar documents were produced for marketing purposes in the prior year and therefore, there are no comparable costs in 1995. Travel and Travel Related Travel and travel related costs decreased by approximately 38% or $50,000, to $81,000 for the year ended December 31, 1996 as compared with $131,000 for the same period in 1995. The decrease in travel and travel related costs are directly associated with travel during 1995 to Europe and the Pacific Rim to report on the Company and its products in those areas. Consulting Fees and Temporary Help Consulting fees and temporary help decreased by approximately 43%, or $101,000, for a total of $135,000 for the year ended December 31, 1996, compared to $236,000 for the same year in 1995. The reduction in costs relates to the completion of multiple consulting projects in 1995 including the analysis of technologies for potential acquisition and the permanent hire or elimination of temporary staff in the 1996 period. In addition, the three-month period ended December 31, 1995 included a third party patent analysis conducted in connection with the patent infringement lawsuit which was decided in the Company's favor in August 1996. Legal Fees Legal fees decreased approximately 37%, or $193,000, for a total of $331,000 for the twelve month period ended December 31, 1996, compared to $524,000 for the same twelve month period in 1995. This decrease is primarily the result of reduced litigation related fees and costs after August 1996 when the Court granted the Company's motion for summary judgment against a competitor's assertions of patent infringement. The competitor has appealed, therefore, additional litigation fees and costs will be incurred by the Company in connection with this matter. General Operating General operating costs were approximately $800,000 for both of the years ended December 31, 1996 and 1995. These costs include rent, telephone, office supplies and stationery, postage, depreciation and similar costs. The lack of increase is the direct result of internal cost controls and cost savings measures taken by the Company including the streamlining of agreements with outside service companies to reduce such costs. RESEARCH AND DEVELOPMENT The research and development activity grew substantially in 1996 with the added operations of the Company's new subsidiary, MDT commencing in June. In addition, the Company continued efforts to identify, validate, and develop new product ideas through DPI and introduced both the Spatializer 3-D Map(TM) positional audio enhancement software for Windows(R) 95 and N22(TM) -- Digital Virtual Surround technologies for multi-channel discrete audio systems in DVD/DVD-ROM and Home Theater products during the year. All research and development activities and related costs continue to be expensed in the period incurred. To support these efforts research and development costs increased by approximately 199% or $1,238,000, to $1,860,000 for the year ended December 31, 1996, compared to $622,000 for the same year in 1995. The increase relates primarily to expenses incurred of $843,000 related to the Company's newly formed subsidiary MDT which began operating in June 1996, along with a fully-staffed operation at DPI. Payroll and Payroll Related Payroll and payroll related costs for the Research and Development Department increased approximately 118% or $636,000, to $1,174,000 for the year ended December 31, 1996 as compared with 15 17 $538,000 for the same period in 1995. The increase is attributed to the increase in staff to fifteen in 1996. The increase in staff includes seven staff members involved in the MDT research and development efforts as well as additional staff costs of DPI which is now operating with employees rather than outside contractors. The Company's new subsidiary, MDT, which began operations on June 24, 1996, represented approximately 43% or $505,000 of the department's payroll and payroll related costs for the year ended December 31, 1996. Technology and Product -- Engineering and Development Research & engineering costs, other than payroll and payroll related, increased substantially to approximately $686,000 for the year ended December 31, 1996 compared to $84,000 for the same period in 1995. The increase is primarily related to the six-months of operations of the Company's new subsidiary, MDT. Costs during future periods are expected to increase as the activities of MDT proceed towards the development of its network based compact disc/DVD server technologies. SALES AND MARKETING Sales and marketing costs increased approximately 40%, or $554,000, for a total of $1,955,000 for the year ended December 31, 1996, compared to $1,401,000 for the same year in 1995. The increase is attributed to payroll and payroll related costs and advertising costs related to a continued advertising and promotional campaign directed at the consumer and computer marketplaces. Payroll and Payroll Related Payroll and payroll related costs for the Sales and Marketing Department increased approximately 67% or $284,000, to $706,000 for the year ended December 31, 1996 as compared with $422,000 for the same period in 1995. The increase is attributed to the increase in staff from ten in 1995 to twelve in 1996, increases in medical insurance due to new hires with family coverage, and timing issues with staffing changes. Advertising and Trade Show Related Advertising which includes publicity, public relations, and press release costs and trade show related costs increased approximately 104%, or $210,000, for a total of $411,000 for the year ended December 31, 1996, compared to $201,000 for the same year in 1995. The increase is attributed to supporting the introduction of the first Spatializer brand consumer hardware product, the HTMS-2510(TM) into the consumer market place as well to public relations and publicity related to the development of an organized advertising and promotional campaign directed at the consumer and computer marketplaces to achieve name brand recognition. In addition, the increase in trade show costs is related primarily to a larger presence at Winter Consumer Electronic Show ("CES") '96 where the Company introduced the HTMS-2510(TM). Other Sales and Marketing Other costs including travel and entertainment, brochure and promotional literature, outside services and general operating costs increased approximately 8% or $60,000, for a total of $838,000 for the year ended December 31, 1996, compared to $778,000 for the same year in 1995. These areas all increased to support the overall increased sales effort for both the Company's licensing and product activities. 16 18 NET LOSS The Company incurred the following significant, non-recurring items in 1996 which aggregated $21,147,000. Including these non-recurring items the Company reported a net loss for fiscal year 1996 of $25,395,000. - The Company recorded a one-time non-cash financial statement charge to earnings of $20,218,000 in the fourth quarter upon final consent by the BCSC to the modification of the Company's performance share escrow arrangement. Under the revised arrangement the Company's 5,776,700 "Performance Shares" (representing approximately 24 percent of fully diluted shares outstanding at December 31, 1996) became subject to a new escrow arrangement under which the shares will be released under a six year passage of time. The overall modification was approved by the Company's shareholders in August 1996. Under the revised arrangement, the performance shares will be released automatically as follows: 5% on June 22, 1997; 5% on June 22, 1998; 10% on June 22, 1999; 20% on June 22, 2000; 30% on June 22, 2001; and 30% on June 22, 2002. In addition to the automatic releases, performance shares can be released based on the cash flow release criteria contained in the original June 22, 1992 escrow agreement although, to maintain a stable market in the Company's stock, in any year not more than 30% of the shares will be released, based on the cash flow criteria. Under the revised escrow arrangement, the performance shares will vest provided the individual has not voluntarily terminated his/her service to the Company prior to applicable vesting dates. Any individual who is involuntarily terminated by the Company has his/her unvested performance shares automatically accelerated to them. The Board, in its discretion, may allow an individual who has voluntarily terminated his/her service to keep a portion or all of his/her unvested performance shares. Based on the revised escrow arrangement, which modifies the escrow shares release from performance criteria to include a time-based criteria as well, the Company recorded as compensation expense the excess of the fair market value of the 5,776,700 performance shares on the date the Company accepted the terms of the new escrow arrangement over the purchase price of such escrow shares. All of the performance shares are included in the issued and outstanding shares for the twelve-month periods ended December 31, 1996, and 1995. For financial reporting purposes, such shares were treated as issued and outstanding but were not reflected in the calculation of loss per common share until earned by and released to the holders as they would be antidilutive. At December 31, 1995, no performance shares had been earned out. At December 31, 1996 these shares are included in the calculation of loss per common share beginning December 30, 1996, the date on which the Company and the BCSC accepted and entered into the terms of the current escrowed arrangement as discussed above. - The Company recorded a one-time charge to earnings in June 1996, in the amount of $680,000 as "In Process Research & Development" in connection with its MultiDisc Technologies CD/DVD robotics system technology acquisition. - Lastly, in connection with the liquidation of its Canadian predecessor, the Company incurred and paid Canadian income taxes in the amount of $249,000. After adjusting for the above referenced one-time items, the net loss for the year ended December 31, 1996, totaled $4,248,000, compared to a net loss of $3,241,000 in 1995, an approximate increase of 31%, or $1,007,000. The increased loss includes operating expenses incurred of $843,000 related to the Company's newly formed subsidiary MDT which began operating in June 1996. During the last quarter of 1996, the Company completed the first phase of re-organization of its Desper Products, Inc. audio signal processing business by relocating the East Coast engineering facilities from Boston, Massachusetts to Mountain View, California. The Company also closed its southern California research 17 19 facility. In addition, the Company has implemented other cost cutting measures during the first quarter of 1997. In an effort to reduce 1997 operating costs from 1996 levels. FOR THE YEAR ENDED DECEMBER 31, 1995, COMPARED TO THE YEAR ENDED DECEMBER 31, 1994 The following discussion and analysis relates to the financial condition and results of operations of Spatializer Audio Laboratories, Inc. (the "Company") for the year ended December 31, 1995, compared with the year ended December 31, 1994, for the four-month period ended December 31, 1994 compared with the four-month period ended December 31, 1993, and the fiscal year ended August 31, 1994 compared with the fiscal year ended August 31, 1993. On December 13, 1994, the Board of Directors approved a change in the Company's year from a fiscal year end of August 31 to a fiscal year end of December 31 resulting in a four-month transition period which is stated in the financials. For comparative purposes of discussion and analysis the financial results of both twelve-month periods ended December 31, 1994 and 1995 are listed in the table below:
DECEMBER 31, DECEMBER 31, 1995 1994 ------------ ------------ (UNAUDITED) REVENUES: Product Revenues........................................ $ 63,507 $ 93,480 Licensing Revenues...................................... 1,166,713 220,090 ----------- ----------- 1,230,220 313,570 Cost of Revenues................................ 78,854 81,806 ----------- ----------- Gross Profit............................................ 1,151,366 231,764 ----------- ----------- OPERATING EXPENSES: General and Administrative.............................. 2,443,379 1,304,415 Research and Development................................ 622,484 434,347 Sales and Marketing..................................... 1,400,794 840,734 ----------- ----------- 4,466,657 2,579,496 Operating Loss.................................. (3,315,291 (2,347,732) Interest Income......................................... 113,701 22,979 Interest Expense........................................ (39,695) (113,642) ----------- ----------- Net Loss........................................ $ (3,241,285) $ (2,438,395) =========== =========== Net Loss Per Common Share....................... $ (0.32) $ (0.32) =========== =========== Weighted Average Common Shares.......................... 10,156,816 7,618,925 =========== ===========
RESULTS OF OPERATIONS REVENUES The Company showed a substantial increase in revenues of 292% or $916,650, reaching $1,230,220 for the year ended December 31, 1995, compared to $313,570 for the twelve month period ended December 31, 1994. Revenues include sales of professional recording systems, license issuance fees and royalties pertaining to the analog IC. This growth occurred as the Company emerged from the development stage during the third quarter of 1995 with a total of three Foundry and twenty-four OEM license agreements as of the end of 1995. The increase in revenues is substantially from license issuance fees and running royalties associated with the increased number of Foundry and OEM license agreements for the Company's IC. The gross profit was approximately 94% of revenues as the majority of sales are associated with license and royalty revenues which have little or no direct costs associated with them. A significant portion of the Company's ongoing revenue will be derived from royalties payable by the OEMs as IC's are incorporated into existing or new products manufactured and sold by the OEMs. As a result, the Company will continue to earn royalty revenues from 18 20 IC's shipped by the foundries in 1995 as these IC units are incorporated into products sold in 1996 by the OEM's OPERATING EXPENSES Operating expenses for the twelve month period ended December 31, 1995, totaled $4,466,657 compared to $2,579,496 for the same twelve month period in 1994. The increase of approximately 73% or $1,887,161, can be attributed primarily to increased payroll costs for personnel brought on to sustain the growth of the Company as it emerged out of the development stage and to support the increased demands of its current licensing and product operations. Payroll and Payroll Related Costs Payroll and payroll related costs showed increases throughout the Company as growth was experienced in all three departments (General & Administrative, Sales & Marketing and Research & Development). Salary and direct salary related costs increased by approximately 72% or $680,034, for a total of $1,623,790 for the twelve month period ended December 31, 1995, compared to $943,756 for the same twelve month period in 1994. At December 31, 1994, the Company had 20 employees. By December 31, 1995, the staff size had grown to 29 employees. Of the three departments, Sales & Marketing had the largest increase of approximately 194% or $422,771, for a total of $640,854 for the twelve month period ended December 31, 1995, compared to $218,083 for the same twelve month period in 1994. The increase in Sales & Marketing can be attributed to the first full year of operations at the Mountain View, CA office which was leased in late 1994 and included the hiring of the Vice President of Sales and Marketing as well as additional sales staff. At December 31, 1994, this department had 5 employees. By December 31, 1995, this department had grown to 10 employees. General & Administrative increased approximately 48% or $211,205, for a total of $653,941 for the twelve month period ended December 31, 1995, compared to $442,736 for the same twelve month period in 1994. The increase in General & Administrative can be attributed to additional regulatory reporting requirements as well as administrative support for additional personnel throughout the Company. At December 31, 1994, there were 3 employees in the Finance and Accounting department and 4 employees in the Administration and Investor Relations department for a total General and Administrative staff size of 7 employees. By December 31, 1995, both departments had grown to 5 employees for a total General and Administrative staff size of 10 employees. Research & Development had an increase of approximately 16% or $46,058, for a total of $328,995 for the twelve month period ended December 31, 1995, compared to $282,937 for the same twelve month period in 1994. The increase can be attributed to a full year of operation at the Company's East Coast office which opened in late 1994 with an engineering staff hired to pursue research and development ideas aimed at improving existing products and creating new products and product concepts. At December 31, 1994, this department had 8 employees. By December 31, 1995, this department had grown to 9 employees. GENERAL AND ADMINISTRATIVE General and administrative expenses (less payroll and payroll related costs discussed above, of $653,941 and $442,736 for the year ended December 31, 1995 and 1994 respectively) consisting primarily of professional and consulting fees, investor relations, and other operating costs, increased by approximately 108% or $927,759, for a total of $1,789,438 for the twelve month period ended December 31, 1995, compared to $861,679 for the same twelve month period in 1994. The majority of this increase can be attributed to the expanding focus on investor relations and legal fees incurred in connection with the registration with the Securities and Exchange Commission ("SEC"), the NASDAQ listing, the liquidation of Spatializer Audio Laboratories, Inc. -- Yukon and with patent litigation costs. 19 21 Professional Fees Legal fees increased approximately 94%, or $254,422, for a total of $523,773 for the twelve month period ended December 31, 1995, compared to $269,351 for the same twelve month period in 1994. This increase is attributed to fees incurred in connection with the following: the patent litigation filed in October 1994; filing requirements for the SEC related to the Company's August 1995 registration with the SEC and NASDAQ listing; fees incurred with private placements; trademark research; licensing negotiations; and the liquidation of Spatializer Audio Laboratories, Inc. -- Yukon. Outside Services and Consulting Outside services and consulting fees increased 448%, or $193,215, for a total of $236,327 for the twelve month period ended December 31, 1995, compared to $43,112 for the same twelve month period in 1994. These costs consist of personnel search fees associated with the hiring of additional employees, consulting fees associated with expanded corporate finance activities and payments to consultants and other personnel working on a part-time or special-project basis. Investor Relations Costs Investor relations costs increased approximately 58%, or $101,381, for a total of $275,443 for the twelve month period ended December 31, 1995, compared to $174,062 for the same twelve month period in 1994. The increased costs were incurred to accommodate increased interest in the Company and to keep the investment community informed of corporate developments. Other Operating Costs Other operating costs including rents, office supplies, travel and telephone increased by approximately 101%, or $378,741, for a total of $753,895 for the twelve month period ended December 31, 1995, compared to $375,154 for the same twelve month period in 1994. These costs reflect the increased costs of additional personnel and new office space leased in Woodland Hills, CA, during 1995. RESEARCH AND DEVELOPMENT COSTS The Company incurs costs in the identification, validation and development of new product ideas, and all such costs are expensed in the period incurred. During the twelve month period ended December 31, 1995, Research & Development expenditures increased as the Company had resources to allocate to this effort and its understanding of market and product needs matured. These increased efforts resulted in the design of three additional IC's which will be available through foundries in the first quarter of 1996. In addition, several consumer products were designed and will be brought to market over the first and second quarters of 1996. Research and development expenses (less payroll and payroll related costs discussed above, of $328,995 and $282,937 for the year ended December 31, 1995 and 1994 respectively) increased approximately 94%, or $142,079, for a total of $293,489 for the twelve month period ended December 31, 1995, compared to $151,410 for the same twelve month period in 1994. The increase can be attributed to engineering costs incurred in research and prototype development for new hardware and software products as well as the completion of development on the Company's first consumer product, the HTMS-2510(TM), which was introduced during the first quarter of 1996. SALES AND MARKETING EXPENSES Sales and marketing expenses (less payroll and payroll related costs discussed above, of $640,854 and $218,083 for the year ended December 31, 1995 and 1994 respectively) increased approximately 22%, or $137,289, for a total of $759,940 for the twelve month period ended December 31, 1995, compared to $622,651 for the same twelve month period in 1994. The increase is attributed to public relations and publicity related to the development of an organized advertising and promotional campaign directed at the consumer and computer marketplaces. Efforts to achieve name brand recognition increased greatly in 1995 when the 20 22 first OEM products, incorporating the Spatializer IC, were introduced to US markets. In addition, company and product information became available on the Company's web site (http://www.spatializer.com). NET LOSS The net loss for the twelve month period ended December 31, 1995, totaled $3,241,285 or $(0.32) per share, compared to a net loss of $2,438,395 or $(0.32) per share in the same twelve month period in 1994. The increase in the net loss is attributed to the growth of the Company necessary to implement its current licensing and product operations primarily related to added personnel and office locations along with associated overhead. The increase in net loss can also be attributed to research and development of new products, an expanding focus on investor relations, legal fees and an organized advertising and promotional campaign. FOR THE FOUR-MONTH PERIODS ENDED DECEMBER 31, 1994 AND 1993 REVENUES Revenues include sales of professional recording systems and license issue fees and royalties pertaining to the analog IC. Revenues of approximately $187,000 for the four-month period ended December 31, 1994 reflect a substantial increase over revenues of approximately $9,000 for the similar period in the prior year. This increase can be primarily attributed to licensing revenues derived from the IC which was first introduced in July 1994 and for which revenues were first recorded in fiscal year ended August 31, 1994. Sales of the professional systems to date have not varied by season. Licensing revenues to date for the analog IC have not been sufficient to establish any pattern that would determine seasonality in sales results. OPERATING EXPENSES GENERAL AND ADMINISTRATIVE General and administrative expenses, which consisted substantially of professional and consulting fees, investor relations and payroll costs, increased approximately 157%, or $374,000, from $238,000 for the four-month period ended December 31, 1993 to $612,000 for the four-month period ended December 31, 1994. This increase can be attributed to the hiring of additional personnel, an expanding focus on investor relations and legal fees incurred in connection with patent prosecution. General and Administrative Payroll Payroll costs rose approximately 58%, or $57,000, from $99,000 for the four-month period ended December 31, 1993 to $156,000 for the four-month period ended December 31, 1994. The increase can be attributed to the addition of administrative and finance personnel in late 1994 to assist with increased workload, to organize new product launches and to pursue new product ideas. Professional and Consulting Fees Legal fees increased approximately 198%, or $97,000, from $49,000 for the four-month period ended December 31, 1993 to $146,000 for the four-month period ended December 31, 1994. This increase can be attributed to fees incurred in late 1994 for private placement transactions, fees incurred in a patent infringement lawsuit filed in October 1994 and developing standard licensing agreements and finalizing terms of various licensing arrangements for the IC. Investor Relations Costs Investor relations costs increased $155,000 from $20,000 for the four-month period ended December 31, 1993 to $175,000 for the four-month period ended December 31, 1994. These costs were incurred to accommodate increased interest in the Company and to keep the investment community informed of corporate developments. 21 23 RESEARCH AND DEVELOPMENT The Company incurs costs in the identification, validation and development of new product ideas, and all such costs are expensed in the period incurred. Historically, research and development expenditures by the Company have been limited by the lack of sufficient resources. The market for products is characterized by continuing technological change. Management expects research and development expenditures to increase in the future as resources permit. Research and development expenses increased approximately 58%, or $67,000, from $116,000 for the four-month period ended December 31, 1993 to $183,000 for the four-month period ended December 31, 1994. The increase can be attributed to engineering costs incurred in the evaluation of development alternatives and costs incurred in developing prototypes as the Company pursued the development of several new products expected to be launched during 1995. Research and Development Payroll Payroll costs increased 36%, or $27,000, from $75,000 for the four-month period ended December 31, 1993 to $102,000 for the four-month period ended December 31, 1994. During the latter period, the Company opened a Licensing and Technical Support office on the East Coast and engineers were hired at this office to pursue research and development ideas aimed at improving existing products and creating prospects for new products. Prototyping Costs Prototyping costs increased approximately 258%, or $31,000, from $12,000 for the four-month period ended December 31, 1993 to $43,000 for the four-month period ended December 31, 1994. During the period ended December 1993, the Company's focus was on marketing the newly-introduced PRO Spatializer(R). During the period ended December 1994, the Company was focused on the evaluation of development alternatives and costs were incurred in developing prototypes of potential new products. SALES AND MARKETING Sales and marketing expenses increased approximately 213%, or $370,000, from $174,000 for the four-month period ended December 31, 1993 to $544,000 for the four-month period ended December 31, 1994. In 1994, the Company increased its sales and licensing efforts in anticipation of the commercial availability of the MEC IC and in anticipation of the introduction of OEM products incorporating the MEC IC. Costs included those associated with the opening of a sales office in the Silicon Valley area, attendance at trade shows and a new advertising campaign. Sales and Marketing Payroll Payroll costs for sales and marketing increased approximately 163%, or $83,000, from $51,000 for the four-month period ended December 31, 1993 to $134,000 for the four-month period ended December 31, 1994. The increase was attributable to the opening of the sales office in the Silicon Valley, a growing sales effort and personnel costs, and the hiring of a Vice President of Sales and Marketing. Advertising and Promotional Costs Costs of sales and marketing increased substantially from $7,000 for the four-month period ended December 31, 1993 to $65,000 for the four-month period ended December 31, 1994. The increase can be attributed to the development of a significant advertising and promotional campaign directed at the consumer and computer marketplaces, including retaining an advertising agency specializing in these markets. 22 24 Trade Show Costs Trade show costs increased significantly from $16,000 for the four-month period ended December 31, 1993 to $207,000 for the four-month period ended December 31, 1994 and were applied principally to marketing the IC, particularly at trade shows directed to the computer and consumer electronics marketplaces. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1996, the Company had $1,587,000 in cash and cash equivalents as compared to $3,113,000 at December 31, 1995. The decrease in cash and cash equivalents is attributed to cash used for the MDT acquisition of assets, cash used in operating activities, the purchase of fixed assets and the retirement of a portion of the related party advances offset by cash received from operations and common stock issuances, including private placements, warrant and option exercises. The Company had working capital of $2,092,000 at December 31, 1996 as compared with $3,159,000 at December 31, 1995. The Company's future cash flow from operations will come primarily from Foundry and OEM royalties. At December 31, 1996 the Company had three Foundry licensees and forty-eight OEM Licensees as compared with three Foundry Licensees and twenty-four OEM Licensees at December 31, 1995. The Company continues to have no long-term debt and has no present commitments or agreements which would require any long-term debt to be incurred. The Company owed $112,500 to related parties as of December 31, 1996 as compared to $325,061 at December 31, 1995. During the first quarter 1997, the Company raised $2,000,000 through a private placement of 1,600,000 units in the Company consisting of a share of common stock and one-half of one non-transferable share purchase warrant. The proceeds of the financing is currently expected to be utilized to finance the Company's research and development activities in its MultiDisc Technologies ("MDT") business unit and for working capital reserves. However, such proceeds may be used at the Company's discretion to fund working capital needs or other obligations as they come due. In addition, the Company has the ability to curtail certain activities including, but not limited to, MDT related research and development, if necessary in order to meet its commitments. The Company also agreed to modify certain outstanding one year warrants to purchase 155,000 shares of stock issued in May and June, 1996 by adjusting the exercise price to an amount consistent with the current market price of the Company's stock ($1.75 US) and by adjusting the shares under warrant to 310,000 shares. Funds generated by these financing activities as well as cash generated from operations is expected to be sufficient for the Company to meet its obligations during the next twelve months. However, additional sources of financing including debt, equity or strategic investments may be required to fund capital expenditures, acquisitions, research and development and marketing costs related to such activities. NET OPERATING LOSSES At December 31, 1996, the Company had $35,100,000 in net operating loss carryforwards for financial reporting purposes and $15,400,000 for income tax purposes. The Company's ability to utilize approximately $900,000 of these tax losses which accrued during 1994 against future income may be restricted as a result of the change in year-ends to December 31, 1994. The net operating loss carryforwards expire through 2011. INFLATION The Company believes that the moderate inflation rate of the 1990's has not impacted its operations. 23 25 ITEM 8. FINANCIAL STATEMENTS INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Spatializer Audio Laboratories, Inc.: We have audited the consolidated balance sheets of Spatializer Audio Laboratories, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, shareholders' equity, and cash flows for the years ended December 31, 1996 and 1995, the four-month period ended December 31, 1994, and the year ended August 31, 1994. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Spatializer Audio Laboratories, Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for the years ended December 31, 1996 and 1995, the four-month period ended December 31, 1994 and the year ended August 31, 1994, in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP Los Angeles, California February 21, 1997, except for Note 15, which is as of March 7, 1997 24 26 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DECEMBER 31, DECEMBER 31, 1996 1995 ------------ ------------ ASSETS Current Assets: Cash and Cash Equivalents..................................... $ 1,587,395 $ 3,113,057 Accounts Receivables, net of allowance for doubtful accounts of $90,000 at December 31, 1996............................ 820,856 412,010 Inventory..................................................... 296,539 262,131 Prepaid Expenses and Deposits................................. 260,984 94,068 ----------- ----------- Total Current Assets.................................. 2,965,774 3,881,266 Fixed Assets, Net (Note 3)...................................... 622,856 294,803 Intangible Assets, Net (Note 4)................................. 451,733 243,532 Other Assets.................................................... 100,832 -- ----------- ----------- $ 4,141,195 $ 4,419,601 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts Payable.............................................. $ 403,870 $ 180,046 Accrued Liabilities........................................... 333,152 203,530 Advances from Related Parties (Note 5)........................ 112,500 325,061 Notes Payable................................................. 23,800 13,493 ----------- ----------- Total Current Liabilities............................. 873,322 722,130 ----------- ----------- Shareholders' Equity: Preferred shares, $.01 par value, 1,000,000 shares authorized, no shares issued or outstanding............................ -- -- Common shares, $.01 par value, 50,000,000 shares authorized, 19,115,429 and 17,457,531 shares issued and outstanding at December 31, 1996 and 1995 respectively (Note 7)........... 191,154 174,575 Additional Paid-In Capital.................................... 38,527,775 13,578,782 Accumulated Deficit........................................... (35,451,056) (10,055,886) ----------- ----------- Total Shareholders' Equity............................ 3,267,873 3,697,471 ----------- ----------- $ 4,141,195 $ 4,419,601 =========== ===========
See accompanying notes to consolidated financial statements 25 27 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED FOUR MONTH ---------------------------- TRANSITION DECEMBER PERIOD ENDED YEAR ENDED DECEMBER 31, 31, DECEMBER 31, AUGUST 31, 1996 1995 1994 1994 ------------ ----------- ------------ ----------- Revenues: Product Revenues................... $ 336,849 $ 63,507 $ 37,403 $ 64,741 Licensing Revenues................. 1,687,338 1,166,713 150,005 75,584 ------------ ----------- ----------- ----------- 2,024,187 1,230,220 187,408 140,325 Cost of Revenues................... 185,540 78,854 25,196 61,433 ------------ ----------- ----------- ----------- 1,838,647 1,151,366 162,212 78,892 ------------ ----------- ----------- ----------- Operating Expenses: General and Administrative......... 2,329,333 2,380,472 612,226 968,090 Research and Development........... 1,860,400 622,484 182,557 363,257 Sales and Marketing................ 1,954,527 1,400,794 544,264 476,391 Compensation Expense (Note 8)...... 20,218,450 -- -- -- In-Process Research & Development (Note 9)........................ 679,684 -- -- -- ------------ ----------- ----------- ----------- 27,042,394 4,403,750 1,339,047 1,807,738 ------------ ----------- ----------- ----------- Operating Loss.................. (25,203,747) (3,252,384) (1,176,835) (1,728,846) Interest Income...................... 132,883 113,701 20,192 7,647 Interest Expense..................... (13,769) (39,695) (36,618) (87,188) ------------ ----------- ----------- ----------- 119,114 74,006 (16,426) (79,541) ------------ ----------- ----------- ----------- Loss Before Income Taxes............. (25,084,633) (3,178,378) (1,193,261) (1,808,387) Income Taxes (Note 10)............... (310,537) (62,907) -- -- ------------ ----------- ----------- ----------- Net Loss........................ $(25,395,170) $(3,241,285) $ (1,193,261) $(1,808,387) ============ =========== =========== =========== Net Loss Per Common Share....... $ (2.01) $ (0.32) $ (0.14) $ (0.26) ============ =========== =========== =========== Weighted Average Common Shares Outstanding........................ 12,644,751 10,156,816 8,552,535 6,891,546 ============ =========== =========== ===========
See accompanying notes to consolidated financial statements 26 28 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
FOUR MONTH YEAR ENDED TRANSITION ----------------------------- PERIOD YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, AUGUST 31, 1996 1995 1994 1994 ------------ ------------ ------------ ----------- Cash Flows from Operating Activities: Net Loss.................................... $(25,395,170) $ (3,241,285) $ (1,193,261) $(1,808,387) Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and Amortization............ 130,057 79,719 20,201 73,600 Compensation Expense (Note 8)............ 20,218,450 -- -- -- In-Process Research and Development (Note 9)..................................... 679,684 -- -- -- Net Change in Assets and Liabilities: Accounts Receivable...................... (408,846) (319,604) 240,442 (307,184) Inventory................................ (34,408) (22,419) 16,487 (61,164) Prepaid Expenses and Deposits............ (166,916) (31,814) (36,661) (20,066) Accounts Payable......................... 223,824 (73,885) 44,472 74,323 Accrued Liabilities...................... 129,622 35,305 92,094 72,696 Other Assets............................. (100,832) -- -- -- ------------ ----------- ----------- ----------- Net Cash Used in Operating Activities......... (4,724,535) (3,573,983) (816,226) (1,976,182) ------------ ----------- ----------- ----------- Cash Flows from Financing Activities: Issuance of Common Shares................... 4,747,122 5,572,142 1,493,725 2,008,386 Subscriptions Advance....................... -- -- -- 1,556,000 Repayment of Subscription Loan.............. -- -- (778,000) -- Due to Related Parties...................... (212,561) (192,221) (21,818) 106,306 Issuance of Notes Payable................... 26,213 -- 5,105 7,751 Repayments of Notes Payable................. (15,907) 972 (198) (291,958) ------------ ----------- ----------- ----------- Net Cash Provided by Financing Activities..... 4,544,867 5,380,893 698,814 3,386,485 ------------ ----------- ----------- ----------- Cash Flows from Investing Activities: Purchase of Fixed Assets.................... (240,720) (164,175) (116,998) (33,327) Increase in Intangible Assets............... (43,118) (69,544) (5,200) (116,044) MDT Asset Acquisition (Note 9).............. (1,062,156) -- -- -- ------------ ----------- ----------- ----------- Net Cash Used in Investing Activities......... (1,345,994) (233,719) (122,198) (149,371) ------------ ----------- ----------- ----------- Foreign Exchange Adjustment................... -- 98 -- 18,946 ------------ ----------- ----------- ----------- Increase (Decrease) in Cash and Cash Equivalents................................. (1,525,662) 1,573,289 (239,610) 1,279,878 Cash and Cash Equivalents, Beginning of Period...................................... 3,113,057 1,539,768 1,779,378 499,500 ------------ ----------- ----------- ----------- Cash and Cash Equivalents, End of Period...... $ 1,587,395 $ 3,113,057 $ 1,539,768 $ 1,779,378 ============ =========== =========== =========== Supplemental Disclosure of Cash Flow Information: Cash paid during the period for: Interest................................. $ 1,639 $ 39,695 $ 34,564 $ 67,463 Income Taxes (Note 10)................... $ 310,729 $ 800 $ 800 $ 800
See accompanying notes to consolidated financial statements 27 29 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
COMMON SHARES ---------------------------------------- TOTAL NUMBER OF ADDITIONAL ACCUMULATED SHAREHOLDERS' SHARES PAR VALUE PAID-IN-CAPITAL DEFICIT EQUITY ---------- --------- --------------- ------------ ------------- Balance, August 31, 1993........ 11,378,674 $ 113,787 $ 3,787,317 $ (3,831,997) $ 69,107 Issuance of Shares in Connection with an Acquisition of Technology.................... 1,000,000 10,000 44,890 -- 54,890 Extension of Loan............... 16,405 164 19,561 -- 19,725 Options Exercised (Note 12)..... 40,000 400 40,236 -- 40,636 Warrants Exercised (Note 12).... 942,917 9,429 1,205,469 -- 1,214,898 Private Placements, Net (Note 7)............................ 600,000 6,000 672,237 -- 678,237 Net Loss........................ -- -- -- (1,789,441) (1,789,441) ---------- -------- ----------- ------------ ------------ Balance, August 31, 1994........ 13,977,996 139,780 5,769,710 (5,621,438) 288,052 Options Exercised (Note 12)..... 25,000 250 23,028 -- 23,278 Warrants Exercised (Note 12).... 25,000 250 38,149 -- 38,399 Private Placements, Net (Note 7)............................ 950,000 9,500 2,200,548 -- 2,210,048 Net Loss........................ -- -- -- (1,193,261) (1,193,261) ---------- -------- ----------- ------------ ------------ Balance, December 31, 1994...... 14,977,996 149,780 8,031,435 (6,814,699) 1,366,516 Issuance of Shares for Debt..... 10,000 100 8,483 -- 8,583 Options Exercised (Note 12)..... 220,500 2,205 258,360 -- 260,565 Warrants Exercised (Note 12).... 197,500 1,975 477,092 -- 479,067 Private Placements, Net (Note 7)............................ 2,051,535 20,515 4,803,412 -- 4,823,927 Net Loss........................ -- -- -- (3,241,187) (3,241,187) ---------- -------- ----------- ------------ ------------ Balance, December 31, 1995...... 17,457,531 174,575 13,578,782 (10,055,886) 3,697,471 Options Exercised (Note 12)..... 363,033 3,630 383,905 -- 387,535 Warrants Exercised (Note 12).... 646,000 6,460 1,704,127 -- 1,710,587 Private Placements, Net (Note 7)............................ 648,865 6,489 2,642,511 -- 2,649,000 Performance Shares (Note 8)..... -- -- 20,218,450 -- 20,218,450 Net Loss........................ -- -- -- (25,395,170) (25,395,170) ---------- -------- ----------- ------------ ------------ Balance, December 31, 1996...... 19,115,429 $ 191,154 $38,527,775 $(35,451,056) $ 3,267,873 ========== ======== =========== ============ ============
See accompanying notes to consolidated financial statements 28 30 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) NATURE OF BUSINESS Spatializer Audio Laboratories, Inc. and subsidiaries (the "Company") is in the business of technology development and licensing. The Company's wholly owned subsidiary Desper Products, Inc. ("DPI") is in the business of developing proprietary advanced audio signal processing technologies and products for consumer electronics, entertainment, and multimedia computing. The Company's wholly owned subsidiary, MultiDisc Technologies, Inc. ("MDT") is in the business of developing scaleable, modular compact disc/DVD server technologies for licensing. Currently the development focus is on technologies associated with a network based compact disc/DVD server for internet and intranet applications. On December 5, 1995 the Board of Directors of the Company authorized the liquidation of Spatializer Audio Laboratories, Inc. -- Yukon pursuant to S.213 of the Business Corporations Act (Yukon). This action was taken to minimize the tax consequences to the Company. The liquidation was completed during the first quarter of 1996. (2) SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation These consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States. During the third quarter of 1995 the Company emerged from a development stage enterprise. Change in Fiscal Year On December 13, 1994, the Board of Directors approved a change in the Company's year from a fiscal year end of August 31 to a fiscal year end of December 31. The consolidated financial statements include presentation of the transition period beginning on September 1, 1994, and ending on December 31, 1994. Basis of Consolidation The consolidated financial statements include the accounts of Spatializer Audio Laboratories, Inc. and its wholly owned subsidiaries, Desper Products, Inc. and MultiDisc Technologies, Inc. All material inter-company transactions have been eliminated. Revenue Recognition The Company recognizes revenue from product sales upon shipment to the customer. The Company recognizes revenue from licensing agreements when earned, in accordance with the contractual arrangements. Currency The operations of the Company take place primarily in the United States and all financial reporting is in U.S. Dollars. Cash and Cash Equivalents Cash equivalents consist of highly liquid investments with original maturities of three months or less. 29 31 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Inventory Inventory, which consists primarily of finished goods, is stated at the lower of cost (first-in, first-out) or market. Research and Development Expenditures The Company expenses research and development expenditures as incurred. Fixed Assets Fixed assets are carried at cost and are depreciated over five to seven years using accelerated-depreciation methods, which approximates 150% declining balance. Leasehold improvements are amortized over the shorter of the useful life or lease term. Intangible Assets Intangible assets consist of patent costs which are amortized on a straight-line basis over the estimated useful lives of the patents which range from five to ten years. Loss per Share Loss per share has been calculated based on the weighted average number of common shares outstanding including escrowed performance shares, which are factored into the calculation as of December 30, 1996 (Note 8). Common stock equivalents have not been included in the calculation of primary loss per share for all periods as the effect of including such securities would be antidilutive. Stock Option Plan Prior to January 1, 1996 the Company accounted for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based Compensation, which permits entities to recognize as expense over the vesting period the fair value of all employee stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income (loss) and pro forma earnings (loss) per share disclosures for employee stock option grants made in 1996 and future years as if the fair-value-based method defined in SFAS No. 123 has been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123 (Note 14). Impairment of Long-Lived Assets and Assets to be Disposed of The Company adopted the provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, on January 1, 1996. This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. 30 32 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Adoption of this Statement did not have a material impact on the Company's financial position, results of operations, or liquidity. Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. Reclassifications Certain amounts have been reclassified to conform with 1996 presentation. (3) FIXED ASSETS Fixed assets, at cost, as of December 31, 1996 and 1995 consist of the following:
1996 1995 -------- -------- Office Computers, Software, Equipment and Furniture............ $595,993 $237,287 Test Equipment................................................. 97,928 60,895 Tooling Equipment.............................................. 44,136 25,000 Trade Show Booth and Demonstration Equipment................... 130,846 144,369 Leasehold Improvements......................................... 45,756 23,916 -------- -------- 914,659 491,467 Less Accumulated Depreciation and Amortization................. 291,803 196,664 -------- -------- $622,856 $294,803 ======== ========
(4) INTANGIBLE ASSETS Intangible assets, as of December 31, 1996 and 1995 consist of the following:
1996 1995 -------- -------- Capitalized patent and technology costs........................ $309,222 $266,104 Capitalized patent costs in association with MDT Asset Acquisition (Note 9)......................................... 200,000 -- -------- -------- 509,222 266,104 Less Accumulated Amortization.................................. 57,489 22,572 -------- -------- $451,733 $243,532 ======== ========
(5) ADVANCES FROM RELATED PARTIES The Company was indebted to certain related parties for amounts totaling $112,500 and $325,061 at December 31, 1996 and 1995, respectively, which includes accrued interest. Amounts bear interest at rates ranging from a fixed 10% annually to prime plus 2% and are due on demand. 31 33 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (6) FINANCIAL INSTRUMENTS The carrying values of cash and cash equivalents, accounts receivable, prepaid expenses and deposits, accounts payable and accrued liabilities at December 31, 1996 and 1995 approximated fair value due to the short maturity of those investments. The fair values of the advances from related parties could not be estimated due to the nature of the investments. The fair values of notes payable at December 31, 1996 and 1995 are materially consistent with the related carrying values based on current rates offered to the Company for instruments with similar maturities. (7) SHAREHOLDERS' EQUITY During the year ended August 31, 1994, shares were issued or converted as follows: In November of 1993, the Company exercised the put option granted to it in 1992 and issued 1,000,000 escrowed performance common shares (upon receipt of par value Cdn. $.01 per share) in exchange for all of the outstanding Class C common shares of DPI, originally issued in exchange for certain technology rights. In November of 1993, all holders of outstanding escrowed performance non-voting shares elected to exercise their rights provided in the Articles of Incorporation/Continuance to convert such shares into an equal number of escrowed performance common shares. In January 1994, the Company completed a private placement of 100,000 units at a price of Cdn. $1.83 per unit, each unit comprised of one common share and one-half of one non-transferable share purchase warrant. One warrant entitles the holder to purchase one additional share at a price of Cdn. $2.15 per share on or before January 4, 1995. These warrants were exercised during the year ended August 31, 1994. Additional warrants for the purchase of 25,000 shares at a price of Cdn. $2.15 per share were accrued ratably over a five month period, ending November 17, 1994, pending the implementation of a shareholder offering under a contemplated SMF committed to by the Company in connection with this placement. These additional warrants, which were to expire on January 4, 1995, were exercised and issued in December, 1994. During the year ended August 31, 1994, the Company issued 16,405 shares as compensation for the extension of the maturity date on an amount borrowed from a shareholder in March of 1994 and repaid during the year ended August 31, 1994. In April 1994, the Company completed a private placement of 500,000 units at a price of Cdn. $1.50 per unit, each unit comprised of one common share and one non-transferable share purchase warrant. One warrant entitles the holder to purchase one additional share at a price of Cdn. $1.60 per share on or before April 20, 1995. These warrants were exercised during the year ended August 31, 1994. During the four-month period ended December 31, 1994, shares were issued or converted as follows: In November 1994, the Company completed a private placement of 650,000 units at a price of Cdn. $3.20 per unit, each unit comprised of one common share and one-half of one non-transferable share purchase warrant. One warrant entitles the holder to purchase one additional common share at a price of Cdn. $3.20 on or before November 2, 1995 and after that date at a price of Cdn. $3.70 on or before November 2, 1996. In December 1994, the Company completed a private placement of 300,000 units at a price of Cdn. $3.60 per unit, each unit comprised of one common share and 55% of one non-transferable share purchase warrant. One warrant entitles the holder to purchase one additional common share at a price of Cdn. $3.60 on or before August 5, 1995, and after that date at a price of Cdn. $4.15 on or before August 5, 1996. 32 34 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) During the year ended December 31, 1995, shares were issued or converted as follows: In August 1995, the Company completed a private placement of 100,000 units at a price of Cdn. $3.25 (US $2.33) per unit, each unit comprised of one common share and one-quarter of one non-transferable share purchase warrant. The Company received Cdn. $325,000 (US $232,772) upon completion of this placement. One warrant entitles the holder to purchase one additional share at a price of Cdn. $3.25 (US $2.33) on or before May 2, 1996, and after that date at a price of Cdn. $3.75 (US $2.69) on or before May 2, 1997. In August 1995, the Company completed a private placement of 1,200,000 units at a price of Cdn. $3.30 (US $2.40) per unit, each unit comprised of one common share and one-quarter of one non-transferable share purchase warrant. The Company received Cdn. $3,960,000 (US $2,876,101) upon completion of this placement. One warrant entitles the holder to purchase one additional share at a price of Cdn. $3.30 (US $2.40) on or before May 19, 1996, and after that date at a price of Cdn. $3.80 (US $2.76) on or before May 19, 1997. In August 1995, the Company completed a private placement of 350,000 units at a price of Cdn. $3.45 (US $2.50) per unit, each unit comprised of one common share and one-quarter of one non-transferable share purchase warrant. The Company received Cdn. $1,207,500 (US $876,405) upon completion of this placement. One warrant entitles the holder to purchase one additional share at a price of Cdn. $3.45 (US $2.50) on or before June 9, 1996, and after that date at a price of Cdn. $4.00 (US $2.90) on or before June 9, 1997. Also in August 1995, the Company completed a private placement of 300,000 units at a price of Cdn. $3.85 (US $2.80) per unit, each unit comprised of one common share and one-quarter of one non-transferable share purchase warrant. The Company received Cdn. $1,155,000 (US $838,649) upon completion of this placement. One warrant entitles the holder to purchase one additional share at a price of Cdn. $3.85 (US $2.80) on or before June 23, 1996 and after that date at a price of Cdn. $4.50 (US $3.27) on or before June 23, 1997. In relation to the private placements of the Company's stock during 1995, finders fees for such placements were paid through the issuance of 101,535 shares of stock. During the year ended December 31, 1996, shares were issued or converted as follows: In May 1996, the Company completed a private placement of 200,000 units at a price of $4.25 U.S. per unit, each unit comprised of one common share and one-quarter of one non-transferable share purchase warrant. One warrant entitles the holder to purchase one additional share at a price of $4.75 U.S. on or before May 9, 1997. Regulatory approval was received in July 1996 from the Vancouver Stock Exchange ("VSE"). Also in May 1996, the Company completed a private placement of 280,000 units at a price of $4.25 U.S. per unit, each unit comprised of one common share and one-quarter of one non-transferable share purchase warrant. One warrant entitles the holder to purchase one additional share at a price of $4.75 U.S. on or before May 31, 1997. Regulatory approval was received in July 1996 from the VSE. In June 1996, the Company completed a private placement of 140,000 units at a price of $4.35 U.S. per unit, each unit comprised of one common share and one-quarter of one non-transferable share purchase warrant. One warrant entitles the holder to purchase one additional share at a price of $5.12 U.S. on or before June 17, 1997. Regulatory approval was received in August 1996 from the VSE. For the year ended December 31, 1996, funds related to private placements totaling $2,649,000 had been received by the Company and included in cash and cash equivalents. 33 35 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) In relation to the private placements of the Company's stock during 1996, finders fees for such placements were paid through the issuance of 28,865 shares of stock. (8) ESCROW PERFORMANCE SHARES In December 1996, the Company accepted the terms outlined by the British Columbia Securities Commissions ("BCSC") for the release of the Company's 5,776,700 escrowed "Performance Shares" from Canadian Escrow into a new escrow arrangement with the Company. The overall modification was approved by the Company's shareholders in August 1996. Under the revised arrangement, the performance shares will be released automatically as follows: 5% on June 22, 1997; 5% on June 22, 1998; 10% on June 22, 1999; 20% on June 22, 2000; 30% on June 22, 2001; and 30% on June 22, 2002. In addition to the automatic releases, performance shares can be released based on the cash flow release criteria contained in the original June 22, 1992 escrow agreement although, to maintain a stable market in the Company's stock, in any year not more than 30% of the shares will be released, based on the cash flow criteria. Under the revised escrow arrangement, the performance shares will vest provided the individual has not voluntarily terminated his/her relationship with the Company prior to applicable vesting dates. Based on the revised escrow arrangement, which primarily converts the escrow shares release from performance criteria to a time-based criteria, the Company recorded as compensation expense the excess of the fair market value of the 5,776,700 performance shares on the date the Company accepted the terms of the new escrow arrangement over the purchase price of such escrow shares. All of the performance shares are included in the issued and outstanding shares for the twelve-month periods ended December 31, 1996, and 1995. For financial reporting purposes, such shares were treated as issued and outstanding but were not reflected in the calculation of loss per common share until earned by and released to the holders as they would be antidilutive. At December 31, 1995, no performance shares had been earned out. At December 31, 1996 these shares are included in the calculation of loss per common share beginning December 30, 1996, the date on which the Company and the BCSC accepted and entered into the terms of the current escrowed agreement as discussed above. (9) ASSET ACQUISITION In June 1996, the Company purchased certain assets from Home Theater Products International, Inc. ("HTP"), a debtor in possession, for $1,062,156, including acquisition costs. Of the purchase price, $679,684 was allocated to In-Process Research & Development ("IPR&D") and expensed at the Closing. IPR&D is defined as those research and development efforts that, as of the acquisition date, June 24, 1996, have not yet generated commercializable products and thus the revenue generating capability of the products is uncertain. At the date of acquisition there were no existing products acquired. IPR&D represents 64% of the total acquisition costs. The remaining 36% was allocated as follows: approximately $200,000 to intangible assets, primarily representing acquired patent applications, and approximately $182,000 to fixed assets, including computers, office equipment, and furniture. The Company had not begun amortizing the intangible assets purchased since the patents had not been approved as of December 31, 1996. 34 36 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (10) INCOME TAXES Spatializer Audio Laboratories, Inc. and subsidiaries (the "Company") file on a consolidated basis for U.S. income tax purposes. As of December 31, 1996, the Company had net operating loss carryforwards of approximately $35,100,000 for financial reporting and $15,400,000 for federal income tax purposes. The Company's ability to utilize approximately $900,000 of the tax losses accrued during 1994 against future income may be restricted as a result of a change in year-end to December 31, 1994. The difference between the financial reporting and the federal income tax net operating loss carryforwards result from the recognition of certain expense items, primarily from compensation expense for escrowed performance shares (see Note 8) and from the exercise of non-qualified stock options, in different periods for financial and tax reporting purposes. In addition, the Company has foreign tax and general business credit carryforwards of $121,000 and $87,000, respectively. The net operating loss carryforwards expire through 2011. Any deferred tax asset relating to the operating loss and credit carryforwards or any other deferred tax asset has been fully offset by a valuation allowance. Accordingly, no income tax benefit has been recorded. Based upon the level of historical losses incurred by the Company, management believes that it is more likely than not that the Company will not realize the benefits of the deferred tax assets. Thus, any deferred tax asset relating to the non-capital tax losses, operating loss carryforwards, or any other deferred tax asset, has been fully reserved by a valuation allowance. Accordingly, no income tax benefit has been recorded. The Company completed the liquidation of Spatializer-Yukon, a Canadian subsidiary in early 1996. The liquidation resulted in a Canadian tax liability of approximately $249,000. In addition, the Company recognized approximately $3,000 in minimum tax for state purposes. Revenues received from customers in foreign countries are sometimes subject to withholding taxes that are deducted from outgoing funds at time of payment. These taxes range from approximately 8.5% to 15% and are recorded as Foreign Tax Expense at the time of deduction from the Company's cash receipts. (11) MAJOR CUSTOMERS The revenues for the year ended December 31, 1996 include revenues from four major customers each of whom represent 25%, 24%, 14%, and 12%, respectively, of total revenues. The revenues for the year ended December 31, 1995 include revenues from three major customers each of whom represent 29%, 13%, and 12%, respectively, of total revenues. (12) OPTIONS AND WARRANTS The Company has issued options to purchase common stock to certain directors, officers and employees under various stock option plans. The option and warrant exercise prices represent fair market values at the dates of grant. 35 37 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Transactions in the stock options under these plans are summarized as follows:
STOCK OPTIONS SHARES OPTION PRICE - -------------------------------------- --------- -------------------------------------- Options Issued During the Year Ended and Outstanding at August 31, 1993................................ 1,050,000 Cdn. $1.20 - Cdn. $2.02 (U.S. $.86 - U.S. $1.44) per Share expiring various dates July 1997 to July 1998 Options Exercised..................... (40,000) Cdn. $1.20 - Cdn. $2.02 (U.S. $.87 - U.S. $1.46) per Share --------- Options Outstanding at August 31, 1994................................ 1,010,000 Cdn. $1.20 - Cdn. $2.02 (U.S. $.87 - U.S. $1.20) per Share expiring on various dates, July 1997 to July 1998 Options Issued........................ 85,000 Cdn. $3.10 (US $2.25) per Share Options Exercised..................... (25,000) Cdn. $1.20 (US $.93) per Share --------- Options Outstanding at December 31, 1994................................ 1,070,000 Cdn. $1.20 - Cdn. $3.10 (U.S. $.87 - U.S. $2.21) per Share expiring on various dates, July 1997 to November 1999 Options Issued........................ 576,932 Cdn. $2.95 - Cdn. $5.84 (U.S. $2.20 - U.S. $4.30) per Share Options Exercised..................... (220,500) Cdn. $1.20 - Cdn. $4.28 (U.S. $.87 - U.S. $3.17) per Share --------- Options Outstanding at December 31, 1995................................ 1,426,432 Cdn. $1.20 - Cdn. $5.84 (U.S. $.87 - U.S. $4.30) per Share expiring on various dates, July 1997 to November 2000 Options Issued........................ 638,333 Cdn. $4.44 - Cdn. $6.56 (U.S. $3.26 - U.S. $4.73) per Share Options Exercised..................... (363,033) Cdn. $1.20 - Cdn. $4.28 (U.S. $.87 - U.S. $3.17) per Share --------- Options Outstanding at December 31, 1996................................ 1,701,732 Cdn. $1.20 - Cdn. $6.56 (U.S. $.87 - U.S. $4.73) per Share expiring on various dates, July 1997 to November 2001 =========
The number of outstanding options exercisable at December 31, 1996 was 1,125,901. 36 38 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following table summarizes the activity relating to warrants and common shares issuable upon exercise of such warrants:
COMMON ISSUABLE WARRANTS SHARES WARRANT PRICE ---------- -------- --------------------------------- Warrants Outstanding at August Cdn. $1.68 - Cdn. $2.00 (U.S. 31, 1993....................... 522,917 72,917 $1.20 - U.S. $1.43) per Share expiring on various dates, August 1994 to June 1995 Warrants Issued.................. 800,000 675,000 Cdn. $1.60 - Cdn. $2.15 (U.S. $1.14 - U.S. $1.53) per Share Warrants Exercised............... (1,312,917) (942,917) Cdn. $1.60 - Cdn. $2.15 (U.S. $1.15 - U.S. $1.55) per Share Warrants Expired................. (10,000) (5,000) Cdn. $2.00 (U.S. $1.43) per Share ---------- -------- Warrants Outstanding at August 31, 1994....................... -- -- Warrants Issued.................. 515,000 515,000 Cdn. $2.15 - Cdn. $4.15 (U.S. $1.53 - U.S. $2.96) per Share Warrants Exercised............... (25,000) (25,000) Cdn. $2.15 (U.S. $1.54) per Share ---------- -------- Warrants Outstanding at December Cdn. $3.20 - Cdn. $4.15 (U.S. 31, 1994....................... 490,000 490,000 $2.28 - U.S. $2.96) per Share expiring on various dates, August 1996 to November 1996 Warrants Issued.................. 487,500 487,500 Cdn. $3.25 - Cdn. $4.50 (U.S. $2.42 - U.S. $3.35) per Share Warrants Exercised............... (197,500) (197,500) Cdn. $3.20 - Cdn. $3.30 (U.S. $2.33 - U.S. $2.47) per Share ---------- -------- Warrants Outstanding at December Cdn. $3.20 - Cdn. $4.50 (U.S. 31, 1995....................... 780,000 780,000 $2.33 - U.S. $3.35) per Share expiring on various dates, August 1996 to June 1997 Warrants Issued.................. 155,000 155,000 Cdn. $6.46 - Cdn. $6.97 (U.S. $4.75 - U.S. $5.12) per Share Warrants Exercised............... (646,000) (646,000) Cdn. $3.20 - Cdn. $4.15 (U.S. $2.33 - U.S. $3.05) per Share Warrants Expired................. (115,000) (115,000) Cdn. $3.70 (U.S. $2.69) per Share ---------- -------- Warrants Outstanding at December Cdn. $3.30 - Cdn. $6.97 (U.S. 31, 1996....................... 174,000 174,000 $2.40 - U.S. $5.12) per Share expiring on various dates, May 1997 to June 1997 ========== ========
The number of outstanding warrants exercisable at December 31, 1996 was 174,000. NOTE: Options and Warrants issued and exercised have been converted to US dollars using the exchange rate on the issue or exercise date. Based upon the results of calculation of fair value utilizing the Black-Scholes methodology for option valuations the effect of applying SFAS No. 123's fair value method to the Company's stock-based awards, the net loss and loss per share amounts are not materially different from amounts reported. 37 39 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (13) COMMITMENTS AND CONTINGENCIES Legal On August 29, 1996 the Court granted the Company's summary judgment motion in its entirety and denied the motion by QSound in the pending patent infringement litigation between the Company and QSound. In granting the Company's summary judgment motion, the Court found that the Company's IC (Integrated Circuit) does not infringe the QSound patent and denied QSound's motion with respect to infringement. The Company's claim that the QSound patent in invalid was not decided and, since the issues which the Court would need to consider on the patent invalidity claim are similar to certain issues considered in the infringement claim, QSound was granted the right to immediately appeal the denial of its motion and trial on the invalidity issue was deferred until after that appeal. In substance, the Court's finding confirms the Company's position that there is no infringement by the Company's IC of any patent held by QSound and that the claims by QSound were without merit. If the appeal is denied and the Court's decision is confirmed on appeal, the Company intends to pursue the remaining claims for damages and for a decision that the QSound patent is invalid. If the appeal is granted and the Court's decision on the motion is overruled, a trial on the merits would follow at which time the Company will again assert its current position, which already was adopted in the grant of the Company's summary judgment motion, and will assert its remaining claims against QSound. QSound has appealed and the appeal is pending. Lease Commitments The Company is obligated for future minimum rental payments for all operating leases of approximately $193,000, $220,000, 104,969, and $2,053 during the years ended December 31, 1997, 1998, 1999, and 2000, respectively. Rent expense amounted to approximately $197,000, 132,000, $28,000, and $48,000 for years ended December 31, 1996 and 1995, the four-month transition period ended December 31, 1994, and the year ended August 31, 1994 respectively. (14) VALUATION AND QUALIFYING RESERVES The Company had reserves for doubtful accounts recorded in the accompanying consolidated financial statements which are summarized as follows:
ALLOWANCE FOR DOUBTFUL ACCOUNTS ----------------- Balance at August 31, 1993.................... $ -- Charges to expenses......................... -- Deductions.................................. -- ----------------- Balance at August 31, 1994.................... -- Charges to expenses......................... -- Deductions.................................. -- ----------------- Balance at December 31, 1994.................. -- Charges to expenses......................... -- Deductions.................................. -- Balance at December 31, 1995.................. -- Charges to expenses......................... 90,000 Deductions.................................. -- ----------------- Balance at December 31, 1996.................. $90,000 =================
38 40 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (15) SUBSEQUENT EVENT Private Placement On March 7, 1997, the Company raised $2,000,000 through a private placement of 1,600,000 units in the Company consisting of a share of common stock and one-half of one non-transferable share purchase warrant. The proceeds of the financing will be utilized to finance the Company's research and development activities in its MultiDisc Technologies business unit and for working capital reserves. The Company also agreed to modify certain outstanding one year warrants to purchase 155,000 shares of stock issued in May and June, 1996 by adjusting the exercise price to an amount consistent with the current market price of the Company's stock ($1.75 US) and by adjusting the shares under warrant to 310,000 shares. Funds from these financing activities as well as cash generated from operations is expected to be sufficient for the Company to meet its obligations during the next twelve months. Vancouver Stock Exchange ("VSE") Delisting On February 12, 1997 the Company's common shares were delisted from the VSE. The Company's common shares will continue to be quoted on NASDAQ small cap markets. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 39 41 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT This information is incorporated by reference to the Company's definitive proxy statement relating to its annual meeting expected to be held on or about June 5, 1997. ITEM 11. EXECUTIVE COMPENSATION This information is incorporated by reference to the Company's definitive proxy statement relating to its annual meeting expected to be held on or about June 5, 1997. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT This information is incorporated by reference to the Company's definitive proxy statement elating to its annual meeting expected to be held on or about June 5, 1997. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS This information is incorporated by reference to the Company's definitive proxy statement relating to its annual meeting expected to be held on or about June 5, 1997. PART IV ITEM 14. EXHIBITS 40 42 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. Dated: March 26, 1997 SPATIALIZER AUDIO LABORATORIES, INC. (Registrant) /s/ STEVEN D. GERSHICK -------------------------------------- Steven D. Gershick President & Chief Executive Officer /s/ KATHY PARTCH -------------------------------------- Kathy Partch Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated /s/ CARLO CIVELLI - ---------------------------------------- Director March 26, 1997 Carlo Civelli /s/ STEPHEN W. DESPER Director March 26, 1997 - ---------------------------------------- Stephen W. Desper /s/ DAVID FOSTER Director March 26, 1997 - ---------------------------------------- David Foster /s/ JAMES D. PACE Director March 26, 1997 - ---------------------------------------- James D. Pace /s/ JEROLD H. RUBINSTEIN Director March 26, 1997 - ---------------------------------------- Jerold H. Rubinstein /s/ GILBERT N. SEGEL Director March 26, 1997 - ---------------------------------------- Gilbert N. Segel
41 43 PART IV ITEM 14. EXHIBITS 2.1* Desper-Spatializer Reorganization Agreement dated January 29, 1992. (Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 2.2* Arrangement Agreement dated as of March 4, 1994 among Spatializer-Yukon, DPI and Spatializer-Delaware. (Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 3.1* Certificate of Incorporation of Spatializer-Delaware as filed February 28, 1994. (Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 3.2* Amended and Restated Bylaws of Spatializer-Delaware. (Incorporated by reference to the Registrant's Registration Statement on Form S- 1, Registration No. 33-90532, effective August 21, 1995.) 4.1* Form of Subscription Agreement for August 1994 Private Placement. (Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 4.2* Form of Subscription Agreement for November 1994 Private Placement. (Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 4.3* Form of Spatializer-Yukon Incentive Stock Option Agreement. (Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 4.4* Spatializer-Delaware Incentive Stock Option Plan (1995 Plan). (Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 4.5* Performance Share Escrow Agreements dated June 22, 1992 among Montreal Trust Company of Canada, Spatializer-Yukon and certain shareholders with respect to escrow of 2,181,048 common shares of Spatializer-Yukon. (Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 4.6* Spatializer-Delaware 1996 Incentive Plan (Incorporated by reference to the Registrant's Proxy Statement dated June 25, 1996 and previously filed with the Commission.) 4.7* Form of Subscription Agreement for 1995 Private Placements. 4.8 Form of Subscription Agreement and Warrant Agreement for March 7, 1997 Private Placement. 4.9 Modification Agreement for Escrowed Performance Shares. 5.1* Opinion of Brand Farrar Dziubla Freilich & Kolstad, LLP concerning legality of unissued securities subject to registration. 10.1*** License Agreement dated June 29, 1994 between DPI and MEC. (Incorporated by 44 reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 10.2*** License Agreement dated November 11, 1994 between DPI and ESS. (Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 10.3* License Agreement dated June 10, 1994 between Joel Cohen and DPI. (Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 10.4* Real Property Lease for executive offices in Woodland Hills, California (effective April 7, 1995). (Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 10.5* Employment Agreement between DPI and Stephen Desper dated December 16, 1991. (Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 10.6* Employment Agreement between DPI and Steven Gershick dated December 16, 1991. (Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 10.7* Employment Agreement between MDT and Irwin Zucker dated June 24, 1996. (Incorporated by reference to the Registrant's Report on Form 8-K for the event occurring on June 24, 1996.) 11.1 Computation of Loss Per Common Share. 21.1 Schedule of Subsidiaries of the Company. 23.1 Consent of KPMG Peat Marwick LLP, independent certified public accountants. __________________ * Previously filed. ** To be filed by amendment. *** Portions subject to request for confidential treatment. The confidential portions omitted have been filed separately with the Commission. [All other schedules have been omitted because they are not applicable, not required, or the information is included elsewhere in the statements or notes thereto. The Registrant filed no reports on Form 8-K for the fiscal quarter ending ending December 31, 1996.] EX-4.8 2 FORM OF SUBSCRIPTION AGRMNT & WARRANT AGRMNT 1 SPATIALIZER AUDIO LABORATORIES, INC. EXHIBIT 4.8 SPATIALIZER AUDIO LABORATORIES, INC. SUBSCRIPTION AGREEMENT AND WARRANT AGREEMENT FOR MARCH 7, 1997 PRIVATE PLACEMENT 2 SPATIALIZER AUDIO LABORATORIES, INC. RESTRICTED STOCK SUBSCRIPTION AGREEMENT ARTICLE I SUBSCRIPTION 1.01 Subscription. The undersigned, ("Purchaser"), hereby unconditionally enters into this Subscription Agreement ("Agreement") to subscribe for and to offer to purchase the Securities (as described below) of Spatializer Audio Laboratories, Inc. ("Company") upon and subject to the following terms and conditions. The Securities shall consist of the number of units specified below ("Units"), each unit consisting of one fully paid and non-assessable share of the Common Stock, par value $.01 per share, of the Company ("Stock") and one-half of a one-year non-transferable share purchase warrant ("Warrants"). The purchase price for the Securities shall be U.S.$__________ per Unit. One full Warrant shall entitle the holder thereof to purchase one additional share of the Company's Stock ("Warrant Stock") at any time up to and including twelve months from date of the issuance of the Warrants ("Last Exercise Date") at an exercise price of U.S.$_______.
Number of Units Price Per Unit Total Purchase Price Exercise Price of Last Exercise Date Warrants
1.02 Payment. The total purchase price of the Securities shall be delivered to the Company at the address shown below concurrently with the execution hereof. The Securities will be issued and registered in the name of the undersigned at the address indicated on the signature page. 1.03 Issuance of Shares. Upon receipt by the Company of the purchase price specified above along with any other documents requested hereunder, and acceptance of this Subscription by the Company, the Company shall promptly cause the issuance and delivery to Purchaser of duly executed Stock certificates and Warrants, representing the Units, duly registered in the name of the Purchaser. 1.04 Exemption from Registration. The Securities have not been registered under the Securities Act of 1933, as amended (the "Securities Act") or qualified under the California Corporate Securities Law of 1968 as amended ("California Bluesky Law"), or the securities laws of any other state, territory, country or jurisdiction and are being offered and will be sold and issued to the Purchaser in reliance upon the exemptions from such registration provided by Rules 501, 504, 505 and 506 or Regulation S promulgated under the Securities Act. 3 ARTICLE II PURCHASER'S REPRESENTATIONS AND WARRANTIES 2.01 Authorization. The Purchaser represents and warrants that this Agreement, when executed and delivered by he, she or it, will constitute a valid and legally binding obligation of such Purchaser. 2.02 Residence. Purchaser represents and warrants that his or her principal residence (or its place of business, in the case of an entity) is at the address listed below. 2.03 Purchase for Own Account. Purchaser acknowledges that the Securities have not been registered under the Securities Act or qualified under the California Bluesky Law, or any other applicable state, provincial or national securities laws in reliance, in part, on the representations and warranties herein. The Securities, including any Warrant Stock acquired on exercise of the Warrants, are being acquired by Purchaser for investment purposes for Purchaser's own account only and not for sale or with a view to distribution of all or any part of such Securities or Warrant Stock. No other person will have any direct or indirect beneficial interest in the Securities or Warrant Stock. Purchaser represents and warrants that such Purchaser is an "accredited investor" as defined in Regulation D, Rule 501 under the U.S. 1933 Act based on meeting any one of the following criteria: (a) Any bank as defined in section 3(a)(2) of the (U.S. 1933) Act, or any savings and loan association or other institution as defined in section 3(a)(5)(A) of the (U.S. 1933) Act whether acting in its individual or fiduciary capacity, any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any insurance company as defined in section 2(13) of the (U.S. 1933) Act; any investment company registered under the Investment Company act of 1940 or a business development company as defined in section 2(a)(48) of that Act; any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state of its political subdivision, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary as defined in section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions solely by persons that are accredited investors. (b) Any private business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940; 4 (c) Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000; (d) Any director, executive officer, or general partner of the Company; (e) Any natural person whose individual net worth, or joint net worth with that person's spouse at the time of the purchase exceeds $1,000,000; (f) Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year; (g) Any trust with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the Securities, whose purchase is directed by a person who either alone or with a purchaser representative has such knowledge and experience in financial and business matters that he or she is capable of evaluating the merits and risks of the prospective investment; and (h) Any entity in which all of the equity owners are accredited investors. 2.02 Ability To Bear Risk. Purchaser recognizes and acknowledges the speculative nature and risks of loss associated with high risk illiquid investments in general and recognizes and acknowledges that the Securities and the Warrant Stock, in particular, constitute an investment in particular, which is suitable and consistent with Purchaser's overall investment program and that Purchaser's financial situation enables Purchaser to bear the high risks of this investment which may include the inability to liquidate it in time of financial emergency. Purchaser represents and warrants that the financial situation of the Purchaser is such that he, she or it can afford to bear the economic risk of holding the Securities and Warrant Stock for an indefinite period and that he, she or it can afford to suffer the complete loss of the investment. 2.03 Access to Information. Purchaser represents and warrants that he, she or it is aware of the Company's business affairs and financial condition, and has been granted the opportunity to ask questions of, and has received answers from, representatives of the Company concerning the business, properties and condition of the Company and the terms and conditions of the purchase of the Securities. Purchaser has been provided by the Company with the information listed on schedule A and has been granted the opportunity to obtain any other information that he, she or it deems necessary to undertake this investment or to confirm the accuracy of information provided hereunder. Prior to his, her or its acquisition of the Securities, Purchaser acquired sufficient information about the Company to reach an informed and knowledgeable decision to acquire the Securities. Purchaser has such knowledge and experience in financial and business matters (or is represented by a person who has such skills and experience) as to make him, her or it capable of utilizing said 5 information to evaluate the risks of the prospective investment and to make an informed investment decision. 2.04 Restricted Securities. The Purchaser understands that the Securities being purchased are not registered under the Act, inasmuch as they are being acquired from the Company in a transaction not involving a public offering, and that such securities may not be resold, transferred or otherwise disposed of without registration under the Act or an exemption therefrom, and further, that the Company is under no obligation to register such securities. The Purchaser understands that the Securities have not been registered under the Act in reliance upon a specific exemption therefrom, which exemption depends upon, among other things, the bona fide nature of its investment intent as expressed herein. In this connection, the Purchaser understands that, in the view of the Securities and Exchange Commission (the "SEC"), the statutory basis for such exemption may be unavailable if its representation was predicated solely upon a present intention to hold the Securities for a deferred sale, or for any other fixed period in the future. Purchaser hereby confirms that Purchaser has been informed that neither the Common Stock, Warrants or Warrant Stock may be resold or transferred unless first registered under the Securities Act or unless an exemption from such registration is available with respect to a resale in the United States or in an "offshore transaction" (see below). Accordingly, Purchaser hereby acknowledges that Purchaser is familiar with such restrictions and is prepared to hold the Securities and Warrant Stock for an indefinite period. Purchaser is aware that Rule 144 and Regulation S, promulgated under the Securities Act, permit limited public resales of securities acquired in a nonpublic offering, subject to the satisfaction of certain conditions. (b) Purchaser understands that under Rule 144 the conditions with respect to transfer or sale include, among other things: the availability of certain current public information about the issuer, the resale occurring not fewer than two years after the party has purchased and paid for the securities (three years in the case of an affiliate), the sale being through a broker in an unsolicited "broker's transaction" and the amount of securities being sold during any three-month period not exceeding specified limitations. The Purchaser understands that the two or three years period with respect to the resale Warrant Stock may be measured from the time of exercise or conversion of the Warrants and thus may continue beyond the two or three year period applicable to the Securities being currently acquired. (c) Purchaser acknowledges that under Regulation S, offers and sales of securities which are deemed to be made "outside the United States" are not required to be registered under the Act. The conditions under which resales of securities may be deemed so made are set forth in Rules 903 and 904 of Regulation S. Rule 904 provides in general that an offer or sale of securities by any person other than the Company, a distributor, any of their respective affiliates (or agents of the foregoing) shall be deemed to occur outside the U.S. if (i) the offer or sale is made in an "offshore transaction" and (ii) no directed selling efforts are made in the U.S. by the seller, an affiliate or their agents. An offer or sale is made in an "offshore transaction," in general, if the offer is not made to a person in the United States and either (i) the buy order is made or reasonably believed to be made outside the United States or (ii) the transaction is executed in, on or through the facilities of a "designated 6 offshore securities market" and the sale is not pre-arranged with a buyer in the United States. Purchaser acknowledges that the Stock of the Company is no longer listed on any "offshore securities market". In addition, Purchaser understands that under Rule 903, so long as the Company is a reporting issuer under U.S. federal securities laws, resales of the Common Stock and the Warrant Stock can be made into the United States, so long as certain holding periods and manner of sale restrictions are accommodated, but in no event can the Warrants be sold or transferred or exercised by or on behalf of an U.S. person absent registration or an independent exemption from such registration and in no event can the Stock or Warrant Stocks be sold or transferred to or for the account of any U.S. person prior to the expiration of a 40 day restricted period. Purchaser understands and acknowledges that any resales in reliance on Regulation S cannot be undertaken in connection with any directed selling efforts in the United States and that the exemption available under Regulation S will not be available in any transaction which, while in technical compliance with Regulation S, is part of a plan or scheme to evade the registration requirements of the Securities Act. Resales by persons who are affiliated of an issuer only by virtue of holding the position of officer or director are also governed by Rule 904 of Regulation S. Resales by persons otherwise deemed affiliates (such as by virtue of levels of share ownership deemed to amount to "control") are regarded as equivalent to sales by the Company, and are thus governed by Rule 903 of Regulation S which imposes additional conditions, and to which specific reference should be made in the case of any such intended resales. (d) Purchaser understands that he, she or it may be precluded from selling the Securities within the Rule 144 or Regulation S safe harbors even if the holding periods have been satisfied either because the other conditions may not have been fulfilled or because markets for resales do not exist. Purchaser understands and acknowledges that the Company is assuming no obligation to register the Securities or the Warrant Stock under the Securities Act, except that, in the event that the Company shall have in effect a registration statement (other than for the issuance of Stock to employees or otherwise, pursuant to a registration statement on form S-8) in respect to its Stock, it will use reasonable efforts to include the Stock in such registration. 2.05 Disposition of Stock, Warrants or Warrant Stock. Purchaser hereby agrees that Purchaser shall make no disposition of the Stock, Warrants or Warrant Stock, except in accordance with the provisions hereof or unless the Stock, Warrants or Warrant Stock have been registered under the Securities Act, and in any event, not unless and until: (a) Purchaser shall have notified the Company of the proposed disposition and provided a written summary of the terms and conditions of the proposed disposition; and (b) Either (i) the proposed disposition does not require registration of the Stock, Warrants or Warrant Stock under the Securities Act or (ii) all appropriate action necessary for compliance with the registration requirements of the Securities Act or of any exemption from registration available under the Securities Act (including Regulation S and Rule 144) has been taken and (iii) to the extent appropriate, the Purchaser shall have delivered to the Company an opinion of counsel in form and substance satisfactory to the 7 Company, to such effect. The Company shall not be required to transfer on its books the Stock, Warrants or Warrant Stock that have been sold or transferred in violation of the provisions of this Article II or to treat as the owner of the securities, or otherwise to accord voting or dividend rights to, any transferee to whom the securities have been transferred in contravention of this Agreement. 2.06 Restrictive Legends. Purchaser acknowledges that in order to reflect the restrictions on disposition of the Stock, Warrants and Warrant Stock, the Company's stock ledgers and records and any certificates representing the Securities, to the extent as required by law, endorsed with the following restrictive legend: (a) "THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED ("1933 ACT"), OR UNDER STATE SECURITIES LAWS, AS APPLICABLE, AND MAY NOT BE SOLD, TRANSFERRED, ASSIGNED, PLEDGED OR HYPOTHECATED UNLESS THERE IS AN EFFECTIVE REGISTRATION STATEMENT UNDER THE 1933 ACT AND APPROPRIATE QUALIFICATION UNDER ANY APPLICABLE STATE SECURITIES LAWS COVERING SUCH SECURITIES OR SUCH SALE, TRANSFER, ASSIGNMENT, PLEDGE OR HYPOTHECATION IS EXEMPT FROM THE REGISTRATION REQUIREMENTS OF THE 1933 ACT AND ANY APPLICABLE STATE SECURITIES LAWS." (b) If required by the authorities of any state or other jurisdiction in connection with the issuance of the Conversion Shares, the legend or legends required by such jurisdiction shall also be endorsed on all such certificates. 2.07 Independent Information. Purchaser represents and warrants that in making the decision to acquire the Securities, the Purchaser has relied upon independent consideration and investigations made by such Purchaser and further that no representations have been made concerning the Securities, the Company, its business, prospects, or other matters. 8 ARTICLE III MISCELLANEOUS 3.01 Additional Assurances. The undersigned and the Company agree that they will each execute or cause to be executed and delivered all such further and other documents and assurances, and do and cause to be done all such further acts and things as may be necessary or desirable to carry out this Agreement. 3.02 Entire Agreement; Assignment; Notices. This Agreement constituted by the acceptance of the subscription herein by the Company constitutes the entire agreement between the parties in respect of the subject matter hereto and supersedes any and all prior agreements, representations, warranties or covenants, express or implied, written or verbal, except as may be expressed herein. This Agreement shall inure to the benefit of and be binding upon the parties and their respective heirs, executors, administrators, successors and assigns. Any notice required or permitted to be given hereunder shall be in writing, addressed to the party at its address as set out herein (or at such other address as a party may provide in writing to the other) and shall be deemed to have been given, if delivered, when delivered; or if telegraphed or telexed, on the date after the date of telegraphing or telexing; or if mailed by registered mail on the fifth business day after the date of mailing. 3.03 Severability. If any provision of this Agreement or the application thereof to any person or circumstance shall be held invalid or unenforceable to any extent, the remainder of this Agreement and the application of any such provision to other persons or circumstances shall not be affected thereby and shall be enforced to the greatest extent permitted by law. 3.04 Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of California. 3.05 Survival; Indemnification. The foregoing representations and warranties are made by Purchaser with the intent that they may be relied upon in determining his qualification and suitability to purchase the securities, and Purchaser hereby agrees that such representations and warranties shall survive the acceptance of this Agreement. Purchaser hereby agrees to indemnify, defend and save harmless the Company, its representatives and agents and each other shareholder from and against any and all losses, claims, damages, liabilities, expenses (including attorneys' reasonable fees and disbursements), judgments and amounts paid in settlement or actions resulting from the untruth of any of the warranties and representations contained hereon. Notwithstanding the foregoing, however, no representation, warranty, acknowledgement, covenant or agreement by Purchaser made herein shall in any manner be deemed to constitute a waiver of any rights granted to him under the federal or state securities laws. 9 IN WITNESS WHEREOF, Purchaser agrees to be bound by this Restricted Stock Subscription Agreement. "PURCHASER" _______________________________ By:_____________________________ Name: _______________________ Title:_______________________ Telephone: _________________ Telecopy: _________________ Dated: _____________________, 19__ Address: ____________________________ ____________________________ SUBSCRIPTION ACCEPTED: SPATIALIZER AUDIO LABORATORIES, INC. By: _______________________________ Name: Steven D. Gershick, President and Chief Executive Officer Telephone: 818-227-3370 Telecopy: 818-227-9750 Dated: ______________________, 19__ 10 NEITHER THIS WARRANT NOR THE SHARES OF COMMON STOCK FOR WHICH THIS WARRANT IS EXERCISABLE HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR QUALIFIED UNDER THE SECURITIES LAWS OF ANY JURISDICTION. NONE OF SUCH SECURITIES MAY BE SOLD, PLEDGED, HYPOTHECATED, TRANSFERRED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT UNDER SAID ACT OR AN OPINION OF COUNSEL SATISFACTORY TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED. SPATIALIZER AUDIO LABORATORIES, INC. Stock Purchase Warrant Number 97-___ Right to Purchase __________Shares of Date of Issuance: ______________, 1997 Common Stock $.01 par value (subject to adjustment) 1. Warrant. For value received,_______________________ is entitled, subject to the terms and conditions hereinafter set forth, after the date hereof and prior to___________, 1997 ("Expiration Time") but not thereafter, to purchase_______non assessable shares of Common Stock, $.01 par ("Common Stock"), of Spatializer Audio Laboratories, Inc., a Delaware corporation (the"Company"), from the Company for a purchase price of U. S. $___________ per share, subject to adjustment as provided for herein (the "Exercise Price"). 2. Exercise. 2.1. Exercise Period. The purchase rights represented by this Warrant are exercisable at the option of the registered owner hereof in whole at any time, or in part from time to time, prior to the Expiration Date, provided that such purchase rights shall not be exercisable with respect to a fraction of a share. The Company will not close its books for the transfer of this Warrant or of any share of Common Stock issued or issuable upon the exercise of this Warrant in any manner which interferes with the timely exercise of this Warrant. 2.2. Exercise Procedure. (a) This Warrant will be deemed to have been exercised upon the date of surrender (the "Exercise Date") of this Warrant to the Company together with a completed and duly executed subscription in the form attached hereto, and payment of the purchase price for each share purchased in cash or other immediately available U. S. federal funds. Certificates representing the shares so purchased shall be delivered to the holder within ten days following the Exercise Date. (b) In case of the purchase of less than all of the shares purchasable under this Warrant, the Company shall cancel this Warrant upon the surrender hereof and shall execute and deliver a new warrant of like tenor and date for the balance of the shares purchasable hereunder. The date the Company initially issues this Warrant will be deemed to be the "Date of Issuance" of this Warrant regardless of the number of times new certificates representing the unexpired and unexercised rights formerly represented by this Warrant are issued. (c) The Common Stock issuable upon the exercise of this Warrant will be deemed to have been issued to the Purchaser on the Exercise Date, and the Purchaser will be deemed for all purposes to have become the record holder of such Common Stock on the Exercise Date. 11 (d) The Company covenants and agrees that all shares to be delivered upon the exercise of this Warrant will, upon delivery, be free from all taxes, liens, and charges with respect to the purchase thereof hereunder. 3. Adjustment. 3.1. Subdivision or Combination of Common Stock and Stock Dividends. In order to prevent dilution of the rights granted under this Warrant, in the event that the Company shall at any time after the Date of Issuance issue any shares of Common Stock or any rights to purchase Common Stock as a dividend upon the Common Stock or issue any shares of Common Stock in subdivision of outstanding shares of Common Stock by reclassification or otherwise or combine outstanding shares of Common Stock, by reclassification or otherwise, then in each of said events ("Adjustment Events"), the Exercise Price which would apply if purchase rights hereunder were being exercised immediately prior to such action by the Company shall be adjusted by multiplying it by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to such dividend, subdivision or combination and the denominator of which shall be the number of shares of Common Stock outstanding immediately after such dividend, subdivision or combination, and in such case the number of shares which would be purchasable hereunder if purchase rights hereunder were being exercised immediately prior to such action by the Company shall be adjusted by multiplying it by a fraction which is the reciprocal of the fraction by which the Exercise Price shall be adjusted. 12 3.2. Notice of Adjustment. Immediately upon any adjustment of the Exercise Price or increase or decrease in the number of shares of Common Stock purchasable upon exercise of this Warrant, the Company will send written notice thereof to the holder, stating the adjusted Exercise Price, the increased or decreased number of shares purchasable upon exercise of this Warrant and the calculation for such adjustment and increase or decrease. When appropriate, such notice may be given in advance and included as part of any notice required to be given pursuant to Section 4 below. 3.3 Discretion. Notwithstanding the provisions of this Section 3, on the occurrence of any Adjustment Events or otherwise, the Company shall have the sole and exclusive power to make other adjustments as it considers necessary or desirable with respect to the Warrants. 4. Prior Notice of Certain Events. In case at any time: (a) the Company shall pay any dividend upon its Common Stock or make any distribution to the holders of its Common Stock (including dividends or distributions payable in shares of the Company's stock); (b) the Company shall offer for subscription pro rata to the holders of its Common Stock any additional shares of stock of any class or any other rights; (c) there shall be any reorganization or reclassification of the capital stock of the Company, or consolidation or merger of the Company with another corporation or a sale or deposition of all or substantially all its assets; or (d) there shall be a voluntary or involuntary dissolution, liquidation or winding up of the Company; then, in each of said cases, the Company shall give prior written notice to the holder hereof of the date on which (i) the books of the Company shall close or a record shall be taken for such dividend, distribution or subscription rights or (ii) such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding up shall take place, as the case may be. Such notice shall also specify the date as of which the holders of distribution or subscription rights or shall be entitled to exchange their Common Stock for securities or other property deliverable upon such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding up, as the case may be. Such written notice shall be given at least twenty days prior to the action in question and not less than twenty days prior to the record date or the date on which the Company's transfer books are closed in respect thereto. 13 5. Restrictions on Transfers. 5.1. Transfer Restrictions. Neither this Warrant nor any rights hereunder are transferable by the registered owner hereof, except with the prior written consent of the Company. The Company may deem and treat the registered owner of this Warrant at any time as the absolute owner hereof for all purposes. 5.2. Restrictive Legend. The holder of this Warrant acknowledges that neither this Warrant nor the shares of Common Stock for which this Warrant is exercisable have been registered under the Securities Act of 1933, as amended, ("1933 Act") or qualified under the securities laws of California or of any other State or jurisdiction. The undersigned agrees not to sell, pledge, hypothecate, transfer or otherwise dispose of this Warrant or any Common Stock issued upon its exercise in the absence of (i) an effective registration statement as to this Warrant or such Common Stock under the 1933 Act (or any similar statute then in effect) or (ii) an opinion of counsel satisfactory to the Company to the effect that such registration is not required. 6. No Further Rights. This Warrant shall not entitle the holder hereof to any voting rights or other rights as a stockholder of the Company, or to any other rights whatsoever except the rights herein expressed, and no dividends shall be payable or accrue in respect of this Warrant or the interest represented hereby or the shares purchasable hereunder until or unless, and except to the extent that, this Warrant shall be exercised. 7. Reservation of Shares. The Company agrees at all times to reserve and hold available for issuance a sufficient number of authorized but unissued shares of Common Stock as will be sufficient to permit the exercise in full of this Warrant, and upon such issuance all such shares of Common Stock will be validly issued, fully paid and nonassessable and not in violation of the preemptive rights of any person. 8. General. 8.1. Notices. Any notices required to be sent to the holder hereof will be delivered to the address of such holder shown on the books of the Company. All notices referred to herein will be delivered in person or sent by first class mail, postage prepaid, and will be deemed to have been given when so delivered or sent. 8.2. Assignment. This Warrant shall be binding upon and inure to the benefit of both parties hereto and their respective successors and assigns. If any provision of this Warrant shall be held to be invalid or unenforceable, in whole or in part, neither the validity nor the enforceability of the remainder hereof shall in any way be affected. 8.3. Headings. The headings in this Agreement are included only for convenience and shall not affect the meaning or interpretation of this Agreement. The words "herein" and "hereof" and other words of similar import refer to this Agreement as a whole and not to any particular part of this Agreement. The word "including" as used herein shall not be construed so as to exclude any other thing not referred to or described. 8.4. Governing Law. This Warrant shall be governed by the laws of the State of California. IN WITNESS WHEREOF, the Company has caused this Warrant to be executed by its duly authorized officer and its corporate seal to be affixed hereto. SPATIALIZER AUDIO LABORATORIES, INC. By _________________________________ Steven D. Gershick President and Chief Executive Officer EX-4.9 3 MODIFICATION AGREEMENT 1 SPATIALIZER AUDIO LABORATORIES, INC. EXHIBIT 4.9 SPATIALIZER AUDIO LABORATORIES, INC. MODIFICATION AGREEMENT FOR ESCROWED PERFORMANCE SHARES 2 AGREEMENT This Agreement is made and entered into as of December 30, 1996, between Spatializer Audio Laboratories, Inc., a Delaware corporation ("Company") with its principal offices at 20700 Ventura Boulevard, Suite 134, Woodlands Hills, California, 91364 and ____________, an individual with an address at 20700 Ventura Boulevard, Woodland Hills, California 91364-2357 ("Stockholder"), who is the holder of _______ Escrowed Performance Shares (as defined below). W I T N E S S E T H: WHEREAS, as of the date hereof, the Stockholder holds ________ Escrowed Performance Shares of the Common Stock of the Company (after giving effect to any concurrent transfers) pursuant to the Escrow Agreement originally dated June 22, 1992 ("Escrow Agreement") which shares were issued to the Stockholder, from time to time, under the Escrow Agreement or have been issued to the Stockholder under the Spatializer Audio Laboratories, Inc. 1996 Incentive Plan ("1996 Plan"); and WHEREAS, such Shares are subject to release based on the performance criteria set forth in the Escrow Agreement (the "Escrowed Performance Shares") or in the Restrictive Share Grant document under the 1996 Plan; and WHEREAS, in early 1996 the Board of Directors of the Company ("Board") concluded that it was in the best interest of the Company to modify the current arrangements for the Escrowed Performance Shares ("Modification") and to establish definite dates on which the Escrowed Performance Shares would become fully vested and available for sale or transfer by the Stockholder without reference to the earnings requirements in the Escrow Agreement ("Fixed Vesting") and the other individuals holding Escrowed Performance Shares, which Modification was intended to provide a stable market in the Company's capital stock and to accommodate certain provisions of the U.S. personal income and corporate tax and corporate financial accounting rules which impact both the holders of the Escrowed Performance Shares and the Company; and WHEREAS, pursuant to the Escrow Agreement and the rules and policies of the Vancouver Stock Exchange ("VSE") and the British Columbia Securities Commission ("BCSC") the Company presented the proposed Modification to the VSE and the BCSC for their consent and support, as applicable ("Support") and to the stockholders of the Company for their approval ("Approval") at the annual meeting held on August 6, 1996; and WHEREAS the Stockholders gave their Approval to the Modification and to the 1996 Plan at the annual meeting and the VSE gave its Support to the Modification as presented, but the BCSC has given its Support only after certain changes which, in effect, have adjusted the Fixed Vesting and provided to the Company the opportunity to combine the Fixed Vesting with a release, based on the earnings requirements ("Cashflow Release") set forth in the original Escrow Agreement; and 3 WHEREAS the Company and the Stockholder wish to enter into this Agreement with respect to the implementation of the Modification (which term incorporates the changes made in connection with the BCSC Support) including arrangements under which the Company will hold the Escrowed Performance Shares in safekeeping on behalf of the Stockholder until the Vesting Dates or the Cashflow Release. NOW, THEREFORE, in accordance with the covenants and premises contained herein, be it agreed that: 1. Implementation of Modification. Effective as of the first business day following the later of the date of the Approval and the VSE and the BCSC Supports, the Escrow Agreement shall terminate in all respects and be of no further force or effect, it being understood that if such Approval and Support are not received on or before December 31, 1996, this Agreement shall automatically terminate and the Shares will be subject only to the Escrow Agreement (as currently in effect or as consented to by persons receiving grants under the 1996 Plan). 2. Delivery Into Safekeeping. Concurrently with the termination of the Escrow Agreement, the Escrow Agent designated thereunder shall be instructed to deliver the certificates representing the Escrowed Performance Shares to the Company, Attention: Secretary, to be held by the Company in safekeeping until the applicable Earnout Dates or Vesting Dates set forth in Section 3 hereof. The Company shall advise the Stockholder of the safekeeping arrangements and shall be responsible for all costs of maintaining the certificates in safekeeping. The Company may make such arrangements as it considers reasonable to assure the safety and security of the certificates during the safekeeping period. 3. Vesting and Earnout. The Stockholder agrees that, notwithstanding the release of such Escrowed Performance Shares from the restrictions in the Escrow Agreement, commencing concurrently with the release, the Escrowed Performance Shares shall become, without interruption, subject to the following vesting and earnout schedule: (a) 5% of the Stockholder's Escrowed Performance Shares shall become fully vested and shall be delivered from safekeeping to the Stockholder on June 22, 1997 (for purposes herein, June 22, 1997, 1998, 1999, 2000 and 2001 are referenced to as "Vesting Dates"); (b) 5% of the Stockholder's Escrowed Performance Shares shall become fully vested and shall be delivered from safekeeping to the Stockholder on June 22, 1998; (c) 10% of the Stockholder's Escrowed Performance Shares shall become fully vested and shall be delivered from safekeeping to the Stockholder on June 22, 1999; and (d) 20% of the Stockholder's Escrowed Performance Shares shall become fully vested and shall be delivered from safekeeping to the Stockholder on June 22, 2000; and (e) 30% of the Stockholder's Escrowed Performance Shares shall become fully vested and shall be delivered from safekeeping to the Stockholder on June 22, 2001; and 4 (f) any remaining Stockholder's Escrowed Performance Shares shall become fully vested and shall be delivered from safekeeping to the Stockholder on June 22, 2002, at which date this Agreement shall terminate in all respects unless sooner terminated or extended pursuant to the provisions of this paragraphs 3 or 4; except that, (g) in addition to and without in any way limiting the foregoing distributions, on the Vesting Dates, the Stockholder also shall be entitled to have released each year, on an Earnout Date specified by the Company, the number of Escrowed Performance Shares the Stockholder would have been entitled to receive pursuant to the formula in the attached Schedule B to the Escrow Agreement, provided, however that the maximum number of additional Escrowed Performance Shares which shall be released to the Stockholder during any of 1998, 1999, 2000 or 2001 based on an Earnings Release shall not exceed 30% of the original Escrowed Performance Shares held by a Stockholder. 4. Termination, Acceleration and Referrals. The Schedule for the Stockholder's Shares shall be subject to termination or adjustment as follows: (a) In the event that the Stockholder shall have voluntarily terminated his or her relationship with the Company and as a result thereof, the Stockholder shall no longer be providing services to the Company or to any of its subsidiaries, whether as an employee, officer, director, consultant or otherwise, the Escrowed Performance Shares that were to become fully vested on such Vesting Date shall lapse and be unavailable to the Stockholder, unless prior to such Vesting Date, the Board, the Compensation and Stock Option Committee or another similar committee designated by the Board to administer this Agreement, has, in its discretion, accelerated the Schedule with respect to some or all of the Escrowed Performance Shares which are not yet fully vested to the Stockholder. In the event that the Company in its discretion shall have terminated its relationship with the Stockholder, whether or not for "cause," and as a result thereof, the Stockholder shall no longer be providing services to the Company or to any of its subsidiaries, whether as an employee, officer, director, consultant or otherwise, all of the Escrowed Performance Shares that have not yet become fully vested shall be accelerated and shall be fully vested to the Stockholder as of the effective date of such termination. (b) In the event that the Stockholder shall die or become permanently incapacitated prior to the Vesting Date with respect to any of the Escrowed Performance Shares, the Schedule for all of the Escrowed Performance Shares shall be automatically accelerated effective on the date of death or the date the Board determines that the Stockholder is permanently incapacitated. For purposes of this Agreement, permanently incapacitated shall mean either (i) mental or physical incapacity, or both (as reasonably determined by the Board based on a certification of such incapacity by, in the discretion of the Board, either the Stockholder's regularly attending physician or a duly licensed physician selected by the Board which renders the Stockholder unable to continue to provide services to the Company and which appears reasonably certain to continue for at least six (6) consecutive months without substantial improvement, or (ii) the Stockholder is unable to continue to provide services to the Company hereunder for any ninety (90) consecutive days in any three hundred and sixty-five (365) day period or one hundred and twenty days (120) in the aggregate in any two (2) year period. (c) In the event that there shall be a change of control in the ownership of the Company, the Schedule shall be automatically adjusted as set forth in paragraph 7 of this Agreement. 5 (d) To the extent that the Stockholder is a "covered employee" pursuant to Section 162(m) of the Internal Revenue Code of 1986, as amended ("Section 162(m)"), and the delivery to the Stockholder of all or some portion of the Escrowed Performance Shares on any one of the Earnout or Vesting Dates would preclude the Company from taking full advantage of the compensation deductions provided to it under Section 162(m) during the applicable year, then the number of Escrowed Performance Shares needed to reduce the compensation to the allowable limits under Section 162(m), shall be deferred to allow the Company to take full advantage of the compensation deduction and to comply with requirements of Section 162(m). The Stockholder's Schedule shall be extended as necessary and, to the extent so required, this Agreement shall continue in effect until all of the Escrowed Performance Shares have vested in accordance with such deferral. 5. Voting Dividends, and Liquidation Rights. Prior to the vesting of the Escrowed Performance Shares, the Stockholder shall be entitled to exercise all voting rights to which such Shares are entitled, provided, however, that if the Stockholder is or becomes a director of the Company, the Stockholder agrees to abstain from voting on any resolution of the Board which would have the effect, if adopted, of permanently cancelling any of the Escrowed Performance Shares. The Stockholder also waives the right: (a) To vote Escrowed Performance Shares that are not yet vested on any resolution, which, if adopted, would have the effect of cancelling any of the Escrowed Performance Shares; (b) To receive dividends on the Escrowed Performance Shares that are not yet vested; and (c) To participate in the distribution of assets and property of the Company on a winding-up or liquidation dissolution of the Company, with respect to Escrowed Performance Shares which are not yet vested. 6. Transfer of Escrow Performance Shares. Escrowed Performance Shares shall not be sold or transferred until vested, and then only in accordance with this Agreement and the legend on the certificate representing the Shares (a copy of which is attached as Exhibit B). 7. Adjustment Provisions. Escrowed Performance Shares shall be subject to adjustments as follows: (a) If the Company shall at any time change the number of shares of Common Stock issued without new consideration to the Company (such as by stock dividend, stock split, recapitalization, reorganization, exchange of shares, liquidation, combination or other change in corporate structure affecting the Common Stock) or makes a distribution of cash or property which has a substantial impact on the value of issued Common Stock, except to the extent specifically limited by this Agreement, the total number of Escrowed Performance Shares shall be appropriately adjusted; and 6 (b) In addition to any adjustments pursuant to paragraph 7(a), all of the Shares shall vest immediately in the event of any merger, consolidation, sale of assets, acquisition of property or stock, recapitalization, or reorganization with a previously unaffiliated and as a result thereof, the Company is not the surviving entity or in the event of a change of control of the Company. For the purposes of this Plan, a "change in control" of the Company shall mean a change in control of a nature that would be required to be reported (assuming the Company were then subject to the provisions of law referred to in this paragraph) in a proxy statement with respect to the Company in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended, except that any merger, consolidation or corporate reorganization in which the owners of the Company capital stock entitled to vote in the election of directors ("Voting Stock") prior to said combination receive 75% or more of the resulting entity's Voting Stock shall not be considered a change in control for the purposes of the Plan; provided further, however, that a "change in control" shall for purposes of this Agreement be deemed not to have occurred with respect to any specific acquisition or other transaction if the Board, in its sole discretion, passes a resolution to such effect at the time of such transaction. "Control" is the power to direct, or cause the direction, of the management and policies of a corporation, whether through the ownership of securities, by contract or otherwise. 8. Withholding. When Escrowed Performance Shares are delivered from safekeeping to the Stockholder, the Company may elect, in its discretion, to require the Stockholder to remit to it cash or may give the Stockholder the option of delivering cash or Escrowed Performance Shares in an amount sufficient to satisfy such tax withholding requirements prior to the delivery of any certificates for Escrowed Performance Shares. The Company may, in its discretion and subject to such rules as it may adopt, permit the Stockholder to pay all or a portion of the U.S. federal, state and local withholding taxes arising in connection with the vesting of Shares, by electing to have the Company withhold Escrowed Performance Shares having a fair market value equal to the amount to be withheld. 9. Tenure. The Stockholder's right, if any, to continue to serve the Company or a subsidiary as an officer, director, employee, independent contractor, or otherwise, shall not be enlarged or otherwise affected by this Agreement, nor shall the existence of this Agreement interfere with the right of the Company, subject to the terms of any separate employment agreement to the contrary, at any time to terminate such service or to increase or decrease the compensation of the Stockholder. 10. Nonexclusivity of the Modification. Neither the adoption of the Modification by the Board nor the submission of the Modification to the stockholders of the Company for approval shall be construed as having any impact on any other benefit plans of the Company, or as creating any limitations on the power of the Board to adopt such other incentive arrangements as it may deem desirable, including, without limitation, the granting of stock awards, options or other incentive awards or rights other than the Escrowed Performance Shares to the Stockholder or any other persons. 11. General Provisions. (a) Binding Effect. This Agreement and the agreements herein contained shall be binding upon and inure to the benefit of the parties and their respective successors and assigns. 7 (b) Severability. Any provision of this Agreement which is invalid, illegal or unenforceable in any jurisdiction, as to that jurisdiction, shall be ineffective to the extent of such invalidity, illegality or unenforceability, without affecting in any way the remaining provisions hereof in such jurisdiction or rendering that or any other provision of this Agreement invalid, illegal or unenforceable in any other jurisdiction. (c) Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original and all of which shall together constitute one and the same instrument. (d) Headings. The headings contained in this Agreement are for the purposes of convenience only and shall not affect the meaning or interpretation of this Assignment. (e) Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of California. (f) Notices, Etc. All notices, demands, instruments and other communications required or permitted to be given to or made upon a party hereto shall be in writing and shall be personally delivered or sent by overnight mail or courier, by registered mail or certified mail, postage prepaid, or by prepaid telecopy, followed by overnight mail or courier and shall be deemed to be given for purposes of this Agreement on the day that such writing is delivered at the address provided for herein or, if given by telecopy followed by mail, or the later of 72 hours after such communication is sent by telecopy or the date on which the mailed copy, directed to such address, is delivered as provided herein. Unless otherwise specified in a notice sent or delivered in accordance herewith; notices, demands, instructions and other communications in writing shall be given to or made upon the respective parties hereto at their respective address first set forth above. IN WITNESS WHEREOF the parties have executed this Agreement effective on the date set forth above. "Company" SPATIALIZER AUDIO LABORATORIES, INC. By: ________________________________ Steven D. Gershick Chairman and Chief Executive Officer "Stockholder" By: ________________________________ EX-11.1 4 COMPUTATION OF LOSS PER COMMON SHARE 1 SPATIALIZER AUDIO LABORATORIES, INC. EXHIBIT 11.1 COMPUTATION OF LOSS PER COMMON SHARE
FISCAL YEAR FISCAL YEAR ENDED FOUR MONTHS ENDED ---------------------------- ENDED ----------- DECEMBER 31, DECEMBER 31, DECEMBER 31, AUGUST 31, 1996 1995 1994 1994 ----------------------------------------------------------- PRIMARY EARNINGS PER COMMON SHARE: Weighted Average Common Shares 12,644,751 15,933,516 14,329,235 12,376,579 Weighted Average Escrowed Performance Shares(1) (5,776,700) (5,776,700) (5,485,033) ----------------------------------------------------------- Adjusted Weighted Average Common Shares 12,644,751 10,156,816 8,552,535 6,891,546 =========================================================== Net Loss for Period (25,395,170) (3,241,285) (1,193,261) (1,808,387) =========================================================== Primary Loss Per share (2.01) (0.32) (0.14) (0.26) =========================================================== FULLY DILUTED EARNINGS PER COMMON SHARE: Adjusted Weighted Average Common Share 12,644,751 10,156,816 8,552,535 6,891,546 Weighted Average Escrowed Performance Shares(1) 0 5,776,700 5,776,700 5,485,033 Shares to be issued on Option Exercise(2) 829,856 806,066 621,486 640,838 Shares to be issued on Warrant Exercise(2) 15,076 312,704 23,143 0 ----------------------------------------------------------- Fully Diluted Weighted Average Common Shares 13,489,683 17,052,256 14,973,864 13,025,417 =========================================================== Net Loss for Period (from above) (25,395,170) (3,241,285) (1,193,261) (1,808,387) =========================================================== Fully Diluted Loss Per Share (1.88) (0.19) (0.08) (0.14) ===========================================================
(1) Escrowed performance shares were excluded from the determination of primary loss per share until conditions for release were met on December 30, 1996 at which time they were released. (2) Outstanding options and warrants to purchase common shares have not been included in the calculation of primary loss per share as the effect of including such securities would be antidilutive. For purposes of computing the fully diluted loss per share, the treasury stock method has been used and the shares have been treated as outstanding for the entire period. EX-21.1 5 SCHEDULE OF SUBSIDIARIES OF THE COMPANY 1 SPATIALIZER AUDIO LABORATORIES, INC. EXHIBIT 21.1 SCHEDULE OF SUBSIDIARIES OF THE COMPANY Desper Products, Inc. - Delaware, USA MultiDisc Technologies, Inc. - Deleware, USA EX-23.1 6 CONSENT OF KPMG PEAT MARWICK LLP 1 SPATIALIZER AUDIO LABORATORIES, INC. EXHIBIT 23.1 CONSENT OF KPMG PEAT MARWICK, LLP 2 ACCOUNTANTS' CONSENT The Board of Directors Spatializer Audio Laboratories, Inc. We consent to the incorporation by reference in the registration statements on Form S-3 (No. 333-12035) and on Form S-8 (No. 33-98168) relating to the consolidated balance sheets of Spatializer Audio Laboratories, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, shareholders' equity, and cash flows for the years ended December 31, 1996 and 1995, the four- month period ended December 31, 1994, and the year ended August 31, 1994, which report appears in the December 31, 1996 annual report of Form 10-K of Spatializer Audio Laboratories, Inc. Los Angeles, California March 24, 1997 -----END PRIVACY-ENHANCED MESSAGE-----