-----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, EmIceEksew5/y5J5apV4U2A6RoVpeDa9dd/vKgpUjNAf6Z2Tvrz/7i+jfQZzI60z vGxhQhu+ub7e108X6xUz5g== 0000950150-99-000482.txt : 19990415 0000950150-99-000482.hdr.sgml : 19990415 ACCESSION NUMBER: 0000950150-99-000482 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990414 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: SEC FILE NUMBER: 000-26460 FILM NUMBER: 99593567 BUSINESS ADDRESS: STREET 1: 20700 VENTURA BOULEVARD SUITE 134 STREET 2: STE 1100 CITY: WOODLAND HILLS STATE: CA ZIP: 90034 BUSINESS PHONE: 3102273370 MAIL ADDRESS: STREET 1: 20700 VENTURA BLVD. #134 CITY: WOODLAND HILLS STATE: CA ZIP: 90034 10-K405 1 FORM 10-K 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, 1998 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 140 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 April 2, 1999 was approximately $1,726,647.66. As of April 2, 1999 there were 27,414,148 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, licensor and marketer of next generation technologies for the consumer electronics, personal computing, enterprise computing and entertainment industries. The Company has two 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 or virtual audio signal processing technologies directed to the consumer electronics and multimedia PC markets. The Company continues to expand its product offerings to take advantage of the emerging digital audio marketplace specifically for consumer products like Digital Versatile Disc (DVD) for personal computers, and home entertainment; and interactive positional audio for PC gaming on the Windows 95/98(TM) platforms. As of December 31, 1998 more than 13 million licensed units had been shipped. DPI's 3-D audio signal processing technologies have been incorporated in over 400 products offered by global brand leaders including in consumer electronics, Toshiba, Panasonic, JVC, Hitachi, Phillips and Sharp, and in the PC multimedia marketplace, Dell, Gateway, Micron, Fujitsu, NEC and Sony, 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. The Company believes that with the accelerating growth in the digital audio/video marketplace, the market for virtual audio technologies, and therefore for the Company's products is entering a new phase of acceptance. 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, the MultiDisc Modular Stackable Storage Library ("MSSL"), of 12 cm CD/DVD based scaleable optical disc storage devices, a technology uniquely designed to combine the speed and performance of CD/DVD server arrays, the low cost, flexibility and capacity of CD Jukebox designs and next generation high speed, high volume robotics. The target markets for the MDT technology currently include Internet and Intranet enterprise networking and backup/archiving, image and document storage, and specialized vertical market applications including medical information technology, data warehousing and video-on-demand. On September 25, 1998, the Company announced its plan to refocus its business on the exploitation of its core audio technologies, suspend research and development at MDT and to properly position the MultiDisc assets for sale. Therefore, MDT has been accounted for as a discontinued operation. This repositioning strategy recognized that the capital investment required to properly commercialize the MDT technology was beyond the Company's current capacity. Management believes this strategy and the victory in the QSound patent litigation provides a better opportunity to further solidify its position as a leading provider of virtual audio solutions, based on available capital resources The Company's executive offices are located at 20700 Ventura Boulevard, Suite 140, Woodland Hills, California 91364, Telephone (818) 227-3370. World Wide Web sites (http://www.spatializer.com), (http://www.multidisc.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" or virtual audio. The objective in each product category is to create or simulate the effect of a multi-speaker sonic environment using two ordinary speakers (or headphones) for playback. The market for 3-D audio is segmented into three broad categories of 1 3 technology as identified in the listing below. Each of these technologies utilizes different underlying scientific principles in accomplishing its design objectives and is targeted to a specific class of consumer electronics or multimedia computer depending on the intended product use and functional capability of the product. DPI currently has other audio signal processing technologies under development which will serve to expand its market scope and partner product capabilities. - ---------------------------------------------------------------------------------------------- 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 an ordinary stereo signal playback -- DVD 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 enCompass(TM) Multimedia Computers under interactive sonic environments V2.0) Windows '95/'97, Virtual including sound objects that Reality 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 multi-speaker cinematic audio Digital Virtual Surround Dolby Digital(R) (AC-3), Dolby experience from two speakers, ProLogic(R) or MPEG-2. Home and headphones utilizing Theater, DVD-Video, Multimedia discrete multi-channel audio Computers utilizing DVD/MPEG information. 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 and headphone 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. DDP(TM) continuously monitors the underlying stereo signal and dynamically optimizes spatial processing, avoiding deleterious sonic artifacts common in other systems and provides "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 four chip foundries (Matsushita, ESS Technologies, Inc., OnChip Systems and Luxsonor) for easy and inexpensive implementation in any consumer electronics or computer products utilizing stereo audio. Matsushita and ESS introduced new Spatializer IC designs in 1997. In addition, the Company has developed reduced cost (Spatializer VBX(TM)) and improved performance analog and DSP software designs, which it introduced during the first quarter of 1997. In 1998, the Company continued development of lower cost 3-D Stereo technology in response to such a need in the marketplace. 2 4 2. SPATIALIZER(R) ENCOMPASS(TM) V2.0 In March 1998, the Company introduced Spatializer(R) enCOMPASS(TM) V2.0, 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. Version 2.0 has variable radiation pattern models for greater sound functionality, variable frequency dependent propagation and distance modeling to provide greater depiction of sound in relation to the player, and a choice of rendering quality levels to address different processing requirements between PC CPUs. Spatializer(R) enCOMPASS(TM) permits PC game developers to 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. This provides the game designer the ability of developing under the industry standard Microsoft DirectSound 5.0 open API, rather than under proprietary systems. The system supports playback over speakers or through headphones. On December 23, 1998, the Company signed its first license of Spatializer(R) enCOMPASS(TM) with Apple Computer, Inc. 3. SPATIALIZER(R) N-2-2(TM) DIGITAL VIRTUAL SURROUND. In September 1996, DPI introduced Spatializer N-2-2, 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 ever 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 Digital Signal Processing ("DSP") hardware platforms like those offered by Motorola, C-Cube, Medianix and Zoran; may be integrated with host based software-only MPEG-2 or DVD decoders (like SoftDVD and DVDExpress, offered by CompCore Multimedia and Mediamatics, respectively, 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. The Spatializer N-2-2 technology is also available for use over headphones, which accurately renders a spatially accurate 5 speaker position simulating the typical home theater arrangement. 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. Certain of the licenses call for the payment of an up-front license issuance fee either in lieu of, or in addition to the running royalty. Per unit 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. 3 5 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 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"), or to be authorized customers in consideration for a higher ("bundled") per unit royalty from the IC Foundry. This license structure has relieved much of the licensing burden from the IC foundries and has resulted in an increase in License signings. Because the Spatializer N-2-2 technology may be fully implemented in software to run in host based (Intel Pentium(R)) or general purpose DSP (Motorola, Zoran, C-Cube and Medianix) environments, no IC Foundry may be involved. In these situations, the Company will enter into royalty bearing licenses directly with the OEM. However, the Company may still pursue bundled agreements with DSP providers, if appropriate. The Company is currently negotiating new IC Foundry and OEM licenses for its N-2-2, enCOMPASS V2.0, and 3-D stereo technologies. IC Foundry Licenses As of December 31, 1998, the Company has entered into six non-exclusive Foundry Licenses for its 3-D Audio Signal Processing technologies with Matsushita Electronics Corporation ("MEC"), ESS Technology, Inc. ("ESS"), OnChip Systems, Inc. ("OnChip"), C-Cube Technologies, Inc. ("C-Cube"), Luxsonor and Medianix. Foundry Licenses generally 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 ES1869 and 1879 Spatializer(R) ICs, two of its highest volume multifunction AudioDrive(R) ICs, which are primarily used for multimedia and notebook applications. OnChip currently manufactures two versions of the 3-D Stereo Spatializer(R) IC. C-Cube currently incorporates N-2-2 on their Ziva-3 DSP. In June of 1998, C-Cube Technology, Inc. entered into a Foundry License for Spatializer N-2-2. Additionally, in 1998, the Company entered into a non-exclusive Foundry license for 3D Stereo and N-2-2 V1.0 with Medianix Corporation. As of December 31, 1998, more than 13 million ICs incorporating Spatializer 3-D audio signal processing technology had been manufactured and sold. OEM Licensees and Customers As of December 31, 1998, the Company technology had been incorporated in products offered by over 80 separate OEM Licensees and customers 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 or were authorized customers under bundled royalty licenses with the IC foundries. The OEM licensees and customers offer a wide range of products, which include DVDs, car stereo systems, 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, and arcade pinball and video games. 4 6 The following table is a partial list of the OEM Licensees and authorized customers as of December 31, 1998: - --------------------------------------------- --------------------------------------------- PARTIAL LIST OF OEM LICENSEES OR CUSTOMERS LISTING -- CONTINUED - --------------------------------------------- --------------------------------------------- Apple Computer, Inc. Panasonic TV & VCR (Matsushita Dell Computer Corp. Kotobuki Electronics Industries, Ltd.) Digital Technology Systems Of California, Panasonic Car Audio (Matsushita Inc. Communications Industrial Co., Ltd. Fujitsu Computer Corp. Proton Electronic Industrial Co., Ltd. Hewlett Packard Samsung Information Systems, America Hitachi, Ltd. Seiko Epson Corp. Iiyama Electric Co., Ltd. Sanyo Corp. Gateway Computer Corp. Sharp Corp. Golden Regent Toshiba DVD JVC Toshiba TV Labtec Enterprises, Inc. Taisei Electric, Inc. Mag Monitors Taiyo Electric Company, Ltd. Micron Computer Corp. Texas Instruments NEC Theta Digital - --------------------------------------------- ---------------------------------------------
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 products of digital audio workstation ("DAW") providers on both the MacIntosh(TM) and PC platforms. 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 developmental stage technologies and assets from Home Theatre Products ("HTP"), for approximately $1,062,000 in June 1996 to form its subsidiary, MultiDisc Technologies, Inc. ("MDT"). The MultiDisc transaction, which was implemented through a court-approved sale in the HTP bankruptcy proceeding, included an array of compact disc server robotics and software technologies in various stages of completion. The MultiDisc transaction was undertaken to position the Company for long term growth in a significant new market. The Company expected to license this technology or enter into third party manufacturing arrangements for sale of MDT CD/DVD changer products to OEMs. The MultiDisc transaction brought to the Company a unique combination of proprietary electromechanical designs, robotics, operating software, firmware, intellectual property, and engineering know-how. The core intellectual property is reflected in five patent applications acquired by the Company in the asset acquisition, four of which have been issued. The Company has added an additional fifty patent applications filed with the United States Patent & Trademark Office ("USPTO") to bring the total to fifty-five patent applications filed. On September 25, 1998, the Company announced a plan to refocus its business on the exploitation of its core audio technologies, suspend research and development of MDT and to properly position the MultiDisc assets for sale. Therefore, MDT has been accounted for as a discontinued operation. The repositioning strategy recognizes that the capital investment required to properly commercialize the MDT technology is beyond the Company's current capacity. As a result, all research and development activities were suspended. The Company continues to explore the sale of the business or the patent portfolio with interested parties. 5 7 REVENUES AND EXPENSES The Company generates revenues in its audio business 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 $1,679,715 in 1998, were derived substantially from Foundry and OEM license fees and 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 has curtailed 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 two major customers Matsushita Electronics Corp. (MEC) and ESS Technology, Inc. (ESS) in 1998, each of whom accounted for greater than 10% of the Company's total 1998 revenues. One OEM accounted for 56% and another accounted for 18% of the Company's royalty revenues during 1998. All other OEM's accounted for less than 10% of royalty revenues individually. On September 18, 1998, the U.S. Court of Appeals upheld U.S. District Court Judge William D. Keller's decision of August 29, 1996 in which the District Court had granted the Company's summary judgment motion in its entirety and denied the motion by QSound in the patent infringement litigation between the Company and QSound. The decision affirmed the District Court's ruling in all aspects and confirmed that Spatializer is entitled to distribute its products free of any infringement claim by QSound. The Company is not pursuing its counterclaims for damages and for a decision that the QSound patent is invalid at the present time. (See ITEM 3 -- LEGAL PROCEEDINGS, Page 7, for further detail). The uncertainties caused by the patent litigation had hindered the performance of the Company, 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) charges aggregating $21,147,000, which represented approximately 83% of the net 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 of 1996 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" 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. In September 1998, the Company implemented cost cutting measures in conjunction with the suspension of its research and development activities at MDT and to further rationalize the overhead of Desper Products and the corporate office in response to lower levels of operating performance. The objective of these initiatives was to reduce future operating costs from 1998 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 speakers, matrix 6 8 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., CRL and Harman International. 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 3D Stereo, interactive positional, and speaker virtualization 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. 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. On July 15, 1997, the Company filed a patent on its N-2-2(TM) intellectual property with the U.S. Patent Office. On March 20, 1998, the Company filed a patent on its enCompass V 2.0 technology with the U.S. Patent Office covering the Company's enCompass 2.0 positional audio gaming technology. Additional patent applications for the Company's reduced cost/higher performance 3-D Stereo designs and other 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. The core MDT data storage technology is covered by U.S. patents 5,774,431, 5,822,283, 5,886,960 and 5,886,974. As of December 31, 1998, MDT had fifty-one patent applications on file with the USPTO covering software, mechanical techniques, implementations and mixed technology designs. The Company has recently been notified by the USPTO that formal notice of allowance is forthcoming on five patent applications. The Company has applied for U.S. trademark protection for its principal product names and logo marks. EMPLOYEES The Company began 1998 with twenty-eight full-time and two part-time employees and reduced its staff to fifteen full-time employees by December 31, 1998. At year-end, there were nine employees engaged in research and development with seven of those employees involved with the development effort at the Company's audio subsidiary, Desper Products. From time to time the Company also employs the services of outside professional consultants. None of the Company's employees are represented by a labor union or are subject to a collective bargaining agreement. The Company considers its relations with its employees and consultants to be satisfactory. 7 9 PART II ITEM 2. PROPERTIES The Company's executive office is located in Woodland Hills, California where it occupies approximately 4,300 square feet with an annual rent of approximately $85,000. The lease term on this space expires March 30, 2000. On March 4, 1999, the Company entered into a new lease and reduced its space to approximately 800 square feet at a rent expense of approximately $1,800 per month. Terms are on a month-to-month basis. During 1998, the Company also leased facilities in Mountain View, CA, Newbury Park, CA, and Huntington Beach, CA. In an effort to consolidate offices by division and control costs, the Company closed both the Newbury Park, CA and Huntington Beach offices during the third and fourth quarters of the fiscal year ended December 31, 1998, respectively. Rent expenses of approximately $99,000 associated with these two facilities are included in the 1998 operating expenses. The Company incurred lease termination costs of $17,582 in connection with the closing of the Huntington Beach office. The Company's regional office in Mountain View, CA, is the primary location for the Company's audio technology division, Desper Products, Inc. ("DPI"). The Company occupies approximately 4,200 square feet in this location and the annual rent for these premises is approximately $52,000, with the lease term expiring February 22, 1999. This lease has been extended for an additional six month term at a cost of $6,930 per month. The Company's regional office in Huntington Beach, CA, was the primary location for the Company's multi-disc server technology division, MultiDisc Technologies, Inc. ("MDT"). The Company occupied approximately 4,000 square feet of office in this location and the annual rent for these premises is approximately $50,000, with the lease term expiring July 31, 1999. The Company vacated this space in November, 1998 and forfeited all rent deposits. 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 technology infringed certain U.S. patents held by QSound. In October 1994 the Company and DPI initiated a proceeding against QSound seeking a determination that the technology did not infringe on Qsound's patents and other relief. On August 29, 1996 the Court granted the Company's summary judgment motion of non-infringement in its entirety and denied the motion by QSound in the pending patent infringement litigation between the Company and QSound. In September, 1998, the U.S. Court of Appeals for the Federal Court upheld the U.S. District Court's ruling of August 1996, finding in favor of DPI and the Company on all aspects of the appeal. 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. Qsound has not appealed and the Company is not pursuing its other claims at the present time. In December 1998, a complaint was filed in the United States District Court for the Northern District of New York, by Alexander, Wescott & Co., Inc., against the Company alleging breach of contract and seeking fees from the Company based on its claim that the amounts were due for arranging a financing. The action 8 10 also seeks attorneys' fees, interest and the costs of suit. The Company has filed a motion to dismiss the action. The motion is pending. In February 1999, a complaint was filed in the Superior Court of Los Angeles County, Northwest District, by I.N. Associates, Inc., against the Company's wholly owned subsidiary, MultiDisc Technologies, Inc. ("MDT"), alleging breach of contract and fraud, and claiming $499,953.94 in damages, attorneys fees, interest and the costs of suit. MDT has answered and denied the claims. In connection with the downsizing of the Company, a number of employees have been terminated and have filed various employment and compensation related claims with the various State labor authorities which claims are pending resolution and funding as Company resources allow. The Company also anticipates that, from time to time, it may be named as a party to other legal proceedings that may arise in the ordinary course of its business. 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, 1998. 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". On December 31, 1998, the Company informed NASDAQ that it would be unable to comply with the requirements for continued listing on the NASDAQ SmallCap Market. On January 5, 1999, the Company's stock was delisted from the NASDAQ SmallCap Market and, on the same day, commenced trading on the NASD Bulletin Board under the symbol "SPAZ". The following table sets forth the high and low sales price of the Company's Common Stock on its principal market for fiscal years 1997 and 1998:
PERIOD: HIGH (U.S. $) LOW (U.S. $) ------- ------------- ------------ 1997 First Quarter................................... $3.75 $1.06 Second Quarter.................................. $2.00 $0.75 Third Quarter................................... $2.56 $1.13 Fourth Quarter.................................. $3.44 $1.31 1998 First Quarter................................... $2.88 $1.00 Second Quarter.................................. $1.56 $0.56 Third Quarter................................... $0.75 $0.19 Fourth Quarter.................................. $0.25 $0.06
On April 2, 1999, the closing price reported by NASDAQ was U.S. $0.09. 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 until March 31, 1997. Beginning April 1, 1997, Harris Trust Company of California became the Company's new transfer agent. RECORD HOLDERS To the Company's knowledge there were approximately 125 holders of record of the stock of the Company as of April 2, 1999. However, the Company's transfer agent has indicated that beneficial ownership is in excess of 1,700 shareholders. 9 11 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. 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, 1998, 1997 and 1996, as of and for the four-month period ended December 31, 1994, and the year ended August 31, 1994, are derived from the consolidated financial statements of Spatializer Audio Laboratories, Inc. and subsidiaries, which consolidated balance sheets have been audited by KPMG Peat Marwick LLP, independent certified public accountants through December 31, 1997 (The Company did not obtain an updated report in connection with this filing.) and by Farber & Hass LLP, Certified Public Accountants, for the year ended December 31, 1998. The consolidated financial statements as of December 31, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity, and cash flows for the years ended December 31, 1998, 1997 and 1996, and the report thereon, are included elsewhere in this Report.
FISCAL YEAR FOUR MONTH FISCAL YEAR ENDED ENDED PERIOD ENDED ----------------------------------------------------------- AUGUST 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, 1994(1) 1994(1&2) 1995(1) 1996 1997 1998 ---------- ------------ ------------ ------------ ------------ ------------ CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenues.................. $ 140 $ 187 $ 1,230 $ 2,024 $ 2,781 $ 1,680 Cost of Revenues.......... (61) (25) (79) (186) (230) (134) ---------- ---------- ----------- ----------- ----------- ----------- Gross Profit.............. 79 162 1,151 1,838 2,551 1,546 Total Operating Expenses....... (1,808) (1,339) (4,403) (27,042)(3) (7,236) (3,490) Other Income (Expense), Net..................... (79) (16) 74 118 27 (108) Loss from Discontinued Ops..................... (3,702) Income Taxes.............. (63) (310)(4) (60) (38) ---------- ---------- ----------- ----------- ----------- ----------- Net Loss.................. $ (1,806) $ (1,193) $ (3,241) $ (25,395) $ (310) $ (5,792) ========== ========== =========== =========== =========== =========== Basic/Diluted Loss Per Share: Continuing Operations(5)....... $ (0.28) $ (0.14) $ (0.32) $ (2.01) $ (0.23) $ (0.12) ========== ========== =========== =========== =========== =========== Total............ $ (0.28) $ (0.14) $ (0.32) $ (2.01) $ (0.23) $ (0.29) ========== ========== =========== =========== =========== =========== Weighted Average Common Shares.................. 6,891,546 8,552,535 10,156,816 12,844,751 20,804,095 22,180,180 ========== ========== =========== =========== =========== =========== CONSOLIDATED BALANCE SHEET DATA: Cash and Cash Equivalents............. $ 1,779 $ 1,540 $ 3,113 $ 1,587 $ 577 $ 264 Working Capital........... 6 982 3,159 2,092 283 (1,975) Total Assets..... 2,676 2,318 4,420 4,141 3,165 893 Advances From Related Parties................. 539 517 325 113 113 857 Total Shareholders' Equity (Deficit)............... $ 288 $ 1,367 $ 3,697 $ 3,268 $ 1,525 $ (1,553)
- --------------- (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 10 12 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 changes. Compensation Expense of $20,218,450 was recorded 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. Additionally, In-Process Research & Development ("IPR&D") expense of $679,684 related to the allocation of costs was incurred as a result of the MultiDisc Technologies, Inc. ("MDT") 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 11 13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis relates to the financial condition and results of operations of Spatializer Audio Laboratories, Inc. and subsidiaries (the "Company") for the year ended December 31, 1998 compared to the year ended December 31, 1997, and the year ended December 31, 1997, compared with the year ended December 31, 1996. RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998, COMPARED TO THE YEAR ENDED DECEMBER 31, 1997 REVENUES Revenues declined to $1,680,000 for the year ended December 31, 1998 compared to $2,781,000 for the year ended December 31, 1997, a decline of 40%. Revenues include license issuance fees and royalties pertaining to the licensing of Spatializer(R) audio signal processing designs and the sales of professional recording systems and consumer products. The decrease in revenues is attributed primarily to decreases in recurring royalties for the licensing of Spatializer audio technology reflecting competitive market pricing pressure, the discontinuation of consumer product sales, the signing in late 1997 of a flat fee license agreement for which there was no comparable license agreement in the current fiscal year and weakness in the Asian market. Gross profit was unchanged at 92% in the year ended December 31, 1998 compared with 92% for the comparable period. This reflects the impact of the discontinuation of lower margin consumer products sales offset by inventory write-downs ($86,000) on the remaining consumer products inventory to market. The Company maintains a high margin as the majority of revenues are from licensing and royalty activities, which have little or no associated direct costs. OPERATING EXPENSES Operating expenses from continuing operations for the year ended December 31, 1998 decreased to $3,490,000 from $7,238,000 for the year ended December 31, 1997, a decrease of 51%. The decrease in operating expenses result primarily from the reclassification of certain MDT expenses as discontinued operation and higher technology demonstrator development expense in 1997. Based on the corporate strategic refocusing, MDT is being treated as a discontinued operation. Operating expenses of MDT of approximately $2,800,000 have been excluded from operating expenses and presented separately as a discontinued operation. Total operating expenses of MDT for the year ended December 31, 1997 were $3,791,000. GENERAL AND ADMINISTRATIVE General and administrative costs decreased to $1,732,000 for the year ended December 31, 1998 from $2,174,000 for the year ended December 31, 1997, a decrease of 20%. The decrease is primarily due to the reclassification of MDT expenses of $511,000 to discontinued operations, partially offset by a provision of $100,000 for corporate restructuring. General operating costs include rent, telephone, office supplies, legal, accounting, postage, depreciation and similar costs. RESEARCH AND DEVELOPMENT Research and Development costs decreased to $756,000 for the year ended December 31, 1998, compared to $3,708,000 for the year ended December 31, 1997, a decrease of 79%. The decrease in research and development expense was due to the suspension of MDT's research and development activity in late September, 1998 and the reclassification of such expenses of $1,771,000 to discontinued operations. In addition, MDT research and development expenses incurred in 1998 were lower than the comparable period last year due to substantially lower ($1,000,000) technology demonstrator development expense. Total 12 14 research and development costs for MDT were $3,013,000 of the $3,708,000 expense for the year ended December 31, 1997. In addition, the Company continued efforts to identify, validate, and develop new product ideas at DPI. Specific engineering efforts were directed toward porting support of N-2-2(TM) -- Digital Virtual Surround technologies to current and potential licensees during the year, simplified low cost 3-D stereo solutions and toward enCompass, a true interactive, real-time 3-D audio positioning technology. SALES AND MARKETING Sales and marketing costs decreased to $1,002,000 for the year ended December 31, 1998, compared to $1,356,000 for the year ended December 31, 1997, a decrease of 26%. The decrease is primarily due to the reclassification of MDT expenses of $531,000 to discontinued operations, partially offset by an expansion in DPI sales personnel, travel and international sales representatives expenses. LOSS ON DISCONTINUED OPERATION Loss on discontinued operation was $3,702,000 for the year ended December 31, 1998. There was no comparable loss in the prior year. Loss on discontinued operation is comprised of the reclassification of $2,847,000 of net MDT expenses and valuation adjustments of $855,000. The net expense represents primarily general and administrative, sales and marketing and research and development expenses for the period January 1 through September 30, 1998. The Board of Directors announced the discontinued operation of MDT on September 25, 1998 and had preliminary indications from its banker and potential buyers that the sale of MDT's assets would not result in a loss to the Company. However, since no transaction has been consummated for the MDT assets as of this filing date, the Company has elected to reserve for this contingency. NET LOSS The net loss increased to $5,792,000 for the year ended December 31, 1998, compared to $4,720,000 for the year ended December 31, 1997, an increase of 22%. The increased net loss for the period is primarily the result of wind down costs for the Company's discontinued operation, MDT and lower revenues of DPI, partially offset by significantly lower MDT technology demonstrator development compared with the prior year. FOR THE YEAR ENDED DECEMBER 31, 1997, COMPARED TO THE YEAR ENDED DECEMBER 31, 1996 REVENUES The Company reported an increase in revenues of 37% or $757,000, reaching $2,781,000 for the year ended December 31, 1997 compared to $2,024,000 for the year ended December 31, 1996. Revenues include license issuance fees and royalties pertaining to the licensing of Spatializer(R) audio signal processing designs and the sales of professional recording systems and consumer products. The increase in revenues is attributed primarily to $880,000 of license fees received in 1997. The Company further solidified its market position in multimedia computing with the signing during the year of a multi-year, multi-technology license agreement with one of the Company's IC Foundries. The decrease in product sales in 1997 is expected to be offset by increased licensing revenues and running royalties. Revenues from hardware product sales have not been substantial in recent periods, and since the margins on these revenues have not been significant, the impact on the Company's results of operations as a result of the termination of the manufacture of hardware products is expected to be minimal. Gross profit remained relatively flat at 92% for the year ended December 31, 1997 as compared with 91% for the same period in 1996. The Company maintains a high margin as the majority of revenues are from licensing and royalty activities, which have little or no associated direct costs. 13 15 OPERATING EXPENSES The operating expenses for the year period ended December 31, 1997 increased by approximately 18% or $1,094,000 to $7,238,000 compared to $6,144,000 for the year ended December 31, 1996 after excluding the effects of one time charges of $20,898,000 in fiscal 1996 for compensation expense and in-process research and development. A one-time charge for compensation expense of $20,218,000 was recorded in 1996 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 increase in operating costs is a direct result of the expansion of the Company's Research and Development department and related activities due to the prototype development undertaken by MDT, the Company's server technology business. GENERAL AND ADMINISTRATIVE General and administrative costs decreased approximately 7% or $156,000, to $2,174,000 for the year period ended December 31, 1997 as compared with $2,330,000 for the same period in 1996. The decrease is primarily due to cost savings in professional service fees and general operating costs partially offset by increased payroll and payroll-related costs as the Company transitioned consulting and temporary help to permanent positions in 1996. General operating costs include rent, telephone, office supplies and stationery, postage, depreciation and similar costs. RESEARCH AND DEVELOPMENT Research and Development costs increased by approximately 99% or $1,848,000, to $3,708,000 for the year period ended December 31, 1997, compared to $1,860,000 for the same period in 1996. The increase in research and development expense was due to the increased cost of MDT's research and development activity of technology demonstrators for the MultiDisc eXpandable Network Server, XNS(TM), with technology expenses partially offset by savings in the DPI subsidiary of the Company. MDT, which began operations on June 24, 1996, represented approximately 81% or $3,013,000 of the total research and development costs of $3,708,000 for the year ended December 31, 1997 and 45% or $843,000 of the total research and development costs of $1,860,000 for the year ended December 31, 1996. In addition, the Company continued efforts to identify, validate, and develop new product ideas through DPI. Specific engineering efforts were directed toward porting support of N-2-2(TM) -- Digital Virtual Surround technologies to current and potential licensees during the year and toward enCompass, a true interactive, real-time 3-D audio positioning technology. A one-time charge for In Process Research and Development of $679,684 was recorded related to the MDT asset acquisition in June 1996. This one-time cost is not included in research and development department costs for purposes of a more accurate comparison of actual and on-going research and development costs of the Company. SALES AND MARKETING Sales and marketing costs decreased approximately 31%, or $599,000 for a total of $1,356,000 for the year ended December 31, 1997, compared to $1,955,000 for the same period in 1996. The decrease is attributed to cost containment efforts which began in the fourth quarter of 1996 along with a reduction in 1997 trade show and trade show related costs and advertising costs associated with the 1996 launch of the Company's subsequently discontinued consumer product, the HTMS-2510. NET LOSS The net loss for the year ended December 31, 1997 increased approximately 11% or $472,000, for a total net loss of $4,720,000 compared to $4,248,000 after excluding the effects of one time charges of $20,218,000 of Compensation Expense and $680,000 in process research and development expense and $249,000 of income tax expense incurred upon liquidation of the Company's Canadian predecessor during year ended 14 16 December 31, 1996. The increased net loss for the period is primarily a result of increased research and development efforts at the Company's subsidiary, MDT, partially offset by the cost savings realized by the continuation of the Company's cost cutting measures which began in the fourth quarter of 1996. In 1997, the Company granted 100,000 warrants as consideration for consulting services rendered during the year. The fair value of the services received ($100,000) was determined to be more reliably measurable and used to value the warrants, consistent with the provisions of SFAS 123 paragraph 8. There were no other compensatory arrangements with third parties in 1997. The pro forma net loss, as disclosed in footnote 13 of the accompanying financial statements, is significantly higher than historical net loss as a result of the Company granting 1,495,000 options to employees and directors during 1996 and 1997 LIQUIDITY AND CAPITAL RESOURCES At December 31, 1998, the Company had $264,000 in cash and cash equivalents as compared to $577,000 at December 31, 1997. The decrease in cash and cash equivalents is attributed to: (i) cash used for research and development at MDT on the Modular Scalable Storage Library, (ii) the repayment of $400,000 of borrowings on a bank line of credit and (iii) cash used in other operating activities. This was partially offset by net proceeds of $2,612,000 from the sale of preferred stock on April 14, 1998 and proceeds from $745,000 related party notes payable. The Company had negative working capital of $1,975,000 at December 31, 1998 as compared with working capital of $283,000 at December 31, 1997. The Company's future cash flows are expected to come primarily from audio signal processing licensing, Foundry and Original Equipment Manufacturers' ("OEM") royalties, debt issuances, common and/or preferred stock issuances including warrant and option exercises or through venture and/or strategic investors. At December 31, 1998 the Company had six Foundry licensees, seventy-three OEM Licensees and eight authorized customers for its audio signal processing business as compared with five Foundry licensees and sixty-two OEM Licensees and fourteen authorized customers at December 31, 1997. The Company is actively engaged in negotiations for additional audio signal processing licensing arrangements, equity and debt financing, which should generate additional cash flow without imposing any substantial costs on the Company. The Company continues to have no material long-term obligations and has no present commitments or agreements that would require any long-term debt or obligations to be incurred. The Company owed $857,500 to related parties as of December 31, 1998 and $112,500 at December 31, 1997. On October 30, 1998, the Compensation Committee of the Board of Directors re-priced qualified stock options to purchase 121,000 shares of common stock granted to various employees beginning in June 1995. The exercise price for these options was adjusted to $0.1875 per share (the closing market price on October 30, 1998) reducing grant date exercise prices ranging from $0.72 to $2.34 per share. Also, on November 12, 1998, the Compensation Committee of the Board of Directors re-priced qualified stock options to purchase 100,000 shares of common stock granted to an employee in March 1998. The exercise price for these options was adjusted to $0.125 per share (the closing market price on November 12, 1998) reducing the grant date exercise price from $1.18 per share. The vesting schedules and expiration dates for these options were not modified. On April 14, 1998, the Company entered into a private placement for up to $5 million of which $3 million was funded at September 30, 1998. In connection with the private placement, the Company authorized 100,000 shares of a new Series A, 7% Convertible Preferred Stock at a stated price of $50 per share and issued 60,000 shares for $3 million. In connection with the April funding, the Company issued purchase warrants, exercisable for three years and entitling the holders to acquire one share of the Company's common stock for each warrant. Of the warrants, 450,000 were issued and 150,000 warrants were issued to placement agents. The investor warrants are exercisable at 140% and the placement warrants are exercisable at 120%, respectively, of the average closing bid price of the Company's common stock for the 10 days preceding the closing. In addition, cash placement fees of 10% were paid. A related party of the Company received 50,000 of the placement agent warrants and $100,000 of the placement agent cash fee for arranging $1 million of the $3 million investment. As of December 31, 1998, $1 million of the remaining $2 million of the funding was due but had not yet been received. 15 17 Holders of the Series A Preferred Stock have a right to convert their shares, at their option on the earlier of (x) ninety (90) days after issuance or (y) on the effective date of this Registration (the "Conversion Date") with such conversion to be based on a per share conversion price ("Conversion Price") equal to the lesser of a price that reflects a discount (the "Conversion Discount") to the average of any three (3) consecutive closing bid prices for the Company's Common Stock within twenty (20) trading days immediately prior to the conversion date (the "Floating Conversion Price") or a price which is equal to one hundred thirty percent (130%) of the closing bid prices of the Company's Common Stock for the ten (10) trading days immediately preceding the date of issuance (the "Fixed Conversion Price") provided that in determining the Conversion Price, the holder shall not count any day on which its sales account for greater than twenty percent (20%) of the volume of the Company's Common Stock and on which the holder has sales in the last hour of trading. The Conversion Discount shall be equal to fifteen percent (15%) if the Conversion Rights are exercised within one hundred twenty (120) days of first issuance of the Series A Preferred Stock, shall be equal to seventeen and one-half percent (17.5%) if the Conversion Rights are exercised after one hundred (120) days and prior to one hundred forty-nine (149) days of first issuance of the Series A Preferred Stock. The applicable Conversion Discount increases by five percent (5%) if the Company is de-listed on NASDAQ. In addition, the percentage of shares that can be converted at any one time is limited during such time periods and the holders cannot own more than 4.99% of the equity of the Company after the Conversion. The beneficial conversion feature of the Series A Preferred Stock will be recorded as a dividend using the most favorable conversion terms available to the shareholder to calculate the dividend in accordance with EITF Topic D-60. Since the Company has an accumulated deficit and, under Delaware Law, must charge dividends against additional paid in capital, the net impact of recording the beneficial conversion feature is zero since both sides of the entry are recorded in additional paid in capital. At December 31, 1998, dividends in arrears were $148,750. In the private placement, the participants were granted certain rights to participate in the separate financing of approximately $6 million which had been pursued by the Company to fund the commercial introduction of its MultiDisc CD/DVD server technology. However, as reported by the Company on September 25, 1998, the Company has decided to refocus on the core audio technologies and to properly position the MultiDisc assets for sale. Therefore this financing is not currently being pursued actively. On September 25, 1998, the Company announced that its Board of Directors was refocusing the Company's business on the exploitation of its audio technologies, and, as noted above, to properly position the MultiDisc assets for sale. In reaching this decision, the Board of Directors noted that the September 18, 1998 decision by the U.S. Court of Appeals confirming the District Court's grant of a Summary Judgment in favor of the Company and against Qsound was expected to eliminate the negative market perceptions faced by the Company over the last four years. Currently the Company is actively pursuing licensing opportunities, including possible strategic alliances and capital funding opportunities based on its core audio technologies. In reaching its decision of September 25, 1998, the Company indicated that while it recognized the prospects of MultiDisc, the capital investment required to properly commercialize the technology was beyond its current capacity and, therefore, it had made the decision to seek a sale transaction. Effective as of that date, Steven D. Gershick resigned as chief executive officer of the Company and as president of MultiDisc Technologies, Inc., but continues to serve as chairman of the board of the Company. Henry R. Mandell, who joined the Company in March, 1998 as senior vice president finance was designated as interim chief executive officer to oversee all of the corporate activities. Michael Bolcerek resigned as president of Desper Products, Inc. Funds generated from the financing business activities and capital transactions described above, as well as cash generated from the Company's existing operations and the cost reductions being undertaken, may not be sufficient for the Company to meet its operation obligations during the next twelve months. In addition, if the refocus on the audio technologies strategy is not successful, if a strategic alliance including capital funding is not concluded, or if an appropriate transaction is not undertaken with respect to the MultiDisc activities, the ability of the Company to meet its operating needs will be materially adversely affected. As of December 31, 1998, the company had a negative working capital of $1,975,000 and, absent continued and improved revenues and successful funding activities, the Company may not be in a position to resolve this deficit. The financial 16 18 statements and the opinion expressed by the Company's independent accountants disclose that the financial statements have been prepared assuming the Company will continue to operate as a going concern which contemplates the realization of assets and the settlement of liabilities in the normal course of business. The Company has responded to inquiries from NASDAQ and attended a hearing with respect to its continued listing on October 29, 1998 at which time it outlined its strategy for continued listing. In November, 1998, NASDAQ provided the Company with an extension and conditional listing until December 31, 1998 to provide evidence of compliance with all requirements for continued listing. On December 31, 1998, the Company informed NASDAQ that it would be unable to comply with these requirements. On January 5, 1999, the Company's stock was delisted from the NASDAQ SmallCap Market and, on the same day, commenced trading on the NASD Bulletin Board under the symbol "SPAZ". On October 31, 1997, the Company entered into a line of credit agreement with Silicon Valley Bank to provide up to $750,000 in short term financing based upon the Company's accounts receivable base. The line of credit expired on October 23, 1998. As of December 31, 1998 and March 31, 1999, no borrowings were outstanding. NET OPERATING LOSS CARRYFORWARDS At December 31, 1998, the Company had net operating loss carryforwards of approximately $25,000,000 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 2013. INFLATION The Company believes that the moderate inflation rate of the 1990's has not impacted its operations. YEAR 2000 The Company is aware that many computer software programs may not currently be designed to properly handle the system date change after December 31, 1999. The Company has addressed this contingency with its computer consultants and upgraded its software programs in 1998, at a cost of approximately $15,000. THE ASIAN ECONOMIC CRISIS The Company believes that the deterioration of Asian markets and economies has had a moderately negative impact on its revenues and profitability. Approximately 25% of the Company's revenues for the year ended December 31, 1998 were derived from foundries and OEM's based in Japan and other Asian countries. In addition, some US-based customers do business globally, including Asia, and have been impacted negatively. The Company continues to work with its Asian customers in developing products and related pricing to help them remain competitive with regard to the Company's products. COMPREHENSIVE INCOME The Financial Accounting Standards Board issued Statement No. 130, Reporting Comprehensive Income ("SFAS 130"), in June 1997. FAS 130 establishes standards for reporting and display of comprehensive income and its components in financial statements. The Company adopted FAS No. 130 in the first quarter of fiscal year ended December 31, 1998. There was no impact on the 1998 and 1997 financial statements. ITEM 8. FINANCIAL STATEMENTS 17 19 INDEPENDENT AUDITORS' REPORT The Board of Directors Spatializer Audio Laboratories, Inc. We have audited the accompanying consolidated balance sheet of Spatializer Audio Laboratories, Inc. and subsidiaries as of December 31, 1998 and the related consolidated statements of operations, shareholders' equity (deficit), and cash flows for the year ended December 31, 1998. 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 audit. We conducted our audit 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 audit provides 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, 1998, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered significant losses from operations and has a net capital deficiency that raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 17. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ FARBER & HASS LLP Oxnard, California April 10, 1999 18 20 ITEM 8. FINANCIAL STATEMENTS SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS
DECEMBER 31, DECEMBER 31, 1998 1997 ------------ ------------ Current Assets: Cash and Cash Equivalents................................. $ 264,054 $ 577,413 Accounts Receivable, net of allowance for doubtful accounts of $190,000 at December 31, 1997................. 134,633 911,505 Employee Advances......................................... 59,086 Inventory................................................. 7,993 93,250 Prepaid Expenses and Deposits............................. 65,718 135,702 Deferred Transaction Costs................................ 146,529 ------------ ------------ Total Current Assets.............................. 472,398 1,923,485 Property and Equipment, Net................................. 184,140 586,961 Intangible Assets, Net...................................... 236,913 654,668 ------------ ------------ $ 893,451 $ 3,165,114 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Current Liabilities: Bank Line of Credit Payable............................... $ 400,000 Notes Payable............................................. $ 14,795 64,272 Notes Payable to Related Parties.......................... 857,500 112,500 Accounts Payable.......................................... 335,784 651,376 Accrued Wages and Benefits................................ 84,423 332,713 Accrued Expenses.......................................... 370,548 79,140 Deferred Income........................................... 250,000 Net Liabilities of Discontinued Operation................. 533,891 ------------ ------------ 2,446,941 1,640,001 ------------ ------------ Commitments and Contingencies Shareholders' Equity (Deficit): Series A 7% Convertible Preferred shares, 100,000 shares authorized, 52,900 shares issued and outstanding....... 529 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, 25,841,867 and 21,410,012 shares issued and outstanding at December 31, 1998 and 1997, respectively.................. 258,418 214,100 Additional Paid-In Capital.................................. 44,150,501 41,481,890 Accumulated Deficit......................................... (45,962,938) (40,170,877) ------------ ------------ Total Shareholders' Equity (Deficit).............. (1,553,490) 1,525,113 ------------ ------------ $ 893,451 $ 3,165,114 ============ ============
See accompanying notes to consolidated financial statements. 19 21 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ------------------------------------------ 1998 1997 1996 ----------- ----------- ------------ Revenues: Product Revenues, net............................ $ 39,496 $ 336,703 $ 336,849 Licensing Revenues............................... 663,522 880,000 Royalty Revenues................................. 976,697 1,564,530 1,687,338 ----------- ----------- ------------ 1,679,715 2,781,233 2,024,187 Cost of Revenues.............................. 134,190 229,736 185,540 ----------- ----------- ------------ 1,545,525 2,551,497 1,838,647 ----------- ----------- ------------ Operating Expenses: General and Administrative....................... 1,732,097 2,173,717 2,329,333 Research and Development......................... 755,899 3,707,995 1,860,400 Sales and Marketing.............................. 1,001,747 1,356,196 1,954,527 Compensation Expense............................. 20,218,450 In-Process Research and Development.............. 679,684 ----------- ----------- ------------ 3,489,743 7,237,908 27,042,394 ----------- ----------- ------------ Operating Loss................................ (1,944,218) (4,686,411) (25,203,747) Interest Income.................................... 27,672 57,305 123,643 Interest Expense................................... (84,723) (21,063) (14,571) Other Income (Expense), net........................ (50,955) (8,949) 10,042 ----------- ----------- ------------ (108,006) 27,293 119,114 ----------- ----------- ------------ Loss From Continuing Operations.................. (2,052,224) (4,659,118) (25,084,633) Loss From Discontinued Operation................. (3,701,599) ----------- ----------- ------------ Loss Before Income Taxes......................... (5,753,823) (4,659,118) (25,084,633) Income Taxes..................................... (38,238) (60,703) (310,537) ----------- ----------- ------------ Net Loss......................................... $(5,792,061) $(4,719,821) $(25,395,170) =========== =========== ============ Basic and Diluted Loss Per Share: Continuing Operations......................... $ (.12) $ (.23) $ (2.01) Discontinued Operation........................ $ (.17) ----------- ----------- ------------ Net Loss......................................... (.29) $ (.23) $ (2.01) =========== =========== ============ Weighted-average shares outstanding.............. 22,180,180 20,604,095 12,644,751 =========== =========== ============
See accompanying notes to consolidated financial statements. 20 22 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ------------------------------------------ 1998 1997 1996 ----------- ----------- ------------ Cash Flows from Operating Activities: Net Loss......................................... $(5,792,061) $(4,719,821) $(25,395,170) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and Amortization................. 126,334 407,238 130,057 Discontinued Operation........................ 962,060 Deferred Transaction Costs.................... 146,529 Loss on Disposal of Property and Equipment.... 50,308 14,281 Provision for Doubtful Accounts............... 100,000 90,000 Options and Warrants Issued for Services...... 56,030 100,000 Compensation Expense.......................... 20,218,450 In-Process Research and Development........... 679,684 Net Change in Assets and Liabilities: Accounts Receivable and Employee Advances..... 798,675 (249,806) (498,846) Inventory..................................... 85,257 203,289 (34,408) Prepaid Expenses and Other Assets............. 31,112 121,147 (267,748) Accounts Payable.............................. 102,737 247,506 223,824 Accrued Expenses and Other Liabilities........ 503,007 78,701 129,622 Changes in Discontinued Operation............. (66,796) ----------- ----------- ------------ Net Cash Used in Operating Activities.............. (2,996,808) (3,697,465) (4,724,535) ----------- ----------- ------------ Cash Flows from Investing Activities: Purchase of Property and Equipment............ (43,079) (187,485) (229,780) Proceeds from Disposal........................ 20,400 Increase in Intangible Assets................. (34,350) (237,036) (43,118) Deferred Transaction Costs.................... (146,529) MDT Asset Acquisition......................... (1,062,156) Discontinued Operation........................ (238,025) ----------- ----------- ------------ Net Cash Used in Investing Activities.............. (295,054) (571,050) (1,335,054) ----------- ----------- ------------ Cash Flows from Financing Activities: Issuance of Common and Preferred Shares, net......................................... 2,611,474 1,966,144 2,649,000 Exercise of Options and Warrants.............. 45,954 910,917 2,098,122 Notes and Amounts Due to Related Parties...... 745,000 (212,561) Proceeds from Issuance of Notes Payable....... 15,273 Proceeds (Repayment) from Bank on Line of Credit...................................... (400,000) 400,000 Discontinued Operation........................ (20,501) Repayments of Notes Payable................... (3,424) (18,528) (15,907) ----------- ----------- ------------ Net Cash Provided by Financing Activities.......... 2,978,503 3,258,533 4,533,927 ----------- ----------- ------------ Decrease in Cash and Cash Equivalents.............. (313,359) (1,009,982) (1,525,662) ----------- ----------- ------------ Cash and Cash Equivalents, Beginning of Year....... 577,413 1,587,395 3,113,057 =========== =========== ============ Cash and Cash Equivalents, End of Year............. $ 264,054 $ 577,413 $ 1,587,395 =========== =========== ============ Supplemental Schedule of Non-Cash Investing and Financing Activities: Capital Expenditures Financed by Lease Obligations and Notes Payable............... $ 0 $ 59,000 $ 10,940 ----------- ----------- ------------ Supplemental Disclosure of Cash Flow Information: Cash Paid During the Year For: Interest...................................... $ 26,370 $ 21,063 $ 13,771 Income Taxes....................................... $ 35,838 $ 60,703 $ 310,729 =========== =========== ============
See accompanying notes to consolidated financial statements. 21 23 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
SERIES A, 7% CONVERTIBLE PREFERRED SHARES COMMON SHARES TOTAL --------------------- ---------------------- SHAREHOLDERS' NUMBER NUMBER OF ADDITIONAL ACCUMULATED EQUITY OF SHARES PAR VALUE SHARES PAR VALUE PAID-IN CAPITAL DEFICIT (DEFICIT) --------- --------- ---------- --------- --------------- ------------ ------------- Balance, December 31, 1995................. -- $ -- 17,457,531 $174,575 $13,578,782 $(10,055,886) $ 3,697,471 Options Exercised...... -- -- 363,033 3,630 383,905 -- 387,535 Warrants Exercised..... -- -- 646,000 6,460 1,704,127 -- 1,710,587 Private Placements, Net.................. -- -- 648,865 6,489 2,642,511 -- 2,649,000 Performance Shares..... -- -- -- -- 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 Options Exercised...... -- -- 339,833 3,399 404,954 -- 408,352 Warrants Exercised..... -- -- 287,250 2,872 499,693 -- 502,565 Private Placements, Net.................. -- -- 1,667,500 16,675 1,949,468 -- 1,966,144 Warrants Issued for Services............. -- -- -- -- 100,000 -- 100,000 Net Loss............... -- -- -- -- -- (4,719,821) (4,719,821) ------ ---- ---------- -------- ----------- ------------ ------------ Balance, December 31, 1997................. -- $ -- 21,410,012 $214,100 $41,481,890 $(40,170,877) $ 1,525,113 Issuance of Preferred Shares, Net.......... 60,000 600 -- -- 2,610,874 -- 2,611,474 Options Exercised...... -- -- 13,333 133 12,571 -- 12,704 Warrants Exercised..... -- -- 19,000 190 33,060 -- 33,250 Options Issued for Services............. -- -- -- -- 56,030 -- 56,030 Conversion of Preferred Shares............... (7,100) (71) 4,399,522 43,995 (43,924) -- -- Net Loss............... -- -- -- -- -- (5,792,061) (5,792,061) ------ ---- ---------- -------- ----------- ------------ ------------ Balance, December 31, 1998................. 52,900 $529 25,841,867 $258,418 $44,150,501 $(45,962,938) $ (1,553,490) ====== ==== ========== ======== =========== ============ ============
See accompanying notes to consolidated financial statements. 22 24 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 developing and licensing technology. 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") was in the business of developing scaleable, modular compact disc and digital versatile disc ("DVD") server technologies associated with a network based compact disc/DVD server for internet and intranet applications. Operations of MDT were discontinued in the fourth quarter of 1998 and the assets are being marketed for sale (see Note 14). 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. The Company has experienced significant operating losses for the three years ended December 31, 1998. In addition, the Company has a negative working capital of $1,975,000 and shareholder's deficit of $1,553,490 at December 31, 1998. The financial statements have been prepared assuming the Company will continue to operate as a going concern which contemplates the realization of assets and the settlement of liabilities in the normal course of business. No adjustment has been made to the recorded amount of assets or the recorded amount or classification of liabilities which would be required if the Company were unable to continue its operations. See Management's Plans at Note 17. (2) SIGNIFICANT ACCOUNTING POLICIES Basis of Consolidation The consolidated financial statements include the accounts of Spatializer Audio Laboratories, Inc. and its wholly owned subsidiary, Desper Products, Inc. MultiDisc Technologies, Inc. has been presented as a discontinued operation (see Note 14). All significant intercompany balances and transactions have been eliminated in consolidation. Revenue Recognition The Company recognizes revenue from product sales upon shipment to the customer. License revenues are recognized when earned, in accordance with the contractual provisions. Royalty revenues are recognized upon shipment of products incorporating the related technology by the original equipment manufacturers (OEM's) and foundries. Cash and Cash Equivalents Cash equivalents consist of highly liquid investments with original maturities of three months or less. Restricted cash balances of $10,000 and $71,500 at December 31, 1998 and 1997, respectively, related to leasehold improvement and credit card guarantees are included in cash and cash equivalents in the accompanying consolidated financial statements. 23 25 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 Costs The Company expenses research and development costs as incurred. Property and Equipment Property and equipment are stated at cost. Property and equipment under capital leases are stated at the present value of minimum lease payments. Property and equipment are depreciated over three to five years using accelerated-depreciation methods, which approximates 150% declining balance. Leasehold improvements are amortized over the shorter of the useful life of the asset 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. Valuation Accounts 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 January 1, 1996.................................. $ -- Charged to expense........................................ 90,000 Deductions................................................ -- --------- Balance at December 31, 1996................................ 90,000 Charged to expense........................................ 100,000 Deductions................................................ -- --------- Balance at December 31, 1997................................ 190,000 Charged to expense........................................ -- Deductions................................................ (190,000) --------- Balance at December 31, 1998................................ $ 0 =========
Loss per Share On December 31, 1997, the Company retroactively adopted the provisions of Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128") which replaces the presentation of primary and fully diluted earnings (loss) per share with a presentation of basic and diluted earnings (loss) per share. Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted earnings (loss) per share is computed similarly to fully diluted earnings (loss) per share pursuant to the Accounting Principles Board ("APB") Opinion No. 15. The following table presents contingently issuable shares, options and warrants to purchase shares of common 24 26 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) stock that were outstanding during 1998, 1997, and 1996 which were not included in the computation of diluted loss per share because the impact would have been antidilutive:
1998 1997 1996 --------- --------- --------- Performance Shares........................ -- 5,746,047 Options................................... 1,972,300 1,855,070 1,701,732 Warrants.................................. 732,000 934,750 174,000 --------- --------- --------- 2,704,300 2,789,820 7,621,779 ========= ========= =========
Adoption of SFAS 128 did not have an impact on loss per share for the year ended December 31, 1996 as previously reported. The loss per share for the year ended December 31, 1998 includes the effect of approximately $371,000 of the beneficial conversion feature of the Series A, 7% Convertible Preferred Stock as well as dividends in arrears of approximately $149,000 related to this Preferred Stock. Stock Option Plan Prior to January 1, 1996 the Company accounted for its stock option plan in accordance with the provisions of 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 using the fair value based method over the vesting period the fair value of all employee stock-based awards on the date of grant. Alternatively, SFAS No. 123 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 1995 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 13). 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 as the amount by which the carrying amounts of the assets exceed the fair value of the assets (see Note 14). Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Segment Reporting The Financial Accounting Standards Board issued Statement No. 131, Disclosures about Segments of an Enterprise and Related Information ("SFAS No. 131"), in June 1997. SFAS No. 131 establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires enterprises to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. It replaces the "industry segment" concept of SFAS No. 14, 25 27 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Financial Reporting for Segments of a Business Enterprise, with a "management approach" concept as to basis for identifying reportable segments. SFAS 131 is effective for financial statements for fiscal years beginning after December 15, 1997. The Company adopted SFAS 131 in December 1997. MDT is considered a discontinued operation as of September 1998. As of December 31, 1998, the Company has only one operating segment, DPI, the Company's 3-D Audio Signal Processing business. Comprehensive Income The Financial Accounting Standards Board issued Statement No. 130, Reporting Comprehensive Income ("SFAS 130"), in June 1997. SFAS 130 establishes standards for reporting and display of comprehensive income and its components in financial statements. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. The Company adopted SFAS No. 130 January 1, 1998. Comprehensive income (loss) is the change in equity of a business enterprise during a period from transactions and all other events and circumstances from nonowner sources. Other comprehensive income (loss) includes foreign currency items, minimum pension liability adjustments, and unrealized gains and losses on certain investments in debt and equity securities. The Company did not have components of other comprehensive income (loss) during the years ended December 31, 1998 and 1997. As a result, comprehensive loss is the same as the net loss for the years ended December 31, 1998 and 1997. Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. 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. Financial Instruments The carrying values of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities at December 31, 1998 and 1997 approximated fair value due to the short maturity of those investments. The fair value of the amounts from related parties could not be estimated due to the nature of the borrowings. The fair values of notes payable at December 31, 1998 and 1997 are materially consistent with the related carrying values based on current rates offered to the Company for instruments with similar maturities. 26 28 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Sales of Common Stock of Subsidiaries At the time a subsidiary or equity affiliate sells existing or newly issued common stock to unrelated parties at a price in excess of its book value, the company records a gain reflecting its share of the change in the subsidiary's shareholders equity resulting from the sale. Discontinued Operation In September, 1998, the Board of Directors approved a plan to refocus corporate activities on the Company's core audio business, Desper Products, Inc. In conjunction to this strategic refocusing, the Company permanently suspended operations of MDT and placed the business and its related patent portfolio up for sale. The Company is accounting for the on-going operating and termination expenses of MDT as a discontinued operation (see Note 14). Reclassification Certain 1997 and 1996 amounts have been reclassified in order to conform with 1998 classifications. (3) DEFERRED TRANSACTION COSTS On November 5, 1997, the Board of Directors adopted a plan in which MDT would be spun-off into a newly formed and separately financed corporation. Costs relating to this transaction for legal, accounting, valuation, and consulting were deferred until the completion of the transaction. Under the plan, the company was, upon closing, to receive majority interest in this new company. Based on the decision by the Board of Directors to discontinue operations of MDT, these costs were written off in the fourth quarter of 1998. (4) PROPERTY AND EQUIPMENT Property and equipment, as of December 31, 1998 and 1997 consists of the following:
1998 1997 -------- ---------- Office Computers, Software, Equipment and Furniture......... $225,907 $ 788,392 Test Equipment.............................................. 60,647 114,225 Tooling Equipment........................................... 44,136 44,136 Trade Show Booth and Demonstration Equipment................ 122,768 137,158 Leasehold Improvements...................................... 22,122 48,783 -------- ---------- 475,580 1,132,694 Less Accumulated Depreciation and Amortization.............. 291,440 545,733 -------- ---------- $184,140 $ 586,961 ======== ==========
(5) INTANGIBLE ASSETS Intangible assets, as of December 31, 1998 and 1997 consist of the following:
1998 1997 -------- -------- Capitalized patent and technology costs..................... $365,637 $546,260 Capitalized patent costs in association with MDT Asset Acquisition............................................... 200,000 -------- -------- 365,637 746,260 Less Accumulated Amortization............................... 128,724 91,592 -------- -------- $236,913 $654,668 ======== ========
27 29 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (6) FINANCING ARRANGEMENTS Bank Credit Agreement The Company had an accounts receivable-based working capital bank line of credit which provided for borrowings up to $750,000 of the Company's qualified and eligible gross domestic accounts receivable at an interest rate of 1.5% of the average gross daily factoring account balance. The line of credit expired on October 23, 1998 and has not been renewed. Notes Payable Notes payable at December 31, 1998 and 1997 consist of the following:
1998 1997 ------- ------- Notes payable, secured by equipment, interest at 11.5% to 22%, payable in monthly installments May 2002.................................................... $14,795 $19,781 Capital lease obligations, payable in monthly installments through February 2000............................................. 44,491 ------- ------- $14,795 $64,272 ======= =======
The notes payable balances as of December 31, 1998 and 1997 have been classified as current liabilities since the long-term portion of the debt is not material to the accompanying consolidated balance sheet. Capital lease obligations totalling $25,552 at December 31, 1998 are included in the Net Liabilities of Discontinued Operations. (7) NOTES PAYABLE TO RELATED PARTIES The Company was indebted to certain related parties for an amount totaling $112,500 at December 31, 1998 and 1997. This amount bears interest at a fixed rate of 10% annually and is due on demand. At December 31, 1998, the Company was indebted to four of its directors and one of its executives for an amount totaling $745,000. This amount bears interest at a fixed rate of 10% annually. Of this amount, $650,000 was due on December 31, 1998, and is currently in default. The remaining $95,000 is due on November 30, 1999, or upon the sale of the MDT assets. The Company granted 95,000 warrants to purchase common stock at $0.20 per share in connection with the $95,000 of indebtedness. (8) SHAREHOLDERS' EQUITY During the year ended December 31, 1998, shares were issued or converted as follows: On April 14, 1998, the Company entered into a private placement for up to $5 million of which $3 million was funded at December 31, 1998. In connection with the private placement, the Company authorized 100,000 shares of a new Series A, 7% Convertible Preferred Stock at a stated price of $50 per share and issued 60,000 shares for the $3 million. In connection with the April funding, the Company issued purchase warrants, exercisable for three years and entitling the holders to acquire one share of the Company's common stock for each warrant. Of the warrants, 450,000 were issued and 150,000 warrants were issued to placement agents. The investor warrants are exercisable at 140% and the placement warrants are exercisable at 120%, respectively, of the average closing bid price of the Company's common stock for the 10 days preceding the closing. In addition, cash placement fees of 10% were paid. A related party of the Company received 50,000 of the placement agent warrants and $100,000 of the placement agent cash fee for arranging $1 million of the 28 30 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) $3 million investment. As of December 31, 1998, $1 million of the remaining $2 million of the funding was due but had not yet been received. Holders of the Series A Preferred Stock have a right to convert their shares, at their option on the earlier of (x) ninety (90) days after issuance or (y) on the effective date of a Form S-3 Registration Statement (the "Conversion Date") with such conversion to be based on a per share conversion price ("Conversion Price") equal to the lesser of a price that reflects a discount (the "Conversion Discount") to the average of any three (3) consecutive closing bid prices for the Company's Common Stock within twenty (20) trading days immediately prior to the conversion date (the "Floating Conversion Price") or a price which is equal to one hundred thirty percent (130%) of the closing bid prices of the Company's Common Stock for the ten (10) trading days immediately preceding the date of issuance (the "Fixed Conversion Price") provided that in determining the Conversion Price, the holder shall not count any day on which its sales account for greater than twenty percent (20%) of the volume of the Company's Common Stock and on which the holder has sales in the last hour of trading. The Conversion Discount shall be equal to fifteen percent (15%) if the Conversion Rights are exercised within one hundred twenty (120) days of first issuance of the Series A Preferred Stock and shall be equal to seventeen and one-half percent (17.5%) if the Conversion Rights are exercised after one hundred (120) days and prior to one hundred forty-nine (149) days of first issuance of the Series A Preferred Stock. The applicable Conversion Discount increases by five percent (5%) if the Company is de-listed on NASDAQ. In addition, the percentage of shares that can be converted at any one time is limited during such time periods and the holders cannot own more than 4.99% of the equity of the Company after the Conversion. At December 31, 1998, 7,100 shares of the Series A Convertible Preferred Stock had been converted into a total of 4,399,522 shares of the Company's Common Stock. The beneficial conversion feature of the Series A Preferred Stock will be recorded as a dividend using the most favorable conversion terms available to the shareholder to calculate the dividend in accordance with FASB (Emerging Issues Task Force) Topic D-60. Since the Company has an accumulated deficit and, under Delaware Law, must charge dividends against additional paid in capital, the net impact of recording the beneficial conversion feature is zero since both sides of the entry are recorded in additional paid in capital. At December 31, 1998, dividends in arrears were $148,750. In the private placement, the participants were granted certain rights to participate in the separate financing of approximately $6 million which was being pursued by the Company to fund the commercial introduction of its MultiDisc CD/DVD server technology. However, as reported by the Company on September 25, 1998, the Company has decided to refocus on the core audio technologies and to properly position the MultiDisc assets for sale. Therefore this financing is not currently being pursued actively. During the year ended December 31, 1997, shares were issued or converted as follows: In March 1997, the Company completed a private placement of 1,600,000 units at a price of $1.25 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 $1.75 on or before April 7, 1998. Stock issuance costs consisted of 67,500 shares of common stock, 12,000 warrants to purchase an equivalent number of shares of common stock at 1.50 per share and $33,856 cash. 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 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 on or before May 9, 1997. Regulatory approval was received in July 1996 from the Vancouver Stock Exchange ("VSE"). 29 31 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Also in May 1996, the Company completed a private placement of 280,000 units at a price of $4.25 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 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 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 on or before June 17, 1997. Regulatory approval was received in August 1996 from the VSE. In relation to the private placements of the Company's stock during 1996, finder's fees for such placements were paid through the issuance of 28,865 shares of stock. (9) ESCROWED 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: 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 years ended December 31, 1998, 1997, and 1996. However, the shares were not reflected in the calculation of loss per common share until earned by and released to the holders on 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. (10) STOCK OPTIONS In 1995, the Company adopted a stock option plan (the "Plan") pursuant to which the Company's Board of Directors may grant stock options to directors, officers and employees. The Plan authorizes grants of options to purchase authorized but unissued common stock up to 10% of total common shares outstanding at each calendar quarter, 2,584,187 as of December 31, 1998. Stock options are granted with an exercise price equal to the stock's fair market value at the date of grant. Stock options have five-year terms and vest and become fully exercisable up to three years from the date of grant. At December 31, 1998, there were 611,887 additional shares available for grant under the Plan. The per share weighted-average fair value of stock options granted during 1998, 1997 and 1996 was $0.25, $1.44, and $3.24, respectively, on the date of grant using the Black-Scholes option-pricing model with the following weighted -average assumptions: 1998 -- expected dividend yield 0%, risk-free interest rate of 9.0%, expected 30 32 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) volatility of 95% and an expected life of 3 years; 1997 -- expected dividend yield 0%, risk-free interest rate of 6.50%, expected volatility of 147% and an expected life of 5 years; 1996 -- expected dividend yield 0%, risk-free interest rate of 6.41%, expected volatility of 147% and an expected life of 5 years. The Company applies APB Opinion No. 25 in accounting for its Plan and, accordingly, no compensation cost has been recognized for the fair value of its stock options in the consolidated financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net loss would have been increased to the pro forma amounts indicated below:
1998 1997 1996 ----------- ----------- ------------ Net loss -- as reported.................... $(5,792,061) $(4,719,821) $(25,395,170) -- pro forma...................... (5,792,061) (6,408,547) (25,954,816) =========== =========== ============ Basic and diluted loss per share -- as reported.................... $ (.29) $ (.23) $ (2.01) -- pro forma...................... $ (.29) (.31) (2.05) =========== =========== ============
Pro forma net loss reflects only options granted since December 31, 1994. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net loss amounts presented above because compensation cost is reflected over the options' vesting period and compensation cost for options granted prior to January 1, 1995 is not considered. Stock option activity during the periods indicated is as follows:
WEIGHTED AVERAGE NUMBER EXERCISE PRICE --------- ---------------- Options Outstanding at January 1, 1996................... 1,426,432 $ 0.864 Options Granted.......................................... 715,000 $ 3.506 Options Exercised........................................ (363,033) $ 1.070 Options Expired.......................................... (76,667) $ 3.506 --------- Options Outstanding at December 31, 1996................. 1,701,732 $ 2.737 Options Granted.......................................... 780,000 $ 1.560 Options Exercised........................................ (339,833) $ 1.182 Options Forfeited........................................ (286,829) $ 3.208 --------- Options Outstanding at December 31, 1997................. 1,855,070 $ 1.897 Options Granted.......................................... 646,000 $ 0.728 Options Exercised........................................ (13,333) $ 0.953 Options Forfeited........................................ (515,437) $ 1.763 --------- Options Outstanding at December 31, 1998................. 1,972,300 $ 1.515 =========
At December 31, 1998, the exercise prices of the outstanding options ranged from $.1875 per share to $3.26 per share, and the remaining contractual life of outstanding options ranged from 14 months to 58 months. At December 31, 1998 and 1997, the number of options exercisable was 1,269,633 and 1,233,403, respectively, and the weighted-average exercise price of those options was $1.937 and $2.059, respectively. On October 30, 1998, the Compensation Committee of the Board of Directors re-priced qualified stock options to purchase 121,000 shares of common stock granted to various employees beginning in June 1995. The exercise price for these options was adjusted to $.01875 per share (the closing market price on 31 33 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) October 30, 1998) reducing grant date exercise prices ranging from $0.72 to $2.34 per share. Also, on November 12, 1998, the Compensation Committee of the Board of Directors re-priced qualified stock options to purchase 100,000 shares of common stock granted to an employee in March 1998. The exercise price for these options was adjusted to $0.125 per share (the closing market price on November 12, 1998) reducing the grant date exercise price from $1.18 per share. The vesting schedules and expiration dates for these options were not modified. (11) WARRANTS Warrant activity for the periods indicated below is as follows:
WARRANTS WARRANT PRICE --------- ------------- Warrants Outstanding at January 1, 1996..................... 780,000 $2.536 Warrants Issued............................................. 155,000 $3.553 Warrants Exercised.......................................... (646,000) $2.645 Warrants Expired............................................ (115,000) $3.700 --------- Warrants Outstanding at December 31, 1996................... 174,000 $3.790 Warrants Issued............................................. 1,067,000 $1.455 Warrants Exercised.......................................... (287,250) $1.750 Warrants Expired............................................ (19,000) $3.800 --------- Warrants Outstanding at December 31, 1997................... 934,750 $1.704 Warrants Issued............................................. 720,000 $1.455 Warrants Exercised.......................................... (19,000) $1.750 Warrants Expired............................................ (903,750) $1.706 --------- Warrants Outstanding at December 31, 1998................... 732,000 $1.118 ---------
All of the warrants granted in 1998, 1997 and 1996 were issued in connection with private placements except for the following: 100,000 warrants were granted in 1997 as consideration for consulting services rendered during 1997; 25,000 warrants were granted in 1998 as consideration for consulting services rendered during 1998; and 95,000 warrants were granted in 1998 in connection with a debt financing with the Company's directors. For those warrants granted as consideration for consulting services, the fair value of the consulting services was included in research and development costs in the accompanying consolidated statement of operations for the year ended December 31, 1998. At December 31, 1998 and 1997, the number of warrants exercisable was 732,000 and 934,750, respectively. (12) INCOME TAXES The Company files a consolidated return for U.S. income tax purposes. Income tax expense for the years ended December 31, 1998, 1997 and 1996 consisted of the following:
1998 1997 1996 ------- ------- -------- State franchise tax.................................. $ 2,400 $ 2,856 $ 58,331 Foreign taxes........................................ 35,838 57,847 252,206 ------- ------- -------- $38,238 $60,703 $310,537 ======= ======= ========
Certain revenues received from customers in foreign countries are subject to withholding taxes that are deducted from outgoing funds at the time of payment. These taxes range from approximately 8.5% to 15% and are recorded as foreign tax expense when incurred. In early 1996, the Company completed the liquidation of 32 34 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Spatializer -- Yukon, a Canadian subsidiary. The liquidation resulted in a Canadian tax liability of approximately $249,000 and approximately $3,000 in minimum state taxes in 1996. Income tax expense for the years ended December 31, 1998, 1997 and 1996 differed from the amounts computed by applying the U.S. federal income tax rate of 34 percent to loss before income taxes primarily due to the generation of additional net operating loss carryforwards for which no tax benefit has been provided. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1998 and 1997 are presented below.
1998 1997 ------------ ----------- Deferred tax assets: Net operating loss carryforwards....................... $ 9,475,000 $ 7,515,000 In-process research and development costs.............. 272,000 272,000 Asset reserves......................................... 313,000 96,000 Accrued liabilities.................................... 32,000 104,000 Property and equipment, principally due to differences in depreciation and capitalized interest............ 20,000 25,000 Other.................................................. 26,000 ------------ ----------- Total gross deferred tax assets.......................... 10,112,000 8,038,000 Less valuation allowance................................. (10,112,000) (8,038,000) ------------ ----------- Net deferred tax assets.................................. $ -- $ -- ============ ===========
The net change in the total valuation allowance for the years ended December 31, 1998 and 1997 was an increase of $2,074,000 and $1,800,000, respectively. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable losses, management believes it is more likely than not the Company will not realize the benefits of these deductible differences and has established a valuation allowance to fully reserve the deferred tax assets at December 31, 1998 and 1997. Additionally, the ultimate realizability of net operating losses may be limited by change of control provisions under section 382 of the Internal Revenue Code. At December 31, 1998, the Company had net operating loss carryforwards for federal income tax purposes of approximately $25,000,000 which are available to offset future federal taxable income, if any, through 2013. In addition, the Company has foreign tax and general business credit carryforwards of $179,000 and $188,000 respectively. 33 35 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (13) SEGMENT REPORTING The following table presents information about reported segment losses and segment assets as of and for the years ended December 31, 1997 and 1996:
1997 1996 -------------------------------------- --------------------------------------- SEGMENT SEGMENT DPI MDT TOTAL DPI MDT TOTAL ---------- ----------- ----------- ----------- ----------- ----------- Revenues from External Customers.......... $2,781,233 $ -- $ 2,781,233 $ 2,024,187 $ -- $ 2,024,187 Interest Income...... 758 3,145 3,904 3,271 3,056 6,327 Interest Expense..... (12,483) (5,353) (17,836) (13,282) (208) (13,490) Depreciation and Amortization....... 134,905 154,730 289,635 134,720 44,034 178,754 In Process Research and Development.... -- -- -- -- 679,684 679,684 Segment Profit....... (645,412) (3,793,522) (4,438,934) (2,233,252) (1,648,059) (3,881,311) Segment Assets....... 616,563 780,189 1,396,752 1,698,660 607,850 2,306,510 Expenditures for Segment Assets..... 34,819 317,808 352,627 80,577 143,382 223,959 ---------- ----------- ----------- ----------- ----------- -----------
The following is a reconciliation of reportable segment loss and assets, to the Company's consolidated totals.
1997 1996 ----------- ------------ LOSS: Total loss for reportable segments....................... $(4,438,934) $ (3,881,311) Compensation Expense (Note 9)............................ (20,218,450) Other Corporate Expenses................................. (280,887) (1,295,409) ----------- ------------ Total Net Loss........................................... $(4,719,821) $(25,395,170) =========== ============ ASSETS: Total assets for reportable segments..................... $ 1,396,752 $ 2,306,510 Corporate assets......................................... 1,768,362 1,834,685 ----------- ------------ Consolidated Total....................................... $ 3,165,114 $ 4,141,195 =========== ============
The revenues for the year ended December 31, 1998 include revenues from two major customers each of whom represent 56% and 18%, respectively, of total revenues. The revenues for the year ended December 31, 1997 include revenues from two major customers, each of whom represent 58% and 16%, respectively, of total revenues. 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. (14) DISCONTINUED OPERATION On September 25, 1998, the Board of Directors determined that it would be unable to raise the necessary capital required to properly commercialize the MDT technology. Therefore, the Company ceased funding the operations of MDT and is actively seeking to sell the assets and technology. All employees of MDT have been terminated and the Company has vacated the MDT facilities. Based on this action, the Company is treating MDT as a discontinued operation. Accordingly, the balance sheet and statement of operations of MDT are not consolidated in the continuing operations of the 34 36 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Company, but rather are disclosed as Net Liabilities of Discontinued Operation and Loss From Discontinued Operation, respectively. The Net Liabilities of Discontinued Operation at December 31, 1998 are comprised of the following: Current assets.............................................. $ 23,052 Property and equipment, net................................. 122,698 Patents..................................................... 637,388 Accounts payable............................................ (277,696) Accrued expenses............................................ (230,643) Notes payable............................................... (25,552) --------- 249,247 Valuation adjustments....................................... (783,138) --------- Net liabilities of discontinued operations.................. $(533,891) =========
Summary of operating results of the discontinued operation was as follows:
1998 1997 ----------- ----------- License revenue................................... $ 50,000 $ -0- Costs and expenses................................ (2,177,396) (3,799,150) ----------- ----------- Loss from discontinued operation before loss on disposal........................................ (2,127,396) (3,799,150) Loss on disposal.................................. (1,574,203) ----------- ----------- Loss from discontinued operation.................. $(3,701,599) $(3,799,150) =========== ===========
(15) COMMITMENTS AND CONTINGENCIES Legal In the Fall of 1994, QSound Labs, Inc. ("QSound") advised MEC that, in its view, the Spatializer technology infringed certain U.S. patents held by QSound. In October 1994 the Company and DPI initiated a proceeding against QSound seeking a determination that the technology did not infringe on Qsound's patents and other relief. On August 29, 1996 the Court granted the Company's summary judgment motion of non-infringement in its entirety and denied the motion by QSound in the pending patent infringement litigation between the Company and QSound. In September, 1998, the U.S. Court of Appeals for the Federal Court upheld the U.S. District Court's ruling of August 1996, finding in favor of DPI and the Company on all aspects of the appeal. 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. Qsound has not appealed and the Company is not pursuing its other claims at the present time. In December 1998, a complaint was filed in the United States District Court for the Northern District of New York, by Alexander, Wescott & Co., Inc., against the Company alleging breach of contract and seeking fees from the Company based on its claim that the amounts were due for arranging a financing. The action 35 37 SPATIALIZER AUDIO LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) also seeks attorneys' fees, interest and the costs of suit. The Company has filed a motion to dismiss the action. The motion is pending. In February 1999, a complaint was filed in the Superior Court of Los Angeles County, Northwest District, by I.N. Associates, Inc., against the Company's wholly owned subsidiary, MultiDisc Technologies, Inc. ("MDT"), alleging breach of contract and fraud, and claiming $499,953.94 in damages, attorneys fees, interest and the costs of suit. MDT has answered and denied the claims. In connection with the downsizing of the Company, a number of employees have been terminated and have filed various employment and compensation related claims with the various State labor authorities which claims are pending resolution and funding if Company resources allow. The Company also anticipates that, from time to time, it may be named as a party to other legal proceedings that may arise in the ordinary course of its business. Operating Lease Commitments The Company is obligated for future minimum rental payments for all operating leases of approximately $105,000 during the year ended December 31, 1999. Rent expense amounted to approximately $251,000, $238,000 and $197,000 for years ended December 31, 1998, 1997 and 1996 respectively. (16) FOURTH QUARTER ADJUSTMENTS During the quarter ended December 31, 1998, the Company recorded non-recurring adjustments which reduced net assets and increased the net loss by approximately $1,323,000. These adjustments relate to reflecting MDT as a discontinued operation ($855,000), the write-off of deferred transaction costs ($218,000) and restructuring costs ($250,000). (17) MANAGEMENT PLANS The Company has implemented significant cost reductions in its continuing operations. Management believes that the proceeds from the sale of MDT, new contracts in 1999 and continuing royalty revenues may not be adequate to finance the 1999 cash flow requirements. Additional debt or equity financing will be required. Management has developed plans which include, but are not limited to, merging with another company and obtaining additional debt or equity financing. ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE -- NONE 36 38 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information with respect to both the directors and executive officers of the Company:
NAME AGE POSITION ---- --- -------- NOMINEES FOR TERMS ENDING IN 2001: James D. Pace...................... 43 Director -- 2/95 to date. Member of Compensation Committee -- 2/95 to date. Gilbert N. Segel................... 66 Director -- 5/95 to date. Member of Audit Committee -- 5/95 to date. Member of Compensation Committee -- 5/95 to date. NOMINEES FOR TERMS ENDING IN 2000: Jerold H. Rubinstein............... 60 Director -- 8/91 to date. Member of Audit Committee -- 8/91 to date. Stephen W. Desper.................. 56 Director -- 7/92 to date. Chairman of the Board -- 7/92 to 12/95. Vice Chairman of the Board -- 12/95 to date. Principal Holder. Steven D. Gershick................. 44 Director -- 7/92 to date. Chairman of the Board -- 12/95 to date. President and Chief Executive Officer -- 7/92 to 9/98. President of Operating Subsidiary Desper Products, Inc. ("DPI") -- 3/97 to 1/98. Chief Executive Officer of DPI -- 10/91 to 9/98. President of Operating Subsidiary MultiDisc Technologies, Inc. ("MDT") -- 9/97 to 9/98. Chief Executive Officer of MDT -- 6/96 to 9/98. NOMINEES FOR TERMS ENDING IN 1999: Carlo Civelli...................... 50 Director -- 3/93 to date. Vice President Finance, Europe -- 8/91 to 3/95. Principal Holder. Scot E. Land....................... 44 Director EXECUTIVE OFFICERS: Michael Bolcerek................... 35 President of Operating Subsidiary Desper Products, Inc. ("DPI") -- 1/98 to 9/98. Chief Financial Officer/V.P. Finance -- 6/97 to 3/98. Henry R. Mandell................... 42 Interim Chief Executive Officer -- 9/98 to date Chief Financial Officer -- 3/98 to date.
JAMES D. PACE. Director since February 1995. Director of DPI since July 1992. For more than the last twelve years, Mr. Pace has specialized in the introduction and distribution of new technologies into the professional recording and film industries. He is an electronics engineer with broad experience in recording and live sound reinforcement. GILBERT N. SEGEL. Director since May 1995. Mr. Segel has spent more than thirty (30) years as an independent business manager representing musical artists, film actors and entertainment industry entrepreneurs. Since 1985, he has concentrated on his personal investments and serves as a director of various private business and charitable enterprises. Mr. Segel is the brother-in law of Mr. Rubinstein. JEROLD H. RUBINSTEIN. Director since August 1991. Chairman and Chief Executive Officer of XTRA Music. Formerly Chairman and Chief Executive Officer DMX, Inc. (previously International Cablecasting Technologies, Inc.). Prior to that, co-owner and chairman of United Artists Records; chairman of ABC Records, Inc.; co-founder and chairman of Bel-Air Savings and Loan of Los Angeles; and co-founder and 37 39 partner of JRC Oil, a Colorado oil and gas exploration company. Attorney and certified public accountant, California. Mr. Rubinstein is the brother-in law of Mr. Segel. STEPHEN W. DESPER. Vice Chairman of the Board, Inventor. Devoted his full time for a number of years to developing and refining Spatializer(R) technology. Recording engineer, over twenty (20) years experience; Director of Engineering for The Beach Boys Organization. Acoustician, Acoustic Design and Noise Control Engineer. December, 1991 to December, 1995, Chairman of Spatializer Audio Laboratories, Inc. Since December, 1995 Vice Chairman of Spatializer Audio Laboratories, Inc. Inventor and President of Desper Products; Inc. ("DPI") -- June 1986 to October, 1991. Vice President and Director of Research, DPI -- October 1991 to December 1996. STEVEN D. GERSHICK. Chairman of the Board, President and Chief Executive Officer. Director since July 1992. Resigned all positions except Chairman of the Board, September 1998. Since December 1995, Chairman of Spatializer Audio Laboratories, Inc. Certified Public Accountant, KPMG Peat Marwick from May 1977 through June, 1980. From 1981 through September, 1991, the principal of a Certified Public Accounting firm specializing in business consulting and entertainment business management. Since October 1, 1991, CEO of DPI. From October, 1991 to June, 1996, President of DPI. From March 1997 to January 1998, resumed role as President of DPI. Since June 1996, CEO of MDT. President of MDT since September 1997. Since December 1991, President and CEO of Spatializer Audio Laboratories, Inc. Practicing C.P.A. to October 1991. CARLO CIVELLI. Director since March 1993. VP Finance -- Europe from August 1991 to March 1995. Has extensive experience in financing emerging public companies. Managing director of Clarion Finanz AG, Zurich, Switzerland, for more than the last five years. Director and Financial Consultant to Clarion Finanz AG. SCOT E. LAND. Director since April 1997, resigned March 1999. Managing Director of EnCompass Group, Inc. 1997 to date. Senior Technology Analyst with Microsoft Corporation 1994 to 1997. From 1993 to 1994, Mr. Land was Vice President of First Marathon Securities, Toronto, Canada with responsibilities in Research and Investment Banking, specializing in High Technology. During this same time, Mr. Land was an advisor to Microsoft Corporation on matters related to strategic planning and competitive product assessment. From 1988 to 1993, Mr. Land was President and CEO of InVision Technologies, Foster City, California. Mr. Land is on the Board of Directors of several private technology companies and non-profit organizations. MICHAEL BOLCEREK. President of DPI since January, 1998, resigned September 1998 Chief Financial Officer and Vice President of Finance June 1997 to March 1998. Controller of Nokia Display Products, Inc. 1995 to 1996. Treasurer and Acting Chief Financial Officer for Axil Computer, Inc. 1994 to 1995. Assistant Treasurer for NeXT Computer, Inc. 1992 to 1993. Manager of U.S. Treasury Operations for NeXT Computer, Inc. 1991 to 1992. Previously worked for Oracle Corporation in various management positions from 1987 to 1991. HENRY R. MANDELL. Interim Chief Executive Officer since September 1998. Chief Financial Officer and Senior Vice President, Finance since March 1998. Executive Vice President and Chief Financial Officer of The Sirena Apparel Group, Inc. from November 1990 to January, 1998. Senior Vice President of Finance and Administration for Media Home Entertainment, Inc. from April 1985 to November 1990. Director of Finance and Accounting for Oak Media Corporation from June 1982 to April 1985. Senior Corporate Auditor for Twentieth Century Fox Film Corporation from June 1981 to June 1982. Senior Auditor for Arthur Young and Company from August 1978 to June 1981, where he qualified as a Certified Public Accountant. 38 40 ITEM 11. EXECUTIVE COMPENSATION The following table sets forth separately, for the last three complete fiscal years, each component of compensation paid or awarded to, or earned by, the Chief Executive Officer ("CEO") of the Company and each of the other most highly compensated executive officers who were serving as executive officers at the end of the last fiscal year (collectively, the "Named Executive Officers"). SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION ----------------------------------- AWARDS PAYOUTS ------------------------ ------- SECURITIES UNDER OPTIONS/ RESTRICTED ANNUAL COMPENSATION SARS STOCK ------------------------------- GRANTED AWARDS LTIP NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OTHER (#) ($) PAYOUTS - --------------------------- ----- -------- -------- ------- ---------- ---------- ------- Henry R. Mandell(1)........ 12/98 $105,833 $ -- $ 6,750 500,000 N/A N/A Interim Chief Executive Officer Steven D. Gershick(1)...... 12/98 $211,635 $ 12,000 $ 6,923 N/A N/A N/A Chairman of the Board, 12/97 $175,000 $ 44,250 $ 9,000 50,000 N/A N/A President and CEO 12/96 $150,000 $ 37,500 $ 8,607 50,000 See note 6 N/A Eric Rene Bos(2)........... 12/98 $120,000 $ 75,000 N/A N/A N/A N/A Vice President, Product 12/97 $120,000 $136,500 N/A10,000 N/A(5) N/A N/A Development for MDT 12/96 $ 60,000 $ 26,500 $ 25,000 N/A N/A Robert L. Montelius(2)..... 12/98 $120,000 $ 75,000 N/A N/A N/A N/A Vice President, Engineering 12/97 $120,000 $136,500 N/A N/A(5) N/A N/A for MDT 12/96 $ 60,000 $ 26,500 $10,000 25,000 N/A N/A Theodore C. Tanner(3)...... 12/98 $122,427 $ -- $ 4,800 50,000 N/A N/A Vice President, 12/97 $ 98,770 $ 13,000 $ 6,000 15,000(4) N/A N/A Engineering for DPI 12/96 $ 64,675 $ 15,500 N/A 45,000(4) See note 6 N/A Peter S. Birch............. 12/98 $129,654 $ -- $ 5,400 30,000 N/A N/A Sr. Vice President, Sales and Marketing for DPI
- --------------- (1) Mr. Mandell became an employee of the Company in March, 1998. He became Interim Chief Executive Officer of the Company on September 25, 1998, concurrent with the effective date of Mr. Gershick's resignation as President and Chief Executive Officer. (2) Mssrs. Bos and Montelius became employees upon the Company's acquisition of MultiDisc Technologies, Inc. in June, 1996. (3) Mr. Tanner became an employee of DPI in March, 1996. (4) The exercise price for these options was adjusted to the closing market price on July 18, 1997. (5) The exercise price for these options was adjusted to the closing market price on December 12, 1997. (6) On September 2, 1996, Steven D. Gershick and Theodore Tanner received performance shares which were transferred from prior holders based on a previous understanding that those shares were held for their benefit. Based on the market closing price of $4.25 on September 2, 1996, the value of the shares they received was $636,405 for Mr. Gershick and $63,640 for Mr. Tanner. On June 22, 1997, 5% of the 5,776,700 originally issued performance shares were released from escrow in accordance with the escrow arrangement. On June 22, 1998 another 5% of the 5,776,700 originally issued performance shares were released from escrow in accordance with the escrow arrangement. As a result, as of December 31, 1998, 5,104,530 of the originally issued performance shares remained outstanding which, based on the $0.125 year end closing price of the stock, were valued at $638,066. Unless released earlier based on cumulative positive cash flow of $.6285 Cdn. per share, the remainder of these shares will vest based on the following schedule: 10% June, 1999; 20% June, 2000; 30% June 2001; and, 30% June, 2002. 39 41 OPTION/STOCK APPRECIATION RIGHT ("SAR") GRANTS DURING THE MOST RECENTLY COMPLETED FINANCIAL YEAR The following table presented in accordance with the Securities Exchange Act of 1934, as amended ("the Exchange Act") and the Regulations thereunder sets forth stock options granted under the Company's Stock Option Plan ("the Stock Option Plan") during the most recently completed financial year to each of the Named Executive Officers:
ALTERNATIVE TO REALIZABLE INDIVIDUAL GRANTS VALUE: --------------------------------------------------------------------- GRANT % OF MARKET POTENTIAL VALUE TOTAL VALUE OF REALIZABLE TO OPTIONS/ SECURITIES VALUE AT ASSUMED REALIZABLE SARS UNDERLYING ANNUAL RATES DATE SECURITIES GRANTED OPTIONS/ OF STOCK PRICE ----------- UNDER TO SARS ON APPRECIATION FOR GRANT OPTIONS/ EMPLOYEES EXERCISE OR DATE OF OPTION TERM DATE SARS IN FISCAL BASE PRICE GRANT EXPIRATION ----------------- PRESENT GRANTED YEAR ($/SECURITY) ($/SECURITY) DATE 5%($) 10%($) VALUE $ ---------- --------- ------------ ------------ ---------- ------- ------- ----------- Henry R. Mandell..... 100,000 15.5% $ 0.125/shr(1) $ 0.125/shr(1) 3/23/03 $ 625 $ 1,250 $ 0 150,000 23.2% $ 0.50/shr $ 0.125/shr 11/12/03 $ 3,750 $ 7,500 $ 0 250,000 38.7% $ 1.00/shr $ 0.125/shr 11/12/03 $12,500 $25,000 $ 0 Steven D. Gershick... N/A N/A N/A N/A N/A N/A N/A N/A Eric Rene Bos........ N/A N/A N/A N/A N/A N/A N/A N/A Robert L. Montelius.......... N/A N/A N/A N/A N/A N/A N/A N/A Theodore C. Tanner... 50,000 7.7% $ 2.13/shr $ 2.13/shr 2/02/03 $ 5,325 $10,650 $ 0 Peter S. Birch....... 20,000 3.1% $0.1875/shr(2) $0.1875/shr(2) 1/16/03 $ 188 $ 375 $ 0 10,000 1.5% $0.1875/shr $0.1875/shr 10/30/03 $ 94 $ 188 $ 0
- --------------- (1) Repriced from $1.18 per share effective November 12, 1998. (2) Repriced from $1.62 per share effective October 30, 1998. AGGREGATED OPTIONS/SAR EXERCISES IN LAST FINANCIAL YEAR AND FINANCIAL YEAR-END OPTION/SAR VALUES The following table (presented in accordance with the Exchange Act and the Regulations) sets forth details of all exercises of stock options/SARs during the most recently completed financial year by each of the Named Executive Officers and the financial year-end value of unexercised options/SARs on an aggregated basis:
VALUE OF UNEXERCISED SECURITIES AGGREGATE UNEXERCISED IN-THE-MONEY OPTIONS/SARS ACQUIRED VALUE OPTIONS/SARS AT FISCAL YEAR-END($) NAME ON EXERCISE REALIZED AT FISCAL YEAR-END EXERCISABLE/UNEXERCISABLE ---- ----------- --------- ------------------ ------------------------- Henry R. Mandell............. N/A N/A 500,000 $0/$0 Steven D. Gershick........... N/A N/A 333,000 $0/$0 Eric Rene Bos................ N/A N/A 25,000 $0/$0 Robert L. Montelius.......... N/A N/A 25,000 $0/$0 Theodore C. Tanner........... N/A N/A 110,000 $0/$0 Peter S. Birch............... N/A N/A 30,000 $0/$0
40 42 TEN-YEAR OPTION/SAR REPRICINGS The following table (presented in accordance with the Exchange Act and the Regulations) sets forth details of all repricings of stock options/SARs during the most recently completed financial year by each of the Named Executive Officers:
NUMBER OF MARKET LENGTH OF SECURITIES PRICE OF EXERCISE ORIGINAL TERM UNDERLYING STOCK AT PRICE AT REMAINING AT OPTIONS/SARS TIME OF TIME OF NEW DATE OF REPRICED OR REPRICING OR REPRICING OR EXERCISE REPRICING OR NAME DATE AMENDED AMENDMENT AMENDMENT PRICE AMENDMENT ---- -------- ------------ ------------ ------------ -------- ------------- Henry R. Mandell............ 11/12/98 100,000 $ 0.125 $1.18 $ 0.125 4 yrs 4 mths Steven D. Gershick.......... N/A N/A N/A N/A N/A N/A Eric Rene Bos............... N/A N/A N/A N/A N/A N/A Robert L. Montelius......... N/A N/A N/A N/A N/A N/A Theodore C. Tanner.......... N/A N/A N/A N/A N/A N/A Peter S. Birch.............. 10/30/98 20,000 $0.1875 $1.62 $0.1875 4 yrs 2 mths
The above referenced stock option repricings were effected to bring the exercise prices down to reflect the current market price in order to properly incentivize the option holders. The modifications to the exercise prices effected on October 30, 1998 were generally applied to all Spatializer and DPI employees whose option exercise prices were above the then current market price. The modifications to the exercise prices effected on November 12, 1998 were generally applied to the interim chief executive officer whose option exercise prices were above the then current market price. EMPLOYMENT AGREEMENTS Effective October 1991, DPI entered into a two-year employment agreement (which continues thereafter from year to year unless terminated) with Steven Gershick pursuant to which Mr. Gershick was designated as President and Chief Executive Officer, at an annual salary of $125,000. Under his agreement, he serves full time and may terminate his employment on 90-days written notice. The Company may terminate the agreement for cause or at the end of the original or any extended term on 90 days prior written notice. In the event of termination, he is entitled to payment of six months to one year's salary, depending on the term remaining on the date of any termination. The employment agreement provides Mr. Gershick with the employee benefits generally available to other employees of the Company and, in addition, entitles him to life insurance, disability insurance and automobile allowance. He is entitled to bonuses at the discretion of the Board of Directors. His agreement contains confidentiality, nondisclosure and invention provisions typical in the industry. As of January 1, 1995, the annual salary for Steven D. Gershick was increased to $150,000. As of January 1, 1997, the annual salary for Mr. Gershick was again increased to $175,000. As of January 1, 1998 the annual salary for Mr. Gershick was decreased to $65,000, with an additional annual salary of $175,000 to be paid to Mr. Gershick directly from MultiDisc Technologies, Inc. Mr. Gershick resigned as President and Chief Executive Officer in September 1998. Effective June 1996, MDT entered into employment agreements through December 1997 (which were automatically extended for one additional year unless written notice was given by either party by June 1) with Eric Rene Bos and Robert Montelius pursuant to which Mr. Bos was designated as Vice President of Product Development and Mr. Montelius was designated as Vice President of Engineering, at annual salaries of $120,000 each. Under their agreements, they serve full time and may terminate their employment on 90-days written notice. The Company may terminate their agreements for cause or at the end of the original or any extended term with or without written notice. In the event of termination, they are each entitled to one years base salary, payable in equal quarterly installments, in addition to lump-sum payments equal to their base salary through the termination date of their agreement. The employment agreement provides Mssrs. Bos and Montelius with the employee benefits generally available to other employees of the Company and, in addition, entitles them to life insurance, disability insurance and automobile allowance. In addition to being entitled to 41 43 bonuses at the discretion of the Board of Directors, they are each entitled to a $5,000 bonus for each new patent application which MDT or the Company chooses to prosecute in which they are an inventor. Their agreements contain confidentiality, nondisclosure and invention provisions typical in the industry. In May 1997, the Company notified Mssrs. Bos and Montelius that it did not intend to renew their agreements beyond December 1997. In September 1997, the Company notified both parties that it would extend their agreements through June 1998. Effective October 1996, DPI entered into an employment agreement through December 1997 (which, by its terms, has been extended through December 1998 with Theodore Tanner pursuant to which he was designated as Vice President of Engineering, at an annual salary of $85,000. Under his agreement, he serves full time and may terminate his employment on 45-days written notice. The Company may terminate the agreement for cause or at the end of the original or any extended term with or without written notice. In the event of termination, he is entitled to a lump-sum payment equal to his base salary through the termination date of his agreement. The employment agreement provides Mr. Tanner with the employee benefits generally available to other employees of the Company and, in addition, entitles him to life insurance, disability insurance and automobile allowance. In addition to being entitled to bonuses at the discretion of the Board of Directors, he is entitled to a $5,000 bonus for each new patent application which DPI or the Company chooses to prosecute in which he is an inventor. His agreement contains confidentiality, nondisclosure and invention provisions typical in the industry. As of May 16, 1997, the annual salary for Mr. Tanner was increased to $100,000. As of July 1, 1997, the annual salary for Mr. Tanner was again increased to $110,000. As of July 31, 1998, Mr. Tanner's annual salary was increased to $130,000. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information (except as otherwise indicated by footnote) as to shares of Common Stock owned as of March 31, 1999 by, or which can be acquired in sixty days, (i) each person known by management to beneficially own more than five percent (5%) of the Company's outstanding Common Stock, (ii) each of the Company's directors and nominees for election as directors, and (iii) all executive officers, directors and nominees for election as directors as a group:
AMOUNT AND NATURE NAME AND ADDRESS OF BENEFICIAL OWNER(1) OF BENEFICIAL OWNERSHIP PERCENT OF CLASS --------------------------------------- ----------------------- ---------------- DIRECTORS Carlo Civelli(2)(5)....................................... 4,070,958 13.8% Stephen W. Desper(3)(5)................................... 1,976,128 6.7% Steven D. Gershick(5)..................................... 1,176,144 4.0% James D. Pace(4)(5)....................................... 326,997 1.1% Jerold H. Rubinstein(5)................................... 250,000 * Gilbert N. Segel(5)....................................... 220,000 * Scot E. Land.............................................. 63,947 * NAMED EXECUTIVE OFFICERS Henry R. Mandell.......................................... 33,333 * Eric Rene Bos............................................. 16,667 * Robert Montelius.......................................... 16,667 * Theodore Tanner(5)........................................ 71,667 * Peter S. Birch............................................ 6,667 All directors and executive officers as a group (12 8,229,174 27.9% persons)(5)(6)..........................................
- --------------- * Indicates that the percentage of shares beneficially owned does not exceed one percent (1%) of the class. (1) Each of the persons named can be reached at the Company's offices at 20700 Ventura Boulevard, Suite 140, Woodland Hills, California, 91364, except for Carlo Civelli, whose address is Seefeld- 42 44 strasse 214, 8034 Zurich, Switzerland. The persons named in the table have sole voting and investment power with respect to all shares shown to be beneficially owned by them, subject to community property laws where applicable and the information contained in the footnotes to this table. (2) Carlo Civelli controls Clarion Finanz AG, a non-reporting investment company. Holdings of Mr. Civelli and Clarion Finanz AG are combined, and include all shares of the Company held of record or beneficially by either, and all additional shares over which he either currently exercises full or partial control, without duplication through attribution. (3) Does not include 37,853 shares held by Sparkle Co. on behalf of the Estate of Stephen Desper's deceased father, Ira Desper, as to which Mr. Desper disclaims any direct or indirect beneficial interest or control. (4) Does not include 134,497 shares held by Jeffrey C. Evans, a director of DPI, and co-owner with Mr. Pace of Audio Intervisual Design and Developing Technologies Distributors. Mr. Pace disclaims any direct or indirect beneficial interest or control of Mr. Evans' shares. (5) Includes an aggregate of 4,109,127 escrowed performance shares held as of March 31, 1999 as follows: Carlo Civelli, 1,251,792 shares; Jerold H. Rubinstein, 135,000 shares; Stephen W. Desper, 1,736,708 shares; Steven D. Gershick, 758,830 shares; James D. Pace, 114,297 shares; Gilbert N. Segel, 99,000 shares; Theodore Tanner, 13,500 shares. (6) Includes options to purchase 1,116,800 shares exercisable at various prices from $0.125 to $3.26 per share, and expiring on various dates from February, 2000 to March, 2003. (7) Included in the denominator of this percent of class calculation are 732,000 warrants and 1,344,633 options which are exercisable as of March 31, 1999, or within 60 days subsequent to March 31, 1999, but are not in-the-money as of March 31, 1999. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS TRANSACTIONS WITH MANAGEMENT AND OTHERS Except for severance paid to Mr. Desper for a six month period following his resignation from Director of Research in December, 1996 no insider and no security holder who is known to the Company to own more than five percent (5%) of the Common Stock and no member of the immediate family of any of the officers or directors has or has had any material interest, direct or indirect, in any transaction in which the amount involved exceeds U.S. $60,000 since the commencement of the Company's last completed financial year or in any proposed transaction which in either such case has materially affected or will materially affect the Company. At the 1996 Annual Meeting the stockholders approved, subject to regulatory consent, a proposal to modify the terms of the performance share escrow arrangements for certain founders, officers and directors. On December 30, 1996, the Company received final consent from the British Columbia Securities Commission ("BCSC") to a modification arrangement which was less favorable to the holders of performance shares than the proposal approved by the stockholders. The Company has implemented the modification as consented to by the BCSC. Under the revised arrangement, 5% of the performance shares were released June 22, 1997 and the remainder are scheduled to be released automatically as follows: 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. In addition, under the revised arrangement the performance shares will vest if the individual holder has not voluntarily terminated his or her service to the Company prior to the applicable vesting dates. Any individual who is involuntarily terminated by the Company will be entitled to an automatic acceleration of the unvested performance shares. The Board, in its discretion, may allow an individual who has voluntarily terminated his or her services to the Company to retain a portion or all of any unvested performance shares. 43 45 The Company's only indebtedness to related parties is a loan payable to the estate of Stephen Desper's deceased father, Ira A. Desper. The amount payable to the estate at December 31, 1997 was U.S. $112,500. At December 31, 1998, the Company was indebted to four of its directors and one of its executives for an amount totaling $745,000. This amount bears interest at a fixed rate of 10% annually. Of this amount, $650,000 was due on December 31, 1998, and is currently in default. The remaining $95,000 is due on November 30, 1999, or upon the sale of the MDT assets. The Company granted 95,000 warrants to purchase common stock at $0.20 per share in connection with the $95,000 of indebtedness. None of the directors or officers of the Company have been involved in any securities transactions in the last fiscal year (excluding grants and exercises of Employee and Director Incentive Options as described below). COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT The Company is not aware of any officer, director, or beneficial owner of more than 10% of its common stock that has failed to file on a timely basis, as disclosed in such forms, the reports required by Section 16(a) of the Securities Exchange Act during the most recent fiscal year. The Company became a reporting person under the Securities Exchange Act in August of 1995. 44 46 PART IV ITEM 14. EXHIBITS
EXHIBIT NO. DESCRIPTION - ----------- ----------- 2.1* Desper-Spatializer Reorganization Agreement dated January 29, 1992. (Incorporated by reference to the Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company'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 Company's Proxy Statement dated June 25, 1996 and previously filed with the Commission.) 4.7* Form of Subscription Agreement for 1995 Private Placements. (Incorporated by reference to the Company's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 4.8* Form of Subscription Agreement and Warrant Agreement for March 7, 1997 Private Placement. (Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.) 4.9* Modification Agreement for Escrowed Performance Shares. (Incorporated by reference to the Company's Definitive Proxy Statement dated June 28, 1996 and previously filed with the Commission.) 4.10* Subscription Agreement for April 1998 Private Placement. (Incorporated by reference to the Company's Registration Statement on Form S-3, Registrations No. 333-52863, filed May 15, 1998.)
45 47
EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.1*** License Agreement dated June 29, 1994 between DPI and MEC. (Incorporated by reference to the Company'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 Company'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 Company's Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.) 11.1 Statement re: computation of per share earnings. 21.1 Schedule of Subsidiaries of the Company.
- --------------- * 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 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 ended December 31, 1998.] 46 48 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: April 14, 1999 SPATIALIZER AUDIO LABORATORIES, INC. (Registrant) /s/ HENRY R. MANDELL -------------------------------------- Henry R. Mandell Interim Chief Executive Officer & 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
NAME TITLE DATE ---- ----- ---- /s/ STEVEN D. GERSHICK Chairman of the Board April 14, 1999 - --------------------------------------------- Steven D. Gershick /s/ CARLO CIVELLI Director April 14, 1999 - --------------------------------------------- Carlo Civelli /s/ STEPHEN W. DESPER Director April 14, 1999 - --------------------------------------------- Stephen W. Desper /s/ JAMES D. PACE Director April 14, 1999 - --------------------------------------------- James D. Pace /s/ JEROLD H. RUBINSTEIN Director April 14, 1999 - --------------------------------------------- Jerold H. Rubinstein /s/ GILBERT N. SEGEL Director April 14, 1999 - --------------------------------------------- Gilbert N. Segel
47 EX-11.1 2 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS 1 EXHIBIT 11.1 SPATIALIZER AUDIO LABORATORIES, INC. COMPUTATION OF LOSS PER SHARE
DECEMBER 31, 1998 ------------------------------------------ 1998 1997 1996 ----------- ----------- ------------ BASIC LOSS PER SHARE: Net Loss for the Year.............................. $(5,792,061) $(4,719,821) $(25,395,170) Preferred Stock: Dividends in Arrears............................. (148,750) -- -- Effective Dividend Feature....................... (371,450) -- -- ----------- ----------- ------------ Adjusted Net Loss for the Year..................... $(6,312,281) $(4,719,821) $(25,395,170) =========== =========== ============ Weighted Average Common Shares..................... 22,180,180 20,604,095 12,644,751 =========== =========== ============ BASIC LOSS PER SHARE............................... (0.29) (0.23) (2.01) =========== =========== ============ DILUTED LOSS PER SHARE: Net Loss for the Year.............................. $(5,792,061) $(4,719,821) $(25,395,170) Weighted Average Common Shares..................... 22,180,180 20,604,095 12,644,751 Effect of Dilutive Securities: Options.......................................... -- 1,113,015 829,856 Warrants......................................... -- 86,889 15,076 Preferred Stock.................................. 33,155,075 ----------- ----------- ------------ 55,335,255 21,803,999 13,489,683 =========== =========== ============ DILUTED LOSS PER SHARE............................. (0.10) (0.22) (1.88) =========== =========== ============
EX-21.1 3 SCHEDULE OF SUBSIDIARIES OF THE COMPANY 1 SPATIALIZER AUDIO LABORATORIES, INC. SCHEDULE OF SUBSIDIARIES EXHIBIT 21.1 TO FORM 10-K DECEMBER 31, 1998 Spatializer Audio Laboratories, Inc. (Delaware) 20700 Ventura Boulevard, Suite 140 Woodland Hills, California 91364 Wholly owned subsidiaries: 1. Desper Products, Inc. (California) 453 Ravendale Drive, Unit C Mountain View, California 94043 2. MultiDisc Technologies, Inc. (Delaware) 20700 Ventura Boulevard, Suite 140 Woodland Hills, California 91364 EX-27 4 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE DECEMBER 31, 1998 FORM 10-K OF SPATIALIZER AUDIO LABORATORIES, INC. AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS 12-MOS DEC-31-1998 DEC-31-1998 264 0 135 0 8 472 476 291 893 2,447 0 0 1 258 (1,812) 893 1,680 1,680 134 0 3,490 0 85 (2,052) 38 (2,014) (3,702) 0 0 (5,792) (0.29) (0.29)
-----END PRIVACY-ENHANCED MESSAGE-----