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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KA
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(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, 1997
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number: 33-90532
SPATIALIZER AUDIO LABORATORIES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-4484725
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
20700 VENTURA BOULEVARD, SUITE 134
WOODLAND HILLS, CALIFORNIA 91364-2357
(Address of principal executive offices)
TELEPHONE NUMBER: (818) 227-3370
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days:
YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X].
The aggregate market value of the voting stock held by non-affiliates of the
registrant at March 20,1998 was approximately $16,425,000.
As of March 20, 1998 there were 21,423,345 shares of the Registrant's Common
Stock outstanding.
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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, 1997 more than 11 million
licensed units had been shipped. DPI's 3-D audio signal processing technologies
have been incorporated in over 380 products offered by global brand leaders
including in consumer electronics, Toshiba, Panasonic, JVC, Hitachi, Sanyo and
Sharp, and in the PC multimedia marketplace, Compaq, Dell, Gateway, Micron,
Fujitsu, NEC and AST, 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.
The Company's executive offices are located at 20700 Ventura Boulevard, Suite
134, Woodland Hills, California 91364, Telephone (818) 227-3370. World Wide Web
sites (http://www.spatializer.com), (http://www.multidisc.com).
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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 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.
<TABLE>
<CAPTION>
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CATEGORY OF TECHNOLOGY PRODUCT CATEGORIES 3-D AUDIO ENHANCEMENT
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<S> <C> <C>
3-D Stereo Consumer electronics products providing Surround Sound enhancement from
(Spatializer(R) 3-D Stereo) stereo playback - DVD Players, Stereo an ordinary stereo signal
TV's, VCR's, Stereo Components and
Systems, Car Audio, Laptop and Desktop
Multimedia Computers, Set-top Boxes
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Positional Audio Interactive Gaming for Multimedia Simulation of immersive, interactive
(Spatializer enCompass(TM) V2.0) Computers under Windows `95/'97, Virtual sonic environments including sound
Reality Applications. objects that move in real time with
related graphics objects or changes in
game player position or perspective.
- ------------------------------------------------------------------------------------------------------------------------
Two-Speaker Virtualization Products incorporating multi-channel Creation of spatially accurate multi-
(Spatializer N-2-2(TM)) Digital audio sources like Dolby Digital(R) (AC-3), speaker cinematic audio experience
Virtual Surround Dolby ProLogic(R) or MPEG-2. Home from two speakers, and headphones
Theater, DVD-Video, Multimedia utilizing discrete multi-channel audio
Computers utilizing DVD/MPEG and information.
decoding.
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</TABLE>
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.
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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 enCOMPASS 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.
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, 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.
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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,
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, 1997, the Company has entered into four non-exclusive Foundry
Licenses for its 3-D Stereo technology with Matsushita Electronics Corporation
("MEC"), ESS Technology, Inc. ("ESS"), OnChip Systems, Inc. ("OnChip") and
Luxsonor. 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.
In July of 1997, ESS Technology, Inc. entered into an additional Foundry License
for Spatializer VBX(TM) N-2-2 V1.0 and enCompass V1.0.
Additionally, 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, 1997, more than 11 million ICs incorporating Spatializer 3-D
Stereo audio signal processing technology had been manufactured and sold.
OEM Licensees and Customers
As of December 31, 1997, the Company technology had been incorporated in
products offered by 81 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.
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The following table is a partial list of the OEM Licensees and authorized
customers as of December 31, 1997:
<TABLE>
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PARTIAL LIST OF OEM LICENSEES OR CUSTOMERS LISTING - CONTINUED
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<S> <C>
AST Panasonic TV & VCR (Matsushita Kotobuki Electronics
Bung Enterprises, Ltd. Industries, Ltd.)
Compaq Computer Corp. Panasonic Car Audio (Matsushita Communications
Dell Computer Corp. Industrial Co., Ltd.)
Digital Equipment Corp. Proton Electronic Industrial Co., Ltd.
Digital Technology Systems Of California, Inc. Samsung Information Systems, America
Fujitsu Computer Corp. Seiko Epson Corp.
Hewlett Packard Sanyo Corp.
Hitachi, Ltd. Sharp Corp.
Iiyama Electric Co., Ltd. Toshiba DVD
Gateway Computer Corp. Toshiba TV
JVC Taisei Electric, Inc.
Labtec Enterprises, Inc. Taiyo Electric Company, Ltd.
Mag Monitors Texas Instruments
Micron Computer Corp. Theta Digital
NEC
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</TABLE>
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.
Professional Recording, Film and Broadcast Products
The Company's PRO Spatializer(R), is a microprocessor-based audio production
system designed for professional recording, film and broadcast applications. It
offers a multi-track real-time processor that permits spatial expansion, 360
degree dynamic sound movement, and localization of monophonic and stereo sources
utilizing conventional two-speaker stereo playback. It may be used in any phase
of the recording process and is fully compatible with all standard stereo
playback systems. The PRO Spatializer(R) is an expandable system, which offers
from sixteen to twenty-four channels with a Manufacturer's Suggested Retail
Price ("MSRP") of $7,500.
In December 1996, the Company introduced Spatializer(R) RETRO(TM), a rack mount
two-channel analog 3-D audio processor for project studios and live performance
with an MSRP of $649. The Company does not intend to further manufacture this
product and is currently negotiating for the license of its design.
The Company's professional products have, however, served as a proving ground
and established credibility of the Company's technologies, gained a strong
measure of acceptance, and created strong brand recognition for the Spatializer
name in the professional recording, film and broadcast markets as reflected by
the following partial list of credits:
- - Van Halen's "VAN HALEN II"
- - Madonna's "RAY OF LIGHT"
- - Soundtrack for the motion picture "EVITA" featuring Madonna
- - Live Broadcast of the 1996 SUMMER OLYMPICS in Atlanta
- - Twentieth Century Fox's film "BROKEN ARROW"
- - Paramount's "CRIMSON TIDE"
- - Disney's "THE LION KING"
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- - The Eagles "HELL FREEZES OVER" CD
- - Bonnie Raitt's Grammy Award winning "LONGING IN THEIR HEARTS" CD
- - Barbra Streisand's live concert album "BARBRA -- THE CONCERT"
- - Michael Jackson's "HISTORY" CD
- - Warner Bros. animated TV series, including "ANIMANIACS"; "BATMAN: THE
ANIMATED SERIES"; "TAZMANIA"; AND "TINY TOON ADVENTURES"
Capitalizing upon that name recognition, the Company has sought to expand the
market for its technology and products into computer games and multimedia title
production environments, particularly well suited to "3-D" sound enhancement.
Consumer Audio Products In January 1996, the Company introduced its first
Spatializer(R) brand product for consumers, the HTMS-2510(TM) Stereo Surround
Sound System. The device is an easy to install add-on, about the size of a VCR,
that converts any two speakers or multiple speaker home stereo into a
state-of-the-art home theater system. The suggested retail price for the HTMS-
2510 is $249.
Consistent with its plans to concentrate on licensing and software-only
products, the Company does not intend to manufacture additional units, but is
pursuing licensing the product designs and trademarks for manufacture and
distribution in selected geographic regions throughout the world.
SOFTWARE PRODUCTS
Focusing on high margin, lower risk software products, and leveraging its
reputation and brand name recognition in the professional recording industry,
the Company introduced Spatializer(R) PT3D(TM), a software plug-in for the
industry leader Digidesign(R) digital audio workstation platform in November
1996. Priced at an MSRP of $399, PT3D provides Spatializer(R) 3-D sound imaging
and enhancement for the editing and production of audio for music, films and
computer games. The product is currently distributed through PRO Audio dealers
around the country. PT3D(TM) has received favorable reviews in leading industry
publications including Recording magazine (December 1996).
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 expects 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. The Company has added an additional forty-seven patent applications
filed with the United States Patent & Trademark Office ("USPTO") to bring the
total to fifty-two patent applications filed. Additional twenty patent
applications have been identified, which are currently in process and are
expected to be filed in the near future.
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During 1997, MDT built an initial functional prototype known as the MultiDisc
XNS(TM) (Expandable Network Server), which was unveiled at the COMDEX tradeshow,
in mid-November 1997. Optical Servers incorporating the MultiDisc MSSL
technology are expected to be fully configurable, scaleable, and drive and media
independent, permitting ready adaptation and upgradeability to revisions and
innovations in future generations of 12cm CD and DVD data storage media
technologies. When fully developed, MDT's MSSL technology is expected to feature
a flexible modular design, permitting infinitely expandable high-density optical
disc storage and management capabilities, that supports all current and future
12cm CD and DVD formats. The net result is a new class of mass storage devices
significantly faster, smaller and more capable than existing solutions at a
fraction of their current cost.
MSSL technology combines the robotics approach of an optical storage jukebox
with the scalability of a drive array to create a unique data storage solution
with unlimited growth potential in both capacity and performance.
The principal competitive advantages of the MultiDisc technology are extremely
high disc storage density, passive expandability, and unlimited scalability of
the system -- all at very small incremental hardware costs. As a result, MDT
MSSL CD/DVD servers are intended to allow easy accessibility to hundreds or even
thousands of CDs or DVDs into a single low cost device -- literally permitting
terabytes of data storage on a desktop. The chief design goal behind the
MultiDisc Technology is "on-line" accessibility at "off-line" costs. With the
forecasted growth in business networking, Internet and Intranet servers, and
on-line access to an ever-growing data storage market, the demand for
network-capable scaleable compact disc-based storage and archiving technologies
is expected to rise markedly beyond the turn of the century.
Within the wide range of possible markets, the Company plans to focus its
initial efforts on the development of general purpose, modular, scaleable
systems, which have the widest possible vertical and horizontal commercial
application. The top four vertical market applications include:
1. Internet Servers
2. Intranet (Enterprise) Servers
3. Document Imaging
4. Data Backup/Archiving
5. Medical Information and (PACS) imaging.
MDT MSSL technology should have applications in on-line or networked
applications on the Internet/Intranet particularly as more audio, graphic and
full-motion video data types become more prominent as these data-rich
applications require tremendous storage capacity. With the increased
requirements for low cost, near on-line storage, and with the adoption of
Re-Writeable storage technology, the MDT MSSL technology is positioned to
compete with hard disk manufactures for the portion of this marketplace whose
needs may be satisfied by "near" on-line access times.
With the greater availability and requirement for the storage of documents and
images in digital formats, and for the required accessibility of this
information in a near on-line format, the MDT MSSL is ideally suited for the
storage and retrieval of such data-rich information. The availability of low
cost, flexible optical storage solutions allows for the access of information
previously stored in either more expensive hard disk RAID storage systems, or in
paper form. MSSL technology opens this world of information to key business
related data mining applications.
Large vertical applications include patient medical record management and
medical image storage and retrieval (PACS Picture Archival and Compression
Systems). In health care, the trend to on-line systems is expected to continue
as pressures on medical cost reduction and quality assurance increase. In these
health information systems environments, an MDT data server can provide
inexpensive storage for thousands of digital diagnostic images and patient
information for access and distribution within a hospital or medical center or
for access by consulting professionals at remote sites
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There are numerous other vertical market applications, including video-on-demand
systems for hotels or cable systems, check image storage in banks, on-line
resources and retrieval in libraries and similar archives, on-line instruction
in schools and industry, real estate and banking, and in government and industry
where large volumes of paper are being reduced to digital data.
Operating software and user interface designs are currently underway initially
targeting the Windows NT(R) and NOVELL(R) network platforms. The Company is
currently in discussions with potential manufacturing and distribution partners
as well as principal software providers for the CD Jukebox/Changer marketplace.
The major development milestones leading to MDT's market viability will be:
1. Software integration of user interface, motion control and data transfer
functions
2. Production prototype design
3. Completion of supplemental patent applications, and
4. Formation of key strategic manufacturing, distribution, licensing and OEM
customer relationships.
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 $2,781,000 in 1997, were derived substantially from Foundry and OEM
license fees and royalties. No revenues were generated by MultiDisc in 1997.
The Company limits its inventory, capital cost, personnel and overhead cost
exposure in connection with its hardware products by entering into third-party
manufacturing and distribution arrangements. The Company is seeking to maximize
return on its intellectual property base by concentrating its efforts in very
high margin licensing and software products and eliminating its hardware product
operations. Licensing operations have been managed internally by Company
personnel. Sales of professional audio products are accomplished through a
worldwide network of professional audio dealers and managed by Company
personnel.
The Company had two major customers Matsushita Electronics Corp. (MEC) and ESS
Technology, Inc. (ESS) in 1997, each of whom accounted for greater than 10% of
the Company's total 1997 revenues. One OEM accounted for 14% of the Company's
royalty revenues during 1997. All other OEM's accounted for less than 10% of
royalty revenues individually. Royalties from each of the two Foundry Licensees
accounted for 44% and 28% of total royalty revenues in 1997, respectively.
As its first effort to broaden the Company's technology portfolio and capitalize
on the Company's strong relationships with manufacturers of consumer electronics
and personal computer peripheral products, the Company acquired certain
technologies and assets from Home Theatre Products ("HTP"), for approximately
$1,062,000 in June 1996 to form its subsidiary, MultiDisc Technologies, Inc.
("MDT"). In 1997, the Company invested an additional $3,707,000 in research and
development, including prototypes. The MultiDisc XNS(TM) was demonstrated at the
COMDEX tradeshow in November 1997.
In August 1996, the Company prevailed in a 22-month legal battle over its 3-D
Stereo intellectual property when the U.S. District Court granted the Company's
motion for summary judgment against a competitor's assertions of patent
infringement. After submission of papers by the parties, the Court of Appeals
for the Federal Circuit heard oral agreement on November 5, 1997, with respect
to the competitor's appeal. The parties are now waiting for the appeals ruling
of the appellate court. (See ITEM 3 -- LEGAL PROCEEDINGS, Page 11, for further
detail). The uncertainties caused by the patent litigation has continued to
hinder the performance of the Company, particularly since licensing revenue
depends upon OEM unit shipments, which follow three to four quarter production
cycles.
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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.
During 1997, the Company continued its cost cutting measures to reduce 1997
operating costs from 1996 levels.
COMPETITION
3-D AUDIO SIGNAL PROCESSING MARKETPLACE
The Company competes with a number of entities that produce various audio
enhancement processes, technologies and products, some utilizing traditional
two-speaker playback, others utilizing multiple speakers, and others restricted
to headphone listening. These include the consumer versions of multiple
speakers, matrix and discrete digital technologies developed for theatrical
motion picture exhibition (like Dolby Digital(R), Dolby ProLogic(R), and
DTS(R)), as well as other technologies designed to create an enhanced stereo
image from two or more speakers.
The Company's principal competitors in the field of 3-D audio are QSound Labs,
Inc. ("QSound"), SRS Labs, Inc., Aureal Semi-conductor, Inc. and Harman
International. 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.
OPTICAL DISC SERVER/JUKEBOX MARKETPLACE
The optical disc server or CD-ROM changer industry is emerging and is currently
characterized by a single market leader NSM, a German based entity which is
adapting its audio "jukebox" expertise to CD-ROM. NSM sells products under its
own label and as an OEM for other manufacturers. NSM offers only hardware and is
dependent on third parties for control and interface software, and on system
integrators and value added resellers (VARs) to implement the hardware for
individual solutions. Also in this marketplace is Pioneer, Panasonic, JVC, Sony
and Hewlett Packard.
The Company believes that through a strategy of licensing to OEMs or through
third-party manufacturing for sale to OEM that MDT is pursuing a strategy of
cooperation rather than competition. This strategic positioning of the MSSL as
an enabling rather than as a competing technology should maximize market
adoption and minimize the competitive barriers facing MDT.
9
<PAGE> 11
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.
As of December 31, 1997, MDT had fifty-two 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 two patent applications. An
additional twenty patent applications have been identified and are currently in
process. The Company has applied for U.S. trademark protection for its principal
product names and logo marks.
EMPLOYEES
The Company began 1997 with thirty-nine full-time and one part-time employee and
reduced its staff to twenty-eight full-time and two part-time employees by
December 31, 1997. At year-end, there were fourteen employees engaged in
research and development with seven of those employees involved with the
development effort at the Company's subsidiary, MDT. 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 excellent.
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<PAGE> 12
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. During 1997, the
Company also had leased facilities in Natick, MA, Tujunga, CA, 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 Tujunga, CA
and Natick, MA offices during the first and second quarters of the fiscal year
ended December 31, 1997, respectively. Rent expenses of approximately $9,000
associated with these two facilities are included in the 1997 operating
expenses. The Company incurred no lease termination costs in connection with the
closing of these offices.
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.
The Company's regional office in Newbury Park, CA, is the primary location for
the Companies multi-disc server technology division, MultiDisc Technologies,
Inc. ("MDT"). The Company occupies approximately 7,000 square feet of office and
warehouse space in this location and the annual rent for these premises is
approximately $73,000, with the lease term expiring February 28, 1999. Currently
the Company has plans to relocate the MultiDisc division to a location in
Huntington Beach, CA and is actively seeking to sub-lease the Newbury Park
facility.
The Company leases its space at rental rates and on terms which management
believes are consistent with those available for similar space in the applicable
local area. The Company's properties are well maintained, considered adequate
and are being utilized for their intended purposes.
ITEM 3. LEGAL PROCEEDINGS
In the Fall of 1994, QSound Labs, Inc. ("QSound") advised MEC that, in its view,
the Spatializer(R) technology infringed certain U.S. patents held by QSound.
Based on its belief that its technology does not infringe QSound's patents, in
October 1994 DPI initiated Desper Products, Inc. and Spatializer Audio
Laboratories, Inc. v. QSound Labs, Inc., Case No. 94-7276WDK(Bx).
On August 29, 1996 the Court granted the Company's summary judgment motion of
non-infringement in its entirety and denied the motion by QSound in the pending
patent infringement litigation between the Company and QSound.
In granting the Company's summary judgment motion, the Court found that the
Company's IC (Integrated Circuit) does not infringe the QSound patent and denied
QSound's motion with respect to infringement. The Company's claim that the
QSound patent is invalid was not decided and, since the issues which the Court
would need to consider on the patent invalidity claim are similar to certain
issues considered in the infringement claim, QSound was granted the right to
immediately appeal the denial of its motion and trial on the invalidity issue
was deferred until after that appeal. In substance, the Court's finding confirms
the Company's position that there is no infringement by the Company's IC of any
patent held by QSound and that the claims by QSound were without merit. If the
appeal is denied and the Court's decision is confirmed on appeal, the Company
intends to pursue the remaining claims for damages and for a decision that the
QSound patent is invalid. If the appeal is granted and the Court's decision on
the motion is overruled, a trial on the merits would follow at which time the
Company will again assert its current position, which already was adopted in the
grant of the Company's summary judgment motion, and will assert its remaining
claims against QSound.
After submission of papers by the parties, the Court of Appeals for the Federal
Circuit heard oral argument on November 5, 1997, with respect to QSound's
appeal. The parties are now waiting for the decision of the appellate court. The
Company expects that it will ultimately prevail in this case, and therefore, the
disposition of this matter is not expected to have a material effect on the
financial position or results of operations of the Company. However, the outcome
of this litigation cannot be predicted at this time.
The Company is not currently a party to any other legal actions and is not aware
of any other pending claims. The Company anticipates, however, that from time to
time it may be named as a party to legal actions in the ordinary course of
business.
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<PAGE> 13
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, 1997.
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". The following table
sets forth the high and low sales price of the Company's Common Stock on its
principal market for fiscal years 1996 and 1997:
<TABLE>
<CAPTION>
PERIOD: HIGH (U.S. $) LOW (U.S. $)
---------------------------------- --------------------- ---------------------
<S> <C> <C>
1996
First Quarter $5.00 $3.75
Second Quarter $5.41 $4.00
Third Quarter $5.06 $3.19
Fourth Quarter $3.88 $2.88
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
---------------------------------- --------------------- ---------------------
</TABLE>
On March 20, 1998, the closing price reported by NASDAQ was U.S. $1.875.
Stockholders are urged to obtain current market prices for the Company's Common
Stock. Montreal Trust Company of Canada, Vancouver, B.C., was the transfer agent
and registrar for the Company's Common Stock for the 1996 fiscal year. Beginning
April 1, 1997, Harris Trust Company of California became the Company's new
transfer agent.
RECORD HOLDERS
To the Company's knowledge there were approximately 126 holders of record of the
stock of the Company as of March 20, 1998. However, the Company's transfer agent
has indicated that beneficial ownership is in excess of 1,600 shareholders.
DIVIDENDS
The Company has not paid any cash dividends on its Common Stock and has no
present intention of paying any dividends. The current policy of the Company is
to retain earnings, if any, for use in operations and in the development of its
business. The future dividend policy of the Company will be determined from time
to time by the Board of Directors.
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<PAGE> 14
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 31,1997, 1996 and 1995, as of
and for four-month period ended December 31, 1994, and the years ended August
31, 1994 and 1993, 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. The consolidated financial statements as of December 31,
1997 and 1996, and the related consolidated statements of operations,
shareholders' equity, and cash flows for the years ended December 31, 1997, 1996
and 1995, and the report thereon, are included elsewhere in this Report.
<TABLE>
<CAPTION>
Fiscal Year
Fiscal Year Ended August 31, Four Month Ended
------------------------------ Period Ended ---------------------------------------------------
December 31, December 31, December 31, December 31,
1993 1994(1) 1994(1 & 2) 1995(1) 1996 1997
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
CONSOLIDATED
STATEMENT OF
OPERATIONS DATA:
Revenues $ 97 $ 140 $ 187 $ 1,230 $ 2,024 $ 2,781
Cost Of Revenues (55) (61) (25) (79) (186) (230)
------------ ------------ ------------ ------------ ------------ ------------
Gross Profit 42 79 162 1,151 1,838 2,551
Total Operating
Expenses (2,120) (1,808) (1,339) (4,403) (27,042)(3) (7,238)
Other Income
(Expense), Net (25) (79) (16) 74 119 27
Income taxes -- -- -- (63) (310)(4) (60)
------------ ------------ ------------ ------------ ------------ ------------
Net Loss $ (2,103) $ (1,808) $ (1,193) $ (3,241) $ (25,395) $ (4,720)
------------ ------------ ------------ ------------ ------------ ------------
Basic Loss Per
Share (5) $ (0.37) $ (0.26) $ (0.14) $ (0.32) $ (2.01) $ (0.23)
============ ============ ============ ============ ============ ============
Diluted Loss Per
Share (5) $ (0.37) $ (0.26) $ (0.14) $ (0.32) $ (2.01) $ (0.23)
============ ============ ============ ============ ============ ============
Weighted Average
Common Shares 5,740,298 6,891,546 8,552,535 10,156,816 12,644,751 20,604,095
============ ============ ============ ============ ============ ============
CONSOLIDATED
BALANCE SHEET DATA:
Cash and Cash
Equivalents $ 500 $ 1,779 $ 1,540 $ 3,113 $ 1,587 $ 577
Working Capital (66) 6 982 3,159 2,092 283
Total Assets 932 2,676 2,318 4,420 4,141 3,165
Advances From
Related Parties 433 539 517 325 113 113
Shareholders'
Note Payable 292 -- -- -- -- --
Total
Shareholders' $ 69 $ 288 $ 1,367 $ 3,697 $ 3,268 $ 1,525
Equity
</TABLE>
(1) A Plan of Arrangement was completed on July 27, 1994 whereby the situs of
the Company was moved to Delaware. Spatializer Audio Laboratories, Inc., a
Delaware corporation, became the parent company for Spatializer-Yukon and
DPI. The financial statements for this fiscal year reflect the
consolidation of all three entities.
(2) Not comparative.
(3) Includes two one-time significant 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
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<PAGE> 15
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, 1997 compared to the year ended
December 31, 1996, and the year ended December 31, 1996, compared with the year
ended December 31, 1995.
RESULTS OF OPERATIONS
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.
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.
14
<PAGE> 16
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 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
FOR THE YEAR ENDED DECEMBER 31, 1996, COMPARED TO THE YEAR ENDED DECEMBER 31,
1995
RESULTS OF OPERATIONS
REVENUES
The Company reported increased revenues of 65% or $794,000, reaching $2,024,000
for the year ended December 31, 1996, compared to $1,230,000 for the year ended
December 31, 1995. Revenues include sales of
15
<PAGE> 17
professional recording systems, consumer products, license issuance fees and
royalties pertaining to the Spatializer(R) analog integrated circuit ("IC").
The growth in revenues reflect the Company's transition to recurring running
royalties. In 1995 the majority of the Company's licensing revenues were derived
from one-time, up-front license issuance fees. In contrast, a substantial
portion of the licensing revenues for 1996 are derived primarily from running
royalties based on usage and include revenues from four major customers. In 1996
these major customers represent 25%, 24%, 14% and 12%, respectively. The full
impact of the increase in recurring royalties was not realized during 1996, as a
portion of the revenue stream was offset by non-refundable advanced royalties
reported in 1995. As of December 31, 1996, the majority of these advance
royalties had been offset, resulting in the future recognition of revenue on a
basis concurrent with unit shipments.
During the year, the Company offered a new streamlined "bundled" royalty
agreement with its foundries. The bundled royalty agreement is designed to
accelerate revenues and to simplify the selling process of the Spatializer(R)
IC. Foundries will continue to pay a royalty as the IC is manufactured and
shipped to Original Equipment Manufacturers (OEM's), however, the new agreement
makes it easier for foundries to sell the ICs to OEMs by eliminating the need to
negotiate a separate royalty with the OEMs. In this new bundled agreement the
OEM royalty is "bundled" in the chip price and paid directly by the IC Foundry
thus accelerating the receipt of such royalties to the Company. OEMs sign a
simplified Logo Usage Agreement ("LUA") in order to promote the usage of the
Spatializer(R) IC. Twenty-four new licensees were added during the year,
bringing the total to fifty-one Foundry and OEM licensees.
The new licensees were a result of a combination of the new "bundled" licensing
agreement, introduction of the Company's N-2-2(TM) - Digital Virtual
Surround(TM) technologies for multi-channel discrete digital audio systems for
DVD/DVD-ROM, Spatializer 3-D Map(TM) positional audio enhancement software for
Windows(R) 95 ("PT-3D(TM)"), and a favorable ruling by the Court in the
intellectual property litigation with QSound Labs, Inc.
The Company increased product sales through sales of its first consumer product,
the HTMS-2510(TM). Product sales for the year ended December 31, 1996, represent
approximately 17% of revenues compared with only 5% for the same period in 1995.
Due to unsatisfactory sales performance, the Company plans to move away from
such hardware products and to concentrate on the higher-margin software products
such as PT-3D(TM). The Company expects the majority of revenues to continue to
come from licensing activities
Gross profit for the year ended December 31, 1996, was approximately 91% as
compared with 94% for same period in 1995. Profit margins are high as the
majority of revenues are derived from licensing activities which carry low
direct costs. The reduction in gross profit is due to the above referenced
increase in product sales during 1996 since the margin on product sales is lower
than licensing margins.
OPERATING EXPENSES
The Operating expenses for the year ended December 31, 1996 reflect two
significant non-recurring items which occurred in 1996. The first significant
item is for a Compensation expense of $20,218,450 associated with the transfer
of the Company's performance shares from Canadian Escrow into a new escrow
arrangement which will provide for the release of the performance shares for a
period up to six years. The second significant item is for In-Process Research &
Development ("IPR&D") of $680,000 related to the allocation of costs incurred as
a result of the MultiDisc Technologies, Inc. ("MDT") subsidiary's asset
acquisition in June 1996.
After adjusting for the two one-time items listed above, operating expenses for
the year ended December 31, 1996, increased by approximately 40% or $1,740,000,
for a total of $6,144,000 compared to $4,404,000 for the same period in 1995.
This increase can be attributed primarily to the added costs of operations
related to the Company's new MDT subsidiary, increased efforts of Sales and
Marketing including the launch of an aggressive advertising campaign for the
HTMS-2510, as well as the effects of a fully staffed operation at the Desper
Products, Inc. ("DPI").
16
<PAGE> 18
GENERAL AND ADMINISTRATIVE
General and administrative costs remained relatively flat with a minor decrease
of approximately 2% or $51,000, to $2,329,000 for the year ended December 31,
1996 as compared with $2,380,000 for the same period in 1995. The change is
primarily the result of increased payroll and payroll related costs and
financial reporting costs partially offset by savings in travel, external
accounting fees, and consulting and temporary help.
RESEARCH AND DEVELOPMENT
The research and development activity grew substantially in 1996 with the added
operations of the Company's new subsidiary, MDT commencing in June. In addition,
the Company continued efforts to identify, validate, and develop new product
ideas through DPI and introduced both the Spatializer 3-D Map(TM) positional
audio enhancement software for Windows(R) 95 and N-2-2(TM) - Digital Virtual
Surround technologies for multi-channel discrete audio systems in DVD/DVD-ROM
and Home Theater products during the year.
To support these efforts research and development costs increased by
approximately 199% or $1,238,000, to $1,860,000 for the year ended December 31,
1996, compared to $622,000 for the same period in 1995. The increase relates
primarily to expenses incurred of $843,000 related to the Company's newly formed
subsidiary MDT which began operating in June 1996, along with a fully-staffed
operation at DPI.
SALES AND MARKETING
Sales and marketing costs increased approximately 40%, or $554,000, for a total
of $1,955,000 for the year ended December 31, 1996, compared to $1,401,000 for
the same period in 1995. The increase is attributed to payroll and payroll
related costs and advertising costs related to a continued advertising and
promotional campaign directed at the consumer and computer marketplaces.
NET LOSS
The Company incurred the following significant, non-recurring items in 1996
which aggregated $21,147,000. Including these non-recurring items the Company
reported a net loss for fiscal year 1996 of $25,395,000.
- - The Company recorded a one-time non-cash financial statement charge to
earnings of $20,218,000 in the fourth quarter upon final consent by the
BCSC to the modification of the Company's performance share escrow
arrangement. Under the revised arrangement the Company's 5,776,700
"Performance Shares" (representing approximately 24 percent of fully
diluted shares outstanding at December 31, 1996) became subject to a new
escrow arrangement under which the shares will be released under a six
year passage of time. The overall modification was approved by the
Company's shareholders in August 1996. Under the revised arrangement, the
performance shares will be released automatically as follows: 5% on June
22, 1997; 5% on June 22, 1998; 10% on June 22, 1999; 20% on June 22, 2000;
30% on June 22, 2001; and 30% on June 22, 2002. In addition to the
automatic releases, performance shares can be released based on the cash
flow release criteria contained in the original June 22, 1992 escrow
agreement although, to maintain a stable market in the Company's stock, in
any year not more than 30% of the shares will be released, based on the
cash flow criteria.
Under the revised escrow arrangement, the performance shares will vest
provided the individual has not voluntarily terminated his/her service to
the Company prior to applicable vesting dates. Any individual who is
involuntarily terminated by the Company has his/her unvested performance
shares automatically accelerate to them. The Board, in its discretion, may
allow an individual who has voluntarily terminated his/her service to keep
a portion or all of his/her unvested performance shares.
Based on the revised escrow arrangement, which modifies the escrow shares
release from performance criteria to include a time-based criteria as
well, the Company recorded as compensation expense the excess of the fair
market value of the 5,776,700 performance shares on the date the Company
accepted the terms of the new escrow arrangement over the purchase price
of such escrow shares.
17
<PAGE> 19
- - The Company recorded a one-time charge to earnings in June 1996, in the
amount of $680,000 as "In Process Research & Development" in connection
with its MultiDisc Technologies CD/DVD robotics system technology
acquisition.
- - Lastly, in connection with the liquidation of its Canadian predecessor,
the Company incurred and paid Canadian income taxes in the amount of
$249,000.
After adjusting for the above referenced one-time items, the net loss for the
year ended December 31, 1996, totaled $4,248,000, compared to a net loss of
$3,241,000 in 1995, an approximate increase of 31%, or $1,007,000. The increased
loss includes operating expenses incurred of $843,000 related to the Company's
newly formed subsidiary MDT which began operating in June 1996.
During the last quarter of 1996, the Company completed the first phase of
re-organization of its Desper Products, Inc. audio signal processing business by
relocating the East Coast engineering facilities from Natick, Massachusetts to
Mountain View, California. The Company also closed its southern California
research facility.
LIQUIDITY AND CAPITAL RESOURCES
During the third and fourth quarters of 1997 the Company's audio licensing
subsidiary, DPI, was profitable for the first time in the Company's history. The
results of operations do not reflect this profitability because of the Company's
commitment to the development of the MDT server technology. In an effort to
relieve the Spatializer shareholders from the significant capital outlays and
negative earnings impact of funding this development, on November 5, 1997, the
Board of Directors adopted a plan in which MDT will be a separately financed
corporation.
On November 10, 1997, the Company announced a plan in which MultiDisc
Technologies, Inc. (MDT), currently a 100 percent-owned subsidiary, will be
reorganized in a newly formed and separately financed corporation, MultiDisc.
The Company is in negotiation with venture and strategic investors to provide a
minimum of $6 million in new funding, resulting in a post-financing gross
valuation for MultiDisc of not less than $18 million. Under the plan,
Spatializer will, upon closing, hold a 67 percent equity interest in MultiDisc,
representing a value of approximately $0.50 per Spatializer share on a fully
diluted basis.
At December 31, 1997, the Company had $577,000 in cash and cash equivalents as
compared to $1,587,000 at December 31, 1996. The decrease in cash and cash
equivalents is attributed to cash used for the development of MDT's principal
technology demonstrators and cash used in other operating activities. The
Company had working capital of $283,000 at December 31, 1997 as compared with
$2,092,000 at December 31, 1996. The Company's future cash flow will come
primarily from the audio signal processing licensing business' Foundry and
Original Equipment Manufacturers' ("OEM") royalties and common stock issuances
including warrant and option exercises. At December 31, 1997 the Company had
five Foundry licensees, sixty-two OEM Licensees and fourteen authorized
customers for its audio signal processing business as compared with three
Foundry licensees and forty-eight OEM Licensees at December 31, 1996. The
Company is actively engaged in negotiations for additional audio signal
processing licensing arrangements which will generate additional cash flow
without imposing any substantial costs on the Company.
The Company's primary sources of liquidity are its cash and cash equivalents,
which amounted to $577,000 at December 31, 1997, and its bank line of credit.
During the year ended December 31, 1997, cash and cash equivalents decreased by
$1,010,000. This decrease consisted of cash used by operating activities of
$3,679,000, expenditures for property and equipment and intangible assets of
$425,000, partially offset by cash proceeds from the issuance of common stock of
$1,966,000, exercise of options and warrants of $811,000 and bank lines of
credit of $400,000. Cash used by operating activities during the year ended
December 31, 1997 was primarily attributed to cash used for the development of
MDT's principal technology demonstrators.
Components of operating working capital decreased $1,809,000 from December 31,
1996. The decrease is primarily comprised of a decrease in cash and cash
equivalents of $1,010,000, a decrease in inventory of $203,000, an increase in
bank line of credit payable of $400,000 and an increase in accounts payable of
$248,000, partially offset by an increase in accounts receivable of $165,000.
18
<PAGE> 20
The Company continues to have no material long-term obligations and has no
present commitments or agreements which would require any long-term debt or
obligations to be incurred. The Company owed $112,500 to related parties as of
December 31, 1997 and at December 31, 1996.
On July 18, 1997, the Compensation Committee of the Board of Directors re-priced
qualified stock options to purchase 220,103 shares of common stock granted to
various employees beginning in December 1995. The exercise price for these
options was adjusted to $1.31 per share (the closing market price on July 18,
1997) reducing grant date exercise prices ranging from $1.50 to $4.73 per share.
The vesting schedules and expiration dates for these options were not modified.
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 bears interest at an
annual rate of 18% in addition to an administration fee of .50% of the purchased
account receivable. In addition, the advance rate on the line of credit cannot
exceed 80% of the gross receivable purchased. As of December 31, 1997 there were
borrowings against this line of credit in the amount of $400,000. As of March
31, 1998, no borrowings were outstanding.
On April 14, 1998, the Company entered into a $5 million private placement of
which $3 million has been funded. 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 investment. Of the balance of the $5 million, $1 million will be funded
within 45 days of the closing and $1 million will be funded between 60 and 120
days after the effective date of a registration statement covering the common
stock into which the Preferred Stock is convertible. In connection with the
private placement, the Company agreed to issue 1,000,000 common stock 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, 750,000
are being issued to investors (of which 450,000 were issued) and 250,000
warrants are being issued to placement agents (of which 150,000 were issued).
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% will be 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 current investment. In addition to the
private placement, during the first quarter of 1998 the Company received short
term unsecured advances of $650,000 from a related party, all of which are
intended to be repaid with interest at 10% per annum on or before December 31,
1998.
In the private placement, the participants were granted certain rights to
participate in the separate financing of approximately $6 million currently
being pursued by the Company to fund the commercial introduction of its
MultiDisc CD/DVD server technology.
Funds generated by these financing activities as well as cash generated from the
Company's existing operations is expected to be sufficient for the Company to
meet its operating obligations and the anticipated additional research,
development, and commercial prototype cost for the MultiDisc business during the
next twelve months. However, if the $6 million MultiDisc funding is not
completed, the Company will require additional capital, and need to identify
other debt, equity or strategic investment sources to complete the research
development and commercial introduction of the MultiDisc CD/DVD server
technology and for marketing costs related to such activities. If the Company is
unsuccessful in completing the MultiDisc funding management will be required to
modify or delay the timing of the additional MultiDisc development and marketing
activities. Currently, the revenues from the audio business are insufficient to
fund the MDT operations and to sustain the corporate operating costs. Thus,
unless there is a substantial increase in the operating results for the
Company's audio division, or financing activities are successful, the Company
will not have the capital resources to pursue its current business plan on a
longer term basis.
NET OPERATING LOSS CARRYFORWARDS
At December 31, 1997, the Company had net operating loss carryforwards of
$20,310,941 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 2012.
19
<PAGE> 21
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 is addressing this contingency with its computer consultants and plans
to upgrade its software programs in 1998, the cost of which is expected to be no
more than $15,000.
THE ASIAN ECONOMIC CRISIS
Approximately 22% of the Company's revenues for the year ended December 31, 1997
were derived from foundries and OEM's based in Japan and other Asian countries.
The Company believes that the relatively moderate level of the Company's Asian
business, and the concentration of this Asian business with Matsushita
Electronics Corporation which comprised 73% of revenues generated from Asian
customers, has not resulted in a significant impact on revenues or its
profitability.
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. FAS No. 130 is effective for fiscal years beginning after
December 15, 1997. The Company will adopt FAS No. 130 in the first quarter of
fiscal year ended December 31, 1998.
20
<PAGE> 22
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Spatializer Audio Laboratories, Inc.
We have audited the accompanying consolidated balance sheets of Spatializer
Audio Laboratories, Inc. and subsidiaries as of December 31, 1997 and 1996,and
the related consolidated statements of operations, shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1997. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Spatializer Audio
Laboratories, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flow for each of the years in the
three-year period ended December 31, 1997 in conformity with generally accepted
accounting principles.
/s/ KPMG PEAT MARWICK LLP
Los Angeles, California
March 6, 1998, except for note 19, which is
as of April 15, 1998
21
<PAGE> 23
ITEM 8. FINANCIAL STATEMENTS
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
<TABLE>
<CAPTION>
ASSETS DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
Current Assets:
Cash and Cash Equivalents $ 577,413 $ 1,587,395
Accounts Receivable, net of allowance for doubtful
accounts of $190,000, and $90,000 at December 31, 1997 911,505 746,257
and 1996, respectively
Employee Advances 59,086 74,599
Inventory 93,250 296,539
Prepaid Expenses and Deposits 135,702 260,984
Deferred Transaction Costs (Note 3) 146,529 --
------------ ------------
Total Current Assets 1,923,485 2,965,774
Property and Equipment, Net (Note 4) 586,961 622,856
Intangible Assets, Net (Note 5) 654,668 451,733
Other Assets -- 100,832
------------ ------------
$ 3,165,114 $ 4,141,195
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Bank Line of Credit Payable (Note 17) $ 400,000 $ --
Notes Payable (Note 17) 64,272 23,800
Accounts Payable 651,376 403,870
Accrued Wages and Benefits 332,713 217,224
Accrued Liabilities 79,140 115,928
Advances from Related Parties (Note 6) 112,500 112,500
------------ ------------
Total Current Liabilities 1,640,001 873,322
------------ ------------
Commitments and contingencies (Note 15)
Liquidity (Note 18)
Subsequent Event (Note 19)
Shareholders' Equity (Notes 8,9,13, and 14):
Preferred shares, $.01 par value, 1,000,000 shares
authorized, no shares issued or outstanding -- --
Common shares, $.01 par value, 50,000,000 shares 214,100 191,154
authorized, 21,410,012 and 19,115,429 shares issued
and outstanding at December 31, 1997 and 1996,
respectively
Additional Paid-In Capital 41,481,890 38,527,775
Accumulated Deficit (40,170,877) (35,451,056)
------------ ------------
Total Shareholders' Equity 1,525,113 3,267,873
------------ ------------
$ 3,165,114 $ 4,141,195
============ ============
</TABLE>
See accompanying notes to consolidated financial statements
22
<PAGE> 24
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
Consolidated Statements of Operations
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Revenues (Note 12):
Product Revenues, net $ 336,703 $ 336,849 $ 63,507
Licensing Revenues 880,000 -- 627,500
Royalty Revenues 1,564,530 1,687,338 539,213
------------ ------------ ------------
2,781,233 2,024,187 1,230,220
Cost of Revenues 229,736 185,540 78,854
------------ ------------ ------------
2,551,497 1,838,647 1,151,366
------------ ------------ ------------
Operating Expenses:
General and Administrative 2,173,717 2,329,333 2,380,472
Research and Development 3,707,995 1,860,400 622,484
Sales and Marketing 1,356,196 1,954,527 1,400,794
Compensation Expense (Note 9) -- 20,218,450 --
In-Process Research and Development (Note 10) -- 679,684 --
------------ ------------ ------------
7,237,908 27,042,394 4,403,750
------------ ------------ ------------
Operating Loss (4,686,411) (25,203,747) (3,252,384)
Interest Income 57,305 123,643 113,701
Interest Expense (21,063) (14,571) (39,695)
Other Income (Expense), net (8,949) 10,042 --
------------ ------------ ------------
27,293 119,114 74,006
------------ ------------ ------------
Loss Before Income Taxes (4,659,118) (25,084,633) (3,178,378)
Income Taxes (Note 11) (60,703) (310,537) (62,907)
------------ ------------ ------------
Net Loss $ (4,719,821) $(25,395,170) $ (3,241,285)
============ ============ ============
Basic and Diluted Loss Per Share $ (.23) $ (2.01) $ (0.32)
============ ============ ============
Weighted-average shares outstanding 20,604,095 12,644,751 10,156,816
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements
23
<PAGE> 25
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net Loss $ (4,719,821) $(25,395,170) $ (3,241,285)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and Amortization 407,238 130,057 79,719
Loss on Disposal of Property and Equipment
14,281 -- --
Provision for Doubtful Accounts 100,000 90,000 --
Warrants issued for services 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 (249,806) (498,848) (319,604)
Inventory 203,289 (34,408) (22,419)
Prepaid Expenses and Deposits 125,282 (166,916) (31,814)
Other Assets (4,135) (100,832) --
Accounts Payable 247,506 223,824 (73,885)
Accrued Liabilities 78,701 129,622 35,305
------------ ------------ ------------
Net Cash Used in Operating Activities (3,697,465) (4,724,535) (3,573,983)
------------ ------------ ------------
Cash Flows from Investing Activities:
Purchase of Property and Equipment (187,485) (229,780) (164,175)
Increase in Intangible Assets (237,036) (43,118) (69,544)
Deferred Transaction Costs (146,529) -- --
MDT Asset Acquisition -- (1,062,156) --
------------ ------------ ------------
Net Cash Used in Investing Activities (571,050) (1,335,054) (233,719)
Cash Flows from Financing Activities:
Issuance of Common Shares, net 1,956,144 2,649,000 4,823,927
Exercise of Options 408,352 387,535 260,565
Exercise of Warrants 502,565 1,710,587 479,067
Due to Related Parties -- (212,581) (183,638)
Proceeds from Issuance of Notes Payable -- 15,273 972
Proceeds from Bank on Line of Credit 400,000 -- --
Repayments of Notes Payable (18,528) (15,907) --
------------ ------------ ------------
Net Cash Provided by Financing Activities 3,258,533 4,533,927 5,380,893
------------ ------------ ------------
</TABLE>
See accompanying notes to consolidated financial statements
24
<PAGE> 26
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Continued)
<TABLE>
<S> <C> <C> <C>
Impact of changes in exchange rates on cash balances -- -- 98
------------ ------------ ------------
Increase (Decrease) in Cash and Cash Equivalents (1,009,982) (1,525,662) 1,573,289
Cash and Cash Equivalents, Beginning of Year 1,587,395 3,113,057 1,539,768
------------ ------------ ------------
Cash and Cash Equivalents, End of Year $ 577,413 $ 1,587,395 $ 3,113,057
============ ============ ============
Supplemental Schedule of Non-Cash Investing and Financing
Activities:
Capital Expenditures Financed by Lease Obligations and
Notes Payable $ 59,000 $ 10,940 $ -
Stock issued to Settle Debt -- -- 8,583
============ ============ ============
Supplemental Disclosure of Cash Flow Information:
Cash Paid During the Year For:
Interest $ 21,063 $ 13,771 $ 39,695
Income Taxes 60,703 310,729 800
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements
25
<PAGE> 27
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
<TABLE>
<CAPTION>
COMMON SHARES
------------------------------------------------ TOTAL
NUMBER OF ADDITIONAL ACCUMULATED SHAREHOLDERS'
SHARES PAR VALUE PAID-IN-CAPITAL DEFICIT EQUITY
------------ ------------ --------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1994 14,977,996 $ 149,780 $ 8,031,435 $ (6,814,601) $ 1,368,614
Issuance of Shares for Debt 10,000 100 8,483 -- 8,583
Options Exercised (Note 13) 220,500 2,205 258,360 -- 260,565
Warrants Exercised (Note 14) 197,500 1,975 477,092 -- 479,067
Private Placements, Net (Note 8) 2,051,535 20,515 4,803,412 -- 4,823,827
Net Loss -- -- -- (3,241,285) (3,241,285)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1995 17,457,531 174,575 13,578,782 (10,055,886) 3,697,471
Options Exercised (Note 13) 363,033 3,630 383,905 -- 387,535
Warrants Exercised (Note 14) 646,000 6,460 1,704,127 -- 1,710,587
Private Placements, Net (Note 8) 648,865 6,489 2,642,511 -- 2,649,000
Performance Shares (Note 9) -- -- 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 (Note 13) 339,833 3,399 404,954 -- 408,352
Warrants Exercised (Note 14) 287,250 2,872 499,693 -- 502,565
Private Placements, Net (Note 8) 1,667,500 16,675 1,949,468 -- 1,966,144
Warrants Issued for Services (Note 14) -- -- 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
============ ============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements
26
<PAGE> 28
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") is 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. MDT plans to both license its technology or engage in third
party manufacturing arrangements.
On December 5, 1995, the Board of Directors of the Company authorized the
liquidation of Spatializer Audio Laboratories, Inc. - Yukon pursuant to
S.213 of the Business Corporations Act (Yukon). This action was taken to
minimize the tax consequences to the Company. The liquidation was
completed during the first quarter of 1996.
(2) SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation
The consolidated financial statements include the accounts of Spatializer
Audio Laboratories, Inc. and its wholly owned subsidiaries, Desper
Products, Inc. and MultiDisc Technologies, Inc. All 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 $71,500
and $51,500 at December 31, 1997 and 1996, respectively, related to
leasehold improvement and credit card guarantees are included in cash and
cash equivalents in the accompanying consolidated financial statements.
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.
27
<PAGE> 29
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 stock that were
outstanding during 1997, 1996, and 1995 which were not included in the
computation of diluted loss per share because the impact would have been
antidilutive:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Performance Shares -- 5,745,047 5,776,700
Options 1,855,070 1,701,732 1,426,432
Warrants 934,750 174,000 780,000
--------- --------- ---------
2,789,820 7,621,779 7,983,132
========= ========= =========
</TABLE>
Adoption of SFAS 128 did not have an impact on loss per share for the
years ended December 31, 1996 and 1995 as previously reported.
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. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell. Adoption of this
Statement did not have a material impact on the Company's financial
position, results of operations, or liquidity.
28
<PAGE> 30
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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,
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. Prior to the formation of MDT in June 1996, the Company had
only one operating segment, DPI, the Company's 3-D Audio Signal Processing
business. Subsequent to the formation of MDT in June 1996, the Company
also began developing CD/DVD technology.
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. FAS No. 130 is effective for
fiscal years beginning after December 15, 1997. The Company will adopt FAS
No. 130 in the first quarter of fiscal year ended December 31, 1998.
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.
Reclassifications
Certain amounts have been reclassified to conform with the 1997
presentation.
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.
29
<PAGE> 31
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) DEFERRED TRANSACTION COSTS
On November 5, 1997, the Board of Directors adopted a plan in which MDT
will be spun-off into a newly formed and separately financed corporation.
Costs relating to this transaction for legal, accounting, valuation, and
consulting are being deferred until the completion of the transaction.
Under the plan, the company will, upon closing, receive majority interest
in this new company.
(4) PROPERTY AND EQUIPMENT
Property and equipment, at cost, as of December 31, 1997 and 1996 consists
of the following:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Office Computers, Software, Equipment and Furniture $ 788,392 $ 595,993
Test Equipment 114,225 97,928
Tooling Equipment 44,136 44,136
Trade Show Booth and Demonstration Equipment 137,158 130,846
Leasehold Improvements 48,783 45,756
---------- ----------
1,132,694 914,659
Less Accumulated Depreciation and Amortization 545,733 291,803
---------- ----------
$ 586,961 $ 622,856
========== ==========
</TABLE>
At December 31, 1997, the Company had $59,000 of equipment under capital
lease with related accumulated depreciation of $14,750.
(5) INTANGIBLE ASSETS
Intangible assets, as of December 31, 1997 and 1996 consist of the
following:
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Capitalized patent and technology costs $546,260 $309,222
Capitalized patent costs in association
with MDT Asset Acquisition (Note 9) 200,000 200,000
-------- --------
746,260 509,222
Less Accumulated Amortization 91,592 57,489
-------- --------
$654,668 $451,733
======== ========
</TABLE>
(6) DUE TO RELATED PARTIES
The Company was indebted to certain related parties for an amount totaling
$112,500 at December 31, 1997 and 1996. This amount bears interest at a
fixed rate of 10% annually and is due on demand.
(7) FINANCIAL INSTRUMENTS
The carrying values of cash and cash equivalents, accounts receivable,
accounts payable and accrued liabilities at December 31, 1997 and 1996
approximated fair value due to the short maturity of those investments.
30
<PAGE> 32
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The fair value of the advances from related parties could not be estimated
due to the nature of the borrowings.
The fair values of notes payable at December 31, 1997 and 1996 are
materially consistent with the related carrying values based on current
rates offered to the Company for instruments with similar maturities.
(8) SHAREHOLDERS' EQUITY
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").
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.
During the year ended December 31, 1995, shares were issued or converted
as follows:
In August 1995, the Company completed a private placement of 100,000 units
at a price of Cdn. $3.25 (US $2.33) per unit, each unit comprised of one
common share and one-quarter of one non-transferable share purchase
warrant. The Company received Cdn. $325,000 (US $232,772) upon completion
of this placement. One warrant entitles the holder to purchase one
additional share at a price of Cdn. $3.25 (US $2.33) on or before May 2,
1996, and after that date at a price of Cdn. $3.75 (US $2.69) on or before
May 2, 1997.
In August 1995, the Company completed a private placement of 1,200,000
units at a price of Cdn. $3.30 (US $2.40) per unit, each unit comprised of
one common share and one-quarter of one non-transferable share purchase
warrant. The Company received Cdn. $3,960,000 (US $2,876,101) upon
completion of this placement. One warrant entitles the holder to purchase
one additional share at a price of Cdn. $3.30 (US $2.40) on or before May
19, 1996, and after that date at a price of Cdn. $3.80 (US $2.76) on or
before May 19, 1997.
31
<PAGE> 33
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In August 1995, the Company completed a private placement of 350,000 units
at a price of Cdn. $3.45 (US $2.50) per unit, each unit comprised of one
common share and one-quarter of one non-transferable share purchase
warrant. The Company received Cdn. $1,207,500 (US $876,405) upon
completion of this placement. One warrant entitles the holder to purchase
one additional share at a price of Cdn. $3.45 (US $2.50) on or before June
9, 1996, and after that date at a price of Cdn. $4.00 (US $2.90) on or
before June 9, 1997.
Also in August 1995, the Company completed a private placement of 300,000
units at a price of Cdn. $3.85 (US $2.80) per unit, each unit comprised of
one common share and one-quarter of one non-transferable share purchase
warrant. The Company received Cdn. $1,155,000 (US $838,649) upon
completion of this placement. One warrant entitles the holder to purchase
one additional share at a price of Cdn. $3.85 (US $2.80) on or before June
23, 1996 and after that date at a price of Cdn. $4.50 (US $3.27) on or
before June 23, 1997.
In relation to the private placements of the Company's stock during 1995,
finders fees for such placements were paid through the issuance of 101,535
shares of stock.
(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: 5% on June 22, 1997; 5% on June 22, 1998; 10% on June 22, 1999;
20% on June 22, 2000; 30% on June 22, 2001; and 30% on June 22, 2002. In
addition to the automatic releases, performance shares can be released
based on the cash flow release criteria contained in the original June 22,
1992 escrow agreement although, to maintain a stable market in the
Company's stock, in any year not more than 30% of the shares will be
released, based on the cash flow criteria.
Under the revised escrow arrangement, the performance shares will vest
provided the individual has not voluntarily terminated his/her
relationship with the Company prior to applicable vesting dates.
Based on the revised escrow arrangement, which primarily converts the
escrow shares release from performance criteria to a time-based criteria,
the Company recorded as compensation expense the excess of the fair market
value of the 5,776,700 performance shares on the date the Company accepted
the terms of the new escrow arrangement over the purchase price of such
escrow shares.
All of the performance shares are included in the issued and outstanding
shares for the years ended December 31, 1997, 1996, and 1995. 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) ASSET ACQUISITION
In June 1996, the Company purchased certain assets from Home Theater
Products International, Inc. ("HTP"), a debtor in possession, for
$1,062,156, including acquisition costs. Of the purchase price, $679,684
was allocated to In-Process Research and Development ("IPR&D") and
expensed at the Closing. IPR&D is defined as those research and
development efforts that, as of the acquisition date, June 24, 1996, have
not yet generated commercializable products and thus the revenue
generating capability of the products is uncertain. At the date of
acquisition there were no existing products acquired. IPR&D represents 64%
of the total acquisition costs. The remaining 36% was allocated as
32
<PAGE> 34
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
follows: approximately $200,000 to intangible assets, primarily
representing acquired patent applications, and approximately $182,000 to
fixed assets, including computers, office equipment, and furniture. The
Company has not begun amortizing the intangible assets purchased since the
patents had not been approved as of December 31, 1997.
(11) INCOME TAXES
The Company files a consolidated return for U.S. income tax purposes.
Income tax expense for the years ended December 31, 1997, 1996 and 1995
consisted of the following:
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
State franchise tax $ 2,856 $ 58,331 $ --
Foreign taxes 57,847 252,206 62,907
---------- ---------- ----------
$ 60,703 $ 310,537 $ 62,907
========== ========== ==========
</TABLE>
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 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, 1997, 1996 and 1995
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, 1997 and 1996 are presented below.
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 7,514,616 $ 5,913,456
In-process research and development costs 271,873 271,873
Asset reserves 96,015 36,000
Accrued liabilities 103,728 12,384
Property and equipment, principally due to differences
in depreciation and capitalized interest 25,070 3,888
Other 26,483 --
------------ ------------
Total gross deferred tax assets 8,307,785 6,237,601
Less valuation allowance (8,307,785) (6,237,601)
------------ ------------
Net deferred tax assets $ -- $ --
============ ============
</TABLE>
The valuation allowance for deferred tax assets, as of January 1, 1997 and
1996 was $6,237,601 and $3,441,200, respectively. The net change in the
total valuation allowance for the years ended December 31, 1997 and 1996
was an increase of $2,070,184 and $2,796,401, 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. In order to fully realize the
deferred tax asset, the
33
<PAGE> 35
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Company will need to generate future taxable income of approximately
$21,600,000 prior to the expiration of the net operating loss
carryforwards in 2012. 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, 1997 and 1996. 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, 1997, the Company had net operating loss carryforwards for
federal income tax purposes of $20,310,941 which are available to offset
future federal taxable income, if any, through 2012. In addition, the
Company has foreign tax and general business credit carryforwards of
$179,000 and $188,000 respectively.
(12) MAJOR CUSTOMERS
The revenues for the year ended December 31, 1997 include revenues from
two major customers each of whom represent 16% and 56%, 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. The revenues for the year ended
December 31, 1995 include revenues from three major customers each of whom
represent 29%, 13% and 12%, respectively, of total revenues.
(13) 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, 2,141,001 as of December 31,
1997. 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, 1997, there were 285,931 additional shares available for
grant under the Plan. The per share weighted-average fair value of stock
options granted during 1997, 1996 and 1995 was $1.44, $3.24, and $2.89,
respectively, on the date of grant using the Black-Scholes option-pricing
model with the following weighted -average assumptions: 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; 1995 - expected dividend yield 0%, risk-free
interest rate of 6.04%, 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:
<TABLE>
<CAPTION>
1997 1996 1995
-------------- -------------- --------------
<S> <C> <C> <C>
Net loss - as reported $ (4,719,821) $ (25,395,170) $ (3,241,285)
- pro forma (6,408,547) (25,954,816) (3,388,485)
============== ============== ==============
Basic and diluted loss per share
- as reported $ (.23) $ (2.01) $ (.32)
- pro forma (.31) (2.05) (.33)
============== ============== ==============
</TABLE>
34
<PAGE> 36
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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:
<TABLE>
<CAPTION>
NUMBER WEIGHTED AVERAGE
EXERCISE PRICE
- ---------------------------------------- ------------ ----------------
<S> <C> <C>
Options Outstanding at December 31, 1994 1,070,000 $1.164
Options Granted 576,932 $3.176
Options Exercised (220,500) $1.129
------------
Options Outstanding at December 31, 1995 1,426,432 $0.864
Options Granted 715,000 $3.506
Options Exercised (363,033) $1.070
Options Forfeited (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
============
</TABLE>
At December 31, 1997, the ranges of exercise prices and weighted-average
remaining contractual life of outstanding options was as follows:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE REMAINING
RANGES OF EXERCISE PRICES CONTRACTUAL LIFE
------------------------- --------------------------
<S> <C> <C>
$0.87 - $1.31 50 months
$1.50 - $2.00 47 months
$2.34 - $3.26 42 months
$4.30 35 months
</TABLE>
At December 31, 1997 and 1996, the number of options exercisable was
1,233,403, and 1,125,901, respectively, and the weighted-average exercise
price of those options was $2.059, and $2.218, respectively.
On July 18, 1997, the Compensation Committee of the Board of Directors
re-priced qualified stock options to purchase 220,103 shares of common
stock granted to various employees beginning in December 1995. The
exercise price for these options was adjusted to $1.31 per share (the
closing market price on July 18, 1997) reducing grant date exercise prices
ranging from $1.50 to $4.73 per share. The vesting schedules and
expiration dates for these options were not modified.
35
<PAGE> 37
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(14) WARRANTS
Warrant activity for the periods indicated below is as follows:
<TABLE>
<CAPTION>
WARRANTS WARRANT PRICE
------------ -------------
<S> <C> <C>
Warrants Outstanding at December 31, 1994 490,000 $2.618
Warrants Issued 487,500 $2.549
Warrants Exercised (197,500) $2.406
------------
Warrants Outstanding at December 31, 1995 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
============
</TABLE>
All of the warrants granted in 1997, 1996 and 1995 were issued in
connection with private placements except for 100,000 warrants granted in
1997 as consideration for consulting services rendered during 1997. The
fair value of the consulting services ($100,000) was determined to be more
reliably measurable and used to value the warrants, consistent with the
provisions of SFAS 123 paragraph 8. The value of the warrants was included
in research and development costs in the accompanying consolidated
statement of operations for the year ended December 31, 1997. At December
31, 1997 and 1996, the number of warrants exercisable was 934,750 and
174,000 respectively.
(15) COMMITMENTS AND CONTINGENCIES
Legal
In the Fall of 1994, QSound Labs, Inc. ("QSound") advised MEC that, in its
view, the Spatializer(R) technology infringed certain U.S. patents held by
QSound. Based on its belief that its technology does not infringe QSound's
patents, in October 1994 DPI initiated Desper Products, Inc. and
Spatializer Audio Laboratories, Inc. v. QSound Labs, Inc., Case No.
94-7276WDK(Bx).
On August 29, 1996, the Court granted the Company's summary judgment
motion in its entirety and denied the motion by QSound in the pending
patent infringement litigation between the Company and QSound. In granting
the Company's summary judgment motion, the Court found that the Company's
IC (Integrated Circuit) does not infringe the QSound patent and denied
QSound's motion with respect to infringement. The Company's claim that the
QSound patent is invalid was not decided and, since the issues which the
Court would need to consider on the patent invalidity claim are similar to
certain issues considered in the infringement claim, QSound was granted
the right to immediately appeal the denial of its motion and trial on the
invalidity issue was deferred until after that appeal. In substance, the
Court's finding confirms the Company's position that there is no
infringement by the Company's IC of any patent held by QSound and that the
claims by QSound were without merit. The Court of Appeals for the Federal
Circuit heard oral arguments on November 5, 1997. The parties are now
waiting for the decision of the appellate court. If the appeal is denied
and the Court's decision is confirmed on appeal, the Company intends to
pursue the remaining claims for damages and for a decision that the QSound
patent is invalid. If the appeal is granted and the Court's decision on
the motion is overruled, a trial on the merits would follow at which time
the Company will again assert its current position, which already was
adopted in the grant of the Company's summary judgment motion, and will
assert its remaining claims against QSound. QSound has appealed and the
appeal is pending.
36
<PAGE> 38
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Operating Lease Commitments
The Company is obligated for future minimum rental payments for all
operating leases of approximately $240,000, $107,000, and $22,000 during
the years ended December 31, 1998, 1999, and 2000, respectively. Rent
expense amounted to approximately $238,000 $197,000, $132,000, for years
ended December 31, 1997, 1996 and 1995 respectively.
(16) VALUATION AND QUALIFYING RESERVES
The Company had reserves for doubtful accounts recorded in the
accompanying consolidated financial statements which are summarized as
follows:
<TABLE>
<CAPTION>
ALLOWANCE FOR
DOUBTFUL ACCOUNTS
-----------------
<S> <C>
Balance at December 31, 1994 $ --
Charges to expenses --
Deductions --
------------
Balance at December 31, 1995 --
Charges to expenses 90,000
Deductions --
------------
Balance at December 31, 1996 90,000
Charges to expenses 100,000
Deductions --
------------
Balance at December 31, 1997 $ 190,000
============
</TABLE>
(17) FINANCING ARRANGEMENTS
Bank Credit Agreement
The Company has an accounts receivable-based working capital bank line of
credit which provides 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 (18% at
December 31, 1997). At December 31, 1997, borrowings outstanding under
this credit facility amounted to $400,000. The line of credit expires on
October 23, 1998. Unused borrowings under the line of credit were $350,000
at December 31, 1997.
NOTES PAYABLE
Notes payable at December 31, 1997 and 1996 consist of the following:
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Notes payable, secured by equipment, interest at
11.5% to 22%, payable in monthly installments
May 2002 $ 19,781 $ 23,800
Capital lease obligations, payable in monthly
installments through February 2000 44,491 --
------------ ------------
$ 64,272 $ 23,800
============ ============
</TABLE>
The notes payable balances as of December 31, 1997 and 1996 have been
classified as current liabilities since the long-term portion of the debt
is not material to the accompanying consolidated balance sheet.
37
<PAGE> 39
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The aggregate amounts of minimum maturities of notes payable and capital
lease obligations as of December 31, 1997 are as follows:
<TABLE>
<CAPTION>
NOTES CAPITAL LEASE
PAYABLE OBLIGATIONS
----------- -------------
<S> <C> <C>
1998 $ 4,582 $ 22,893
1999 4,582 23,218
2000 4,428 3,906
2001 5,222 --
2002 967 --
----------- -----------
$ 19,781 50,017
===========
Less amounts
representing interest 5,526
-----------
$ 44,491
===========
</TABLE>
(18) LIQUIDITY
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. The Company
has suffered recurring losses from operations and has an accumulated
deficit of $40,170,877 at December 31, 1997. The operating loss of
$4,686,411 in 1997 was primarily the result of $3,793,522 of costs
incurred to develop technology by the Company's subsidiary MDT. MDT is a
development stage enterprise which is devoting substantially all of its
present efforts to develop technology. Planned operations have not
commenced, and accordingly, no revenue has been derived therefrom. Much of
the Company's cash resources have been utilized to develop MDT's
technology since June 1996. The Company has historically relied on cash
from private placements and exercises of options and warrants to provide
funding for operations and its research and development efforts.
Management believes that the Company's cash resources, the private
placement completed on April 14, 1998 (Note 19) and borrowing capacity on
its working capital line of credit combined with the Company's ability, if
necessary to temporarily reduce MDT's research activity, will be
sufficient to fund operations for at least the next year.
(19) SUBSEQUENT EVENT
On April 14, 1998, the Company entered into a $5 million private placement
of which $3 million has been funded. 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 investment. Of the balance of the $5
million, $1 million will be funded within 45 days of the closing and $1
million will be funded between 60 and 120 days after the effective date of
a registration statement covering the common stock into which the
Preferred Stock is convertible. In connection with the private placement,
the Company agreed to issue 1,000,000 common stock 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, 750,000
are being issued to investors (of which 450,000 were issued) and 250,000
warrants are being issued to placement agents (of which 150,000 were
issued). 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% will be 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 current
investment. In addition to the private placement, during
38
<PAGE> 40
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the first quarter of 1998 the Company received short term unsecured
advances of $650,000 from a related party, all of which are intended to be
repaid with interest at 10% per annum on or before December 31, 1998.
In the private placement, the participants were granted certain rights to
participate in the separate financing of approximately $6 million
currently being pursued by the Company to fund the commercial introduction
of its MultiDisc CD/DVD server technology.
(20) 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:
<TABLE>
<CAPTION>
1997 1996
--------------------------------------------- ---------------------------------------------
SEGMENT SEGMENT
DPI MDT TOTAL DPI MDT TOTAL
--------------------------------------------- ---------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
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
============================================= =============================================
</TABLE>
The following is a reconciliation of reportable segment loss and assets,
to the Company's consolidated totals.
<TABLE>
<CAPTION>
1997 1996
------------ ------------
LOSS:
<S> <C> <C>
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
============ ============
</TABLE>
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE - NONE
39
<PAGE> 41
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:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
NOMINEES FOR TERMS ENDING IN 2001:
James D. Pace 42 Director - 2/95 to date.
Member of Compensation Committee - 2/95 to date.
Gilbert N. Segel 65 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 59 Director - 8/91 to date.
Member of Audit Committee - 8/91 to date.
Stephen W. Desper 55 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 43 Director - 7/92 to date.
Chairman of the Board - 12/95 to date.
President and Chief Executive Officer - 7/92 to date.
President of Operating Subsidiary Desper Products, Inc. ("DPI")
- 3/97 to 1/98.
Chief Executive Officer of DPI - 10/91 to date.
President of Operating Subsidiary MultiDisc Technologies, Inc.
("MDT") - 9/97 to date.
Chief Executive Officer of MDT - 6/96 to date.
NOMINEES FOR TERMS ENDING IN 1999:
Carlo Civelli 49 Director - 3/93 to date.
Vice President Finance, Europe - 8/91 to 3/95.
Principal Holder.
Scot E. Land 43 Director
EXECUTIVE OFFICERS:
Michael Bolcerek 35 President of Operating Subsidiary Desper Products, Inc. ("DPI")
- 1/98 to date.
Chief Financial Officer/V.P. Finance - 6/97 to 3/98.
Henry R. Mandell 41 Chief Financial Officer/Senior V.P. Finance - 3/98 to date.
</TABLE>
40
<PAGE> 42
JAMES D. PACE. Director since February 1995. Director of DPI since July 1992.
For more than the last five 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 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. 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. 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. 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. 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.
41
<PAGE> 43
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
<TABLE>
<CAPTION>
=====================================================================================================================
Long Term Compensation
----------------------------------------
Annual Compensation Awards Payouts
-------------------------------------------------------------------------------
Securities
Under
Options/ Restricted
Name and Principal SARs Stock Awards LTIP
Position Year Salary Bonus Other Granted (#) ($) Payouts
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Steven D. Gershick 12/97 $175,000 $ 44,250 $ 9,000 50,000 N/A N/A
Chairman of the Board, 12/96 $150,000 $ 37,500 $ 8,607 50,000 See note 6 N/A
President and CEO 12/95 $150,000 $ 37,500 $ 8,100 150,000 (3) N/A N/A
- ---------------------------------------------------------------------------------------------------------------------
Irwin Zucker (1) 12/97 $140,000 $ 13,000 $ 9,000 N/A N/A N/A
Vice President, 12/96 $ 70,000 $ 37,500 $ 5,007 50,000 (5) See note 6 N/A
Strategic Development
for MDT
- ---------------------------------------------------------------------------------------------------------------------
Eric Rene Bos (1) 12/97 $120,000 $136,500 N/A N/A N/A N/A
Vice President, Product 12/96 $ 60,000 $ 26,500 $10,000 25,000 (5) N/A N/A
Development for MDT
- ---------------------------------------------------------------------------------------------------------------------
Robert Montelius (1) 12/97 $120,000 $136,500 N/A N/A N/A N/A
Vice President, 12/96 $ 60,000 $ 26,500 $10,000 25,000 (5) N/A N/A
Engineering for MDT
- ---------------------------------------------------------------------------------------------------------------------
Theodore Tanner (2) 12/97 $ 98,770 $ 13,000 $ 6,000 15,000 (4) N/A N/A
Vice President, 12/96 $ 64,675 $ 15,500 N/A 45,000 (4) See note 6 N/A
Engineering for DPI
=====================================================================================================================
</TABLE>
(1) Messrs. Zucker, Bos and Montelius all became employees upon the Company's
acquisition of MultiDisc Technologies, Inc. in June, 1996.
(2) Mr. Tanner became an employee of DPI in March, 1996.
(3) The exercise price for these options was adjusted to the closing market
price on April 1, 1997.
(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, Theodore Tanner and Irwin Zucker
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
42
<PAGE> 44
received was as follows: Mr. Gershick, $636,405; Mr. Tanner, $63,640; and Mr.
Zucker, $127,281. On June 22, 1997, 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, 1997, 5,445,115 of the originally
issued performance shares remained outstanding which, based on the $1.50 year
end closing price of the stock, were valued at $8,167,673. Unless released
earlier based on cumulative positive cash flow of $.6285 Cdn. per share, the
remainder of these shares will vest based on the following schedule: 5% June,
1998; 10% June, 1999; 20% June, 2000; 30% June 2001; and, 30% June, 2002.
OPTION/STOCK APPRECIATION RIGHT ("SAR") GRANTS DURING THE
MOST RECENTLY COMPLETED FINANCIAL YEAR
The following table presented in accordance with the Securities Exchange Act of
1934, as amended ("the Exchange Act") and the Regulations thereunder sets forth
stock options granted under the Company's Stock Option Plan ("the Stock Option
Plan") during the most recently completed financial year to each of the Named
Executive Officers:
<TABLE>
<CAPTION>
================================================================================================================================
Individual Grants Alternative
- ----------------------------------------------------------------------------------------- Potential Realizable to
Value at Assumed Realizable
Annual Rates of Stock Value: Grant
Market Value Price Appreciation Value Date
of for Option Term
% of Total Securities
Options Underlying --------------------------------------
Securities /SARs Options/
Under Granted to SARs on Date Grant Date
Options/ Employees in Exercise or of Grant Present
SARs Fiscal Year Base Price ($/Security) Expiration 5%($) 10%($) Value $
Granted ($/Security) Date
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Steven D. 50,000 6.4% $1.50/ $1.50/ share 4/01/02 $3,750 $7,500 $0
Gershick share
- --------------------------------------------------------------------------------------------------------------------------------
Irwin Zucker 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 N/A N/A N/A N/A N/A N/A N/A N/A
Montelius
- --------------------------------------------------------------------------------------------------------------------------------
Theodore 15,000 1.9% $1.31/ $1.31/ share(1) 4/01/02 $ 983 $1,965 $0
Tanner share(1)
================================================================================================================================
</TABLE>
(1) Repriced from $1.50 per share effective July 18, 1997.
43
<PAGE> 45
AGGREGATED OPTIONS/SAR EXERCISES IN LAST FINANCIAL YEAR
AND FINANCIAL YEAR-END OPTION/SAR VALUES
The following table (presented in accordance with the Exchange Act and the
Regulations) sets forth details of all exercises of stock options/SARs during
the most recently completed financial year by each of the Named Executive
Officers and the financial year-end value of unexercised options/SARs on an
aggregated basis:
<TABLE>
<CAPTION>
=======================================================================================================================
Unexercised Value of Unexercised In-the-Money
Securities Aggregate Options/SARs at Options/SARs at Fiscal Year-End ($)
Acquired on Value Realized Fiscal Year-End Exercisable/Unexercisable
Name Exercise
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Steven D. Gershick N/A N/A 333,000 $53,784/ $0
- -----------------------------------------------------------------------------------------------------------------------
Irwin Zucker N/A N/A 50,000 $0/ $0
- -----------------------------------------------------------------------------------------------------------------------
Eric Rene Bos N/A N/A 25,000 $0/ $0
- -----------------------------------------------------------------------------------------------------------------------
Robert Montelius N/A N/A 25,000 $0/ $0
- -----------------------------------------------------------------------------------------------------------------------
Theodore Tanner N/A N/A 60,000 $2,850/ $8,550
=======================================================================================================================
</TABLE>
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:
<TABLE>
<CAPTION>
=====================================================================================================================
Number of Market Price Exercise Length of
Securities of Stock at Price at Original
Underlying Time of Time of Term
Options/SARs Repricing or Repricing or New Exercise Remaining at
Name Date Repriced or Amendment Amendment Price Date of
Amended Repricing or
Amendment
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Steven D. Gershick
Chairman of the Board,
President and CEO 4/1/97 150,000 $1.50 $3.90 $1.50 3 yrs 9 mths
- ---------------------------------------------------------------------------------------------------------------------
Irwin Zucker
Vice President, Strategic 12/12/97 50,000 $1.875 $3.95 $1.875 3 yrs 9 mths
Development for MDT
- ---------------------------------------------------------------------------------------------------------------------
Eric Rene Bos
Vice President, Product
Development for MDT 12/12/97 25,000 $1.875 $3.95 $1.875 3 yrs 9 mths
- ---------------------------------------------------------------------------------------------------------------------
Robert Montelius
Vice President,
Engineering for MDT 12/12/97 25,000 $1.875 $3.95 $1.875 3 yrs 9 mths
- ---------------------------------------------------------------------------------------------------------------------
Theodore Tanner
Vice President, 7/18/97 20,000 $1.31 $4.73 $1.31 4 yrs 0 mths
Engineering for DPI 7/18/97 25,000 $1.31 $3.26 $1.31 4 yrs 3 mths
7/18/97 15,000 $1.31 $1.50 $1.31 4 yrs 9 mths
=====================================================================================================================
</TABLE>
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 July
18, 1997 were generally applied to all Spatializer and DPI employees whose
option exercise
44
<PAGE> 46
prices were above the then current market price. The modifications to the
exercise prices effected on December 12, 1998 were generally applied to all MDT
employees whose option exercise prices were above the then current market price.
Neither of these repricings were undertaken as a special benefit for any
particular executive officer.
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.
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 Messrs. 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 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 Messrs. 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.
45
<PAGE> 47
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, 1998 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:
<TABLE>
<CAPTION>
NAME AND ADDRESS OF BENEFICIAL OWNER (1) AMOUNT AND NATURE OF BENEFICIAL PERCENT OF CLASS
OWNERSHIP
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
DIRECTORS
Carlo Civelli(2)(5) 4,120,958 17.4%
Stephen W. Desper(3)(5) 1,980,845 8.3%
Steven D. Gershick(5) 1,126,144 4.7%
James D. Pace(4)(5) 326,997 1.4%
Jerold H. Rubinstein(5) 250,000 1.1%
Gilbert N. Segel(5) 220,000 *
Scot E. Land 63,947 *
NAMED EXECUTIVE OFFICERS
Irwin Zucker(5) 46,667 *
Eric Rene Bos 8,333 *
Robert Montelius 8,333 *
Theodore Tanner(5) 35,000 *
All directors and executive officers as a
group (13 persons)(5)(6) 8,237,224 34.7%
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
* 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 134, Woodland Hills, California, 91364, except
for Carlo Civelli, whose address is Seefeldstrasse 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 4,365,912 escrowed performance shares held as of
March 31, 1998 as follows: Carlo Civelli, 1,321,336 shares; Jerold H.
Rubinstein, 142,500 shares; Stephen W. Desper, 1,833,192 shares; Steven D.
Gershick, 800,987 shares; James D. Pace, 120,647 shares; Gilbert N. Segel,
104,500 shares; Irwin Zucker, 28,500 shares; Theodore Tanner, 14,250
shares.
46
<PAGE> 48
(6) Includes options to purchase 1,056,800 shares exercisable at various
prices from $0.85 to $3.26 per share, and expiring on various dated from
February, 2000 to January, 2003.
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: 5% on June 22, 1998; 10% on June 22, 1999; 20% on June 22, 2000; 30% on
June 22, 2001; and 30% on June 22, 2002. In addition to the automatic releases,
performance shares can be released based on the cash flow release criteria
contained in the original June 22, 1992 escrow agreement although, to maintain a
stable market in the Company's stock, in any year not more than 30% of the
shares will be released, based on the cash flow criteria.
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.
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.
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.
47
<PAGE> 49
PART IV
ITEM 14. EXHIBITS
2.1* Desper-Spatializer Reorganization Agreement dated January 29, 1992.
(Incorporated by reference to the Registrant's Registration Statement on
Form S-1, Registration No. 33-90532, effective August 21, 1995.)
2.2* Arrangement Agreement dated as of March 4, 1994 among Spatializer-Yukon,
DPI and Spatializer-Delaware. (Incorporated by reference to the
Registrant's Registration Statement on Form S-1, Registration No.
33-90532, effective August 21, 1995.)
3.1* Certificate of Incorporation of Spatializer-Delaware as filed February
28, 1994. (Incorporated by reference to the Registrant's Registration
Statement on Form S-1, Registration No. 33-90532, effective August 21,
1995.)
3.2* Amended and Restated Bylaws of Spatializer-Delaware. (Incorporated by
reference to the Registrant's Registration Statement on Form S-1,
Registration No. 33-90532, effective August 21, 1995.)
4.1* Form of Subscription Agreement for August 1994 Private Placement.
(Incorporated by reference to the Registrant's Registration Statement on
Form S-1, Registration No. 33-90532, effective August 21, 1995.)
4.2* Form of Subscription Agreement for November 1994 Private Placement.
(Incorporated by reference to the Registrant's Registration Statement on
Form S-1, Registration No. 33-90532, effective August 21, 1995.)
4.3* Form of Spatializer-Yukon Incentive Stock Option Agreement.
(Incorporated by reference to the Registrant's Registration Statement on
Form S-1, Registration No. 33-90532, effective August 21, 1995.)
4.4* Spatializer-Delaware Incentive Stock Option Plan (1995 Plan).
(Incorporated by reference to the Registrant's Registration Statement on
Form S-1, Registration No. 33-90532, effective August 21, 1995.)
4.5* Performance Share Escrow Agreements dated June 22, 1992 among Montreal
Trust Company of Canada, Spatializer-Yukon and certain shareholders with
respect to escrow of 2,181,048 common shares of Spatializer-Yukon.
(Incorporated by reference to the Registrant's Registration Statement on
Form S-1, Registration No. 33-90532, effective August 21, 1995.)
4.6* Spatializer-Delaware 1996 Incentive Plan (Incorporated by reference to
the Registrant's Proxy Statement dated June 25, 1996 and previously
filed with the Commission.)
4.7* Form of Subscription Agreement for 1995 Private Placements.
4.8* Form of Subscription Agreement and Warrant Agreement for March 7, 1997
Private Placement.
4.9* Modification Agreement for Escrowed Performance Shares.
5.1* Opinion of Brand Farrar Dziubla Freilich & Kolstad, LLP concerning
legality of unissued securities subject to registration.
10.1*** License Agreement dated June 29, 1994 between DPI and MEC. (Incorporated
by
48
<PAGE> 50
reference to the Registrant's Registration Statement on Form S-1,
Registration No. 33-90532, effective August 21, 1995.)
10.2*** License Agreement dated November 11, 1994 between DPI and ESS.
(Incorporated by reference to the Registrant's Registration Statement on
Form S-1, Registration No. 33-90532, effective August 21, 1995.)
10.3* License Agreement dated June 10, 1994 between Joel Cohen and DPI.
(Incorporated by reference to the Registrant's Registration Statement on
Form S-1, Registration No. 33-90532, effective August 21, 1995.)
10.4* Real Property Lease for executive offices in Woodland Hills, California
(effective April 7, 1995). (Incorporated by reference to the
Registrant's Registration Statement on Form S-1, Registration No.
33-90532, effective August 21, 1995.)
10.6* Employment Agreement between DPI and Steven Gershick dated December 16,
1991. (Incorporated by reference to the Registrant's Registration
Statement on Form S-1, Registration No. 33-90532, effective August 21,
1995.)
21.1* Schedule of Subsidiaries of the Company.
23.1 Consent of KPMG Peat Marwick LLP, independent certified public
accountants.
- ------------------
* Previously filed.
** To be filed by amendment.
*** Portions subject to request for confidential treatment. The confidential
portions omitted have been filed separately with the Commission.
[All 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, 1996.]
49
<PAGE> 51
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: June 25, 1998
SPATIALIZER AUDIO LABORATORIES, INC.
(REGISTRANT)
/s/ Steven D. Gershick
---------------------------------------------------
STEVEN D. GERSHICK
President & Chief Executive Officer
/s/ Henry R. Mandell
---------------------------------------------------
HENRY R. MANDELL
Senior V.P. of Finance & 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
<TABLE>
<S> <C> <C> <C>
CARLO CIVELLI Director June 25, 1998 /s/ Carlo Civelli
----------------------------------
STEPHEN W. DESPER Director June 25, 1998 /s/ Stephen W. Desper
----------------------------------
SCOT LAND Director June 25, 1998 /s/ Scot Land
----------------------------------
JAMES D. PACE Director June 25, 1998 /s/ James D. Pace
----------------------------------
JEROLD H. RUBINSTEIN Director June 25, 1998 /s/ Jerold H. Rubinstein
----------------------------------
GILBERT N. SEGEL Director June 25, 1998 /s/ Gilbert N. Segel
----------------------------------
</TABLE>
50
<PAGE> 1
CONSENT OF INDEPENDENT ACCOUNTANTS
The Board of Directors
Spatializer Audio Laboratories, Inc.:
We consent to the use of our report incorporated herein by reference in the
registration statements on Form S-3 (No. 333-12035) and on Form S-8 (No.
33-98168) on the consolidated balance sheets of Spatializer Audio Laboratories,
Inc. and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the years in the three-year period ended December 31, 1997, which report
appears in the December 31, 1997 annual report on Form 10-K of Spatializer Audio
Laboratories, Inc.
/s/ KPMG Peat Marwick LLP
Los Angeles, California
June 24, 1998
