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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------------
FORM 10-Q
--------------------------------
(MARK ONE)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the period ended: SEPTEMBER 30, 1998
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number: 33-90532
SPATIALIZER AUDIO LABORATORIES, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 95-4484725
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
</TABLE>
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 ___
As of November 10, 1998 there were 24,165,286 shares of the Registrant's Common
Stock outstanding.
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<PAGE> 2
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
----------- -----------
(unaudited)
<S> <C> <C>
Current Assets:
Cash and Cash Equivalents $ 257,777 $ 577,413
Accounts Receivable, net 621,809 911,505
Employee Advances 18,966 59,086
Inventory 100,482 93,250
Prepaid Expenses and Deposits 222,174 135,702
Deferred Transaction Costs 217,586 146,529
----------- -----------
Total Current Assets 1,438,794 1,923,485
Property and Equipment, net 486,821 586,961
Capitalized Patent and Technology Costs, net 831,653 654,668
----------- -----------
Total Assets $ 2,757,268 $ 3,165,114
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Bank Line of Credit Payable $ 120,000 $ 400,000
Notes Payable 166,632 64,272
Accounts Payable 364,623 651,376
Accrued Liabilities 85,826 79,140
Accrued Wages and Benefits 155,941 332,713
Due to Related Parties 762,500 112,500
----------- -----------
Total Current Liabilities 1,655,522 1,640,001
Shareholders' Equity:
Series A, 7% Convertible Preferred shares, $.01 par
value, 1,000,000 shares authorized, 57,400 and 0
shares issued and outstanding at September 30,
1998 and December 31, 1997, respectively 574 -
Common shares, $.01 par value, 50,000,000 shares
authorized, 22,069,652 and 21,410,012 shares
issued and outstanding at September 30, 1998 and
December 31, 1997, respectively 220,696 214,100
Additional Paid-In Capital 44,188,178 41,481,890
Accumulated Deficit (43,307,702) (40,170,877)
----------- -----------
Total Shareholders' Equity 1,101,746 1,525,113
----------- -----------
$ 2,757,268 $ 3,165,114
=========== ===========
</TABLE>
2
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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTH PERIOD ENDED FOR THE NINE MONTH PERIOD ENDED
------------------------------------ ----------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues:
License Revenues $ 55,000 $ 778,971 $ 955,322 $ 898,971
Royalty Revenues 336,120 26,911 566,127 716,453
Product Development Revenues - - 50,000 -
Product Revenues (739) 27,000 16,918 312,788
------------ ---------- ------------ ------------
390,381 832,882 1,588,367 1,928,212
Cost of Revenues 5,556 36,261 35,846 223,502
------------ ---------- ------------ ------------
Gross Profit 384,825 796,621 1,552,521 1,704,710
Operating Expenses:
General and Administrative 655,725 458,236 1,823,176 1,566,791
Research and Development 610,948 775,166 1,774,455 2,154,231
Sales and Marketing 213,342 211,519 1,026,841 831,403
------------ ---------- ------------ ------------
1,480,015 1,444,921 4,624,472 4,552,425
------------ ---------- ------------ ------------
Operating Loss (1,095,190) (648,300) (3,071,951) (2,847,715)
Interest and Other Income 10,283 11,645 25,418 43,337
Interest and Other Expense (31,317) (6,028) (61,856) (15,647)
------------ ---------- ------------ ------------
(21,034) 5,617 (36,438) 27,690
------------ ---------- ------------ ------------
Loss Before Income Taxes (1,116,224) (642,683) (3,108,389) (2,820,025)
Income Taxes (8,056) (18,752) (28,436) (39,252)
------------ ---------- ------------ ------------
Net Loss $ (1,124,280) $ (661,435) $ (3,136,825) $ (2,859,277)
============ ========== ============ ============
Basic and Diluted Loss Per Share $ (0.05) $ (0.03) $ (0.14) $ (0.14)
============ ========== ============ ============
Weighted Average Shares
Outstanding 22,069,652 20,807,516 22,056,157 20,406,282
============ ========== ============ ============
</TABLE>
3
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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------------
1998 1997
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net Loss $ (3,136,825) $ (2,859,277)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and Amortization 129,789 211,625
Options Issued for Services 56,954 -
Net change in Assets and Liabilities:
Accounts Receivable and Employee Advances 329,816 (13,114)
Inventory (7,232) 195,668
Prepaid Expenses and Deposits (86,472) 97,141
Deferred Transaction Costs (71,057) -
Accounts Payable (166,753) (22,663)
Other Assets - (1,821)
Accrued Liabilities (170,086) (147,430)
------------ ------------
Net Cash Used In Operating Activities (3,121,866) (2,539,871)
Cash Flows from Investing Activities:
Purchase of Property and Equipment (29,649) (179,633)
Increase in Capitalized Patent and Technology Costs (176,985) (147,837)
------------ ------------
Net Cash Used in Investing Activities (206,634) (327,470)
------------ ------------
Cash flows from Financing Activities:
Issuance of Preferred Shares, Net 2,610,874 -
Issuance of Common Shares, Net - 2,004,125
Exercise of Options 12,571 -
Exercise of Warrants 33,060 -
Issuance of Notes Payable 120,000 59,532
Issuance of Related Party Payable 650,000 -
Repayment of Bank Line of Credit (400,000) -
Repayment of Notes Payable (17,640) (13,508)
------------ ------------
Net Cash Provided by Financing Activities 3,008,865 2,050,149
------------ ------------
Increase (Decrease) in Cash and Cash Equivalents (319,635) (817,192)
Cash and Cash Equivalents, Beginning of Period 577,413 1,587,395
------------ ------------
Cash and Cash Equivalents, End of Period $ 257,778 $ 770,203
============ ============
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest $ 51,690 $ 15,647
Income Taxes 28,435 39,252
------------ ------------
</TABLE>
4
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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
SERIES A, 7% CONVERTIBLE
PREFERRED SHARES COMMON SHARES
------------------------ -------------
NUMBER OF NUMBER OF ADDITIONAL
SHARES PAR VALUE SHARES PAR VALUE PAID-IN-CAPITAL
----------- --------- ----------- --------- ---------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1997 - $ - 21,410,012 $ 214,100 $41,481,890
Issuance of Preferred Shares, Net 60,000 600 - - 2,610,874
Options Exercised - - 13,333 133 12,571
Warrants Exercised - - 19,000 190 33,060
Options Issued for Services - - - - 56,030
Conversion of Preferred Shares, Net (2,600) (26) 627,307 6,273 (6,247)
Net Loss - - - - -
------ ----- ---------- --------- -----------
Balance, September 30, 1998 57,400 $ 574 22,069,652 $ 220,696 $44,188,178
====== ===== ========== ========= ===========
<CAPTION>
TOTAL
ACCUMULATED SHAREHOLDERS'
DEFICIT EQUITY
------------- -------------
<S> <C> <C>
Balance, December 31, 1997 $ (40,170,877) 1,525,113
Issuance of Preferred Shares, Net - 2,611,474
Options Exercised - 12,704
Warrants Exercised - 33,250
Options Issued for Services - 56,030
Conversion of Preferred Shares, Net - -
Net Loss (3,136,825) (3,136,825)
------------- -----------
Balance, September 30, 1998 $ (43,307,702) $ 1,101,746
============= ===========
</TABLE>
<PAGE> 6
SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) NATURE OF BUSINESS
Spatializer Audio Laboratories, Inc. and subsidiaries (the "Company") are 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 ("CD") and digital
versatile disc ("DVD") server technologies associated with a network based CD /
DVD server for internet and intranet applications. MDT plans to either license
its technology or engage in third party manufacturing arrangements.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The interim consolidated financial statements of the Company are condensed and
do not include some of the information necessary to obtain a complete
understanding of the financial data. Management believes that all adjustments
necessary for a fair presentation of results have been included in the unaudited
consolidated Financial Statements for the interim periods presented.
Accordingly, your attention is directed to footnote disclosures found in the
December 31, 1997 Annual Report and particularly to Note 1 which includes a
summary of 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 accrues foundry revenues based on licensee royalty reports,
management estimates and reports from third parties. At March 31, 1998, the
Company accrued $362,750 of royalty revenue from a major customer based on the
results of a royalty audit, which was settled in June 1998 for $350,000.
Research and Development Expenditures
The Company expenses research and development expenditures as incurred.
(3) LOSS PER SHARE
Loss per share for the three and nine months ended September 30, 1998 includes
the effect of approximately $262,000 of the beneficial conversion feature of the
Series "A", 7% Convertible Preferred Stock as well as dividends in arrears of
$96,250 related to the Series "A", 7% Convertible Preferred Stock.
The following table presents options and warrants to purchase shares of common
stock that were outstanding during the nine month periods ended September 30,
1998 and 1997 which were not included in the computation of diluted loss per
share because the impact would have been antidilutive:
<TABLE>
<CAPTION>
1998 1997
-------------- --------------
<S> <C> <C>
Options 2,008,300 2,051,403
Warrants 1,521,750 834,750
-------------- --------------
3,530,050 2,886,153
============== ==============
</TABLE>
6
<PAGE> 7
(4) COMPREHENSIVE INCOME
The Financial Accounting Standards Board issued Statement No. 130, Reporting
Comprehensive Income ("SFAS 130"), in June 1997. SFAS 130 establishes standards
for reporting and display of comprehensive income and its components in
financial statements. SFAS No. 130 is effective for fiscal years beginning after
December 15, 1997. The Company adopted SFAS No. 130 on January 1, 1998.
Comprehensive income (loss) is the change in equity of a business enterprise
during a period from transactions and all other events and circumstances from
non-owner sources. Other comprehensive income (loss) includes foreign currency
items, minimum pension liability adjustments, and unrealized gains and losses on
certain investments in debt and equity securities. The Company did not have
components of other comprehensive income (loss) during the three-month and nine
month periods ended September 30, 1998 and 1997. As a result, comprehensive loss
is the same as the net loss for the three-month and nine-month periods ended
September 30, 1998 and 1997.
(5) SEGMENT REPORTING
The following table presents information about reported segment losses and
segment assets as of and for the nine-month periods ended September 30, 1998 and
1997.
<TABLE>
<CAPTION>
1998 1997
---------------------------------------------------------------------------------------------
SEGMENT SEGMENT
DPI MDT TOTAL DPI MDT TOTAL
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Revenues from External Customers $ 1,538,367 $ 50,000 $ 1,588,367 $ 1,928,212 $ - $ 1,928,212
Segment Loss (764,218) (2,097,547) (2,861,765) (283,379) (1,964,491) (2,247,870)
Segment Assets 1,259,685 877,654 2,137,339 1,524,832 724,965 2,249,797
</TABLE>
The following is a reconciliation of reportable segment loss to the Company's
consolidated totals.
<TABLE>
<CAPTION>
LOSS: 1998 1997
-------------- --------------
<S> <C> <C>
Total Loss for Reportable Segments $ (2,861,765) $ (2,247,870)
Other Corporate Expenses (275,060) (611,407)
-------------- --------------
Consolidated Total $ (3,136,825) $ (2,859,277)
============== ==============
</TABLE>
(6) MAJOR CUSTOMERS
A substantial portion of the Company's licensing and royalty revenues are
derived from three major customers. The following customers comprised greater
than 10% of total revenues during the nine months ended June 30, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Customer A 57% 31%
Customer B 10% 16%
</TABLE>
(7) CONTINGENCIES
Legal
On September 18, 1998, the U.S. Court of Appeals upheld U.S. District
Court Judge William D. Keller's decision of August 29, 1996 in which the
District Court had granted the Company's summary judgment motion in its entirety
and denied the motion by QSound in the patent infringement litigation between
the Company and QSound. The decision affirmed the District Court's ruling in all
aspects and confirmed that Spatializer is entitled to distribute its products
free of any infringement claim by QSound. The Company intends to maintain and
continue to pursue its counterclaims for damages and for a decision that the
QSound patent is invalid.
In the District Court decision, which was upheld by the Court of
Appeals, the District Court had found that the Company's IC (Integrated Circuit)
does not infringe the QSound patent and had denied in QSound's motion with
respect to infringement. The Company's claim that the QSound patent is invalid
was not decided in the summary judgment and, since the issues which the District
Court would have been required 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 of Appeals decision further 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.
7
<PAGE> 8
(8) SALE OF PREFERRED STOCK
On April 14, 1998, the Company entered into a private placement for up
to $5 million of which $3 million was funded at September 30, 1998. In
connection with the private placement, the Company authorized 100,000 shares of
a new Series A, 7% Convertible Preferred Stock at a stated price of $50 per
share and issued 60,000 shares for $3 million. In connection with the April
funding, the Company issued purchase warrants, exercisable for three years and
entitling the holders to acquire one share of the Company's common stock for
each warrant. Of the warrants, 450,000 were issued and 150,000 warrants were
issued to placement agents. The investor warrants are exercisable at 140% and
the placement warrants are exercisable at 120%, respectively, of the average
closing bid price of the Company's common stock for the 10 days preceding the
closing. In addition, cash placement fees of 10% were paid. A related party of
the Company received 50,000 of the placement agent warrants and $100,000 of the
placement agent cash fee for arranging $1 million of the $3 million investment.
As of September 30, 1998, $1 million of the remaining $2 million of the funding
was due but had not yet been received.
Holders of the Series A Preferred Stock have a right to convert their
shares, at their option on the earlier of (x) ninety (90) days after issuance or
(y) on the effective date of a Form S-3 Registration Statement (the "Conversion
Date") with such conversion to be based on a per share conversion price
("Conversion Price") equal to the lesser of a price that reflects a discount
(the "Conversion Discount") to the average of any three (3) consecutive closing
bid prices for the Company's Common Stock within twenty (20) trading days
immediately prior to the conversion date (the "Floating Conversion Price") or a
price which is equal to one hundred thirty percent (130%) of the closing bid
prices of the Company's Common Stock for the ten (10) trading days immediately
preceding the date of issuance (the "Fixed Conversion Price") provided that in
determining the Conversion Price, the holder shall not count any day on which
its sales account for greater than twenty percent (20%) of the volume of the
Company's Common Stock and on which the holder has sales in the last hour of
trading. The Conversion Discount shall be equal to fifteen percent (15%) if the
Conversion Rights are exercised within one hundred twenty (120) days of first
issuance of the Series A Preferred Stock and shall be equal to seventeen and
one-half percent (17.5%) if the Conversion Rights are exercised after one
hundred (120) days and prior to one hundred forty-nine (149) days of first
issuance of the Series A Preferred Stock. The applicable Conversion Discount
increases by five percent (5%) if the Company is de-listed on NASDAQ. In
addition, the percentage of shares that can be converted at any one time is
limited during such time periods and the holders cannot own more than 4.99% of
the equity of the Company after the Conversion.
The beneficial conversion feature of the Series A Preferred Stock will
be recorded as a dividend using the most favorable conversion terms available to
the shareholder to calculate the dividend in accordance with FASB (Emerging
Issues Task Force) Topic D-60. Since the Company has an accumulated deficit and,
under Delaware Law, must charge dividends against additional paid in capital,
the net impact of recording the beneficial conversion feature is zero since both
sides of the entry are recorded in additional paid in capital. At September 30,
1998, dividends in arrears were $96,250.
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. However, as reported by the Company on
September 25, 1998, the Company has decided to refocus on the core audio
technologies and to properly position the MultiDisc assets for sale. Therefore
this financing is not currently being pursued actively.
8
<PAGE> 9
Item 2. Management's discussion and analysis of financial condition and results
of operations
RESULTS OF OPERATIONS
This form 10-Q contains forward-looking statements, within the meaning of the
Private Securities Reform Act of 1995, which are subject to a variety of risks
and uncertainties. The Company's actual results, performance, or achievements
may differ significantly from the results, performance, or achievements
expressed or implied in such forward-looking statements.
REVENUES
Revenue decreased to $390,000 in the three months ended September 30,
1998 from $833,000 in the comparable period last year, a decrease of 53%.
Revenue in the nine-months ended September 30, 1998 decreased to $1,588,000 from
$1,928,000 in the comparable period last year, a decrease of 18%. Revenues
include licensing and royalties pertaining to the licensing of Spatializer(R)
audio signal processing designs, product development and evaluation fees at
MultiDisc Technologies, Inc. and sales of professional recording systems and
consumer products. The decrease in revenue results primarily from decreases in
recurring royalties for the licensing of the Spatializer technologies and on
chip foundry sales incorporating the usage of Spatializer(R) advanced audio
solutions by the Company's licensees, reflecting weakness in the Asian Market,
as well as the signing, in the third quarter of 1997, of a multi-year,
multi-technology license agreement for which there was no comparable license
agreement in the current quarter.
Desper Products, Inc.'s licensing and royalty revenues decreased to
$390,000 and $1,538,000 in the three and nine months ended September 30, 1998,
from $833,000 and $1,928,000 in the comparable periods last year, decreases of
53% and 20%, respectively.
In addition, there were negligible product sales in the three and nine
months ended September 30, 1998 as compared with the same periods in 1997. The
Company made the decision in late 1997 to discontinue sales of hardware products
in order to focus its efforts on licensing and software-only products. Product
sales for the three months ended September 30, 1998 were ($1,000) as compared to
$27,000 for the comparable period last year. Product sales for the nine months
ended September 30, 1998 were $17,000 as compared to $313,000 for the comparable
period last year.
GROSS PROFIT
Gross profit decreased to $385,000 (99% of revenue) in the three months
ended September 30, 1998 from $797,000 (96% of revenue) in the comparable period
last year, a decrease of 52%. Gross profit for the nine-months ended September
30, 1998 decreased to $1,553,000 (98% of revenue) from $1,705,000 (88% of
revenue) in the comparable period last year, a decrease of 9%. Gross profit
decreased due to the decrease in revenue. Gross margin increased due to the
shift in product mix to licensing revenues, which provide a higher margin than
product revenues.
OPERATING EXPENSES
Operating expenses increased to $1,480,000 (379% of revenue) in the
three months ended September 30, 1998 from $1,445,000 (173% of revenue) in the
comparable period last year, an increase of 2%. Operating expenses in the
nine-months ended September 30, 1998 increased to $4,624,000 (291% of revenue)
from $4,552,000 (236% of revenue) in the comparable period last year, an
increase of 2%. The increase in operating expenses for the three months ended
September 30, 1998 results primarily from increased general and administrative
and sales and marketing expenses partially offset by lower research and
development expenses. The increase in operating expenses as a percentage of
sales in the three and nine months ended September 30, 1998 result from the
decline in revenue.
General and Administrative
General and administrative expenses increased to $655,000 (168% of
revenue) in the three months ended September 30, 1998 from $458,000 (55% of
revenue) in the comparable period last year, an increase of 43%. General and
administrative expenses increased to $1,822,000 (115% of revenue) in the
nine-months ended September 30, 1998 from $1,567,000 (81% of revenue) in the
comparable period last year, an increase of 16%. The increase in general and
administrative expense result from staffing of key executive positions and
related expenses in 1998 that were vacant in the prior comparable period.
9
<PAGE> 10
Research and Development
Research and Development expenses decreased to $610,000 (156% of
revenue) in the three months ended September 30, 1998 from $775,000 (93% of
revenue) in the comparable period last year, a decrease of 21%. Research and
Development expenses decreased to $1,774,000 (112% of revenue) in the
nine-months ended September 30, 1998 from $2,154,000 (112% of revenue) in the
comparable period last year, a decrease of 18%. The decrease in research and
development in the three and nine month periods result from lower research and
development expenditures for prototypes of the MultiDisc eXpandable Network
Server and XNS technology required in the current period compared to the prior
year as well as efficiencies in research and development activities at Desper
Products Inc.
Sales and Marketing
Sales and marketing expenses increased to $215,000 (55% of revenue) in
the three months ended September 30, 1998 from $212,000 (25% of revenue) in the
comparable period last year, an increase of 1%. Sales and marketing expenses
increased to $1,028,000 (65% of revenue) in the nine-months ended September 30,
1998 from $831,000 (43% of revenue) in the comparable period last year, an
increase of 24%. The increase is attributed to the hiring of additional sales
executives at Desper Products Inc., and the initiation of marketing activity at
MultiDisc Technologies, Inc. as it enters its next phase of development.
NET LOSS
Net loss increased to $1,124,000 (288% of revenues) in the three months
ended September 30, 1998 from $661,000 (79% of revenues) in the comparable
period last year, an increase of 70%. Net loss increased to $3,137,000 (198% of
revenue) in the nine-months ended September 30, 1998 from $2,859,000 (148% of
revenue) in the comparable period last year, an increase of 10%. The increased
net loss for the three and nine month period is primarily a result of the
decrease in revenue and gross profit. The increase in loss per share resulted
from the beneficial conversion discount on the issuance of the Preferred Stock.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998, the Company had $258,000 in cash and cash
equivalents as compared to $577,000 at December 31, 1997. The decrease in cash
and cash equivalents is attributed to: (i) cash used for research and
development at MDT on the Modular Scalable Storage Library, (ii) the repayment
of $400,000 of borrowings on a bank line of credit and (iii) cash used in other
operating activities. This was partially offset by net proceeds of $2,620,893
from the sale of preferred stock on April 14, 1998 and proceeds from a $650,000
related party note payable. The Company had negative working capital of $217,000
at September 30, 1998 as compared with working capital of $283,000 at December
31, 1997. The Company's future cash flows are expected to come primarily from
audio signal processing licensing, Foundry and Original Equipment Manufacturers'
("OEM") royalties, common and/or preferred stock issuances including warrant and
option exercises, through venture and/or strategic investors or product
development revenues of MDT. At September 30, 1998 the Company had six Foundry
licensees, seventy-two OEM Licensees and eight authorized customers for its
audio signal processing business as compared with five Foundry licensees and
sixty-two OEM Licensees and fourteen authorized customers at December 31, 1997.
The Company is actively engaged in negotiations for additional audio signal
processing licensing arrangements and equity capital, which should generate
additional cash flow without imposing any substantial costs on the Company.
The Company continues to have no material long-term obligations and has
no present commitments or agreements that would require any long-term debt or
obligations to be incurred. The Company owed $762,500 to related parties as of
September 30, 1998 and $112,500 at December 31, 1997.
On April 14, 1998, the Company entered into a private placement for up
to $5 million of which $3 million was funded at September 30, 1998. In
connection with the private placement, the Company authorized 100,000 shares of
a new Series A, 7% Convertible Preferred Stock at a stated price of $50 per
share and issued 60,000 shares for $3 million. In connection with the April
funding, the Company issued purchase warrants, exercisable for three years and
entitling the holders to acquire one share of the Company's common stock for
each warrant. Of the warrants, 450,000 were issued and 150,000 warrants were
issued to placement agents. The investor warrants are exercisable at 140% and
the placement warrants are exercisable at 120%, respectively, of the average
closing bid price of the Company's common stock for the 10 days preceding the
closing. In addition, cash placement fees of 10% were paid. A related party of
the Company received 50,000 of the placement agent warrants and $100,000 of the
placement agent cash
10
<PAGE> 11
fee for arranging $1 million of the $3 million investment. As of September 30,
1998, $1 million of the remaining $2 million of the funding was due but had not
yet been received.
Holders of the Series A Preferred Stock have a right to convert their
shares, at their option on the earlier of (x) ninety (90) days after issuance or
(y) on the effective date of this Registration (the "Conversion Date") with such
conversion to be based on a per share conversion price ("Conversion Price")
equal to the lesser of a price that reflects a discount (the "Conversion
Discount") to the average of any three (3) consecutive closing bid prices for
the Company's Common Stock within twenty (20) trading days immediately prior to
the conversion date (the "Floating Conversion Price") or a price which is equal
to one hundred thirty percent (130%) of the closing bid prices of the Company's
Common Stock for the ten (10) trading days immediately preceding the date of
issuance (the "Fixed Conversion Price") provided that in determining the
Conversion Price, the holder shall not count any day on which its sales account
for greater than twenty percent (20%) of the volume of the Company's Common
Stock and on which the holder has sales in the last hour of trading. The
Conversion Discount shall be equal to fifteen percent (15%) if the Conversion
Rights are exercised within one hundred twenty (120) days of first issuance of
the Series A Preferred Stock, shall be equal to seventeen and one-half percent
(17.5%) if the Conversion Rights are exercised after one hundred (120) days and
prior to one hundred forty-nine (149) days of first issuance of the Series A
Preferred Stock. The applicable Conversion Discount increases by five percent
(5%) if the Company is de-listed on NASDAQ. In addition, the percentage of
shares that can be converted at any one time is limited during such time periods
and the holders cannot own more than 4.99% of the equity of the Company after
the Conversion.
The beneficial conversion feature of the Series A Preferred Stock will
be recorded as a dividend using the most favorable conversion terms available to
the shareholder to calculate the dividend in accordance with EITF Topic D-60.
Since the Company has an accumulated deficit and, under Delaware Law, must
charge dividends against additional paid in capital, the net impact of recording
the beneficial conversion feature is zero since both sides of the entry are
recorded in additional paid in capital. At September 30, 1998, dividends in
arrears were $96,250.
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. However, as reported by the Company on
September 25, 1998, the Company has decided to refocus on the core audio
technologies and to properly position the MultiDisc assets for sale. Therefore
the financing is not currently being pursued actively.
On September 25, 1998, the Company announced that its Board of
Directors was refocusing the Company's business on the exploitation of its audio
technologies, and, as noted above, to properly position the MultiDisc assets for
sale. In reaching this decision, the Board of Directors noted that the September
18, 1998 decision by the U.S. Court of Appeals confirming the District Court's
grant of a Summary Judgment in favor of the Company and against Qsound was
expected to eliminate the negative market perceptions faced by the Company over
the last four years. Currently the Company is actively pursuing licensing
opportunities, including possible strategic alliances and capital funding
opportunities based on its core audio technologies. In reaching its decision of
September 25, 1998, the Company indicated that while it recognized the prospects
of MultiDisc, the capital investments required to properly commercialize the
technology was beyond its current capacity and, therefore, it had made the
decision to seek a sale transaction. Effective as of that date, Steven D.
Gershick resigned as chief executive officer of the Company and as president of
MultiDisc Technologies, Inc., but continues to serve as chairman of the board of
the Company. Henry R. Mandell, who joined the Company in March, 1998 as senior
vice president finance was designated as interim chief executive officer to
oversee all of the corporate activities with support from Kibel Green Issa, Inc.
Michael Bolcerek resigned as president of Desper Products, Inc.
Funds generated from the financing business activities and capital
transactions described above, as well as cash generated from the Company's
existing operations and the cost reductions being undertaken, are expected to be
sufficient for the Company to meet its operation obligations during the next
twelve months. However, if the refocus on the audio technologies strategy is not
successful, if a strategic alliance including capital funding is not concluded,
or if an appropriate transaction is not undertaken with respect to the MultiDisc
activities, the ability of the Company to meet its operating needs will be
materially adversely affected. As of September 30, 1998, the Company had a
negative working capital of $217,000 and, absent continued and improved revenues
and successful funding activities, the Company may not be in a position to
resolve this deficit.
The Company has responded to inquiries from NASDAQ and attended a
hearing with respect to its continued listing on October 29, 1998 at which time
it outlined its strategy for continued listing. A decision is pending.
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 is
currently upgrading its software programs, the cost of which is expected to be
no more than $15,000.
11
<PAGE> 12
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On September 18, 1998 the U.S. Court of Appeals for the Federal Circuit issued
its decision (97-1135) affirming the decision of the U.S. District Court for the
Central District of California (No. CV 94-7276) in which the District Court had
granted the Company's Motion for Summary Judgment in its entirety and had denied
the Motion by QSound Labs, Inc. ("QSound") in the patent infringement litigation
which had been pending between the Company and QSound since 1994. The Court of
Appeals decision affirmed the District Court's ruling in all respects, with the
effect that it confirmed that the Company is entitled to distribute its products
free of any infringement claim by QSound. The Company intends to maintain and
continue to pursue its counterclaims for damages and for a determination that
the QSound patent is invalid.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
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 third quarter of the
fiscal year ending December 31, 1998.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits -- None
(b) Reports on Form 8-K:
(i) Report on Form 8-K filed on October 2, 1998; date of
events reported - September 25, 1998.
(ii) Report on Form 8-K filed on October 27, 1998 to amend
Report on Form 8-K filed on October 2, 1998
12
<PAGE> 13
SIGNATURES
Pursuant to the requirements 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: November 13, 1998
SPATIALIZER AUDIO LABORATORIES, INC.
(REGISTRANT)
/s/ HENRY R. MANDELL
-----------------------------------
HENRY R. MANDELL
Interim Chief Executive Officer
Chief Financial Officer
13
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<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
SEPTEMBER 30, 1998 FINANCIAL STATEMENT AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 257,777
<SECURITIES> 0
<RECEIVABLES> 621,809
<ALLOWANCES> 0
<INVENTORY> 100,482
<CURRENT-ASSETS> 1,438,794
<PP&E> 1,162,343
<DEPRECIATION> 675,522
<TOTAL-ASSETS> 2,757,268
<CURRENT-LIABILITIES> 1,655,522
<BONDS> 0
0
574
<COMMON> 220,696
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 2,757,268
<SALES> 1,588,367
<TOTAL-REVENUES> 1,588,367
<CGS> 35,846
<TOTAL-COSTS> 4,624,472
<OTHER-EXPENSES> 0
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<INTEREST-EXPENSE> 61,856
<INCOME-PRETAX> (3,108,389)
<INCOME-TAX> 28,436
<INCOME-CONTINUING> (3,136,825)
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