Enveric Biosciences, Inc. - Quarter Report: 2002 March (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

(Mark One)

OR

Commission File Number: 33-90532

SPATIALIZER AUDIO LABORATORIES, INC.

920 Hampshire Road, Suite A-34
Westlake Village, California 91361

900 Lafayette Street, Suite 710
Santa Clara, California 95050

Telephone Number: (408) 296-0600

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:

As of May 8, 2002, there were 47,406,939 shares of the Registrant’s Common Stock outstanding.

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PART I. FINANCIAL INFORMATION

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS

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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)

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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(unaudited)

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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(1) Nature of Business

Spatializer Audio Laboratories, Inc. and subsidiaries (the “Company”, “our” and “we”) are in the business of developing and licensing technology.

Our 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.

Our wholly owned subsidiary, MultiDisc Technologies, Inc. (“MDT”) was in the business of developing scalable, modular compact disc (“CD”) and digital versatile disc (“DVD”) server technologies associated with a network based CD / DVD server for internet and intranet applications. Operations of MDT were discontinued in the fourth quarter of 1998. Our efforts to sell these assets, though continuing, have not been successful to date.

(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. Operating results for the three-month period ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. Accordingly, your attention is directed to footnote disclosures found in the December 31, 2001 Annual Report and particularly to Note 2 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 subsidiary, Desper Products, Inc. MultiDisc Technologies, Inc. has been presented as a discontinued operation. All significant intercompany balances and transactions have been eliminated in consolidation.

Revenue Recognition
We accrue revenues based on licensee royalty reports, management estimates and reports from third parties. While management endeavors to minimize the use of estimates, any deviation from estimates utilized are adjusted in the subsequent quarter. Royalty income reported is based on the shipment of product incorporating the related technology by the original equipment manufacturer or foundries.

Research and Development Expenditures
We expense research and development expenditures as incurred.

(3) 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)

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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 the three month periods ended March 31, 2002 and 2001 which were not included in the computation of diluted loss per share because the impact would have been antidilutive or insignificant:

(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 was effective for fiscal years beginning after December 15, 1997. We 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. We did not have components of other comprehensive income during the three-month periods ended March 31, 2002 and 2001. As a result, comprehensive income is the same as the net income for the three-month periods ended March 31, 2002 and 2001.

(5) 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 was effective for financial statements for fiscal years beginning after December 15, 1997. We adopted SFAS 131 in December 1997. At March 31, 2002, we have only one operating segment, DPI, the Company’s Audio Signal Processing business.

(6) Major Customers

A substantial portion of our licensing and royalty revenues are derived from three major customers. The following customers comprised greater than 10% of total revenues during the three months ended March 31, 2002 and 2001:

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(7) Contingencies

Legal

In connection with the downsizing of the Company in 1998, a number of employees were terminated and have filed, on various dates, employment and compensation related claims with California State labor authorities, all but two of which claims have been settled. Two former officers and employees of MDT initiated proceedings before the Labor Commissioner in 2000 seeking amounts allegedly due under their employment agreements, which claims, if resolved in favor of the claimants, could be material to the financial statements of the Company. The Labor Commissioner has postponed those proceedings. In that action, the claimants filed a motion to strike the MDT complaint under the California “anti-Slapp” legislation. The Court rejected that motion and the litigation is in the discovery stages. Separately, MDT initiated litigation in the Superior Court, Orange County seeking declaratory relief to bar the labor claims, as well as return of intellectual property and unspecified damages for breaches of the former officers’ and employees’ employment agreements. These employees, however, have filed for personal bankruptcy and as a result, the claims became inactive. At December 2001, bankruptcy for one such employee had been dismissed and that proceeding could be reactivated.

We also anticipated that, from time to time, we may be named as a party to other legal proceedings that may arise in the ordinary course of our business.

(8) Sale of Preferred Stock

In the December 1999, $895,000 in short term loan advances from officers, directors and their affiliates and certain other securities holders, and accrued interest of $134,647, were restructured into the $1,000,000 in new Series B preferred stock. The Series B preferred stock, and any dividends therefrom not converted into cash, are convertible commencing in 2001 into restricted Common Stock at a 10% discount, based on the 10 day average closing bid price prior to the conversion, but subject to a minimum conversion of $.56 per share and a maximum of $1.12 per share. We have a three year option to redeem any Series B preferred stock, not sooner converted, in whole or in part, in cash.

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(9) Discontinued Operations

In September, 1998, the Board of Directors approved a plan to refocus corporate activities on our core audio business, Desper Products, Inc. In conjunction to this strategic refocusing, we permanently suspended operations of MDT and placed the business and its related patent portfolio up for sale. We are accounting for the on-going operating and termination expenses of MDT as a discontinued operation.

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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. Our actual results, performance, or achievements may differ significantly from the results, performance, or achievements expressed or implied in such forward-looking statements.

Revenues

     Revenues for the three months ended March 31, 2002 were $440,000, compared to revenues of $426,000 in the comparable period last year, an increase of 3%. The increase in revenues resulted primarily from royalties from new accounts including SANYO and Sharp which were beginning to come on stream, partially offset by the reduction in royalties from an account which suspended use of our technology in mid-2001.

Gross Profit

Gross profit for the three months ended March 31, 2002 was $412,000 (94% of revenue) compared to gross profit of $399,000 (94% of revenue) in the comparable period last year, an increase of 3%. Gross profit increased due to the increase in revenue.

Operating Expenses

Operating expenses in the three months ended March 31, 2002 were $389,000 (88% of revenue) compared to operating expenses of $402,000 (94% of revenue) in the comparable period last year, decrease of 3%. The decrease in operating expenses for the three months ended March 31, 2002 resulted primarily from decreased use of outside consultants.

General and Administrative

General and administrative expenses in the three months ended March 31, 2002 were $135,000 (31% of revenue) compared to general and administrative expenses of $151,000 (35% of revenue) in the comparable period last year, a decrease of 11%. The decrease in general and administrative expense resulted from termination of the outside investor relations consultant, who provided such services in the comparable period last year.

Research and Development

Research and development expenses in the three months ended March 31, 2002 were $124,000 (28% of revenue) compared to research and development expenses of $137,000 (32% of revenue) in the comparable period last year, a decrease of 9%. The decrease in such expenses resulted primarily from more applications engineering performed in-house as compared with the prior period.

Sales and Marketing

Sales and marketing expenses in the three months ended March 31, 2002 were $130,000 (30% of revenue) compared to sales and marketing expenses of $114,000 (27% of revenue) in the comparable period last year, an increase of 14%. The increase in sales and marketing expense resulted primarily from greater international travel in the current period and marketing support expense as compared with the comparable period last year.

Net Income

     Net Income in the three months ended March 31, 2002 was $21,000, ($0.00) basic and diluted per share, compared with net income of $6,000 ($0.00) basic and fully diluted per share in the comparable period last year, an increase of 250%. The increase in net income resulted from increased revenues and a decrease in operating expenses. This increase in net income was partially offset by a reduction in interest income, resulting from declining interest rates.

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Liquidity and Capital Resources

     At March 31, 2002, we had $878,000 in cash and cash equivalents as compared to $869,000 at December 31, 2001. The increase in cash and cash equivalents is attributed to cash components of net income. We had working capital of $1,084,000 at March 31, 2002 as compared with working capital of $1,124,000 at December 31, 2001. Our future cash flow will come primarily from the audio signal processing licensing, Original Equipment Manufacturers’ (“OEM”) royalties and from possible common stock issuances including warrants and options. We are actively engaged in negotiations for additional audio signal processing licensing arrangements which should generate additional cash flow without imposing any substantial costs on the Company.

     Like other operating enterprises, the events of September 11, 2001 in the United States brought a degree of uncertainty to our operations and hindered our ability to plan and meet with our contractual partners outside the United States in this dynamic environment. The operations of our business, and those of our competitors, may also be impacted by the continued trend in the semiconductor industry to offer free, but minimal audio solutions to certain product classes to maintain and attract market share. This challenges our ability to convert business opportunities to licensing agreements in those segments that allow us to maintain or rapidly increase revenue. As a result, the Company must develop and license its products and software solutions in a market that treats some audio products, including those of our competitors, on a commodity basis in those cases where the OEM product is considered a commodity product. While our software applications deliver what we and most manufacturers who listen to it believe is a significantly superior audio experience, the competitive market forces that pressure manufacturers to reduce their costs may create some resistance to new technology adoption or use. In addition, certain of our competitors appear to be pursuing a business plan that disregards commercially reasonable pricing to achieve a larger market penetration even if the penetration will not provide for viable margins or returns. The Company has responded by offering additional products targeted to each price/quality segment of the market and continues to aggressively pursue new opportunities in emerging product categories and complements to our existing core business. In addition, our products have been positioned as a means for manufacturers to save money while delivering an enhanced audio experience. Nevertheless, these market conditions and competitive forces make it more challenging for the Company, and its rational commercial competitors, to enhance their operating results.

     We have a related party obligation of $112,500, which is due upon demand. We repaid related party obligations of $225,000 plus accrued interest of approximately $30,000, which were convertible into Common Stock at our or the Lender’s option in June 2001. The Company owed a total of $112,500 to related parties on December 31, 2001.

     In December 1999, we completed a set of financial transactions (the “December Transactions”) with certain existing holders of our equity and debt and with new institutional investors. The December Transactions included the private placement of 1,884,254 additional shares of our Common Stock ($1.05 million in new capital or $0.56 per share), the issuance of warrants to acquire 2,100,000 shares of Common Stock exercisable for three years at an exercise price of $.67 per share), the cancellation of 500,000 warrants to acquire Common Stock issued in that earlier financing, the conversion of $1 million of short term debt into a new Series B Redeemable Convertible Preferred Stock (“Series B Preferred Stock”) and the conversion of $225,000 of secured debt into secured convertible debt.

     In the December Transactions, $895,000 in short term loan advances from officers, directors and their affiliates and certain other securities holders, and accrued interest of $134,647, were restructured into the $1,000,000 in new Series B Preferred Stock. The Series B Preferred Stock, and any dividends there from not converted into cash, are convertible commencing in 2001 into restricted Common Stock at a 10% discount, based on the 10 day average closing bid price prior to the conversion, but subject to a minimum conversion of $.56 per share and a maximum of $1.12 per share. We have a three year option to redeem any Series B Preferred Stock, not sooner converted, in whole or in part, in cash.

     In the December Transactions, $225,000 of secured debt, including accrued interest, was converted into secured long term convertible debt. The long term debt is held by existing institutional investors and is secured by essentially all of our assets. The debt, and accrued interest, is convertible at our or the holder’s options into registered Common Stock at a conversion price equal to the

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average 10 day closing bid price prior to conversion but subject to the same minimum and maximum conversion prices set for the Series B Preferred Stock.

     Funds generated by these financing activities as well as cash generated from our existing operations and customer base is expected to be sufficient for us to meet our operating obligations and the anticipated additional research and development for our audio technology business.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In connection with the downsizing of the Company in 1998, a number of employees were terminated and have filed, on various dates, employment and compensation related claims with California State labor authorities, all but two of which claims have been settled. Two former officers and employees of MDT initiated proceedings before the Labor Commissioner in 2000 seeking amounts allegedly due under their employment agreements, which claims, if resolved in favor of the claimants, could be material to the financial statements of the Company. The Labor Commissioner has postponed those proceedings. In that action, the claimants filed a motion to strike the MDT complaint under the California “anti-Slapp” legislation. The Court rejected that motion and the litigation is in the discovery stages. Separately, MDT initiated litigation in the Superior Court, Orange County seeking declaratory relief to bar the labor claims, as well as return of intellectual property and unspecified damages for breaches of the former officers’ and employees’ employment agreements. These employees, however, have filed for personal bankruptcy and as a result, the claims became inactive. At December 2001, bankruptcy for one such employee had been dismissed and that proceeding could be reactivated.

We also anticipated that, from time to time, we may be named as a party to other legal proceedings that may arise in the ordinary course of our business.

ITEM 2. CHANGES IN SECURITIES

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

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ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS AND REPORTS ON FORM 8K

None

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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.