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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




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FORM 10-Q



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(Mark One)



| |  | [X]     Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the period ended: March 31, 2004
| |  | ------------------------------------------------------------------------------------------------------------------------------------

OR



| |  | [  ]     Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
| |  | -------------------------------------------------------------------------------------------------

Commission File Number:
000-26460

SPATIALIZER AUDIO LABORATORIES, INC.

(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)
    
    95-4484725
(IRS Employer
Identification No.)


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

(Address of principal executive offices)

1754 Technology Drive, Suite 125
San Jose, California 95110

(Address of principal corporate offices)

Telephone Number: (408) 453-4180

(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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act): Yes [   ]
    
    No[X]
 As of May 7, 2004, there were 47,015,865 shares of the Registrants Common
Stock outstanding.




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TABLE OF CONTENTS  PART I. FINANCIAL INFORMATIONITEM I. FINANCIAL STATEMENTSCONSOLIDATED BALANCE SHEETSCONSOLIDATED STATEMENTS OF OPERATIONSCONSOLIDATED STATEMENT OF CASH FLOWSCONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITYNotes to Consolidated Financial StatementsItem 2. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3. Quantitative and Qualitative Disclosures About Market RiskItem 4. Controls and ProceduresPART II. OTHER INFORMATIONITEM 1. LEGAL PROCEEDINGSITEM 2. CHANGES IN SECURITIESITEM 3. DEFAULTS UPON SENIOR SECURITIESITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSITEM 5. OTHER INFORMATIONITEM 6. EXHIBITS AND REPORTS ON FORM 8KSIGNATURESEXHIBIT 31.1EXHIBIT 32.1    Table of Contents  
 PART I. FINANCIAL
INFORMATION 
 ITEM I. FINANCIAL
STATEMENTS SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS March 31,
    
    December 31,2004
    
    2003(unaudited)ASSETSCurrent Assets:Cash and Cash Equivalents
    
    $
    647,148
    
    
    $
    589,797Accounts Receivable, net
    
    
    182,519
    
    
    
    345,411Prepaid Expenses and Deposits
    
    
    7,844
    
    
    
    35,430Total Current Assets
    
    
    837,511
    
    
    
    970,638Property and Equipment, net
    
    
    38,221
    
    
    
    42,022Intangible Assets, net
    
    
    188,897
    
    
    
    192,485Total Assets
    
    $
    1,064,629
    
    
    $
    1,205,145LIABILITIES AND SHAREHOLDERS EQUITYCurrent Liabilities:Notes Payable to Related Party, Short Term
    
    
    37,500
    
    
    
    37,500Accounts Payable
    
    
    40,246
    
    
    
    21,466Accrued Wages and Benefits
    
    
    44,491
    
    
    
    36,973Accrued Professional Fees
    
    
    5,000
    
    
    
    20,000Accrued Commissions
    
    
    17,813
    
    
    
    33,856Accrued Expenses
    
    
    29,197
    
    
    
    28,197Total
Current Liabilities
    
    
    174,247
    
    
    
    177,992Notes Payable to Related Party, Long Term
    
    
    57,771
    
    
    
    70,746Commitments and ContingenciesSeries B-1, Redeemable Convertible Preferred shares, $.01 par
value, 1,000,000 shares authorized, 102,762
shares issued and outstanding at March 31, 2004
and December 31, 2003.
    
    
    1,028
    
    
    
    1,028Shareholders Equity:Common shares, $.01 par value, 65,000,000 shares
authorized, 47,015,865 shares
issued and outstanding at March 31, 2004 and
December 31, 2003.
    
    
    470,159
    
    
    
    470,159Additional Paid-In Capital
    
    
    46,428,615
    
    
    
    46,428,615Accumulated Deficit
    
    
    (46,067,191
    )
    
    
    (45,943,395
    )Total Shareholders Equity
    
    
    831,583
    
    
    
    955,379Total
Liabilities and Shareholders Equity
    
    
    1,064,629
    
    
    
    1,205,145




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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited) For the Three Month Period EndedMarch 31,
    
    March 31,2004
    
    2003Revenues:License Revenues
    
    $
    
    
    
    $
    Royalty Revenues
    
    
    170,679
    
    
    
    332,378Product Revenues
    
    
    
    
    
    
    170,679
    
    
    
    332,378Cost of Revenues
    
    
    17,004
    
    
    
    35,942Gross Profit
    
    
    153,675
    
    
    
    296,436Operating Expenses:General and Administrative
    
    
    166,630
    
    
    
    156,402Research and Development
    
    
    95,482
    
    
    
    109,003Sales and Marketing
    
    
    13,701
    
    
    
    102,139275,813
    
    
    
    367,544Operating (Loss)
    
    
    (122,138
    )
    
    
    (71,108
    )Interest and Other Income
    
    
    941
    
    
    
    2,492Interest and Other Expense
    
    
    (2,599
    )
    
    
    (2,813
    )(1,658
    )
    
    
    (321
    )(Loss) Before Income Taxes
    
    
    (123,796
    )
    
    
    (71,429
    )Income Taxes
    
    
    
    
    
    
    (3,020
    )Net (Loss)
    
    $
    (123,796
    )
    
    $
    (74,449
    )Basic (Loss) Per Share
    
    $
    (0.00
    )
    
    $
    (0.00
    )Weighted Average Shares
Outstanding
    
    
    47,015,865
    
    
    
    47,406,939




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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES 
 CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)
 Three Months EndedMarch 31,2004
    
    2003Cash Flows from Operating Activities:Net (Loss)
    
    $
    (123,796
    )
    
    $
    (74,449
    )Adjustments to reconcile net (loss) to net cash
provided by (used in) operating activities:Depreciation and Amortization
    
    
    17,097
    
    
    
    25,806Net Change in Assets and Liabilities:Accounts Receivable and Employee Advances
    
    
    162,892
    
    
    
    153,523Prepaid Expenses and Deposits
    
    
    27,586
    
    
    
    (7,238
    )Accounts Payable
    
    
    18,780
    
    
    
    (7,034
    )Accrued Wages and Benefits
    
    
    7,518Accrued Professional Fees
    
    
    (15,000
    )Accrued Commissions
    
    
    (16,043
    )Accrued Expenses
    
    
    1,000
    
    
    
    (53,985
    )Net Cash Provided By (Used In) Operating Activities
    
    
    80,034
    
    
    
    36,623Cash Flows from Investing Activities:Purchase/Disp of Property and Equipment
    
    
    
    
    
    
    (1,770
    )Increase in Capitalized Patent and Technology Costs
    
    
    (9,708
    )
    
    
    Net Cash Provided By (Used in) Investing Activities
    
    
    (9,708
    )
    
    
    (1,770
    )Cash flows from Financing Activities:Issuance of Preferred Shares, Net
    
    
    
    
    
    
    Issuance of Common Shares, Net
    
    
    
    
    
    
    Exercise of Options
    
    
    
    
    
    
    Exercise of Warrants
    
    
    
    
    
    
    Issuance of Notes Payable
    
    
    
    
    
    
    Issuance of Related Party Payable
    
    
    
    
    
    
    Repayment of Notes Payable
    
    
    (12,975
    )
    
    
    Net Cash Provided by Financing Activities
    
    
    (12,975
    )
    
    
    Increase (Decrease) in Cash and Cash Equivalents
    
    
    57,351
    
    
    
    34,853Cash and Cash Equivalents, Beginning of Period
    
    
    589,797
    
    
    
    858,724Cash and Cash Equivalents, End of Period
    
    $
    647,148
    
    
    $
    893,577Supplemental Disclosure of Cash Flow Information:Cash paid during the period for:Interest
    
    $
    2,599
    
    
    $
    2,811Income Taxes
    
    
    
    
    
    
    3,020




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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY
(unaudited) Common SharesTotalNumber of
    
    
    
    
    
    Additional
    
    Accumulated
    
    Shareholdersshares
    
    Par value
    
    paid-in-capital
    
    Deficit
    
    EquityBalance, December 31, 2003
    
    
    47,015,865
    
    
    $
    470,159
    
    
    $
    46,428,615
    
    
    $
    (45,943,395
    )
    
    $
    955,379Issuance of Preferred Shares, Net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options Exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Warrants Exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options Issued for Services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Conversion of Preferred Shares, Net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net (Loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (123,796
    )
    
    
    (123,796
    )Balance, March 31, 2004
    
    
    47,015,865
    
    
    $
    470,159
    
    
    $
    46,428,615
    
    
    $
    (46,067,191
    )
    
    $
    831,583




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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) is
in the business of developing and licensing technology. The Company sales,
research and subsidiary administration are conducted out of facilities in Santa
Clara, California. 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. All Company revenues are generated from this subsidiary. The foregoing interim
financial information is unaudited and has been prepared from the
books and records of the Company. The financial information reflects
all adjustments necessary for a fair presentation of the financial
condition, results of operations and cash flows of the Company in
conformity with generally accepted accounting principles. All such
adjustments were of a normal recurring nature for interim financial
reporting. Operating results for the three months ended
March 31, 2004 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2004.
Accordingly, your attention is directed to footnote disclosures found
in the December 31, 2003 Annual Report and particularly to
Note 1, which includes a summary of significant accounting
policies. (2) Significant Accounting Policies Basis of Consolidation The consolidated financial statements include
the accounts of Spatializer Audio Laboratories, Inc. and its wholly-owned
subsidiary, Desper Products, Inc. All significant intercompany balances and
transactions have been eliminated in consolidation. Corporate administration is
not allocated to subsidiaries. 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 (OEMs) and foundries. Concentration of Credit Risk Financial instruments, which potentially
subject the company to concentrations of credit risk, consist principally of
cash, cash equivalents and trade accounts receivable. The Company places its
temporary cash investments in certificates of deposit in excess of FDIC
insurance limits, principally at CitiBank FSB. At March 31, 2004 substantially
all cash and cash equivalents were on deposit at two financial institutions. At March 31, 2004, four major customers, not presented in order of
importance, each accounted for 10% or more of our total accounts receivable:
Matsushita, Samsung, Sharp and Orion Corporation, each of whom accounted for
greater than 10% of our total 2004 accounts receivable. One OEM accounted for
44.0%, another accounted for 15%, another accounted for 12.0% and one accounted
for 12% of our total accounts receivable at March 31, 2004.




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The Company performs ongoing credit evaluations of its customers and
normally does not require collateral to support accounts receivable. Due to the
contractual nature of sales agreements and historical trends, no allowance for
doubtful accounts has been provided. The Company does not apply interest charges to past due accounts
receivable. Cash and Cash Equivalents Cash equivalents consist of highly liquid
investments with original maturities of three months or less. Customers Outside of the U.S. Sales to foreign customers were 100% and
77% of total sales in the year to date periods ended March 31, 2004 and 2003,
respectively. Approximately 88% of sales were generated in Japan. Major Customers During the quarter ended March 31, 2004, four customers
accounted for 44%, 15%, 12% and 12%, respectively, of the Companys net sales. Research and Development Costs The Company expenses research and
development costs as incurred, which is presented as a separate line on the
statement of operations. Property and Equipment Property and equipment are stated at cost. Major
renewals and improvements are charged to the asset accounts while replacements,
maintenance and repairs, which do not improve or extend the lives of the
respective assets, are expensed. At the time property and equipment are retired
or otherwise disposed of, the asset and related accumulated depreciation
accounts are relieved of the applicable amounts. Gains or losses from
retirements or sales are credited or charged to income. Property and equipment
are depreciated over the useful lives of the asset ranging from 3 years to 5
years under the straight line method. Intangible Assets Intangible assets consist of patent costs and
trademarks which are amortized on a straight-line basis over the estimated
useful lives of the patents which range from five to twenty years. The weighted
average useful life of patents was approximately 12 years. Earnings 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. 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, 2004 and 2003 which
were not included in the computation of diluted loss per share because the
impact would have been antidilutive or less than $0.01 per share: 2004
    
    2003Options
    
    
    3,035,000
    
    
    
    2,571,500Warrants
    
    
    0
    
    
    
    03,035,000
    
    
    
    2,571,500




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During the three months ended March 31, 2004, no options were granted to
officers and board members and no options had expired. 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. 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. MDT is considered a discontinued
operation as of September 1998. As of March 31, 2004, the Company has only one
operating segment, DPI, the Companys Audio Signal Processing business. 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 carry forwards. 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. Recent Accounting Pronouncements- The FASB recently issued the following
statements: FASB 146 - Accounting for Costs Associated with Exit or Disposal
Activities, FASB 147 - Acquisitions of Certain Financial Institutions, FASB 148
- Accounting for Stock-Based Compensation. These FASB statements did not, or
are not expected to, have a material impact on the Companys financial position
and results of operations, FASB 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity and FASB Interpretation 46 Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51. 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.




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Fair Value of Financial Instruments- The fair and carrying values of cash
equivalents, accounts receivable, accounts payable, short-term debt to a
related party and accrued liabilities and those potentially subject to
valuation risk at December 31, 2003 and March 31, 2004 approximated fair value
due to their short maturity or nature. The fair values of notes payable to a related party at December 31, 2003
and March 31, 2004 are materially consistent with the related carrying values
based on current rates offered to the Company for instruments with similar
maturities. (3) Property and Equipment Property and equipment, as of December 31, 2003 and March 31, 2004,
consists of the following, net of a reserve for impairment loss in 1998 in
accordance with application of SFAS 121: March 31, 2004
    
    December 31, 2003Office Computers, Software, Equipment and Furniture
    
    $
    309,744
    
    
    $
    309,744Test Equipment
    
    
    73,300
    
    
    
    73,300Tooling Equipment
    
    
    45,539
    
    
    
    45,539Trade Show Booth and Demonstration Equipment
    
    
    171,301
    
    
    
    171,301Automobiles
    
    
    7,000
    
    
    
    7,000Leasehold Improvements
    
    
    0
    
    
    
    0Total Property and Equipment
    
    
    606,884
    
    
    
    606,884Less Accumulated Depreciation and Amortization
    
    
    568,663
    
    
    
    564,862Property and Equipment, Net
    
    $
    38,221
    
    
    $
    42,022
 (4) Intangible Assets Intangible assets, as of December 31, 2003 and March 31, 2004 consist of
the following: March 31, 2004
    
    December 31, 2003Capitalized Patent, Trademarks and Technology Costs
    
    $
    515,196
    
    
    $
    505,487Less Accumulated Amortization
    
    
    326,299
    
    
    
    313,002Intangible Assets, Net
    
    $
    188,897
    
    
    $
    192,485
 Estimated amortization is as follows: 2004
    
    $
    43,7942005
    
    $
    25,7332006
    
    $
    16,7022007
    
    $
    16,702Thereafter
    
    $
    85,966188,897




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(5) Notes Payable to Related Parties The Company was indebted to the Desper Family Trust, a related party, in
the amount of $95,271 at March 31, 2004. In the fourth quarter of 2003, in
response to the calling of the Note by the holder, we negotiated and completed
the conversion of the original $112,500 related party 10% demand note to a
three-year 10% term note. This amount bears interest at a fixed rate of 10%
annually, is paid in monthly installments of $5,191 that commenced on
December 1, 2003 and continues for twenty-four months until the entire balance
of principal and interest is paid in full. (6) Shareholders Equity During the quarter ended March 31, 2004, no shares were issued or
converted. During the year ended December 31, 2003, shares were issued or converted
as follows: An employee exercised options to purchase 166,666 shares of common stock in 2003, increasing shareholders equity by $10,000. Capitalization Series A Preferred Stock:On December 26, 2002 the Company filed a Certificate
of Elimination with the Delaware Secretary of State stating that no shares of
the Companys Series A Preferred Stock are outstanding and that no shares of
the Series A Preferred Stock will be issued. Series B Preferred Stock:On December 26, 2002 the Company filed a Certificate
of Elimination with the Delaware Secretary of State stating that no shares of
the Companys Series B Preferred Stock are outstanding and that no shares of
the Series B Preferred Stock will be issued. Series B-1 Redeemable Convertible Preferred Stock:On November 6, 2002 the
Board of Directors Designated a Series B-1 Preferred Stock. The series has a
par value of $0.01 and a stated value of $10.00 per share which is designated
as a liquidation preference. The stock ranks prior to the Companys common
stock. No dividends will be paid on the Series B-1 Preferred Stock. Conversion
rights exist on or after January 1, 2003 to convert the Series B-1 Preferred
Stock to common at a certain formula. At December 29, 2005 certain mandatory
conversion requirements exist subject to a certain formula. The Series B-1
Preferred Stock has no voting power. Certain restrictions on trading exist
based on date sensitive events. In December 2002, 87,967 shares of Series B-1
Preferred Stock were issued in exchange for the Series B Preferred Stock and
14,795 shares were issued in lieu of the adjusted accrued dividends on the
Series B Preferred Stock.




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(7) Escrowed Performance Shares In December 1996, the Company accepted the terms outlined by the British
Columbia Securities Commission (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 stockholders in August 1996. Under the revised arrangement, the
performance shares were released automatically as follows: 20% prior to June
22, 2000, 20% on June 22, 2000; 30% on June 22, 2001; and 30% on June 22, 2002.
Under the revised escrow arrangement, the performance shares vested, provided
the individual had not voluntarily terminated his/her relationship with the
Company prior to applicable vesting dates. Based on the revised escrow arrangement, which primarily converted 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, 2003, 2002 and 2001. 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. As of December 31, 2002, all performance shares under the
escrow arrangement have been released. In December 2003, the remaining 557,740
shares of former employees or participants, who lost entitlement to such shares
under the terms of the BCSC, were cancelled. (8) 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 which was approved by the stockholders
authorizes grants of options to purchase authorized but unissued common stock
up to 10% of total common shares outstanding at each calendar quarter,
4,701,587 as of December 31, 2004. 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
March 31, 2004, there were 1,666,587 additional shares available for
grant under the Plan. There
were no options granted in the quarter ended March 31, 2004.




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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 income (loss) would have
been increased to the pro forma amounts indicated below: 2004NET INCOME (LOSS):As Reported
    
    $
    (124,000
    )Pro Forma
    
    $
    (125,000
    )BASIC AND DILUTED LOSS:As Reported
    
    $
    (0.00
    )Pro Forma
    
    $
    (0.00
    )
 At March 30, 2004, the number of options exercisable was 3,035,000 and the
weighted-average exercise price of those options was $0.10. There were no warrants outstanding at December 31, 2003 and March 31, 2004. (9) Commitments and Contingencies We also anticipate 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. Operating Lease Commitments The Company is obligated under several non-cancelable operating leases.
Future minimum rental payments at March 30, 2004 for all operating leases were
approximately $17,000 through November 2004. Rent expense amounted to
approximately $5,400 and $21,000 for the quarters ended March 30, 2004 and
2003, respectively. (10) Profit Sharing Plan The Company has a 401(k) profit sharing plan covering substantially all
employees, subject to certain participation and vesting requirements. The
Company may elect to make discretionary contributions to the Plan, but has
never done so over the life of the Plan..




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations Approach to MD&A The purpose of MD&A is to provide our shareholders and other interested
parties with information necessary to gain an understanding of our financial
condition, changes in financial condition and results of operations. As such,
we seek to satisfy three principal objectives:  
    
    to provide a narrative explanation of a companys financial
statements that enables investors to see the Company through the eyes of
management;
    
    to enhance the overall financial disclosure and provide the
context within which financial information should be analyzed; and
    
    to provide information about the quality of, and potential
variability of, a companys earnings and cash flow, so that investors
can ascertain the likelihood that past performance is indicative of
future performance. We believe the best way to achieve this is to give the reader:  
    
    An understanding of our operating environment
    
    An outline of critical accounting policies
    
    A review of the key components of the financial statements and our
cash position and capital resources
    
    Disclosure on our internal controls and procedures Operating Environment We operate in a very competitive business environment. This environment
impacts us in the following ways, further discussed in greater detail under
Risk Factors:  
    
    Our Operating Results Fluctuate and If We Are Unable to Achieve or
Sustain Profitability in the Future or Obtain Future Financing Our
Business Operations May Fail  
    
    Because The Market In Which We Operate Is Highly Competitive, We Face
Significant Pricing Pressure and Competition.  
    
    We Rely on the Schedules and Cooperation of Chip Makers or Other Third
Parties to Deliver Our Technology in Consumer Products. These Third
parties Have Their Own Priorities and Alliances that May Delay or Thwart
our Sales Efforts to Potential Customers.  
    
    If New Product Development Is Delayed, We Will Experience Delays In
Revenues And Competitive Products May Reach The Market Before Our
Products.  
    
    Because The Technology Environment In Which We Operate Is Rapidly
Changing, We May Not Be Successful In Establishing And Maintaining The
Technological Superiority Of Our Products Over Those Of Our Competitors  
    
    If We Are Unable To Attract And Retain Our Key Personnel, We May Not Be
Able To Successfully Operate Our Business.




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The PC and consumer electronics markets are under intense pressure, primarily
from retailers, to reduce selling prices, with resultant pressure to reduce
costs. Cost reductions are driven by lower cost sourcing, often in China,
design simplification and reduction in features. While we present a value
proposition that stresses the cost reducing capabilities of our audio solutions
through improved performance from lower cost components as well as product
differentiation that Spatializer technology can deliver, all such features are
closely scrutinized by potential customers product marketing and engineering.
This makes it more challenging to secure new design wins, particularly in
product categories that have become commoditized, such as the case with DVD
players. It also may result in the elimination of features, including ours, if
cost is of paramount importance. When this occurs, we receive very short notice
and revenues from such an account will typically begin a steep decline in the
subsequent quarter, resulting in period-to-period fluctuation. Our response has
been to strengthen our value proposition, more aggressively price and feature
enrich our products and enter new segments, such as cell phones, with different
competitive pressure. Manufacturers design-in cycles for our technology range from four to twelve
months, from the decision to adopt our technology to actual cash flow. These
schedules are also prone to delays at the manufacturer level and in some cases,
manufacturers new products may be cancelled due to market testing or resource
allocation. Since these events are beyond our control, it is difficult to
absolutely project when new deals will begin generating revenues or if signed
deals will generate financial results. For this reason, we do not typically
announce new deals until the target product is being introduced. Spatializer does not develop or market semiconductors. That is why we carry no
inventory or have order backlogs that typically are good indicators of near
term performance. Rather, we develop audio algorithms that are embedded on
third party processors or semiconductors used by our customers. While our
algorithms are implemented on a wide array of processors, often times a
customer uses a processor where there is no such implementation, or where a
competing solution has been implemented. In this case, our customers request
that our algorithm be implemented. While these requests are typically honored,
processor manufacturers must schedule such implementation as their resources or
corporate strategies allow. Therefore, the supply-chain is often quite long and
complicated, which potentially can result in delays or deadlines that may not
always coincide with our customers requirements and which are beyond the
control of our company. Therefore, when reviewing the operating results or drawing conclusions with
regard to future performance, these competitive forces and uncertainties must
be taken into consideration. Without absolute long-term visibility, it is
difficult to draw such conclusions in absolute terms. Further, the dynamic
nature of the business environment creates the potential for both positive and
negative fluctuations in near and long term operating performance. While
management strives to mitigate these risks, as outlined in Risk Factors,it is
not possible to be fully immune from such dynamics.




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Critical Accounting Policies Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses based on historical experience and various
other factors that are believed to be reasonable under the circumstances.
Actual results may differ from these estimates under different assumptions or
conditions. In consultation with our Board of Directors and Audit Committee, we
have identified three accounting policies that we believe are critical to an
understanding of our financial statements. These are important accounting
policies that require managements most difficult, subjective judgments. The first critical accounting policy relates to revenue recognition. We
recognize 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
(OEMs) and foundries. The second critical accounting policy relates to research and development
expenses. We expense all research and development expenses as incurred. Costs
incurred to establish the technological feasibility of our algorithms (which is
the primary component of our licensing) is expensed as incurred and included in
Research and Development expenses. Such algorithms are refined based on
customer requirements and licensed for inclusion in the customers specific
product. There are no production costs to capitalize as defined in Statement on
Financial Accounting Standards No. 86. The third critical accounting policy relates to intangible assets. Our
intangible assets consist primarily of patents. We capitalize all costs
directly attributable to patents, consisting primarily of legal and filing
fees, and amortize such costs over the remaining life of the patent (which
range from 3 to 20 years) using the straight-line method. In accordance with
SFAS 142, Goodwill and Other Intangible Assets, only intangible assets with
definite lives are amortized. Non-amortized intangible assets are instead
subject to annual impairment testing. Audit Committee This committee is directed to review the scope, cost and results of the
independent audit of our books and records, the results of the annual audit
with management and the internal auditors and the adequacy of our accounting,
financial, and operating controls; to recommend annually to the Board of
Directors the selection of the independent auditors; to approve proposals made
by our independent auditors for consulting work; and to report to the Board of
Directors, when so requested, on any accounting of financial matters. Additionally, following the completion of the audit, the committee meets
with the independent accountants to review with the independent accountants any
problems or difficulties the accountants may have encountered in connection
with the audit, the adequacy of the internal accounting controls, the financial
and accounting personnel and any management letter provided by the independent
accountants and the Companys response to that letter. The committee also
discusses with the independent accountants any matters that are required to be
discussed under applicable rules, including without limitation those matters
required to be discussed by Statement on Auditing Standards No. 61 relating to
the conduct of the audit. Compensation and Stock Committee Our Compensation and Stock Option Committee (the Compensation Committee)
currently consists of Messrs. Pace and Segel, each of whom is a non-employee
director of the Company and a disinterested person with respect to the plans
administered by such




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committee, as such term is defined in Rule 16b-3 adopted under the
Securities Exchange Act of 1934, as amended, and the rules and regulations
thereunder (collectively, the Exchange Act). The Compensation Committee
reviews and approves annual salaries, bonuses and other forms and items of
compensation for our senior officers and employees. Except for plans that are,
in accordance with their terms or as required by law, administered by the Board
of Directors or another particularly designated group, the Compensation
Committee also administers and implements all of our stock option and other
stock-based and equity-based benefit plans (including performance-based plans),
recommends changes or additions to those plans or awards under the plans. Special Committee In
November of 2002, the Board of Directors created a Special Committee
to review certain strategic opportunities as they arise and to obtain
additional information regarding such opportunities for consideration
and evaluation by the Board of Directors. 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, 2004 were $171,000, compared to
revenues of $332,000 in the comparable period last year, a decrease of 48%. The
decline in revenue resulted from the expiration of a licensing agreement with a
major computer account in January 2003 ($75,000 reduction) and the effects of cost reductions by
DVD player accounts resulting in outsourcing to manufacturers in China who
generally decline to pay for such software or where features must be eliminated
to achieve manufacturing cost targets. This resulted in an additional
reduction of revenue of approximately $90,000. This was partially offset by an increase
in revenues from cell phone accounts that started shipping commercial
quantities with our technologies in the first quarter. Gross Profit Gross profit for the three months ended March 31, 2004 was $154,000 (90% of
revenue) compared to gross profit of $296,000 (89% of revenue) in the
comparable period last year, a decrease of 48%. Gross profit decreased due to
the decrease in revenue. Operating Expenses Operating
expenses in the three months ended March 31, 2004 were $276,000 (161%
of revenue) compared to operating expenses of $368,000 (111% of revenue) in the
comparable period last year, decrease of 25%. The decrease in operating
expenses for the three months ended March 31, 2004 resulted primarily from
decreased sales and marketing expenses. General and Administrative General and administrative expenses in the three months ended March 31, 2004
were $167,000 (98% of revenue) compared to general and administrative
expenses of $156,000 (47% of revenue) in the comparable period last year, an
increase of 7%. The increase in general and administrative expense resulted
primarily from higher legal and accounting expenses arising from new
regulatory public company requirements and higher executive overseas
travel by the chief executive to secure additional contracts with
manufacturers and maintain existing relationships with our customers.




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Research and Development Research and development expenses in the three months ended March 31, 2004
were $95,000 (56% of revenue) compared to research and development expenses
of $109,000 (33% of revenue) in the comparable period last year, a decrease
of 13%. The decrease in such expenses resulted primarily from lower cost
Silicon Valley facilities, partially offset by greater use of outside
specialist engineering consulting compared with the prior period. Sales and Marketing Sales and marketing expenses in the three months ended March 31, 2004 were
$14,000 (8% of revenue) compared to sales and marketing expenses of $102,000
(31% of revenue) in the comparable period last year, a decrease of 86%. The
decrease in sales and marketing expense resulted primarily from the
elimination of a senior sales executive position ($50,000), transition of Japan sales
to a commission only structure ($20,000), lower cost Silicon Valley
facilities ($15,000) and lower marketing support staff expense
($3,000) as compared with the comparable period
last year. Net (Loss) Net loss in the three months ended March 31, 2004 was $124,000, ($0.00)
basic per share, compared with net loss of $74,000 ($0.00) basic per share in
the comparable period last year. The net loss resulted from decreased revenues,
partially offset by slightly lower operating expenses. Liquidity and Capital Resources At March 31, 2004, we had $647,000 in cash and cash equivalents as
compared to $589,000 at December 31, 2003. The increase in cash and cash
equivalents is attributed to the decreases in accounts receivable. We had
working capital of $663,000 at March 31, 2004 as compared with working capital
of $792,000 at December 31, 2003. 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. We anticipated that
there will be a wind down of our licensing program in 2003 with a large
computer account and reductions in licensing to DVD accounts that are under
extreme pressure to reduce costs. We announced two new licensing arrangements
in the cellular phone market and expect this category to expand in 2004. We are
also targeting other markets where the cost pressure is not as acute and which
might be more receptive to licensing our products. In November 2002, the Board of Directors and the holders of our previously
outstanding Series B Preferred Stock agreed to exchange the Series B Preferred
Stock for a new Series B-1 Preferred Stock, which are convertible commencing in
December 2005 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. The exchange was
completed in December 2002. In connection with the exchange the Series B-1
Preferred Stock, we withdrew the Series A and Series B Preferred Stock and,




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therefore, currently the Series B-1 Preferred Stock is our only authorized
or outstanding class of preferred stock. In the fourth quarter of 2003, we negotiated and completed the conversion
of a $112,500 related party 10% demand note to a three-year 10% term note.
Principal and interest of $5,191 is paid monthly, which we pay on a current
basis. Installments due in more than twelve months are classified as Notes
Payable to Related Parties-long-term. We continue to maintain an accrual for unasserted claims or settlement
costs of approximately $28,000. We do not expect any final liability to be in
excess of this balance. Future
payments due under operating lease obligations as of March 31, 2004
are described below: Payments due by periodLess than
    
    
    
    
    
    
    
    
    
    More thanContractual obligations
    
    Total
    
    1 year
    
    1-3 years
    
    3-5 years
    
    5 years[Long-Term Debt
Obligations]
    
    $
    95,271
    
    
    $
    37,500
    
    
    $
    57,771[Capital Lease
Obligations][Operating Lease
Obligations]
    
    $
    16,600
    
    
    $
    16,600[Purchase Obligations][Other Long-Term
Liabilities Reflected
on the Registrants
Balance Sheet under
GAAP]Total
    
    $
    111,871
    
    
    $
    54,100
    
    
    $
    57,771
 Our future cash flow will come primarily from the audio signal processing
licensing, 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 we believe should generate
additional cash flow without imposing any substantial costs on us. We
anticipate that there may continue to be dislocations of individual licensing
programs due to continuing pressure to reduce costs, particularly in the DVD
player segment. We currently believe that growth from other licensing
arrangements, which include new markets such as cellular phones, and other
arrangements that are pending but not announced or in negotiation, will
substantially offset any revenue shortfalls from market dynamics or
transitioning platforms. Further, we anticipate that our cost reduction
initiative implemented in the fourth quarter of 2003 will lower the revenues
needed to reach the break-even point. The fluid, competitive and dynamic nature of the market continues a degree
of uncertainty to our operations. 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, we
must develop




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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. We have responded by offering additional
products targeted to each price/quality segment of the market and continue to
aggressively pursue new opportunities in emerging product categories such as
cellular phones and notebook computers that complements 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 us, and our rational commercial competitors, to enhance their
operating results. To the extent we maintain or exceed our projected revenues and are not
required to fund significant contingencies, we expect to continue to retain our
current cash reserves and therefore, maintain our liquidity position at a
consistent level both on a short-term and long-term basis. To the extent that
we do not achieve current operating levels or are required to fund
contingencies, we will be required to use some of our cash reserves and this
could impact our longer term liquidity. In addition, we wish to achieve
accelerated growth and to take advantage of the dynamic market forces in which
we operate, rather than to be affected by them. We believe our current cash
reserves and cash generated from our existing operations and customer base are
sufficient for us to meet our operating obligations and the anticipated
additional research and development for our audio technology business for at
least the next 12 months. We will also continue to consider and evaluate
capital investment or business arrangements with financial or strategic
participants or investors as such opportunities become available to us on terms
that enhance shareholder value and support our business strategy. Net Operating Loss Carry forwards At
December 31, 2003, we had net operating loss carry forwards for Federal
income tax purposes of approximately $27,000,000 which are available to offset
future Federal taxable income, if any, through 2023. Approximately
$17,000,000
of these net operating loss carry forwards are subject to an annual limitation
of approximately $1,000,000. Inflation We believe that the moderate inflation rate of the last several years has
not impacted our operations. Recently Issued Accounting Pronouncements In July 2001, the FASB issued SFAS No. 141, Business Combinations, which
establishes financial accounting and reporting for business combinations and
supersedes APB Opinion No. 16, Business Combinations, and FASB statement No.
38, Accounting for Preacquisition Contingencies of Purchased Enterprises.
SFAS No. 141 requires that all business combinations be accounted for using one
method, the purchase method. The




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provisions apply to all business combinations
initiated after June 30, 2001. In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets, which establishes financial accounting and reporting for acquired
goodwill and other intangible assets and supersedes APB Opinion No. 17,
Intangible Assets. SFAS No. 142 addresses how intangible assets that are
acquired individually or with a group of other assets (but not those acquired
in a business combination) should be accounted for in financial statements upon
their acquisition, and after they have been initially recognized in the
financial statements. The provisions of SFAS no. 142 were effective for fiscal
years beginning after December 15, 2001. We adopted SFAS No. 142 during the
first quarter of fiscal 2002, and the adoption of SFAS No. 142 had no material
impact on our financial reporting and related disclosures. In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations, which is effective for us beginning fiscal 2003. SFAS
No. 143 requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred if a reasonable
estimate of fair value can be made, with the associated asset retirement costs
capitalized as part of the carrying amount of the long-lived assets. We do not
expect the adoption of SFAS No. 143 to have a material impact on our financial
position and results of operations. In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which is effective for fiscal
years beginning after December 15, 2001 and interim periods within those fiscal
periods. SFAS No. 144 supersedes FASB Statement No. 121 and parts of APB
Opinion No. 30, Reporting the Results of Operations  Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions Relating to Extraordinary
Items. However, SFAS No. 144 retains the requirement of APB Opinion No. 30 to
report discontinued operations separately from continuing operations and
extends that reporting to a component of an entity that either has been
disposed of (by sale, by abandonment or in a distribution to owners) or is
classified as held for sale. SFAS No. 144 addresses financial accounting and
reporting for the impairment of certain long-lived assets and for long-lived
assets to be disposed of. We do not expect the adoption of SFAS No. 144 to have
a material impact on our financial position and results of operations. In June 2002, the FASB issued SFAS 146, Accounting for Costs Associated
with Exit or Disposal Activities, which nullifies EITF Issue 94-3. SFAS 146 is
effective for exit and disposal activities that are initiated after December
31, 2002 and requires that a liability for a cost associated with an exit or
disposal activity be recognized when the liability is incurred in contrast to
the date of an entitys commitment to an exit plan, as required by EITF Issue
94-3. We do not expect the adoption of SFAS No. 146 to have a material impact
on our financial position and results of operations. In December 2002, the FASB issued SFAS 148 Accounting for Stock-Based
Compensation an amendment to SFAS 123. SFAS 148 provides alternative methods
of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of Statement 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. This statement is effective for fiscal years




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ending after December 15, 2002 for transition guidance and annual disclosure
provisions; for financial reports containing financial statements for interim periods
beginning after December 15, 2002 for interim disclosure provisions. The
adoption of SFAS No. 148 did not have a material impact on our financial
position and results of operations. In January 2003 the FASB issued Interpretation 46 Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51. This Interpretation
requires a Company to consolidate the financial statements of a Variable
Interest Entity (VIE), sometimes also known as a special purpose entity,
even if the entity does not hold a majority equity interest in the VIE. The
Interpretation requires that if a business enterprise has a controlling
financial interest in a VIE, the assets, liabilities, and results of the
activities of the VIE should be included in consolidated financial statements
with those of the business enterprise, even if it holds a minority equity
position. This Interpretation was effective immediately for all VIEs created
after January 31, 2003; for the first fiscal year or interim period beginning
after June 15, 2003 for VIEs in which a Company holds a variable interest that
it acquired before February 1, 2003. In May 2003 the FASB issued SFAS 150 Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This
Statement establishes standards for how an issuer of debt or equity classifies
and measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as equity.
This Statement is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. The adoption of this
pronouncement is not expected to have a material effect on the Companys
financial position, results from operations or cash flows. In December 2003, the FASB issued SFAS 132R Employers Disclosures about
Pensions and Other Postretirement Benefits  an amendment of FASB Statements
No. 87, 88, and 106". This Statement revises employers disclosures about
pension plans and other postretirement benefit plans. It does not change the
measurement or recognition of those plans required by FASB Statements No. 87,
EmployersAccounting for Pensions,No. 88, Employers Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits,and No. 106, Employers Accounting for Postretirement
Benefits Other Than Pensions.This Statement retains the disclosure
requirements contained in FASB Statement No. 132, Employers Disclosures about
Pensions and Other Postretirement Benefits,which it replaces. It requires
additional disclosures to those in the original Statement 132 about the assets,
obligations, cash flows, and net periodic benefit cost of defined benefit
pension plans and other defined benefit postretirement plans. The Company will
adopt the provisions of SFAS 132R on January 1, 2004. The adoption of this
pronouncement is not expected to have a material effect on the Companys
financial position, results from operations or cash flows. Risk Factors Certain information in this report includes forward-looking statements.
Forward-looking statements include statements regarding our expectations,
beliefs, intentions, plans, objectives, goals, strategies, future events or
performance and underlying assumptions and other statements that are other than
statements of historical fact. When used in this report the




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words shall,
should, forecast, all of, projected, believes, anticipates,
expects, and similar expressions are intended to identify these forward-looking
statements. In addition, we may from time to time make oral forward-looking
statements. We wish to caution readers that a number of important factors could
cause actual results to differ materially from those in the forward-looking
statements. Factors that could cause or contribute to such differences include
those discussed below, as well as those discussed above in Managements
Discussion and Analysis of Financial Condition and Results of Operations,
elsewhere in this report or from time to time described in our other filings
with the Securities and Exchange Commission. Our Operating Results Fluctuate and If We Are Unable to Achieve or Sustain
Profitability in the Future or Obtain Future Financing Our Business Operations
May Fail We experienced a loss from operations in 2003 and 2001 but were profitable
in 2002. We experienced small losses in the last quarter of 2002, the first
quarter of 2003, a larger loss in the second quarter of 2003 and a reduced loss
in subsequent quarters. While our objective and full effort is on managing a
profitable business, due to the market conditions and factors outlined above
and below and their impact on fluctuations in operating expenses and revenues ,
we cannot provide assurance that we will be able to generate a positive profit
position in any given future period. We cannot guarantee that we will increase
sales of our products and technologies, or that we will successfully develop
and market any additional products, or achieve or sustain future profitability,
and we may have to rely on the sale of shares or on debt financings in the
future, which may have a dilutive effect on our existing shareholders. Further,
we cannot assure you that debt or equity financing will be available as
required and if not available, we would have to further scale down operations
or even cease operations. Because The Market In Which We Operate Is Highly Competitive, We Face
Significant Pricing Pressure and Competition. We are seeking commercial acceptance of our products in highly competitive
markets. 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. We have responded by offering additional products targeted to each
price and quality segment of the market and continue 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 us, and its rational commercial competitors, to enhance their
operating results. There is no assurance that our present or contemplated
future products will achieve or maintain sufficient commercial acceptance, or
if they do, that functionally equivalent products will not be developed by
current or future competitors who had access to significantly greater resources
or which are willing to give away their products. We Rely on the Schedules and Cooperation of Chip Makers or Other Third Parties
to Deliver Our Technology in Consumer Products. These Third parties Have Their
Own Priorities and Alliances that May Delay or Thwart our Sales Efforts to
Potential Customers. Spatializer does not develop or market semiconductors. That is why we carry no
inventory or




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have order backlogs that typically are good indicators of near
term performance. Rather, we develop audio algorithms that are embedded on third party processors or
semiconductors used by our customers. While our algorithms are implemented on a
wide array of processors, often times a customer uses a processor where there
is no such implementation, or where a competing solution has been implemented.
In this case, our customers request that our algorithm be implemented. While
these requests are typically honored, processor manufacturers must schedule
such implementation as their resources or corporate strategies allow.
Therefore, the supply-chain is often quite long and complicated, which
potentially can result in delays or deadlines that may not always coincide with
our customers requirements and which are beyond the control of our company. If New Product Development Is Delayed, We Will Experience Delays In Revenues
And Competitive Products May Reach The Market Before Our Products. Since our inception, we have experienced delays in bringing new products
to market and commercial application as a result of delays inherent in
technology development, financial resource limits and industry responses and
maturity. These delays have resulted in delays in the timing of revenues and
product introduction. In the future, delays in new product development or
technology introduction on behalf of us, our original equipment manufacturers
of consumer electronics and multimedia computer products (OEMs), integrated
circuit (IC) foundries or our software producers and marketers could result in
further delays in revenues and could allow competitors to reach the market with
products before us. In view of the emerging nature of the technology involved,
and the rapidly changing character of the entire media, internet and computer
markets, our expansion into other technology areas such as cellular
telephones and the uncertainties
concerning the ability of our current products and new products to achieve
meaningful commercial acceptance in these new technology areas, there can be no assurance of when or if we
will achieve or sustain profitability. Manufacturers design-in cycles for our technology range from four to
twelve months, from the decision to adopt our technology to cash flow. These
schedules are also prone to delays at the manufacturer level and in some cases,
manufacturers new products may be cancelled due to market testing or resource
allocation. Since these events are beyond our control, it is difficult to
absolutely project when new deals will begin generating revenues or if signed
deals will generate financial results. For this reason, we do not typically
announce new deals until the target product is being introduced. We expect that we will continue to be dependent upon a limited number of
OEMs for a significant portion of our net sales in future periods, although no
OEM is presently obligated either to purchase a specified amount of products or
to provide us with binding forecasts of product purchases for any period. Our
four largest customers as of March 30, 2004 accounted for 44%, 15%, 12% and 12%
of our net sales. The loss of any one of our major customers or licensees would
significantly reduce our revenues and harm our ability to achieve or sustain
acceptable levels of operating results. The loss, or signing of a similarly
sized account or accounts would have a material short term impact on our
operations and there is no assurance that we will not lose all or some of the
revenues from one or more of these accounts. While we are working to broaden
the sources of our royalty streams, there can be no assurance that we will be
successful in retaining or attracting such key accounts and broadening such
revenue stream sources.




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Our products are typically one of many related products used by consumer
electronic users. Demand for our products is therefore subject to many risks
beyond our control, including, among others:  
    
    competition faced by our OEM customers in their particular end
markets;
    
    the technical, sales and marketing and management capabilities
of our OEM customers;
    
    the pressure faced by our OEM customers to reduce cost There can be no assurance that we will not lose sales in the future as a
result of the pressure to reduce costs faced by our customers. The reduction of
orders from our significant OEM customers, or the discontinuance of our
products by our end users may subject us to potential adverse revenue
fluctuations. Because The Technology Environment In Which We Operate Is Rapidly Changing, We
May Not Be Successful In Establishing And Maintaining The Technological
Superiority Of Our Products Over Those Of Our Competitors. We operate in a technology environment which is competitive and rapidly
changing. 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. Our
future success is dependent on establishing and maintaining the technological
superiority of our products over those of competitors, our ability to
successfully identify and bring other compatible technologies and products to
market and a recognition by the market of product value. We compete with a
number of entities that produce various stereo audio enhancement processes,
technologies and products in both traditional two-speaker environments such as
consumer electronics and multimedia computing, and in multi-channel,
multi-speaker applications such as Home Theater. In the field of 3-D or
virtual audio, our principal competitors are SRS Labs, Inc., QSound Labs,
Inc. and Dolby Laboratories or technologies and products developed by other
companies, including entities that have business relationships with us. There
can be no assurance that we will be able to favorably compete in this market in
the future. If We Are Unable To Attract And Retain Our Key Personnel, We May Not Be Able To
Successfully Operate Our Business. Our future success primarily depends on the abilities and efforts of a
small number of individuals, with particular management obligations and
technical expertise. Loss of the services of any of these persons could
adversely affect our business prospects. There is no assurance that we will be
able to retain this group or successfully recruit other personnel, as needed.
We compete with other enterprises with stronger financial resources and larger
staffs that may offer employment opportunities to our staff which are more
desirable than those which we are able to offer. Failure to maintain skilled
personnel with the software and engineering skills critical to our business
could have an adverse impact upon our business, the results of our operations
and our prospects. Currently, we have an employment agreement with Henry R.
Mandell with a term expiring in November 2005.




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Item 3.Quantitative and Qualitative Disclosures About Market Risk We have not been exposed to material future earnings or cash flow fluctuations
from changes in interest rates on our short-term investments at
March 31, 2004.
A hypothetical decrease of 100 basis points in interest rate (ten percent of
our overall earnings rate) would not result in a material fluctuation in future
earnings or cash flow. We have not entered into any derivative financial
instruments to manage interest rate risk or for speculative purposes and we are
not currently evaluating the future use of such financial instruments. 
 Item 4.Controls and Procedures The Company carried out an evaluation of the effectiveness of the Companys disclosure controls and procedures, as defined in
Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934. Based on that evaluation, the Chief Executive
Officer and Chief Financial Officer had concluded that the Companys disclosure controls and procedures as of
March 31, 2004 were effective to ensure that information required to be disclosed by the Company in reports that it files or
submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commissions rules and forms.
There were no changes in the Companys internal control over financial reporting that occurred during the quarter
ended March 31, 2004 that have materially affected, or are reasonably likely to materially affect, the Companys internal
control over financial reporting.




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PART II. OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

From time to time we may be involved in various disputes and litigation
matters arising in the normal course of business. As of May 13,
2004, we are not involved in any legal proceedings that are expected to have a
material adverse effect on our consolidated financial position, results of
operations or cash flows. However, litigation is subject to inherent
uncertainties. Were an unfavorable ruling to occur, there exists the
possibility of a material adverse impact on our results of operations of the
period in which the ruling occurs. Our estimate of the potential impact on our
financial position or overall results of operations for new legal proceedings
could change in the future.




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




ITEM 5. OTHER INFORMATION

None




ITEM 6. EXHIBITS AND REPORTS ON FORM 8K

(a)  Exhibits

|     |  |                                                                                                                               
|---- |  | ------------------------------------------------------------------------------------------------------------------------------
|31.1 |  | Certificate of Chief Executive Officer and Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002  
|32.1 |  | Certificate of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
|*    |  | Certification will not be deemed filed for purposes of Section 18 of
the Securities Exchange Act of 1934.                   

(b) Reports on Form 8-K:

On March 18, 2004, we filed a Current Report on Form 8-K regarding a press
release issued with earnings information for the year ended December 31, 2003.
The information furnished in the report shall not be deemed to be filed for
purposes of Section 18 of the Securities Exchange Act of 1934.





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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.

Dated: May 13, 2004

| |  |                                                                                                     
| |  | ----------------------------------------------------------------------------------------------------
| |  | SPATIALIZER AUDIO LABORATORIES, INC.
(Registrant)                                                   
|
|
| |  | /s/ Henry R. Mandell                                                                                
| |  |                                                                                                     
| |  | Henry R. MandellChairman of the Board, Chief Executive Officer
Chief Financial Officer and Secretary