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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549   FORM 10-K   (Mark One) [X]
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 For the period ended: December 31, 2003 OR [   ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT 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
(I.R.S. Employer
Identification No.)
 2625 Hampshire Road, Suite 330
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) Securities registered pursuant to Section 12(b) of the Act:
None Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value 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 [   ]








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|                             |                                                                                               |                                                           |  |  |  |  |  | 
|---------------------------- | --------------------------------------------------------------------------------------------- | --------------------------------------------------------- |  |  |  |  |  | 
|PART I                      
|                             | Item 1. Business                                                                             
|                             | Item 2. Properties                                                                           
|                             | Item 3. Legal Proceedings                                                                    
|                             | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                             | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                
|                             | Item 6. Selected Consolidated Financial Data                                                 
|                             | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                             | Item 7A. Quantitative and Qualitative Disclosures About Market Risk                          
|                             | Item 8. Financial Statements and Supplementary Data                                          
|INDEPENDENT AUDITORS REPORT
|                             |                                                                                               | CONSOLIDATED BALANCE SHEETS                              
|                             |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS                    
|                             |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS                    
|                             |                                                                                               | CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)
|                             |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS               
|                             | Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosure  
|                             | Item 9A. Controls and Procedures                                                             
|PART III                    
|                             | Item 10. Directors and Executive Officers of the Registrant                                  
|                             | Item 11. Executive Compensation                                                              
|                             | Item 12. Security Ownership of Certain Beneficial Owners and Management                      
|                             | Item 13. Certain Relationships and Related Transactions                                      
|                             | Item 14. Principal Accounting Fees and Services                                              
|PART IV                     
|                             | Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K                     
|SIGNATURES                  
|EX-23.1                     
|EX-31.1                     
|EX-32.1                     



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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [   ] No [X]

The aggregate market value of the voting stock held by non-affiliates of
the registrant computed by reference to the price at which the common equity
was last sold as of the last business of the registrants most recently
completed second quarter (June 29, 2003) was approximately $2,844,416 and at
February 25, 2004 was approximately $7,992,697. In addition, affiliates held
non-voting preferred stock valued at $879,670, plus accrued dividends, at both
June 29, 2003 and March 8, 2004.

As of March 8, 2004, there were 47,015,865 shares of the Registrants
Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement for the 2003 Annual Meeting are
incorporated by reference into Part III hereof.



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CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended,
and Section 27A of the Securities Act of 1933, as amended, reflecting
managements current expectations. Examples of such forward-looking statements
include our expectations with respect to our strategy. Although we believe that
our expectations are based upon reasonable assumptions, there can be no
assurances that our financial goals will be realized. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors
that may cause our actual results, performance or achievements, or industry
results, to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements. Numerous
factors may affect our actual results and may cause results to differ
materially from those expressed in forward-looking statements made by or on
behalf of our company. For this purpose, any statements contained herein that
are not statements of historical fact may be deemed to be forward-looking
statements. Without limiting the foregoing, the words, believes,
anticipates, plans, expects and similar expressions are intended to
identify forward-looking statements. The important factors discussed under the
caption Factors That May Affect Future Results in Item 7. Managements
Discussion and Analysis of Financial Condition and Results of Operations,
herein, among others, would cause actual results to differ materially from
those indicated by forward-looking statements made herein and represent
managements current expectations and are inherently uncertain. Investors are
warned that actual results may differ from managements expectations. We assume
no obligation to update the forward-looking information to reflect actual
results or changes in the factors affecting such forward-looking information. 
 PART I 
 Item 1.Business Overview Spatializer Audio Laboratories, Inc. (Spatializer or Company) is a
developer, licensor and marketer of next generation technologies for the
consumer electronics, personal computing, enterprise computing and
entertainment industries. Our position as a developer of next generation
technologies is based on our business relationships with brand leaders, such as
Toshiba, Samsung, Sanyo and Matsushita. We conduct our audio business through
our parent company and our wholly owned subsidiary, Desper Products, Inc.
(DPI). DPI has developed a full complement of patented and proprietary 3-D or
virtual audio signal processing technologies directed to the consumer
electronics and multimedia PC markets. We continue to expand our product
offerings to take advantage of the growing digital audio marketplace
specifically for consumer products like Digital Versatile Disc (DVD) players,
portable mp3 players, digital televisions and digital home, portable and auto
entertainment devices. As of December 31, 2003, more than 45 million licensed
units had been shipped covering all of these applications. DPIs virtual audio
signal processing technologies are currently incorporated in products offered
by global brand leaders in consumer electronics, including Toshiba, Panasonic,
JVC, Samsung, Sanyo, and Sharp. We are focused on broadening recognition of the
Spatializer brand name through association with these and other globally
recognized consumer electronics and multimedia computer brand leaders, and on
broadening our audio technology and software base to position ourselves for
continued growth. We believe that with the accelerating growth in the digital
audio/video marketplace, the market for virtual audio technologies, and
therefore for our products, is entering a new phase of opportunity. Our other wholly owned subsidiary, MultiDisc Technologies, Inc., (MDT)
formed in June 1996 when we acquired development stage optical disc storage and
robotics assets and technologies from Home Theater Products International,
Inc., a debtor in possession, is now inactive. In September 1998, we announced
our plan to refocus our business on the exploitation of our core audio
technologies, suspend research and development at MDT and to properly position
the MDT assets for sale. Therefore, MDT has been accounted for as a
discontinued operation. Since 1998, we have been unsuccessful in identifying a
purchaser for the MDT assets or technology. Our repositioning in 1998
recognized that the capital investment required to properly commercialize the
MDT technology was beyond our capacity. We believe this strategy provides a
better opportunity to further solidify our position as a provider of virtual
audio solutions, based on our available capital resources. We were incorporated in the State of Delaware in February, 1994 as the
successor company in a Plan of Arrangement pursuant to which the outstanding
shares of Spatializer Audio Laboratories, Inc., a publicly held Yukon, Canada
corporation, were exchanged for an equal number of shares of our common stock.
Our corporate office and research center is located at 1754 Technology Drive,
Suite 125, San Jose, California 95110, Telephone (408) 453-4180. We also
maintain offices at 2625 Hampshire Road, Suite 330, Westlake Village,
California 91361. We have a Website at www.spatializer.com. Copies of this
Annual Report, including our financial statements and our quarterly reports on
Form 10-Q as well as other corporate information, including press releases, of
interest to our




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stockholders are available on our website promptly after filing or
distribution. As used herein, Spatializer, the Company, we or our means
Spatializer Audio Laboratories, Inc. and its wholly-owned subsidiaries. Desper Products, Inc.  Virtual Audio Signal Processing Technologies DPI has developed a suite of proprietary advanced audio signal processing
technologies for the entire spectrum of applications falling under the general
category of virtual audio. The objective in each product category is to create
or simulate the effect of a multi-speaker sonic environment using two ordinary
speakers (or headphones) for playback. The market for virtual audio is
segmented into six broad categories of technology as identified in the listing
below. Each of these technologies utilizes different underlying scientific
principles in accomplishing its design objectives and is targeted to a specific
class of consumer electronics or multimedia computer depending on the intended
product use and functional capability of the product. DPI currently has other
audio signal processing technologies under development which will serve to
expand its market scope and partner product capabilities. Virtual AudioCategory of Technology
    
    Product Categories
    
    Enhancement3-D Stereo(Spatializer® 3-D Stereo)
SpatializerVirtualSurround
VBX
Spatializer ((environ)) 
    
    Consumer electronics products
providing stereo playback  DVD
Players, Stereo TVs, VCRs, Stereo
Components and Systems, Car Audio,
Laptop and Desktop Multimedia
Computers, Set-top Boxes and
Cellular Phones
    
    Surround Sound
enhancement from an
ordinary
stereo(two-channel)
signal, optimized
for various form
factors and speaker
configurationsTwo-SpeakerVirtualization(Spatializer N-2-2,
Spatializer N-2-2Ultra)
    
    Products incorporating multi-channel
audio sources likeDolby Digital®
(AC-3), DolbyProLogic® or MPEG-2.
Home Theater, DVD-Video, Multimedia
    
    Creation of
spatially accurate
multi-speaker
cinematic audio
experience from two
speakers, and
headphones
utilizing discrete
multi-channel audio
information.Bass Enhancement (Vi.B.E.)
    
    Consumer electronics products
providing stereo playback  DVD
Players, Stereo TVs, VCRs, Stereo
Components and Systems, Car Audio,
Laptop and Desktop Multimedia
Computers and Speakers
    
    Simulation of lower
frequency response
from speakers with
relatively high low
frequency
capabilityInternet Audio Enhancement(SpatializerVSP-11,
StreamFX)
    
    Laptop and Desktop Multimedia
Computers and portable musicdevices
running digital media player
Software
    
    Surround Sound and
bass enhancement to
playback of
ordinary internet
audio filesHeadphone Virtualization(Spatializer Natural
Headphone)
    
    Products incorporating multi-channel
audio sources likeDolby Digital®
(AC-3), Dolby ProLogic®, MPEG-2 or
stereo. Home Theater, DVD-Video,
Multimedia Computers utilizing
DVD/MPEG Decoding or stereo.
    
    Creation of
spatially accurate
multi- speaker
cinematic audio
experience from
headphones
utilizing discrete
multi-channel audio
information.Phase Corrected Equalization
(Spatializer PCE)
    
    All audio products with one or more
speakers
    
    Creation of more
recognizable and
cleaner music or
dialog from
broadcast media
sourcesMatrixed Surround Sound
(Spatializer enCompass AV)
    
    All audio products with five or more
speakers
    
    Creation of actual
surround sound (5.1
or more channels)
from mono or stereo
sourcesVirtual Low Frequency Effects
(Spatializer VirtuaLFE)
    
    All audio products with two
speakers and access to a 5.1 channel audio stream.
    
    Creation of
sub-woofer like
effect (.1 channel)
through two
speakers




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Virtual AudioCategory of Technology
    
    Product Categories
    
    EnhancementNoise Reduction
(Spatializer Audio Alchemy)
    
    All recordable digital audio products
    
    Eliminates unwanted
environmental noise
from recordings
while reinforcing
desired source
audio
 Licensed Products Our current technology product applications are directed to (1) speaker
enhancement, (2) stereo surround sound enhancement, (3) mobile entertainment
enhancement and (4) noise reduction.  1.
    
    Spatializer3D Stereo.Based upon proprietary and patented methods of
stereo signal processing, our Spatializer 3D Stereotechnology is
designed to create a vivid and expansive three- dimensional surround
sound listening experience from any stereo source input using only two
ordinary speakers. Along with professional audio quality and coherent
stable sonic imaging, the technology includes our unique DDP (Double
Detect and Protect) algorithm. DDP continuously monitors the underlying
stereo signal and dynamically optimizes spatial processing, avoiding
deleterious sonic artifacts common in other systems and provides set
and forget ease of use for consumers. First introduced in July 1994 by
DPI, in the form of a 20 pin analog integrated circuit (IC) from
Matsushita Electronics Corporation (MEC), the technology is now
incorporated into low-cost, standard process ICs by three chip foundries
(Matsushita, ESS Technologies, Inc., OnChip Systems and) for easy and
inexpensive implementation in any consumer electronics or computer
products utilizing stereo audio. The technology is currently available
in both analog and digital formats. Matsushita introduced a new
Spatializer IC design in 1999, offering the Spatializer 3-D Stereo
effect in a simplified, lower cost package. In early 2002, we introduced
a new algorithm-based technology which provides a virtual surround sound
effect from a two channel input for DSP-based environments. In 2003, we
introduced Spatializer ((environ)), especially designed for cellular
phones with two, closely spaced speakers to enhance both ring tones and
music.  2.
    
    SpatializerN-2-2 Ultra Digital Virtual Surround. In September 1996, DPI
introduced Spatializer N-2-2,which we consider a core, and enabling
technology for DVD based home theater products and personal computers.
In mid-2001, DPI introduced Spatializer N-2-2 Ultraas the latest
generation of this core audio technology. Through outstanding
performance and continuous enhancement, Spatializer N-2-2 has emerged as
the de facto standard for branded virtual surround sound as measured
by most brand adoptions, cumulative shipments and market share of such
brands in the DVD player market. DVD is considered by many to be the
single most important and fastest adopted consumer audio/computer
technology ever introduced. The audio standards for DVD (based upon
geographic region) are multi-channel audio formats (Dolby Digital®
(AC-3) and MPEG-2) which carry six (or more) discrete (independent)
channels of audio  the front left and right channels, a center channel
(for vocal tracks), two rear surround channels and a Low Frequency
Effects (LFE or sub-woofer) channel for sound effects. The Spatializer
N-2-2software- based algorithms permit spatially accurate reproduction
of this multi-channel audio over any ordinary stereo system using two
rather than the five or six speakers normally required in traditional
home theater setups. Spatializer N-2-2runs in real-time on general
purpose Digital Signal Processing (DSP) hardware platforms like those
offered by LSI, Acer Labs, Inc., Motorola, VM Labs and Zoran; may be
integrated with host based software-only MPEG-2 or DVD decoders (like
WinDVD and PowerDVD, offered by InterVideo and Cyberlink, respectively,
for the Intel® Pentium® series of microprocessors); and can be ported to
any of the principal audio codecs or media processor/accelerator
platforms performing Dolby Digital (AC-3) or MPEG-2 audio decoding.
Spatializer N-2-2has been approved by Dolby Laboratories and qualifies
Spatializer licensees to use the newly created Dolby Digital VIRTUAL
trademark on products incorporating the technology. We believe our
Spatializer N-2-2Ultra process has helped to widen and accelerate the
market for DVD acceptance, because it delivers the full cinematic audio
experience to ordinary consumers without the additional expense and
complication of multi-speaker home theater playback systems.  3.
    
    SpatializerVi.B.E. In early 1999, DPI introduced Spatializer
Vi.B.E., a virtual bass enhancement technology. Spatializer Vi.B.E.
produces a dynamic bass response from even the lowest-end speakers or
headphones. This is particularly important in enhancing the audio of all
forms of portable digital audio devices. Spatializer Vi.B.E. uses
proprietary technology to generate the perception of realistic bass
frequencies that are unaffected by actual speaker system frequency
response capability.  4.
    
    SpatializerVSP-11First introduced by DPI in early 2002,
Spatializer VSP-11 (Virtual Sound Processor 11) is a stand-alone
application program for Microsoft Windows 95, 98, ME, 2000 and XP
platforms that utilizes Spatializer proprietary psychoacoustic
techniques to allow consumers to enjoy the benefits of the renowned
Spatializer audio enhancement technologies on all leading media players,
soft DVD players and file sharing programs. This means that Spatializer
VSP-11 is a universal audio enhancement software package that will
enhance output from the Microsoft®Media Player, Real




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Player®, Real Jukebox®, WinAmp®, WinDVD®, PowerDVD®, among others, without
any special modification. It will run in conjunction with any sound card, as
well as with USB audio.  5.
    
    SpatializerNatural Headphone Spatializer Natural Headphone,
introduced by DPI in March 2001, renders spatially accurate multiple
speaker positions simulating the typical home theater or stereo
arrangement through a headphone. The headphone algorithm delivers a high
performance simulated surround sound experience, using a reasonable
amount of processing power at a reasonable cost. Thus, this solution is
equally practical and effective for both low-power portable devices and
home theater applications. Unlike typical virtual surround sound
headphone solutions, which rely heavily on reverberation which can sound
unnatural, Spatializer Natural Headphone utilizes a combination of
techniques to provide an expanded, yet natural sound field.  6.
    
    SpatializerPCESpatializer PCE, introduced in October 2001, makes
high frequencies clearer, crisper and more brilliant while low
frequencies are more dramatic, tighter and have more impact.
Spatializer® PCE gives the manufacturer an inexpensive way to
dramatically improve the sound of low-end loudspeakers, such as the kind
found in televisions, boom boxes and computers. Spatializer PCE is also
ideal for improving the quality of Internet audio, which can sound
rather lackluster and dull due to compression or low bit rates. It can
be applied prior to encoding audio streams, and can just as easily
enhance the playback of the decompressed audio. It can improve the
clarity, intelligibility and impact of both dialog and music.
Spatializer PCE works by both modifying and smoothing non-linear phase
response and by creating psycho-acoustic cues. Typical equalization
techniques cause phase distortion (non-zero group delay) due to
non-linear phase response. Spatializer PCE has a nearly-linear phase
response, which results in a near-zero group delay. This improves the
naturalness, or transparency of the dialog or music by not adding to
phase distortion already present in many playback systems.. Spatializer
PCE can be custom tailored for two or an array of speaker
configurations. The technology, without a surround sound effect, can
enhance single speaker applications as well.  7.
    
    SpatializerenCompass AVSpatializer enCompass AV, launched in late
2002, is designed to offer high quality, multi-channel audio, even from
mono or stereo sources. This technology allows owners of home theater
systems with five or more speakers to hear a surround sound effect,
utilizing all of their speakers to deliver full system utility from CDs,
cassettes or VHS tape or records.  8.
    
    SpatializerVirtuaLFEprocesses the sub-woofer channel with
proprietary psycho-acoustic techniques to virtualize, reinforce and
enhance the effect for accurate reproduction through two speaker home
audio or on-board television speakers. The result is an emotive low
frequency effect that brings DVDs alive as if an actual sub-woofer
speaker were employed. The efficient algorithm architecture makes
implementation feasible on a wide array of home entertainment products.  9.
    
    SpatializerAudio Alchemydynamically removes noise from up to six
input channel simultaneously. Utilizing state of the art noise removal
and reduction techniques, Spatializer Audio Alchemy dynamically adjusts
to changing noise levels and environments. Tailored for the human
voice, Spatializer Audio Alchemy removes background noise such as fans,
motor hum, and tape hiss. Spatializer Audio Alchemy features an advanced
equalization processor to compensate for frequency response limitations
in the audio recording hardware and transducers. In addition,
Spatializer Audio Alchemy also performs spatial reconstruction to
simulate the original acoustic environment, and normalizes the dynamic
range of the digital audio source to a level compatible with home
theater environments In addition, we offer three whole product solutions with multiple Spatializer
technologies that comprehensively address the unique audio delivery challenges
inherent in each targeted platform. The Spatializer HD Class is comprised of
three new products specifically targeted at home audio, cellular telephones and
other mobile applications and personal computers. The Spatializer technologies
in each package operate in a complementary fashion, such that the concurrent
technologies deliver a more powerful and effective audio experience than that
possible from a single solution. Further, each technology has been optimized
and customized for the targeted application and is designed to overcome the
audio challenges presented by small form factor, transducer limitations and
even cost constraints. Spatializer UltraMobile HD delivers higher definition digital audio to mobile
audio systems through the multiple and complementary use of Spatializer Natural
Headphone, Spatializer Vi.B.E. and Spatializer PCE. UltraMobile HD improves the
performance of low cost headphones or ear buds, as well as from compressed
audio by opening up the sound field while improving bass performance. In
cellular telephone applications, Spatializer ((environ)) delivers maximum
performance from micro-speakers that are mounted closely together and helps
compensate for the more limited dynamic range as compared with standard size
speakers.




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When applied to stereophonic ring tones, Spatializer ((environ)) creates a
startling and expressive sound field when such speakers are utilized in
cellular handsets. Spatializer UltraTV HD delivers higher definition digital audio performance to
digital televisions, DVD players and DVD Recorders. HDTV signals can
realistically be retrieved only in limited ways, leading to customer
disappointment. The Spatializer UltraTV HD processor is designed to compensate
for these shortcomings in digital home entertainment for the millions of
households without home theater systems. Realistic surround sound,
near-sub-woofer effects and crisp dialog is made possible through two speakers,
rather than through expensive arrays of external speakers. Another unique
aspect of this product is that it is designed specifically for playback through
television speakers and can be custom tailored to the frequency aspects of a
manufacturers speaker set. Spatializer UltraPC HD helps ease the transition of the personal computer from
business tool to a comprehensive component of the digital home entertainment
experience. Spatializer UltraPC HD includes Spatializer N-2-2 Ultra that
delivers surround sound through only two speakers, Spatializer Natural
Headphone for personal surround sound, Spatializer VirtuaLFE that processes
the sub-woofer channel for a low frequency effect through ordinary speakers and
Spatializer PCE for dialog clarity. Each of these technologies has been
optimized for small speaker or headphone playback and can be custom tuned to a
manufacturers specific speaker set. Licensing Activities Until 2000, we licensed our technologies primarily through semiconductor
manufacturing and distribution licenses (Foundry Licenses) with semiconductor
foundries. In turn, the foundries manufacture and distribute integrated
circuits ICs (integrated circuits) or DSPs (digital signal processors)
incorporating Spatializer technology to consumer electronics and multimedia
computer OEMs (original equipment manufacturers). In 2000, we began offering foundries the option of entering into a
non-royalty bearing distribution agreement with us. Under this business model,
the foundry offers Spatializer technology as an optional feature, promotes our
technology in their sales materials and cooperates with the Spatializer sales
force in closing license agreements for Spatializer technology with the OEM
customer. This business model provides the foundry with an additional selling
feature at no additional cost to the foundry. The OEM can obtain use of the
technology directly from Spatializer without any additional mark-up from the
foundry. The terms of all of our licenses are negotiated on an individual basis
requiring the payment of a per unit running royalty according to sliding scales
based upon cumulative volume. Some of our licenses call for the payment of an
up-front license issuance fee either in lieu of, or in addition to the running
royalty. Other agreements require the OEM customer, rather than the foundry, to
pay the royalty. Per unit royalties are generally reportable and payable 45
days after the end of the quarter following shipment from the foundry to the
OEM or, in the case of a distribution agreement, by the OEM to its accounts. OEMs who desire to incorporate these DSPs or ICs into their products are
required to enter into a license (OEM Licenses) with us before they may
purchase the ICs in quantity. Foundry Licenses generally have limited the sale
of DSPs or ICs with Spatializer technology to OEMs who have entered into an OEM
License with us. OEM licenses generally provide for the payment of a further
per unit royalty by the OEM for OEM products incorporating a Spatializer IC
(Licensed Products) payable in the quarter following shipment by the OEM of
its Licensed Products. In early 2001, we reached an agreement with C-Cube Semiconductor II (now
LSI Logic Corporation) to unbundle the royalty on their DSPs in order to
facilitate the licensing of multiple technologies to OEM manufacturers and to
help ensure that their products remained highly competitive in the market. As
such, effective April 1, 2001, C-Cubes customers using Spatializer technology
have entered into direct licenses with us. We are currently negotiating new IC/DSP Foundry Licenses and OEM Licenses
with potential customers for Spatializer N-2-2 Ultra, Spatializer Vi.B.E.,
Spatializer Natural Headphone , Spatializer PCE and combinations and
optimizations of these technologies under the Spatializer Ultra HD series.
Currently, all new licenses are negotiated by our Chief Executive Officer.




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IC/DSP Foundry Licenses In 2000 and early 2001, VM Labs, Inc., MIPS Technologies, New Japan Radio
Corporation (NJRC), Tvia, Inc. and Link Up Systems entered into Foundry
License or Distribution Agreements for Spatializer N-2-2. All but the NJRC
agreements were non-royalty bearing distribution agreements, with per unit
royalties to be paid by the OEM customer. In 2001, we entered into license or distribution agreements with Texas
Instruments, Cirrus Logic, Sanyo, Sharp and Kenwood, among others. In 2002, we entered into distribution agreements with MediaTek, Amlogic,
LSI Logic and Samsung Semiconductor for the porting and distribution of our
technologies to OEM manufacturers. These Distribution agreements grant the
right to port and or distribute our technology only to licensed customers of
Spatializer, who then pay a royalty for the use of such technologies. As of December 31, 2003, we have entered into non-exclusive Foundry
Licenses for our Virtual Audio Signal Processing technologies with Matsushita
Electronics Corporation (MEC), ESS Technology, Inc. (ESS), OnChip Systems,
Inc. (OnChip), LSI Logic, Inc. (LSI), Acer Labs, Inc. (Ali), MIPS
Technologies, NJRC, Tvia, Inc., Texas Instruments, Cirrus Logic and Link Up
Systems. Foundry Licenses generally require the payment of per unit running
royalties based upon a sliding scale computed on the number of Spatializer ICs
or DSPs sold. As of December 31, 2003, more than 45 million ICs and DSPs incorporating
Spatializer audio signal processing technology had been manufactured and sold. OEM Licensees and Customers As of December 31, 2003, our technology has been incorporated in products
offered by more than 100 separate OEM Licensees and customers on various
economic and business terms. Some of these OEM Licenses required a license
issuance fee and/or a separate per unit royalty, while others were licensed
under the Logo Usage Agreement (LUA) or were authorized customers under
bundled royalty licenses with the IC foundries. The OEM Licensees and customers
offer a wide range of products, which include DVD players, car stereo systems,
direct view TVs, wide screen and projection TVs, cellular phones, powered
speakers, portable audio systems (Boomboxes), HiFi stereo systems and
components, computer sound cards and graphics accelerator cards, multimedia
desktop personal computers, notebook computers, LCD projectors, multimedia
computer monitors, and arcade pinball and video games. In 2003, four major customers, not presented in order of importance, each
accounted for 10% or more of our total revenues: Apple Computer, Orion, JVC and
Samsung, each of whom accounted for greater than 10% of our total 2003
revenues. One OEM accounted for 34%, two accounted for 20% each and one
accounted for 10% of our royalty revenues during 2003. Two other accounts
comprised more than 5%, but less than 10% of revenues, each. All other OEMs
accounted for less than 5% of royalty revenues individually. During 2003 we
anticipated a significant reduction in revenues from Apple as it completes its
migration to its newest operating system and from Toshiba due to sourcing
reallocation on some products. The following table is a partial list of the OEM Licensees and authorized
customers as of December 31, 2003: Partial List of OEM Licensees or CustomersAmlogic
    
    NECCirrus Logic
    
    Panasonic TV & VCR (Matsushita
Kotobuki Electronics Industries,Ltd.)Emerson
    
    Panasonic Car Audio (Matsushita
Communications Industrial Co., Ltd.)Fujitsu Computer Corp.
    
    Proton Electronic Industrial Co., Ltd.Hewlett Packard
    
    SamsungHitachi, Ltd.
    
    Seiko Epson Corp.Iiyama Electric Co., Ltd.
    
    Sanyo Corp.Gateway Computer Corp.
    
    Sharp Corp.Golden Regent
    
    Toshiba DVDLG Electronics
    
    Toshiba TVJVC
    
    Taisei Electric, Inc.Labtec Enterprises, Inc.
    
    Taiyo Electric Company, Ltd.




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##### Table of Contents



Partial List of OEM Licensees or CustomersMediaTek
    
    Texas Instruments
Theta DigitalMitsubishi Image and Information Works
 We have extensive relationships with OEM licensees and customers outside
the United States. Japanese and Korean based entities accounted for 71% and 20%
of our total revenues, respectively in 2003, 50% and 17% of our total
revenues, respectively in 2002, and 31% and 15% of our total revenues,
respectively in 2001. The products incorporating our technology are, in turn,
sold throughout the world, in market segments and amounts that are consistent
with the overall general world markets for consumer electronics and software. Customers, Revenues and Expenses We generate revenues in our audio business from royalties pursuant to our
Foundry, OEM, and other licenses, and from non-recurring engineering fees to
port our technologies to specific licensees applications. Our revenues, which
totaled $1,269,000 in 2003, were derived almost entirely from Foundry and OEM
license fees and royalties. We seek to maximize return on our intellectual property base by
concentrating our efforts in higher margin licensing and software products and
eliminated our hardware product operations. Licensing operations have been
managed internally by our personnel and through use of an international sales
rep force. In 2003, four major customers, not presented in order of importance, each
accounted for 10% or more of our total revenues: Apple Computer, Inc., JVC,
Samsung and Orion Corporation, each of whom accounted for greater than 10% of
our total 2002 revenues. One OEM accounted for 34%, another accounted for 20%,
another accounted for 20% and one accounted for 10% of our royalty revenues
during 2003. Two other accounts comprised more than 5%, but less than 10% of
revenues, each. All other OEMs accounted for less than 5% of royalty revenues
individually. We achieved improved operating results in 2002 as a result of overhead
reductions combined with the strong growth of DVD-related revenues. In 2001, we
began expanding our headcount, primarily in the engineering area in
anticipation of continued growth. At midyear, in light of a weakening in market
conditions and lower than anticipated royalties from a key Asian account,
expenditures were once again curtailed in order to bring overhead levels more
in line with current revenues. In 2003, declining revenues were experienced
from three major customers resulting primarily from the cessation of use of our
products by these customers. In most of these cases, the DVD player market,
where we had a high concentration of accounts, became commoditized and resulted
in a steep decline in price and margins. Manufacturers were forced to strip out
features, such as those from our company, in order to compete. Another PC
account migrated completely in 2003 to a new operating system and chose
not to include any audio software enhancements. Competition We compete with a number of entities that produce various audio
enhancement processes, technologies and products, some utilizing traditional
two-speaker playback, others utilizing multiple speakers, and others restricted
to headphone listening. These include the consumer versions of multiple
speakers, matrix and discrete digital technologies developed for theatrical
motion picture exhibition (like Dolby Digital®, Dolby ProLogic®, and DTS®), as
well as other technologies designed to create an enhanced stereo image from two
or more speakers. Our principal competitors in the field of virtual audio are SRS Labs, Inc.
and Qsound Labs, Inc. In addition, some DSP foundries and OEMs have proprietary
virtual audio technologies that they regularly offer to OEMs at no cost.
These companies have, or may have, substantially greater resources than us to
devote to further technologies and new product developments. Pressure on OEMs to reduce their costs, particularly in the DVD market is
intense. The marketplace is also susceptible to undisciplined competitors who,
from time to time, may offer below market prices to generate short term revenue
and larger market penetrations even if it does not provide for viable margins.
In the future, our products and technologies also may compete with audio
technologies and product applications developed by other companies including
entities that have business relationships with us. Factors that affect our
ability to compete include product quality, performance and features,
conformance to existing and new standards, price, customer support and
marketing and distribution strategies.




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We believe that we will favorably compete in this market because we offer
a single source, complete suite of patented and proprietary 3D Stereo,
interactive positional, virtual surround sound, headphone and speaker
virtualization technologies. By virtue of our specialized engineering and OEM
support, we can offer a turn-key audio solution to OEMs who do not possess
this expertise internally. We also have developed new products that address our
customers need for a low cost solution. In addition, the strength of our IC
Foundry and OEM relationships and the Spatializer brand name recognition in the
industry are other key differentiators between both our branded and unbranded
competition. Lastly, we continue to explore new and alternative business models
that we believe serve the interests of both our customers and our stockholders. Research and Development Our research and development expenditures in 2003, 2002 and 2001 were
approximately 28%, 25% and 35% of total operating expenses respectively. These
expenses consist of salaries and related costs of employees and consultants
engaged in ongoing research, design and development activities and costs for
engineering materials and supplies As of December 31, 2003, we had five employees and consultants in our R&D
group representing 56% of our total human resources. Our software, hardware and
application engineers focus on developing intellectual property, technology
solutions and consumer products. Intellectual Property and Proprietary Information We rely on a variety of intellectual property protections for our products
and services, including patent, copyright, trademark and trade secret laws, and
contractual obligations. Our core signal processing technology is covered by
U.S. patents 5,412,731, 5,896,456 and 6,307,941. On March 20, 1998, we filed a
patent application on our enCompass V 2.0 technology with the United States
Patent & Trademark Office (USPTO) covering our enCompass 2.0 positional audio
gaming technology. In June 2000, we filed an additional patent application for
our reduced cost/higher performance 3-D Stereo circuit design. In late 2002, we
filed a patent application covering our Spatializer PCE technology. In 2003, we
filed a patent application for Spatializer Audio Alchemy. Much of our
intellectual property consists of trade secrets. In 2002, patent 6,307,941 was
issued by the USPTO covering our Spatializer N-2-2 technology. We possess
copyright protection for its principal software applications and has U.S. and
foreign trademark protection for its key product names and logo marks. There can be no assurance that these measures will be successful, or that
competitors will not be able to produce a non-infringing competitive product or
service. In addition, the laws of certain countries in which our products are
or may be developed, manufactured or sold, including various countries in Asia,
may not protect our products and intellectual property rights to the same
extent as the laws of the United States, or at all. There can be no assurance
that third parties will not assert infringement claims against us, or that if
required to obtain any third party licenses as a result of an infringement
dispute, we will be able to obtain such licenses. In June 1996, we acquired certain developmental stage technologies and
assets from Home Theatre Products (HTP), for approximately $1,062,000 in June
1996 and formed a subsidiary, MultiDisc Technologies, Inc. (MDT). The MDT
transaction brought a combination of proprietary electromechanical designs,
robotics, operating software, firmware, intellectual property, and engineering
know-how and five patent applications acquired in the asset acquisition. MDT
added an additional forty-seven patent applications filed with the USPTO to
bring the total to fifty-two patent applications filed. On September 25, 1998,
we announced our plan to refocus our business on the exploitation of our core
audio technologies and to properly position the MDT assets for sale. The
repositioning strategy recognized that the capital investment required to
properly commercialize the MDT technology was beyond our capacity. As a result,
all operations, including research and development activities, were suspended
and we have accounted for MDT as a discontinued operation. We have explored the
sale of the business or the patent portfolio with interested parties, but to
date, no transaction has been consummated. Seasonality Due to our dependence on the consumer electronics market, we experience
seasonal fluctuation is sales and earnings. In particular, we believe that
there is seasonality relating to the Christmas season in the third and fourth
quarters, as well as the first quarter, which is generally the weakest. We are
moving toward diversifying our key market segments in the consumer electronics
industry in an effort to even out our seasonal fluctuation. Overall,
seasonality does not have a material effect on our business.




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Employees We began 2003 with five full-time and nine part-time employees and sales
representatives and decreased our staff to four full time and five part-time
employees, consultants and sales representatives by December 31, 2003. At
year-end, there were two full-time employees and three consultants engaged in
research and development. We employ the services of outside professional
consultants, particularly in the audio engineering area, due to the costly and
tight labor market for such professionals in Silicon Valley as well as the need
for specialized expertise in the course of our business. None of our employees
are represented by a labor union or are subject to a collective bargaining
agreement. We consider our relations with our employees and consultants to be
satisfactory. 
 Item 2.Properties Our corporate office and research center in San Jose, California, is the
primary location for our audio technology division, (DPI). We occupy
approximately 1,200 square feet with an annual rent on a full service basis of
approximately $22,000. The lease expires on December 30, 2004 and is renewable
at market rates thereafter. Our executive office is located in Westlake Village, California, where we
occupy approximately 100 square feet with an annual rent of approximately
$5,000. The lease term on this space expires on September 30, 2004 and is
renewable on a month to month basis thereafter. This space in the Los Angeles
area is used to facilitate business and contacts with the entertainment
community as well as with our accountants, lawyers and directors. We lease an apartment in San Jose, California for use by the chief
executive officer when away from the executive office. The annual rent on this
apartment is approximately $18,000. The lease is on a month-to-month basis. We lease our space at rental rates and on terms which management believes
are consistent with those available for similar space in the applicable local
area. Our properties are well maintained and we believe they are adequate to
support our current requirements.




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Item 3.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 the date of this Annual Report
on Form 10-K, 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 the above legal
proceedings could change in the future. 
 Item 4.Submission of Matters to a Vote of Security Holders There
were no matters submitted to a vote of our security holders either
through solicitation of proxies or otherwise in the fourth quarter of the
fiscal year ended December 31, 2003. 
 Item 5.Market for Registrants Common Equity and Related Stockholder Matters Our Common Stock was listed and commenced trading on the NASDAQ SmallCap
market on August 21, 1995 under the symbol SPAZ. In January 1999, the Common
Stock was delisted by the NASDAQ SmallCap Market due to our inability to
maintain listing requirements. Our Common Stock immediately commenced trading
on the OTC Bulletin Board under the same symbol. The following table sets forth
the high and low bid price of our Common Stock as reported on the OTC Bulletin
Board for fiscal years 2001 and 2002. The quotations listed below reflect
interim dealer prices without retail mark-up, mark-down or commission and may
not represent actual transactions. Period:
    
    High (U.S. $)
    
    Low (U.S. $)2002First Quarter
    
    $
    0.22
    
    
    $
    0.12Second Quarter
    
    $
    0.14
    
    
    $
    0.09Third Quarter
    
    $
    0.13
    
    
    $
    0.06Fourth Quarter
    
    $
    0.09
    
    
    $
    0.062003First Quarter
    
    $
    0.08
    
    
    $
    0.04Second Quarter
    
    $
    0.07
    
    
    $
    0.04Third Quarter
    
    $
    0.06
    
    
    $
    0.04Fourth Quarter
    
    $
    0.19
    
    
    $
    0.04
 On February 25, 2004, the closing price reported by the OTC Bulletin Board
was U.S. $0.17. Stockholders are urged to obtain current market prices for our
Common Stock. Computershare Investor Services, LLC is our transfer agent and
registrar. There were no sales of unregistered securities by the Company during the
year ended December 31, 2003. To our knowledge there were approximately 200 holders of record of the
stock of the Company as of March 5, 2003. Our transfer agent has indicated that
beneficial ownership is in excess of 4,000 stockholders. We have not paid any cash dividends on its Common Stock and have no
present intention of paying any dividends. Our current policy is to retain
earnings, if any, for use in operations and in the development of its business.
Our future dividend policy will be determined from time to time by the Board of
Directors. 
 Item 6.Selected Consolidated Financial Data The following selected consolidated financial data should be read in
conjunction with our Consolidated Financial Statements and related Notes and
with Managements Discussion and Analysis of Financial Condition and Results
of Operations, included in Item 7. The selected financial data for the years
ended December 31, 2003, 2002, 2001, 2000 and 1999 are derived from our
consolidated financial statements that have been audited by Farber & Hass LLP,
independent certified public accountants. The consolidated statements of
operation and cash flows for the year ended December 31, 2003 and the report
thereon are included elsewhere in this Report.




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##### Table of Contents



Fiscal Year EndedDecember 31,
    
    December 31,
    
    December 31,
    
    December 31,
    
    December 31,1999
    
    2000
    
    2001
    
    2002
    
    2003Consolidated Statement of Operations Data:Revenues
    
    $
    1,660
    
    
    $
    2,202
    
    
    $
    1,604
    
    
    $
    1,856
    
    
    $
    1,269Cost Of Revenues
    
    
    (49
    )
    
    
    (248
    )
    
    
    (97
    )
    
    
    (131
    )
    
    
    (122
    )Gross Profit
    
    
    1,611
    
    
    
    1,954
    
    
    
    1,507
    
    
    
    1,725
    
    
    
    1,147Total Operating Expenses
    
    
    (1,156
    )
    
    
    (1,596
    )
    
    
    (1,823
    )
    
    
    (1,711
    )
    
    
    (1,631
    )Other Income (Expense), Net
    
    
    (94
    )
    
    
    34
    
    
    
    73
    
    
    
    (2
    )
    
    
    (6
    )Loss from Discontinued OperationsIncome taxes
    
    
    (6
    )
    
    
    (10
    )
    
    
    3
    
    
    
    (6
    )
    
    
    (5
    )Net Income (Loss)
    
    $
    355
    
    
    $
    382
    
    
    $
    (240
    )
    
    $
    18
    
    
    $
    (495
    )Basic Income (Loss) Per Share
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    (0.01
    )
    
    $
    0.00
    
    
    $
    (0.01
    )Diluted Income (Loss) Per Share
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    (0.01
    )
    
    $
    0.00
    
    
    $
    (0.01
    )Weighted Average Common Shares
    
    
    33,805,512
    
    
    
    46,736,224
    
    
    
    47,388,235
    
    
    
    47,406,939
    
    
    
    47,309,171Consolidated Balance Sheet DataCash and Cash Equivalents
    
    $
    1,022
    
    
    $
    1,468
    
    
    $
    869
    
    
    $
    859
    
    
    $
    590Working Capital
    
    
    395
    
    
    
    1,195
    
    
    
    1,124
    
    
    
    1,125
    
    
    
    793Total Assets
    
    
    2,118
    
    
    
    2,457
    
    
    
    1,753
    
    
    
    1,746
    
    
    
    1,205Redeemable Preferred Stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    1Advances From Related Parties
    
    
    337
    
    
    
    337
    
    
    
    113
    
    
    
    113
    
    
    
    108Total Shareholders Equity
    
    $
    768
    
    
    $
    1,651
    
    
    $
    1,411
    
    
    $
    1,429
    
    
    $
    955
 
 Item 7.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




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##### Table of Contents



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:  
    
    We Face Significant Pricing Pressure and Competition that can Result
in Our Technology Being Designed Out Within a Short Time Frame, or
Impeding Efforts to Secure New Design Wins
    
    New Customer Product Development Can be Delayed. This Results in
Delays In Revenues. Further, Where our Products are Delayed,
Competitive Products May Reach The Market Before, or Replace Our
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.  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 cashflow. 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. 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




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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. 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 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. Results of Operations The following discussion and analysis relates to our financial condition
and results of operations for the year ended December 31, 2003 compared to the
year ended December 31, 2002, and the year ended December 31, 2002 compared to
the year ended December 31, 2001. The following discussion of the financial
condition and results of operations should be read in conjunction with the
Consolidated Financial Statements and Notes thereto included elsewhere in this
report. For the Year Ended December 31, 2003, Compared to the Year Ended December 31,
2002 Revenues Revenues decreased to $1,269,000 for the year ended December 31, 2003
compared to $1,856,000 for the year ended December 31, 2002, a decrease of 32%.
Revenues are almost entirely comprised royalties pertaining to the licensing of
Spatializer® audio signal processing algorithms. The decrease in revenues is attributed primarily to the loss or reduction
at two key accounts which generated in excess of 20% of total revenue each,
partially offset by revenue from a new account. The first lost account was in
the PC market, which completed its migration to a new operating system in which
it chose not to include any software audio enhancements. The second account was
in the DVD player market, where it selected a lower cost solution for its low
cost, high volume DVD players.




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Gross Profit Gross profit decreased to $1,147,000 for the year ended December 31, 2003
compared to $1,725,000 in the comparable period last year, a decrease of 34%.
Gross margin decreased to 90% of revenue in the year ended December 31, 2003
compared with 93% of revenue for the comparable period last year. The decrease
in gross profit results from lower revenues in the current year and from lower
gross margin. The decrease in the gross margin percentage reflects a change in
mix to commissionable foreign royalty revenue compared to non-commissionable
U.S. sourced revenue. We maintain a high margin since revenues are from
licensing and royalty activities, which have little or no associated direct
manufacturing or selling costs other than commissions paid to our independent
representatives that solicit and oversee the particular accounts. Operating Expenses Operating expenses for the year ended December 31, 2003 decreased to
$1,631,000 (128% of sales) from $1,711,000 (92% of sales) for the year ended
December 31, 2002, a decrease of 5%. The decrease in operating expenses results
primarily from reductions in sales and marketing due to the elimination of a
marketing and business development executive position and related travel. These
responsibilities were transferred to another executive and to a new
representative firm in Japan. In the fourth quarter of fiscal 2003, we implemented a cost reduction
program that included the elimination of an executive position, relocation of
the corporate offices to smaller and lower cost facilities, replacement of a
stipended representative with a commissioned representative and other overhead
related cost savings. The annualized reduction to be provided by these
initiatives are expected to result in an overall overhead reduction of at least
20%. General and Administrative General and administrative costs increased to $811,000 for the year ended
December 31, 2003 from $766,000 for the year ended December 31, 2002, an
increase of 6%. The increase is primarily due to increased legal expenses
related to public filings, in part in response to the additional requirements
imposed on public companies by the Sarbanes-Oxley Act, and increased travel by
the CEO. General operating costs include rent, telephone, legal, public filing,
office supplies and stationery, postage, depreciation and similar costs. Research and Development Research and Development costs increased to $459,000 for the year ended
December 31, 2003, compared to $433,000 for the year ended December 31, 2002,
an increase of 6%. The increase in research and development expense was due
strategic use of outside specialist consultants, wage increases and increased
health insurance premiums for such personnel. We continued efforts to identify, validate, and develop new product ideas
at DPI. Specific engineering efforts were directed toward the launch of
Spatializer Audio Alchemy, refinement of Spatializer Natural Headphone,
development of the HD Series of whole product solutions and applications
engineering to port our technology to leading processor platforms. Sales and Marketing Sales and Marketing costs decreased to $361,000 for the year ended
December 31, 2003, compared to $513,000 for the year ended December 31, 2002, a
decrease of 30%. The reduction in such expenses resulted from the elimination
of a sales consultant position, the elimination of a sales executive position
in the third quarter of 2003 and fewer trade show participations. Net Income (Loss) Net loss was $495,000 for the year ended December 31, 2003, ($0.01) basic
per share, compared to net income of $18,000, ($0.00) per share basic and
diluted, for the year ended December 31, 2002. Net loss for the current period
is primarily the result of lower gross margin, partially offset by lower
overhead.




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For the Year Ended December 31, 2002, Compared to the Year Ended December 31,
2001 Revenues Revenues increased to $1,856,000 for the year ended December 31, 2002
compared to $1,604,000 for the year ended December 31, 2001, an increase of
16%. Revenues are almost entirely comprised royalties pertaining to the
licensing of Spatializer® audio signal processing algorithms. The increase in revenues is attributed primarily to the addition of two
new accounts which generated in excess of 10% of total revenue each, partially
offset by declining royalties on declining analog chip sales from another
account. Gross Profit Gross profit increased to $1,725,000 for the year ended December 31, 2002
compared to $1,507,000 in the comparable period last year, an increase of 14%.
Gross margin decreased to 93% of revenue in the year ended December 31, 2002
compared with 94% of revenue for the comparable period last year. The increase
in gross profit results from higher revenues in the current year, partially
offset by slightly lower gross margin. This decrease in the gross margin
percentage reflects a slight change in mix to commissionable foreign royalty
revenue compared to non-commissionable U.S. sourced revenue. We maintain a
high margin since revenues are from licensing and royalty activities, which
have little or no associated direct manufacturing or selling costs other than
commissions paid to our independent representatives that solicit and oversee
the particular accounts. Operating Expenses Operating expenses for the year ended December 31, 2002 decreased to
$1,711,000 (92% of sales) from $1,823,000 (114% of sales) for the year ended
December 31, 2001, a decrease of 6%. The decrease in operating expenses results
primarily from completion of various outside engineering consulting projects in
2001 for which we paid outside engineering fees. In 2002, a much greater level
of applications engineering projects were either done in house or by our
licensed distributors and the fees incurred for such work was significantly
reduced over the prior year. However, levels of pure R&D were unchanged between
the two years, as reflected by the level of new product introductions. General and Administrative General and administrative costs increased to $766,000 for the year ended
December 31, 2002 from $707,000 for the year ended December 31, 2001, an
increase of 9%. The increase is primarily due to increased legal expenses
related to public filings and increased travel by the CEO. General operating
costs include rent, telephone, legal, public filing, office supplies and
stationery, postage, depreciation and similar costs. Research and Development Research and Development costs decreased to $433,000 for the year ended
December 31, 2002, compared to $639,000 for the year ended December 31, 2001, a
decrease of 32%. The decrease in research and development expense was due
completion of various outside engineering consulting projects in 2001 for which
we paid outside engineering fees. In 2002, a much greater level of applications
engineering projects were either done in house or by our licensed distributors
and as such, the fees incurred for such work were significantly reduced over
the prior year. However, levels of pure R&D were unchanged between the two
years, as reflected by the level of new product introductions. We continued efforts to identify, validate, and develop new product ideas
at DPI. Specific engineering efforts were directed toward the launch of
encompass AV , development of Spatializer Audio Alchemy, refinement of
Spatializer Natural Headphone and applications engineering to port our
technology to leading processor platforms. Sales and Marketing Sales and Marketing costs increased to $513,000 for the year ended
December 31, 2002, compared to $476,000 for the year ended December 31, 2001,
an increase of 8%. Spending was increase in the area of foreign travel, where
the Asian customer visitation frequency was doubled in the second half of 2002.




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Net Income (Loss) Net Income was $18,000 for the year ended December 31, 2002, compared to
net loss of $240,000 for the year ended December 31, 2001. Net Income for the
current period is primarily the result of higher revenues and improved overhead
management. Liquidity and Capital Resources At December 31, 2003, we had $590,000 in cash and cash equivalents as
compared to $859,000 at December 31, 2002. The decrease in cash and cash
equivalents is attributed to the operating loss. We had working capital of
$793,000 at December 31, 2003 as compared with working capital of $1,125,000 at
December 31, 2002. Net cash used in operating activities was $253,965 for the year ended
December 31, 2003, as compared to net cash provided by operating activities of
$85,138 for the year ended December 31, 2002 and net cash used in operating
activities of $339,675 for the year ended December 31, 2001. The decrease in
cash flows from operations for the year ended December 31, 2003 was primarily a
result of decreases in net income in 2003. Accounts receivable decreased
$153,612 for the year ended December 31, 2003, due to year over year decline in
sales and resulting collections We use cash in investing activities primarily to secure patent and
trademark protection for our proprietary technology and brand name, and to
purchase short-term investments such as bank certificates of deposit. Cash used
in investing activities totaled $20,709, $95,891 and $34,593, respectively, in
the years ended December 31, 2003, 2002, and 2001. The decrease in cash used in
investing activities during for the year ended December 31, 2003 is the result
of curtailment of capital expenditures. All expenditures for on-going research
and development are expenses and therefore included in the Net Loss. Net cash flows provided by financing activities totaled $5,746 for the
year ended December 31, 2003 and cash used in financing activities totaled $0
and $224,242 for the years ended December 31, 2002 and 2001, respectively. 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,
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 December 31,
2003 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]
    
    $
    108,246
    
    
    $
    37,500
    
    
    $
    70,746[Capital Lease Obligations][Operating Lease Obligations]
    
    $
    22,000
    
    
    $
    22,000[Purchase Obligations][Other Long-Term Liabilities Reflected on
the Registrants Balance Sheet under GAAP]Total
    
    $
    130,246
    
    
    $
    59,500
    
    
    $
    70,746




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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 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 continues 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 $26,500,000 which are available to offset
future Federal taxable income, if any, through 2013. Approximately $21,700,000
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.




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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 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 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.




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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. Factors That May Affect Future Results 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 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 the current quarter. 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




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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 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 and the uncertainties
concerning the ability of our current products and new products to achieve
meaningful commercial acceptance, 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 cashflow. 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 September 30, 2003 accounted for 31%, 21%, 18% and
11% of our net sales for nine months ended September 30, 2003. 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. 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;




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
    
    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. 
 Item 7A.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 December 31,
2003. 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 8.Financial Statements and Supplementary Data




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INDEPENDENT AUDITORS REPORT To the Board of Directors Of Spatializer Audio Laboratories, Inc.: We have audited the accompanying consolidated balance sheets of
Spatializer Audio Laboratories, Inc. and subsidiaries (The Company) as of
December 31, 2003 and 2002 and the related consolidated statements of
operations, shareholders equity, and cash flows for the years ended December
31, 2003, 2002 and 2001. These consolidated financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Spatializer
Audio Laboratories, Inc. and subsidiaries as of December 31, 2003 and 2002, and
the results of its operations and its cash flows for the years ended December
31, 2003, 2002 and 2001 in conformity with accounting
policies generally accepted in the United States of America. /s/ FARBER & HASS LLP Oxnard, California
March 10, 2004




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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS December 31,
    
    December 31,2003
    
    2002ASSETSCurrent Assets:Cash and Cash Equivalents
    
    $
    589,797
    
    
    $
    858,725Accounts Receivable
    
    
    345,411
    
    
    
    499,023Prepaid Expenses and Other Current Assets
    
    
    35,430
    
    
    
    82,920Total Current Assets
    
    
    970,638
    
    
    
    1,440,668Property and Equipment, Net
    
    
    42,022
    
    
    
    70,842Intangible Assets, Net
    
    
    192,485
    
    
    
    225,859Other Assets
    
    
    
    
    
    
    8,471$
    1,205,145
    
    
    $
    1,745,840LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Notes Payable to Related Party, Short Term
    
    
    37,500
    
    
    
    112,500Accounts Payable
    
    
    21,466
    
    
    
    39,027Accrued Wages and Benefits
    
    
    36,973
    
    
    
    108,771Accrued Professional Fees
    
    
    20,000
    
    
    
    Accrued Commissions
    
    
    33,856
    
    
    
    Accrued Expenses
    
    
    28,197
    
    
    
    55,682Total Current Liabilities
    
    
    177,992
    
    
    
    315,980Notes Payable to Related Party, Long Term
    
    
    70,746
    
    
    
    Commitments and ContingenciesSeries B-1 Redeemable Convertible Preferred Shares, $0.01 par value:1,000,000 shares authorized; 102,762 shares issued and outstanding
at December 31, 2003 (liquidation preference of $1,027,620)
    
    
    1,028
    
    
    
    1,028Stockholders Equity (Deficit):10% Series B Convertible Preferred Shares $0.01 par value
1,000,000 shares authorized; 87,967 converted to Series B-1Common shares, $0.01 par value; 65,000,000 shares
authorized; 47,015,865 and 47,406,939 shares issued and
outstanding at December 31, 2003 and 2002, respectively
    
    
    470,159
    
    
    
    474,070Additional Paid-In Capital
    
    
    46,428,615
    
    
    
    46,402,704Accumulated Deficit
    
    
    (45,943,395
    )
    
    
    (45,447,942
    )Total Shareholders Equity
    
    
    955,379
    
    
    
    1,428,832$
    1,205,145
    
    
    $
    1,745,840
 See accompanying notes to consolidated financial statements




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##### Table of Contents



SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31,2003
    
    2002
    
    2001Revenues:Product Revenues, NetLicensing RevenuesRoyalty Revenues
    
    $
    1,269,286
    
    
    $
    1,855,934
    
    
    $
    1,603,782Cost of Revenues
    
    
    122,417
    
    
    
    130,516
    
    
    
    96,7831,146,869
    
    
    
    1,725,418
    
    
    
    1,506,999Operating Expenses:General and Administrative
    
    
    811,024
    
    
    
    765,637
    
    
    
    707,115Research and Development
    
    
    458,940
    
    
    
    432,826
    
    
    
    639,223Sales and Marketing
    
    
    360,692
    
    
    
    512,727
    
    
    
    476,4321,630,656
    
    
    
    1,711,190
    
    
    
    1,822,770Operating Income (Loss)
    
    
    (483,787
    )
    
    
    14,228
    
    
    
    (315,771
    )Interest Income
    
    
    7,201
    
    
    
    12,432
    
    
    
    41,358Interest Expense
    
    
    (13,447
    )
    
    
    (14,493
    )
    
    
    (11,250
    )Other Income (Expense), Net
    
    
    0
    
    
    
    25
    
    
    
    42,691(6,246
    )
    
    
    (2,036
    )
    
    
    72,799Income (Loss) Before Income Taxes
    
    
    (490,033
    )
    
    
    12,192
    
    
    
    (242,972
    )Income Taxes
    
    
    (5,420
    )
    
    
    (6,100
    )
    
    
    2,865Net Income (Loss)
    
    $
    (495,453
    )
    
    $
    18,292
    
    
    $
    (240,107
    )Basic and Diluted Income (Loss) per Share:
    
    $
    (.01
    )
    
    $
    .00
    
    
    $
    (.01
    )Weighted-Average Shares Outstanding
    
    
    47,309,171
    
    
    
    47,406,939
    
    
    
    47,247,455
 See accompanying notes to consolidated financial statements




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##### Table of Contents



SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31,2003
    
    2002
    
    2001Cash Flows from Operating Activities:Net Income (Loss)
    
    $
    (495,453
    )
    
    $
    18,292
    
    
    $
    (240,107
    )Adjustments to Reconcile Net Income (Loss) to
Net Cash Provided (Used) by Operating
Activities:Depreciation
    
    
    30,591
    
    
    
    54,737
    
    
    
    77,785Amortization
    
    
    52,313
    
    
    
    50,766
    
    
    
    61,345Stock and Options Issued for Services
    
    
    12,000Net Change in Assets and Liabilities:Accounts Receivable
    
    
    153,612
    
    
    
    (56,460
    )
    
    
    64,003Prepaid Expenses, Deposits and Other Assets
    
    
    55,960
    
    
    
    43,370
    
    
    
    (63,132
    )Accounts Payable
    
    
    (17,561
    )
    
    
    24,155
    
    
    
    (36,910
    )Accrued Expenses and Other Liabilities
    
    
    (45,427
    )
    
    
    50,286
    
    
    
    (46,819
    )Discontinued Operations
    
    
    
    
    
    
    (100,000
    )
    
    
    (155,840
    )Net Cash Provided (Used) by Operating Activities
    
    
    (253,965
    )
    
    
    85,138
    
    
    
    (339,675
    )Cash Flows from Investing Activities:Purchase of Property and Equipment
    
    
    (1,771
    )
    
    
    (74,993
    )
    
    
    (20,311
    )Intangible Assets
    
    
    (18,938
    )
    
    
    (20,898
    )
    
    
    (14,282
    )Net Cash Used by Investing Activities
    
    
    (20,709
    )
    
    
    (95,891
    )
    
    
    (34,593
    )Cash Flows from Financing Activities:Exercise of Options and Warrants
    
    
    10,000
    
    
    
    
    
    
    
    1,000Notes and Amounts Due to (from) Related Parties
    
    
    108,246
    
    
    
    
    
    
    
    (225,242
    )Repayments/Termination of Notes Payable
    
    
    (112,500
    )Net Cash Provided (Used) by Financing Activities.
    
    
    5,746
    
    
    
    
    
    
    
    (224,242
    )Increase (Decrease) in Cash and Cash Equivalents.
    
    
    (268,928
    )
    
    
    (10,753
    )
    
    
    (598,510
    )Cash and Cash Equivalents, Beginning of Year
    
    
    858,725
    
    
    
    869,478
    
    
    
    1,467,988Cash and Cash Equivalents, End of Year
    
    $
    589,797
    
    
    $
    858,725
    
    
    $
    869,478Supplemental Disclosure of Cash Flow Information:Cash Paid During the Year for:Interest
    
    $
    11,250
    
    
    $
    14,493
    
    
    $
    11,250Income Taxes
    
    $
    4,800
    
    
    $
    2,400
    
    
    $
    3,237
 See accompanying notes to consolidated financial statements




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##### Table of Contents



SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT) 10% Series B Convertible
    
    CommonPreferred Shares
    
    Shares
    
    Common SharesAdditional
    
    
    
    
    
    TotalNumber of
    
    Par
    
    Number of
    
    Par
    
    Paid-In-
    
    Accumulated
    
    Shareholders'Shares
    
    Value
    
    Shares
    
    Value
    
    Capital
    
    Deficit
    
    EquityBalance, December 31, 2000
    
    
    102,967
    
    
    $
    1,030
    
    
    
    47,087,971
    
    
    $
    470,880
    
    
    $
    46,404,892
    
    
    $
    (45,226,127
    )
    
    $
    1,650,675Conv. of Pfd. Shares, net
    
    
    (15,000
    )
    
    
    (150
    )
    
    
    313,968
    
    
    
    3,140
    
    
    
    (2,990
    )Options Exercised Warrants Exercised
    
    
    
    
    
    
    
    
    
    
    5,000
    
    
    
    50
    
    
    
    950
    
    
    
    
    
    
    
    1,000Net Loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (240,107
    )
    
    
    (240,107
    )Balance, December 31, 2001
    
    
    87,967
    
    
    $
    880
    
    
    
    47,406,939
    
    
    $
    474,070
    
    
    $
    46,402,852
    
    
    $
    (45,466,234
    )
    
    $
    1,411,568Conversion of 10% Series B to Redeemable
Series B-1
    
    
    (87,867
    )
    
    
    (880
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (880
    )Series B Pfd. Share dividend
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (148
    )
    
    
    
    
    
    
    (148
    )Net Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,292
    
    
    
    18,292Balance, December 31, 2002
    
    
    -0-
    
    
    $
    -0-
    
    
    
    47,406,939
    
    
    $
    474,070
    
    
    $
    46,402,704
    
    
    $
    (45,447,942
    )
    
    $
    1,428,832Options Exercised Warrants Exercised
    
    
    
    
    
    
    
    
    
    
    166,666
    
    
    
    1,667
    
    
    
    8,333
    
    
    
    
    
    
    
    10,000Options Issued for Services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,000
    
    
    
    
    
    
    
    12,000Cancellation of Unissued Performance Shares
    
    
    
    
    
    
    
    
    
    
    (557,740
    )
    
    
    (5,578
    )
    
    
    5,578Net Loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (495,453
    )
    
    
    (495,453
    )Balance, December 31, 2003
    
    
    -0-
    
    
    $
    -0-
    
    
    
    47,015,865
    
    
    $
    470,159
    
    
    $
    46,428,615
    
    
    $
    (45,943,395
    )
    
    $
    955,379
 See accompanying notes to consolidated financial statements




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##### Table of Contents



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 San
Jose, 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 Companys wholly-owned subsidiary, MultiDisc Technologies, Inc.
(MDT), has been dormant since the fourth quarter of 1998 and the
assets have been marketed for sale (see Note 11). (2) Significant Accounting Policies Basis of Consolidation The consolidated financial statements include the
accounts of Spatializer Audio Laboratories, Inc. and its wholly-owned
subsidiary, Desper Products, Inc. MultiDisc Technologies, Inc. has been
presented as a discontinued operation (see Note 11). All significant
intercompany balances and transactions have been eliminated in consolidation.
Corporate administration expenses are 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. The Company recognizes revenue in
accordance with SEC Staff Accounting Bulletin 101. 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 December 31, 2003 and 2002,
substantially all cash and cash equivalents were on deposit at one financial
institution. At December 31, 2003, three major customers, not presented in order of
importance, each accounted for 10% or more of our total accounts receivable:
JVC, Samsung and Orion Corporation, each of whom accounted for greater than 10%
of our total 2002 accounts receivable. One customer accounted for 42.0%,
another accounted for 23% and one accounted for 16% of our total accounts
receivable at December 31, 2003. At December 31, 2002, one customer accounted
for 28%, two customers each accounted for 20% and a fourth customer accounted
for 15%. 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 91%, 90%
and 67% of total sales in the years ended December 31, 2003 and 2002 and 2001,
respectively.




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##### Table of Contents



Major Customers During the year ended December 31, 2003, three customers
accounted for 34%, 20%, and 20%, respectively, of the Companys net sales.
During the year ended December 31, 2002, three customers accounted for 33%,
25%, and 17%, 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. Advertising Costs Costs incurred for producing and communicating
advertising are expensed when incurred and included in selling, general and
administrative expenses. Consolidated advertising expense amounted to $2,960,
$4,087 and $27,645 in 2003, 2002 and 2001, respectively. 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. Earnings Per Share The Company determines earnings per share in
accordance with Statement of Financial Accounting Standards No. 128, Earnings
Per Share(SFAS 128). 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. Since the Company generated a net loss in 2003 and 2001, outstanding stock
options and warrants would have been anti-dilutive and are not applicable to
this calculation. The impact of Statement 128 on the calculation of earnings per share is as
follows: Year Ended December 31,2002BASIC:Net Income (Loss) Available to Common Shareholders
    
    $
    18,292Weighted Average Shares Outstanding
    
    
    47,406,939Basic Earnings(Loss)per Share
    
    $
    0.00DILUTED:Net Income (Loss) Available to Common Shareholders
    
    $
    18,292Weighted Average Shares Outstanding
    
    
    47,406,939Net Effect of Dilutive Stock Options and WarrantsBased on the Treasury Stock Method Using Average
Market PriceTotal Shares
    
    
    47,406,939Diluted Earnings per Share
    
    $
    0.0000Average Market Price of Common Stock
    
    $
    .1234Ending Market Price of Common Stock
    
    $
    .06
 The following table presents contingently issuable shares, options and
warrants to purchase shares of common stock at December 31, 2002. Those that
were outstanding during 2003 and 2001 were not included in the computation of
diluted loss per share because the impact would have been anti-dilutive: 2002Options.
    
    
    2,671,500Warrants
    
    
    -0-Total
    
    
    2,671,500




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##### Table of Contents



Stock Option Plan The Company determines the effect of stock based
compensation in accordance with SFAS No. 123, Accounting for Stock-Based
Compensation,which permits entities to recognize as expense using the
fair-value method over the vesting period of all employee
stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows
entities to continue to utilize the intrinsic value method for equity
instruments granted to employees and provide pro forma net income (loss) and
pro forma earnings (loss) per share disclosures for employee stock option
grants after 1994 as if the fair-value-based method defined in SFAS No. 123 has
been applied. The Company has elected to continue to utilize the intrinsic
value method for employee stock option grants and provide the pro forma
disclosure provisions of SFAS No. 123 (Note 8). Impairment of Long-Lived Assets and Assets to be Disposed of- The Company
adopted the provisions of SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed of,on January 1,
1996. This Statement requires that long-lived assets and certain identifiable
intangibles be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured as the amount by which the carrying
amounts of the assets exceed the fair value of the assets (see Notes 4). Assets
to be disposed of are reported at the lower of the carrying amount or fair
value less costs to sell. Segment Reporting- The Company adopted SFAS 131, Disclosures about
Segments of an Enterprise and Related Information(SFAS No. 131), in December
1997. MDT has been considered a discontinued operation since September 1998. As
of December 31, 2002, 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- 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. 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




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##### Table of Contents



plans. The Company will adopt the provisions of SFAS 132R on January 1, 2004. The Company believes that the adoption of these pronouncements will not have a material effect on
the Companys financial position, results from operations or cash flows. 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. 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 2002 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 2002 are materially consistent with the related carrying values based on
current rates offered to the Company for instruments with similar maturities. Discontinued Operation- In September 1998, the Board of Directors
approved a plan to refocus corporate activities on the Companys core audio
business, Desper Products, Inc. In conjunction to this strategic refocusing,
the Company permanently suspended operations of MDT and placed the business and
its related patent portfolio up for sale. The Company is accounting for the
on-going operating and termination expenses of MDT as a discontinued operation
(see Note 11). (3) Property and Equipment Property and equipment, as of December 31, 2003 and 2002, consists of the
following, net of a reserve for impairment loss in 1998 in accordance with
application of SFAS 121: 2003
    
    2002Office Computers, Software, Equipment and Furniture
    
    $
    309,744
    
    
    $
    307,973Test Equipment
    
    
    73,300
    
    
    
    73,300Tooling Equipment
    
    
    45,539
    
    
    
    45,539Trade Show Booth and Demonstration Equipment
    
    
    171,301
    
    
    
    171,301Automobiles
    
    
    7,000
    
    
    
    7,000Total Property and Equipment
    
    
    606,884
    
    
    
    605,113Less Accumulated Depreciation and Amortization
    
    
    564,862
    
    
    
    534,271Property and Equipment, Net
    
    $
    42,022
    
    
    $
    70,842
 (4) Intangible Assets Intangible assets, as of December 31, 2003 and 2002 consist of the
following: 2003
    
    2002Capitalized Patent, Trademarks and Technology Costs
    
    $
    505,487
    
    
    $
    486,549Less Accumulated Amortization
    
    
    313,002
    
    
    
    260,690Intangible Assets, Net
    
    $
    192,485
    
    
    $
    225,859
 Estimated amortization is as follows: 2004
    
    $
    43,7942005
    
    $
    25,7332006
    
    $
    16,7022007
    
    $
    16,702Thereafter
    
    $
    89,554192,485
 (5) Notes Payable to Related Parties  The Company was indebted to the Desper Family Trust, a related party, in the
amount of $108,246 at December 31, 2003. 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 $112,500 related party 10%
demand note to a three-




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##### Table of Contents



year 10% term note. Principal and interest of $5,191 are due 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. (6) Shareholders Equity  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 were
exercised in 2003, increasing shareholders equity by $10,000.Options to purchase common shares in exchange for services were issued with
a value of $12,000.During the year ended December 31, 2002, no shares were issued or
converted. 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 Corporations 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 Corporations 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 US and is designated
as a liquidation preference. The stock will rank prior to the Companys common
stock. No dividends will be paid on the Series B-1 Preferred Stock. Conversion
rights vested on January 1, 2003 to convert the Series B-1 Preferred Stock to
common at a certain formula based on an average closing share price, subject to
a floor of $0.56 and a ceiling of $1.12. At December 29, 2005 certain
mandatory conversion requirements exist subject to the above formula. The
Series B-1 Preferred Stock has no voting power. Certain restrictions on trading
exist based on date sensitive events based on the Companys Insider Trading
Policy. 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. (7) Escrowed Performance Shares In December 1996, the Company accepted the terms outlined by the British
Columbia Securities Commissions (BCSC) for the release of the Companys
5,776,700 escrowed Performance Shares from Canadian Escrow into a new escrow
arrangement with the Company. The overall modification was approved by the
Companys 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.




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(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,
4,757,360 as of December 31, 2003. Stock options are granted with an exercise
price equal to the stocks fair market value at the date of grant. Stock
options have five-year terms and vest and become fully exercisable up to three
years from the date of grant. At December 31, 2003, there were 1,716,587 additional shares available for
grant under the Plan. The per share weighted-average fair value of stock
options granted during 2003, 2002 and 2001was $0.05, $0.11and $0.29,
respectively, on the date of grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions: 2003- expected dividend yield
0%, risk-free interest rate of 2.25%, expected volatility of 137% and an
expected life of 5 years, 2002: expected dividend yield 0%, risk-free interest
rate of 6%, expected volatility of 427% and expected life of 5 years; 2001
expected dividend yield 0%, risk-free interest rate of 9.0%, expected
volatility of 332% and an expected life of 5 years; 2000- expected dividend
yield 0%, risk-free interest rate of 9.0%, expected volatility of 654% and an
expected life of 5 years. The Company applies APB Opinion No. 25 in accounting for its Plan and,
accordingly, no compensation cost has been recognized for the fair value of its
stock options in the consolidated financial statements. Had the Company
determined compensation cost based on the fair value at the grant date for its
stock options under SFAS No. 123, the Companys net income (loss) would have
been increased to the pro forma amounts indicated below: 2003
    
    2002
    2001NET INCOME (LOSS):As Reported
    
    $
    (495,453
    )
    
    $
    18,292
    
    
    $
    (240,107
    )Pro Forma
    
    $
    (538,368
    )
    
    $
    (136,498
    )
    
    $
    (344,853
    )BASIC AND DILUTED LOSS:As Reported
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    (0.01
    )Pro Forma
    
    $
    (0.01
    )
    
    $
    (0.01
    )
    
    $
    (0.01
    )
 Stock option activity during the periods indicated is as follows: Weighted-AverageNumber
    
    Exercise PriceOptions outstanding at December 31, 2000
    
    
    2,212,299
    
    
    $
    1.13Options granted
    
    
    410,000
    
    
    $
    0.29Options exercised
    
    
    (0
    )
    
    $
    0.00Options forfeited
    
    
    (750,000
    )
    
    $
    0.83Options outstanding at December 31, 2001
    
    
    1,872,299
    
    
    $
    0.45Options granted
    
    
    1,300,000
    
    
    $
    0.11Options exercised
    
    
    (0
    )
    
    $
    0.00Options forfeited
    
    
    (500,799
    )
    
    $
    2.29Options outstanding at December 31, 2002
    
    
    2,671,500Options granted
    
    
    1,150,000
    
    
    $
    0.05Options exercised
    
    
    (166,666
    )
    
    $
    0.06Options forfeited/expired
    
    
    (669,834
    )
    
    $
    0.18Options outstanding at December 31, 2003
    
    
    2,985,000
    
    
    $
    0.18
 At December 31, 2003, the number of options exercisable was 2,540,000 and
the weighted-average exercise price of those options was $0.21.




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##### Table of Contents



(9) Warrants Warrant activity for the periods indicated below is as follows: Warrants
    
    Warrant PriceWarrants outstanding at December 31, 2000
    
    
    2,520,000
    
    
    $
    0.72Warrants issued
    
    
    0
    
    
    $
    0.00Warrants exercised
    
    
    (5,000
    )
    
    $
    0.20Warrants expired
    
    
    (415,000
    )
    
    $
    1.16Warrants outstanding at December 31, 2001
    
    
    2,100,000
    
    
    $
    0.65Warrants issued
    
    
    0
    
    
    $
    0.00Warrants exercised
    
    
    0
    
    
    $
    0.00Warrants expired
    
    
    (2,100,000
    )
    
    $
    0.65Warrants outstanding at December 31, 2002
    
    
    0
    
    
    $
    0.00Warrants issued
    
    
    0
    
    
    $
    0.00Warrants exercised
    
    
    0
    
    
    $
    0.00Warrants expired
    
    
    0
    
    
    $
    0.00Warrants outstanding at December 31, 2003
    
    
    0
    
    
    $
    0.00
 All of the warrants granted in 1999 were issued in connection with private
placements. At December 31, 2003, all such warrants had expired, without
exercise. (10) Income Taxes The Company files a consolidated return for U.S. income tax purposes.
Income tax expense for the years ended December 31, 2003, 2002 and 2001
consisted of the following: 2003
    
    2002
    
    2001State franchise tax
    
    $
    4,800
    
    
    $
    2,400
    
    
    $
    2,864Federal taxes
    
    
    (0
    )
    
    
    (0
    )
    
    
    (0
    )Total
    
    $
    4,800
    
    
    $
    2,400
    
    
    $
    2,864
 Certain revenues received from customers in foreign countries are subject
to withholding taxes that are deducted from outgoing funds at the time of
payment. These taxes range from approximately 10% to 16.5% and are recorded as
net foreign revenue. Income tax expense for the years ended December 31, 2003, 2002 and 2001
differed from the amounts computed by applying the U.S. federal income tax rate
of 34 percent to loss before income taxes primarily due to the generation of
additional net operating loss carry forwards for which no tax benefit has been
provided. The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets at December 31, 2001 is composed primarily
of the net loss carry forwards. The net change in the total valuation allowance
for the year ended December 31, 2001 was insignificant. In assessing the
realizability of deferred tax assets, management considers whether it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income during the periods in which those temporary
differences become deductible. Management considers projected future taxable
income and tax planning strategies in making this assessment. Based upon the
level of historical taxable losses, management believes it is more likely than
not the Company will not realize the benefits of these deductible differences
and has established a valuation allowance to fully reserve the deferred tax
assets at December 31, 2003. Additionally, the ultimate realizability of net
operating losses may be limited by change of control provisions under Section
382 of the Internal Revenue Code. At December 31, 2003, the Company had net operating loss carry forwards
for Federal income tax purposes of approximately $26,500,000 which are
available to offset future Federal taxable income, if any, through 2013.
Approximately $21,700,000 of these net operating loss carry forwards are
subject to an annual limitation of approximately $1,000,000.




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(11) Discontinued Operation On September 25, 1998, the Board of Directors determined that it would be
unable to raise the necessary capital required to properly commercialize the
MDT technology. Therefore, the Company ceased funding the operations of MDT and actively sought to sell the assets and technology. All employees of MDT
were terminated and the Company has vacated the MDT facilities. Based on this action, the Company treated MDT as a discontinued operation.
Accordingly, the balance sheet and statement of operations of MDT are not
consolidated in the continuing operations of the Company, but rather were as
Net Liabilities of Discontinued Operation and Loss From Discontinued Operation,
respectively. At December 31, 2002, after four years of inactivity and
inability to sell the assets, the remaining liability of $71,045 was
eliminated. (12) 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 for all operating leases of approximately
$18,469 through November 2004. Rent expense amounted to approximately $83,000,
$ 78,000 and $78,000 for the years ended December 31, 2003, 2002 and 2001,
respectively. (13) 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. The amount charged to administrative
expense for the Plan in 2003, 2002 and 2001 was approximately $2,000 per annum. (14) Quarterly Financial Data (unaudited) The following is a summary of the quarterly results of operations for the
years ended December 31, 2003 and 2002: Quarter Ended2003
    
    March 31
    
    June 30
    
    September 30
    
    December 31Net Revenues
    
    $
    332,378
    
    
    $
    250,902
    
    
    $
    341,339
    
    
    $
    344,667Gross Margin
    
    $
    296,436
    
    
    $
    228,405
    
    
    $
    306,192
    
    
    $
    315,836Net Income (Loss)
    
    $
    (74,449
    )
    
    $
    (212,461
    )
    
    $
    (106,502
    )
    
    $
    (102,041
    )Basic and Diluted
    
    $
    (0.00
    )
    
    $
    (0.00
    )
    
    $
    (0.00
    )
    
    $
    (0.01
    )Income (Loss) Per Share Quarter Ended2002
    
    March 31
    
    June 30
    
    September 30
    
    December 31Net Revenues
    
    $
    440,481
    
    
    $
    583,280
    
    
    $
    480,851
    
    
    $
    463,971Gross Margin
    
    $
    412,279
    
    
    $
    524,841
    
    
    $
    442,874
    
    
    $
    439,353Net Income (Loss)
    
    $
    21,280
    
    
    $
    (286,910
    )
    
    $
    11,124
    
    
    $
    (17,156
    )Basic and Diluted
    
    $
    0.00
    
    
    $
    (0.01
    )
    
    $
    0.00
    
    
    $
    (0.00
    )Income (Loss) Per Share




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##### Table of Contents



Item 9.Change in and Disagreements with Accountants on Accounting and Financial Disclosure None. 
 Item 9A.Controls and Procedures We carried out an evaluation of the effectiveness of our 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 our disclosure
controls and procedures as of the end of the period covered by this report 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 our internal control over financial reporting that occurred during the
quarter ended December 31, 2003 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting. 
 PART III 
 Item 10.Directors and Executive Officers of the Registrant Information required for this item incorporated by reference to our Proxy
Statement for the 2004 Annual Meeting of Stockholders. Code of Ethics We adopted a Code of Ethics that applies to all of our directors, officers
and employees, including our Chief Executive Officer, our Chief Financial
Officer and other senior financial officers. Our Code of Ethics will be posted
on our website, www.spatializer.com, under the heading Code of Ethics. We
intend to disclose on our website any amendment to, or waiver of, a provision
of the Code of Ethics that applies to our Chief Executive Officer, our Chief
Financial Officer or any other senior financial officers. 
 Item 11.Executive Compensation Information required for this item incorporated by reference to our Proxy
Statement for the 2004 Annual Meeting of Stockholders. 
 Item 12.Security Ownership of Certain Beneficial Owners and Management Equity Compensation Plan Information Number of securitiesNumber of securities
    
    
    
    
    
    remaining available forto be issued
    
    Weighted-average
    
    future issuance underupon exercise of
    
    exercise price of
    
    equity compensation plansoutstanding options,
    
    outstanding options,
    
    (excluding securitiesPlan category
    
    warrants and rights
    
    warrants and rights
    
    reflected in column (a))(a)
    
    (b)
    
    (c)Equity compensation
plans approved by
security holders
    
    
    2,985,000
    (1)
    
    $
    0.18
    (1)
    
    
    (2
    )Equity compensation
plans not approved
by security holders.
    
    
    0
    
    
    
    0
    
    
    
    
    
    
    
    0Total
  (1)
    
    Represents options to acquire the Companys Common Stock under the
Companys 1995 Stock Option Plan and 1996 Incentive Plan approved by the
Companys stockholders in 1995 and 1996, respectively. The 1995 Plan
authorizes grants of options to purchase authorized but unissued common
stock in an amount of up to 10% of total common shares outstanding at each
calendar quarter or 4,701,587 as at December 31, 2003. 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 as determined by the committee on date of grant. The
1996 Plan supplements the 1995 Plan by allowing for stock appreciation,
incentive shares and similar accruals aggregating not more than the
equivalent of 500,000 shares and the regrant of any Performance Shares
that become available for regrant. See Note 2.




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##### Table of Contents



(2)
    
    In December 1996, the Company accepted the terms outlined by the British
Columbia Securities Commissions 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 arrangements, the
final release date was June 22, 2002. Since all the Performance Shares
were included in the issued and outstanding shares as of 1996 and
thereafter, the Performance Shares have no dilutive effect on the
Companys equity. The remaining information is required for this item is incorporated by
reference to our Proxy Statement for the 2004 Annual Meeting of Stockholders. 
 Item 13.Certain Relationships and Related Transactions Information required for this item incorporated by reference to our Proxy
Statement for the 2004 Annual Meeting of Stockholders. 
 Item 14.Principal Accounting Fees and Services Information required for this item incorporated by reference to our Proxy
Statement for the 2004 Annual Meeting of Stockholders. 
 PART IV 
 Item 15.Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) Financial Statements See Item 8. (b) Reports on 8-K On November 12, 2003 we furnished a report on Form 8-K under Item 12
disclosing that we announced our financial results for the quarter ended
September 30, 2003 and attaching the corresponding press release. (c) Exhibits The following Exhibits are filed as part of, or incorporated by reference
into, this Report: ExhibitNumber
    
    Description2.1*
    
    Desper-Spatializer Reorganization Agreement dated January 29, 1992. (Incorporated by reference
to the Companys Registration Statement on Form S-1, Registration No. 33-90532, effective
August 1, 1995.)2.2*
    
    Arrangement Agreement dated as of March 4, 1994 among Spatializer-Yukon, DPI and
Spatializer-Delaware (Incorporated by reference to the Companys Registration Statement on
Form S-1, Registration No 33-90532, effective August 21, 1995.)3.1*
    
    Certificate of Incorporation of Spatializer-Delaware as filed February 28, 1994. (Incorporated
by reference to the Companys Registration Statement on Form S-1, Registration No. 33-90532,
effective August 21, 1995.)3.2*
    
    Amended and Restated Bylaws of Spatializer-Delaware. (Incorporated by reference to the
Companys Registration Statement on Form S-1, Registration No. 33-90532, effective August 21,
1995.)3.3*
    
    Certificate of Designation of Series B 10% Redeemable Convertible Preferred Stock of the
Company as filed December 27, 1999 (Incorporated by reference to the Companys Annual Report
on Form 10-K, for the period ended December 31, 1999.)3.4*
    
    Certificate of Amendment of Certificate of Incorporation of the Company as filed on February
25, 2000 (Incorporated by reference to the Companys Annual Report on Form 10-K, for the
period ended December 31, 1999.)3.5*
    
    Certificate of Designation of Series B-1 Redeemable Convertible Preferred Stock as filed
December 20, 2002 (Incorporated by reference to the Companys Annual Report on Form 10-K, for
the period ended December 31, 2002.)




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##### Table of Contents



ExhibitNumber
    
    Description3.6*
    
    Certificate of Elimination of Series A Preferred Stock as filed December 26, 2002
(Incorporated by reference to the Companys Annual Report on Form 10-K, for the period ended
December 31, 2002.)3.7*
    
    Certificate of Elimination of Series B Preferred Stock as filed December 26,2002 (Incorporated
by reference to the Companys Annual Report on Form 10-K, for the period ended December 31,
2002.)4.1*
    
    Spatializer-Delaware Incentive Stock Option Plan (1995 Plan). (Incorporated by reference to
the Companys Registration Statement on Form S-1, Registration No. 33-90532, effective August
21, 1995.)4.2*
    
    Performance Share Escrow Agreements dated June 22, 1992 among Montreal Trust Company of
Canada, Spatializer-Yukon and certain shareholders with respect to escrow of 2,181,048 common
shares of Spatializer-Yukon. (Incorporated by reference to the Companys Registration
Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.)4.3*
    
    Spatializer-Delaware 1996 Incentive Plan. (Incorporated by reference to the Companys Proxy
Statement dated June 25, 1996 and previously filed with the Commission.)4.4*
    
    Modification Agreement for Escrowed Performance Shares. (Incorporated by reference to the
Companys Definitive Proxy Statement dated June 28, 1996 and previously filed with the
Commission.)4.5*
    
    Form of Exchange Agreement effective December 26, 2002 entered into by holders of Series B
Preferred Stock in connection with exchange of same for Series B-1 Preferred Stock
(Incorporated by reference to the Companys Annual Report on Form 10-K, for the period ended
December 31, 2002.)10.1*
    
    License Agreement dated June 29, 1994 between DPI and MEC. (Incorporated by reference to the
Companys Registration Statement on Form S-1, Registration No. 33-90532, effective August 21,
1995.)10.2*
    
    Agreement Regarding Indebtedness dated as of December 29, 1999 among the Company and CPR (USA)
Inc., LibertyView Funds, L.P. and LibertyView Fund, LLC10.3
    
    Employment Agreement dated November 12, 2004, between the Company and Henry Mandell, as amended10.4
    
    Related Party Promissory Note to the Successor Trustee of the Ira A. Desper Marital Trust
dated November 1, 2003.21.1*
    
    Schedule of Subsidiaries of the Company (Incorporated by reference to the Companys Annual
Report on Form 10-K, for the period ended December 31, 2002.)23.1
    
    Consent of Independent Auditors31.1
    
    Certificate of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 200232.1
    
    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)
    *
    
    Previously filed.




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized. Dated: March 22, 2004 SPATIALIZER AUDIO LABORATORIES, INC.(Registrant)/s/ Henry R. MandellHenry R. MandellChief Executive Officer & Chief Financial Officer
 Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/ Carlo Civelli
    
    Director
    
    March 22, 2004Carlo Civelli/s/ James D. Pace
    
    Director
    
    March 22, 2004James D. Pace/s/ Gilbert N. Segel
    
    Director
    
    March 22, 2004Gilbert N. Segel/s/ Henry R. Mandell
    
    Director
    
    March 22, 2004Henry R. Mandell