##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-K
 
 (Mark One)
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the period ended: December 31, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 Commission File Number: 000-26460
 SPATIALIZER AUDIO LABORATORIES, INC.
 (Exact name of registrant as specified in its charter)
 Delaware
    
    95-4484725(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)
 2025 Gateway Place, Suite 365
San Jose, California 95110
 Telephone Number: (408) 453-4180
 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
 o þ
 o þ
 þ o
 þ
  o o þ
 o þ
   DOCUMENTS INCORPORATED BY REFERENCE




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##### 



TABLE OF CONTENTS
 PART IItem 1. BusinessItem 1A. Risk FactorsItem 1B. Unresolved Staff CommentsItem 2. PropertiesItem 3. Legal ProceedingsItem 4. Submission of Matters to a Vote of Security HoldersPART IIItem 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesItem 6. Selected Financial DataItem 7. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 7A. Quantitative and Qualitative Disclosures About Market RiskItem 8. Financial Statements and Supplementary DataINDEPENDENT AUDITORS REPORTCONSOLIDATED BALANCE SHEETSCONSOLIDATED STATEMENTS OF OPERATIONSCONSOLIDATED STATEMENTS OF CASH FLOWSCONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSItem 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureItem 9A. Controls and ProceduresItem 9B. Other InformationPART IIIItem 10. Directors and Executive Officers of the RegistrantItem 11. Executive CompensationItem 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersItem 13. Certain Relationships and Related TransactionsItem 14. Principal Accountant Fees and ServicesPART IVItem 15. Exhibits and Financial Statement SchedulesSIGNATURESEX-23.1EX-31.1EX-32.1EXHIBIT 10.10EXHIBIT 21.1EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 32.1
  2




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CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
  
 PART I
 
 Item 1. Business
 Overview
   www.spatializer.com
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##### Table of Contents



Desper Products, Inc.  Virtual Audio Signal Processing Technologies
  Technology
    
    Product Categories
    
    Audio EnhancementSpatializer® 3-D Stereo
    
    Stereo TVs, Stereo
Components and
Systems, Car Audio,
Laptop and Desktop
Multimedia
Computers, Set-top
Boxes
    
    Surround sound
enhancement from an
ordinary stereo
(two-channel)
signalSpatializer ((environ))TM
    
    Cell Phones and
Mobile Multimedia
Players
    
    Widens sound stage
and improves stereo
separation from
two-channel ring
tones, compressed
audio, FM and TV
broadcast and
games.Spatializer N-2-2 UltraTM
    
    DVDP, DVDR, PVR, AV
Receivers,
Multimedia PCs,
DTV,STB
    
    Creation of
spatially accurate
home theater
surround sound from
two channel sourcesSpatializer enCompass AVTM
    
    Products
incorporating
multi-channel audio
sources like Dolby
ProLogic II®: AV
Receivers
    
    Creation of
spatially accurate
multi-speaker
cinematic audio
experience from
two-channel audio
informationSpatializer Audio AlchemyTM
    
    Computers and
Recordable DVD
utilizing DVD/MPEG
and decoding, Cell
phone handsets.
    
    Static noise
reduction combined
with stabilization
of dynamic audio
rangeSpatializer Vi.B.E.TM
    
    Mobile Multimedia
Players, Cell
Phones, DVD
Players/Recorders,
DTV, Stereo
Components and
Systems, Car Audio,
Laptop and Desktop
Multimedia PCs and
Headphones.
    
    Simulation of low
frequency response
from speakers with
poor low frequency
capabilitySpatializer DRCTM
    
    Laptop and Desktop
Multimedia
Computers, Cell
Phones and Portable
Multimedia Players
    
    Prevents
over-driving
speakers, headphones or ear
buds while
maximizing the
dynamic audio
outputSpatializer Natural HeadphoneTM
    
    Headphones, Mobile
Phones, Mobile
Multimedia Players
    
    Creation of
spatially accurate
multi- speaker
cinematic audio
experience from
headphones
utilizing discrete
multi-channel audio
informationSpatializer PCETM
    
    DTV, Mobile Phones,
Mobile Multimedia
Players, Multimedia
PCs, Headphones
    
    Creation of more
recognizable and
cleaner music or
dialog from all
media sources
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Licensed Products
  1.
    
    Spatializer3D Stereo.Based upon proprietary 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. and OnChip Systems) 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 Stereoeffect 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 Dolby
Digital-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. The audio
standards for multi-channel digital audio(based upon geographic region) are multi-channel
audio formats (Dolby Digital® (AC-3) and MPEG-2) which carry up to eight (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-2-2Ultrasoftware- 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-2-2Ultraruns in real-time on general purpose Digital Signal
Processing (DSP) hardware platforms like those offered by LSI, Acer Labs, Inc., NEC,
Motorola, MediaTek 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-2-2Ultrahas 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. The Company holds a patent on
this technology.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 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 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.
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5.
    
    SpatializerNatural HeadphoneSpatializer 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.
    
    SpatializerPCE, 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. This technology is patent pending. 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. This technology
is patent pending.
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.
  Licensing Activities
      IC/DSP Foundry Licenses
    7




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OEM Licensees and Customers
   Acer Labs
    
    MediaTek
    
    Sanyo Corp.Apple Computer
    
    Micronas
    
    Sharp Corp.Cirrus Logic
    
    Mitsubishi Image and Information Works
    
    SigmatelInterVideo
    
    Motorola
    
    Texas InstrumentsJVC
    
    NEC
    
    Theta DigitalLG Electronics
    
    Panasonic Car Audio
    
    Toshiba DVDLogitech
    
    Panasonic TV
    
    Toshiba TVLSI
    
    Samsung
    
    Zoran
  Customers, Revenues and Expenses
    8




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Competition
 ® ® ®
    Research and Development
   Intellectual Property and Proprietary Information
   9




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Seasonality
  Employees
  
 Item 1A. Risk Factors
  Our Board of Directors has Determined it is in the Companys and its Stockholders Best Interests to
Attempt to Sell the Companys Assets.
  10




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Our Operating Results Fluctuate, We Are Unable to Achieve or Sustain Profitability in the Future
or Obtain Future Financing and Our Business Operations Will Fail
  Because The Market In Which We Operate Is Highly Competitive, We Face Significant Pricing Pressure
and Competition.
  Because Our Relative Size and Power Is Small Compared To That of Our Customers, Our Business
Leverage With Some Customers Is Generally Weak and Communication Not Always Transparent
  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.
  11




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.
 If New Product Development Is Delayed, We Will Experience Delays In Revenues And Competitive
Products May Reach The Market Before Our Products.
   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
  Demand for Our Products is Subject to Risks Beyond Our Control.
  
    
    competition faced by our OEM customers in their particular end markets;
    
    the technical, sales and marketing and management capabilities of our OEM customers;
    
    the pressure faced by our OEM customers to reduce cost
  Because The Technology Environment In Which We Operate Is Rapidly Changing, We May Not Be
Successful In Establishing And
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Maintaining The Technological Superiority Of Our Products Over Those Of Our Competitors.
  If We Are Unable To Attract And Retain Our Key Personnel, We May Not Be Able To Successfully
Operate Our Business.
  The Market For Our Stock May Be Not Remain Liquid And The Stock Price May Be Subject To Volatility
  
 Item 1B. Unresolved Staff Comments
  
 Item 2 Properties
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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
  Period:
    
    High (U.S. $)
    
    Low (U.S. $)2004First Quarter
    
    $
    0.22
    
    
    $
    0.11Second Quarter
    
    $
    0.14
    
    
    $
    0.06Third Quarter
    
    $
    0.10
    
    
    $
    0.05Fourth Quarter
    
    $
    0.09
    
    
    $
    0.052005First Quarter
    
    $
    0.10
    
    
    $
    0.06Second Quarter
    
    $
    0.09
    
    
    $
    0.05Third Quarter
    
    $
    0.07
    
    
    $
    0.05Fourth Quarter
    
    $
    0.07
    
    
    $
    0.03
     14




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15




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Item 6. Selected Financial Data
  Fiscal Year EndedDecember 31, 2001
    
    
    December 31, 2002
    
    
    December 31, 2003
    
    
    December 31, 2004
    
    
    December 31, 2005Consolidated
Statement of Operations
Data:Revenues
    
    $
    1,604
    
    
    $
    1,856
    
    
    $
    1,269
    
    
    $
    1,106
    
    
    $
    1,192Cost Of Revenues
    
    
    (97
    )
    
    
    (131
    )
    
    
    (122
    )
    
    
    (111
    )
    
    
    (106
    )Gross Profit
    
    
    1,507
    
    
    
    1,725
    
    
    
    1,147
    
    
    
    995
    
    
    
    1,086Total Operating Expenses
    
    
    (1,823
    )
    
    
    (1,711
    )
    
    
    (1,631
    )
    
    
    (1,146
    )
    
    
    (1,177
    )Other Income (Expense),
Net
    
    
    73
    
    
    
    (2
    )
    
    
    (6
    )
    
    
    (5
    )
    
    
    8Income taxes
    
    
    3
    
    
    
    (6
    )
    
    
    (5
    )
    
    
    (1
    )
    
    
    (1
    )Net Income (Loss)
    
    $
    (240
    )
    
    $
    18
    
    
    $
    (495
    )
    
    $
    (157
    )
    
    $
    (82
    )Basic Income (Loss) Per
Share
    
    $
    (0.01
    )
    
    $
    0.00
    
    
    $
    (0.01
    )
    
    $
    (0.00
    )
    
    $
    (0.00
    )Diluted Income (Loss) Per
Share
    
    $
    (0.01
    )
    
    $
    0.00
    
    
    $
    (0.01
    )
    
    $
    (0.00
    )
    
    $
    (0.00
    )Weighted Average Common
Shares
    
    
    47,388,235
    
    
    
    47,406,939
    
    
    
    47,309,171
    
    
    
    46,975,363
    
    
    
    46,990,059Consolidated Balance
Sheet DataCash and Cash Equivalents
    
    $
    869
    
    
    $
    859
    
    
    $
    590
    
    
    $
    871
    
    
    $
    551Working Capital
    
    
    1,124
    
    
    
    1,125
    
    
    
    793
    
    
    
    603
    
    
    
    560Total Assets
    
    
    1,753
    
    
    
    1,746
    
    
    
    1,205
    
    
    
    1,464
    
    
    
    897Redeemable Preferred Stock
    
    
    0
    
    
    
    1
    
    
    
    1
    
    
    
    1
    
    
    
    0Advances From Related
Parties
    
    
    113
    
    
    
    113
    
    
    
    108
    
    
    
    0
    
    
    
    0Total Shareholders Equity
    
    $
    1,411
    
    
    $
    1,429
    
    
    $
    955
    
    
    $
    798
    
    
    $
    717
 
 Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Executive Overview
 ®
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Approach to MD&A
  
    
    to provide a narrative explanation of a companys financial statements in plain English
that enables the average investor 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 and relationship of
past performance being indicative of future performance.
  
    
    An understanding of our operating environment and its risks
    
    An outline of critical accounting policies
    
    A review of our corporate governance structure
    
    A review of the key components of the financial statements and our cash position and capital
resources
    
    A review of the important trends in the financial statements and our cash flow
    
    Disclosure on our internal controls and procedures
 Operating Environment
  
    
    Our Board of Directors has Determined it is in the Companys and its Stockholders
Interests to Attempt to Sell the Companys Assets
    
    We Face Significant Pricing Pressure and Competition that has Resulted in Our Technology
Being Designed Out Within a Short Time Frame, and Impeded Efforts to Secure New Design Wins
    
    New Customer Product Development Has been Delayed. This Resulted 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 Delayed or Could Thwart our Sales Efforts to Potential Customers.
 17




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.
  Critical Accounting Policies
  18




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Corporate Governance
 Audit Committee
  Compensation and Stock Committee
   19




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Key Components of the Financial Statements and Important Trends
  Liquidity and Capital Resources.
  Liquidity
and Capital Resources.
 Liquidity and Capital Resources.
 Results of Operations
  For the Year Ended December 31, 2005, Compared to the Year Ended December 31, 2004
 Revenues
 ®
  20




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Gross Profit
  Operating Expenses
  General and Administrative
  Research and Development
   Sales and Marketing
  Net Income (Loss)
  For the Year Ended December 31, 2004, Compared to the Year Ended December 31, 2003
 Revenues
 ®
 21




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Gross Profit
  Operating Expenses
  General and Administrative
  Research and Development
   Sales and Marketing
  22




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Net Income (Loss)
  Liquidity and Capital Resources
        Payments due by periodLess than
    
    
    
    
    
    
    
    
    
    More thanContractual obligations
    
    Total
    
    1 year
    
    1-3 years
    
    3-5 years
    
    5 yearsLong-Term Debt ObligationsCapital Lease ObligationsOperating Lease Obligations
    
    $
    26,900
    
    
    $
    26,700
    
    
    $
    200Purchase ObligationsTotal
    
    $
    26,900
    
    
    $
    26,700
    
    
    $
    200
   23




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Net Operating Loss Carry forwards
  Recently Issued Accounting Pronouncements
   
 Item 7A. Quantitative and Qualitative Disclosures About Market Risk
 24




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25




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Item 8. Financial Statements and Supplementary Data
 REPORT of REGISTERED PUBIC ACCOUNTING FIRM
 To the Board of Directors of Spatializer Audio Laboratories, Inc.:
      
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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
 
 CONSOLIDATED BALANCE SHEETS
 December 31,
    
    
    December 31,2005
    
    
    2004ASSETSCurrent Assets:Cash and Cash Equivalents
    
    $
    550,633
    
    
    $
    871,155Accounts Receivable
    
    
    155,233
    
    
    
    325,712Prepaid Expenses and Other Current Assets
    
    
    34,104
    
    
    
    70,940Total Current Assets
    
    
    739,970
    
    
    
    1,267,807Property and Equipment, Net
    
    
    18,403
    
    
    
    29,527Intangible Assets, Net
    
    
    138,548
    
    
    
    166,710TOTAL ASSETS
    
    $
    896,921
    
    
    $
    1,464,044LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Notes Payable
    
    
    10,443
    
    
    
    66,252Accounts Payable
    
    
    14,195
    
    
    
    71,873Accrued Wages and Benefits
    
    
    48,095
    
    
    
    50,446Accrued Professional Fees
    
    
    34,000
    
    
    
    20,000Accrued Commissions
    
    
    31,917
    
    
    
    32,182Accrued Expenses
    
    
    40,869
    
    
    
    32,979Deferred Income
    
    
    
    
    
    
    391,395Total Current Liabilities
    
    
    179,519
    
    
    
    665,127Commitments and ContingenciesSeries B-1 Redeemable Convertible Preferred Shares, $0.01 par value:1,000,000 shares authorized; 118,351 shares issued and outstanding
at December 31, 2004 (liquidation preference of $1,183,510)
    
    
    
    
    
    
    1,182Stockholders Equity (Deficit):Common shares, $0.01 par value; 65,000,000 shares authorized;
48,763,383 and 46,975,363 shares issued and outstanding at
December 31, 2005 and 2004, respectively
    
    
    469,772
    
    
    
    469,754Additional Paid-In Capital
    
    
    46,430,030
    
    
    
    46,428,866Accumulated Deficit
    
    
    (46,182,400
    )
    
    
    (46,100,885
    )Total Shareholders Equity
    
    
    717,402
    
    
    
    797,735Total Liabilities and Shareholders Equity
    
    $
    896,921
    
    
    $
    1,464,044
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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 Year Ended December 31,2005
    
    
    2004
    
    
    2003Revenues:Royalty Revenues
    
    $
    1,192,447
    
    
    $
    1,105,923
    
    
    $
    1,269,286Cost of Revenues
    
    
    106,062
    
    
    
    111,395
    
    
    
    122,4171,086,385
    
    
    
    994,528
    
    
    
    1,146,869Operating Expenses:General and Administrative
    
    
    670,124
    
    
    
    615,412
    
    
    
    811,024Research and Development
    
    
    354,138
    
    
    
    393,004
    
    
    
    458,940Sales and Marketing
    
    
    152,473
    
    
    
    137,889
    
    
    
    360,6921,176,735
    
    
    
    1,146,305
    
    
    
    1,630,656Operating Income (Loss)
    
    
    (90,350
    )
    
    
    (151,777
    )
    
    
    (483,787
    )Interest Income
    
    
    13,230
    
    
    
    4,982
    
    
    
    7,201Interest Expense
    
    
    (5,269
    )
    
    
    (10,295
    )
    
    
    (13,447
    )7,961
    
    
    
    (5,313
    )
    
    
    (6,246
    )Income (Loss) Before Income Taxes
    
    
    (82,389
    )
    
    
    (157,090
    )
    
    
    (490,033
    )Income Taxes
    
    
    874
    
    
    
    (400
    )
    
    
    (5,420
    )Net Income (Loss)
    
    $
    (81,515
    )
    
    $
    (157,490
    )
    
    $
    (495,453
    )Basic and Diluted Income (Loss) per Share:
    
    $
    (.00
    )
    
    $
    (.00
    )
    
    $
    (.01
    )Weighted-Average Shares Outstanding
    
    
    46,990,059
    
    
    
    46,975,363
    
    
    
    47,309,171
  28




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##### Table of Contents



SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 Year Ended December 31,2005
    
    
    2004
    
    
    2003Cash Flows from Operating Activities:Net Income (Loss)
    
    $
    (81,515
    )
    
    $
    (157,490
    )
    
    $
    (495,453
    )Adjustments to Reconcile Net Income (Loss) to
Net Cash Provided (Used) by Operating
Activities:Depreciation
    
    
    16,401
    
    
    
    11,942
    
    
    
    30,591Amortization
    
    
    31,030
    
    
    
    46,915
    
    
    
    52,313Stock and Options Issued for Services
    
    
    1,000
    
    
    
    0
    
    
    
    12,000Net Change in Assets and Liabilities:Accounts Receivable
    
    
    170,479
    
    
    
    19,699
    
    
    
    153,612Prepaid Expenses, Deposits and Other Assets
    
    
    36,836
    
    
    
    (35,510
    )
    
    
    55,960Accounts Payable
    
    
    (57,678
    )
    
    
    50,407
    
    
    
    (17,561
    )Accrued Expenses and Other Liabilities
    
    
    18,274
    
    
    
    16,581
    
    
    
    (45,427
    )Deferred Revenue
    
    
    (391,395
    )
    
    
    391,395
    
    
    
    0Net Cash Provided (Used) by Operating Activities
    
    
    (256,568
    )
    
    
    343,939
    
    
    
    (253,965
    )Cash Flows from Investing Activities:Purchase of Property and Equipment
    
    
    (5,277
    )
    
    
    (4,007
    )
    
    
    (1,771
    )Intangible Assets
    
    
    (2,868
    )
    
    
    (16,580
    )
    
    
    (18,938
    )Net Cash Used by Investing Activities
    
    
    (8,145
    )
    
    
    (20,587
    )
    
    
    (20,709
    )Cash Flows from Financing Activities:Conversion of B-1 Pfd to Common Stock
    
    
    0
    
    
    
    0
    
    
    
    10,000Notes Payable
    
    
    (55,809
    )
    
    
    66,252
    
    
    
    0Notes and Amounts Due to (from) Related Parties
    
    
    0
    
    
    
    (108,246
    )
    
    
    108,246Repayments/Termination of Notes Payable
    
    
    0
    
    
    
    0
    
    
    
    (112,500
    )Net Cash Provided (Used) by Financing Activities
    
    
    (55,809
    )
    
    
    (41,994
    )
    
    
    5,746Increase (Decrease) in Cash and Cash Equivalents
    
    
    (320,522
    )
    
    
    281,358
    
    
    
    (268,928
    )Cash and Cash Equivalents, Beginning of Year
    
    
    871,155
    
    
    
    589,797
    
    
    
    858,725Cash and Cash Equivalents, End of Year
    
    $
    550,633
    
    
    $
    871,155
    
    
    $
    589,797Supplemental Disclosure of Cash Flow InformationCash Paid During the Year for:Interest
    
    $
    5,269
    
    
    $
    10,295
    
    
    $
    11,250Income Taxes
    
    $
    0
    
    
    $
    400
    
    
    $
    4,800
  29




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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, 2002
    
    
    -0-
    
    
    $
    -0-
    
    
    
    47,406,939
    
    
    $
    474,070
    
    
    $
    46,402,550
    
    
    $
    (45,447,942
    )
    
    $
    1,428,678Options 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
    
    
    $
    46,428,461
    
    
    $
    (45,943,395
    )
    
    $
    955,225Cancellation of Unissued
Performance Shares
    
    
    
    
    
    
    
    
    
    
    (40,500
    )
    
    
    (405
    )
    
    
    405Net Loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (157,490
    )
    
    
    (157,490
    )Balance, December 31, 2004
    
    
    -0-
    
    
    $
    -0-
    
    
    
    46,975,365
    
    
    $
    469,754
    
    
    $
    46,428,866
    
    
    $
    (46,100,885
    )
    
    $
    797,735Conversion of Series B-1 Pfd
to Common Shares
    
    
    
    
    
    
    
    
    
    
    1,788,018
    
    
    
    18
    
    
    
    1,164
    
    
    
    
    
    
    
    1,182Net Loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (81,515
    )
    
    
    (81,515
    )Balance, December 31, 2005
    
    
    -0-
    
    
    $
    -0-
    
    
    
    48,763,383
    
    
    $
    469,772
    
    
    $
    46,430,030
    
    
    $
    (46,182,400
    )
    
    $
    717,402
  30




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##### Table of Contents



SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (1) Nature of Business
   (2) Significant Accounting Policies
 Basis of Consolidation 
 Reclassification 
 Going Concern
 Revenue Recognition 
 Concentration of Credit Risk 
    31




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##### Table of Contents



Cash and Cash Equivalents 
 Customers Outside of the U.S.-
 Major Customers 
 Research and Development Costs 
 Advertising Costs 
 Property and Equipment 
 Intangible Assets 
 Earnings Per Share  Earnings Per Share
  Stock Option Plan  Accounting for Stock-Based Compensation ,as amended
 Impairment
of Long-Lived Assets and Assets to be Disposed of Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed of,
 Segment Reporting Disclosures about Segments of an Enterprise
and Related Information
 32




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##### Table of Contents



Income Taxes
 Recent
Accounting Pronouncements
   Use of Estimates
 Fair Value of Financial Instruments
  (3) Property and Equipment
  33




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##### Table of Contents



2005
    
    
    2004Office Computers, Software, Equipment and Furniture
    
    $
    337,145
    
    
    $
    331,867Test Equipment
    
    
    73,300
    
    
    
    73,300Tooling Equipment
    
    
    45,539
    
    
    
    45,539Trade Show Booth and Demonstration Equipment
    
    
    174,548
    
    
    
    174,548Automobiles
    
    
    7,000
    
    
    
    7,000Total Property and Equipment
    
    
    637,531
    
    
    
    632,253Less Accumulated Depreciation and Amortization
    
    
    619,128
    
    
    
    602,727Property and Equipment, Net
    
    $
    18,403
    
    
    $
    29,527
 (4) Intangible Assets
  2005
    
    
    2004Capitalized Patent, Trademarks and Technology Costs
    
    $
    525,695
    
    
    $
    522,827Less Accumulated Amortization
    
    
    387,147
    
    
    
    356,117Intangible Assets, Net
    
    $
    138,548
    
    
    $
    166,710
  2006
    
    $
    16,7022007
    
    $
    16,7022008
    
    $
    16,7022009
    
    $
    16,702Thereafter
    
    $
    71,740$
    138,548
  (5) Notes Payable to Related Parties
   34




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##### Table of Contents



(6) Shareholders Equity
 During the year ended December 31, 2005, shares were issued or converted as follows:
    During the year ended December 31, 2004, shares were issued or converted as follows:
 Unissued Performance Shares held in escrow were cancelled.
  Capitalization
 Series B-1 Redeemable Convertible Preferred Stock:
 (7) Stock Options
   35




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##### Table of Contents



2005
    
    
    2004
    
    
    2003NET INCOME (LOSS):As Reported
    
    $
    (81,515
    )
    
    $
    (157,490
    )
    
    $
    (495,453
    )Pro Forma
    
    $
    (89,715
    )
    
    $
    (172,770
    )
    
    $
    (538,368
    )BASIC AND DILUTED LOSS:As Reported
    
    $
    (0.00
    )
    
    $
    (0.00
    )
    
    $
    (0.01
    )Pro Forma
    
    $
    (0.00
    )
    
    $
    (0.00
    )
    
    $
    (0.01
    )
  Weighted-AverageExercisable
    
    Number
    
    Exercise PriceOptions outstanding at December 31, 2002
    
    
    2,668,332
    
    
    
    2,671,500Options granted
    
    
    
    
    
    
    1,200,000
    
    
    $
    0.05Options exercised
    
    
    
    
    
    
    (166,666
    )
    
    $
    0.06Options forfeited/expired
    
    
    
    
    
    
    (669,834
    )
    
    $
    0.18Options outstanding at December 31, 2003
    
    
    2,540,000
    
    
    
    3,035,000
    
    
    $
    0.18Options granted
    
    
    
    
    
    
    200,000
    
    
    $
    0.09Options exercised
    
    
    
    
    
    
    
    
    
    
    Options forfeited
    
    
    
    
    
    
    (600,000
    )
    
    $
    0.43Options outstanding at December 31, 2004
    
    
    2,381,666
    
    
    
    2,635,000
    
    
    $
    0.11Options granted
    
    
    
    
    
    
    500,000
    
    
    $
    0.10Options exercised
    
    
    
    
    
    
    (0
    )
    
    $
    Options forfeited/expired
    
    
    
    
    
    
    (325,000
    )
    
    $
    0.31Options outstanding at December 31, 2005
    
    
    2,726,666
    
    
    
    2,810,000
    
    
    $
    0.10
  (8) Warrants
   (9) Income Taxes
  36




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##### Table of Contents



2005
    
    
    2004
    
    
    2003State franchise tax
    
    $
    400
    
    
    $
    400
    
    
    $
    4,800Federal taxes
    
    
    (1,274
    )
    
    
    (0
    )
    
    
    (0
    )Total
    
    $
    (874
    )
    
    $
    400
    
    
    $
    4,800
     (10) Commitments and Contingencies
  Operating Lease Commitments
  (11) Profit Sharing Plan
  (12) Quarterly Financial Data (unaudited)
  Quarter Ended2005
    
    March 31
    
    June 30
    
    September 30
    
    December 31Net Revenues
    
    $
    331,950
    
    
    $
    428,912
    
    
    $
    270,914
    
    
    $
    160,670Gross Margin
    
    $
    298,078
    
    
    $
    386,022
    
    
    $
    258,162
    
    
    $
    144,122Net Income (Loss)
    
    $
    10,014
    
    
    $
    57,566
    
    
    $
    36,545
    
    
    $
    (186,514
    )Basic (Loss) Per Share
    
    $
    0.00
    
    
    $
    0.00
    
    
    $
    0.00
    
    
    $
    (0.00
    )
 37




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##### Table of Contents



Quarter Ended2004
    
    March 31
    
    June 30
    
    September 30
    
    December 31Net Revenues
    
    $
    170,679
    
    
    $
    234,860
    
    
    $
    205,324
    
    
    $
    495,060Gross Margin
    
    $
    153,675
    
    
    $
    216,727
    
    
    $
    179,210
    
    
    $
    444,916Net Income (Loss)
    
    $
    (123,796
    )
    
    $
    (123,259
    )
    
    $
    (80,576
    )
    
    $
    170,141Basic (Loss) Per Share
    
    $
    (0.00
    )
    
    $
    (0.00
    )
    
    $
    (0.00
    )
    
    $
    0.00
 (13) Subsequent Events and Management Plans (unaudited)
  38




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##### Table of Contents



Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosure
  
 Item 9A. Controls and Procedures
  
 Item 9B. Other Information
  
 PART III
 
 Item 10. Directors and Executive Officers of the Registrant
  Code of Ethics
  
 Item 11. Executive Compensation
  
 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
 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
    
    
    2,810,000
    (1)
    
    $
    0.10
    (1)
    
    
    2,066,339Equity compensation
plans not approved by
security holders
    
    
    0
    
    
    
    0
    
    
    
    0Total
    
    
    2,810,000
    
    
    $
    0.10
    
    
    
    2,066,339
 39




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##### Table of Contents



(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 4,876,339 as at
December 31, 2005. 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.  
 Item 13. Certain Relationships and Related Transactions
  
 Item 14. Principal Accountant Fees and Services
  
 PART IV
 
 Item 15. Exhibits and Financial Statement Schedules
    40




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##### Table of Contents



ExhibitNumber
    
    Description2.1
    
    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.)3.6
    
    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
    
    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.)4.2
    
    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.)4.3
    
    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*
    
    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.)
 41




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##### Table of Contents



ExhibitNumber
    
    Description10.2*
    
    Spatializer-Delaware 1996 Incentive Plan. (Incorporated by reference
to the Companys Proxy Statement dated June 25, 1996 and previously
filed with the Commission.)10.3*
    
    Form of Stock Option Agreement (Incorporated by reference to Exhibit
10.3 to the Companys Annual Report on Form 10-K for the period
ended December 31, 2004.)10.4
    
    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.)10.5*
    
    Employment Agreement dated November 12, 2004, between the Company
and Henry Mandell, as amended. (Incorporated by reference to Exhibit
10.5 to the Companys Annual Report on Form 10-K for the period
ended December 31, 2004.)10.6
    
    Related Party Promissory Note to the Successor Trustee of the Ira A.
Desper Marital Trust dated November 1, 2003. (Incorporated by
reference to Exhibit 10.6 to the Companys Annual Report on Form
10-K, for the period ended December 31, 2004.)10.7
    
    Lease for Office and Research Center in San Jose, CA.10.8
    
    Lease for Executive Office in Westlake Village, CA.10.9
    
    License Agreement between Spatializer Audio Laboratories, Inc.,
Desper Products, Inc. and Samsung Electronics, effective August 22,
2004. (Incorporated by reference to the Companys Quarterly Report
on Form 10-Q for the period ended September 30, 2004.)10.10
    
    Employment Agreement dated January 6, 2006, between the Company and
Henry Mandell. (Incorporated by reference to Exhibit 10.10 to the
Companys Annual Report on Form 10-K for the period ended December
31, 2005.)21.1
    
    Subsidiaries of the Company23.1
    
    Consent of Independent Auditors31.1
    
    Certificate pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1
    
    Certificate 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, as amended)
 
 *
    
    Previously filed. 42




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##### Table of Contents



SIGNATURES
  Dated: March 27, 2006SPATIALIZER AUDIO LABORATORIES, INC.(Registrant)/s/ Henry R. MandellHenry R. MandellChairman & Secretary
  Signature
    
    Title
    
    Date/s/ Carlo Civelli

Carlo Civelli
    
    Director
    
    March 27, 2006/s/ Henry R. Mandell

Henry R. Mandell
    
    Director
    
    March 27, 2006
 43