**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM10-K**

 

**(Mark one)**

** **

| **ý** | **ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                      |
|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                           |
|       | **For the fiscal year ended December 31, 2005**                                                                                                                                                |
|       |                                                                                                                                                                                           |
| **o**      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                  |
|       |                                                                                                                                                                                           |
|       | **For the transition period from                  to           ** |
|       |                                                                                                                                                                                           |
|       | **Commission file number 0-5576**                                                                                                                                                              |

 

**SPHERIXINCORPORATED**

(Exact name of Registrantas specified in its Charter)

 

| **Delaware**                                                              | ** ** | **52-0849320**                                                              |
|---------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|
| (State or other  jurisdiction of incorporation or organization)           |       | (I.R.S. Employer  Identification No.)                                       |
|                                                                      |       |                                                                        |
| **12051  Indian Creek Court, Beltsville, Maryland 20705**                 |
| (Address of principal  executive offices)                                 |
|                                                                      |       |                                                                        |
| Registrant’s telephone number, including area code: **301-419-3900** |       |
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| Securities registered pursuant to Section 12(b) of  the Act:              |       |                                                                        |
|                                                                      |       |                                                                        |
| **Title of each class**                                    | ** ** | **Name of each exchange on which registered** |
| **None**                                                                  | ** ** | ** **                                                                  |
| ** **                                                                | ** ** | ** **                                                                  |
| Securities registered  pursuant to Section 12(g) of the Act:              |       |                                                                        |
|                                                                      |       |                                                                        |
| **Common Stock  ($.005 par value per share)**                             |
| (Title of class)                                                          |

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act.  Yes  o  No  ý

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Act. Yes  oNo ý

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes  ý  No  o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form10-K.  ý

 

Indicate by checkmark whether the Registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer (as defined in Rule 12b-2 of the Act).  Large Accelerated Filer o  AcceleratedFiler o  Non-accelerated Filer ý

 

Indicate by check markwhether the Registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes  o  No ý

 

State the aggregatemarket value of the voting and non-voting common equity held by non-affiliatescomputed by reference to the price at which the common equity was last sold, orthe average bid and asked price of such common equity, as of the last businessday of the registrant’s most recently completed second fiscal quarter (forpurposes of this determination, only our Directors and Executive Officers havebeen deemed affiliates):

 

Common Stock (Par Value$.005) – $16,092,004

 

There were 13,578,356 shares of the Registrant’sCommon Stock outstanding as of March 10, 2006.

 

**DOCUMENTS INCORPORATED BYREFERENCE**

 

Portions of the Spherix Incorporated definitive ProxyStatement, to be filed with the Securities and Exchange Commission pursuant toRegulation 14A of the Securities Exchange Act of 1934 not later than 120 daysafter the end of the fiscal year to which this report relates, are incorporatedby reference into Part III of this Form 10-K.

 

 

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**PART I**

 

Certain statements contained in this Form 10-K,including without limitation, statements containing the words “believes,” “estimates,”“expects” and words of similar import, constitute “forward looking statements”within the meaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934. Such words and expressions are intended to identify such forward lookingstatements, but are not intended to constitute the exclusive means ofidentifying such statements.  Suchforward looking statements involve known and unknown risks, uncertainties andother factors that may cause the actual results, performance or achievements ofthe Company, or industry results, to be materially different from any futureresults, performance or achievements expressed or implied by such forwardlooking statements.  Given theseuncertainties, prospective investors are cautioned not to place undue relianceon such forward looking statements.  TheCompany disclaims any obligation to update any such factors or to publiclyannounce the results of any revisions to any of the forward looking statementscontained herein to reflect any events or developments.  See the Company’s Form 8-K filing dated March26, 1999, for a more detailed statement concerning forward looking statements.

 

**Item 1.  DESCRIPTION OF BUSINESS**

 

**General**

 

Spherix Incorporated (the “Company” or “Registrant”),a Delaware corporation, was founded in 1967. The Company consists of a biotechnology division (“BioSpherix”) and aninformation services division (“InfoSpherix”). At the May 2005 annual meeting shareholders approved the establishmentof InfoSpherix as a wholly-owned subsidiary of Spherix, which took effectJanuary 2006.

 

The principal executiveoffices of the Company are located at 12051 Indian Creek Court, Beltsville,Maryland 20705, and its telephone number is (301) 419-3900.  The Company’s Common Stock trades on theNASDAQ National Market System under the symbol SPEX.

 

**Available Information**

 

Our principal Internetaddress is www.spherix.com.  We makeavailable free of charge on www.spherix.com our annual, quarterly and currentreports, and amendments to those reports, as soon as reasonably practicable afterwe electronically file such material with, or furnish it to, the Securities andExchange Commission (“SEC”).

 

**BioSpherixDivision**

** **

The BioSpherix Divisionis located at 304A Harry S. Truman Parkway, Annapolis, MD 21401, and itstelephone number is 1-877-SPHERIX.  Thisdivision is the Company’s biotechnology research and development arm, dedicatedto developing proprietary products with a view toward commercialapplications.  The Company hasaccumulated a number of patents on the products and processes developed by theBioSpherix Division.

 

Tagatose as aLow-Calorie, Full-Bulk Sweetener.  Spherix has patented the use of a naturallyoccurring sugar, tagatose, as a low-calorie, full-bulk sweetener.  It is a true sugar that looks, feels, andtastes like table sugar.  Tagatose occursin nature in amounts too small for economic recovery.  The Company has developed and patented aneconomic method for making tagatose from whey or lactose.  Whey is a waste product from cheesemanufacturing.

 

The Firm has beendeveloping its sweetener since receiving a U.S. patent for its use andmanufacture as a low-calorie sweetener in 1988, which patent expires August 29,2006.  Tagatose has also been found to bea pre-biotic, a substance that improves the digestion of food and is beneficialto health.  Pre-biotics are widely soldin Europe and Asia and are increasingly appearing in the U.S.  The Company received two U.S. patents for itstagatose production process in 1991 and 1992, which expire July 19, 2009, andMarch 25, 2011, respectively.  It has receiveda number of foreign patents corresponding to these three and other U.S.patents.  These countries include Canadaand Japan, both large potential markets.

 

In January 1997, theCompany completed a license agreement with Arla Foods Ingredients amba (“Arla”)(formerly MD Foods Ingredients amba, “MDFI”) of Denmark for the exclusiveworldwide rights to manufacture, market, and distribute tagatose as a food andbeverage ingredient in return for a non-refundable up-front payment and fees onnet sales of the sugar for these purposes. Arla manufactures a wide variety of dairy products, foods and food

 

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ingredients; it ranks as one of the largest dairyproducts manufacturers in the world. Arla operates cheese plants producing large amounts of whey as aby-product.  The License Agreement and anamendment thereto provide Arla the exclusive, world-wide right to manufactureand sell tagatose for food uses, and the exclusive right to manufacturetagatose for all uses.  Spherix retainsall rights to sell tagatose for drug use, and use in drugs, including rights tothe use of tagatose as a sweetener or other functional ingredient in drugs andcosmetics such as toothpaste, cough syrup, fiber laxative, and mouthwash.  To distinguish these non-food uses from thelicensed food uses, Spherix has coined the name Naturlose®.  A supply agreement with Arla provides for theamount of Naturlose required by Spherix.

 

A panel of expertsretained by Arla declared tagatose as Generally Recognized As Safe (“GRAS”) onApril 11, 2001, permitting sale of tagatose as a food ingredient in theU.S.  The U.S. Food and DrugAdministration (“FDA”) issued a “no objection” letter on October 25, 2001.  Tagatose was recommended by the Joint FAO/WHOExpert Committee on Food Additives (JECFA) panel in June 2001 to its manymember countries for use in foods, and in June 2004, JECFA removed its formerlimit on daily consumption of tagatose. In 2003, approval was obtained in South Korea.  In April 2004, tagatose was approved by theFood Standards Australia New Zealand (“FSANZ”), the food health and safetyagency for Australia and New Zealand.  InDecember 2005, tagatose was approved in the European Union.  Arla has begun the approval process for tagatosein Canada, Japan and Mexico.

 

The U.S. FDA approvedArla’s recommended caloric value of 1.5 kilocalories per gram, permittinglabeling of products containing it as “reduced calorie” in the U.S.  At Spherix’s request, the right to request asmaller reduced calorie rating in the future has been reserved.  Spherix believes that test data support alower value.

 

In 2002, Arla formed a50/50 joint venture with Nordzucker, a German sugar producer, for themanufacture and sale of tagatose. Production from the joint venture factory, capable of producing 1,200metric tons per year, permitted sales of tagatose to the U.S. sweetener marketto begin in 2003 when the 7-Eleven chain introduced Diet Pepsi Slurpeescontaining tagatose.  At present Arlabelieves it has produced a sufficient backlog of inventory to satisfy its needsfor the foreseeable future based on current demand, and accordingly has stoppedproduction at its pilot plant until there is a sufficient increase in thedemand for tagatose.  Arla is currentlyhaving discussions with potential users and Arla has stated that, if they cancreate enough market interest, production will be resumed and/or a largertagatose plant will be established. Spherix is also pursing the possibility of other production options,including recovering its technology from Arla either directly or through athird party.

 

Potential food andbeverage markets for tagatose include confections, ice cream, frozen desserts,diet sodas, cereals, frosting, chocolate candy, baked goods, heat-processedfoods, other dairy products, and other products in which the full bulk of sugaris required.  Tagatose may also be usedin prebiotics, healthy drinks and foods, and dietary supplements.  Manufacturers have long sought a low-calorie,full-bulk substitute for table sugar; however, none has been as successful inemulating the flavor of table sugar as has tagatose.  Unlike table sugar, tagatose has been shownto cause no tooth decay, and has now won FDA approval to carry the label “doesnot cause tooth decay”, or “noncariogenic.” An unexpected market for tagatose was opened up in the soft drinkindustry by the discovery that tagatose is synergistic with the high intensitysweeteners used in diet sodas, thereby improving the taste and mouthfeel of dietsodas.  To promote greater marketinterest in tagatose by food and beverage manufacturers, Arla teamed withSymrise in 2004, one of the world’s top producers of flavors and fragrances, indeveloping new flavor blends using tagatose.

 

In 2002, Spherix filed a Notice of Arbitration againstArla under the terms of its License Agreement with that firm, contending thatit had suffered from Arla’s slow progress in bringing tagatose to market.  On November 13, 2003, the Company settled itsarbitration and entered into an Amendment to the September 27, 1996 LicenseAgreement with Arla.  The amendmentextended the period under which the high-end fees on the commercial sales oftagatose are due the Company until at least March 25, 2011, and until August25, 2016, subject to certain conditions. In turn, the Company relinquished its rights to raise any additionaldelay claims against Arla.  Arla agreedto give up its right to deduct the $1 million prepayment against futureroyalties payable to the Company.  Arlawas granted the exclusive worldwide rights to manufacture tagatose for any typeof product or purpose.  Most importantly,Arla agreed to supply tagatose to Spherix for Spherix’s use in the non-food anddrug markets.

 

In the year 2000, theCompany achieved GRAS status for the use of Naturlose as a sweetener(excipient) in drugs for non-chronic use by adults and children.  Also in the year 2000, the Company achievedGRAS status for the uses of Naturlose in toothpaste, mouthwash, lipstick andother cosmetic products.

 

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Spherix has patented theuse of Naturlose in treating Type 2 diabetes, and for other uses in health andmedicine as outlined below:

 

*Treatmentfor Type 2 Diabetes.* Phase 1 and Phase 2 clinical trials at the University of Maryland Schoolof Medicine have found tagatose effective as an adjuvant treatment of Type 2diabetes in humans.  In addition, overthe one-year trial, all subjects lost weight at physician-approved rates alongwith a significant increase in the desirable type of cholesterol, HDL.  Other than for initial laxation at high doses(45 to 75 grams per capita per day), accommodated in about two weeks, nountoward effects were found in any of the research.  In addition, the studies found that tagatoseproduced no rise in blood glucose or insulin levels in diabetic or normalsubjects.  Tagatose taken before theconsumption of glucose produced a blunting effect on the otherwise normallyexpected rise in blood glucose.

 

On November 4, 2005,following review ofpharmacological, toxicological, and efficacy data from Spherix’s completedPhase 1 and 2 clinical trials, the U.S. FDA’s Center for Drug Evaluation and Research found tagatose to be qualifiedfor Phase 3 clinical trials.  Patientrecruitment for the clinical trials is expected to begin in 2006.  The trials could last as little as twoyears.  More than 200 subjects,representing the demographic mix in the U.S., will receive oral doses ofNaturlose to test its ability to treat Type 2 diabetes.  A Phase 3 clinical trial, which gathersevidence regarding effectiveness and safety, is needed to evaluate the overallbenefit-risk relationship of new drugs proposed to the FDA.  Because Naturlose has already beenestablished as a substance “Generally Recognized as Safe” under FDAregulations, Spherix believes the elapsed time to approval should be shorterthan that for most new drugs.  Asuccessful Phase 3 trial would permit Spherix to file a New Drug Applicationwith the FDA, the approval of which would be the final step before marketingNaturlose as a diabetes-fighting pharmaceutical.  The FDA generally decides on suchapplications within one year.

 

*Anti-hyperglycemicAgent.*  Tagatosefunctions as an anti-hyperglycemic agent to prevent the formation of advancedglycosylation end-products, which is one of the major causes of aging.

 

*Increasingthe shelf life of stored blood, platelets and medicinal proteins.*  The Company has been funding a research project at the Albert Einstein College ofMedicine (AECOM) to develop the use of Naturlose to preserve hemoglobin andother blood components, including platelets and various medicinalproteins.  Under a licenseagreement, Spherix obtained the rights to Naturlose-containing products andprocesses under development at AECOM. Spherix will pay royalties to AECOM on sales of any forthcoming patentedproducts or processes.

 

*Anti-plaqueAgent*:* *In 2005, the Company contractedwith the University of Maryland School of Dentistry to conduct human clinicaltrials on the oral anti-plaque efficacy of Naturlose.  The study demonstrated tagatose to be muchmore resistant to oral bacteria, which form plaque, than is sorbitol, a sugarsubstitute that is widely used in oral care products.  The study suggested ways of modifying theNaturlose product to effect desired plaque reduction.  Such modifications have been made, and aclinical trial of a Naturlose toothpaste at the University of Maryland Schoolof Dentistry will begin in 2006 to test the effects against oral plaque andgingivitis.

 

*Anemiaand Hemophilia Treatment*. Naturlose has been shown to improve blood factors indicating thattagatose may be useful as a drug or drug adjuvant in the treatment of anemiaand hemophilia.

 

*IncreasedFertility and Improved Fetal Development Drug.*  Naturlose may increase the fertility ofhumans and other animals, to effect higher percentages of live fetuses, and tocause those fetuses to be heavier, but within normal bounds, than those ofhuman or animal controls.

 

*Preservativeof Human Organs.*  Naturlosehas shown potential for use in the transplanting and storage of human organs toprotect against cyto-oxidation and toxic chemicals.

 

The drug uses mentionedabove require regulatory approval before they can be brought to market.

 

Capital for Development.  While the products under development showpromise, continued progress is dependent upon many factors, including, but notlimited to, the Company’s having sufficient funds and resources to pursuethem.  Over its history, the Company hassupported its research and development in part by using funds generated by itsInfoSpherix Division; however, given the lower margin on government business,the capital needs of InfoSpherix, and bank covenants restrictions, theInfoSpherix Division may not be able to support all of the activities of theBioSpherix Division.  Funds have alsobeen raised from private placements of Company stock and warrants, some of theproceeds of which have been used to increase the state of development, marketpenetration and sales of the

 

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products mentioned above.  Spherix believes it has sufficient funds tocomplete most, if not all, of the Phase 3 clinical trial of Naturlose as a drugagainst Type 2 diabetes.  If needed, theCompany will seek additional funding through additional sales of stock orpartnering with another Company.  Inorder to fully develop, manufacture, distribute and sell Naturlose for thispurpose, the Company is seeking a relationship with a major pharmaceuticalcompany.

 

BioSpherix revenueaccounted for less than 1% of the Company’s total revenue in 2005.

 

**InfoSpherix Division**

 

InfoSpherixprofessionals design and operate contact centers providing informationmanagement and materials to the public on various socially beneficial subjects,as well as other information services, such as reservations and tourism.  InfoSpherix focuses on those clients who arelooking to leverage technology in the ever-advancing world of informationmanagement.  InfoSpherix researches,collects, organizes and disseminates information by providing customizedcontact center services combining advanced data collection systems, expertdecision support systems, tele-support utilizing live operators, and advancedtelecommunication technologies such as Interactive Voice Response (“IVR”).  InfoSpherix answers millions of callsannually from professionals and the public nationwide.  It operates a contact center in Cumberland,Maryland and a second contact center in Rapid City, South Dakota. The SouthDakota contact center will be relocating to Indiana in 2006.  All contact centers efficiently manage andtrack high volumes of data.  CouplingInfoSpherix’s expert staff with its advanced technologies results in aneffective system to collect and disseminate large amounts of information.  The Company also provides reservationservices for campgrounds and other parks via its ReserveWorld businessline.  Since 1998, InfoSpherix has grownits government park reservation business from one contract to seventeengovernment reservation contracts, and six new state reservation contracts willbe available for InfoSpherix to bid on in 2006. InfoSpherix’s reservation business accounted for over 60% of the Company’srevenue in 2005.  InfoSpherix is now oneof only two major companies in this market.

 

In 2005, Spherix won parkreservation contracts for Orange County, California, the State of Pennsylvania,and the State of Michigan.  The OrangeCounty contract consists of three base years and is valued at less than half a million.  The State of Pennsylvania contract is afive-year contract, consisting of one base year and four option years, valuedat approximately $8 million.  The Stateof Michigan contract is a continuation of our current contract with theState.  The new contract is for fiveyears, and consists of three base years plus two option years, valued atapproximately $14 million.

 

In July 2005, Spherix filed an official protest of theU.S. Department of Agriculture’s award of the National Recreation ReservationSystem (“NRRS”) contract to ReserveAmerica, a TicketMaster subsidiary.  The NRRS will provide reservation servicesfor all Federal recreation facilities, including the National Park sitescurrently serviced by Spherix under its ongoing National Park ReservationService (“NPRS”) contract with the Department of Interior.  On October 20, 2005, the GovernmentAccountability Office (“GAO”) sustained Spherix’s challenge to the USDA ForestService award and recommended that the Department of Agriculture reopen thecompetition and make a new award decision. This is the second time that GAO has found the Forest Service’s attemptto award the NRRS contract to ReserveAmerica to be flawed.  The Department of Agriculture subsequentlydecided not to follow GAO’s decision and is seeking to proceed with the awardof the NRRS contract to ReserveAmerica. The Department of Agriculture has agreed not to proceed while the Courtof Federal Claims hears Spherix’s appeal. Meanwhile, the Company’s NPRS contract has been formally extendedthrough September 30, 2006.  The Companyhas operated the NPRS contract for eight years; revenue from such contract was$4.0 million and $3.9 million for the years ended December 31, 2005 and 2004,respectively, or 17% of total revenue for each year.

 

InfoSpherix accounted forsubstantially all of the Company’s revenue in 2005.  Most of InfoSpherix’s revenues traditionallyhave been generated by a few large government contracts.  See Note 1, “Concentrations,” of the Notes tothe Financial Statements included herein pursuant to Part II of this Form 10-K.

 

In January 2006, theInfoSpherix business started operating as a wholly-owned subsidiary of SpherixIncorporated under the name “InfoSpherix Incorporated.”

 

**GovernmentContracts**

 

See Note 10, “Commitment and Contingencies – *Government Contracts*,” of the Notes to the FinancialStatements included herein pursuant to Part II, Item 8 of this Form 10-K, whichinformation is incorporated herein by reference.

 

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Government contracts typically have terms andconditions which, while providing annual or multi-year terms, subject them totermination upon convenience or default.

 

**Industry Segments**

 

See Note 13, “Information by Business Segment,” of theNotes to the Financial Statements included herein pursuant to Part II, Item 8of this Form 10-K for industry segment information of the Company, whichinformation is incorporated herein by reference.

 

**Market Concentration**

 

During 2005, 2004, and 2003, InfoSpherix contributed100%, 99%, and 94% of total Company revenue. The Company’s business operations are usually dependent upon substantialrevenue from a select group of customers. In 2005, 2004, and 2003, revenue from the U.S. Government, the State ofMichigan and the State of Maryland each accounted for more than 10% of totalCompany revenues.

 

It is currently expected that revenue from the U.S.Government, State of Michigan, and the State of Maryland will each account formore than 10% of total Company revenues in 2006.

 

**Patents and Trademarks**

 

The Company has established a strong worldwide patentposition for tagatose.  These patents andother significant Company patents are detailed in the following table:

 
| **Patent No.** | ** ** | **Patent Title**                                                                           | ** ** | **Issue  Date** | ** ** | **Expiration  Date** |
|---------------------|------------|-------------------------------------------------------------------------------------------------|------------|-----------------|------------|----------------------|
| U.S. 6,585,964      |       | Method for Preventing or Minimizing Biodegradation  of a Substance                              |       | 7/1/03          |       | 5/6/19               |
| U.S. 6,355,409      |       | Tagatose as a Cytoprotective Supplement for the  Storage of Organs to Reduce Reperfusion Injury |       | 3/12/02         |       | 9/1/20               |
| Canada 2,077,257*   |       | Process for Manufacturing D-Tagatose                                                            |       | 2/19/02         |       | 1/7/11               |
| U.S. 6,225,452      |       | Increased Fertility and Improved Fetal Development  Drug                                        |       | 5/1/01          |       | 4/26/19              |
| Finland 106861*     |       | Process for Manufacturing D-Tagatose                                                            |       | 4/30/01         |       | 1/7/11               |
| Japan 3,120,403*    |       | Process for Manufacturing D-Tagatose                                                            |       | 10/20/00        |       | 1/7/11               |
| U.S. 6,015,793      |       | Use of Tagatose to Enhance Key Blood Factors                                                    |       | 1/18/00         |       | 4/26/19              |
| Korea 190671*       |       | Process for Manufacturing D-Tagatose                                                            |       | 1/21/99         |       | 1/7/11               |
| Japan 2,138,363*    |       | D-Tagatose as a Low-Calorie Carbohydrate Sweetener  and Bulking Agent                           |       | 9/18/98         |       | 8/29/07              |
| U.S. 5,690,950      |       | Insecticidal Aliphatic Carboxylic Acid Compositions                                             |       | 11/25/97        |       | 10/4/16              |
| EPO 0 518 874*      |       | Process for Manufacturing D-Tagatose                                                            |       | 5/15/96         |       | 1/7/11               |
| U.S. 5,447,917      |       | D-Tagatose as Anti-Hyperglycemic Agent                                                          |       | 9/5/95          |       | 2/3/14               |
| Hong Kong 127095A*  |       | D-Tagatose as a Low-Calorie Carbohydrate Sweetener  and Bulking Agent                           |       | 8/18/95         |       | 8/25/07              |
| U.S. 5,356,879      |       | D-Tagatose an Anti-Hyperglycemic Agent                                                          |       | 10/18/94        |       | 2/14/12              |
| Canada 1,321,730*   |       | D-Tagatose as a Low-Calorie Carbohydrate Sweetener and  Bulking Agent                           |       | 8/31/93         |       | 8/31/10              |
| U.S. 5,166,193      |       | Method for Killing Pests                                                                        |       | 11/24/92        |       | 11/24/09             |
| Australia 655,166*  |       | Process for Manufacturing D-Tagatose                                                            |       | 1/7/92          |       | 1/7/07               |
| U.S. 5,078,796*     |       | Process for Manufacturing D-Tagatose (Tagatate)                                                 |       | 1/7/92          |       | 3/25/11              |
| U.S. 5,002,612*     |       | Process for Manufacturing D-Tagatose                                                            |       | 03/26/91        |       | 7/19/09              |
| EPO 257 626*        |       | D-Tagatose as a Low-Calorie Carbohydrate Sweetener  and Bulking Agent                           |       | 7/25/90         |       | 8/25/07              |
| U.S. 4,786,722*     |       | D-Tagatose as a Low-Calorie Carbohydrate Sweetener  and Bulking Agent                           |       | 11/22/88        |       | 8/29/06              |

 

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*Licensed to Arla Foods.

 

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Patent Applications.  In addition to the above-listed issuedpatents, the Company has applied for patent protection as follows:

 

•                  D-Tagatose as anAnti-Biofilm Agent

•                  Use of Tagatosein Fiber Laxatives

 

Trademarks.  The Company has trademarked its name, “Spherix,”“ReserveWorld,” its reservation system and “FlyCracker,” its safe-for-humanspesticide.  It has applied for thetrademark “Naturlose” for non-food uses of tagatose and for the trademark “BioSpherix.”  It retains trademarks on its original name, “Biospherics,”and a former subsidiary, “Vitalian Corp.”

 

With respect to all of its inventions, the Company hasreceived approximately 130 patents, including foreign issues.  It has several patents pending and manyadditional invention disclosures.  Inaddition to its strong patent position, the Company relies on the common lawprotection of such information as trade secrets and on confidentiality agreementsto protect the value of these assets.

 

Royalties.  Fees are payable to the Company from Arlaunder the above-described License Agreement through August 25, 2016.  Initial royalties will be used to offsetapproximately $195,000 in patent maintenance costs incurred by Arla Foods andfuture patent maintenance costs.  In late2003, Arla began sales of tagatose and the Company has earned approximately$5,000, $4,000 and $3,000 in royalties for the years 2005, 2004 and 2003,respectively, which were credited against Arla’s patent maintenance costs.

 

**Seasonality**

 

Revenues from reservation and tourism services aregreatest in the spring and summer when vacation planning is the heaviest.  Revenues from other sources tend to be moreevenly spread throughout the year, although the fourth quarter is historicallythe low period of the year.

 

**Sales Backlog**

 

Sales backlog, consisting of both funded and unfundedamounts, at December 31, 2005 and 2004, were as follows (in $000s):

 
| ** **                | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|---------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                | ** ** | **Current**                     | ** ** | **Non-Current**                 | ** ** | **Total** | ** ** | **Current** | ** ** | **Non-Current** | ** ** | **Total** | ** ** |
| InfoSpherix -  Government |       | $                               | 24,100     |                            | $          | 48,200 |   | $ | 72,300 |   | $ | 22,100 |   | $ | 38,900 |   | $ | 61,000 |   |
| InfoSpherix -  Commercial |       | 100                             |       | —                          |       | 100 |   | — |   | — |   | — |   |
|                      |       | $                               | 24,200     |                            | $          | 48,200 |   | $ | 72,400 |   | $ | 22,100 |   | $ | 38,900 |   | $ | 61,000 |   |

 

The increased backlog between years is the result ofwinning the State of Pennsylvania reservation contract and winning therecompete of the State of Michigan reservation contract.

 

**Competition**

 

**InfoSpherix**

 

The information systems industry is subject to rapidand significant technological change. The Company is in competition with other information services companiesacross the nation.  Many of these competitorshave substantially greater financial and technical resources than theCompany.  While acknowledging strongcompetition from other information services firms, the Company has developed aspecialized niche by concentrating on high quality, personalized servicecombined with computerization for efficiency and cost-effectiveness.  The Company has established a reputation forrapidly starting up information projects to meet its clients’ critical needs,while not compromising high quality and reasonable pricing.  The Company has also established a successfulniche in government campground reservation services and is now one of only twomajor suppliers of campground services in the U.S.  The other major supplier isIAC/InterActiveCorp’s ReserveAmerica. Over the last five years, the Company has invested over $3 million incomputer and telephony systems and over $3 million in the development ofspecialized computer software products to improve its competitiveposition.  The Company continues toupgrade and enhance those systems.

 

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**BioSpherix**

 

Competitors of BioSpherix are numerous and include,among others, major pharmaceutical, chemical, consumer, and biotechnologycompanies, specialized firms, universities and other researchinstitutions.  Over the past severalyears, various sugar alcohols have been used in food products as bulksweeteners.  However, none has the tasteof table sugar and most are more caloric than tagatose.  Bulk sweeteners are used in products wherethe bulk of sugar is essential, such as baked goods, chocolates, and icecream.  High intensity sweeteners, suchas aspartame, saccharin, and sucralose do not provide the bulk needed for theseproducts.  The Company’s competitors maysucceed in developing technologies and products that are more effective thanany that are being developed by the Company, and that could render the Company’stechnology and potential products obsolete and noncompetitive.  Many of these competitors have substantiallygreater financial and technical resources and production and marketing capabilitiesthan the Company.

 

**Research and Development**

 

BioSpherix expenditures for research and developmentwere approximately $288,000, $196,000, and $391,000 in 2005, 2004, and 2003,respectively.  These expenditures wereincurred primarily in the ongoing efforts to commercialize tagatose, includingits development for drug uses and improved production processes.

 

**Governmental Regulation**

 

The business activities of the Company are subject toa variety of Federal and state compliance, licensing, and certificationrequirements.  Management believes thatthe Company is, and has been at all times, in full compliance with Federal andstate environmental protection and worker safety laws.  The Company has not incurred significantexpense in complying with such laws and does not anticipate material expense.

 

The Company is also required to comply with theSarbanes-Oxley Act of 2002.  On September21, 2005, the SEC announced the extension of the compliance dates of Section404 of the Sarbanes-Oxley Act for non-accelerated filers.  Under the extension, non-accelerated filers,such as Spherix, will begin to comply with the internal control over financialreporting requirements for its first fiscal year ending on or after July 15,2007.  The Company anticipates that thecost of implementing Section 404 over the next two years could have a materialimpact on the results of operations.

 

**Environment**

** **

Compliance with current federal, state and localprovisions regulating the discharge of materials into the environment, orotherwise relating to the protection of the environment, has not had, and inthe opinion of management will not have, a material effect on the Company’sfinancial position, results of operations, capital expenditures, cash flows orcompetitive position.

 

**Employees**

 

In 2005, the Company employed an average of 570individuals on a full- or part-time basis. Of this total, approximately 325 were full-time employees.  The Company’s employees are not currentlyunionized, and management believes that its relations with the Company’semployees are harmonious.

 

**Geographic Areas**

 

InfoSpherix’s business is, and has been, based in theUnited States.  Accordingly, InfoSpherixrevenues are entirely from U.S.-based operations.

 

BioSpherix’s licensee for tagatose’s food use, Arla,is located in Europe.  Arla introducedtagatose to U.S. markets first, prior to worldwide distribution.

 

**Item 1A. RISK FACTORS**

 

Any of the risk factors we describe below couldseverely harm our business, financial condition and operating results.  The market price of our common stock coulddecline if one or more of these risks and uncertainties develop into actualevents.

 

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** **

**RISKS RELATED TO OUR BUSINESS**

 

**WE CONTINUE TO BE DEPENDENT ONOUR INFORMATION SERVICES DIVISION FOR NEARLY ALL OF OUR REVENUE**.  We are almost entirely dependent on theinformation services division for our revenue. In each of 2005 and 2004, our information services division accountedfor nearly 100% of our revenue.  Despitelicensing tagatose in 1996 for food and beverage use, our principalbiotechnology product, we have yet to receive any substantial royalties fromthe sales of tagatose by our licensee. Thus, we have incurred substantial and continuing losses in ourbiotechnology division which have adversely affected our overall financialresults and our stock price.  If wecontinue to be unsuccessful in commercializing our biotechnology products, ourfinancial results will continue to be adversely affected to the detriment ofour stock price.

 

**OUR LARGEST INFORMATION SERVICESCONTRACT COULD BE AWARDED TO A COMPETITOR.**  In both 2005 and 2004, our NPRS contractaccounted for approximately 17% of our aggregate revenue.  This contract has been bundled with aNational Forest Services contract and rebid as the National RecreationReservation System (“NRRS”).  In 2005,the bundled NRRS contract was awarded to a competitor for the second time; weprotested and our protest was again upheld. This is the second time that GAO has found the USDA Forest Service’sattempt to award the NRRS contract to our competitor to be flawed.  The Department of Agriculture hassubsequently decided not to follow GAO’s decision and is seeking to proceedwith the award of the NRRS contract to our competitor.  Spherix has filed an appeal of this actionwith the Court of Federal Claims, but we cannot predict the outcome of theappeal.  The Department of Agriculturehas agreed not to proceed while the Court of Federal Claims hears Spherix’sappeal.  Meanwhile, the Company’s NPRScontract has been formally extended through September 30, 2006.  If we lose this contract, we will need toreplace it with other work or scale back our operations to avoid an adverseimpact on our financial results.

 

**OUR INFORMATION SERVICES BUSINESSCOULD BE ADVERSELY AFFECTED BY SIGNIFICANT CHANGES IN THE CONTRACTING OR FISCALPOLICIES OF THE U.S. FEDERAL GOVERNMENT.**  We derive substantial revenues from contractswith the U.S. federal government and we believe that the success anddevelopment of our business will continue to depend on our successfulparticipation in U.S. federal government contract programs.  Accordingly, changes in U.S. federalgovernment contracting policies could directly affect our financialperformance.  Among the factors thatcould have a material adverse affect on our U.S. federal government contractingbusiness are:

 

•                  budgetaryconstraints affecting U.S. federal government spending generally, or specificdepartments or agencies in particular, and changes in fiscal policies oravailable funding;

•                  technologicaldevelopments;

•                  U.S. federalgovernmental shutdowns and other potential delays in the governmentappropriations process;

•                  delays in thepayment of our invoices by government payment offices due to problems with, orupgrades to, government information systems, or for other reasons;

•                  competition andconsolidation in the information services industry; and

•                  general economicconditions.

 

**OUR INFORMATION SERVICES BUSINESSIS RELIANT ON TECHNOLOGY.** We have devoted significant resources to developing and acquiringspecialized hardware and software in our information services business.  In order to remain competitive, we mustcontinue to select, invest in, acquire and develop new and enhanced technologyon a timely basis.  We may not besuccessful in these efforts or in anticipating developments in technology.  In addition, competitors could developsimilar applications.  Third partiescould independently develop similar technology, obtain unauthorized access toour proprietary technology or misappropriate technology to which we havegranted access.  Failure to remaincurrent with technology or misappropriation of our technology could adverselyaffect our ability to compete for information services business and could leadto reduced business and reduced financial results.

 

**ROYALTIES FROM TAGATOSE SALES AREUNCERTAIN.**  We havedeveloped tagatose, a full bulk, low calorie sweetener.  In September 1996, we granted an exclusive,world-wide license to a foreign entity for the manufacture and sale of tagatosefor use in foods and beverages.  To date,tagatose has only been commercially introduced into a limited number ofproducts.  We have not yet received anysubstantial royalties.  We initiated anarbitration proceeding against our licensee due to the delay in bringingtagatose to market.  We subsequentlydismissed the arbitration in exchange for various agreements including anextension of the period during which we are entitled to

 

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receive royalties.  Our prospectsfor receiving royalties from tagatose food and beverage sales are uncertain dueto numerous factors, most of which are out of our control, including:

 

•                  our licensee hasexclusive control over the commercialization of tagatose for food and beverageuses;

•                  the delay inbringing tagatose to market results in a shortening of the time we are entitledto royalties;

•                  significantroyalties are possible only if our licensee constructs a larger tagatosemanufacturing facility; at present, our licensee has ceased production at itscurrent facility due to excess inventories; and

•                  we are entitledto royalties only after reimbursing our licensee for the ongoing costs ofmaintaining patent protection on tagatose throughout the world.

 

**WE HAVE NOT YET SUCCESSFULLYCOMMERCIALIZED NATURLOSE.** We are in the process of attempting to develop other uses of tagatose,under the brand name Naturlose, in non-food products such as toothpaste,mouthwash, and over-the-counter and pharmaceutical drugs.  To date, we have yet to secure anysubstantial revenue from Naturlose sales. One of the hurdles we will have to overcome is that our foreign licenseefor tagatose (which has the exclusive right to manufacture tagatose) does notcurrently have sufficient capacity to manufacture enough tagatose to supplyboth food and nonfood markets if such markets mature and grow.  Failure to successfully commercializeNaturlose may adversely affect our stock price.

 

**OTHER BIOTECH PRODUCTS ARE STILLIN THE DEVELOPMENT STAGE.** We are developing other biotech products.  None of these have been developed to a stagewhere any significant revenue has been generated.  Development of products will requiresignificant additional research and development.  Such additional effort will requiresubstantial funding which may not be available to us.  Further, our research and developmentactivities may not result in any saleable products.  It is also possible that we will license orseek an affiliation with a third party to bring some products to market.  In such an event, we would likely haveminimal control over the manufacture and marketing of such products.

 

**DEVELOPMENT OF ANY BIOTECHPRODUCTS WILL DEPEND ON OBTAINING FDA AND FOREIGN REGULATORY APPROVALS.**  Development of new products are subject toextensive regulation by governmental regulatory authorities in the UnitedStates and other countries.  Theserigorous regulatory approval processes can take five to ten years or more andrequire the expenditure of substantial resources.  We may not be able to obtain the necessaryapprovals for clinical testing or for the marketing of products.  Continuing failure to commercializebiotechnology products may adversely affect our financial results and stockprice.

 

**OUR SUCCESS WILL DEPEND, IN PART,ON OUR ABILITY TO OBTAIN AND MAINTAIN PATENT PROTECTION FOR OUR PRODUCTS.**  We have several patents for tagatose andother products under development.  We maynot be able to obtain additional patents. Further, future patents may not be held valid if subsequentlychallenged.  Failure to obtain andmaintain patent protection for our biotechnology products may further delay oreliminate our ability to commercialize such products, which may adverselyaffect our financial results and stock price.

 

**WE HAVE SUSTAINED LOSSES IN THEPAST AND WE MAY SUSTAIN LOSSES IN THE FUTURE.**  We have incurred losses in prior years,including the last three (3) years. Our net losses for the years ended December31, 2005, December 31, 2004 and December 31, 2003 were $2.8 million, $2.8million and $2.3 million, respectively. Our net accumulated losses from the date of our organization throughDecember 31, 2005 are $15.2 million.  Wemay not return to profitable operations.

 

**WE MAY NOT BE ABLE TO OBTAINADDITIONAL FINANCING THAT WE WILL NEED. **During2005, our working capital decreased by $1.1 million, largely as a result of theincurred losses and continued investment in our business.  In recent years, we have funded ouroperations through private placements of our common stock and through theexercise of warrants issued in connection with such private placementtransactions.  We believe that we mayneed to raise additional funding to continue to finance our product developmentoperations.  We may also need to raiseadditional money to fund operations if the sale of tagatose as a food andbeverage product continues to be delayed or is not as successful as weanticipate.  We may not be able to obtainadditional financing on acceptable terms, or at all.  Failure to obtain required financing maycause us to curtail or cease our operations.

 

**WE MAY NOT BE ABLE TO RETAIN OURKEY EXECUTIVES AND PERSONNEL.** As a small company, our success depends on theservices of key employees in executive and other positions.  None of our key employees have employmentagreements.  Further, our Chief ScienceOfficer, who is principally responsible for 

 

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commercializing our biotechnology products, is 81 years of age.  The loss of the services of one or more ofsuch employees could have a material adverse effect on us.

 

**WE FACE INTENSE COMPETITION BYCOMPETITORS IN BOTH DIVISIONS.**  Our competitors in the information servicesbusiness are numerous.  Many of ourcompetitors have significantly greater financial, marketing and distributionresources than we do.  Our principalinformation services competitor, ReserveAmerica, is a division of Ticketmasterwhich is a subsidiary of IAC/InterActive Corp., a significantly larger publiccompany than Spherix.  Our competitorsmay succeed in developing or marketing technologies and biotechnology productsthat are more effective than ours. Alternative sweetener(s) may adversely affect sales of tagatose.  In the past year or two, the alternatesweetener Splenda has made substantial inroads into markets we expectedtagatose to capture.

 

**RISKS RELATED TO OWNERSHIP OF OURCOMMON STOCK**

 

**THE PRICE OF SPHERIX’S COMMONSTOCK HAS BEEN HIGHLY VOLATILE DUE TO SEVERAL FACTORS WHICH WILL CONTINUE TOEFFECT THE PRICE OF OUR STOCK.**  Our common stock has traded as low as $1.19and as high as $5.85 between January 3, 2005 and December 30, 2005. Some of thefactors leading to this volatility include:

 

•                  relatively smallamounts of our stock trading on any given day;

•                  fluctuations inour operating results;

•                  announcements oftechnological innovations or new products which we or our competitors make;

•                  developmentswith respect to patents or proprietary rights; and

•                  the status ofour licensee’s efforts to market tagatose.

 

**CORNELL CAPITAL PARTNERS WILL PAYLESS THAN THE MARKET PRICE AND WILL HAVE AN INCENTIVE TO SELL ITS SHARES, WHICHMAY CAUSE OUR STOCK PRICE TO DECLINE.**  Cornell Capital Partners will purchase sharesof our common stock pursuant to the Standby Equity Distribution Agreement(SEDA) at a purchase price that is less than the then-prevailing market priceof our common stock.  Cornell CapitalPartners will have an incentive to immediately sell any shares of our commonstock that it purchases pursuant to the SEDA to realize a gain on thedifference between the purchase price and the then-prevailing market price ofour common stock.  To the extent CornellCapital Partners sells its common stock, the common stock price may decrease.

 

**NEW SHAREHOLDERS WILL EXPERIENCESIGNIFICANT DILUTION FROM OUR SALE OF SHARES UNDER THE SEDA.**  The sale of shares pursuant to the SEDA willhave a dilutive impact on our stockholders. As a result, our net income per share could decrease in future periods,and the market price of our common stock could decline.  In addition, the lower our stock price, themore shares of common stock we will have to issue under the SEDA.  If our stock price is lower, then ourexisting stockholders would experience greater dilution.

 

**OUR COMMON STOCK WILL BE DELISTEDFROM NASDAQ NATIONAL MARKET SYSTEM IF WE FAIL TO COMPLY WITH CONTINUED LISTINGSTANDARDS.**  We werepreviously advised that we were in danger of our common stock being delistedfrom the NASDAQ National Market due to our stockholders’ equity falling belowthe $10 million minimum requirement.  AtDecember 31, 2005, the Company’s shareholder’s equity was $7,879,220, or$2,120,780 below the $10,000,000 required by NASDAQ; however, the Company hassubsequently raised, as of March 10, 2006, an additional $2.7 million throughthe SEDA and warrant transactions so as to bring the Company into compliancewith the NASDAQ equity requirement.  Ifat some point we are unable to meet the listing standards, we intend to applyto list our common stock on the NASDAQ SmallCap Market.

 

**DIVIDENDS ON OUR COMMON STOCK ARENOT LIKELY. **We intendto retain future earnings, if any, in order to provide funds for use in theoperation and expansion of our business and for further research anddevelopment.  Accordingly, we do notanticipate paying cash dividends on our common stock in the foreseeablefuture.  Investors must look solely toappreciation in the market price of the shares of our common stock to obtain areturn on their investment.

 

**BECAUSE OF THE RIGHTS AGREEMENTAND “ANTI-TAKEOVER” PROVISIONS IN OUR CERTIFICATE OF INCORPORATION AND BYLAWS,A THIRD PARTY MAY BE DISCOURAGED FROM MAKING A TAKEOVER OFFER WHICH COULD BEBENEFICIAL TO OUR STOCKHOLDERS.**  In 2001, we adopted a shareholder rightsplan.  The effect of this rights plan andof certain provisions of our Certificate of Incorporation, By-Laws, and theanti-takeover provisions of the Delaware General Corporation Law, could delayor

 

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prevent a third party from acquiring us or replacing members of ourboard of directors, even if the acquisition or the replacements would bebeneficial to our stockholders.  Thesefactors could also reduce the price that certain investors might be willing topay for shares of the common stock and result in the market price being lowerthan it would be without these provisions.

 

**INSIDERS OWN A SIGNIFICANTPORTION OF OUR COMMON STOCK, WHICH COULD LIMIT OUR STOCKHOLDERS’ ABILITY TOINFLUENCE THE OUTCOME OF KEY TRANSACTIONS**.  As of December 31, 2005, our officers anddirectors and their affiliates owned approximately 20% of the outstandingshares of our common stock.  As a result,our officers and directors are able to exert considerable influence over theoutcome of any matters submitted to a vote of the holders of our common stock,including the election of our Board of Directors.  The voting power of these stockholders couldprevent or frustrate attempts to effect a transaction that is in the bestinterests of the other stockholders and could also discourage others fromseeking to purchase our common stock, which might depress the price of ourcommon stock.

 

**WE EXPERIENCE QUARTERLYVARIATIONS IN OUR OPERATING RESULTS.**  We have experienced and expect to continue toexperience quarterly variations in revenues and operating income as a result ofmany factors, including the seasonality of our information services business,timing of customers’ budget processes and slowdowns or accelerations of work bycustomers.  General work economicconditions may result in customer deferral of projects or cancellation inplanned expenditures.  These factors mayadversely affect our financial results and our stock price.

 

**Item 2. PROPERTIES**

 

In November 1997, the Company signed a lease agreementeffective May 1, 1998, for 51,625 square feet of office, call center, researchlabs, and warehouse space in the same Beltsville, Maryland, facility previouslyoccupied, under the terms of a lease that expires on February 28, 2009.  This facility contains corporateadministration, human resources, accounting, sales and marketing, technicalservices and warehousing, for support of both InfoSpherix and BioSpherixDivisions, and through September 2005 contained call center operations forInfoSpherix.  In November 2003, theCompany signed a lease agreement for 31,526 square feet of office and callcenter space in Cumberland, Maryland. The lease expires on October 31, 2007. In 2004, as part of its acquisition of certain assets of Daksoft, Inc.’sreservation business, the Company signed an agreement to lease 8,280 squarefeet of call center space in Rapid City, South Dakota.  The current lease, if not further extended,expires on April 30, 2006.  In 2004, theCompany also signed an agreement to lease 5,000 square feet of office, researchlab and warehouse space for BioSpherix in Annapolis, Maryland.  The lease expires June 30, 2009.

 

Throughout 2005, the Beltsville and Annapolisfacilities had sufficient capacity.  TheCumberland and Rapid City facilities were operating at an estimated 75%-90%capacity during the peak months.

 

**Item 3. LEGAL PROCEEDINGS**

 

Information required by this Item 3 is included inNote 10 “Commitments and Contingencies” of the Notes to Financial Statements,included herein pursuant to Part II of this Form 10-K.

 

**Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

There were no matters submitted by the Company duringthe fourth quarter of 2005 to a vote of security holders through solicitationof proxies or otherwise.

 

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**PART II**

 

**Item 5.  MARKET FOR REGISTRANT’S COMMON EQUITY,RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.**

 

The Company’s common stock is traded in theover-the-counter market and is quoted in the NASDAQ National Market Systemunder the symbol SPEX.  No cash dividendshave been paid.  The Company’s loanagreement with its bank does not expressly restrict the payment of dividends;however, no such payments are anticipated in the near future.

 

As of March 10, 2006, the number of shareholders ofrecord of the Company’s common stock was approximately 7,000.  The following table states the high and lowsales prices of the Company’s common stock for each quarter during the two yearperiod ended December 31, 2005, based on the daily closing prices as reportedon the NASDAQ National Market System:

 

| ** **       | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------|------------|----------|------------|---------|------------|
| 1st Quarter 2005 |       | $        | 3.940      |    | $          | 2.540 |   |
| 2nd Quarter 2005 |       | $        | 3.029      |    | $          | 1.500 |   |
| 3rd Quarter 2005 |       | $        | 2.150      |    | $          | 1.370 |   |
| 4th Quarter 2005 |       | $        | 5.850      |    | $          | 1.190 |   |
|             |       |     |       |    |       |
| 1st Quarter 2004 |       | $        | 7.800      |    | $          | 5.910 |   |
| 2nd Quarter 2004 |       | $        | 7.740      |    | $          | 4.050 |   |
| 3rd Quarter 2004 |       | $        | 5.141      |    | $          | 2.680 |   |
| 4th Quarter 2004 |       | $        | 4.350      |    | $          | 2.600 |   |

 

The Company recognized that, as of June 30, 2005, itwas approximately $454,000 short of meeting NASDAQ’s National Market listingrequirement of maintaining a minimum of $10,000,000 in shareholders’equity.  NASDAQ gave the Company untilSeptember 1, 2005, to correct this situation, which the Company achievedthrough its third quarter results. However, in anticipation of incurring losses due to seasonalfluctuations in the InfoSpherix business segment that occurs in the first andfourth quarters of the year, the Company, on July 22, 2005, entered into aStandby Equity Distribution Agreement (“SEDA”) with Cornell Capital Partners,L.P. (“Cornell”).  Under the SEDA,Spherix can require Cornell to purchase up to $4,000,000 of the Company’scommon stock over a two-year period following the effective date, October 12,2005, of the registration covering the shares of our common stock to be sold toCornell.  The SEDA establishes what issometimes termed an “equity line of credit” or an “equity draw-down facility.”  The $4,000,000 facility may be drawn downupon by us in installments, the maximum amount of each of which is limited to$350,000.  For each share of common stockpurchased under the SEDA, Cornell will pay 95% of the lowest volume weightedaverage price (“VWAP”) of our shares during the five trading days following ourdraw down notice to Cornell.  The VWAPthat will be used in the calculation will be that reported by Bloomberg, LLC, athird-party reporting service.  Ingeneral, the VWAP represents the sum of the value of all the sales of ourcommon stock for a given day (the total shares sold in each trade times thesales price per share of the common stock for that trade), divided by the totalnumber of our shares sold on that day. We are also committed to pay to Cornell an amount equal to 5% of eachpurchase of our common stock made by Cornell under the SEDA.  Under the terms of the SEDA agreement, we arenot obligated to draw down on the SEDA facility, but once we satisfy normalconditions for this type of transaction, we have the right to require Cornellto purchase our common shares under the SEDA. In connection with the SEDA, we have issued to Cornell 95,000 shares ofour common stock and paid a due diligence fee of $5,000.  We also paid Yorkville Advisors Management,LLC, the investment manager for Cornell, a structuring fee of $15,000, and oneach sale under the SEDA we will pay an additional structuring fee of$500.  Newbridge Securities Corporationacted as our placement agent for the SEDA, and we paid that firm a fee of 5,000shares of our common stock as compensation. We also granted Newbridge Securities Corporation piggy-back registrationrights covering these shares. Registration of our common shares allocated to this facility wascompleted in October 2005.  During theterm of the SEDA, our Officers and Directors have agreed not to sell any oftheir shares of our common stock, except to the extent permitted under Rule144.  The number of shares of our commonstock issuable to Cornell under the SEDA is subject to a 9.99% cap on thebeneficial ownership that Cornell and its affiliates may have at the time ofeach sale (beneficial ownership is to be calculated in accordance with Section13(d) of the Exchange Act).  Further, wemay not issue more than 19.99% of our currently outstanding shares under theSEDA unless shareholder approval is received. In 2005, the Company sold

 

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310,076 shares under the SEDA agreement for total proceeds of$376,500.  Subsequent to December 31,2005, the Company has sold an additional 624,365 shares under the SEDA for anadditional $1.5 million in proceeds.

 

On February 18, 2004, warrants for 500,000 shares ofCommon Stock were exercised at $6.91 per share, compared to the then currentmarket price of $6.76 per share, by an institutional investor, and theexpiration date of the remaining 585,973 warrants was extended until February25, 2008, at an exercise price of $7.00 per share of common stock.  The remaining warrants were assigned andtransferred to another institutional investor in 2004.  On March 9, 2006, in exchange for the Company’sagreement to reduce the exercise price to $2.04 per share, the Investor agreedto exercise the warrants for the full 585,973 shares for total proceeds ofapproximately $1.2 million.  Inconnection with these warrants, the Investor agreed that it would not exerciseany of the warrants to the extent that it would acquire shares of Common Stockexceeding 9.9% of the outstanding Common Stock, nor would it knowingly sellshares to anyone to the extent that their holdings in the Company would exceed4.9% of the outstanding Common Stock. The warrants and shares of Common Stock were issued in transactionsexempt from Registration pursuant to Section 4(2) of the Securities Act.  The Company has registered the sharesissuable upon exercise of the warrants for resale by the institutionalInvestor.

 

At December 31, 2005, the Company’s shareholder’sequity was $7,879,220, or $2,120,780 below the $10,000,000 required by NASDAQ;however, as noted above, the Company has subsequently raised an additional $2.7million through the SEDA and warrant transactions so as to bring the Companyinto compliance with the NASDAQ equity requirement.

 

Information concerning the Company’s equitycompensation plans is incorporated by reference from the Proxy Statement forthe Annual Meeting of Stockholders for the fiscal year ended December 31, 2005,which will be filed with the Securities and Exchange Commission not later than120 days after the end of the 2005 fiscal year.

 

The Company has a share repurchase program in placethat initially authorized the purchase of up to $1,000,000 of the Company’sshares in the open market.  To date, only34,750 shares aggregating $160,000 of the Company’s shares have beenrepurchased.  There was no repurchaseactivity during 2005.

 

**Item 6.    SELECTEDFINANCIAL DATA**

 
| ** **                                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003**   | ** ** | **2002** | ** ** | **2001** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|------------|------------|----------|------------|----------|------------|
|                                      |       |     |       |     |       |       |       |     |       |     |       |
| Revenue                                   |       | $        | 23,045,657 |     | $          | 22,348,418 |       | $        | 18,086,711 |     | $          | 15,131,855 |   | $ | 19,937,461 |   |
|                                      |       |     |       |     |       |       |       |     |       |     |       |
| Net (loss)  income                        |       | $        | (2,848,748 | )        | $          | (2,822,046 | )          | $        | (2,256,770 | )        | $          | (2,921,926 | ) | $ | 567,823 |   |
|                                      |       |     |       |     |       |       |       |     |       |     |       |
| Net (loss)  income per share, diluted     |       | $        | (0.24      | )        | $          | (0.24      | )          | $        | (0.20      | )        | $          | (0.26 | ) | $ | 0.05 |   |
|                                      |       |     |       |     |       |       |       |     |       |     |       |
| Total assets                              |       | $        | 13,118,263 |     | $          | 15,243,949 |       | $        | 14,167,257 |     | $          | 15,453,140 |   | $ | 13,240,928 |   |
|                                      |       |     |       |     |       |       |       |     |       |     |       |
| Long-term debt  obligations               |       | $        | 27,455     |     | $          | 45,580     |       | $        | 63,310     |     | $          | 90,530 |   | $ | 104,190 |   |
|                                      |       |     |       |     |       |       |       |     |       |     |       |
| Cash dividends  declared per common share |       | $        | —     |     | $          | —     |       | $        | —     |     | $          | — |   | $ | — |   |
|                                      |       |     |       |     |       |       |       |     |       |     |       |
| Stockholders  equity                      |       | $        | 7,879,220  |     | $          | 10,367,690 |       | $        | 9,489,236  |     | $          | 11,261,458 |   | $ | 9,522,930 |   |
|                                      |       |     |       |     |       |       |       |     |       |     |       |
| Working capital                           |       | $        | 3,139,711  |     | $          | 4,215,573  |       | $        | 5,043,672  |     | $          | 8,787,502 |   | $ | 7,139,196 |   |

 

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** **

**Item 7.****           MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Overview**

 

The Companyoperates via two principal segments, BioSpherix and InfoSpherix.  BioSpherix develops proprietary products forcommercial applications.  InfoSpherixprovides contact center information and reservations services for government andindustry.

 

InfoSpherixgenerates substantially all of the Company’s revenue.  In 2005, 2004, and 2003, InfoSpherixgenerated substantially all of its revenue from government customers.  The Company has developed a niche inproviding campground and other reservation services via its ReserveWorldbusiness line, which accounted for approximately 60%, 58%, and 49% of theCompany’s revenue in 2005, 2004, and 2003. During 2005, the company won reservation contracts from Orange County(California), the State of Pennsylvania, and the recompete of the State ofMichigan contract.

 

In July 2005, Spherix filed an official protest of the U.S. Department ofAgriculture’s award of the National Recreation Reservation System (“NRRS”)contract to ReserveAmerica, a TicketMaster subsidiary.  The NRRS will provide reservation servicesfor all Federal recreation facilities, including the National Park sitescurrently serviced by Spherix under its ongoing National Park ReservationService (“NPRS”) contract with the Department of Interior.  On October 20, 2005, the GovernmentAccountability Office (“GAO”) sustained Spherix’s challenge to the USDA ForestService award and recommended that the Department of Agriculture reopen thecompetition and make a new award decision. This is the second time that GAO has found the Forest Service’s attemptto award the NRRS contract to ReserveAmerica to be flawed.  The Department of Agriculture subsequently decided notto follow GAO’s decision and is seeking to proceed with the award of the NRRScontract to ReserveAmerica.  The Department of Agriculture has agreed notto proceed while the Court of Federal Claims hears Spherix’s appeal.  Meanwhile, the Company’s NPRS contract hasbeen formally extended through September 30, 2006.  The Company has operated the NPRS contractfor eight years; revenue recognized was $4.0 million, $3.9 million and $4.2million for the years ended December 31, 2005, 2004 and 2003, respectively, or17%, 17% and 23% of total revenue for each year.

 

BioSpherix engagesin product development, notably tagatose. The exclusive rights to manufacture tagatose have been licensed to aforeign entity along with the exclusive rights to sell tagatose for food andbeverage uses.  Tagatose was firstintroduced in commercial products in 2003. Beginning July 2003, the Company has earned approximately $5,000,$4,000, and $3,000 in royalty revenue for the years 2005, 2004, and 2003,respectively, which have been credited against Arla’s patent maintenancecosts.  The royalties rates payable underthe licensing agreement with Arla vary based on a complex matrix that isdependent on such factors as quantity, price and intended use.  The royalty rates under the originalagreement with Arla contained rates payable during the patent term (referred tohereafter as “high-end royalties”) and lower rates payable after the patentterm that continue for another five years after the last to expirepatents.  The precise royalty rates havenot been disclosed as they are proprietary and confidential.  As part of the fall 2003 settlement of thearbitration proceeding with its licensee, the parties agreed to extend the datethrough which the Company shall be entitled to high-end royalties for tagatosesales until at least March 25, 2011, and until August 25, 2016, subject tocertain conditions.  Future royaltieswill depend on increased sales of this product by the licensee, which areoutside of the control of the Company. Development of sales for non-food uses of tagatose (“Naturlose”)retained by the Company may be further limited by the lack of adequate andcontinuing supply from Arla.

 

**Results of Operations****3⁄42005Compared with 2004**

 

In 2005, the Company reported a net loss of $2.8million ($0.24 per diluted share) on revenues of $23.0 million for the year, comparedwith a net loss of $2.8 million ($0.24 per diluted share) on revenues of $22.3million in 2004.

 

**Revenue**

 

Revenue between yearsincreased $697,000 (3%).  Revenue fromthe InfoSpherix Division increased $802,000 (4%) and the BioSpherix Division’srevenue decreased by $104,000 (82%).  Theincreased revenue from the InfoSpherix Division was less than anticipated as aresult of an unexpected temporary funding shortage on one of our major Federalcontracts that lasted for a period of four months until the Federal Government’sfiscal year ended September 2005, and from hurricanes and the rise in gasolineprices that impacted reservation sales on our park reservation contracts duringthe third quarter of 2005.  The Divisionalso saw a decrease in revenue of approximately 

 

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$2.9 million between years as a result of the decreasein revenue under the new State of Maryland contract that started November 2004and the IRS contract that ended in April 2004. However, these set-backs were more than off-set by the division’scontinued overall growth from the award of new contracts.  The revenue growth was primarily driven bycontracts such as the Federal Retirement Thrift Investment Board that startedin May 2004, the Georgia contract that started in March 2004, and fromincreases under existing contracts with the state of Ohio and the Office ofPersonnel Management.  The decrease inBioSpherix revenue was related to the discontinuance of the sale of FlyCrackerin 2004.

 

**Direct Contract and Operating Costs**

 

Direct contract and operating costs increased $566,000(3%) between years.  This increaseincluded the recognition of a forward loss provision of $135,000 on one of theCompany’s contracts.  The increase isalso attributed to approximately $100,000 in start-up costs related to the newState of Pennsylvania contract that began in January 2006.  South Dakota operations operated at abreak-even for 2005, up $100,000 from 2004.

 

**Selling, Generaland Administrative**

** **

Selling, general and administrative expense (“S,G&A”)for 2005 decreased by $216,000 (4%) from that of the prior year.  In 2005, the Company cut its consulting costsby approximately $265,000, most of which were related to marketing.  The Company plans to increase its marketingstaff in 2006 with the addition of two to three more sales persons for thepurpose of pursuing government contact center opportunities.

 

**Research and Development**

 

Research and development costs increased $92,000between years.  In 2004, the BioSpherixDivision began a program of outsourcing development of its patented drug usesof Naturlose.  A research project wasfunded at the Albert Einstein College of Medicine to follow up on thatinstitution’s discovery that Naturlose may lengthen shelf life of stored bloodfractions and medicinal proteins.  In2005, the Company contracted with the University of Maryland School ofDentistry to conduct human clinical trials on the oral anti-plaque efficacy ofNaturlose.  The study demonstratedtagatose to be much more resistant to oral bacteria, which form plaque, than issorbitol, a sugar substitute that is widely used in oral care products.  Contrary to earlier laboratory findings bySpherix, however, a human study at the University of Maryland School ofDentistry did not show anti-plaque activity. Conditions in the mouth may have prevented the desired effect, accordingto the University researchers.  Spherixis currently following up on corrective suggestions made by the University, andmay conduct new human trials if results warrant.

 

**Depreciation and Amortization**

 

Depreciation and amortization costs increased $297,000(13%) between years as a result of investments of approximately $3 million inproperty and equipment added in the prior year, compared to investments ofapproximately $1.5 million in 2005.  Thefixed asset investment in 2004 included approximately $900,000 used to upgradecomputer software and hardware at our Cumberland call center facility and approximately$1 million in intangibles related to the March 1, 2004, purchase from DaksoftInc.

 

**InfoSpherix Operations**

** **

The following schedule summarizes the breakdown ofInfoSpherix revenue between government and commercial contracts (in $000s):

 

| ** ** | ** ** | **For the Year Ended December 31** | ** ** |
|------------|------------|-------------------------------------------------------------|------------|
| ** ** | ** ** | **2005**                                                    | ** ** | **2004** | ** ** |
|       |       |                                                        |       |   |   |
| Government |       | $                                                           | 22,935     |   | $ | 22,054 |   |
| Commercial |       | 88                                                          |       | 167 |   |
|       |       | $                                                           | 23,023     |   | $ | 22,221 |   |

 

As noted above, InfoSpherix revenue for 2005 increased$802,000 (4%) over that of the prior year. The increased revenue from the InfoSpherix Division was less thananticipated as a result of an unexpected temporary funding shortage on one ofour major Federal contracts that lasted for a period of four months until theFederal Government’s fiscal year ended September 2005, and from hurricanes andthe rise in gasoline prices that impacted

 

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reservation sales on our park reservation contracts during the thirdquarter of 2005.  The Division also saw adecrease in revenue of approximately $2.9 million between years from thedecrease in revenue under the new State of Maryland contract that startedNovember 2004, and the IRS contract that ended in April 2004.  However, these set-backs were more thanoff-set by the division’s continued overall growth.  This revenue growth was primarily driven bycontracts such as the Federal Retirement Thrift Investment Board that startedin May 2004, Georgia that started in March 2004, and from increases underexisting contracts such as Ohio and the Office of Personnel Management.  The fourth quarter in particular saw asignificant improvement over the prior year, with an increase in revenue of$399,000 as a result of increased revenue in the Federal Retirement ThriftInvestment Board contract and a general growth across the board on our existingreservation contracts.  This combinedwith a reduction in direct costs of $139,000 between the fourth quarter of 2005and 2004, contributed to the $472,000 improvement in operations betweenquarters.

 

In 2005, Spherix won park reservation contracts forOrange County, California, the State of Pennsylvania, and the State ofMichigan.  The Orange County contractconsists of three base years and is valued at less than half a million.  The State of Pennsylvania contract is afive-year contract, consisting of one base year and four option years, valuedat approximately $8 million.  The Stateof Michigan contract is a continuation of our current contract with theState.  The new contract is for fiveyears, and consists of three base years plus two option years, valued atapproximately $14 million.

 

In March 2004, the Company won a one-year,multi-million dollar Federal Retirement Thrift Investment Board (“FRTIB”)contract with four option years.  Also,on March 1, 2004, the Company purchased certain assets of Daksoft, Inc. relatedto its reservation business, which operates under the name “ReserveIt.”  The purchase included the acquisition of sixadditional government reservation contracts and the intellectual propertyrights to the name “ReserveIt,” as well as other assets of the division.  Spherix purchased the assets for $700,000plus 43,029 shares of the Company’s common stock, then trading at $6.699 pershare.

 

Park reservation contracts now make up approximately60% of the Company’s revenue and the Company is now one of only two majorsuppliers of campground reservation services in the U.S.

 

In July 2005, Spherix filed an official protest of theU.S. Department of Agriculture’s award of the National Recreation ReservationSystem (“NRRS”) contract to ReserveAmerica, a TicketMaster subsidiary.  The NRRS will provide reservation servicesfor all Federal recreation facilities, including the National Park sitescurrently serviced by Spherix under its ongoing National Park ReservationService (“NPRS”) contract with the Department of Interior.  On October 20, 2005, the GovernmentAccountability Office (“GAO”) sustained Spherix’s challenge to the USDA ForestService award and recommended that the Department of Agriculture reopen thecompetition and make a new award decision. This is the second time that GAO has found the Forest Service’s attemptto award the NRRS contract to ReserveAmerica to be flawed.  The Department of Agriculture subsequentlydecided not to follow GAO’s decision and is seeking to proceed with the awardof the NRRS contract to ReserveAmerica.  The Department of Agriculture has agreed notto proceed while the Court of Federal Claims hears Spherix’s appeal.  Meanwhile, the Company’s NPRS contracthas been formally extended through September 30, 2006.  The Company has operated the NPRS contractfor eight years; revenue recognized was $4.0 million, $3.9 million and $4.2million for the years ended December 31, 2005, 2004 and 2003, respectively, or17%, 17% and 23% of total revenue for each year.

 

In 2004, the Company won the re-procurement of theMaryland information center contracts, which the company has operated since1998.  The new contracts are for threeyears plus two additional option years. The combined Maryland contracts contributed 12% to the Company’srevenues in 2005 and 22% in 2004.  Thenew contract started on November 1, 2004, and is subject to a more competitivepricing structure, which was necessary to win the recompete.  While Spherix was not the lowest bidder, theCompany’s higher technical scoring resulted in the Company achieving an overallhigher score than the competition. Management is uncertain as to the long-term financial impact the pricereduction will have over the course of the contract and believes that the lowerrates may encourage the state to outsource more of its call center needs toSpherix under this contract.  Theprevious contract initially operated at a loss during its first year and hadmatured to a respectable contribution margin by the time the contract ended in late2004.  This increase was gained throughthe continued outsourcing of more of the state’s call center needs to Spherixunder the contract.  The new contract,which was bid at a lower contribution margin, is the principal cause for thedecrease in operating income between years. The Company hopes to increase the contribution margin over the next fouryears through continued expansion of services to the state and through costreductions and other efficiency gains. The Company is working to increase the amount of business performedunder this contract as well as other contracts. Starting October 1, 2005, as part of the cost reduction efforts, theMaryland contract began operating exclusively out of

 

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the Company’s Cumberland office instead of the Beltsville office, andits margins for the fourth quarter were now consistent with our othercontracts.

 

Revenue from commercial contracts decreased betweenyears.  Commercial contracts aretypically for shorter terms than government contracts and that can result insubstantial variations in commercial revenues. Commercial contracts are being pursued by the Company, but the Company’srecent history has been that contracts have been received on a sporadic basis.

 

The Company’s business development group is targetingthe government contact center and technology markets, and the ReserveWorldproduct and services market for continued growth.  Currently, the Company is bidding on severalcontracts and expects to bid on more contracts throughout the coming year,although no assurance can be given at this time that these efforts will resultin new business for the Company.

 

**BioSpherix Operations**

** **

The $104,000 decrease inthe BioSpherix revenue from $127,000 to $23,000 between years was related tothe discontinuance of the sale of FlyCracker in 2004.

 

BioSpherix isentitled to high end royalties from Arla’s sales of tagatose until at least2011, and, depending upon certain conditions, until 2016.  The payments are net of accumulated andcontinuing foreign patent maintenance costs. Accumulated patent maintenance costs were approximately $195,000 atyear-end.

 

We have receivedminimal royalties from Arla in 2005, 2004, and 2003.  While tagatose has been introduced intoseveral food and beverage products, Arla currently has insufficient salesvolume and manufacturing capacity to produce tagatose at the rate necessary togenerate meaningful royalties.  Atpresent, Arla believes it has produced a sufficient backlog of inventory tosatisfy its needs for the foreseeable future based on current demand, andaccordingly has stopped production at its plant until there is a sufficientincrease in the demand for tagatose. Arla is currently having discussions with potential users and Arla hasstated that any decision to construct a larger tagatose plant will depend onthe ability to create greater market interest in tagatose.  Spherix is also pursing the possibility ofother production options.

 

Commercialization of Naturlose will focus on its useas a sweetener or flavor enhancer in toothpaste, mouthwash, over-the-counterdrugs, pharmaceuticals and other products to which the Company retains rights.

 

**Sales Backlog**

 

The Company’s funded and unfunded backlog as ofDecember 31, 2005, was $72 million, compared to $61 million as of December 31,2004.  In 2005, the Company won five yearcontracts with the States of Pennsylvania and Michigan.  In addition, the NPRS contract has beenextended through September 30, 2006.

 

**Results of Operations****3⁄42004Compared with 2003**

 

In 2004, the Company reported a net loss of $2.8million ($0.24 per diluted share) on sales of $22.3 million for the year,compared with a net loss of $2.3 million ($0.20 per diluted share) on sales of$18.1 million in 2003.

 

**Revenue**

 

Revenue between the years2004 and 2003 increased $4.3 million (24%). Revenue from the InfoSpherix Division increased $5.2 million, and theBioSpherix Division’s revenue decreased approximately $900,000.  The increased revenue from the InfoSpherixDivision was from the addition of five new government contracts that theCompany won late in 2003 and early 2004, and from the purchase of six otherstate and county government reservation contracts in March 2004.  The decrease in the BioSpherix revenue wasthe result of $1 million that was recognized in 2003 as part of the Arbitrationsettlement with Arla Foods (see “BioSpherix Operations” below).

 

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** **

**Direct Contract and Operating Costs**

 

Direct contract and operating costs increased $5.1million (42%) between years as a result of the new contracts noted above andthe increase in overhead costs related to the larger facility in Cumberland,Maryland, the addition of a Rapid City, South Dakota contact center, and the newBioSpherix facility in Annapolis, Maryland.

 

Additional overhead costs of approximately $600,000related to operating a larger facility in Cumberland was offset by the benefitgained from the new FRTIB, Ohio and Georgia contracts in 2004.

 

For 2004, the South Dakota operation’s direct contractand operating costs of $1.5 million (inclusive of $116,000 in amortizationexpense related to the purchase of the six contracts from Daksoft) exceededtheir revenues by approximately $100,000.

 

**Selling, Generaland Administrative**

** **

Selling, general and administrative expense (“S,G&A”)for 2004 decreased by $885,000 (14%) from that of the prior year.  In 2004, the Company increased itsInfoSpherix marketing activity by approximately $500,000, with a strong focuson telecommunications business.  Theincrease in marketing costs, however, was more than offset by the decrease inlegal expenses between years.  Legalexpenses accounted for $1.5 million of the decrease between years, from $1.6million in 2003 to approximately $110,000 in 2004.  The 2004 legal costs were net of a $250,000credit related to legal fees incurred in 2003. Included in the 2003 legal costs were $981,000 related to the Arla arbitration,$331,000 related to the NPS re-procurement cancellation, and $127,000 relatedto other legal matters.

 

**Research and Development**

 

Research and development costs decreased $195,000(50%) between years.  The reduction isprimarily related to independent studies that we conducted in 2003 and areduction in overhead costs attributed to R&D activities.

 

**Net Loss**

 

The Company incurred a $2.8 million loss in 2004compared to a $2.3 million loss in 2003. The loss incurred by InfoSpherix increased by approximately $1.3 millionin 2004 due to the relocation of the Cumberland operations to a larger facilityand to the addition of a Rapid City, South Dakota, contact center.  The loss incurred by BioSpherix decreased byapproximately $700,000 between years due to the settlement of the Arla arbitrationin late 2003, a $250,000 credit in 2004 against legal fees incurred in 2003,and the reduction in research and development activity.

 

**InfoSpherix Operations**

** **

The following schedule summarizes the breakdown ofInfoSpherix revenue between government and commercial contracts (in $000s):

 

| ** ** | ** ** | **For the Year Ended December 31** | ** ** |
|------------|------------|-------------------------------------------------------------|------------|
| ** ** | ** ** | **2004**                                                    | ** ** | **2003** | ** ** |
|       |       |                                                        |       |   |   |
| Government |       | $                                                           | 22,054     |   | $ | 16,247 |   |
| Commercial |       | 167                                                         |       | 807 |   |
|       |       | $                                                           | 22,221     |   | $ | 17,054 |   |

 

InfoSpherix revenue for 2004 increased $5.2 million(30%) over that of the prior year as a result of the addition of five newgovernment contracts that the Company won in late 2003 and early 2004, and thepurchase of six other government reservation contracts.

 

In March 2004, the Company also won a one-year,multi-million dollar Federal Retirement Thrift Investment Board (“FRTIB”)contract with four option years.  Inaddition, in early 2004, the Company acquired six additional governmentreservation contracts.  In thatacquisition, the Company purchased certain assets of Daksoft, Inc. related toits reservation business, which operates under the name “ReserveIt.”  The purchase includes the intellectualproperty rights to the name “ReserveIt” and the related contracts, as well asother assets of the division.  Thecompany also won reservation contracts for the states of Georgia and NewMexico.

 

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Revenue from commercial contracts decreased betweenyears.  Commercial contracts aretypically for shorter terms than government contracts and that can result insubstantial variations in commercial revenues. Commercial contracts are being pursued by the Company, but the Company’srecent history has been that contracts have been received on a sporadic basis.

 

**BioSpherix Operations**

** **

The arbitrationaction initiated in 2002 against Arla, the Company’s tagatose licensee for foodand beverage uses, was settled in November 2003.  The arbitration was initiated as a result ofthe delay in tagatose commercialization by Arla Foods.  As a part of the settlement, Arla Foodsagreed that $1 million previously paid to the Company would no longer berequired to offset future royalties.  Asa result, $1 million, previously classified as deferred revenue, was recognizedas revenue in 2003 and is directly related to the decrease in revenue between2003 and 2004.

 

Sales of FlyCracker began in 2000 and while feedbackfrom users remained positive, sales remained below expectations and wereinsufficient to cover the related operating and marketing efforts of theCompany.  As a result the Company decidedto scale back active efforts to sell and promote the product in 2003, and inJanuary of 2004 the Company discontinued its remaining sales activities.

 

In July 2004, the BioSpherix Division relocated to anew laboratory and offices in 5,000 square feet of rented space in Annapolis,Maryland.

 

# ***Critical Accounting Policies***

# ** **

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and the disclosure of the contingent assetsand liabilities at the date of the financial statements and revenue andexpenses for the period reported. Estimates are based upon historical experience and various otherassumptions that are believed to be reasonable under the circumstances.  These estimates are evaluated periodicallyand form the basis for making judgments regarding the carrying values of assetsand liabilities and the reported amount of revenue and expenses.  Actual results may differ substantially fromthese estimates.

 

Spherix’s critical accounting policies are those itbelieves are the most important in determining its financial condition andresults, and require significant subjective judgment by management as a resultof inherent uncertainties.  A summary ofthe Company’s significant accounting policies is set out in the notes to theconsolidated financial statements.  Suchpolicies are discussed below.

 

# ***Accounting for Taxes and Valuation Allowances***

# ** **

We currently have significant deferred tax assets,resulting from net operating loss carry forwards.  These deferred tax assets may reduce taxableincome in future periods.  Based on theCompany’s losses and its accumulated deficit, the Company has provided a fullvaluation allowance against the net deferred tax asset.  A valuation allowance is required when it ismore likely than not that all or a portion of a deferred tax asset will not berealized.  Cumulative losses weighheavily in the overall assessment of valuation allowances.

 

We expect to continue to maintain a full valuationallowance on future tax benefits until an appropriate level of profitability issustained, or we are able to develop tax strategies that would enable us toconclude that it is more likely than not that a portion of our deferred taxassets would be realizable.

 

# ***Long-Lived Assets and Other Intangible Assets***

# ** **

Long-lived assets and other intangible assets arereviewed for impairment whenever the carrying amount of the asset may not berecoverable. An impairment loss is recognized when the carrying amount of along-lived asset exceeds the sum of the undiscounted cash flows expected toresult from the asset’s use and eventual disposition.

 

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*** ***

***Allowances forDoubtful Accounts***

 

We are required to estimate the collectibility of ourtrade receivables.  A considerable amountof judgment is required in assessing the realization of these receivables,including the current creditworthiness of each customer and the related agingof past due balances. We evaluate specific accounts when we become aware ofinformation indicating that a customer may not be able to meet its financialobligations.

 

**NewAccounting Pronouncements**

** **

*Share-Based Payment*

 

In December 2004, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards 123-revised2004 (“SFAS 123R”), “Share-Based Payment” which replaces Statement of FinancialAccounting Standards No. 123 (“SFAS 123”), Accounting for Stock-BasedCompensation” and supersedes APB Opinion No. 25 (“APB 25”), “Accounting forStock Issued to Employees and Related Interpretations.” SFAS 123R requires themeasurement of all employee share-based payments to employees, including grantsof employee stock options, using a fair-value-based method and the recording ofsuch expense in our consolidated statements of operations. In April 2005, theSEC announced that the accounting provisions of SFAS 123R are to be applied in the first quarter of the fiscal year beginningafter June 15, 2005. As a result, we are now required to adopt SFAS 123R in thefirst quarter of fiscal 2006 and will recognize stock-based compensationexpense using the modified prospective method. The pro forma disclosurespreviously permitted under SFAS 123 no longer will be an alternative tofinancial statement recognition. See “Accounting for Stock-Based Compensation”above for the pro forma net loss and net loss per share amounts as if we hadused a fair-value-based method similar to the methods required under SFAS 123Rto measure compensation expense for employee stock incentive awards. We areevaluating the requirements under SFAS 123R and expect the adoption could havea significant impact on our consolidated statements of operations and net lossper share related to any future stock option compensation grants.

 

*Accounting changes and error corrections*

 

In May 2005, the Financial Accounting Standards Boardissued Statement 154, Accounting Changes and Error Corrections-a replacement ofAPB Opinion No. 20 and FASB Statement No. 3. Statement 154 requires that all voluntary changes in accountingprinciples and changes required by a new accounting pronouncement that do notinclude specific transition provisions be applied retrospectively to priorperiods’ financial statements, unless it is impracticable to do so.  This Statement is effective for accountingchanges and corrections of errors made in fiscal years beginning after December15, 2005.  The Company does not believethat the adoption of Statement 154 will have a significant effect on itsfinancial statements.

 

**Liquidity and Capital Resources**

 

Working capital as of December 31, 2005, was $3.1million, which represents a $1.1 million decrease from working capital of $4.2million at December 31, 2004.  Thedecrease in working capital is related to operating losses and continuedinvestment in our business.

 

Spherix renewed its Line-of-Credit (the “Agreement”)with Bank of America (the “Bank”) on December 29, 2005, which provides forborrowing up to $2 million.  Outstandingborrowings under the Agreement aggregated $1.4 million at December 31, 2005,and are collateralized by a restricted $2.0 million certificate of deposit.  The interest rate under the agreement isbased on the LIBOR rate, which was 6.29% at year-end.  The total amount available for furtheradvance to the Company was $551,000 under the Agreement at December 31,2005.  As a result of the creation ofInfoSpherix as a wholly-owned subsidiary, management no longer considersmaintaining a bank line of credit for the parent company, Spherix, necessary,and, therefore has decided not to renew the above Agreement when it matures onMarch 31, 2006.  On March 31, 2006, theCompany entered into a new agreement with the Bank to establish a bankLine-of-Credit (“New Agreement”) for the subsidiary, InfoSpherixIncorporated.  Management considers thecreation of this credit facility for the subsidiary necessary to ensure timelycash flow for the subsidiary’s operations. The New Agreement provides for borrowings up to $1.5 million, iscollateralized by the subsidiary’s assets, contains covenants on tangible networth and funded debt to EBITDA ratios, and matures on March 31, 2007.  Such covenants could have a limiting effecton the amount of cash that the subsidiary can transfer to Spherix.  The interest rate under the New Agreement isbased on the LIBOR rate plus 300 basis points.

 

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InfoSpherix Incorporated intends to finance itsfurniture and equipment needs through financing or leasing arrangements wherepracticable, including those for a new call center facility in Indiana as wellas those related to the start-up costs of new contracts.

 

Cash flow for the year ended December 31, 2005,reflects a net cash outflow of $808,000, consisting of $526,000 used inoperating activities, $659,000 used in investing activities, and $377,000provided by financing activities.  The$140,000 increase in cash used in operating activities in 2005 from that of theprior year was primarily due to funding issues on one of our contracts and thelower margins on the Maryland contract during the first nine months of theyear.  The $3.3 million decrease ininvesting activities is directly related to the 2004 purchase of certain assetsof Daksoft, Inc., and to the 2004 property and equipment and leaseholdimprovements related to the new Cumberland and Annapolis leases.  The 2004 investing activities were primarilyfinanced through the proceeds of $3.5 million from the February 18, 2004exercise of warrants by an institutional investor.

 

**Trendsand Outlooks**

 

The InfoSpherix business continues to enjoy manysuccesses, including:

 

•                  On October 20,2005, the GAO sustained our challenge to the USDA Forest Service award of theNRRS contract to a competitor.  TheDepartment of Agriculture has subsequently decided not to follow GAO’s decisionand is seeking to go ahead and award the NRRS contract to ReserveAmerica.  Spherix has filed an appeal of this actionwith the Court of Federal Claims.  Thisaction has resulted in an extension of our current National Park ServiceReservation contract through September 30, 2006.

 

•                  In January 2006,the InfoSpherix business started operating as a wholly-owned subsidiary ofSpherix Incorporated under the name “InfoSpherix Incorporated”.

 

•                  In 2005, theCompany won a new five-year contract with the State of Pennsylvania for parkreservations.  Revenue on the contractwill begin to be realized starting in 2006.

 

•                  The Companyrecently won the State of Michigan park reservation contract for another fiveyears.  Under the new contract, the callcenter operations are required to be located in the State of Michigan;accordingly, Spherix has partnered with an in-state subcontractor.  Spherix has noticed an increasing trend amongstates to include such requirements in their contracts.

 

•                  The InfoSpherixDivision was successful in increasing its sales backlog between December 31,2004 and December 31, 2005, to a record level of $72 million.  The extension of the National Park ServiceReservation contract through September 30, 2006 accounted for $3.8 million ofthe increase in the sales backlog; the rest of the increase was from the awardof new government contracts, including the renewal of the Michigan reservationcontract and the contracts acquired from Daksoft, Inc.

 

•                  Since 1998,InfoSpherix has grown its government park reservation business from onecontract to seventeen government reservation contracts, and six new state reservationcontracts will be available for InfoSpherix to bid on in 2006.  InfoSpherix’s reservation business accountedfor over 60% of the Company’s revenue in 2005. InfoSpherix is now one of only two major suppliers of Governmentcampground reservation services in the U.S.

 

•                  In October 2005,the operations of the State of Maryland contract were moved from the Beltsvillefacility to the Cumberland facility, where the Company will be able to operatethe contract more cost efficiently.

 

•                  On February 8,2006, the Company signed an agreement to lease 12,805 square feet of facilityspace in Indiana effective March 15, 2006, plus an additional 5,796 square feetstarting January 1, 2007, for use as a call center to replace the currentoperation in South Dakota and to provide the InfoSpherix Division withadditional space for growth.  The currentfacility lease in South Dakota ends April 30, 2006; however, the Company isnegotiating to extend this through December 31, 2006, so as to avoid atransition during the Company’s peak reservation months.  Some of the furniture and equipment for theIndiana facility will be relocated from the Beltsville call center and the restwill be purchased or leased.

 

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•                  The newly-formedInfoSpherix Incorporated subsidiary has entered into its own bank line ofcredit.  The line contains covenants ontangible net worth and funded debt to EBITDA ratios.  Such covenants could have a limiting effecton the amount of cash that can be transferred to Spherix.  The InfoSpherix subsidiary will also bepursuing financing arrangement for purchases of property and equipment.

 

Our BioSpherix business continues in its development stage:

 

•                  Our entitlementto royalties for tagatose food and beverage use is totally dependent on thesuccess of Arla, our licensee.  Atpresent, Arla believes it has produced a sufficient backlog of inventory tosatisfy its needs for the foreseeable future based on current demand, and accordinglyhas stopped production at its pilot plant until there is a sufficient increasein the demand for tagatose.  Arlacontinues to state that it must see greater demand for the product before itcould commit to building a larger manufacturing facility.  To date, Arla has not decided to build alarger manufacturing facility, which is key to any significant royaltiespayable to us.  The construction of sucha plant is estimated to take 18 to 24 months, during which time royalties fromArla will remain limited.  Spherix isalso pursuing the possibility of other production options.

 

•                  BioSpherix haspurchased limited quantities of tagatose from Arla for use as Naturlose inselling for non-food uses by such product manufacturers, including uses intoothpaste, mouthwash, cough syrup, and a fiber digestive aid, for whichSpherix has developed prototypes.  We areexploring licensing opportunities for BioSpherix prototypes with some oral caremanufacturers.

 

•                  The BioSpherixDivision’s emphasis is being directed toward clinical trials to promote the non-foodbenefits of Naturlose, with the focus on Naturlose’s potential use fordiabetics, providing increased shelf life for blood, blood products and othermedicinal proteins, and for its use as an anti-plaque agent.  Patient recruitment for the diabetes clinicaltrials is expected to begin in 2006.  Thetrials could last as little as two years. More than 200 subjects from the United States and abroad, representingthe demographic mix in the U.S., will receive oral doses of Naturlose to testits ability to treat Type 2 diabetes.  APhase 3 clinical trial, which gathers evidence regarding effectiveness andsafety, is needed to evaluate the overall benefit-risk relationship of newdrugs proposed to the FDA.  BecauseNaturlose has already been established as a substance “Generally Recognized asSafe” under FDA regulations, Spherix believes the elapsed time to approvalshould be shorter than that for most new drugs. A successful Phase 3 trial would permit Spherix to file a New DrugApplication with the FDA, the approval of which would be the final step beforemarketing Naturlose as a diabetes-fighting pharmaceutical.  The FDA generally decides on suchapplications within one year.

 

On June 8, 2005, the NASDAQ National Market advisedthe Company that the Company’s stockholders’ equity had decreased below the $10million minimum requirement.  NASDAQ gavethe Company until September 1, 2005, to correct this situation, which theCompany achieved through its third quarter earnings.  However, anticipating the normal seasonallosses that the company incurs in the first and fourth quarters, the Companyentered into the SEDA on July 22, 2005, with a view to selling additionalshares of common stock as necessary to maintain compliance with NASDAQ listingrequirements.  At December 31, 2005, theCompany’s shareholder’s equity was $7,879,220, or $2,120,780 below the$10,000,000 required by NASDAQ; however, through March 10, 2006, the Companyhas subsequently raised an additional $2.7 million through the SEDA and warranttransactions in order to bring the Company into compliance with the NASDAQequity requirement.  If the Company isunsuccessful in maintaining the required equity balance in future periods, thenthe Company will apply to register its shares of common stock on the NASDAQSmall Cap exchange.

 

23

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** **

**Contractual Obligations**

** **

The following table summarizes the Company’s knowncontractual obligations at December 31, 2005, and indicates the year paymentsare due.  In some cases estimates havebeen used where the exact amount and/or timing of the obligation is notpresently known.  The table does notinclude ordinary accounts payable and payroll type obligations and does notinclude estimates for future interest obligation payments under the Company’sbank line of credit noted above in the Liquidity and Capital Resourcessections.  The Company’s Debt Obligation,as of December 31, 2005, consisted solely of the bank line of credit notedabove.

 

*(numbersin 000’s)*

 
| ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | **2007 -** | ** ** | **2009 -** | ** ** | ** **     | ** ** |
|------------------------------|------------|------------|------------|------------|------------|-----------------|------------|-----------------|------------|----------------|------------|
| ** **                   | ** ** | **Total**  | ** ** | **2006**   | ** ** | **2008**        | ** ** | **2010**        | ** ** | **Thereafter** | ** ** |
| Debt Obligations             |       | $          | 1,449      |       | $          | 1,449           |       | $               | —     |           | $          | — |   | $ | — |   |
| Capital Lease  Obligations   |       | 44         |       | 27         |       | 17              |       | —          |       | —         |       |
| Operating Lease  Obligations |       | 3,351      |       | 1,204      |       | 1,977           |       | 170             |       | —         |       |
| Purchase  Obligations        |       | 1,151      |       | 1,151      |       | —          |       | —          |       | —         |       |
| Post-retirement  Obligations |       | 747        |       | 116        |       | 199             |       | 245             |       | 187            |       |
| Total                        |       | $          | 6,742      |       | $          | 3,947           |       | $               | 2,193      |           | $          | 415 |   | $ | 187 |   |

 

No dividends were paid in 2005 and none areanticipated in 2006.

 

**Item 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

The Company manages its debt and its available cash byconsidering available investment opportunities, risks, tax consequences andoverall financing strategies.

 

At December 31, 2005, the Company did not have anyfixed-rate indebtedness and had approximately $1.4 million ofvariable-rate indebtedness.  The Companyhas not entered into any interest rate swaps or other derivatives with respectto its indebtedness.

 

Cash available for investment is typically invested inshort term funds, which generally mature in 30 days, or money-marketfunds.  In general, such funds are notsubject to market risk because the interest paid on such funds fluctuates withthe prevailing interest rate.  Thecarrying amounts approximate market value. It is the Company’s practice to hold these investments to maturity.

 

Assuming year-end 2005 variable rate debt and cashavailable for investment, a one percent change in interest rates would impactnet interest income by less than $10,000.

 

**Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

Financial statements and supplementary data requiredby this Item 8 follow.

 
| **Index to Financial Statements**                                                           | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **                                                                                                 | ** ** | ** ** |
| Report of  Independent Registered Public Accounting Firm                                                   |       |       |
| Statements of  Operations for the years ended December 31, 2005, 2004, and 2003                            |       |       |
| Balance  Sheets as of December 31, 2005 and 2004                                                           |       |       |
| Statements  of Changes in Stockholders’ Equity for the years ended December 31, 2005,  2004, and 2003 |       |       |
| Statements of Cash Flows  for the years ended December 31, 2005, 2004, and 2003                            |       |       |
| Notes to Financial  Statements                                                                             |       |       |

 

24

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**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

 

**Board of Directors and**

 

**Shareholders of Spherix Incorporated**

 

Wehave audited the accompanying balance sheets of Spherix Incorporated (aDelaware corporation) (the Company) as of December 31, 2005 and 2004, and therelated statements of operations, changes in stockholders’ equity, and cashflows for each of the three years in the period ended December 31, 2005.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States).  Those standardsrequire that we plan and perform the audits to obtain reasonable assuranceabout whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit ofits internal control over financial reporting.  Our audits includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting.  Accordingly, we express nosuch opinion.  An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  Webelieve that our audits provides a reasonable basis for our opinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of Spherix Incorporated as ofDecember 31, 2005 and 2004, and the results of its operations and its cashflows for each of the three years in the period ended December 31, 2005, inconformity with accounting principles generally accepted in the United Statesof America.

 

 
| /s/ Grant Thornton LLP |   |
|------------------------|--------|

 

Vienna,Virginia

March10, 2006 (except for Note 6, as to which the date is March 31, 2006)

 

25

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**SpherixIncorporated**

**Statements of Operations**

**For theyears ended December 31, 2005, 2004, and 2003**

 
| ** **                                    | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
|                                          |       |       |       |       |       |       |       |
| **Revenue**                                   |       | $          | 23,045,657 |       | $          | 22,348,418 |       | $ | 18,086,711 |   |
|                                          |       |       |       |       |       |       |       |
| **Operating expense**                         |       |       |       |       |       |       |       |
| Direct contract and operating costs           |       | 17,928,018 |       | 17,362,430 |       | 12,224,650 |       |
| Selling, general and administrative expense   |       | 5,141,173  |       | 5,357,435  |       | 6,242,811  |       |
| Research and development expense              |       | 288,112    |       | 196,364    |       | 390,893    |       |
| Depreciation and amortization expense         |       | 2,574,247  |       | 2,277,682  |       | 1,503,003  |       |
| Total operating expense                       |       | 25,931,550 |       | 25,193,911 |       | 20,361,357 |       |
|                                          |       |       |       |       |       |       |       |
| **Loss from operations**                      |       | (2,885,893 | )          | (2,845,493 | )          | (2,274,646 | )          |
|                                          |       |       |       |       |       |       |       |
| Interest income (expense), net                |       | 37,145     |       | 23,447     |       | 17,876     |       |
|                                          |       |       |       |       |       |       |       |
| Loss before taxes                             |       | (2,848,748 | )          | (2,822,046 | )          | (2,256,770 | )          |
| Income tax expense                            |       | —     |       | —     |       | —     |       |
|                                          |       |       |       |       |       |       |       |
| **Net loss**                                  |       | $          | (2,848,748 | )          | $          | (2,822,046 | )          | $ | (2,256,770 | ) |
|                                          |       |       |       |       |       |       |       |
| Net loss per share, basic                     |       | $          | (0.24      | )          | $          | (0.24      | )          | $ | (0.20 | ) |
| Net loss per share, diluted                   |       | $          | (0.24      | )          | $          | (0.24      | )          | $ | (0.20 | ) |
|                                          |       |       |       |       |       |       |       |
| Weighted average shares outstanding, basic    |       | 12,037,479 |       | 11,890,470 |       | 11,378,309 |       |
| Weighted average shares outstanding,  diluted |       | 12,037,479 |       | 11,890,470 |       | 11,378,309 |       |

 

The accompanying notes to financial statements are an integral part ofthese financial statements.

 

26

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**SpherixIncorporated**

**Balance Sheets**

**As of December 31, 2005 and2004**

** **
| ** **                                                                                                                                                                            | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| **ASSETS**                                                                                                                                                                            |       |        |       |        |       |
| Current assets                                                                                                                                                                        |       |        |       |        |       |
| Cash and cash equivalents                                                                                                                                                             |       | $           | 2,667,733  |        | $          | 3,475,846 |   |
| Restricted investments                                                                                                                                                                |       | 2,000,000   |       | 2,700,000   |       |
| Trade accounts receivable, net of allowance  for doubtful accounts of $15,000                                                                                                         |       | 2,139,061   |       | 1,742,699   |       |
| Other receivables                                                                                                                                                                     |       | 271,287     |       | 140,314     |       |
| Prepaid expenses and other assets                                                                                                                                                     |       | 582,279     |       | 638,983     |       |
| Total current assets                                                                                                                                                                  |       | 7,660,360   |       | 8,697,842   |       |
|                                                                                                                                                                                  |       |        |       |        |       |
| Property and equipment, net of accumulated  depreciation  of $6,077,074 and $5,172,785                                                                                                |       | 4,603,032   |       | 5,517,279   |       |
| Patents, net of accumulated amortization of  $402,026 and $247,374                                                                                                                    |       | 854,871     |       | 1,028,828   |       |
| Total assets                                                                                                                                                                          |       | $           | 13,118,263 |        | $          | 15,243,949 |   |
|                                                                                                                                                                                  |       |        |       |        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                         |       |        |       |        |       |
| Current liabilities                                                                                                                                                                   |       |        |       |        |       |
| Bank line of credit                                                                                                                                                                   |       | $           | 1,449,318  |        | $          | 1,966,784 |   |
| Accounts payable and accrued expenses                                                                                                                                                 |       | 1,950,584   |       | 1,493,683   |       |
| Accrued salaries and benefits                                                                                                                                                         |       | 1,104,102   |       | 969,046     |       |
| Capital lease obligations                                                                                                                                                             |       | 16,645      |       | 18,124      |       |
| Deferred revenue                                                                                                                                                                      |       | —      |       | 34,632      |       |
| Total current liabilities                                                                                                                                                             |       | 4,520,649   |       | 4,482,269   |       |
|                                                                                                                                                                                  |       |        |       |        |       |
| Capital lease obligations, net of current  position                                                                                                                                   |       | 10,810      |       | 27,456      |       |
| Deferred compensation                                                                                                                                                                 |       | 511,325     |       | 125,959     |       |
| Deferred rent                                                                                                                                                                         |       | 196,259     |       | 240,575     |       |
| Total liabilities                                                                                                                                                                     |       | 5,239,043   |       | 4,876,259   |       |
|                                                                                                                                                                                  |       |        |       |        |       |
| Commitments and contingencies                                                                                                                                                         |       | —      |       | —      |       |
|                                                                                                                                                                                  |       |        |       |        |       |
| Stockholders’ equity                                                                                                                                                             |       |        |       |        |       |
| Preferred stock, $0.01 par value, 2,000,000  shares authorized;  none issued and outstanding                                                                                          |       | —      |       | —      |       |
| Common stock, $0.005 par value, 50,000,000  shares authorized; 12,448,456 and   12,031,395 issued, 12,368,018 and 11,950,957 outstanding at December 31, 2005  and 2004, respectively |       | 62,242      |       | 60,157      |       |
| Paid-in capital in excess of par value                                                                                                                                                |       | 23,521,109  |       | 23,162,916  |       |
| Treasury stock, 80,438 shares, at cost at  December 31, 2005 and 2004, respectively                                                                                                   |       | (464,786    | )          | (464,786    | )          |
| Accumulated deficit                                                                                                                                                                   |       | (15,239,345 | )          | (12,390,597 | )          |
| Total stockholders’ equity                                                                                                                                                       |       | 7,879,220   |       | 10,367,690  |       |
| Total liabilities and stockholders’ equity                                                                                                                                       |       | $           | 13,118,263 |        | $          | 15,243,949 |   |

 

The accompanying notes to financial statements are an integral part ofthese financial statements.

 

27

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**SpherixIncorporated**

**Statements of Changes inStockholders’ Equity**

**For theyears ended December 31, 2005, 2004 and 2003**

 
| ** **                                      | ** ** | ** **            | ** ** | **Paid-in**                                  | ** ** | ** **              | ** ** | **Retained  Earnings**     | ** ** | ** **                         | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|----------------------------------------------|------------|-------------------------|------------|----------------------------|------------|------------------------------------|------------|
| ** **                                      | ** ** | **Common Stock** | ** ** | **Capital in  Excess of Par** | ** ** | **Treasury Stock** | ** ** | **(Accumulated  Deficit)** | ** ** | **Stockholders’ Equity** | ** ** |
| **Shares**                                      | ** ** | **Amount**            | **Shares** | ** **                                   | **Amount** |
| ** **                                      | ** ** | ** **            | ** ** | ** **                                   | ** ** | ** **              | ** ** | ** **                 | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance, December  31, 2002                     |       | 11,412,545            |       | $                                            | 57,063     |                    | $          | 18,906,610                 |       | 61,488                             |       | $ | (390,434 | ) | $ | (7,311,781 | ) | $ | 11,261,458 |   |
|                                            |       |                  |       |                                         |       |                    |       |                       |       |                               |       |   |   |   |   |
| Issuance of  common stock                       |       |                  |       |                                         |       |                    |       |                       |       |                               |       |   |   |   |   |
| Exercise of employee  stock options             |       | 74,025                |       | 370                                          |       | 455,127                 |       | —                     |       | —                             |       | — |   | 455,497 |   |
| Cost of stock  issuance                         |       | —                |       | —                                       |       | (2,000                  | )          | —                     |       | —                             |       | — |   | (2,000 | ) |
| Stock-based  compensation                       |       | —                |       | —                                       |       | 31,050                  |       | —                     |       | —                             |       | — |   | 31,050 |   |
| Net loss                                        |       | —                |       | —                                       |       | —                  |       | —                     |       | —                             |       | (2,256,770 | ) | (2,256,770 | ) |
| Balance, December  31, 2003                     |       | 11,486,570            |       | 57,433                                       |       | 19,390,787              |       | 61,488                     |       | (390,434                           | )          | (9,568,551 | ) | 9,489,235 |   |
| Issuance of  common stock                       |       |                  |       |                                         |       |                    |       |                       |       |                               |       |   |   |   |   |
| Sale of common  stock in private placement, net |       | 43,029                |       | 215                                          |       | 282,715                 |       | —                     |       | —                             |       | — |   | 282,930 |   |
| Proceeds from  Employee Stock Purchase Plan     |       | 1,796                 |       | 9                                            |       | 7,739                   |       | —                     |       | —                             |       | — |   | 7,748 |   |
| Exercise of stock  warrants                     |       | 500,000               |       | 2,500                                        |       | 3,450,625               |       | —                     |       | —                             |       | — |   | 3,453,125 |   |
| Purchase of  treasury stock                     |       | —                |       | —                                       |       | —                  |       | 18,950                     |       | (74,352                            | )          | — |   | (74,352 | ) |
| Stock-based  compensation                       |       | —                |       | —                                       |       | 31,050                  |       | —                     |       | —                             |       | — |   | 31,050 |   |
| Net loss                                        |       | —                |       | —                                       |       | —                  |       | —                     |       | —                             |       | (2,822,046 | ) | (2,822,046 | ) |
| Balance, December  31, 2004                     |       | 12,031,395            |       | 60,157                                       |       | 23,162,916              |       | 80,438                     |       | (464,786                           | )          | (12,390,597 | ) | 10,367,690 |   |
| Issuance of  common stock                       |       |                  |       |                                         |       |                    |       |                       |       |                               |       |   |   |   |   |
| Sale of common  stock in private placement, net |       | 410,076               |       | 2,050                                        |       | 312,428                 |       | —                     |       | —                             |       | — |   | 314,478 |   |
| Proceeds from  Employee Stock Purchase Plan     |       | 6,985                 |       | 35                                           |       | 14,715                  |       | —                     |       | —                             |       | — |   | 14,750 |   |
| Stock-based  compensation                       |       | —                |       | —                                       |       | 31,050                  |       | —                     |       | —                             |       | — |   | 31,050 |   |
| Net loss                                        |       | —                |       | —                                       |       | —                  |       | —                     |       | —                             |       | (2,848,748 | ) | (2,848,748 | ) |
| Balance, December  31, 2005                     |       | 12,448,456            |       | $                                            | 62,242     |                    | $          | 23,521,109                 |       | 80,438                             |       | $ | (464,786 | ) | $ | (15,239,345 | ) | $ | 7,879,220 |   |

 

The accompanying notes to financial statements are an integral part ofthese financial statements.

 

28

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** **

**Spherix Incorporated**

**Statements of Cash Flows**

**For theyears ended December 31, 2005, 2004 and 2003**

** **
| ** **                                                                    | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Cash flows from operating activities**                                      |       |       |       |       |       |       |       |
| Net loss                                                                      |       | $          | (2,848,748 | )          | $          | (2,822,046 | )          | $ | (2,256,770 | ) |
| Adjustments to reconcile net loss to net  cash  used in operating activities: |       |       |       |       |       |       |       |
| Depreciation and amortization                                                 |       | 2,574,247  |       | 2,277,682  |       | 1,503,002  |       |
| Provision for uncollectible accounts  receivable                              |       | —     |       | (5,000     | )          | (51,000    | )          |
| Loss on disposal or write-down of assets                                      |       | 8,576      |       | 11,426     |       | 30,896     |       |
| Loss on write-down of patents                                                 |       | 13,254     |       | —     |       | 28,572     |       |
| Stock-based compensation                                                      |       | 31,050     |       | 31,050     |       | 31,050     |       |
| Changes in assets and liabilities:                                            |       |       |       |       |       |       |       |
| Trade accounts receivable                                                     |       | (396,362   | )          | (245,972   | )          | 728,744    |       |
| Other receivables                                                             |       | (130,973   | )          | (123,131   | )          | (3,839     | )          |
| Prepaid expenses and other assets                                             |       | 56,704     |       | 214,320    |       | (104,076   | )          |
| Accounts payable and accrued expenses                                         |       | (139,906   | )          | 221,503    |       | 499,728    |       |
| Deferred rent                                                                 |       | (44,316    | )          | 16,330     |       | 9,369      |       |
| Deferred compensation                                                         |       | 385,366    |       | 3,304      |       | 9,768      |       |
| Deferred revenue                                                              |       | (34,632    | )          | 34,632     |       | (1,103,662 | )          |
|                                                                          |       |       |       |       |       |       |       |
| Net cash used in operating activities                                         |       | (525,740   | )          | (385,902   | )          | (678,218   | )          |
|                                                                          |       |       |       |       |       |       |       |
| **Cash flows from investing activities**                                      |       |       |       |       |       |       |       |
| Purchase of property and equipment                                            |       | (1,359,283 | )          | (3,212,340 | )          | (2,246,219 | )          |
| Restricted cash                                                               |       | 700,000    |       | —     |       | (2,700,000 | )          |
| Proceeds from the sale of property and  equipement                            |       | —     |       | 1,093      |       | —     |       |
| Additions to patent costs                                                     |       | —     |       | (7,736     | )          | (18,386    | )          |
| Purchase of certain assets of Daksoft, Inc.                                   |       | —     |       | (700,000   | )          | —     |       |
|                                                                          |       |       |       |       |       |       |       |
| Net cash used in investing activities                                         |       | (659,283   | )          | (3,918,983 | )          | (4,964,605 | )          |
|                                                                          |       |       |       |       |       |       |       |
| **Cash flows from financing activities**                                      |       |       |       |       |       |       |       |
| Net change on bank line of credit                                             |       | (517,466   | )          | 250,041    |       | 994,359    |       |
| Net change in book overdraft                                                  |       | 583,273    |       | (99,780    | )          | (166,882   | )          |
| Payments on capital lease obligations                                         |       | (18,125    | )          | (17,730    | )          | (27,220    | )          |
| Proceeds from issuance of common stock, net                                   |       | 329,228    |       | 3,455,551  |       | 453,498    |       |
| Purchase of treasury stock                                                    |       | —     |       | (74,352    | )          | —     |       |
|                                                                          |       |       |       |       |       |       |       |
| Net cash provided by financing activities                                     |       | 376,910    |       | 3,513,730  |       | 1,253,755  |       |
|                                                                          |       |       |       |       |       |       |       |
| **Net decrease in cash and cash equivalents**                                 |       | (808,113   | )          | (791,155   | )          | (4,389,068 | )          |
| **Cash and cash equivalents, beginning of  year**                             |       | 3,475,846  |       | 4,267,001  |       | 8,656,069  |       |
|                                                                          |       |       |       |       |       |       |       |
| **Cash and cash equivalents, end of year**                                    |       | $          | 2,667,733  |       | $          | 3,475,846  |       | $ | 4,267,001 |   |
|                                                                          |       |       |       |       |       |       |       |
| **Supplemental cash flow information**                                        |       |       |       |       |       |       |       |
| Interest paid                                                                 |       | $          | 75,802     |       | $          | 60,550     |       | $ | 34,763 |   |
| Property and equipment financed by accounts  payable                          |       | $          | 214,721    |       | $          | 66,131     |       | $ | 276,193 |   |

 

The accompanying notes to financial statements are an integral part ofthese financial statements.

 

29

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** **

**SpherixIncorporated**

**Notesto Financial Statements**

** **

**1.             Summary of Significant AccountingPolicies**

 

# ***Nature of Business***

# ** **

SpherixIncorporated was founded in 1967, is incorporated in Delaware, and maintainsthree facilities in Maryland, including its corporate headquarters inBeltsville, and one facility in South Dakota. The Company consists of a biotechnology division (“BioSpherix”) and aninformation services division (“InfoSpherix”). BioSpherix is dedicated to research, development, and productization ofproprietary products.  InfoSpherixoperates contact center services providing consulting, information management,and materials management to the public as well as reservation and tourismsolutions.  These services are providedprimarily under government contracts.

 

***Cash Equivalents***

 

The Company considersall highly liquid investments with original maturities of three months or lessto be cash equivalents.  At December 31,2005, the Company had approximately $2.3 million invested in treasury fundswith a maturity of three months or less, which are included as cash and cashequivalents.

 

***Concentrations***

 

During 2005,revenue from four major government contracts accounted for 17%, 16%, 12%, and12% of the Company’s total revenue.  Noother contracts were greater than 10%. At December 31, 2005, four major contracts constituted 75% of the tradeaccounts receivable, the components of which were 30%, 16%, 15% and 14%.  No other single contract was greater than 10%of total trade accounts receivable. Receivables from Federal and state government agencies represented 91%of the total trade accounts receivable.

 

***Use of Estimates and Assumptions***

 

Theaccompanying financial statements have been prepared in conformity withaccounting principles generally accepted in the United States of America.  This requires management to make estimatesand assumptions that affect certain reported amounts of assets and liabilitiesand disclosures of contingent assets and liabilities at the date of thefinancial statements, and the reported amounts of revenue and expenses duringthe period.  Accordingly, actual resultscould differ from those estimates and assumptions.

 

***Property and Equipment and Depreciation***

 

Property andequipment are stated at cost and consist of office furniture and equipment,computer hardware and software, leasehold improvements, and capitalleases.  Computer hardware and softwareinclude the cost of internally developed software programs, which havelong-term benefits.  The Company hasdeveloped and continues to develop a large variety of software applicationsthat are used in the performance of its multiple contact center and parkreservation contracts.  Theseapplications are designed to aid our telephone operators in providinginformation to the public as well as collecting caller information.  The Company has also developed softwareapplications that we use to process park reservation transactions.  The Company capitalizes the labor and fringecosts incurred by our software programmers in the development of these applicationsas well as the costs incurred in creating functionality enhancements.  In 2005, the Company capitalizedapproximately $804,000 in internally developed software.  The Company computes depreciation and amortizationunder the straight-line method and typically over the following estimateduseful lives of the related assets:

 
| Office  furniture and equipment |   | 3 to 10 years |
|---------------------------------|--------|---------------|
| Computer  hardware and software |   | 3 to 5 years  |

 

Leaseholdimprovements are depreciated or amortized over the lesser of the term of therelated lease or the estimated useful lives of the assets (generally 5 to 10years).  Major additions, improvementsand renewals are capitalized and ordinary repairs, maintenance, and renewalsare expensed in the year incurred.  Gainsor losses from the sale or retirement of property and equipment result from thedifference between sales proceeds (if any) and the assets’ net book value, andare recorded in the Statement of Operations.

 

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** **

***Inventory***

 

Included inprepaid expenses at December 31, 2005, is approximately $11,000 of Naturloseinventory.  The inventory is valued atlower of cost or market.

 

***Deferred Rent***

 

The Companyentered into leases for its Beltsville, Cumberland and Annapolis facilities in1997, 2003 and 2004, respectively.  The excessof the rent expense over the cash payments for rent is recorded as deferredrent and is being amortized over the life of the leases.

 

***Research and Development Costs***

 

Research anddevelopment costs are charged to operations as incurred.

 

***Patent Costs***

 

Legal costs incurred inconnection with patent applications and costs of acquiring patents arecapitalized when incurred.  When patentsare granted, costs are amortized over a term representing the lesser of thelife of the patent or the projected sales period of the product or process.

 

***Revenue Recognition***

 

Revenue isrecognized using the following methods depending upon the terms of thecontracts:  time and materials or fixedprice.  Revenue under time and materialscontracts is recognized at contractually agreed-upon rates based upon directlabor hours expended and other direct costs incurred.  Revenue for fixed-price contracts isrecognized using unit-of-delivery methods. Losses, if any, on contracts are recorded during the period when firstdetermined.

 

***Direct Contract and Operating Costs***

 

The Company’sdirect contract and operating costs consist primarily of labor and fringe costsfor contact center personnel, subcontractors, telephone related costs,depreciation on computer hardware and software and related facilities costs.

 

***Selling, General and Administrative Expense***

 

The Company’sselling, general and administrative expenses consist primarily of executivemanagement salaries and fringes, sales and marketing costs, finance andaccounting, human resources, as well as general corporate costs and costsrelated to being a public company.

 

***LicenseFees and Advance Royalties***

 

License fees androyalties are recognized as revenue over the fixed term of the contract.  Non-refundable fees are recognized when theyare earned in accordance with the applicable contractual terms.  Payments received that are related to futureperformance are deferred and recorded as revenue as they are earned overcontractually specified future performance periods.  See Note 10.

 

***Income Taxes***

 

Deferredincome taxes are recognized for the tax consequences in future years ofdifferences between the tax bases of assets and liabilities and their financialreporting amounts at each year end, based on enacted tax laws and statutory taxrates applicable to the periods in which the differences are expected to affecttaxable income.  Valuation allowances areestablished based upon periodic assessments made by management to reducedeferred tax assets to the amount expected to be realized.  Income tax expense is the tax payable for theperiod and the change during the period in deferred tax assets and liabilities.

 

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*** ***

***Fair Value Information***

 

The estimatedfair value of the Company’s financial instruments, which include cash,receivables, accounts payable, bank line of credit, and short-term notespayable reported in the balance sheet, approximate their carrying value giventheir short maturities.

 

***Accounting for Stock-Based Compensation***

 

The Companyapplies APB Opinion No. 25 and related interpretations in accounting forstock-based compensation.  Accordingly,because the exercise price of options granted has typically been at marketprice, no compensation cost has been recognized, with the exception ofapproximately $31,050 of compensation expense recognized in 2005, 2004 and 2003as a result of issuing certain option grants at below fair market value in2002.  In 2003, the Company realized anet benefit from stock-based employee compensation as a result of options thatwere forfeited upon the termination of the employment of the Company’s formerPresident and COO.  The Company electedthe “disclosure only” presentation of Statement of Financial AccountingStandards No. 123, *Accounting for Stock-BasedCompensation*in 1996 and, consequently, makes no charge againstincome in the financial statements with respect to options granted withexercise prices at or above fair market value. Starting in the first quarter of 2006, the Company will be required to adoptStatement of Financial Accounting Standards No. 123-revised 2004, “Share-BasedPayment” (“SFAS 123R”) (see “New Accounting Pronouncements” below).

 

On November 4,2005, the Company had a total of 176,658 previously unvested stock optionsoutstanding.  The exercise prices of allof these options were greater than the fair value of the Company’s stock.  At the Board of Directors meeting on thisday, the Board members voted to fully vest all of the then outstanding stockoptions.  The average weighted exerciseprice of these options was $7.98.  Theprimary purpose of the accelerated vesting was to enable the Company to avoidrecognizing the future compensation expense for these options upon adoption of “SFAS123R.”  The related future stock-basedemployee compensation expense that was eliminated as a result of theacceleration of the vesting of these options is approximately $562,000, and hadthe effect of increasing the 2005 proforma loss from $3,110,977 to $3,672,738and the proforma loss per share from $(0.26) to $(0.31).

 

To measure stock-basedcompensation in accordance with SFAS 123, the fair value of each option grantwas estimated on the date of grant using the Black-Scholes option-pricingmodel.  The following table summarizes thepro-forma net loss and net loss per share resulting from applying SFAS 123.

** **
| ** **                                                                                                                        | ** ** | ** **  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003**   | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|----------|------------|----------|------------|------------|------------|
| Net loss, as reported                                                                                                             |       |        |       | $        | (2,848,748 | )        | $          | (2,822,046 | )          | $ | (2,256,770 | ) |
| Add: stock-based employee compensation  expense included in reported net loss                                                     |       |        |       | 31,050   |       | 31,050   |       | 31,050     |       |
| (Deduct) add: total stock-based employee  compensation (expense) benefit determined under fair-value based method for  all awards |       |        |       | (855,040 | )          | (605,051 | )          | 145,072    |       |
| Pro forma net loss                                                                                                                |       |        |       | $        | (3,672,738 | )        | $          | (3,396,046 | )          | $ | (2,080,648 | ) |
| Net loss per share – basic                                                                                                   |       | As reported |       | $        | (0.24      | )        | $          | (0.24      | )          | $ | (0.20 | ) |
|                                                                                                                              |       | Pro forma   |       | $        | (0.31      | )        | $          | (0.29      | )          | $ | (0.18 | ) |
| Net loss per share – diluted                                                                                                 |       | As reported |       | $        | (0.24      | )        | $          | (0.24      | )          | $ | (0.20 | ) |
|                                                                                                                              |       | Pro forma   |       | $        | (0.31      | )        | $          | (0.29      | )          | $ | (0.13 | ) |

 

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*** ***

***Net Loss Per Share***

 

Basic net lossper common share has been computed by dividing net loss by the weighted-averagenumber of common shares outstanding during the year.  Diluted net loss per common share has beencomputed by dividing net loss by the weighted-average number of common sharesoutstanding without an assumed increase in common shares outstanding for commonstock equivalents, as common stock equivalents are antidilutive.  At December 31, 2005, the Company hadoutstanding 585,973 warrants and 507,200 options.  Common stock equivalents, which consist ofstock options and warrants that are assumed likely to be exercised, totaled 389at December 31, 2005.

 
| ** **                                          | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
|                                                |       |       |       |       |       |       |       |
| Weighted average shares outstanding, basic          |       | 12,037,479 |       | 11,890,470 |       | 11,378,309 |       |
| Weighted average dilutive common stock  equivalents |       | —     |       | —     |       | —     |       |
| Weighted average shares outstanding,  diluted       |       | 12,037,479 |       | 11,890,470 |       | 11,378,309 |       |

 

**NewAccounting Pronouncements**

** **

*Share-BasedPayment*

 

In December2004, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standards 123-revised 2004 (“SFAS 123R”), “Share-BasedPayment” which replaces Statement of Financial Accounting Standards No. 123 (“SFAS123”), Accounting for Stock-Based Compensation” and supersedes APB Opinion No.25 (“APB 25”), “Accounting for Stock Issued to Employees and RelatedInterpretations.” SFAS 123R requires the measurement of all employeeshare-based payments to employees, including grants of employee stock options,using a fair-value-based method and the recording of such expense in ourconsolidated statements of operations. In April 2005, the SEC announced thatthe accounting provisions of SFAS 123R are to be applied in the first quarterof the fiscal year beginning after June 15, 2005. As a result, we are nowrequired to adopt SFAS 123R in the first quarter of fiscal 2006 and willrecognize stock-based compensation expense using the modified prospectivemethod. The pro forma disclosures previously permitted under SFAS 123 no longerwill be an alternative to financial statement recognition. See “Accounting forStock-Based Compensation” above for the pro forma net loss and net loss pershare amounts as if we had used a fair-value-based method similar to themethods required under SFAS 123R to measure compensation expense for employeestock incentive awards. We are evaluating the requirements under SFAS 123R andexpect the adoption could have a significant impact on our consolidatedstatements of operations and net loss per share related to any future stockoption compensation grants.

 

*Accountingchanges and error corrections*

 

In May 2005,the Financial Accounting Standards Board issued Statement 154, AccountingChanges and Error Corrections-a replacement of APB Opinion No. 20 and FASBStatement No. 3.  Statement 154 requiresthat all voluntary changes in accounting principles and changes required by anew accounting pronouncement that do not include specific transition provisionsbe applied retrospectively to prior periods’ financial statements, unless it isimpracticable to do so.  This Statementis effective for accounting changes and corrections of errors made in fiscalyears beginning after December 15, 2005. The Company does not believe that the adoption of Statement 154 willhave a significant effect on its financial statements.

 

**2.             Restricted Investments**

 

At December 31, 2005 and 2004, the Company held $2,000,000 and$2,700,000 in restricted investments, respectively.  The December 31, 2004, balance consisted of$2,000,000 in a restricted certificate of deposit as collateral on the Company’sbank line of credit and $700,000 in a restricted certificate of deposit ascollateral for a performance bond. During 2005, the Company received a release from the performance bondcollateral restriction.  At December 31,2005, the restricted investments consisted solely of the $2,000,000 restrictedas collateral on the Company’s bank line of credit.  The Company will receive a release from thebank line of credit restriction when the line of credit matures on March 31,2006, (see Note 6 “Line of Credit”).  Therelated certificate of deposit matures on June 30, 2006.

 

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** **

**3.             Allowance for Doubtful Accounts**

 

Managementregularly reviews the accounts receivables for uncollectible and potentiallyuncollectible accounts and when necessary establishes an allowance for doubtfulaccounts.

 
| Balance, December 31, 2002          |   | $       | 71,000 |   |
|-------------------------------------|--------|---------|--------|--------|
| Write-off of uncollectible accounts |   | (1,000  | )      |
| Valuation adjustment                |   | (50,000 | )      |
| Balance, December 31, 2003          |   | 20,000  |   |
| Write-off of uncollectible accounts |   | (9,000  | )      |
| Valuation adjustment                |   | 4,000   |   |
| Balance, December 31, 2004          |   | 15,000  |   |
| Write-off of uncollectible accounts |   | —  |   |
| Valuation adjustment                |   | —  |   |
| Balance, December 31, 2005          |   | $       | 15,000 |   |

 

**4.             Property and Equipment**

 

The componentsof property and equipment as of December 31, at cost are:

 
| ** **                                                                                                           | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Computer software                                                                                                    |       | $          | 4,222,000  |       | $          | 3,639,000 |   |
| Computer hardware                                                                                                    |       | 4,487,000  |       | 5,050,000  |       |
| Office furniture and equipment                                                                                       |       | 627,000    |       | 609,000    |       |
| Leasehold improvements                                                                                               |       | 1,272,000  |       | 1,306,000  |       |
| Capital leases                                                                                                       |       | 72,000     |       | 86,000     |       |
| Total cost                                                                                                           |       | 10,680,000 |       | 10,690,000 |       |
| Accumulated depreciation and amortization  (including capital lease accumulated  depreciation of $47,000 and $41,000 |       | (6,077,000 | )          | (5,173,000 | )          |
| Property and equipment, net                                                                                          |       | $          | 4,603,000  |       | $          | 5,517,000 |   |

 

**5.             Intangible Assets**

 

On March 1,2004, the Company purchased certain assets of Daksoft, Inc. related to itsreservation business, which operates under the name “ReserveIt.”  The purchase included the acquisition of sixadditional government reservation contracts and the intellectual propertyrights to the name “ReserveIt,” as well as other assets of the division.  Spherix purchased the assets for $700,000plus 43,029 shares valued at $288,000 of the Company’s common stock (subject tocertain restrictions).  The Companyassessed the value of the purchased contracts to be $976,000 and will amortize$139,000 annually over seven years, the estimated life of the contracts.  In 2005 and 2004, the Company recognized atotal of $139,000 and $116,000 in related amortization expense.

 

**6.             Debt**

 

***Line of Credit***

 

Spherixrenewed its Line-of-Credit (the “Agreement”) with Bank of America (the “Bank”)on December 29, 2005, which provides for borrowing up to $2 million.  Outstanding borrowings under the Agreementaggregated $1.4 million at December 31, 2005, and are collateralized by arestricted $2.0 million certificate of deposit. The interest rate under the agreement is based on the LIBOR rate, whichwas 6.29% at year-end.  The total amountavailable for further advance to the Company was $551,000 under the Agreementat December 31, 2005.  As a result of thecreation of InfoSpherix as a wholly-owned subsidiary, management no longerconsiders maintaining a bank line of credit for the parent company, Spherix,necessary, and, therefore has decided not to renew the above Agreement when itmatures on March 31, 2006.  On March 31,2006, the Company entered into a new agreement with the Bank to establish abank Line-of-Credit (“New Agreement”) for the subsidiary, InfoSpherixIncorporated.  Management considers thecreation of this credit facility for the subsidiary necessary to ensure timelycash flow for the subsidiary’s operations. The New Agreement provides for borrowings up to $1.5 million, iscollateralized by the subsidiary’s assets, contains covenants

 

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on tangible net worth andfunded debt to EBITDA ratios, and matures on March 31, 2007.  Such covenants could have a limiting effecton the amount of cash that the subsidiary can transfer to Spherix.  The interest rate under the New Agreement isbased on the LIBOR rate plus 300 basis points.

 

**7.             Accounts Payable and AccruedExpenses**

 

Accountspayable and accrued expenses consisted of the following at December 31:

 
| ** **       | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------|------------|----------|------------|----------|------------|
|             |       |     |       |     |       |
| Accrued expenses |       | $        | 542,000    |     | $          | 436,000 |   |
| Book overdraft   |       | 644,000  |       | 61,000   |       |
| Accounts payable |       | 765,000  |       | 997,000  |       |
|             |       | $        | 1,951,000  |     | $          | 1,494,000 |   |

 

**8.             Stockholder Equity**

** **

***Private Placements***

** **

The Companydetermined that, as of June 30, 2005, it was approximately $454,000 short ofmeeting NASDAQ’s National Market listing requirement of maintaining a minimumof $10,000,000 in shareholders’ equity. NASDAQ gave the Company until September 1, 2005, to correct thissituation, which the Company achieved through its third quarter results.  However, in anticipation of incurring lossesdue to seasonal fluctuations in the InfoSpherix business segment that occurs inthe first and fourth quarters of the year, the Company entered into a StandbyEquity Distribution Agreement (“SEDA”) with Cornell Capital Partners, L.P. (“Cornell”)on July 22, 2005.  Under the SEDA,Spherix can require Cornell to purchase up to $4,000,000 of the Company’scommon stock over a two-year period following the effective date, October 12,2005, of the registration covering the shares of our common stock to be sold toCornell.  The SEDA establishes what issometimes termed an “equity line of credit” or an “equity draw-down facility.”  The $4,000,000 facility may be drawn downupon by us in installments, the maximum amount of each of which is limited to$350,000.  For each share of common stockpurchased under the SEDA, Cornell will pay 95% of the lowest volume weightedaverage price (“VWAP”) of our shares during the five trading days following ourdraw down notice to Cornell.  The VWAPthat will be used in the calculation will be that reported by Bloomberg, LLC, athird-party reporting service.  Ingeneral, the VWAP represents the sum of the value of all the sales of ourcommon stock for a given day (the total shares sold in each trade times thesales price per share of the common stock for that trade), divided by the totalnumber of our shares sold on that day. We are also committed to pay to Cornell an amount equal to 5% of eachpurchase of our common stock made by Cornell under the SEDA.  Under the terms of the SEDA agreement, we arenot obligated to draw down on the SEDA facility, but once we satisfy normalconditions for this type of transaction, we have the right to require Cornellto purchase our common stock.  Inconnection with the SEDA, we have issued to Cornell 95,000 shares of our commonstock and paid a due diligence fee of $5,000. We also paid Yorkville Advisors Management, LLC, the investment managerfor Cornell, a structuring fee of $15,000, and on each sale under the SEDA wewill pay an additional structuring fee of $500. Newbridge Securities Corporation acted as our placement agent for theSEDA, and we paid that firm a fee of 5,000 shares of our common stock valued at$10,000.  We also granted NewbridgeSecurities Corporation piggy-back registration rights covering these shares.  Registration of our common shares coveredunder the SEDA was completed in October 2005. During the term of the SEDA, our Officers and Directors have agreed notto sell any of their shares of our common stock, except to the extent permittedunder Rule 144.  The number of shares ofour common stock issuable to Cornell under the SEDA is subject to a 9.99% capon the beneficial ownership that Cornell and its affiliates may have at thetime of each installment (beneficial ownership is to be calculated inaccordance with Section 13(d) of the Exchange Act).  Further, we may not issue more than 19.99% ofour currently outstanding shares under the SEDA unless shareholder approval isreceived.  Fees paid through cash andcommon stock to Cornell, Yorkville Advisors, and Newbridge Security totaling$220,000 were charged against the proceeds of the initial draw on thefacility.  In 2005, the Company sold310,076 shares under the SEDA agreement for total proceeds of $376,500.  Subsequent to December 31, 2005, the Companysold an additional 624,365 shares under the SEDA for an additional $1.5 millionin proceeds.

 

On February18, 2004, warrants for 500,000 shares of Common Stock were exercised at $6.91per share, compared to the then current market price of $6.76 per share, by aninstitutional investor, and the expiration date of the remaining 585,973warrants held by the investor was extended until February 25, 2008, at anexercise price of $7.00 per

 

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share of common stock.  Such warrants were subsequently assigned andtransferred to another institutional investor in 2004.  On March 9, 2006, in exchange for the Company’sagreement to reduce the exercise price to $2.04 per share, the Investor agreedto exercise the warrants for the full 585,973 shares for total proceeds ofapproximately $1.2 million.  Inconnection with these warrants, the new holder of the warrants agreed that itwould not exercise any of the warrants to the extent that it would acquireshares of Common Stock exceeding 9.9% of the outstanding Common Stock, norwould it knowingly sell shares to anyone to the extent that their holdings inthe Company would exceed 4.9% of the outstanding Common Stock.  The warrants and shares of Common Stock wereissued in transactions exempt from Registration pursuant to Section 4(2) of theSecurities Act.  The Company hasregistered the shares issuable upon exercise of the warrants for resale by theinstitutional investor.

 

At December31, 2005, the Company’s shareholder’s equity was $7,879,220, or $2,120,780below the $10,000,000 required by NASDAQ; however, the Company has subsequentlyraised an additional $2.7 million through the SEDA and warrant transactions soas to bring the Company into compliance with the NASDAQ equity requirement.

 

***Stock Option Plan***

 

The Companyhas an Employees’ Stock Option Plan (the “Plan”) which permits issuance of bothIncentive Stock Options (ISO) and Non-Qualified Stock Options, whereby optionsmay be granted to officers and Directors and other key employees to purchase upto 1,000,000 shares of common stock in amounts determined by the CompensationCommittee of the Board of Directors through December 31, 2007.  During 2005, 2004, and 2003, 12,500, 60,000,and 407,800 options were granted under the Plan, respectively.  At December 31, 2005, 402,000 options wereavailable for grant under the Plan. During 2003, 14,000 options were granted outside the Plan to Directors.

 

On November 4,2005, the Company had a total of 176,658 previously unvested stock optionsoutstanding.  The exercise prices of allof these options were greater than the fair value of the Company’s stock.  At the Board of Directors meeting on thisday, the Board members voted to fully vest all of the then outstanding stockoptions.  The average weighted exerciseprice of these options was $7.98.  Theprimary purpose of the accelerated vesting was to enable the Company to avoidrecognizing the future compensation expense for these options upon adoption of “SFAS123R.”  The related future stock-basedemployee compensation expense that was eliminated as a result of theacceleration of the vesting of these options is approximately $562,000, and hadthe effect of increasing the 2005 proforma loss from $3,110,977 to $3,672,738and the proforma loss per share from $(0.26) to $(0.31).

 

Activity forthe three years ended December 31, 2005, for all option grants is shown below:

 
| ** **                                                       | ** ** | **2005  Shares** | ** **  | **2005  Weighted  Average  Exercise  Price** | ** ** | **2004  Shares** | ** ** | **2004  Weighted**

**Average  Exercise  Price** | ** ** | **2003  Shares** | ** ** | **2003  Weighted  Average  Exercise  Price** | ** **  |
|------------------------------------------------------------------|------------|------------------|-------------|----------------------------------------------|------------|------------------|------------|--------------------------------------------------|------------|------------------|------------|----------------------------------------------|-------------|
| Outstanding at  beginning of year                                |       | 677,800          |        | $                                            | 7.82       |             | 653,650    |                                             | $          | 7.97             |       | 911,475                                      |        | $ | 7.52 |   |
| Granted                                                          |       | 12,500           |        | $                                            | 3.41       |             | 60,000     |                                             | $          | 5.98             |       | 421,800                                      |        | $ | 7.76 |   |
| Exercised                                                        |       | —           |        | $                                            | —     |             | —     |                                             | $          | —           |       | (74,025                                      | )           | $ | 6.15 |   |
| Expired or  forfeited                                            |       | (183,100         | )           | $                                            | 7.79       |             | (35,850    | )                                                | $          | 7.36             |       | (605,600                                     | )           | $ | 7.36 |   |
| Outstanding at  end of year                                      |       | 507,200          |        | $                                            | 7.73       |             | 677,800    |                                             | $          | 7.82             |       | 653,650                                      |        | $ | 7.97 |   |
|                                                             |       |             |        |                                         |       |             |       |                                             |       |             |       |                                         |        |
| Options  exercisable at end of year                              |       | 507,200          |        |                                         |       | 345,822          |       |                                             |       | 305,404          |       |                                         |        |
| Weighted-average  fair value of  options granted during the year |       | $                | 1.92        |                                         |       |             | $          | 3.22                                             |       |             |       | $                                            | 3.23        |   |   |   |
|                                                             |       |             |        |                                         |       |             |       |                                             |       |             |       |                                         |        |
| Price range of  options                                          |       |             |        |                                         |       |             |       |                                             |       |             |       |                                         |        |
| Outstanding                                                      |       | $                | 2.25-$10.51 |                                         |       |             | $          | 2.25-$10.51                                      |       |             |       | $                                            | 2.25-$10.51 |   |   |   |
| Exercised                                                        |       | $                | —      |                                         |       |             | $          | —                                           |       |             |       | $                                            | 5.78-$6.44  |   |   |   |
| Expired or forfeited                                             |       | $                | 6.35-$9.55  |                                         |       |             | $          | 6.00-$9.55                                       |       |             |       | $                                            | 5.78-$9.55  |   |   |   |
|                                                             |       |             |        |                                         |       |             |       |                                             |       |             |       |                                         |        |
|                                                                  |            |                  |             |                                              |            |                  |            |                                                  |            |                  |            |                                              |             |  |  |  |  |  |  |  |  |  |

 

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The followingtable summarizes information with respect to stock options outstanding atDecember 31, 2005:

 
| **Range of  Exercise Price** | ** ** | **Number of  Options  Outstanding  at 12/31/05** | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|-----------------------------------|------------|------------------------------------------------------------|------------|---------------------------------------------------------|------------|--------------------------------------------|------------|
| $2.25 - $4.99                     |       | 97,500                                                     |       | 2.4                                                     |       | $                                          | 4.12       |   |
| $6.35 - $7.84                     |       | 84,850                                                     |       | 2.0                                                     |       | $                                          | 6.74       |   |
| $8.09 - $10.51                    |       | 324,850                                                    |       | 3.5                                                     |       | $                                          | 9.07       |   |
|                              |       | 507,200                                                    |       |                                                    |       |                                       |       |

 

The following table summarizes informationwith respect to stock options outstanding at December 31, 2005:

 
| **Year of Option  Expiration** | ** ** | **Number of Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Price Range** | ** ** |
|------------------------------------------|------------|---------------------------------|------------|--------------------------------------------|------------|----------------------|------------|
| 2006                                     |       | 34,100                          |       | $                                          | 9.75       |                 | $          | 9.55-$10.51 |   |
| 2007                                     |       | 137,550                         |       | $                                          | 6.28       |                 | $          | 2.25-$10.51 |   |
| 2008                                     |       | 193,050                         |       | $                                          | 8.28       |                 | $          | 6.35-$8.67 |   |
| 2009                                     |       | 30,000                          |       | $                                          | 4.99       |                 | $          | 4.99 |   |
| 2010                                     |       | 12,500                          |       | $                                          | 3.41       |                 | $          | 3.41 |   |
| 2011                                     |       | 100,000                         |       | $                                          | 9.34       |                 | $          | 9.34 |   |
|                                     |       |                            |       |                                       |       |                 |       |
| All Years                                |       | 507,200                         |       |                                       |       |                 |       |

 

The Company used the followingassumptions in the Black-Scholes calculation used to measure the fair value ofstock-based compensation in accordance with SFAS 123.

 
| ** **              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|----------|------------|
| Risk-free interest rate |       | 5.11     | %          | 4.28     | %          | 3.12     | %          |
| Expected life (years)   |       | 4        |       | 4        |       | 4-6      |       |
| Volatility              |       | 69.6     | %          | 66.8     | %          | 55.3     | %          |
| Dividend yield          |       | 0        | %          | 0        | %          | 0        | %          |

** **

***Treasury Stock Transactions***

** **

During 2004,the Company purchased 18,950 shares of Common Stock at a total cost of$74,352.  No treasury transactionsoccurred in 2005 or 2003.

 

**9.             Income Taxes**

 

There was noincome tax expense for the years 2005, 2004, and 2003 as a result of net lossesand the net operating loss carryforwards and increases in the valuationallowance.

 

37

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The tax effectof significant temporary differences representing deferred tax assets as ofDecember 31, 2005 and 2004, is as follows:

 
| ** **                      | ** ** | **2005**    | ** ** | **2004**        | ** ** |
|---------------------------------|------------|-------------|------------|-----------------|------------|
| ** **                      | ** ** | **Current** | ** ** | **Non-Current** | ** ** | **Current** | ** ** | **Non-Current** | ** ** |
| Property and  equipment         |       | $           | —     |            | $          | (762,137 | ) | $ | — |   | $ | (901,473 | ) |
| Deferred rent                   |       | 75,795      |       | —          |       | 65,876 |   | — |   |
| Accrued vacation                |       | 70,218      |       | —          |       | 55,600 |   | — |   |
| Allowance for doubtful accounts |       | 5,793       |       | —          |       | 5,793 |   | — |   |
| Deferred revenue                |       | —      |       | —          |       | — |   | 13,375 |   |
| Deferred compensation           |       | —      |       | 241,443         |       |   |   |   |   |
| Forward loss provision          |       | 52,137      |       | —          |       |   |   |   |   |
| Net operating loss carryforward |       | —      |       | 7,353,528       |       | — |   | 6,612,253 |   |
| Accrued bonus                   |       | 32,055      |       | —          |       | — |   | 48,646 |   |
| Other                           |       | (10,728     | )          | —          |       | (10,192 | ) | — |   |
|                            |       |        |       |            |       |   |   |   |   |
|                            |       | 225,270     |       | 6,832,834       |       | 117,077 |   | 5,772,801 |   |
| Valuation allowance             |       | (225,270    | )          | (6,832,834      | )          | (117,077 | ) | (5,772,801 | ) |
|                            |       |        |       |            |       |   |   |   |   |
| Deferred tax asset              |       | $           | —     |            | $          | — |   | $ | — |   | $ | — |   |

 

Approximately$2.3 million in U.S. tax net operating losses was created in 2005.  The Company has $19.0 million in netoperating loss carryforwards that will be available to offset regular taxableU.S. income during the carryforward period, which will begin to expire in2018.  Based on the Company’s loss in2005 and its accumulated deficit, the Company has provided a full valuationallowance against the net deferred tax asset. During fiscal year 2005, the Company increased the allowance in theamount of $1.2 million to fully reserve the net deferred tax asset at December31, 2005.  At December 31, 2005,approximately $388,000 of the valuation allowance, related to benefits fromstock compensation, will be credited to “paid in capital” when recognized infuture periods.

 

Reconciliationbetween actual tax expenses and taxes computed at the statutory Federal rate of34 percent for 2005, 2004, and 2003 are as follows:

 
| ** **                                         | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003** | ** ** |
|----------------------------------------------------|------------|-----------|------------|-----------|------------|----------|------------|
| U.S. Federal income tax rate at 34%                |       | $         | (968,575   | )         | $          | (959,495 | )          | $ | (767,302 | ) |
| State taxes, net of federal tax benefit            |       | (131,612  | )          | (130,378  | )          | (104,263 | )          |
| Change in valuation allowance                      |       | 1,168,226 |       | 1,099,331 |       | 883,014  |       |
| Expenses not deductible for tax purposes           |       | 13,195    |       | 13,269    |       | 34,448   |       |
| Valuation allowance related to stock  compensation |       | —    |       | —    |       | (45,818  | )          |
| Adjustment for prior year taxes                    |       | (81,234   | )          | (22,727   | )          | (79      | )          |
|                                               |       |      |       |      |       |     |       |
| Income tax provision (benefit)                     |       | $         | —     |      | $          | —   |       | $ | — |   |

 

**10.          Commitments and Contingencies**

 

***Government Contracts***

 

The principalportion of the Company’s revenue has been generated under government contracts,by the InfoSpherix Division.  Thesecontracts are awarded pursuant to a competitive bidding process.  As of December 31, 2005, none of the Company’scontracts were under protest.  TheGovernment has the right to audit billings and Spherix does not expectadjustments to such billings.

 

38

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*** ***

***Leases***

 

The Companyhas various commitments under capital and operating leases through 2010relating to office equipment, its call center facility in Cumberland, Maryland,its call center facility in Rapid City, South Dakota, its call center andadministrative offices in Beltsville, Maryland, and its research lab and administrativeoffice in Annapolis, Maryland.

 

Future minimumrentals as of December 31, 2005, under noncancellable leases are as follows:

 
| **Year Ending December 31,** | ** ** | **Capital  Leases** | ** ** | **Operating  Leases** | ** ** |
|---------------------------------------------|------------|---------------------|------------|-----------------------|------------|
|                                        |       |                |       |                  |       |
| 2006                                        |       | $                   | 27,059     |                  | $          | 927,912 |   |
| 2007                                        |       | 16,537              |       | 898,419               |       |
| 2008                                        |       | —              |       | 708,818               |       |
| 2009                                        |       | —              |       | 152,004               |       |
| 2010                                        |       | —              |       | 1,961                 |       |
| Thereafter                                  |       | —              |       | —                |       |
|                                        |       | 43,596              |       | $                     | 2,689,114  |   |
| Less: executory costs                       |       | 14,731              |       |                  |       |
| Less: amount representing interest          |       | 1,410               |       |                  |       |
| Capital lease obligations                   |       | 27,455              |       |                  |       |
| Less current portion                        |       | 16,645              |       |                  |       |
| Long-term obligations                       |       | $                   | 10,810     |                  |       |   |

 

Some of theCompany’s building leases contain step rent provisions and capital improvementfunding.  The rental expense on theseleases is recognized on a straight-line basis over the life of the respectiveleases.  The Company incurred rentalexpenses of $942,000 in 2005, $860,000 in 2004, and $659,000 in 2003, underoperating leases.

 

***Related Party Transactions***

 

Employment,Deferred Compensation, and Consulting Agreements for Principal Stockholders

 

Dr. Gilbert V.Levin, Company founder and former CEO, has served under an Employment Agreementsince March 3, 1969.  This Agreement wasamended and restated in 2004, and continued through December 31, 2004.  On February 17, 1993, the Company entered intoagreements with Dr. Levin and Mrs. M. Karen Levin, to provide adequateretirement benefits and to protect the Company’s stock from a precipitous saleto pay estate taxes upon their deaths. These agreements provided that, upon retirement, under a SupplementalExecutive Retirement Plan (SERP), these individuals would receive deferredcompensation equal to 70% and 60%, respectively, of their average annual totalcompensation less the assumed returns from investment of their funded pensionplans, and less their social security payments. On March 23, 2004, after lengthy consideration and consultation, theBoard and the Levins approved new deferred compensation agreements.  At March 23, 2004, the deferred compensationplan for Dr. Levin was unfunded and the Company had no liability under theplan.  Under the March 23, 2004,agreement Dr. Levin voluntarily forgave the Company of its obligations underhis SERP agreement.  The Company also hasagreed to provide Dr. Levin with lifetime payments of $12,500 each quarter andto fund long-term lifetime healthcare and health insurance policies followinghis full retirement from the Company.  In2004, Dr. and Mrs. Levin voluntarily forgave the Company its obligation toretain key man life insurance on them and to buy back stock from the last tosurvive.  On November 29, 2005, the Boardand Mrs. Levin approved a new agreement concerning her retirement benefitsfollowing her January 4, 2006 retirement from the Company.  At November 29, 2005, the deferredcompensation plan for Mrs. Levin was unfunded and the Company had no liabilityunder the plan as actuarially determined. Under the November 29, 2005, agreement M. Karen Levin voluntarilyforgave the Company its obligations under her SERP agreement.  The Company also has agreed to provide M.Karen Levin lifetime payments of $12,500 each quarter and to fund long-termlifetime healthcare and health insurance policies following her January 4,2006, retirement from the Company.  AtDecember 31, 2005, the Company’s liability for both Dr. Levin and Mrs. Levinwas estimated to be $354,000 for the lifetime payments and $157,000 for fundingthe long-term lifetime healthcare and health insurance policies.  These amounts are reported on the accompanyingbalance sheet as deferred compensation.

 

39

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Uponcompletion of their employment, the officer-stockholders agree to serve asconsultants to the Company on an as-needed basis, at a specified daily rate.

 

***Other***

 

On May 23,2002, the Company filed for arbitration against its licensee, Arla Foodsamba.  The filing sought damages for whatthe Company claims has been an unreasonably long time for its licensee to bringtagatose to market and other measures to accelerate the pace towardcommercialization of food and beverage uses of the new sweetener licensed tothe Danish firm, and for favorable interpretation of License Agreement clausesaffecting royalty payments and other issues. On November 13, 2003, the Company entered into a settlement agreementwith Arla that materially extended the fee payment period at rates equaling thehigh-end royalties and provided that Arla supply Spherix with tagatose forNaturlose uses.  The Company settled itsarbitration proceeding.  The Companyincurred approximately $1.5 million in related legal expenses in the years 2002and 2003.

 

In July 2005,Spherix filed an official protest of the U.S. Department of Agriculture’s awardof the National Recreation Reservation System (“NRRS”) contract toReserveAmerica, a TicketMaster subsidiary. The NRRS will provide reservation services for all Federal recreationfacilities, including the National Park sites currently serviced by Spherixunder its ongoing National Park Reservation Service (“NPRS”) contract with theDepartment of Interior.  On October 20,2005, the Government Accountability Office (“GAO”) sustained Spherix’schallenge to the USDA Forest Service award and recommended that the Departmentof Agriculture reopen the competition and make a new award decision.  This is the second time that GAO has foundthe Forest Service’s attempt to award the NRRS contract to ReserveAmerica to beflawed.  The Department of Agriculturesubsequently decided not to follow GAO’s decision and is seeking to proceedwith the award of the NRRS contract to ReserveAmerica.  TheDepartment of Agriculture has agreed not to proceed while the Court of FederalClaims hears Spherix’s appeal.  Meanwhile,the Company’s NPRS contract has been formally extended through September 30,2006.  The Company has operated the NPRScontract for eight years; revenue recognized was $4.0 million, $3.9 million and$4.2 million for the years ended December 31, 2005, 2004 and 2003,respectively, or 17%, 17% and 23% of total revenue for each year.

 

**11.          Employee Benefit Plans**

 

EffectiveJanuary 1, 1990, the Company established the Spherix Incorporated 401(k)Retirement Plan.  The Plan is adiscretionary defined contribution plan and covers substantially all employeeswho have attained the age of 21, have completed one year of service, and haveworked a minimum of 1,000 hours in the past Plan or anniversary year.

 

Underprovisions of the Plan, the Company, for any plan year, has contributed anamount equal to 50% of the participant’s contribution or 21⁄2% of the participant’seligible compensation, whichever is less. The Company may, at its own discretion, make additional matchingcontributions to participants.  Companycontributions, net of forfeitures, amounted to $113,000, $105,000, and $89,000in 2005, 2004, and 2003, respectively.

 

**12.          Employee Stock Purchase Plan**

 

On May 15, 2003, the Company approved an Employee Stock Purchase Planwhereby the employees could purchase shares of the Company’s stock.  The Plan is authorized to initially issue upto 500,000 shares of common stock, with additional amounts determined annuallybased on the terms of the Plan.  The Planbecame available to the employees on January 1, 2004.  In 2005 and 2004, 6,985 and 1,796 shares wereissued under the plan, respectively.  TheBoard of Directors voted to discontinue the plan effective June 30, 2005.

 

**13.          Information by Business Segment**

 

Operatingsegments are components of an enterprise about which separate financialinformation is available that is evaluated regularly by the chief operatingdecision maker, or decision-making group, in deciding how to allocate resourcesand in assessing performance.  TheCompany is managed along two business segments, InfoSpherix and BioSpherix.

 

40

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Financialinformation by business segment for the years ended December 31, 2005, 2004,and 2003 is summarized below:

 
| ** **              | ** ** | ** **                          | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------|------------|-------------------------------------|------------|--------------------------------------------|------------|
| ** **              | ** ** | ** **                          | ** ** | **(Dollars in thousands)**       | ** ** |
| ** **              | ** ** | ** **                          | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Revenues**            |       | InfoSpherix                         |       | $                                          | 23,023     |   | $ | 22,221 |   | $ | 17,054 |   |
|                    |       | BioSpherix                          |       | 23                                         |       | 127 |   | 1,032 |   |
|                    |       | Total revenues                      |       | $                                          | 23,046     |   | $ | 22,348 |   | $ | 18,086 |   |
|                    |       |                                |       |                                       |       |   |   |   |   |
| **Operating Loss and**  |       | InfoSpherix                         |       | $                                          | (1,853     | ) | $ | (2,051 | ) | $ | (787 | ) |
| **Loss Before Income**  |       | BioSpherix                          |       | (1,033                                     | )          | (794 | ) | (1,488 | ) |
| **Taxes**               |       | Total  operating loss               |       | (2,886                                     | )          | (2,845 | ) | (2,275 | ) |
|                    |       | Interest income (expense), net      |       | 37                                         |       | 23 |   | 18 |   |
|                    |       | Loss from operations before         |       |                                       |       |   |   |   |   |
|                    |       | income taxes                        |       | $                                          | (2,849     | ) | $ | (2,822 | ) | $ | (2,257 | ) |
|                    |       |                                |       |                                       |       |   |   |   |   |
| **Identifiable Assets** |       | InfoSpherix                         |       | $                                          | 7,887      |   | $ | 8,012 |   | $ | 5,688 |   |
|                    |       | BioSpherix                          |       | 288                                        |       | 196 |   | 138 |   |
|                    |       | General corporate assets            |       | 4,943                                      |       | 7,036 |   | 8,341 |   |
|                    |       | Total assets                        |       | $                                          | 13,118     |   | $ | 15,244 |   | $ | 14,167 |   |
|                    |       |                                |       |                                       |       |   |   |   |   |
| **Capital**             |       | InfoSpherix                         |       | $                                          | 1,493      |   | $ | 2,941 |   | $ | 2,485 |   |
| **Expenditures**        |       | BioSpherix                          |       | 13                                         |       | 44 |   | 5 |   |
|                    |       | General corporate assets            |       | 2                                          |       | 17 |   | 27 |   |
|                    |       | Total capital expenditures          |       | $                                          | 1,508      |   | $ | 3,002 |   | $ | 2,517 |   |
|                    |       |                                |       |                                       |       |   |   |   |   |
| **Depreciation**        |       | InfoSpherix                         |       | $                                          | 2,401      |   | $ | 2,101 |   | $ | 1,315 |   |
| **and Amortization**    |       | BioSpherix                          |       | 41                                         |       | 24 |   | 27 |   |
|                    |       | General corporate assets            |       | 132                                        |       | 153 |   | 161 |   |
|                    |       | Total depreciation and amortization |       | $                                          | 2,574      |   | $ | 2,278 |   | $ | 1,503 |   |

 

During 2005,InfoSpherix recognized revenue from four of its customers, all of which weregovernment agencies, representing 17%, 16%, 12% and 12% of the total Companyrevenues.  During 2004, InfoSpherixrecognized revenue from three of its customers, all of which were governmentagencies, representing 21%, 17%, and 13% of the total Company revenues.  During 2003, InfoSpherix recognized revenuefrom three of its customers, all of which were government agencies, representing31%, 23%, and 16% of the total Company revenues.  Government contracts accounted forapproximately 100%, 99%, and 95% of the InfoSpherix revenue in 2005, 2004, and2003, respectively.

 

BioSpherix hasinvented and patented for the Company the use of tagatose as a low-caloriesweetener.  In 1996, the Company signedan exclusive worldwide licensing agreement with MD Foods Ingredients (MDFI)amba of Denmark for the use, manufacture and sale of Spherix’s low-caloriesugar, tagatose, as a sweetener (see**Note 10 “Commitmentsand Contingencies”).  In 2000, MDFI wasmerged into Arla Foods.

 

Operating lossconsists of revenue less operating expenses. In computing operating profit, interest expense and income taxes werenot considered.  Operating loss forInfoSpherix was 8%, 9%, and 5% of InfoSpherix revenue for 2005, 2004 and 2003.

 

Identifiableassets by business segment are those assets used in the Company’s operations ineach segment, such as accounts receivable, inventories, fixed assets, andpatent costs.  Corporate assets areprincipally cash and certain other assets not related to a particular segment’soperations.

 

41

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** **

**14.          Selected Quarterly Information (inthousands, except per share data), unaudited**

 

The tablebelow sets forth selected unaudited financial information for each quarter ofthe last two years.

 

 
| ** **                            | ** ** | **Quarter Ended** | ** ** |
|---------------------------------------|------------|------------------------|------------|
| ** **                            | ** ** | **March 31,**     | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| 2004                                  |       |                   |       |   |   |   |   |   |   |
| Revenue                               |       | $                      | 5,053      |   | $ | 6,761 |   | $ | 7,091 |   | $ | 3,443 |   |
| Gross profit                          |       | $                      | 1,218      |   | $ | 2,261 |   | $ | 2,196 |   | $ | (689 | ) |
| Net (loss) income                     |       | $                      | (547       | ) | $ | 192 |   | $ | 294 |   | $ | (2,761 | ) |
| Net (loss) income  per share, basic   |       | $                      | (0.05      | ) | $ | 0.02 |   | $ | 0.02 |   | $ | (0.23 | ) |
| Net (loss) income  per share, diluted |       | $                      | (0.05      | ) | $ | 0.02 |   | $ | 0.02 |   | $ | (0.23 | ) |
|                                  |       |                   |       |   |   |   |   |   |   |
| 2005                                  |       |                   |       |   |   |   |   |   |   |
| Revenue                               |       | $                      | 5,435      |   | $ | 7,064 |   | $ | 6,705 |   | $ | 3,842 |   |
| Gross profit                          |       | $                      | 989        |   | $ | 2,111 |   | $ | 2,170 |   | $ | (152 | ) |
| Net (loss) income                     |       | $                      | (1,073     | ) | $ | 228 |   | $ | 285 |   | $ | (2,288 | ) |
| Net (loss) income  per share, basic   |       | $                      | (0.09      | ) | $ | 0.02 |   | $ | 0.02 |   | $ | (0.19 | ) |
| Net (loss) income  per share, diluted |       | $                      | (0.09      | ) | $ | 0.02 |   | $ | 0.02 |   | $ | (0.19 | ) |

 

**Item 9.****           CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**Item9A.  CONTROLS AND PROCEDURES**

 

*Disclosure Controls and Procedures.*  Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in our Exchange Act reports, such as thisreport on Form 10-K, is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms, and that such informationis accumulated and communicated to our management, including our ChiefExecutive Officer/Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure. These controls and procedures arebased closely on the definition of “disclosure controls and procedures” inRule 13a-15(e) promulgated under the Exchange Act.  Rules adopted bythe SEC require that we present the conclusions of the Chief ExecutiveOfficer/Chief Financial Officer about the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this annualreport.

 

*Limitations on the Effectiveness of Controls.* Management, including our Chief Executive Officer/Chief Financial Officer, donot expect that our disclosure controls and procedures will prevent all errorsand fraud.  In designing and evaluating the disclosure controls andprocedures, management recognized that any controls and procedures, no matterhow well designed and operated, can provide only reasonable, not absolute,assurance of achieving the desired control objectives.  Further, thedesign of a control system must reflect the fact that there are resourceconstraints, and management necessarily was required to apply its judgment inevaluating the cost-benefit relationship of possible controls andprocedures.  Because of the inherent limitations in all control systems,no evaluation of controls can provide absolute assurance that all controlissues and instances of fraud, if any, within the Company have beendetected.  These inherent limitationsinclude the realities that judgments in decision-making can be faulty, and thatbreakdowns can occur because of simple error or mistake.  Additionally, controls can be circumvented bythe individual acts of some persons, by collusion of two or more people, or bymanagement’s override of the control. The design of any system of controls also is based in part upon certainassumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions.  Over time,

 

42

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controls may become inadequatebecause of changes in conditions, or the degree of compliance with the policiesor procedures may deteriorate.  Becauseof the inherent limitations in a cost-effective control system, misstatementsdue to error or fraud may occur and not be detected.

 

*Periodic Evaluation and Conclusion. *  The Company carried out an evaluation, underthe supervision and with the participation of the Company’s management,including the Company’s Chief Executive Officer/Chief Financial Officer, of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures to provide reasonable assurance of achieving their objectivepursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the ChiefExecutive Officer/Chief Financial Officer concluded that the Company’sdisclosure controls and procedures are effective at that reasonable assurancelevel.  There were no significant changesin internal controls during the latest quarter over financial reporting thatmaterially affected, or is reasonably likely to materially affect, internalcontrols over financial reporting.

 

**Item9B.  OTHER INFORMATION**

 

There was noinformation required to be disclosed on Form 8-K during the fourth quarter of2005, which was not so disclosed.

 

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** **

**PART III**

 

**Items 10through 14.**

 

Informationrequired by Part III (Items 10 through 14) of this Form 10-K is incorporated byreference to the Company’s definitive Proxy Statement for the Annual Meeting ofStockholders for the fiscal year ended December 31, 2005, which will be filedwith the Securities and Exchange Commission not later than 120 days after theend of the fiscal year to which this report relates.

 

**PART IV**

 

**Item15.  EXHIBITS, FINANCIAL STATEMENTS,SCHEDULES AND REPORTS ON FORM 8-K**

 
| **(a)**    | **Exhibits** | ** **                                                                                                                                                                                                                          | ** ** |
|------------|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** ** | ** **   | ** **                                                                                                                                                                                                                          |
| (3)        |         | Certificate  of Incorporation and Bylaws of the Company (incorporated by reference to the  Company’s Annual Proxy Statement for meeting held on May 15, 1992, as filed  with the Commission)                                   |
| (3.1)      |         | Articles of  Amendment of the Company (incorporated by reference to the Company’s Proxy  Statement for its May 1996, May 2000, and May 2001 annual meetings, as filed  with the Commission)                                    |
| (10.1)     |         | Summary of  Annual Compensation of Members of the Board of Directors of Spherix  Incorporated                                                                                                                                       |
| (10.2)     |         | Restated  Consulting Agreement dated as of March 23, 2004, by and between Gilbert V.  Levin and the Company (incorporated by reference to Form 10-K filed March 30,  2004)                                                          |
| (10.3)     |         | Restated  Consulting Agreement dated as of November 29, 2005, by and between M. Karen  Levin and the Company (incorporated by reference to Form 8-K filed December  1, 2005)                                                        |
| (10.4)     |         | Amended and  Restated Employment Agreement dated as of March 23, 2004, by and between  Gilbert V. Levin and the Company (incorporated by reference to Form 10-K  filed March 30, 2004)                                              |
| (10.5)     |         | Stock  Purchase Warrant dated as of February 24, 2000 (incorporated by reference to  Form 8-K filed March 3, 2000)                                                                                                                  |
| (10.6)     |         | Agreement  and License between the Company and MD Foods Ingredients Amba (incorporated  by reference to Form 8-K filed October 22, 1996 and Form 10-KSB filed March  31, 1997)                                                      |
| (10.7)     |         | Securities  Purchase Agreement dated as of February 24, 2000, by and between the Company  and RGC International Investors, LDC, c/o Rose Glen Capital Management, L.P.  (incorporated by reference to Form 8-K filed March 3, 2000) |
| (10.8)     |         | Standby  Equity Distribution Agreement dated July 22, 2005, by and between the Company  and Cornell Capital Partners, L.P. (incorporated by reference to Form 8-K  filed July 25, 2005)                                             |
| (10.9)     |         | 1997 Stock  Option Plan (incorporated by reference from the Company’s Proxy Statements  for its May 1998, May 2001 and May 2005 annual meetings, as filed with the  Commission)                                                |
| (10.10)    |         | Rights  Agreement dated as of February 16, 2001, between Spherix Incorporated and  American Stock Transfer and Trust Company (incorporated by reference to Form  8-K filed in March 2001)                                           |
| (10.11)    |         | Amendment to  the September 27, 1996 Agreement and License between the Company and Arla  Foods Ingredients amba (formerly MD Foods Ingredients amba (incorporated by  reference to Form 8-K filed November 17, 2003)                |
| (10.12)    |         | G.V. Levin Exit Agreement  Resolution approved by the Board of Directors on March 23, 2004 (incorporated  by reference to Form 10-K filed March 30, 2004)                                                                           |
| (10.13)    |         | Exit  Agreement dated November 29, 2005, by and between M. Karen Levin and the  Company (incorporated by reference to Form 8-K filed December 1, 2005)                                                                              |
| (23)       |         | Consent of  Independent Registered Public Accounting Firm                                                                                                                                                                           |
| (31)       |         | Certification of Chief Executive Officer/Chief Financial Officer of  Spherix Incorporated pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                                                |
| (32)       |         | Certification of Chief Executive Officer/Chief Financial Officer of  Spherix Incorporated pursuant to Section 906 of the Sarbanes-Oxley Act of  2002                                                                                |
|            |              |                                                                                                                                                                                                                                     |            |  |  |

** **

**44**

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** **

**(b)           Reports on Form 8-K**

 

On November10, 2005, the Company filed a Form 8-K reporting its results of operations forthe period ended September 30, 2005.

 

On November30, 2005, the Company filed a Form 8-K/A reporting sales of its common stockunder the SEDA through that date.

 

On December 1,2005, the Company filed a Form 8-K announcing the retirement of Mrs. M. KarenLevin.

 

**SIGNATURES**

 

                Pursuant to the requirements of Section 13 or15(d) of the Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 
|   | Spherix  Incorporated |   |
|--------|-----------------------|--------|
|   | (Registrant)          |

 

 
| Date:  |  March 27, 2006 |   | By:                                               |  /s/ Richard C. Levin |   |
|--------|----------------------|--------|---------------------------------------------------|----------------------------|--------|
|   |                 |   | Chief  Executive Officer and President, Director, |
|   |                 |   | and Chief Financial Officer                       |

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.

 

 
| /s/ Douglas  T. Brown        |   | Director                      |   | March 27,  2006 |
|------------------------------|--------|-------------------------------|--------|-----------------|
| Douglas T.  Brown            |   |                          |   |            |
|                         |   |                          |   |            |
|                         |   |                          |   |            |
| /s/ A. Paul  Cox, Jr.        |   | Director                      |   | March 27,  2006 |
| A. Paul Cox,  Jr.            |   |                          |   |            |
|                         |   |                          |   |            |
|                         |   |                          |   |            |
| /s/ George  C. Creel         |   | Director                      |   | March 27,  2006 |
| George C.  Creel             |   |                          |   |            |
|                         |   |                          |   |            |
|                         |   |                          |   |            |
| /s/ Gilbert  V. Levin        |   | Chair,  Executive Officer     |   | March 27,  2006 |
| Gilbert V.  Levin            |   | for Science                   |   |            |
|                         |   |                          |   |            |
|                         |   |                          |   |            |
| /s/ M. Karen  Levin          |   | Director                      |   | March 27,  2006 |
| M. Karen  Levin              |   |                          |   |            |
|                         |   |                          |   |            |
|                         |   |                          |   |            |
| /s/ Richard  C. Levin        |   | CEO and  President, Director, |   | March 27,  2006 |
| Richard C.  Levin            |   | and Chief  Financial Officer  |   |            |
|                         |   |                          |   |            |
|                         |   |                          |   |            |
| /s/ Robert  A. Lodder, Jr.   |   | Director                      |   | March 27,  2006 |
| Robert A.  Lodder, Jr.       |   |                          |   |            |
|                         |   |                          |   |            |
|                         |   |                          |   |            |
| /s/ Robert  J. Vander Zanden |   | Director                      |   | March 27,  2006 |
| Robert J.  Vander Zanden     |   |                          |   |            |

 

45

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