10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

ü	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the period ended: September 30, 2004
	OR
o	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 000-26460

SPATIALIZER AUDIO LABORATORIES, INC.

(Exact name of registrant as specified in its charter)

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

2625 Townsgate Road, Suite 330
Westlake Village, California 91361

(Address of principal executive offices)

1754 Technology Drive, Suite 125
San Jose, California 95110

(Address of principal corporate offices)

Telephone Number: (408) 453-4180

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:

Yes ü                                                                                               No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act):

Yes o                                                                                               No ü

As of October 28, 2004, there were 46,975,365 shares of the Registrant’s Common Stock outstanding.

TABLE OF CONTENTS

		CONSOLIDATED BALANCE SHEETS
		CONSOLIDATED STATEMENTS OF OPERATIONS
		CONSOLIDATED STATEMENT OF CASH FLOWS
		CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
		Notes to Consolidated Financial Statements
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
PART II. OTHER INFORMATION
	ITEM 1. LEGAL PROCEEDINGS
	ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
	ITEM 3. DEFAULTS UPON SENIOR SECURITIES
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
	ITEM 5. OTHER INFORMATION
	ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
Exhibit 10.5
Exhibit 31.1
Exhibit 32.1

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	September 30,			December 31,
	2004			2003
	(unaudited)
ASSETS
Current Assets:
Cash and Cash Equivalents	$	920,047		$	589,797
Accounts Receivable, net		208,029			345,411
Prepaid Expenses and Deposits		95,074			35,430
Total Current Assets		1,223,150			970,638
Property and Equipment, net		33,868			42,022
Intangible Assets, net		167,650			192,485
Total Assets	$	1,424,668		$	1,205,145
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Notes Payable to Related Party, Short Term		37,500			37,500
Note Payable		36,745			—
Accounts Payable		17,221			21,466
Accrued Wages and Benefits		39,898			36,973
Accrued Professional Fees		15,000			20,000
Accrued Commissions		38,548			33,856
Accrued Expenses		32,196			28,197
Deferred Income		547,953			—
Total Current Liabilities		765,061			177,992
Notes Payable to Related Party, Long Term		30,831			70,746
Commitments and Contingencies
Series B-1, Redeemable Convertible Preferred shares, $.01 par value, 1,000,000 shares authorized, 102,762 shares issued and outstanding at September 30, 2004 and December 31, 2003.		1,028			1,028
Shareholders’ Equity:
Common shares, $.01 par value, 65,000,000 shares authorized, 46,975,365 shares issued and outstanding at September 30, 2004 and December 31, 2003.		469,754			470,159
Additional Paid-In Capital		46,429,020			46,428,615
Accumulated Deficit		(46,271,026	)		(45,943,395	)
Total Shareholders’ Equity		627,748			955,379
	$	1,424,668		$	1,205,145

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

	For the Three Month Period Ended						For the Nine Month Period Ended
	September 30,			September 30,			September 30,			September 30,
	2004			2003			2004			2003
Revenues :
License Revenues	$	—		$	—		$	—		$	—
Royalty Revenues		205,324			341,339			610,863			924,619
Product Revenues		—			—			—			—
		205,324			341,339			610,863			924,619
Cost of Revenues		26,114			35,147			61,252			93,586
Gross Profit		179,210			306,192			549,611			831,033
Operating Expenses:
General and Administrative		155,268			193,293			528,181			585,830
Research and Development		93,842			122,145			295,630			333,289
Sales and Marketing		11,484			93,488			46,962			295,180
		260,594			408,926			870,773			1,214,299
Operating (Loss)		(81,384	)		(102,734	)		(321,162	)		(383,266	)
Interest and Other Income		744			1,444			2,633			5,908
Interest and Other Expense		(1,936	)		(2,812	)		(8,702	)		(10,634	)
		(1,192	)		(1,368	)		(6,069	)		(4,726	)
(Loss) Before Income Taxes		(82,576	)		(104,102	)		(327,231	)		(387,992	)
Income Taxes		2,000			(2,400	)		(400	)		(5,420	)
Net (Loss)	$	(80,576	)	$	(106,502	)	$	(327,631	)	$	(393,412	)
Basic and Diluted(Loss) Per Share	$	(0.00	)	$	(0.00	)	$	(0.01	)	$	(0.01	)
Weighted Average Shares Outstanding		46,975,365			47,406,939			46,975,365			47,406,939

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)

	Nine Months Ended
	September 30,
	2004			2003
Cash Flows from Operating Activities:
Net (Loss)	$	(327,631	)	$	(393,412	)
Adjustments to reconcile net (loss) to net cash provided by (used in) operating activities:
Depreciation and Amortization		52,816			65,980
Net Change in Assets and Liabilities:
Accounts Receivable and Employee Advances		137,382			172,079
Prepaid Expenses and Deposits		(59,644	)		(14,854	)
Note Payable					36,745
Accounts Payable		(4,245	)		1,711
Accrued Wages and Benefits		2,925			—
Accrued Professional Fees		(5,000	)		—
Accrued Commissions		4,692			—
Accrued Expenses		3,999			(28,528	)
Deferred Income		547,953			—
Net Cash Provided By (Used In) Operating Activities		389,992			(197,024	)
Cash Flows from Investing Activities:
Purchase/Disp of Property and Equipment		(3,247	)		(3,680	)
Increase in Capitalized Patent and Technology Costs		(16,580	)		(1,030	)
Net Cash Provided By (Used in) Investing Activities		(19,827	)		(4,710	)
Cash flows from Financing Activities:
Repayment of Notes Payable		(39,915	)		—
Net Cash Provided by Financing Activities		(39,915	)		—
Increase (Decrease) in Cash and Cash Equivalents		330,250			(201,734	)
Cash and Cash Equivalents, Beginning of Period		589,797			858,725
Cash and Cash Equivalents, End of Period	$	920,047		$	656,991
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest	$	10,149		$	10,632
Income Taxes		400			5,420

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(unaudited)

	Common Shares									Total
	Number of				Additional		Accumulated			Shareholders’
	shares		Par value		paid-in-capital		Deficit			Equity
Balance, December 31, 2003		47,015,865	$	470,159	$	46,428,615	$	(45,943,395	)	$	955,379
Issuance of Preferred Shares, Net		—		—		—		—			—
Options Exercised		—		—		—		—			—
Warrants Exercised		—		—		—		—			—
Options Issued for Services		—		—		—		—			—
Conversion of Preferred Shares, Net		—		—		—		—			—
Net (Loss)		—		—		—		(123,796	)		(123,796	)
Balance, March 31, 2004		47,015,865	$	470,159	$	46,428,615	$	(46,067,191	)	$	831,583
Net (Loss)								(123,259	)	$	(123,259	)
Cancellation of Unissued Performance Shares		-40,500		-405		405
Balance, June 30, 2004		46,975,365		469,754		46,429,020		(46,190,450	)		708,324
Net (Loss)								(80,576	)		(80,576	)
Balance, September 30, 2004		46,975,365		469,754		46,429,020		(46,271,026	)		627,748

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(1) Nature of Business

     Spatializer Audio Laboratories, Inc. and subsidiaries (the “Company”) is in the business of developing and licensing technology. The Company’s sales, research and subsidiary administration are conducted out of facilities in San Jose, California.

     The Company’s wholly-owned subsidiary, Desper Products, Inc. (“DPI”), is in the business of developing proprietary advanced audio signal processing technologies and products for consumer electronics, entertainment, and multimedia computing. All Company revenues are generated from this subsidiary.

     The foregoing interim financial information is unaudited and has been prepared from the books and records of the Company. The financial information reflects all adjustments necessary for a fair presentation of the financial condition, results of operations and cash flows of the Company in conformity with generally accepted accounting principles. All such adjustments were of a normal recurring nature for interim financial reporting. Operating results for the three and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. Accordingly, your attention is directed to footnote disclosures found in the December 31, 2003 Annual Report and particularly to Note 1, which includes a summary of significant accounting policies.

(2) Significant Accounting Policies

     Basis of Consolidation — The consolidated financial statements include the accounts of Spatializer Audio Laboratories, Inc. and its wholly-owned subsidiary, Desper Products, Inc. All significant intercompany balances and transactions have been eliminated in consolidation. Corporate administration expenses are not allocated to subsidiaries.

     Revenue Recognition — The Company recognizes revenue from product sales upon shipment to the customer. License revenues are recognized when earned, in accordance with the contractual provisions. Royalty revenues are recognized upon shipment of products incorporating the related technology by the original equipment manufacturers (OEMs) and foundries.

     Deferred Revenue — The Company receives License Fee advances from certain customers in accordance with contract terms. The Company does not require advances from all customers. Advances are negotiated on a per contract basis. Cash received in advance of revenue earned from a contract is recorded as deferred revenue until the related contract revenue is earned under the Company’s revenue recognition policy.

     Concentration of Credit Risk — Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash, cash equivalents and trade accounts receivable. The Company places its temporary cash investments in certificates of deposit in excess of FDIC insurance limits, principally at CitiBank FSB. At September 30, 2004 substantially all cash and cash equivalents were on deposit at two financial institutions.

     At September 30, 2004, four major customers, not presented in order of importance, each accounted for 10% or more of our total accounts receivable: Matsushita, Toshiba, InterVideo

and Sharp, each of whom accounted for greater than 10% of our total 2004 accounts receivable. One OEM accounted for 38%, another accounted for 17%, another accounted for 16% and one accounted for 15% of our total accounts receivable at September 30, 2004.

     The Company performs ongoing credit evaluations of its customers and normally does not require collateral to support accounts receivable. Due to the contractual nature of sales agreements and historical trends, no allowance for doubtful accounts has been provided.

     The Company does not apply interest charges to past due accounts receivable.

     Cash and Cash Equivalents — Cash equivalents consist of highly liquid investments with original maturities of three months or less.

     Customers Outside of the U.S. — Sales to foreign customers were 88% and 100% of total sales in the year to date periods ended September 30, 2004 and 2003, respectively. Approximately 54% and 42% of sales were generated in Japan and Korea, respectively.

     Major Customers — During the quarter ended September 30, 2004, four customers accounted for 42%, 19%, 13% and 12%, respectively, of the Company’s net sales.

     Research and Development Costs — The Company expenses research and development costs as incurred, which is presented as a separate line on the statement of operations.

     Property and Equipment — Property and equipment are stated at cost. Major renewals and improvements are charged to the asset accounts while replacements, maintenance and repairs, which do not improve or extend the lives of the respective assets, are expensed. At the time property and equipment are retired or otherwise disposed of, the asset and related accumulated depreciation accounts are relieved of the applicable amounts. Gains or losses from retirements or sales are credited or charged to income. Property and equipment are depreciated over the useful lives of the asset ranging from 3 years to 5 years under the straight line method.

     Intangible Assets — Intangible assets consist of patent costs and trademarks which are amortized on a straight-line basis over the estimated useful lives of the patents which range from five to twenty years. The weighted average useful life of patents was approximately 12 years.

     Earnings Per Share — Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The following table presents contingently issuable shares, options and warrants to purchase shares of common stock that were outstanding during the three month periods ended September 30, 2004 and 2003 which were not included in the computation of diluted loss per share because the impact would have been antidilutive or less than $0.01 per share:

	2004		2003
Options		3,135,000		2,771,500
Warrants		0		0
		3,135,000		2,771,500

During the three months ended September 30, 2004, no options to purchase shares of the Company’s common stock were granted.

     Impairment of Long-Lived Assets and Assets to be Disposed of - The Company adopted the provisions of SFAS No. 1, Accounting for the Impairment of Long-Lived Assets on January 1, 2002. This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amounts of the assets exceed the fair value of the assets.

     Segment Reporting - The Financial Accounting Standards Board issued Statement No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS No. 131”), in June 1997. SFAS No. 131 establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires enterprises to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. It replaces the “industry segment” concept of SFAS No. 14, Financial Reporting for Segments of a Business Enterprise, with a “management approach” concept as to basis for identifying reportable segments. SFAS 131 is effective for financial statements for fiscal years beginning after December 15, 1997. The Company adopted SFAS 131 in December 1997. MDT is considered a discontinued operation as of September 1998. As of September 30, 2004, the Company has only one operating segment, DPI, the Company’s Audio Signal Processing business.

     Income Taxes - Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

     Recent Accounting Pronouncements - The FASB recently issued the following statements: FASB 146 — Accounting for Costs Associated with Exit or Disposal Activities, FASB 147 — Acquisitions of Certain Financial Institutions, FASB 148 - - Accounting for Stock-Based Compensation, FASB 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity and FASB Interpretation 46 “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51”. These FASB statements did not, or are not expected to, have a material impact on the Company’s financial position and results of operations.

     Use of Estimates - Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.

     Fair Value of Financial Instruments - The fair and carrying values of cash equivalents, accounts receivable, accounts payable, short-term debt to a related party and accrued liabilities and those potentially subject to valuation risk at December 31, 2003 and September 30, 2004 approximated fair value due to their short maturity or nature.

     The fair values of notes payable to a related party at December 31, 2003 and September 30, 2004 are materially consistent with the related carrying values based on current rates offered to the Company for instruments with similar maturities.

(3) Property and Equipment

     Property and equipment, as of December 31, 2003 and September 30, 2004, consists of the following, net of a reserve for impairment loss in 1998 in accordance with application of SFAS 121:

	September 30, 2004		December 31, 2003
Office Computers, Software, Equipment and Furniture	$	331,866	$	309,744
Test Equipment		73,300		73,300
Tooling Equipment		45,539		45,539
Trade Show Booth and Demonstration Equipment		174,548		171,301
Automobiles		7,000		7,000
Total Property and Equipment		632,253		606,884
Less Accumulated Depreciation and Amortization		598,385		564,862
Property and Equipment, Net	$	33,868	$	42,022

(4) Intangible Assets

     Intangible assets, as of December 31, 2003 and September 30, 2004 consist of the following:

	September 30, 2004		December 31, 2003
Capitalized Patent, Trademarks and Technology Costs	$	522,068	$	505,487
Less Accumulated Amortization		354,418		313,002
Intangible Assets, Net	$	167,650	$	192,485

     Estimated amortization is as follows:

2004	$	29,563
2005	$	25,733
2006	$	16,702
2007	$	16,702
Thereafter	$	78,950
		167,650

(5) Notes Payable to Related Parties

     The Company was indebted to the Desper Family Trust, a related party, in the amount of $68,331 at September 30, 2004. The Desper Family Trusts’ principle beneficiary is the mother of a former Director of the Company. In the fourth quarter of 2003, in response to the calling of the Note by the holder, we negotiated and completed the conversion of the original $112,500 related party 10% demand note to a three- year 10% term note. This amount bears interest at a fixed rate of 10% annually, is paid in monthly installments of $5,191 that commenced on December 1, 2003 and continues for twenty-four months until the entire balance of principal and interest is paid in full.

(6) Note Payable

     The Company was indebted to the Premium Finance, Inc., an unrelated insurance premium finance company, in the amount of $36,745 at September 30, 2004. This note finances the Company’s annual Directors’ and Officers’ Liability Insurance. This amount bears interest at a fixed rate of 8% annually, is paid in monthly installments of $5,191 that commenced on June 1, 2004 and continues for nine months until the entire balance of principal and interest is paid in full.

(7) Shareholders’ Equity

     During the quarter ended September 30, 2004, no shares were issued, cancelled or converted.

     During the year ended December 31, 2003, shares were issued or converted as follows:

An employee exercised options to purchase 166,666 shares of common stock in 2003, increasing shareholders’ equity by $10,000.

Capitalization

Series A Preferred Stock: On December 26, 2002 the Company filed a Certificate of Elimination with the Delaware Secretary of State stating that no shares of the Company’s Series A Preferred Stock are outstanding and that no shares of the Series A Preferred Stock will be issued.

Series B Preferred Stock: On December 26, 2002 the Company filed a Certificate of Elimination with the Delaware Secretary of State stating that no shares of the Company’s Series B Preferred Stock are outstanding and that no shares of the Series B Preferred Stock will be issued.

Series B-1 Redeemable Convertible Preferred Stock: On November 6, 2002 the Board of Directors designated a Series B-1 Preferred Stock. The series has a par value of $0.01 and a stated value of $10.00 per share which is designated as a liquidation preference. The stock ranks prior to the Company’s common stock. No dividends will be paid on the Series B-1 Preferred Stock. Conversion rights exist on or after January 1, 2003 to convert the Series B-1 Preferred Stock to common at a certain formula. At December 29, 2005 certain mandatory conversion requirements exist subject to a certain formula. The Series B-1 Preferred Stock has no voting power. Certain restrictions on trading exist based on date sensitive events. In December 2002, 87,967 shares of Series B-1 Preferred Stock were issued in exchange for the Series B Preferred Stock and 14,795 shares were issued in lieu of the adjusted accrued dividends on the Series B Preferred Stock.

(8) Escrowed Performance Shares

In December 1996, the Company accepted the terms outlined by the British Columbia Securities Commission (“BCSC”) for the release of the Company’s 5,776,700 escrowed “Performance Shares” from Canadian Escrow into a new escrow arrangement with the Company. The overall modification was approved by the Company’s stockholders in August 1996. Under the revised arrangement, the performance shares were released automatically as follows: 20% prior to June 22, 2000, 20% on June 22, 2000; 30% on June 22, 2001; and 30% on June 22, 2002. Under the revised escrow arrangement, the performance shares vested, provided the individual had not voluntarily terminated his/her relationship with the Company prior to applicable vesting dates.

Based on the revised escrow arrangement, which primarily converted the escrow shares

release from performance criteria to a time-based criterion, the Company recorded as compensation expense the excess of the fair market value of the 5,776,700 performance shares on the date the Company accepted the terms of the new escrow arrangement over the purchase price of such escrow shares.

All of the performance shares are included in the issued and outstanding shares for the years ended December 31, 2003, 2002 and 2001. However, the shares were not reflected in the calculation of loss per common share until earned by and released to the holders on December 30, 1996, the date on which the Company and the BCSC accepted and entered into the terms of the current escrowed agreement as discussed above. As of December 31, 2002, all performance shares under the escrow arrangement have been released. In December 2003 and June 2004, 557,740 and 40,500 shares, respectively, of former employees or participants, who lost entitlement to such shares under the terms of the escrow arrangement, were cancelled.

(9) Stock Options

     In 1995, the Company adopted a stock option plan (the “Plan”) pursuant to which the Company’s Board of Directors may grant stock options to directors, officers and employees. The Plan which was approved by the stockholders authorizes grants of options to purchase authorized but unissued common stock up to 10% of total common shares outstanding at each calendar quarter, 4,697,537 as of September 30, 2004. Stock options are granted with an exercise price equal to the stock’s fair market value at the date of grant. Stock options have five-year terms and vest and become fully exercisable up to three years from the date of grant.

     At September 30, 2004, there were 1,562,537 additional shares available for grant under the Plan.

     There were 200,000 options granted in the quarter ended September 30, 2004 to board members for board compensation and 100,000 shares granted to board members in 1999 expired.

     The Company applies APB Opinion No. 25 in accounting for its Plan and, accordingly, no compensation cost has been recognized for the fair value of its stock options in the consolidated financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company’s net income (loss) would have been increased to the pro forma amounts indicated below:

	2004
NET INCOME (LOSS):
As Reported	$	(327,631	)
Pro Forma	$	(327,631	)
BASIC AND DILUTED LOSS:
As Reported	$	(0.01	)
Pro Forma	$	(0.01	)

     At September 30, 2004, the number of options exercisable was 3,135,000 and the weighted-average exercise price of those options was $0.178.

     There were no warrants outstanding at December 31, 2003 and September 30, 2004.

(10) Commitments and Contingencies

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

Operating Lease Commitments

     The Company is obligated under several non-cancelable operating leases. Future minimum rental payments at September 30, 2004 for all operating leases were approximately $5,400 through December 2004. Rent expense amounted to approximately $5,400 and $21,000 for the quarters ended September 30, 2004 and 2003, respectively.

(11) Profit Sharing Plan

     The Company has a 401(k) profit sharing plan covering substantially all employees, subject to certain participation and vesting requirements. The Company may elect to make discretionary contributions to the Plan, but has never done so over the life of the Plan.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This information should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, the audited consolidated financial statements and the notes thereto included in the Form 10-K and the unaudited interim consolidated financial statements and notes thereto included in this report.

Approach to MD&A

     The purpose of MD&A is to provide our shareholders and other interested parties with information necessary to gain an understanding of our financial condition, changes in financial condition and results of operations. As such, we seek to satisfy three principal objectives:

• to provide a narrative explanation of a Company’s financial statements that enables investors to see the company through the eyes of management;

• to enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and

• to provide information about the quality of, and potential variability of, a company’s earnings and cash flow, so that investors can ascertain the likelihood that past performance is indicative of future performance.

     We believe the best way to achieve this is to give the reader:

• An understanding of our operating environment

• An outline of critical accounting policies

• A review of the key components of the financial statements and our cash position and capital resources

• Disclosure on our internal controls and procedures

Operating Environment

     We operate in a very competitive business environment. This environment impacts us in the following ways, further discussed in greater detail under Risk Factors:

• Our Operating Results Fluctuate and If We Are Unable to Achieve or Sustain Profitability in the Future or Obtain Future Financing Our Business Operations May Fail.

• Because The Market In Which We Operate Is Highly Competitive, We Face Significant Pricing Pressure and Competition.

• We Rely on the Schedules and Cooperation of Chip Makers or Other Third Parties to Deliver Our Technology in Consumer Products. These Third parties Have Their Own Priorities and Alliances that May Delay or Thwart our Sales Efforts to Potential Customers.

• If New Product Development Is Delayed, We Will Experience Delays In Revenues And Competitive Products May Reach The Market Before Our Products.

• If We Are Unable To Attract And Retain Our Key Personnel, We May Not Be Able To Successfully Operate Our Business.

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

The personal computer (PC) and consumer electronics markets are under intense pressure, primarily from retailers, to reduce selling prices, with resultant pressure to reduce costs. Cost reductions are driven by lower cost sourcing, often in China, design simplification and reduction in features. While we present a value proposition that stresses the cost reducing capabilities of our audio solutions through improved performance from lower cost components as well as product differentiation that Spatializer technology can deliver, all such features are closely scrutinized by potential customers’ product marketing and engineering. This makes it more challenging to secure new design wins, particularly in product categories that have become commoditized, such as became the case with DVD players. It also may result in the elimination of features, including ours, if cost is of paramount importance. When this occurs, we receive very short notice and revenues from such an account will typically begin a steep decline in the subsequent quarter, resulting in period-to-period fluctuation. Our response has been to strengthen our value proposition, more aggressively price and feature enrich our products and enter new segments, such as cell phones, with different competitive pressure.

Manufacturer’s design-in cycles for our technology range from four to twelve months, from

the decision to adopt our technology to actual cash flow to us. These schedules are also prone to delays at the manufacturer level and in some cases, manufacturer’s new products may be cancelled due to market testing or resource allocation. Since these events are beyond our control, it is difficult to absolutely project when new deals will begin generating revenues or if signed deals will generate financial results. For this reason, we do not typically announce new deals until the target product is being introduced.

Spatializer does not develop or market semiconductors. That is why we carry no inventory or have order backlogs that typically are good indicators of near term performance. Rather, we develop audio algorithms that are embedded on third party processors or semiconductors used by our customers. While our algorithms are implemented on a wide array of processors, often times a customer uses a processor where there is no such implementation, or where a competing solution has been implemented. In this case, our customers request that our algorithm be implemented. While these requests are typically honored, processor manufacturers must schedule such implementation as their resources or corporate strategies allow. Therefore, the supply-chain is often quite long and complicated, which potentially can result in delays or deadlines that may not always coincide with our customer’s requirements and which are beyond the control of our company.

Therefore, when reviewing the operating results or drawing conclusions with regard to future performance, these competitive forces and uncertainties must be taken into consideration. Without absolute long-term visibility, it is difficult to draw such conclusions in absolute terms. Further, the dynamic nature of the business environment creates the potential for both positive and negative fluctuations in near and long term operating performance. While management strives to mitigate these risks, as outlined in Risk Factors, it is not possible to be fully immune from such dynamics.

Critical Accounting Policies

     Our discussion and analysis of our financial condition and results of operations are based upon our consolidated statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses based on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. In consultation with our Board of Directors and Audit Committee, we have identified three accounting policies that we believe are critical to an understanding of our financial statements. These are important accounting policies that require management’s most difficult, subjective judgments.

     The first critical accounting policy relates to revenue recognition. We recognize revenue from product sales upon shipment to the customer. License revenues are recognized when earned, in accordance with the contractual provisions. Royalty revenues are recognized upon shipment of products incorporating the related technology by the original equipment manufacturers (OEMs) and foundries.

     The second critical accounting policy relates to research and development expenses. We expense all research and development expenses as incurred. Costs incurred to establish the technological feasibility of our algorithms (which is the primary component of our licensing) is expensed as incurred and included in Research and Development expenses. Such algorithms are refined based on customer requirements and licensed for inclusion in the customer’s specific product. There are no production costs to capitalize as defined in Statement on Financial Accounting Standards No. 86.

     The third critical accounting policy relates to intangible assets. Our intangible assets consist primarily of patents. We capitalize all costs directly attributable to patents, consisting primarily of legal and filing fees, and amortize such costs over the remaining life of the patent (which range from 3 to 20 years) using the straight-line method. In accordance with SFAS 142, “Goodwill and Other Intangible Assets”, only intangible assets with definite lives are amortized. Non-amortized intangible assets are instead subject to annual impairment testing.

     Audit Committee

     This committee is directed to review the scope, cost and results of the independent audit of our books and records, the results of the annual audit with management and the internal auditors and the adequacy of our accounting, financial, and operating controls; to recommend annually to the Board of Directors the selection of the independent auditors; to approve proposals made by our independent auditors for consulting work; and to report to the Board of Directors, when so requested, on any accounting of financial matters.

Additionally, following the completion of the audit, the committee meets with the independent accountants to review with the independent accountants any problems or difficulties the accountants may have encountered in connection with the audit, the adequacy of the internal accounting controls, the financial and accounting personnel and any management letter provided by the independent accountants and the Company’s response to that letter. The committee also discusses with the independent accountants any matters that are required to be discussed under applicable rules, including without limitation those matters required to be discussed by Statement on Auditing Standards No. 61 relating to the conduct of the audit.

     Compensation and Stock Committee

     Our Compensation and Stock Option Committee (the “Compensation Committee”) currently consists of Messrs. Pace and Segel, each of whom is a non-employee director of the Company and a “disinterested person” with respect to the plans administered by such committee, as such term is defined in Rule 16b-3 adopted under the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder (collectively, the “Exchange Act”). The Compensation Committee reviews and approves annual salaries, bonuses and other forms and items of compensation for our senior officers and employees. Except for plans that are, in accordance with their terms or as required by law, administered by the Board of Directors or another particularly designated group, the Compensation Committee also administers and implements all of our stock option and other stock-based and equity-based benefit plans (including performance-based plans), recommends changes or additions to those plans or awards under the plans.

     Special Committee

In November of 2002, the Board of Directors created a Special Committee to review certain strategic opportunities as they arise and to obtain additional information regarding such opportunities for consideration and evaluation by the Board of Directors.

Results of Operations

     This report contains forward-looking statements, within the meaning of the Private Securities Reform Act of 1995, which are subject to a variety of risks and uncertainties. Our actual results, performance, or achievements may differ significantly from the results, performance, or achievements expressed or implied in such forward-looking statements.

Revenues

     Revenues for the three months ended September 30, 2004 were $205,000, compared to revenues of $341,000 in the comparable period last year, a decrease of 40%. Revenues in the three months ended September 30, 2004 were lower due to a DVD OEM account with one manufacturer in 2003 for which there was no comparable account in the current period. Revenues in the nine months ended September 30, 2004 were $611,000, compared to revenues of $925,000 in the comparable period last year, a decrease of 34%.The decline in revenue resulted from the expiration of a licensing agreement with a major computer account in January 2003 ($125,000 reduction) and the inability to replace a prior year DVD OEM account in the current nine month period This was partially offset by an increase in revenues from cell phone accounts.

Gross Profit

     Gross profit for the three months ended September 30, 2004 was $179,000 (87% of revenue) compared to gross profit of $306,000 (90% of revenue) in the comparable period last year, a decrease of 42%. Gross profit for the nine months ended September 30, 2004 were $550,000 (90% of revenue) compared to $831,000 (90% of revenue) in the comparable period last year. Gross profit in the three and nine-month periods decreased primarily due to the decrease in revenue. Gross margin decline in the current three month period resulted from a portion of royalty paid and expensed on deferred revenue.

Operating Expenses

     Operating expenses in the three months ended September 30, 2004 were $261,000 (127% of revenue) compared to operating expenses of $409,000 (120% of revenue) in the comparable period last year, a decrease of 36%. Operating expenses in the nine months ended September 30, 2004 were $871,000 (143% of revenue) compared to $1,214,000 (131% of revenue) in the comparable nine-month period last year. The decrease in operating expenses for the three and nine months ended September 30, 2004 resulted primarily from reductions in occupancy and headcount effected in the fourth quarter of 2003.

General and Administrative

     General and administrative expenses in the three months ended September 30, 2004 were $155,000 (76% of revenue) compared to general and administrative expenses of $193,000 (57% of revenue) in the comparable period last year, a decrease of 20%. General and administrative expenses in the nine-months ended September 30, 2004 were $528,000 (86% of revenue) compared to $586,000 (63% of revenue) in the comparable nine-month period last year. The decrease in general and administrative expense for the three and nine month periods resulted primarily from reductions in occupancy and support services, partially offset by higher legal and accounting expenses arising from new regulatory public company requirements and higher executive overseas travel by the chief executive to secure additional contracts with manufacturers and to maintain existing relationships with our customers.

Research and Development

     Research and Development expenses in the three months ended September 30, 2004 were $94,000 (46% of revenue) compared to research and development expenses of $122,000 (36% of revenue) in the comparable period last year, a decrease of 23%. Research and Development expenses for the nine months ended September 30, 2004 were $296,000 (48% of revenue) compared to $333,000 (36% of revenue) in the comparable nine-month period last year. The decrease in three and nine-month research and development expenses resulted from lower cost Silicon Valley facilities, and greater use of lower cost off-shore applications engineering, rather than domestic contracting compared with the prior period.

Sales and Marketing

     Sales and Marketing expenses in the three months ended September 30, 2004 were $11,000 (5% of revenue) compared to sales and marketing expenses of $93,000 (27% of

revenue) in the comparable period last year, a decrease of 88%. Sales and Marketing expenses for the nine months ended September 30, 2004 were $47,000 (8% of revenue) compared to $295,000 (32% of revenue) in the comparable nine-month period last year. The decrease in sales and marketing expense in the three and nine-month periods resulted primarily from the elimination of a senior sales executive position ($50,000/$150,000), transition of Japan sales to a commission only structure ($20,000/$60,000 and lower cost Silicon Valley facilities ($12,000/$40,000).

Net (Loss)

     Net loss in the three months ended September 30, 2004 was ($81,000), ($0.00) basic per share, compared with net loss of ($107,000), ($0.00) basic per share in the comparable period last year. Net loss in the nine months ended September 30, 2004 was ($328,000), ($0.01) basic per share, compared with net loss of ($393,000), ($0.01) basic per share in the comparable period last year. The net loss resulted from decreased revenues, partially offset by lower operating expenses.

Liquidity and Capital Resources

     At September 30, 2004, we had $920,000 in cash and cash equivalents as compared to $590,000 at December 31, 2003. The increase in cash and cash equivalents results from a royalty advance received in the third quarter, partially offset by the net loss. We had working capital of $458,000 at September 30, 2004 as compared with working capital of $792,000 at December 31, 2003.

     In the fourth quarter of 2003, we negotiated and completed the conversion of a $112,500 related party 10% demand note to a three-year 10% term note. Principal and interest of $5,191 is paid monthly, which we pay on a current basis. Installments due in more than twelve months are classified as Notes Payable to Related Parties-long-term.

     We continue to maintain an accrual for unasserted claims or settlement costs of approximately $28,000. We do not expect any final liability to be in excess of this balance.

     We currently believe our future cash flow will come primarily from the audio signal processing licensing, original equipment manufacturers’ (OEM) royalties and from possible common stock issuances including warrants and options. We are actively engaged in negotiations for additional audio signal processing licensing arrangements which we believe should generate additional cash flow without imposing any substantial costs on us. We announced two new licensing arrangements in the cellular phone market and expect this category to expand in 2004. We are also targeting other markets where the cost pressure is not as acute and which might be more receptive to licensing our products.

     We anticipated that there would be a wind down of our licensing program in 2003 with a large computer account and reductions in licensing to DVD accounts that are under extreme pressure to reduce costs. We anticipate that there may continue to be dislocations of individual licensing programs due to continuing pressure to reduce costs, particularly in the DVD player segment.

     We believe that growth from other licensing arrangements, which include new markets such as cellular phones, and other arrangements that are pending but not announced or in negotiation, will substantially offset any revenue shortfalls from market dynamics or

transitioning platforms. Further, we anticipate that our cost reduction initiative implemented in the fourth quarter of 2003 will lower the revenues needed to reach the break-even point.

     To the extent we maintain or exceed our projected revenues and are not required to fund significant contingencies, we expect to continue to retain our current cash reserves and therefore, maintain our liquidity position at a consistent level both on at least a short-term basis. However, to the extent that we do not achieve current projected operating levels, fail to close deals in process timely or are required to fund contingencies, we will be required to use our cash reserves and this will negatively impact our longer term liquidity. We believe our current cash reserves and cash generated from our existing operations and customer base are at a minimal level for us to meet our operating obligations and the anticipated additional research and development for our audio technology business for the short term. This constrained working capital currently limits our ability to capitalize fully on market opportunities and to compete as rigorously as we would like. Indeed, a continued deterioration in our cash position will, absent new financing or licensing arrangements, impair our ability to operate as a going concern. If we do not achieve current projected operating levels, our current cash reserves may be depleted within    months. In such case, we may have to rely on the sale of equity, debt or convertible debt financings in the future, which may have a dilutive effect on our existing shareholders. Further, we cannot assure you that debt or equity financing will be available as required and if not available, we would have to further scale down operations or even cease operations.

     We will continue to consider and evaluate capital investment or business arrangements with financial or strategic participants or investors as such opportunities become available to us on terms that enhance shareholder value and support our business strategy.

Net Operating Loss Carry Forwards

     At December 31, 2003, we had net operating loss carry forwards for Federal income tax purposes of approximately $27,000,000 which are available to offset future Federal taxable income, if any, through 2023. Approximately $17,000,000 of these net operating loss carry forwards are subject to an annual limitation of approximately $1,000,000.

Risk Factors

     Certain information in this report includes forward-looking statements. Forward-looking statements include statements regarding our expectations, beliefs, intentions, plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements that are other than statements of historical fact. When used in this report the words “shall,” “should,” “forecast,” “all of,” “projected,” “believes,” “anticipates,” “expects,” and similar expressions are intended to identify these forward-looking statements. In addition, we may from time to time make oral forward-looking statements. We wish to caution readers that a number of important factors could cause actual results to differ materially from those in the forward-looking statements. Factors that could cause or contribute to such differences include those discussed below, as well as those discussed above in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” elsewhere in this report or from time to time described in our other filings with the Securities and Exchange Commission.

Our Operating Results Fluctuate and If We Are Unable to Achieve or Sustain Profitability in the Future or Obtain Future Financing Our Business Operations May Fail

     We continue to experience operating losses. While our objective and full effort is on managing a profitable business, due to the market conditions and factors outlined above and below and their impact on fluctuations in operating expenses and revenues, we cannot provide assurance that we will be able to generate a positive profit position in any given future period. We cannot guarantee that we will increase sales of our products and technologies, or that we will successfully develop and market any additional products. We may not be able to re-establish or sustain future profitability. We may have to rely on the sale of equity, debt or convertible debt financings in the future, which may have a dilutive effect on our existing shareholders. Further, we cannot assure you that debt or equity financing will be available as required and if not available, we would have to further scale down operations or even cease operations.

Because The Market In Which We Operate Is Highly Competitive, We Face Significant Pricing Pressure and Competition.

     We operate in a technology environment which is competitive and rapidly changing. While our software applications deliver what we, and most manufacturers who listen to it, believe is a significantly superior audio experience, the competitive market forces that pressure manufacturers to reduce their costs may create some resistance to new technology adoption or use. Our future success is dependent on establishing and maintaining the technological superiority of our products over those of competitors, our ability to successfully identify and bring other compatible technologies and products to market and a recognition by the market of product value. We compete with a number of entities that produce various stereo audio enhancement processes, technologies and products in both traditional two-speaker environments such as consumer electronics and multimedia computing, and in multi-channel, multi-speaker applications such as Home Theater. In the field of 3-D or “virtual audio”, our principal competitors are SRS Labs, Inc., QSound Labs, Inc. and Dolby Laboratories or technologies and products developed by other companies, including entities that have business relationships with us. Many of our competitors have greater financial, technical, sales and marketing resources, better name recognition and a larger customer base than ours. In addition, some of our large competitors may offer customers a broader product line, which may provide a more comprehensive solution than our current offerings.

     In addition, certain of our competitors appear to be pursuing a business plan that disregards commercially reasonable pricing to achieve a larger market penetration even if the penetration will not provide for viable margins or returns. We have responded by offering additional products targeted to each price and quality segment of the market and continue to aggressively pursue new opportunities in emerging product categories and complements to our existing core business. We believe our products have been positioned as a means for manufacturers to save money while delivering an enhanced audio experience. Nevertheless, these market conditions and competitive forces make it more challenging for us, and our rational commercial competitors, to enhance their operating results. There is no assurance that our present or contemplated future products will achieve or maintain sufficient commercial acceptance, or if they do, that functionally equivalent products will not be developed by current or future competitors who had access to significantly greater resources or which are willing to “give away” their products.

We Rely on the Schedules and Cooperation of Chip Makers or Other Third Parties to Deliver Our Technology in Consumer Products. These Third Parties Have Their Own Priorities and Alliances that May Delay or Thwart our Sales Efforts to Potential Customers.

Spatializer does not develop or market semiconductors. That is why we carry no inventory or have order backlogs that typically are good indicators of near term performance. Rather, we develop audio algorithms that are embedded on third party processors or semiconductors used by our customers. While our algorithms are implemented on a wide array of processors, often times a customer uses a processor where there is no such implementation, or where a competing solution has been implemented. In this case, our customers request that our algorithm be implemented. While these requests are typically honored, processor manufacturers must schedule such implementation as their resources or corporate strategies allow. Therefore, the supply-chain is often quite long and complicated, which potentially can result in delays or deadlines that may not always coincide with our customer’s requirements and which are beyond the control of our company.

If New Product Development Is Delayed, We Will Experience Delays In Revenues And Competitive Products May Reach The Market Before Our Products.

     Since our inception, we have experienced delays in bringing new products to market and commercial application as a result of delays inherent in technology development, financial resource limits and industry responses and maturity. These delays have resulted in delays in the timing of revenues and product introduction. In the future, delays in new product development or technology introduction on behalf of us, our original equipment manufacturers of consumer electronics and multimedia computer products (OEMs), integrated circuit (IC) foundries or our software producers and marketers could result in further delays in revenues and could allow competitors to reach the market with products before us. In view of the emerging nature of the technology involved, and the rapidly changing character of the entire media, internet and computer markets, our expansion into other technology areas, such as cellular telephones, and the uncertainties concerning the ability of our current products and new products to achieve meaningful commercial acceptance in the new technology areas, there can be no assurance of when or if we will achieve or sustain profitability.

     Manufacturer’s design-in cycles for our technology range from four to twelve months, from the decision to adopt our technology to actual cash flow to us. These schedules are also prone to delays at the manufacturer level and in some cases, manufacturer’s new products may be cancelled due to market testing or resource allocation. Since these events are beyond our control, it is difficult to absolutely project when new deals will begin generating revenues or if signed deals will generate financial results. For this reason, we do not typically announce new deals until the target product is being introduced.

     We expect that we will continue to be dependent upon a limited number of OEMs for a significant portion of our net sales in future periods, although no OEM is presently obligated either to purchase a specified amount of products or to provide us with binding forecasts of product purchases for any period. Our four largest customers as of September 30, 2004 accounted for 42%, 19%, 13% and 12% of our net sales in the third quarter. The loss of any one of our major customers or licensees would significantly reduce our revenues and harm our ability to achieve or sustain acceptable levels of operating results. The loss, or signing of

a similarly sized account or accounts would have a material short term impact on our operations and there is no assurance that we will not lose all or some of the revenues from one or more of these accounts. While we are working to broaden the sources of our royalty streams, there can be no assurance that we will be successful in retaining or attracting such key accounts and broadening such revenue stream sources.

     Our products are typically one of many related products used by consumer electronic users. Demand for our products is therefore subject to many risks beyond our control, including, among others:

• competition faced by our OEM customers in their particular end markets;

• the technical, sales and marketing and management capabilities of our OEM customers; and

• the pressure faced by our OEM customers to reduce cost

     There can be no assurance that we will not lose sales in the future as a result of the pressure to reduce costs faced by our customers. The reduction of orders from our significant OEM customers, or the discontinuance of our products by our end users may subject us to potential adverse revenue fluctuations.

If We Are Unable To Attract And Retain Our Key Personnel, We May Not Be Able To Successfully Operate Our Business.

     Our future success primarily depends on the abilities and efforts of a small number of individuals, with particular management obligations and technical expertise. Loss of the services of any of these persons could adversely affect our business prospects. There is no assurance that we will be able to retain this group or successfully recruit other personnel, as needed. We compete with other enterprises with stronger financial resources and larger staffs that may offer employment opportunities to our staff which are more desirable than those which we are able to offer. Failure to maintain skilled personnel with the software and engineering skills critical to our business could have an adverse impact upon our business, the results of our operations and our prospects. Currently, we have an employment agreement with Henry R. Mandell with a term expiring in November 2005.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     We have not been exposed to material future earnings or cash flow fluctuations from changes in interest rates on our short-term investments at September 30, 2004. A hypothetical decrease of 100 basis points in interest rate (ten percent of our overall earnings rate) would not result in a material fluctuation in future earnings or cash flow. We have not entered into any derivative financial instruments to manage interest rate risk or for speculative purposes and we are not currently evaluating the future use of such financial instruments.

Item 4. Controls and Procedures

     The Company carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer had concluded that the Company’s disclosure controls and procedures as of September 30, 2004 were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission’s rules and forms. There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2004 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

     From time to time we may be involved in various disputes and litigation matters arising in the normal course of business. As of November 8, 2004, we are not involved in any legal proceedings that are expected to have a material adverse effect on our consolidated financial position, results of operations or cash flows. However, litigation is subject to inherent uncertainties. Were an unfavorable ruling to occur, there exists the possibility of a material adverse impact on our results of operations of the period in which the ruling occurs. Our estimate of the potential impact on our financial position or overall results of operations for new legal proceedings could change in the future.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

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

None

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

10.5	License Agreement between Spatializer Audio Laboratories, Inc., Desper Products, Inc. and Samsung Electronics, effective August 22, 2004.*
31.1	Certificate of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certificate of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**

*	Confidential treatment requested. Confidential portions of this exhibit have been redacted and filed separately with the Securities and Exchange Commission.
**	Certification will not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934.

(b) Reports on Form 8-K:

     On August 10, 2004, we filed a Current Report on Form 8-K regarding a press release issued with earnings information for the quarter ended June 30, 2004. The information furnished in the report shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934.

     On August 26, 2004, we filed a Current Report on Form 8-K regarding a press release issued with information on the License Agreement between Spatializer Audio Laboratories, Inc., Desper Products, Inc. and Samsung Electronics. The information furnished in the report shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: November 10, 2004

SPATIALIZER AUDIO LABORATORIES, INC.

(Registrant)

/s/ Henry R. Mandell

Henry R. Mandell

Chairman of the Board, Chief Executive Officer

Chief Financial Officer and Secretary

EX-10.5

EXHIBIT 10.5

CONFIDENTIAL TREATMENT REQUESTED. CONFIDENTIAL PORTIONS OF THIS DOCUMENT HAVE BEEN REDACTED AND HAVE BEEN SEPARATELY FILED WITH THE COMMISSION.

DEVELOPMENT AND DISTRIBUTION AGREEMENT

     This Development and Distribution Agreement (“Agreement”) is entered into as of August 16, 2004 (the “Effective Date”) by and between Spatializer Audio Laboratories, Inc. (“Spatializer”) and its wholly-owned subsidiary, Desper Products, Inc.(“Desper”) , corporations organized and existing under the laws of the State of Delaware and the State of California, respectively, and having a principal place of business at 1754 Technology Drive, Suite 125, San Jose, California 95110, United States of America (collectively referred to as “Licensor”), and Samsung Electronics Co., Ltd., acting through its System LSI Division , a corporation organized and existing under the laws of Republic of Korea, and having a principal place of business at San #24 Nongseo-Ri, Giheung-Eup, Yongin-City, Gyeonggi-Do, Korea 449-711(“Licensee”).

BACKGROUND

     A. Desper, a subsidiary of Spatializer, has developed certain proprietary audio signal processing software products for providing enhanced audio reproduction from stereo loudspeakers and/or headphones.

     B. The term “Licensor” includes Spatializer and Desper, which will undertake the rights and obligations as set forth herein, and conduct and perform as a party under this Agreement.

     C Licensee is engaged in, among other things, the business of manufacturing and distributing certain integrated circuit devices that are capable of providing audio signal processing capabilities.

     D Licensee desires to receive from Licensor, and Licensor desires to grant to Licensee, a non-exclusive license to develop Compatible Software Products (as defined below) for use with Distributor Products (as defined below) and to distribute such Compatible Software Products and Distributor Products, subject to the terms and conditions of this Agreement.

     NOW, THEREFORE, in consideration of the foregoing and the mutual covenants contained herein, the parties agree as follows:

Section 1
DEFINITIONS

     For purposes of this Agreement the following terms shall have the meanings set forth below:

     1.1 “Authorized DSP IC(s)” means digital signal processing or other programmable digital processor integrated circuit devices manufactured by Licensee which: (i) are capable of performing the digital signal processing functions necessary to properly perform the Core Functionality (as defined below) of a Licensed Product (as defined below); and (ii) have on-board or are bundled with sufficient on-board read-only memory to contain the corresponding Compatible Software Product(s).

     1.2 “Compatible Software Product(s)” means the executable code version of a software product developed by Licensee using Licensed Product(s) that implements the Core Functionality corresponding to such Licensed Product and is designed for and is capable of being properly executed by, and is compatible with, the respective Authorized DSP IC.

     1.3 “Core Functionality” means the digital audio signal processing functionality embodied in each of the Licensed Products and Modifications thereto, as described in Exhibit A attached hereto.

     1.4 “Current Release” means the then-current, unmodified release of a Licensed Product provided by Licensor to Licensee hereunder.

     1.5 “Deliverables” means those tangible items specified in Exhibit A attached hereto, and includes the Documentation (as defined below).

     1.6 “Distributor Product(s)” means an Authorized DSP IC bundled with a copy of a Compatible Software Product loaded into the on-board read-only memory of such Authorized DSP IC.

     1.7 “Documentation” means the written reference materials designated by Licensor for use by development partners and distributors of the Licensed Products that Licensor furnishes to Licensee hereunder in conjunction with the Licensed Products, as may be amended by Licensor from time to time. Documentation includes the Licensed Products’ filter coefficients, block diagrams, test bench and Matlab scripts.

     1.8 “Evaluation Boards” means evaluation board level products which Licensee provides to potential third party customers enabling such potential third party customers to evaluate the Authorized DSP ICs and the Compatible Software Products prior to making a purchase decision regarding the Authorized DSP ICs.

     1.9 “Fees” or “Distribution Fees” means all license, distribution, royalty, and other fees payable to Licensor hereunder, as specified in Section 4 and Exhibit A attached hereto.

     1.10 “Licensed Product(s)” means the current machine readable, executable code versions and floating point source code versions of Licensor’s proprietary audio signal processing software products listed on Exhibit A attached hereto and made a part hereof, including any improvements, updates, modifications, and derivatives thereof furnished to Licensee by Licensor during the term of this Agreement. It is understood that the provision of any such improvements, updates, modifications, and derivatives shall be at Licensor’s sole discretion and may be subject to additional fees and/or additional terms and conditions.

     1.11 “Modifications” means any and all enhancements, improvements, updates and revisions of the Licensed Products, Deliverables and Core Functionality.

     1.12 “Quarter” means a period of three (3) consecutive calendar months, commencing January 1, April 1, July 1 or October 1.

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Section 2
LICENSE GRANTS

     2.1 Development License. Subject to the terms and conditions of this Agreement, Licensor hereby grants to Licensee, a non-exclusive, non-transferable, worldwide right and license to use and reproduce the Licensed Products, including the Deliverables, and Modifications thereto, solely for the purpose of developing and having developed a Compatible Software Product(s) corresponding to each Licensed Product listed on Exhibit A hereto. Licensee shall not distribute any Distributor Product to a third party customer without first providing a copy of the applicable Compatible Software Product to Licensor for its acceptance in accordance with Section 3.3 of this Agreement, which acceptance shall not be unreasonably withheld or delayed by Licensor, provided that Licensee shall not be obligated to provide the Compatible Software Product in case of Licensee’s demonstrations to its customers, internal and external, under the terms and conditions set forth in Section 2.3. Such acceptance shall not be delayed more than seven (7) days after the receipt of the applicable Compatible Software Product. Licensor shall not disclose to any third party the applicable Compatible Software Product provided by Licensee, and shall use such Compatible Software solely for the acceptance purpose as provided in this Section. Upon request by Licensee, Licensor shall immediately return to Licensee such Compatible Software. Nothing in this Agreement shall be construed as granting any right or license by Licensee. Licensee shall not grant sublicenses to the rights set forth in this Section 2.1 and shall not in any event disclose or distribute the Core Functionality or Deliverables or any portion thereof to third parties unless as provided herein or agreed in writing by Licensor. Licensee shall not be authorized to prepare derivative works or create Modifications of the Licensed Products, the Core Functionality or the Deliverables.

     2.2 Distribution License. Subject to the terms and conditions of this Agreement, Licensor hereby grants to Licensee a non-exclusive, non-transferable, worldwide right and license to make, have made, distribute, ship, consume or otherwise transfer the Compatible Software Products developed by Licensee, and the related Distributor Products, (i) * * * (collectively “Internal Consumption”) and (ii) * * * (“External Consumption”). THIS AGREEMENT AUTHORIZES INTERNAL CONSUMPTION AND EXTERNAL CONSUMPTION WITH RESPECT TO DISTRIBUTOR PRODUCTS USED ONLY FOR * * *. INTERNAL CONSUMPTION OR EXTERNAL CONSUMPTION OF DISTRIBUTOR PRODUCTS FOR USE IN * * * AND OTHER ELECTRONIC DEVICES IS NOT AUTHORIZED. STANDALONE DISTRIBUTION OF DOCUMENTATION IS STRICTLY PROHIBITED AND IS GROUNDS FOR IMMEDIATE TERMINATION OF THIS AGREEMENT.

     2.3 Demonstration License. Subject to the terms and conditions of this Agreement, Licensor hereby grants to Licensee a non-exclusive, non-transferable, worldwide rights and license to demonstrate pre-production versions of the Compatible Software Product on Evaluation Boards or otherwise, provided Licensee shall make best efforts to protect the Core Functionality during such demonstrations as it would to protect its own intellectual property or proprietary information.

     2.4 Customer Support and Warranties. Licensee shall be solely responsible for, and Licensor shall have no obligation to honor, any representations or warranties that Licensee provides with respect to the Compatible Software Products and Distributor Products except for

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any warranties and representations provided by Licensor under this Agreement. Licensee shall be solely responsible for providing support and maintenance to its customers.

     2.5 Restrictions and Ownership of Licensed Products. Licensee shall not (except as expressly provided in this Agreement) copy, decompile, disassemble or reverse engineer the Licensed Products and Deliverables. Licensee acquires no title, right or interest in the Licensed Products, Deliverables and Core Functionality other than the non-exclusive license rights expressly granted herein. Licensee shall not exercise its rights under this Agreement in any manner, or take any other action, which adversely affects Licensor’s ownership and rights in and to the Licensed Products, Deliverables and Core Functionality. ALL RIGHTS NOT EXPRESSLY GRANTED HEREUNDER ARE RESERVED TO LICENSOR.

     2.6 Ownership of Modifications. Licensor shall exclusively develop and own any Modifications during the term of this Agreement. Licensee shall not develop, and acquires no title, right or interest in Modifications other than the non-exclusive license rights expressly granted herein. Licensee shall promptly notify Licensor of, and fully disclose to Licensor, any and all proposed Modifications suggested by Licensee, and Licensor may, in its discretion, develop such Modifications (at no cost to Licensee), and is exclusively entitled to seek patents and patent applications disclosing, claiming or otherwise relating to any such Modifications. Licensee hereby assigns to Licensor all right, title and interest in all such proposed Modifications throughout the world. Licensee further agrees to execute all documents reasonably requested by Licensor to perfect Licensor’s interest in such proposed Modifications throughout the world.

     2.7 Future Product Versions. In the event that Licensor develops and makes generally available to any other licensees a new version of a Licensed Product during the term of this Agreement, Licensor shall add or substitute the new version under this Agreement as an additional version of the Licensed Product or in substitution of another version of the Licensed Product, upon thirty (30) days notice to and express written consent by Licensee.

     2.8 Ownership of Compatible Software Products. Licensee shall exclusively develop and own the Compatible Software Products and any revisions thereto (excluding Licensor’s pre-existing intellectual property contained therein). Licensor shall not develop, and acquires no title, right or interest in Compatible Software Products and any revisions thereto (except Licensor’s pre-existing intellectual property contained therein).

Section 3
OBLIGATIONS OF LICENSOR

     3.1 Delivery. Subject to the terms and conditions of this Agreement, Licensor shall deliver one copy of the Current Release of each Licensed Product listed on Exhibit A hereto, along with the corresponding Deliverables, to Licensee within fifteen (15) days after the Effective Date.

     3.2 Technical Assistance. During the first year of this Agreement, upon reasonable notice and subject to reasonable availability, Licensor will provide Licensee, free of charge, with up to twenty (20) hours of technical assistance during normal business hours to assist Licensee in developing the Compatible Software Products. If Licensee requires more than twenty (20) hours of technical assistance, then each hour in excess of the twenty (20) hours, shall be billed at

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Licensor’s then-current hourly rate. The current hourly rate is * * *, subject to change at any time by Licensor. Such assistance shall be provided by telephone consultation unless otherwise mutually agreed. In the event of any travel by Licensor personnel requested by Licensee, Licensee shall reimburse Licensor for all pre-approved reasonable costs for travel, food and lodging for such Licensor personnel for such travel. Within a reasonable period of time after the Effective Date, Licensor shall dispatch one (1) of its employees for the provision of on-site assistance at Licensee’s facilities, provided that such support shall not be included in the twenty (20) hours mentioned above. Licensor’s travel expenses (economy class air fares, food, and lodging) incurred in performing such assistance shall be paid by Licensee thirty (30) days after the receipt of proper receipts.

     3.3 Verification Procedures. The parties will cooperate to ensure that the Distributor Products comply with the following standard of quality of Licensor (“Standard of Quality”). For Dolby® certification if necessary, the parties will cooperate to ensure such certification. For all Distributor Products, whether or not Dolby® certification is sought, the Standard of Quality consists of compliance with the Deliverables and Licensor’s audio quality assurance review. Licensee shall provide a minimum of two (2) samples of Distributor Products per each major model of the Distributor Products to Licensor as soon as reasonably practical in advance of initial commercial release of such Distributor Products. Licensee shall notify Licensor that such samples are being provided for verification testing under this Section 3.3. Licensor will then report to Licensee any non-compliance with the Standard of Quality and Licensee shall correct such non-compliances prior to initial commercial release. In the event that Licensor does not notify Licensee of any non-compliance within ten (10) business days after receipt of the samples, the Distributor Product will be deemed to have passed verification testing for purposes of initial commercial release. In the event that any non-compliance are discovered after a Distributor Product has passed verification testing, Licensee shall have a reasonable period of time to bring the Distributor Product into conformity, taking into account Licensee’s normal design cycle and manufacturing lead times. In the event that modification of a Distributor Product would materially interfere with Licensee’s ongoing business, the parties may mutually agree upon special branding and other terms and conditions to allow Licensee to continue distributing the respective Distributor Products.

     3.4 Marketing Assistance. Licensor will confer with Licensee from time to time during the term of this Agreement regarding the promotion, sales and marketing of Authorized DSP ICs to Licensee customers. During the first year of this Agreement, upon reasonable notice and subject to reasonable availability, Licensor will provide Licensee, free of charge, with up to twenty (20) hours of assistance during regular business hours for mutually agreed marketing and promotional activities for the Authorized DSP ICs. During the first (1st) year of this Agreement, at the reasonable request of Licensee, Licensor will provide its then current applicable standard marketing literature for the Licensed Products to potential Licensee customers and will participate in joint sales calls to actual and potential Licensee customers as mutually agreed.

Section 4
COMPENSATION TO LICENSOR

     4.1 Distribution Fees. In consideration of the rights, licenses, and assistance provided to Licensee hereunder, Licensee shall pay to Licensor per-unit license fees in the amount

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indicated on Exhibit A hereto for the specified Compatible Software Products consumed, distributed, sold or otherwise transferred by or on behalf or under authority of Licensee as part of a Distributor Product under Section 2.2 above during the term of this Agreement. Notwithstanding the foregoing, Distribution Fees payable by Licensee during the term of this Agreement shall be less than the license fees payable by the most favored licensee of the Licensed Products pursuant to a license agreement with Licensor in effect at the same time and having substantially similar terms and conditions as this Agreement.

     4.2 Fee Reports. Within thirty (30) days of the last day of each Quarter, Licensee shall provide Licensor with a written report in reasonable detail which sets forth all Distributor Products and Authorized DSP ICs distributed internally or externally during such Quarter, and the aggregate amount of, and basis for, per unit Distribution Fees due to Licensor for such Quarter, if any.

     4.3 Payment. Any per unit Distribution Fees that may be due as set forth in Exhibit A, shall be due and paid net thirty (30) days after receipt of the applicable original invoice, which invoice shall be submitted following Licensee’s notification that Licensee shall exercise its option set forth in Exhibit A or Licensor’s receipt of the applicable Quarter’s fee report, whichever is applicable according to Exhibit A. Any per-unit Distribution Fees that may be due shall be calculated based on the cumulative total number of units, both Internally Consumed, and shipped for External Consumption, less any copies returned with a Distributor Product for refund. All Distribution Fee payments shall be calculated and made in United States Dollars by wire transfer to:

	Desper Products, Inc.
	Citibank, attention Steven Port
	One Sansome Street
	San Francisco, CA 94104
	Account #: * * *
	Routing #: * * *
with notification to:	Henry Mandell
	Chief Executive Officer
	Desper Products, Inc.
	1754 Technology Drive, Suite 125
	San Jose, CA 95110
	Fax: (408) 437-5787

unless otherwise specified in writing by Licensor.

     4.4 Taxes. Amounts payable to Licensor under this Agreement are payable in full to Licensor without reduction for taxes (excluding any withholding tax on Licensor’s income) or customs duties. In the event that Licensee is required to deduct any income tax from any payment payable or due hereunder to Licensor by the Korean Tax Authority, Licensee agrees to deduct such withholding tax from the payment; use reasonable efforts to ensure that the deduction or withholding does not exceed the minimum amount legally required; pay to the Korean Tax Authority within the period for payment permitted by law the full amount of the deduction; provide Licensor with an official receipt issued by the Korean Tax Authority within a reasonable

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time after such official receipt having been issued so that Licensor may claim the credit in order to avoid double taxation in the US.

     4.5 Late Payment. Any payments due under this Agreement which are not paid when due shall bear interest to the maximum extent permitted by applicable law, or three percent (3%) per annum, calculated on the number of days such payment is delinquent, whichever is less.

     4.6 Maintenance and Inspection of Records. Licensee agrees to make and to maintain until the expiration of two (2) years after the year to which such records pertain, sufficient books, records and accounts regarding its sales, distribution and other activities in order to calculate and confirm its payment obligations hereunder. Licensor will have the right, at its own expense and not more than once in any twelve (12) months, to have an independent certified public accountant, or other reasonably acceptable professional, inspect, upon reasonable notice and during regular business hours, Licensee’s relevant accounting records to verify the accuracy of Fees paid by Licensee under the terms of this Agreement within the twelve (12) months immediately prior to the audit. If any such examination discloses a shortfall in the Fees due to Licensor hereunder, Licensee shall reimburse Licensor for the full amount of such shortfall and if the amount of the underpayment for any period is more than eight percent (8 %) Licensee shall pay Licensor’s costs of performing the audit with respect to such period.

Section 5
MARKETING, TRADEMARKS AND PROPRIETARY NOTICES

     5.1 Licensor Trademarks. Licensee acknowledges that the symbols, logos, trademarks and service marks adopted by Licensor or its suppliers to identify the Licensed Products, as set forth in Exhibit B as may be amended from time to time (“Licensor Trademarks”), belong to Licensor and that Licensee shall have no rights in such Licensor Trademarks except as expressly set forth herein. All Distributor Products used or shipped by Licensee incorporating the Compatible Software Products and all documentation, associated brochures, packaging and advertising may display the Licensor Trademarks, and if Licensee utilizes the Licensor Trademarks, it shall do so according to the guidelines set forth in Exhibit B hereto, and as Exhibit B may be amended from time to time, as required by laws or regulations. Alternatively, Licensee may private label the Distributor Products with new symbols, logos, trademarks and service marks adopted by Licensee to identify the Distributor Products (“Party Trademarks”). Party Trademarks shall include a reference to Licensor as follows “[Party Trademark] Spatializer [with Spatializer’s “Circle/Square logo”] ™” and all new logos, symbols, trademarks and service marks contained in the Party Trademarks (other than the Licensor Trademarks included therein) shall be co-owned by the parties. All such Party Trademarks are subject to the provisions of Section 5.2 of this Agreement. Any good will arising out of the use of Licensor’s Trademarks hereunder shall inure to the benefit of Licensor. At no time during or after the term of this Agreement will Licensee challenge or assist others to challenge Licensor’s Trademarks or the registration thereof or attempt to register any trademarks, marks or trade names confusingly similar to Licensor’s Trademarks.

     5.2 Approval of Representations. All depictions of Licensor’s Trademarks, including Party Trademarks that Licensee intends to use, shall be submitted to Licensor for approval of design, color, or other details or, in the case of Licensor Trademarks, will be exact copies of those used by Licensor for the Licensed Products. In the event Licensor does not approve of such depiction, Licensee shall cease using such depiction as soon as is practical upon reasonable notice, provided that Licensor shall not unreasonably withhold or delay its approval.

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Any Licensor Trademarks used in conjunction with another trademark on or in relation to the Distributor Products will be presented legibly and with reasonable prominence.

     5.3 Registered User Agreements. Licensor and Licensee may enter into registered user agreements with respect to Licensor Trademarks to the extent applicable under trademark law requirements in any jurisdiction in which Licensee distributes Distributor Products. Licensor and Licensee shall be jointly responsible for proper filing of the registered user agreement with government authorities within such jurisdiction and shall pay all costs or fees associated with such filing.

     5.5 Press Release. At a mutually agreed time, Licensor and Licensee shall use best efforts to issue a press release announcing the relationship contemplated by this Agreement, provided that the contents of such press release shall be approved by both parties prior to announcement. Notwithstanding the foregoing, Licensor shall be entitled to submit a disclosure to Securities and Exchange Commission (“SEC”) on its own if specifically required within a certain period by applicable law, provided that such disclosure shall include only information that is specifically required to be disclosed by such applicable law and shall exclude anything, express or implicit, that may be interpreted to indicate Licensee.

Section 6
CONFIDENTIALITY

     6.1 Obligations. The parties acknowledge and agree that the information provided by one party (the “Disclosing Party”) to the other party (the “Receiving Party”) directly or indirectly (which other information is marked as “proprietary” or “confidential”, or, if disclosed orally, is summarized in writing and similarly marked and delivered to the Receiving Party within thirty (30) days of initial disclosure) hereunder constitutes the confidential and proprietary information of the Disclosing Party for a period of three (3) years after disclosure, or for so long as this Agreement remains in effect, whichever is longer, provided that the Deliverables shall remain confidential and proprietary for a period of five (5) years after disclosure. Licensor’s confidential information shall be deemed to include without limitation the Deliverables, Core Functionality, Licensed Products, and Modifications. Licensee’s confidential information shall be deemed to include without limitation any software, samples, and any other technical information related to the Distributor Products and Compatible Software Products. The Receiving Party shall retain in strict confidence and not disclose to any third party or use any and all such information (except as expressly authorized by this Agreement) without the Disclosing Party’s express written consent except as reasonably necessary to exercise the rights granted under this Agreement. Without limiting the foregoing, each party shall use at least the same procedures and degree of care which it uses to protect its own confidential information of like importance, and in no event less than reasonable care.

     6.2 Exceptions. The Receiving Party shall be relieved of this obligation of confidentiality to the extent any such information:

          (a) was in the public domain at the time it was disclosed or has become in the public domain through no fault of the Receiving Party;

          (b) was independently developed by the Receiving Party without any use of the Disclosing Party’s confidential information and by employees or other agents of the Receiving Party who have not had access to any of the Disclosing Party’s confidential information, as demonstrated by the Receiving Party’s records;

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          (c) was known to or developed by the Receiving Party prior to receipt of such information from the Disclosing Party; or

          (d) becomes known to the Receiving Party, without restriction, from a source other than the Disclosing Party without breach of this Agreement and otherwise not in violation of the Disclosing Party’s rights.

          (e) is disclosed pursuant to a valid order of a court or government body provided that the Receiving Party shall promptly notify the Disclosing Party upon recognition of such order.

     6.3 Protections. Licensee shall not under any circumstances distribute, reproduce, perform, publicly display or disclose the Deliverables in any manner except as provided herein, and shall use the same procedures to protect the Deliverables from unauthorized use and disclosure as it uses to protect its own most sensitive confidential and proprietary information from unauthorized use and disclosure. Licensor shall not under any circumstances distribute, reproduce, perform, publicly display or disclose the Distributor Products and Compatible Software Products in any manner, and shall use the same procedures to protect the Distributor Products and Compatible Software Products from unauthorized use and disclosure as it uses to protect its own most sensitive confidential and proprietary information from unauthorized use and disclosure.

Section 7
TERM AND TERMINATION

     7.1 Term. This Agreement shall be effective as of the Effective Date and shall continue for a term of * * *, provided that the initial year for the purpose of this Agreement shall include the First Year as defined in Exhibit A. Thereafter, this Agreement shall automatically renew for successive one (1) year terms at Licensee’s sole discretion, provided that Licensee shall notify Licensor of such discretion at least sixty (60) days prior to the end of the initial * * * term or any successive one (1) year renewal.

     7.2 Termination for Breach. In the event of a material breach by either party, the non-breaching party shall be entitled to give the breaching party written notice of such breach. Failure to make timely payment shall constitute a material breach of this Agreement by Licensee which shall have thirty (30 ) days to cure after receipt of written notice from Licensor. With respect to all other material breaches, the breaching party shall have sixty (60 ) days to cure such breach after receipt of written notice from the non-breaching party. Thereafter, the non-breaching party shall be entitled, in addition to any other rights it may have under this Agreement or otherwise under law, to terminate this Agreement by giving notice thereof to the other party which shall take effect immediately.

     7.3 Effect of Termination or Expiration. Upon termination of this Agreement by Licensor for Licensee’s material breach of failing to make timely payment hereunder, the rights and licenses granted under this Agreement shall immediately terminate except as expressly set

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forth in Section 7.4 below. Notwithstanding anything to the contrary in this Agreement, Licensee may continue to distribute the Distributor Products for a period of one (1) year (“sell-off period”) after termination by Licensor if there is no material breach for failure to pay, upon payment of * * * per unit under Section 4. Upon such termination, Licensee shall immediately destroy or return to Licensor all tangible items in its possession or control which are proprietary to Licensor, including all copies of the Deliverables, Core Functionality, Licensed Products, and Modifications. Notwithstanding the foregoing, upon expiration of this Agreement or termination by Licensee for Licensor’s material breach hereunder, Licensee shall retain the right to continue to distribute the Distributor Products upon payment of * * * per unit, provided that such right shall be restricted to the Distributor Products which Licensee developed during the Term.

     7.4 Survival. The provisions of Sections 1, 2.4, 2.5, 2.6, 2.8, 4 (only so long as Licensee continues to distribute Distributor Products subject to section 7.3) , 7.3, 7.4, 8.2, 9, 10 and 11 shall survive the termination or expiration of this Agreement for any reason. The provisions of Section 6 shall survive the termination or expiration of this Agreement for the remainder of the period specified therein.

Section 8
LIMITED WARRANTY AND DISCLAIMER

     8.1 Product Warranty. Licensor warrants to Licensee that the Current Release of each Licensed Product as provided by Licensor to Licensee hereunder will conform in all material respects with Licensor’s Documentation for such Licensed Product from the Effective Date until the ninetieth (90th) day following the completion of Licensor’s verification under Section 3.3 of this Agreement of such Licensed Product to Licensee hereunder (the “Warranty Period”). Licensor does not warrant the Licensed Products will meet all of Licensee’s or Licensee’s customer’s requirements nor that the use of the Licensed Products will be uninterrupted or error free. Notwithstanding the foregoing, throughout the term of this Agreement, and after expiration of the applicable Warranty Period, Licensor shall correct errors, bugs and other defects in the Licensed Products that do not permit the Compatible Software Products to conform to the Documentation, and to issue Modifications to correct errors, bugs and other defects in the Licensed Products to Licensee at no additional expense to Licensee. Licensee shall provide Licensor with commercially reasonable assistance in such corrections of errors, bugs and other defects.

     8.2 Disclaimer. EXCEPT FOR THE ABOVE EXPRESS LIMITED WARRANTY, THE LICENSED PRODUCTS ARE PROVIDED “AS IS” AND WITHOUT WARRANTY OF ANY KIND WHETHER EXPRESS, IMPLIED, STATUTORY, OR IN ANY OTHER PROVISION OF THIS AGREEMENT OR COMMUNICATION WITH LICENSEE, AND LICENSOR SPECIFICALLY DISCLAIMS ANY IMPLIED WARRANTY OF MERCHANTABILTY, NONINFRINGEMENT OR FITNESS FOR A PARTICULAR PURPOSE.

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Section 9
INDEMNIFICATION

     9.1 Intellectual Property Indemnification by Licensor. Licensor agrees to defend, indemnify and hold Licensee harmless against any liability and any related costs and expenses arising out of any infringement of a copyright, patent, trademark, trade secret right, or any other intellectual property rights of any third party by Licensee’s use of the Licensed Products as intended by this Agreement. Notwithstanding the foregoing, Licensor assumes no liability for infringement claims solely arising from (i) the use of a Compatible Software Product alone or in combination with other products not provided by Licensor, if such infringement would have been avoided by the use of the corresponding Licensed Product alone, (ii) the modification of a Compatible Software Product, if such infringement would have been avoided but for such modification, or (iii) any willful infringement by Licensee having prior knowledge of such infringement. Licensor shall pay all attorney’s fees, damages and costs awarded against Licensee, including any settlement amount agreed to be paid and related expenses in such action that are attributable to such claim. In the event that a Licensed Product or Deliverables infringes, or if Licensor believes is likely to infringe, any intellectual property or proprietary right of a third party, Licensor shall, at its sole expense, (x) procure for Licensee the right to continue using the Licensed Product or Deliverables; (y) replace or modify the Licensed Product, Deliverables or part thereof in such a way that it is non-infringing but functionally equivalent; or if (x) and (y) are not commercially reasonable (z) terminate this Agreement with respect to such Licensed Product or Deliverables and refund any and all prepaid license fees paid by Licensee to Licensor.

     9.2 Procedures. Licensor’s obligation to indemnify Licensee under this Section 9 shall be subject to Licensee : (i) promptly notifying it of the claim or action giving rise to the indemnity; (ii) providing it with control and authority over the defense of such action or claim; and (iii) providing it with proper and full information and reasonable assistance to defend and/or settle any such claim or action. .

Section 10
LIMITATION OF LIABILITY

     THE TOTAL LIABILITY OF LICENSOR AND ITS DISTRIBUTORS ARISING OUT OF OR RELATED TO THIS AGREEMENT (EXCLUDING SECTION 9) SHALL NOT EXCEED THE TOTAL AMOUNT PAID BY LICENSEE TO LICENSOR HEREUNDER AND THE LIABILITY OF LICENSOR AND ITS DISTRIBUTORS RELATING TO SPECIFIC PRODUCT(S) PROVIDED HEREUNDER (EXCLUDING SECTION 9) SHALL NOT EXCEED THE AMOUNT PAID BY LICENSEE TO LICENSOR FOR SUCH PRODUCT(S). EXCEPT FOR LIABILITY ARISING UNDER SECTIONS 6 AND 9 OF THIS AGREEMENT, IN NO EVENT SHALL LICENSOR, ITS DISTRIBUTORS OR LICENSEE HAVE ANY LIABILITY FOR ANY INDIRECT, INCIDENTAL, SPECIAL, OR CONSEQUENTIAL DAMAGES, HOWEVER CAUSED AND ON ANY THEORY OF LIABILITY, WHETHER FOR BREACH OF CONTRACT, TORT (INCLUDING NEGLIGENCE) OR OTHERWISE, ARISING OUT OF OR RELATED TO THIS AGREEMENT, INCLUDING BUT NOT LIMITED TO LOSS OF ANTICIPATED PROFITS, EVEN IF SUCH PARTY HAVE BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES. THESE LIMITATIONS SHALL APPLY NOTWITHSTANDING ANY FAILURE OF ESSENTIAL PURPOSE OF ANY LIMITED REMEDY.

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Section 11
GENERAL PROVISIONS

     11.1 Assignment. Either Party may not assign this Agreement or any rights or obligations hereunder, by operation of law or otherwise, without the prior written approval of the other party and any such attempted assignment shall be void; provided, however, that either party may assign this Agreement to a successor to all or substantially all of its business or assets to which this Agreement relates if the assignee agrees in writing to comply with all terms and conditions of this Agreement. Subject to the foregoing, this Agreement shall be binding upon and inure to the benefit of the parties hereto, their successors and permitted assigns.

     11.2 Notices. All notices between the parties shall be in writing and shall be deemed to have been given if personally delivered or sent by certified or registered mail (return receipt), or by internationally recognized overnight courier, or by telecopy to the addresses set forth as follows, or such other contact and/or address as is provided by notice as set forth herein.

If to Licensor to:	Desper Products, Inc.
	1754 Technology Drive, Suite 125
	San Jose, CA 95110
	Attention: Henry Mandell
	Fax: (408) 437-5787
If to Licensee to:	Samsung Electronics CO., LTD.
	San #24, Nongseo-Ri, Giheung-Eup, Yongin-City,
	Gyeonggi-Do, Korea 449-711
	Attention: * * *
	Fax: * * *

Notices shall be deemed effective upon receipt or, if delivery is not effected by reason of some fault of the addressee, when tendered.

     11.3 Export Regulations. Licensee understands that Licensor is subject to regulation by agencies of the U.S. government, including, but not limited to, the U.S. Department of Commerce, which prohibit export or diversion of certain technical products to certain countries. Licensee warrants that it will comply in all respects with the Export Administration Regulations and all other export and re-export restrictions applicable to the technology and documentation licensed hereunder.

     11.4 Governing Law and Dispute Resolution

          (a) Any dispute or claim arising out of or in relation to this Agreement, or the interpretation, making, performance, breach or termination thereof, shall be finally and exclusively settled by binding arbitration in San Jose, California, USA, if initiated by Licensee, and in Yongin-City, Gyeonggi-Do, Korea, if initiated by Licensor, or such other location as the parties may agree, in either case under the Rules of Arbitration of the International Chamber of Commerce by three (3) arbitrators appointed in accordance with the said Rules. The arbitral proceedings and all pleadings and written evidence shall be in the English language. Any written

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evidence originally in a language other than English shall be submitted in English translation accompanied by the original or a true copy thereof. Judgment on the award rendered by the arbitrators may be entered in any court having jurisdiction thereof.

          (b) This Agreement shall not be governed by the 1980 United Nations Convention on Contracts for the International Sale of Goods; rather, this Agreement shall be governed by and construed under the laws of the State of New York without reference to conflict of laws principles. The arbitrators shall apply New York law to the merits of any dispute or claim, without reference to that state’s conflict of laws principles.

     11.5 Relationship of the Parties. Nothing in this Agreement shall constitute, nor shall any party represent that there is any relationship of employee and employee, principal and agent or partnership between the parties as a result of this Agreement.

     11.6 Severability. Any term or provision of this Agreement held to be illegal or unenforceable shall, if possible, be interpreted so as to be construed as valid, but in any event the validity or enforceability of the remainder hereof shall not be affected.

     11.7 Waiver. The waiver of, or failure to enforce, any breach or default hereunder shall not constitute the waiver of any other or subsequent breach or default.

     11.8 Headings The paragraph headings appearing in this Agreement are inserted only as a matter of convenience and in no way define, limit, construe or describe the scope or extent of such paragraph, or in any way affect such agreements.

     11.9 Entire Agreement. This Agreement, along with the Exhibits attached hereto which are incorporated herein by reference, sets forth the entire agreement between the parties and supersedes, merges, and renders void any and all prior proposals, agreements, and representations between them, whether written or oral, to the extent they relate in any way to the subject matter hereof. This Agreement specifically supersedes and terminates that agreement captioned DESPER PRODUCTS, INC. DEVELOPMENT AND DISTRIBUTION AGREEMENT between the parties dated May 22, 2002, as amended. This Agreement may be changed only by mutual agreement of the parties in writing.

     11.10 Counterparts. This Agreement may be executed simultaneously in two or more counterparts, each of which will be considered an original, but all of which together will constitute one and the same instrument.

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     IN WITNESS WHEREOF, the parties have caused this Agreement to be signed by duly authorized representatives on the dates set forth below to be effective as of the Effective Date set forth above.

SAMSUNG ELECTRONICS CO., LTD.	DESPER PRODUCTS, INC.
* * *
(Signature)	(Signature)
* * *
(Printed Name)	(Printed Name)
(Title)	(Title)
Date:	Date:
Spatializer Audio Laboratories, Inc.
(Signature)
(Printed Name)
(Title)
Date:

*** CONFIDENTIAL MATERIAL REDACTED AND FILED SEPARATELY WITH THE COMMISSION.

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EXHIBIT A

LICENSED PRODUCTS

1. Licensed Product

Spatializer VBX^TM

Spatializer N-2-2^TM Ultra

Spatializer VirtuaLFE^TM

Spatializer® 3-D Stereo audio technology

Spatializer Natural Headphone^TM

Spatializer Vi.B.E. ^TM

Spatializer PCE^TM

(separately or all four together in
a package known as Spatializer UltraMobile HD^TM)

2. Specification of Core Functionality

Note: The core functionalities may be identified via a “fingerprinting” method that involves using an Audio Precision System which measures the frequency and phase response of an audio system. In all cases, the filter coefficients and delays are dependant on sampling rate and may differ somewhat depending on the specific application of the algorithm. The specification of core functionalities is confidential and proprietary to Licensor.

Virtual Surround VBX and 3-D Stereo audio
The VBX and 3-D Stereo * * *.

N-2-2 ULTRA
N-2-2 ULTRA * * *.

VirtuaLFE
The VirtuaLFE * * *.

*** CONFIDENTIAL MATERIAL REDACTED AND FILED SEPARATELY WITH THE COMMISSION.

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Natural Headphone
* * *

Vi.B.E.
The Vi.B.E. * * * .

PCE
In the PCE * * *.

3. Deliverables

Sample source code including, without limitation, working C-level source code for each of the Licensed Products.

Documentation, which contains (1) the filter coefficients, block diagrams, Matlab scripts and test bench, (2) explanation of source code for each of the Licensed Products including, but not limited to, the definition of input and output and detailed explanation of each effect, and (3) verification procedures.

4. Distribution Fees

Upon execution of this Agreement

Within thirty (30) days upon the receipt of original invoice after the execution of this Agreement, Licensee shall pay the total amounts of * * * Distribution Fees, which shall be applied to all Distributor Products (i.e. Internally Consumed and/or externally shipped, both inclusive, cumulatively the * * *). For the avoidance of doubts, Licensee shall have no obligation to pay any additional fees or charges, other than such prepaid per-unit Distribution Fees set forth herein.

First Year after Licensee Distributes the * * * Units

When the numbers of cumulative Distributor Products distributed by Licensee * * *. Licensee shall have the right to exercise such option up to three (3) times within the first year after Licensee distributes the * * * mentioned in the above paragraph (“First Year”). * * * Distribution Fees shall be applied to each unit of Distributor Products exceeding * * * for the First Year. In the event that the total number of Licensed Products distributed in the First Year fails to reach * * *, the First Year shall be extended for up to * * *, at which time, the First Year will end and the next year will begin on the next proximate calendar quarter. For the avoidance of doubts, in the event that Licensee fails to distribute the full amount of Distributor Products covered by the option(s)

*** CONFIDENTIAL MATERIAL REDACTED AND FILED SEPARATELY WITH THE COMMISSION.

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that Licensee exercised during the First Year, * * *.

Each Year after the First Year

For each year after the First Year during the term of this Agreement, Licensee shall have the right to exercise * * * Distribution Fees shall be applied to each unit of Distributor Products exceeding ** * for such year. In the event that Licensee fails to distribute the full amount of Distributor Products covered by the option(s) that Licensee exercised during such year, the * * *.

Upon termination or expiration

Subject to Section 7 of this Agreement, upon termination or expiration of this Agreement, Licensee shall retain the right to continue to distribute Distributor Products with payment of * * * for every unit distributed by Licensee.

*** CONFIDENTIAL MATERIAL REDACTED AND FILED SEPARATELY WITH THE COMMISSION.

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EXHIBIT B

TRADEMARKS AND PROPRIETARY NOTICES

General

The Parties understand and agree that this Exhibit B shall be governed and interpreted by the terms and conditions set forth in Section 5.

For Distributor Products

     1. Licensee shall (i) mark each copy of a Distributor Product on the packaging and media label (the label affixed to the form of media) in an easily readable typeface, with the following legend:

“Portions of this product are licensed from Desper Products, Inc., a subsidiary of Spatializer Audio Laboratories, Inc. © 1997-2004 Spatializer Audio Laboratories, Inc., All Rights Reserved Worldwide. Spatializer^®, Spatializer N-2-2™, and the circle-in-square device are trademarks of Desper Products, Inc.”

and (ii) include the above legend in all Distributor Product brochures, manuals, descriptive literature and advertising. Such legend may appear in English as shown above, or in the native language of the country into which the Distributor Product is intended to be sold. In addition, the legend shall include a listing of any other Licensor Trademark used on the Distributor Product, along with an attribution of its ownership by Licensor, and a listing of patent numbers applicable to the Distributor Product which Licensor designates from time to time in writing to Licensee.

     2. Licensee agrees to have printed on the media label for each Distributor Product, and on associated packaging, in a manner conforming to Licensor’s trademark usage guidelines, as may be amended from time to time, the trademark “Spatializer^® N-2-2, preceded by the circle-in-square device, or other identifying mark approved by Licensor in writing in advance.

For Products of Licensee including a Distributor Product

     Products of Licensee shall have printed in a permanent form on the front or top panel and on associated packaging of each product containing a Distributor Product, in a location, size and typeface readily visible to users and purchasers of the product, and in a manner conforming to Licensor’s trademark usage guidelines, a copy of which is attached hereto and which may be amended from time to time, the trademark “Spatializer® N-2-2™” preceded by the circle-in-square device, or other identifying mark approved by Licensor in writing in advance. Where products provide control of the Distributor Product or associated circuitry, Licensee agrees that such control is marked with the term “Spatializer® N-2-2™” as applicable. Where such control occurs by way of software interface, Licensee agrees to provide, in the customary locations notice as follows:

“Spatializer® N-2-2™ [or “OnTheGoFX™”], digital virtual surround processing provided by Desper Products, Inc.”

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Licensee agrees to mark the back panel of each product containing a Distributor Product in an easily readable typeface , with the following legend:

“Certain audio features of this product manufactured under a license from Desper Products, Inc., Spatializer N-2-2™ [and/or “OnTheGoFX™]” and the circle-in-square device are trademarks owned by Desper Products, Inc.”

and, include the above legend in all brochures, manuals, descriptive literature and advertising, for products containing a Distributor Product. Such legend may appear in English as shown above, or in the native language of the country into which such product is intended to be sold. In addition, the legend shall include a listing of any other Licensor trademark used on the product, along with an attribution of its ownership by Licensor, and a listing of the following U.S. patent numbers: #4,308,423, #4,355,203, #5,412,731, #5,896,456 and #6,307,941 where applicable. In the event that new patent numbers are set forth in a supplemented writing, Licensee shall have a reasonable time to add such numbers to the legend.

Licensee agrees to identify Desper Products, Inc. as the source of the audio features provided by the Distributor Product, on all written material and advertising associated with products containing a Distributor Product, wherever such written material or advertising refers to any of the features provided by the Distributor Product (e.g. Digital Virtual Surround sound, Surround sound, 3-D Stereo, 3-D audio, 3-D sound, audio localization, mono to stereo expansion), enhanced therein.

TRADEMARK USAGE GUIDELINES

n Trademark Protection (® and ™ Usage)

Trademark usage is generally based on legal precedent, not idiomatic usage. This sometimes results in awkward or redundant wording. We have done our best to make these recommendations easy to abide by and they are requirements. Please contact us if you have any questions or would like additional information regarding the proper use of our trademarks and logo.

Camera-ready artwork of our trademarks and logo are available upon request.

Through registration with trademark authorities worldwide or through common-law acceptance, Desper Products, Inc. owns the following trademarks. This table shows which trademarks are currently registered with the US and other trademark offices, and which are owned by common-law trademark rights.

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Registered (®)	Common-Law (™)
Spatializer	DDP
	N-2-2
	VBX

“Proper” trademark usage (as defined by national and international conventions) dictates that:

(1) All trademarked words should be used as an adjective, not a noun. In other words, “Spatializer” should modify or describe the word that follows it.

(2) Each trademarked word should be off-set from the surrounding text. Typically, we off-set trademarked words by italicizing them, though you may choose to bold them or put them in all capital letters.

Correct Usage

• Spatializer^® 3-D Stereo provides highly effective 3-D stereo enhancement at lower cost.

• Spatializer^® N-2-2™, digital virtual surround is fast becoming a standard..

Incorrect Usage

• Spatializer^® is a leading audio technology.

     (“Spatializer” is being used as a noun.)

Note: An exception occurs when “Spatializer” refers to the company Spatializer Audio Laboratories, Inc. Then it can be a noun — and never with a ^® or ™, as in — “Spatializer’s President and Chief Executive Officer Henry Mandell said,...”.

Size and position of ® and ™ symbols

As you will notice in the usage examples above, these two symbols belong in the upper right hand corner of the trademarked word or symbol. The proper size and position can be achieved by making the symbol the same font and font size as the regular body text, and then making the symbol “Superscript”.

Alternately, you could make the font at least 2 points smaller (for example, leave the body text at 12 and change the symbol size to 10) and put it in a text box to elevate it to the appropriate position. Some writing programs allow you to adjust the character spacing, so you could raise the symbol position without a text box.

Avoiding overuse of the ® and ™ symbols

Although each occurrence of the Spatializer marks should be off-set from the surrounding text (by italicizing or bolding the mark, for example), each use does not necessarily require a ® or ™ symbol. The following guidelines will help you to determine the proper usage.

1. The first time a Spatializer trademark is used in a document, italicize it and use the appropriate symbol. On subsequent occurrences, just italicize it.

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2.	If the document is long and in sections, use the appropriate symbol with the first occurrence of the trademark in each section.
3.	If the trademark occurs in a title or subtitle, do the same (italicization and symbol).

n Making best use of the Spatializer Marks and Logo

The Spatializer marks, when displayed in a prominent (but tasteful) manner, can positively influence your customers’ buying decisions. The following guidelines are designed to help you get the most from the Spatializer logos. We will be more than happy to review your front panel designs for conformance to these guidelines.

1. Your own brand name should appear on the front panel of the product and be more prominent than the full Spatializer logo. (The circle-in-square next to “Spatializer”, with the tag line 3-D Stereo, or N-2-2 or OnTheGoFX below, lines above and below text, and ® is “the full Spatializer logo”.)

Your own brand name should be larger and placed in a position customarily reserved for brand names. You do not want customers confusing the Spatializer feature with the brand name, and neither do we. The same rule applies for the product box, product literature and other printed materials.

2. You may use the components of the full Spatializer logo only to emphasize the full logo presence.

Therefore, you may use just the circle-in-square or just “Spatializer” to mark the Spatializer On/Off button on a remote control provided that the full logo appears on the faceplate. Please refer to the Software and Hardware Controls Section for more specific suggestions.

Note: This does not give you permission to replace our tag line, 3-D Stereo or N-2-2 or OnTheGoFX with a tag line of your own choosing. We do require that you use 3-D Stereo and N-2-2 or OnTheGoFX whenever you refer to that specific Spatializer technology. However, you should be using your own tag line when you refer to the overall audio quality or the combination of features of your product.

3. The Spatializer logo is always one solid color foreground over one solid color background. In most printed material, the foreground color is black and the background color is white. When it comes to the product facing, we ask that you be consistent with the look of your product. So, if the product is computer-tan, with black writing, then the background of our logo should be tan, with the foreground being the same black silk-screen. When it comes to advertising, we ask that you maintain the integrity of our trademark by selecting colors that lend it a sophisticated look. We ask that you refrain from neon colors, and combinations like hot pink over lime yellow. Since color is the most difficult aspect to define, we ask that if you are in doubt as to the color scheme you are considering, please contact us with a copy of the proposed artwork, for our prompt evaluation and response.

4. Logo size. The Spatializer logo shall be reproduced in size and prominence at least equal to the Dolby Digital Logo reproduced on your products.

5. You may not make changes to our logo without written approval. Occasionally, we have received requests from our licensees to make changes to the full Spatializer logo.

• Is the ® necessary? In all situations where it is possible to print the ®, it is mandatory to do so. However, like in the case of television on-screen menus, it may not be possible to reproduce the ® symbol. If there are other situations in which you deem it

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is impossible or impractical, you may request that we waive this requirement. We will always provide a prompt, written response to these requests. However, it would still be necessary to use the symbol in other places on the same product (like the back plate) and in the associated print materials.

• Is it permissible to narrow the spacing between the letters S, P, A, T, I, A, L, I, Z, E, and R of the logo? You must submit artwork of your proposed alterations. We will most likely allow this modification as long as it preserves the essential look of the logo.

• Do we allow visual designs to express Spatializer effects in print materials and depicting the switch positions visually, like on a LCD? Yes. We use this picture on the left which we call the “Virtual Speaker Array” to depict the Spatializer 3-D Stereo effect. It is our pleasure to make this picture available to you in camera-ready or any computer format that would be helpful to you. You must ask for permission to make you own graphic interpretations of the Spatializer effect, especially if it incorporates the components of the full Spatializer logo. We also have Spatializer N-2-2 and OnTheGoFX visual designs in camera-ready art or any computer format that would be helpful to you. Below is an example of the full N-2-2 and OnTheGoFX logos without a visual design.

For translations please contact the Sales & Marketing office by telephone at (408) 453.4180, or by facsimile at (408) 437-5787. We can also be reached via e-mail at info@spatializer.com.

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EX-31.1

Exhibit 31.1

CERTIFICATIONS

I, Henry R. Mandell certify that:

1. I have reviewed this quarterly report on Form 10-Q of Spatializer Audio Laboratories, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant weaknesses and deficiencies in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 10, 2004

/s/ Henry R. Mandell

Henry R. Mandell
Chief Executive Officer and Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
(SUBSECTIONS (a) AND (b) OF SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES
CODE)

Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of Title 18, United States Code), the undersigned officer of Spatializer Audio Laboratories, Inc. (the “Company”) hereby certifies with respect to the Quarterly Report on Form 10-Q of the Company for the quarter ended September 30, 2004 as filed with the Securities and Exchange Commission (the “10-Q Report”) that to his knowledge:

1)         The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities and
Exchange Act of 1934; and

2)         The information contained in the Report fairly presents, in all material respects, the financial condition
and results of operations of the Company.

Date: November 10, 2004

/s/ Henry R. Mandell

Henry R. Mandell
Chief Executive Officer and Chief Financial Officer