10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the period ended: December 31, 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	(I.R.S. Employer
incorporation or organization)	Identification No.)

2625 Townsgate Road, Suite 330
Westlake Village, California 91361
(Address of principal executive offices)

2025 Gateway Place, Suite 365
San Jose, California 95110
(Address of principal corporate offices)

Telephone Number: (408) 453-4180
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes þ No o

TABLE OF CONTENTS

EX-23.1

EX-31.1

EX-32.1

 Exhibit 10.3

 Exhibit 10.5

 Exhibit 10.6

 Exhibit 10.7

 Exhibit 21.1

 Exhibit 23.1

 Exhibit 31.1

 Exhibit 32.1

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

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

     The aggregate market value of the voting stock held by non-affiliates of the registrant computed by reference to the price at which the common equity was last sold as of the last business of the registrant’s most recently completed second quarter (June 30, 2004) was approximately $4,227,783 and at February 7, 2005 was approximately $2,818,522. In addition, affiliates held non-voting preferred stock valued at $1,183,510 at both June 30, 2004 and February 7, 2005.

     As of February 7, 2005, there were 46,975,363 shares of the Registrant’s Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the definitive proxy statement for the 2004 Annual Meeting are incorporated by reference into Part III hereof.

2

CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS

     This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, reflecting management’s current expectations. Examples of such forward-looking statements include our expectations with respect to our strategy. Although we believe that our expectations are based upon reasonable assumptions, there can be no assurances that our financial goals will be realized. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Numerous factors may affect our actual results and may cause results to differ materially from those expressed in forward-looking statements made by or on behalf of our company. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words, “believes,” “anticipates,” “plans,” “expects” and similar expressions are intended to identify forward-looking statements. The important factors discussed under the caption “Factors That May Affect Future Results” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, herein, among others, would cause actual results to differ materially from those indicated by forward-looking statements made herein and represent management’s current expectations and are inherently uncertain. Investors are warned that actual results may differ from management’s expectations. We assume no obligation to update the forward-looking information to reflect actual results or changes in the factors affecting such forward-looking information.

PART I

Item 1. Business

Overview

     Spatializer Audio Laboratories, Inc. (“Spatializer” or “Company”) is a developer, licensor and marketer of next generation technologies for the consumer electronics, personal computing, entertainment and cellular telephone markets. Our technology is incorporated into products offered by our licensees and customers on various economic and business terms. Our position as a developer of next generation technologies is based on our business relationships with brand leaders, such as Toshiba, Samsung, Sanyo and Matsushita. We conduct our audio business through our parent company and our wholly owned subsidiary, Desper Products, Inc. (“DPI”). DPI has developed a full complement of patented and proprietary 3-D or virtual audio signal processing technologies directed to the consumer electronics and multimedia PC markets. We continue to expand our product offerings to take advantage of the growing digital audio marketplace specifically for consumer products like Digital Versatile Disc (“DVD”) players, portable mp3 players, digital televisions and digital home, portable and cellular handset devices. As of December 31, 2004, more than 47 million licensed units had been shipped covering all of these applications. DPI’s virtual audio signal processing technologies are currently incorporated in products offered by global brand leaders in consumer electronics, PCs and cell phones including Toshiba, Matsushita, Samsung, Intervideo, Sanyo, and Sharp. We are focused on broadening recognition of the Spatializer brand name through association with these and other globally recognized consumer electronics and multimedia computer brand leaders, and on broadening our audio technology and software base to position ourselves for continued growth. We believe that with the accelerating growth in the digital audio/video marketplace, the market for virtual audio technologies, and therefore for our products, is entering a new phase of opportunity.

     We were incorporated in the State of Delaware in February, 1994 as the successor company in a Plan of Arrangement pursuant to which the outstanding shares of Spatializer Audio Laboratories, Inc., a publicly held Yukon, Canada corporation, were exchanged for an equal number of shares of our common stock. Our corporate office and research center is located at 2025 Gateway Place, Suite 365, San Jose, California 95110, Telephone (408) 453-4180. We also maintain executive offices at 2625 Townsgate Road, Suite 330, Westlake Village, California 91361. We have a Website at www.spatializer.com. Copies of this Annual Report, including our financial statements and our quarterly reports on Form 10-Q as well as other corporate information, including press releases, of interest to our stockholders are available on our website promptly after filing or distribution. As used herein, Spatializer, the “Company,” “we” or “our” means Spatializer Audio Laboratories, Inc. and its wholly-owned subsidiaries.

3

     Desper Products, Inc. — Virtual Audio Signal Processing Technologies

     DPI has developed a suite of proprietary advanced audio signal processing technologies for the entire spectrum of applications falling under the general category of virtual audio. The objective in each product category is to create or simulate the effect of a multi-speaker sonic environment using two ordinary speakers (or headphones) for playback. The market for virtual audio is segmented into six broad categories of technology as identified in the listing below. Each of these technologies utilizes different underlying scientific principles in accomplishing its design objectives and is targeted to a specific class of consumer electronics or multimedia computer depending on the intended product use and functional capability of the product. DPI currently has other audio signal processing technologies under development which will serve to expand its market scope and partner product capabilities.

Category of Technology	Product Categories	Audio Enhancement
Stereo Surround Sound	Consumer electronics products providing stereo playback — DVD Players, Stereo TV’s, Stereo Components and Systems, Car Audio, Laptop and Desktop Multimedia Computers, Set-top Boxes	Surround sound enhancement from an ordinary stereo (two-channel) signal
Micro-Speaker Virtualization (Ring tones, music, multimedia)	Cell Phones and Mobile Multimedia Players	Widens sound stage and improves stereo separation from Two-Channel Ring tones, compressed audio, FM and TV broadcast and games in small form factor applications.
Surround Sound Enhancement	Products incorporating stereo audio sources for playback through 5.1 or more home theater systems: AV Receivers	Creation of spatially accurate home theater surround sound from two channel sources
Multi-Channel-Speaker Virtualization	Products incorporating multi-channel audio sources like Dolby Digital® (AC-3), DolbyProLogic® or MPEG-2. Home Theater, DVD-Video, Multimedia	Creation of spatially accurate multi-speaker cinematic audio experience from two speakers utilizing discrete multi-channel audio information
Noise Reduction	Computers and Recordable DVD utilizing DVD/MPEG and decoding. Cell phone handsets.	Static noise reduction combined with stabilization of dynamic audio range
Virtual Bass Enhancement	Consumer electronics products providing stereo playback —Mobile Multimedia Players, Cell Phones, DVD Players/Recorders, Stereo TV’s, Stereo Components and Systems, Car Audio, Laptop and Desktop Multimedia Computers and Speakers and Headphones.	Simulation of lower frequency response from speakers with relatively high low frequency capability
Dynamic Range Compression	Laptop and Desktop Multimedia Computers, Cell Phones and Portable Multimedia Players running digital media player software	Prevents over-driving speakers, headphones or ear buds while maximizing the dynamic audio output
Headphone Virtualization	Any consumer, cell phone or mobile application incorporating both stereo and multi-channel audio sources like Dolby Digital® (AC-3), Dolby ProLogic®, MPEG-2 or stereo. DVD-Video, Multimedia Computers utilizing DVD/MPEG Decoding or stereo	Creation of spatially accurate multi- speaker cinematic audio experience from headphones utilizing discrete multi-channel audio information
Phase Corrected Equalization	All audio products with one or more speakers	Creation of more recognizable and “cleaner” music or dialog from all media sources
Virtual Digital Theatre	PCs and Notebooks	Audio enhancement to help ease the transition of PCs and Notebooks into entertainment platforms

4

Licensed Products

     Our current technology product applications are directed to (1) speaker enhancement, (2) stereo surround sound enhancement, (3) mobile entertainment enhancement and (4) noise reduction.

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

5

5.	Spatializer Natural Headphone Spatializer Natural Headphone, introduced by DPI in March 2001, renders spatially accurate multiple speaker positions simulating the typical home theater or stereo arrangement through a headphone. The headphone algorithm delivers a high performance simulated surround sound experience, using a reasonable amount of processing power at a reasonable cost. Thus, this solution is equally practical and effective for both low-power portable devices and home theater applications. Unlike typical virtual surround sound headphone solutions, which rely heavily on reverberation which can sound unnatural, Spatializer Natural Headphone utilizes a combination of techniques to provide an expanded, yet natural sound field.
6.	Spatializer PCE, introduced in October 2001, makes high frequencies clearer, crisper and more brilliant while low frequencies are more dramatic, tighter and have more impact. Spatializer® PCE gives the manufacturer an inexpensive way to dramatically improve the sound of low-end loudspeakers, such as the kind found in televisions, boom boxes and computers. Spatializer PCE is also ideal for improving the quality of Internet audio, which can sound rather lackluster and dull due to compression or low bit rates. It can be applied prior to encoding audio streams, and can just as easily enhance the playback of the decompressed audio. It can improve the clarity, intelligibility and impact of both dialog and music. Spatializer PCE works by both modifying and smoothing non-linear phase response and by creating psycho-acoustic cues. Typical equalization techniques cause phase distortion (non-zero group delay) due to non-linear phase response. Spatializer PCE has a nearly-linear phase response, which results in a near-zero group delay. This improves the “naturalness”, or transparency of the dialog or music by not adding to phase distortion already present in many playback systems. This technology is patent pending. Spatializer PCE can be custom tailored for two or an array of speaker configurations. The technology, without a surround sound effect, can enhance single speaker applications as well.
7.	Spatializer enCompass AV Spatializer enCompass AV, launched in late 2002, is designed to offer high quality, multi-channel audio, even from mono or stereo sources. This technology allows owners of home theater systems with five or more speakers to hear a surround sound effect, utilizing all of their speakers to deliver full system utility from CDs, cassettes or VHS tape or records.
8.	Spatializer VirtuaLFE processes the sub-woofer channel with proprietary psycho-acoustic techniques to virtualize, reinforce and enhance the effect for accurate reproduction through two speaker home audio or on-board television speakers. The result is an emotive low frequency effect that brings DVDs alive as if an actual sub-woofer speaker were employed. The efficient algorithm architecture makes implementation feasible on a wide array of home entertainment products.
9.	Spatializer Audio Alchemy dynamically removes noise from up to six input channel simultaneously. Utilizing state of the art noise removal and reduction techniques, Spatializer Audio Alchemy dynamically adjusts to changing noise levels and environments. Tailored for the human voice, Spatializer Audio Alchemy removes background noise such as fans, motor hum, and tape hiss. Spatializer Audio Alchemy features an advanced equalization processor to compensate for frequency response limitations in the audio recording hardware and transducers. In addition, Spatializer Audio Alchemy also performs spatial reconstruction to simulate the original acoustic environment, and normalizes the dynamic range of the digital audio source to a level compatible with home theater environments. This technology is patent pending.

In addition, we offer three whole product solutions with multiple Spatializer technologies that comprehensively address the unique audio delivery challenges inherent in each targeted platform. The Spatializer HD Class is comprised of three new products specifically targeted at home audio, cellular telephones and other mobile applications and personal computers. The Spatializer technologies in each package operate in a complementary fashion, such that the concurrent technologies deliver a more powerful and effective audio experience than that possible from a single solution. Further, each technology has been optimized and customized for the targeted application and is designed to overcome the audio challenges presented by small form factor, transducer limitations and even cost constraints.

Spatializer UltraMobile HD™ delivers higher definition digital audio to mobile audio systems through the multiple and complementary use of Spatializer Natural Headphone, Spatializer Vi.B.E. and Spatializer PCE. UltraMobile HD improves the performance of low cost headphones or ear buds, as well as from compressed audio by opening up the sound field while improving bass performance. In cellular telephone applications, Spatializer ((environ)) delivers maximum performance from micro-speakers that are mounted closely together and helps compensate for the more limited dynamic range as compared with standard size speakers. When applied to stereophonic ring tones, Spatializer ((environ)) creates a startling and expressive sound field when such speakers are utilized in cellular handsets.

6

Spatializer UltraTV HD™ delivers higher definition digital audio performance to digital televisions, DVD players and DVD Recorders. HDTV signals can realistically be retrieved only in limited ways, leading to customer disappointment. The Spatializer UltraTV HD processor is designed to compensate for these shortcomings in digital home entertainment for the millions of households without home theater systems. Realistic surround sound, near-sub-woofer effects and crisp dialog is made possible through two speakers, rather than through expensive arrays of external speakers. Another unique aspect of this product is that it is designed specifically for playback through television speakers and can be custom tailored to the frequency aspects of a manufacturer’s speaker set.

Spatializer UltraPC HD™ helps ease the transition of the personal computer from business tool to a comprehensive component of the digital home entertainment experience. Spatializer UltraPC HD includes Spatializer N-2-2 Ultra that delivers surround sound through only two speakers, Spatializer Natural Headphone for personal surround sound, Spatializer VirtuaLFE™ that processes the sub-woofer channel for a low frequency effect through ordinary speakers and Spatializer PCE for dialog clarity. Each of these technologies has been optimized for small speaker or headphone playback and can be custom tuned to a manufacturer’s specific speaker set.

Licensing Activities

     Until 2000, we licensed our technologies primarily through semiconductor manufacturing and distribution licenses (“Foundry Licenses”) with semiconductor foundries. In turn, the foundries manufacture and distribute integrated circuits ICs (integrated circuits) or DSPs (digital signal processors) incorporating Spatializer technology to consumer electronics and multimedia computer OEMs (original equipment manufacturers).

     In 2000, we began offering foundries the option of entering into a non-royalty bearing distribution agreement with us. Under this business model, the foundry offers Spatializer technology as an optional feature, promotes our technology in their sales materials and cooperates with the Spatializer sales force in closing license agreements for Spatializer technology with the OEM customer. This business model provides the foundry with an additional selling feature at no additional cost to the foundry. The OEM can obtain use of the technology directly from Spatializer without any additional mark-up from the foundry.

     The terms of all of our licenses are negotiated on an individual basis requiring the payment of a per unit running royalty according to sliding scales based upon cumulative volume. Some of our licenses call for the payment of an up-front license issuance fee either in lieu of, or in addition to the running royalty. Other agreements require the OEM customer, rather than the foundry, to pay the royalty. Per unit royalties are generally reportable and payable 45 days after the end of the quarter following shipment from the foundry to the OEM or, in the case of a distribution agreement, by the OEM to its accounts.

     OEMs who desire to incorporate these DSPs or ICs into their products are required to enter into a license (“OEM Licenses”) with us before they may purchase the ICs in quantity. Foundry Licenses generally have limited the sale of DSPs or ICs with Spatializer technology to OEMs who have entered into an OEM License with us. OEM licenses generally provide for the payment of a further per unit royalty by the OEM for OEM products incorporating a Spatializer IC (“Licensed Products”) payable in the quarter following shipment by the OEM of its Licensed Products.

     We are currently negotiating new IC/DSP Foundry Licenses and OEM Licenses with potential customers for Spatializer N-2-2 Ultra, Spatializer Vi.B.E., Spatializer Natural Headphone , Spatializer PCE and combinations and optimizations of these technologies under the Spatializer Ultra HD series. Currently, all new licenses are negotiated by our Chief Executive Officer.

7

     IC/DSP Foundry Licenses

     On August 26, 2004, the Company announced that , through its wholly-owned subsidiary, Desper Products, Inc., it entered into a major multi-technology licensing agreement with Samsung Electronics, Co. Ltd. on August 22, 2004.

     As of December 31, 2004, we have entered into non-exclusive Foundry Licenses for our Virtual Audio Signal Processing technologies with Matsushita Electronics Corporation (“MEC”), Samsung Electronics, Sigmatel, ESS Technology, Inc. (“ESS”), OnChip Systems, Inc. (“OnChip”), LSI Logic, Inc. (“LSI”), Acer Labs, Inc. (“Ali”), MIPS Technologies, NJRC, Tvia, Inc., Texas Instruments, Cirrus Logic and MediaTek. Foundry Licenses generally require the payment of per unit running royalties based upon a sliding scale computed on the number of Spatializer ICs or DSPs sold.

     As of December 31, 2004, more than 47 million ICs, programmable processors and DSPs incorporating Spatializer audio signal processing technology had been manufactured and sold.

OEM Licensees and Customers

     As of December 31, 2004, our technology has been incorporated in products offered by more than 105 separate OEM Licensees and customers on various economic and business terms. Some of these OEM Licenses required a license issuance fee and/or a separate per unit royalty, while others were licensed under the Logo Usage Agreement (“LUA”) or were authorized customers under bundled royalty licenses with the IC foundries. The OEM Licensees and customers offer a wide range of products, which include DVD players and recorders, cellular phones, portable digital audio players, programmable processors, multimedia desktop personal computers, notebook computers and digital televisions.

     In 2004, four major customers, not presented in order of importance, each accounted for 10% or more of our total revenues: Matsushita, Toshiba, Sharp and Samsung, each of whom accounted for greater than 10% of our total 2003 revenues. One OEM accounted for 29%, one accounted for 25% each, one accounted for 21% and one accounted for 13% of our royalty revenues during 2004. One other account comprised more than 5%, but less than 10% of revenues. All other OEM’s accounted for less than 5% of royalty revenues individually. The following table is a partial list of the OEM Licensees and authorized customers as of December 31, 2004:

•   Acer Labs

•   Apple Computer

•   Cirrus Logic

•   InterVideo

•   JVC

•   LG Electronics

•   Logitech

•   LSI

•   MediaTek

•   Micronas

•   Mitsubishi Image and Information Works

•   Motorola

•   NEC

•   Panasonic Car Audio

•   Panasonic TV

•   Samsung

•   Sanyo Corp.

•   Sharp Corp.

•   Sigmatel

•   Texas Instruments

•   Theta Digital

•   Toshiba DVD

•   Toshiba TV

•   Zoran

     We have extensive relationships with OEM licensees and customers outside the United States. Japanese and Korean based entities accounted for 70% and 25% of our total revenues, respectively in 2004, 71% and 20% of our total revenues, respectively in 2003, and 50% and 17% of our total revenues, respectively in 2002. The products incorporating our technology are, in turn, sold throughout the world, in market segments and amounts that are consistent with the overall general world markets for consumer electronics and software.

     Customers, Revenues and Expenses

     We generate revenues in our audio business from royalties pursuant to our Foundry, OEM, and other licenses, and from non-recurring engineering fees to port our technologies to specific licensees’ applications. Our revenues, which totaled $1,106,000 in 2004, were derived almost entirely from Foundry and OEM license fees and royalties.

     We seek to maximize return on our intellectual property base by concentrating our efforts in higher margin licensing and software

8

products and eliminated our hardware product operations. Licensing operations have been managed internally by our personnel and through use of an international sales representative force.In 2004, four major customers, not presented in order of importance, each accounted for 10% or more of our total revenues: Matsushita, Toshiba, Sharp and Samsung, each of whom accounted for greater than 10% of our total revenues. One OEM accounted for 29%, one accounted for 25% each, one accounted for 21% and one accounted for 13% of our royalty revenues during 2004. One other account comprised more than 5%, but less than 10% of revenues. All other OEM’s accounted for less than 5% of royalty revenues individually.

     In 2004, declining revenues were experienced from three major DVD customers resulting primarily from the cessation of use of our products by these customers. In most of these cases, the DVD player market, where we had a high concentration of accounts, became commoditized and resulted in a steep decline in price and margins. Manufacturers were forced to strip out features, such as those from our company, in order to compete. Another PC account migrated completely in 2003 to a new operating system and chose not to include any audio software enhancements. In 2004, we expanded our efforts to penetrate the DVD recorder, PC and cellular handset markets. While we achieved some success in this regard, with 49% of 2004 revenue coming from these new sources, securing revenue traction proved difficult since the accounts we lost represented approximately 56% of 2003 revenue. Revenue from new or expanded relationships outside the DVD player category were insufficient to totally offset these losses, resulting in a continued decline in revenue, although reductions in overhead helped to significantly reduce the net loss compared to 2003.

Competition

     We compete with a number of entities that produce various audio enhancement processes, technologies and products, some utilizing traditional two-speaker playback, others utilizing multiple speakers, and others restricted to headphone listening. These include the consumer versions of multiple speakers, matrix and discrete digital technologies developed for theatrical motion picture exhibition (like Dolby Digital®, Dolby ProLogic®, and DTS®), as well as other technologies designed to create an enhanced stereo image from two or more speakers.

     Our principal competitors in the field of virtual audio are SRS Labs, Inc., Dolby Laboratories, Inc., Sonaptic. and Qsound Labs, Inc. In addition, some DSP foundries and OEMs have proprietary virtual audio technologies that they regularly offer to OEMs at no cost. These companies have, or may have, substantially greater resources than us to devote to further technologies and new product developments.

     Pressure on OEMs to reduce their costs, particularly in the DVD market is intense. The marketplace is also susceptible to undisciplined competitors who, from time to time, may offer below market prices to generate short term revenue and larger market penetrations even if it does not provide for viable margins. In the future, our products and technologies also may compete with audio technologies and product applications developed by other companies including entities that have business relationships with us. Factors that affect our ability to compete include product quality, performance and features, conformance to existing and new standards, price, customer support and marketing and distribution strategies.

     We believe that we will favorably compete in this market because we offer a single source, complete suite of patented and proprietary 3D Stereo, interactive positional, virtual surround sound, headphone and speaker virtualization technologies. By virtue of our specialized engineering and OEM support, we can offer a “turn-key” audio solution to OEMs who do not possess this expertise internally. We also have developed new products that address our customer’s need for a low cost solution. We also focus intensely on customer support and have expanded our low-cost contract engineering capabilities with the use of a consulting firm in India. In addition, the strength of our IC Foundry and OEM relationships and the Spatializer brand name recognition in the industry are other key differentiators between both our branded and unbranded competition. Lastly, we continue to explore new and alternative business models that we believe serve the interests of both our customers and our stockholders.

Research and Development

     Our research and development expenditures in 2004, 2003 and 2002 were approximately 54%, 28% and 25% of total operating expenses respectively. These expenses consist of salaries and related costs of employees and consultants engaged in ongoing research, design and development activities and costs for engineering materials and supplies

     As of December 31, 2004, we had three employees and consultants in our R&D group representing 38% of our total human resources. In addition and not included above, we have the availability of three dedicated engineers at an outside consulting company in India for applications engineering. Our software, hardware and application engineers focus on developing intellectual property,

9

technology solutions and consumer products. In 2004, we established a relationship with an engineering services firm in Bangalore, India for the substantial transfer of all applications engineering work to this firm. In addition to substantially lower cost for consulting services as compared to domestic contractors, project completion dates have been reliable and throughput expanded due to their relatively large engineering staff. Thus, multiple projects can be completed simultaneously and within budgeted cost and time parameters.

Intellectual Property and Proprietary Information

     We rely on a variety of intellectual property protections for our products and services, including patent, copyright, trademark and trade secret laws, and contractual obligations. Our core signal processing technology is covered by U.S. patents 5,412,731, 5,896,456 and 6,307,941. On March 20, 1998, we filed a patent application on our enCompass V 2.0 technology with the United States Patent & Trademark Office (“USPTO”) covering our enCompass 2.0 positional audio gaming technology. In June 2000, we filed an additional patent application for our reduced cost/higher performance 3-D Stereo circuit design. In late 2002, we filed a patent application covering our Spatializer PCE technology. In 2003, we filed a patent application for Spatializer Audio Alchemy. Much of our intellectual property consists of trade secrets. In 2002, patent 6,307,941 was issued by the USPTO covering our Spatializer N-2-2 technology. We possess copyright protection for its principal software applications and has U.S. and foreign trademark protection for its key product names and logo marks.

     There can be no assurance that these measures will be successful, or that competitors will not be able to produce a non-infringing competitive product or service. In addition, the laws of certain countries in which our products are or may be developed, manufactured or sold, including various countries in Asia, may not protect our products and intellectual property rights to the same extent as the laws of the United States, or at all. There can be no assurance that third parties will not assert infringement claims against us, or that if required to obtain any third party licenses as a result of an infringement dispute, we will be able to obtain such licenses.

Seasonality

     Due to our dependence on the consumer electronics market, we experience seasonal fluctuation is sales and earnings. In particular, we believe that there is seasonality relating to the Christmas season in the third and fourth quarters, as well as the first quarter, which is generally the weakest. We are moving toward diversifying our key market segments in the consumer electronics industry in an effort to even out our seasonal fluctuation. Overall, seasonality does not have a material effect on our business.

Employees

     We began 2004 with four full-time and five part-time employees and sales representatives and decreased our staff to three full time and five part-time employees, consultants and sales representatives by December 31, 2004. At year-end, there were two full-time employees and one consultant engaged in research and development. In addition, we utilize an engineering firm with three dedicated engineers to our projects on an as-needed basis. We employ the services of outside professional consultants, particularly in the audio engineering area, due to the costly and tight labor market for such professionals in Silicon Valley as well as the need for specialized expertise in the course of our business. None of our employees are represented by a labor union or are subject to a collective bargaining agreement. We consider our relations with our employees and consultants to be satisfactory.

Item 2. Properties

     Our corporate office and research center in San Jose, California, is the primary location for our audio technology division, Desper Products, Inc. (“DPI”). We occupy approximately 1,300 square feet with an annual rent on a full service basis of approximately $25,500 in calendar 2005 and $26,275 in calendar 2006. The lease expires on December 30, 2006 and is renewable at market rates thereafter .

     Our executive office is located in Westlake Village, California, where we occupy approximately 100 square feet with an annual rent of approximately $5,300. The lease term on this space expires on June 30, 2005 and is renewable on a month to month basis thereafter. This space in the Los Angeles area is used to facilitate business and contacts with the entertainment community as well as with our accountants, lawyers and directors.

     We lease an apartment in San Jose, California for use by the chief executive officer when away from the executive office. The annual rent on this apartment is approximately $16,800. The lease is on a month-to-month basis.

10

     We lease our space at rental rates and on terms which management believes are consistent with those available for similar space in the applicable local area. Our properties are well maintained and we believe they are adequate to support our current requirements.

Item 3. Legal Proceedings

     From time to time we may be involved in various disputes and litigation matters arising in the normal course of business. As of the date of this Annual Report on Form 10-K, we are not involved in any legal proceedings that are expected to have a material adverse effect on our consolidated financial position, results of operations or cash flows. However, litigation is subject to inherent uncertainties. Were an unfavorable ruling to occur, there exists the possibility of a material adverse impact on our results of operations of the period in which the ruling occurs. Our estimate of the potential impact on our financial position or overall results of operations for the above legal proceedings could change in the future.

Item 4. Submission of Matters to a Vote of Security Holders

     There were no matters submitted to a vote of our security holders either through solicitation of proxies or otherwise in the fourth quarter of the fiscal year ended December 31, 2004.

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

     Our Common Stock was listed and commenced trading on the NASDAQ SmallCap market on August 21, 1995 under the symbol “SPAZ”. In January 1999, the Common Stock was delisted by the NASDAQ SmallCap Market due to our inability to maintain listing requirements. Our Common Stock immediately commenced trading on the OTC Bulletin Board under the same symbol. The following table sets forth the high and low bid price of our Common Stock as reported on the OTC Bulletin Board for fiscal years 2003 and 2004. The quotations listed below reflect interim dealer prices without retail mark-up, mark-down or commission and may not represent actual transactions.

Period:	High (U.S. $)		Low (U.S. $)
2003
First Quarter	$	0.08	$	0.04
Second Quarter	$	0.07	$	0.04
Third Quarter	$	0.06	$	0.04
Fourth Quarter	$	0.19	$	0.04
2004
First Quarter	$	0.22	$	0.11
Second Quarter	$	0.14	$	0.06
Third Quarter	$	0.10	$	0.05
Fourth Quarter	$	0.09	$	0.05

     On February 7, 2005, the closing price reported by the OTC Bulletin Board was U.S. $0.06. Stockholders are urged to obtain current market prices for our Common Stock. Computershare Investor Services, LLC is our transfer agent and registrar.

     There were no sales of unregistered securities by the Company during the years ended December 31, 2002, 2003 and 2004.

     To our knowledge there were approximately 200 holders of record of the stock of the Company as of February 7, 2005. Our transfer agent has indicated that beneficial ownership is in excess of 4,000 stockholders.

     We have not paid any cash dividends on its Common Stock and have no present intention of paying any dividends. Our current policy is to retain earnings, if any, for use in operations and in the development of its business. Our future dividend policy will be determined from time to time by the Board of Directors.

     The Company has not repurchased any of its equity securities and as of the date hereof, has not made any plans to do so.

11

Item 6. Selected Consolidated Financial Data

     The following selected consolidated financial data should be read in conjunction with our Consolidated Financial Statements and related Notes and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, included in Item 7. The selected financial data for the years ended December 31, 2003, 2002, 2001, 2000 and 1999 are derived from our consolidated financial statements that have been audited by Farber & Hass LLP, independent certified public accountants. The consolidated statements of operation and cash flows for the years ended December 31, 2002, 2003 and 2004 and the report thereon are included elsewhere in this Report.

	Fiscal Year Ended (   , 000 Omitted)
	December 31, 2000			December 31, 2001			December 31, 2002			December 31, 2003			December 31, 2004
Consolidated Statement of Operations Data:
Revenues	$	2,202		$	1,604		$	1,856		$	1,269		$	1,106
Cost Of Revenues		(248	)		(97	)		(131	)		(122	)		(111	)
Gross Profit		1,954			1,507			1,725			1,147			995
Total Operating Expenses		(1,596	)		(1,823	)		(1,711	)		(1,631	)		(1,146	)
Other Income (Expense), Net		34			73			(2	)		(6	)		(5	)
Loss from Discontinued Operations Income taxes		(10	)		3			(6	)		(5	)		(1	)
Net Income (Loss)	$	382		$	(240	)	$	18		$	(495	)	$	(157	)
Basic Income (Loss) Per Share	$	0.01		$	(0.01	)	$	0.00		$	(0.01	)	$	(0.00	)
Diluted Income (Loss) Per Share	$	0.01		$	(0.01	)	$	0.00		$	(0.01	)	$	(0.00	)
Weighted Average Common Shares		46,736,224			47,388,235			47,406,939			47,309,171			46,975,363
Consolidated Balance Sheet Data
Cash and Cash Equivalents	$	1,468		$	869		$	859		$	590		$	871
Working Capital		1,195			1,124			1,125			793			603
Total Assets		2,457			1,753			1,746			1,205			1,464
Redeemable Preferred Stock								1			1			1
Advances From Related Parties		337			113			113			108			0
Total Shareholders’ Equity	$	1,651		$	1,411		$	1,429		$	955		$	798

12

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Overview

     Revenues decreased to $1,106,000 for the year ended December 31, 2004 compared to $1,269,000 for the year ended December 31, 2003, a decrease of 13%. Revenues are almost entirely comprised of royalties pertaining to the licensing of Spatializer® audio signal processing algorithms. A key issue discussed is the difficulty in obtaining revenue traction when traditional revenue sources are eroding, while being replaced by new revenue sources at a lower rate.

     Net loss was $157,000 for the year ended December 31, 2004; ($0.00) basic per share, compared to net loss of $495,000, ($0.01) per share basic and diluted, for the year ended December 31, 2003. Net loss for the current period is primarily the result of lower revenue, partially offset by lower overhead. A key issue discussed is management’s efforts to reduce overhead is view of declining revenue, while maintaining competitiveness.

     Net cash provided by operating activities was $343,939 for the year ended December 31, 2004, as compared to net cash used in operating activities of $253,965 for the year ended December 31, 2003 and net cash provided by operating activities of $85,138 for the year ended December 31, 2002. The increase in cash flows from operations for the year ended December 31, 2004 was primarily a result of the increase in deferred income, a decrease in accounts receivable, partially offset by the net loss. Deferred income increased due to the licensing prepayment and accounts receivable decreased a portion of fourth quarter 2004 revenues being realized through the recognition of deferred income. A key issue is the Company’s ability to generate continued positive cash flow, or if needed, raise additional capital to fund its business.

     The business environment in which we operate is highly competitive and is offers substantial risk. These risks should be studied and understood, as outlined in Risk Factors later in this document.

Approach to MD&A

     An important demonstration of our commitment to our stockholders is a clear explanation of the Company’s operating results, risks and opportunities. 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 “in plain English” that enables the average investor to see the company through the eyes of management;

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

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

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

•   An understanding of our operating environment and its risks

•   An outline of critical accounting policies

•   A review of our corporate governance structure

13

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

•   A review of the important trends in the financial statements and our cash flow

•   Disclosure on our internal controls and procedures

Operating Environment

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

•   We Face Significant Pricing Pressure and Competition that can Result in Our Technology Being Designed Out Within a Short Time Frame, or Impeding Efforts to Secure New Design Wins

•   New Customer Product Development Can be Delayed. This Results in Delays In Revenues. Further, Where our Products are Delayed, Competitive Products May Reach The Market Before, or Replace Our Products.

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

The PC and consumer electronics markets are under intense pressure, primarily from retailers, to reduce selling prices, with resultant pressure to reduce costs. In addition, pricing action by our competitors may be very aggressive. Cost reductions are driven by lower cost sourcing, often in China, design simplification and reduction in or substitution of features. While we present a value proposition that stresses the cost reducing capabilities of our audio solutions through improved performance from lower cost components as well as product differentiation that Spatializer technology can deliver, all such features are closely scrutinized by potential customers’ product marketing and engineering. This makes it more challenging to secure new design wins, particularly in product categories that have become commoditized, such as the case with DVD players. It also may result in the elimination of features, including ours, if cost is of paramount importance. When this occurs, we receive very short notice and revenues from such an account will typically begin a steep decline in the subsequent quarter, resulting in period-to-period fluctuation. This also results limited visibility with regard to future revenues and their impact on our operating results. Our response has been to strengthen our value proposition, more aggressively price and include additional features in our products. We have also entered new segments, such as cell phones, with different competitive pressure. We also emphasize to our overseas sales representatives the need for close customer support, with the objective that both new opportunities and possible difficulties are brought to light as soon as possible.

Manufacturer’s design-in cycles for our technology range from four to twelve months, from the decision to adopt our technology to actual cashflow. Many of our customers operate under very fluid development schedules. These schedules are 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. Whether such processors become an industry standard, or gain wide acceptance in the market, is speculative. 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 must request that our algorithm be implemented. While these requests may be honored, processor manufacturers must schedule such implementation as their resources or corporate strategies allow. Some chip makers, particularly in the cell phone market, have already incorporated solutions from our competitors as a component of the chip itself, making it costly and time consuming to implement alternate solutions like ours. 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

14

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. These revenues are reported to us by our Licensees in formal, written royalty reports, which serve as the basis for our quarterly revenue accruals. Infrequently, certain written reports are received after our required reporting deadlines, sometimes due to contractual requirements. In such cases, management tries to obtain verbal reports or informal reports from the Licensee. In the absence of such information, management may utilize conservative estimates based on information received or historical trends. In such isolated cases, management strives to under-estimate such revenues to err on the side of caution. In the event such estimates are used, the revenue for the following quarter is adjusted based on receipt of the written report. In addition, any error in Licensee reporting, which is very infrequent, is adjusted in the subsequent quarter when agreed by both parties as correct.

     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 and trademarks, consisting primarily of legal and filing fees, and amortize such costs over the remaining life of the asset (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.

Corporate Governance

     Audit Committee

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

     Compensation and Stock Committee

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

15

Our Audit Committee and Compensation and Stock Committee charters are available in print to any stockholder upon request in writing to our principal executive office at 2625 Townsgate Road, Suite 330, Westlake Village, California 91361.

Key Components of the Financial Statements and Important Trends

     The financial statements, including Balance Sheet, results of operations, cash flow and Changes in Stockholders’ Equity should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this report. MD&A explains the key components of each of these financial statements, key trends and reasons for reporting period-to-period fluctuations.

     The Balance Sheet provides a snapshot view of our financial condition at the end of our fiscal year. A balance sheet helps management and our stockholders understand the financial strength and capabilities of our business. Balance sheets can help identify and analyze trends, particularly in the area of receivables and payables. A review of cash compared to the comparable year and in relation to ongoing profit or loss can show the ability of the Company to withstand business variations. The relationship between Current Assets and Current Liabilities Working capital (current assets less current liabilities) measures how much in liquid assets a company has available to build its business . The presence of Deferred Revenue indicates cash received on revenue to be earned over the next twelve months. Receivables that are substantially higher than revenue for the quarter may indicate a slowdown of collections, with an impact on future cash position. This is addressed further in MD&A under Liquidity and Capital Resources.

     The Consolidated Statement of Operations tells the reader whether the Company had a profit or loss. It shows key sources of revenue and major expense categories. It is important to note period-to-period comparisons of each line item of this statement, reasons for any fluctuation and how costs are managed in relation to the overall revenue trend of the business. These statements are prepared using accrual accounting under generally accepted accounting standards. This is addressed further in MD&A under Revenues and Expenses.

     The Consolidated Statement of Cashflows explains the actual sources and uses of cash. Some expenses of the Company, such as depreciation and amortization do not result in a cash outflow in the current period, since the underlying patent expenditure or asset purchase was made years earlier. New capital expenditures, on the other hand, resulted in a disbursement of cash, but will be expensed in the Statement of Operations over its useful life. Fluctuations in Receivables and payables also explain why the net change in cash is not equal to the loss reported on the Statement of Operations. Therefore, it is possible that the impact of a net loss on cash is less or more than the actual amount of the loss. This is discussed further in MD&A under Liquidity and Capital Resources.

          The Consolidated Statement of Changes in Stockholders’ Equity shows the impact of the operating results on the Company’s equity. In addition, this statement shows new equity brought into the Company through stock sales or stock option exercise. This is discussed further in MD&A under Liquidity and Capital Resources.

Results of Operations

     The following discussion and analysis relates to our financial condition and results of operations for the year ended December 31, 2004 compared to the year ended December 31, 2003, and the year ended December 31, 2003 compared to the year ended December 31, 2002. The following discussion of the financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this report.

For the Year Ended December 31, 2004, Compared to the Year Ended December 31, 2003

     Revenues

     Revenues decreased to $1,106,000 for the year ended December 31, 2004 compared to $1,269,000 for the year ended December 31, 2003, a decrease of 13%. Revenues are almost entirely comprised of royalties pertaining to the licensing of Spatializer® audio signal processing algorithms.

     While the overall decrease was relatively modest, the revenue mix by licensee platform was significantly different year over year. The decrease in revenues is attributed primarily to the loss or reduction at three key DVD player accounts and one PC account which in aggregate, generated approximately 56% of total fiscal 2003 revenue. In each case, these licensees decided to use no licensed virtual surround solution or opted for a free solution from their chip supplier, driven primarily by cost reduction pressure. These losses

16

were partially offset by three new revenue sources in cellular phones, mobile audio semiconductors and PCs, and the expansion of an existing license relating to recordable DVD.

     Gross Profit

     Gross profit decreased to $995,000 for the year ended December 31, 2004 compared to $1,147,000 in the comparable period last year, a decrease of 13%. Gross margin held steady at 90% of revenue in the year ended December 31, 2004 compared with 90% of revenue for the comparable period last year. The decrease in gross profit results from lower revenues in the current year We maintain a high margin since revenues are from licensing and royalty activities, which have little or no associated direct manufacturing or selling costs other than commissions paid to our independent representatives that solicit and oversee the particular accounts. All development costs are expensed as engineering and development expenses in the period they are incurred.

     Operating Expenses

     Operating expenses for the year ended December 31, 2004 decreased to $1,146,000 (105% of sales) from $1,631,000 (128% of sales) for the year ended December 31, 2003, a decrease of 30%. The decrease in operating expenses results primarily from reductions in general and administrative expense and sales and marketing expense. General and Administrative expenses declined due to the relocation to smaller and less expensive offices in December 2003 and lower occupancy-related expenses. Sales and marketing expenses declined due to the elimination of a marketing and business development executive position and related travel in the fourth quarter of 2003 and the restructuring of our Japan sales operation. These responsibilities were transferred to another executive and to a new commissioned representative firm in Japan.

     General and Administrative

     General and administrative expense decreased to $615,000 for the year ended December 31, 2004 from $811,000 for the year ended December 31, 2003, a decrease of 24%. The decrease is primarily due to the relocation of our offices to smaller and lower cost facilities in December 2003, upon expiration of an existing lease, lower occupancy related expenses, partially offset by increased legal and accounting expenses related to public filings, in part in response to the additional requirements imposed on public companies by the Sarbanes-Oxley Act and increased travel by the CEO. General operating costs include rent, telephone, legal, public filing, office supplies and stationery, postage, depreciation and similar costs.

     Research and Development

     Research and Development costs decreased to $393,000 for the year ended December 31, 2004, compared to $459,000 for the year ended December 31, 2003, a decrease of 14%. The decrease in research and development expense was due to the commencement of the use of lower cost specialist consultants in India in the second half of 2004.

     We continued efforts to identify, validate, and develop new product ideas at DPI. Specific engineering efforts were directed toward the launch of Spatializer Audio Alchemy, refinement of Spatializer Natural Headphone, development of new cell phone solutions and applications engineering to port our technology to leading processor platforms.

     Sales and Marketing

     Sales and Marketing costs decreased to $138,000 for the year ended December 31, 2004, compared to $361,000 for the year ended December 31, 2003, a decrease of 62%. The reduction in such expenses resulted from the elimination of a sales consultant position, the elimination of a sales executive position in the third quarter of 2003 and fewer trade show participations.

     Net Income (Loss)

     Net loss was $157,000 for the year ended December 31, 2004; ($0.00) basic per share, compared to net loss of $495,000, ($0.01) per share basic and diluted, for the year ended December 31, 2003. Net loss for the current period is primarily the result of lower revenue, partially offset by lower overhead.

17

For the Year Ended December 31, 2003, Compared to the Year Ended December 31, 2002

     Revenues

     Revenues decreased to $1,269,000 for the year ended December 31, 2003 compared to $1,856,000 for the year ended December 31, 2002, a decrease of 32%. Revenues are almost entirely comprised of royalties pertaining to the licensing of Spatializer® audio signal processing algorithms.

     The decrease in revenues is attributed primarily to the loss or reduction at two key accounts which generated in excess of 20% of total revenue each, partially offset by revenue from a new account. The first lost account was in the PC market, which completed its migration to a new operating system in which it chose not to include any software audio enhancements. The second account was in the DVD player market, where it selected a lower cost solution for its low cost, high volume DVD players.

     Gross Profit

     Gross profit decreased to $1,147,000 for the year ended December 31, 2003 compared to $1,725,000 in the comparable period last year, a decrease of 34%. Gross margin decreased to 90% of revenue in the year ended December 31, 2003 compared with 93% of revenue for the comparable period last year. The decrease in gross profit results from lower revenues in the current year and from lower gross margin. The decrease in the gross margin percentage reflects a change in mix to commissionable foreign royalty revenue compared to non-commissionable U.S. sourced revenue. We maintain a high margin since revenues are from licensing and royalty activities, which have little or no associated direct manufacturing or selling costs other than commissions paid to our independent representatives that solicit and oversee the particular accounts.

     Operating Expenses

     Operating expenses for the year ended December 31, 2003 decreased to $1,631,000 (128% of sales) from $1,711,000 (92% of sales) for the year ended December 31, 2002, a decrease of 5%. The decrease in operating expenses results primarily from reductions in sales and marketing due to the elimination of a marketing and business development executive position and related travel in late 2003. These responsibilities were transferred to another executive and to a new representative firm in Japan.

     In the fourth quarter of fiscal 2003, we implemented a cost reduction program that included the elimination of an executive position, relocation of the corporate offices to smaller and lower cost facilities, replacement of a stipended representative with a commissioned representative and other overhead related cost savings. The annualized reduction to be provided by these initiatives is expected to result in an overall overhead reduction of at least 20%.

     General and Administrative

     General and administrative costs increased to $811,000 for the year ended December 31, 2003 from $766,000 for the year ended December 31, 2002, an increase of 6%. The increase is primarily due to increased legal expenses related to public filings, in part in response to the additional requirements imposed on public companies by the Sarbanes-Oxley Act, and increased travel by the CEO. General operating costs include rent, telephone, legal, public filing, office supplies and stationery, postage, depreciation and similar costs.

     Research and Development

     Research and Development costs increased to $459,000 for the year ended December 31, 2003, compared to $433,000 for the year ended December 31, 2002, an increase of 6%. The increase in research and development expense was due to strategic use of outside specialist consultants, wage increases and increased health insurance premiums for such personnel.

     We continued efforts to identify, validate, and develop new product ideas at DPI. Specific engineering efforts were directed toward

18

the launch of Spatializer Audio Alchemy, refinement of Spatializer Natural Headphone, development of the HD Series of whole product solutions and applications engineering to port our technology to leading processor platforms.

     Sales and Marketing

     Sales and Marketing costs decreased to $361,000 for the year ended December 31, 2003, compared to $513,000 for the year ended December 31, 2002, a decrease of 30%. The reduction in such expenses resulted from the elimination of a sales consultant position, the elimination of a sales executive position in the third quarter of 2003 and fewer trade show participations.

     Net Income (Loss)

     Net loss was $495,000 for the year ended December 31, 2003; ($0.01) basic per share, compared to net income of $18,000, ($0.00) per share basic and diluted, for the year ended December 31, 2002. Net loss for the current period is primarily the result of lower gross margin, partially offset by lower overhead.

Liquidity and Capital Resources

     At December 31, 2004, we had $871,000 in cash and cash equivalents as compared to $590,000 at December 31, 2003. The increase in cash and cash equivalents is attributed to an increase in deferred revenue resulting from prepayments on a licensing agreement of $391,395, partially offset by the operating loss of $174,103. We had working capital of $586,000 at December 31, 2004 as compared with working capital of $793,000 at December 31, 2003.

     Net cash provided by operating activities was $343,939 for the year ended December 31, 2004, as compared to net cash used in operating activities of $253,965 for the year ended December 31, 2003 and net cash provided by operating activities of $85,138 for the year ended December 31, 2002. The increase in cash flows from operations for the year ended December 31, 2004 was primarily a result of the increase in deferred income, a decrease in accounts receivable, partially offset by the net loss. Deferred income increased due to the licensing prepayment and accounts receivable decreased a portion of fourth quarter 2004 revenues being realized through the recognition of deferred income.

     We use cash in investing activities primarily to secure patent and trademark protection for our proprietary technology and brand name, and to purchase short-term investments such as bank certificates of deposit. Cash used in investing activities totaled $20,587, $20,709 and $95,891, respectively, in the years ended December 31, 2004, 2003, and 2002. All expenditures for on-going research and development are expenses and therefore included in the Net Loss.

     Net cash flows used in financing activities totaled $41,994 for the year ended December 31, 2004 and cash provided by financing activities totaled $5,746 and $0 for the years ended December 31, 2003 and 2002, respectively.

     In November 2002, the Board of Directors and the holders of our previously outstanding Series B Preferred Stock agreed to exchange the Series B Preferred Stock for a new Series B-1 Preferred Stock, which are convertible commencing in December 2005 into restricted Common Stock at a 10% discount, based on the 10 day average closing bid price prior to the conversion, but subject to a minimum conversion of $.56 per share and a maximum of $1.12 per share. The exchange was completed in December 2002. In connection with the exchange the Series B-1 Preferred Stock, we withdrew the Series A and Series B Preferred Stock and, therefore, currently the Series B-1 Preferred Stock is our only authorized or outstanding class of preferred stock.

     In the fourth quarter of 2003, we negotiated and completed the conversion of a $112,500 related party 10% demand note to a three-year 10% term note. Principal and interest of $5,191 is paid monthly, which we pay on a current basis. Since the director who was an indirect beneficiary of the demand note retired from the Board of Directors in June 2003, the demand note is classified as a note payable at December 31, 2004. There are no installments due in more than twelve months as of December 31, 2004.

     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.

19

     Future payments due under operating lease obligations as of December 31, 2004 are described below:

	Payments due by period
			Less than					More than
Contractual obligations	Total		1 year		1-3 years		3-5 years	5 years
Long-Term Debt Obligations
Capital Lease Obligations
Operating Lease Obligations	$	54,955	$	28,680	$	26,275
Purchase Obligations
Total	$	54,955	$	28,680	$	26,275

     Our future cash flow will come primarily from the audio signal processing licensing, OEM royalties and from possible common stock issuances including warrants and options. We are actively engaged in negotiations for additional audio signal processing licensing arrangements which we believe should generate additional cash flow without imposing any substantial costs on us. We anticipate that there may continue to be dislocations of individual licensing programs due to continuing pressure to reduce costs, particularly in the DVD player segment. We currently believe that growth from other licensing arrangements, which include new markets such as cellular phones, and other arrangements that are pending but not announced or in negotiation, will substantially offset any revenue shortfalls from market dynamics or transitioning platforms. The four new or expanded licensing deals from such sources that generated approximately 60% of fiscal 2004 revenue support this belief. Further, our cost reduction initiative implemented in the fourth quarter of 2003 has lowered the revenues needed to reach the break-even point.

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

     To the extent we maintain or exceed our projected revenues and are not required to fund significant contingencies, we expect to continue to retain our current cash reserves and therefore, maintain our liquidity position at a consistent level both on a short-term and long-term basis. To the extent that we do not achieve current operating levels or are required to fund contingencies, we will be required to use some of our cash reserves and this could impact our longer term liquidity. In addition, we wish to achieve accelerated growth and to take advantage of the dynamic market forces in which we operate, rather than to be affected by them. We believe our current cash reserves and cash generated from our existing operations and customer base are sufficient for us to meet our operating obligations and the anticipated additional research and development for our audio technology business for at least the next 12 months. We will also continue to consider and evaluate capital investment or business arrangements with financial or strategic participants or investors as such opportunities become available to us on terms that enhance shareholder value and support our business strategy.

Net Operating Loss Carry forwards

     At December 31, 2004, we had net operating loss carry forwards for Federal income tax purposes of approximately $26,500,000 which are available to offset future Federal taxable income, if any, through 2013. Approximately $21,700,000 of these net operating loss carry forwards is subject to an annual limitation of approximately $1,000,000.

20

In December 2003, the FASB issued SFAS 132R “Employers’ Disclosures about Pensions and Other Postretirement Benefits—an amendment of FASB Statements No. 87, 88, and 106”. This Statement revises employers’ disclosures about pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those plans required by FASB Statements No. 87, Employers’Accounting for Pensions, No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, and No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions. This Statement retains the disclosure requirements contained in FASB Statement No. 132, Employers’ Disclosures about Pensions and Other Postretirement Benefits, which it replaces. It requires additional disclosures to those in the original Statement 132 about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The Company will adopt the provisions of SFAS 132R on January 1, 2004. The adoption of this pronouncement is not expected to have a material effect on the Company’s financial position, results from operations or cash flows.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs-an amendment of ARB. No. 43, Chapter 4”. This Statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that “... under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges....” This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities.

In December 2004, the FASB issued SFAS No. 152, “Accounting for Real Estate Time-Sharing Transactions – an amendment of FASB statements no. 66 and 67”. This Statement amends FASB Statement No. 66, “Accounting for Sales of Real Estate”, to reference the financial accounting and reporting guidance for real estate time-sharing transactions that is provided in AICPA Statement of Position (SOP) 04-2, Accounting for Real Estate Time-Sharing Transactions. This Statement also amends FASB Statement No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects”, to state that the guidance for (a) incidental operations and (b) costs incurred to sell real estate projects does not apply to real estate time-sharing transactions. The accounting for those operations and costs is subject to the guidance in SOP 04-2.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary assets – an amendment of APB Opinion No. 29”. This Statement amends APB Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange.

In December 2004, the FASB issued SFAS No. 123R, “Share Based Payment”. This Statement is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation”. This Statement supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and its related implementation guidance. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. The Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement does not change the accounting guidance for share-based payment transactions with parties other than employees provided in Statement 123 as originally issued and EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” This Statement does not address the accounting for employee share ownership plans, which are subject to AICPA Statement of Position 93-6, “Employers’ Accounting for Employee Stock Ownership Plans”.

Factors That May Affect Future Results

     This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, reflecting management’s current expectations. Examples of such forward-looking statements include our expectations with respect to our strategy. Although we believe that our expectations are based upon reasonable assumptions, there can be no assurances that our financial goals will be realized. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Numerous factors may affect our actual results and may cause results to differ materially from those expressed in forward-looking statements made by or on behalf of our company. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words, “believes,” “anticipates,” “plans,” “expects” and similar expressions are intended to identify forward-looking statements. The important factors discussed under the caption “Factors That May Affect Future Results” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, herein, among others, would cause actual results to differ materially from those indicated by forward-looking statements made herein and represent management’s current expectations and are inherently uncertain. Investors are warned that actual results may differ from management’s expectations. We assume no obligation to update the forward-looking information to reflect actual results or changes in the factors affecting such forward-looking information.

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 have experienced a loss from operations in three of the last four years. We experienced declining losses in the second and third quarters of 2004, and a profit in the fourth quarter of 2004. While our objective and full effort is on managing a profitable business, due to the market conditions and factors outlined above and below and their impact on fluctuations in operating expenses and revenues,, we cannot provide assurance that we will be able to generate a positive profit position in any given future period. We cannot guarantee that we will increase sales of our products and technologies, or that we will successfully develop and market any additional products, or achieve or sustain future profitability, and we may have to rely on the sale of shares or on debt financings in the future, which may have a dilutive effect on our existing shareholders. Further, we cannot assure you that debt or equity financing will be available as required and if not available, we would have to further scale down operations or even cease operations.

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

22

     The PC and consumer electronics markets are under intense pressure, primarily from retailers, to reduce selling prices, with resultant pressure to reduce costs. 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. Cost reductions are driven by lower cost sourcing, often in China, design simplification and reduction in or substitution of features. Therefore, we are seeking commercial acceptance of our products in highly competitive markets. We have responded by offering additional products targeted to each price and quality segment of the market, more aggressively price and feature enrich our products and enter new segments, such as cell phones, with different competitive pressure. While we present a value proposition that stresses the cost reducing capabilities of our audio solutions through improved performance from lower cost components as well as product differentiation that Spatializer technology can deliver, all such features are closely scrutinized by potential customers’ product marketing and engineering. This makes it more challenging to secure new design wins, particularly in product categories that have become commoditized, such as the case with DVD players. It also may result in the elimination of features, including ours, if cost is of paramount importance. 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.

Because Our Relative Size and Power Is Small Compared To That of Our Customers, Our Business Leverage With Some Customers Is Generally Weak and Communication Not Always Transparent

     We deal with some of the largest global consumer electronics makers in the world, the vast majority of which are in Asia. Spatializer is a small company and there are other options for manufacturers, including those from our competitors, their chip suppliers, or eliminating the use of audio enhancement technology altogether. As such, our leverage with our customers is generally weak. In addition, the culture in our local markets may not dictate clear, direct and transparent communication of business plans or technology usage as is the culture in our home country. When this occurs, we could receive very short notice of discontinued use of our technology and revenues from such an account would typically begin a steep decline in the subsequent quarter, resulting in period-to-period fluctuation. This also results in limited visibility with regard to future revenues and its impact on our operating results. Our response has been to strengthen our business relationships with more onsite visits, increase our understanding of cultural differences and focus more intently on service. We also emphasize to our overseas sales representatives the need for close customer support, with the objective that both new opportunities and possible difficulties are brought to light as soon as possible.

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. In addition, standards may be adopted by cell phone system operators or manufacturers that may impede or prevent the penetration of non-standard technology onto their platforms. While our efforts are focused on promoting our technology to such potential customers, there is no assurance that we will be successful in making our technology a standard.

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

     Since our inception, we have experienced delays in bringing new products to market and commercial application as a result of delays inherent in technology development, financial resource limits and industry responses and maturity. These delays have resulted in delays in the timing of revenues and product introduction. In the future, delays in new product development or technology introduction on behalf of us, our original equipment manufacturers of consumer electronics and multimedia computer products (OEMs), integrated circuit (IC) foundries or our software producers and marketers could result in further delays in revenues and could allow competitors to reach the market with products before us. In view of the emerging nature of the technology involved, and the rapidly changing character of the entire media, internet and computer markets, our expansion into other technology areas and the

23

uncertainties concerning the ability of our current products and new products to achieve meaningful commercial acceptance, there can be no assurance of when or if we will achieve or sustain profitability.

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

     We Expect That We Will Continue to be Dependent upon a Limited Number of OEMs for a Significant Portion of Our Net Sales in Future Periods

     Although no OEM is presently obligated either to purchase a specified amount of products or to provide us with binding forecasts of product purchases for any period, we anticipate being dependent upon a limited number of OEMs for a large port of our net sales. Our four largest customers as of December 31, 2004 accounted for 30%, 25%, 21% and 13% of our net sales.. The loss of any one of our major customers or licensees would significantly reduce our revenues and harm our ability to achieve or sustain acceptable levels of operating results. The loss, or signing of a similarly sized account or accounts would have a material short term impact on our operations and there is no assurance that we will not lose all or some of the revenues from one or more of these accounts. While we are working to broaden the sources of our royalty streams, there can be no assurance that we will be successful in retaining or attracting such key accounts and broadening such revenue stream sources.

     Demand for Our Products is Subject to Risks Beyond Our Control.

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

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

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

•   the pressure faced by our OEM customers to reduce cost

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

Because The Technology Environment In Which We Operate Is Rapidly Changing, We May Not Be Successful In Establishing And Maintaining The Technological Superiority Of Our Products Over Those Of Our Competitors.

     We operate in a technology environment which is competitive and rapidly changing. While our software applications deliver what we, and most manufacturers who listen to it, believe is a significantly superior audio experience, the competitive market forces that pressure manufacturers to reduce their costs may create some resistance to new technology adoption or use. Our future success is dependent on establishing and maintaining the technological superiority of our products over those of competitors, our ability to successfully identify and bring other compatible technologies and products to market and a recognition by the market of product value. We compete with a number of entities that produce various stereo audio enhancement processes, technologies and products in both traditional two-speaker environments such as consumer electronics and multimedia computing, and in multi-channel, multi-speaker applications such as Home Theater. In the field of 3-D or “virtual audio”, our principal competitors are SRS Labs, Inc., QSound Labs, Inc. and Dolby Laboratories or technologies and products developed by other companies, including entities that have business relationships with us. There can be no assurance that we will be able to favorably compete in this market in the future.

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

     Our future success primarily depends on the abilities and efforts of a small number of individuals, with particular management obligations and technical expertise. Loss of the services of any of these persons could adversely affect our business prospects. There is no assurance that we will be able to retain this group or successfully recruit other personnel, as needed. We compete with other

24

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, all new licenses are negotiated by Henry R. Mandell, our Chief Executive Officer, with whom we have an employment agreement with a term expiring in November 2006.

The Market For Our Stock May Be Not Remain Liquid And The Stock Price May Be Subject To Volatility

     Our stock is quoted on the OTC Bulletin Board, where low trading volume and high volatility is often experienced. While a few firms make a market in our stock, the historically low trading volume and relatively few market makers of our stock makes it more likely that a severe fluctuation in volume, either up or down, will significantly impact the stock price. There can be no assurance that these market makers will continue to quote our stock and a reduction in such market makers would negatively impact trading liquidity. Further, with our constrained resources and increased cost and time associated with implementation of Sarbanes-Oxley, it may not be possible for us to remain listed on the OTC Bulletin Board in the future as a fully reporting company. This and the existing limited market and volume in the trading of our stock, may result in our shareholders having difficulty selling our common stock.The trading price of our Common Stock has been, and will likely continue to be, subject to wide fluctuations in response to quarterly variations in our operating results, announcements of new products or technological innovations by the Company or our competitors, strategic alliances between us and third parties, general market fluctuations and other events and factors, some of which may be beyond our control.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

We have not been exposed to material future earnings or cash flow fluctuations from changes in interest rates on our short-term investments at December 31, 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.

25

Item 8. Financial Statements and Supplementary Data

INDEPENDENT AUDITORS’ REPORT

     To the Board of Directors Of Spatializer Audio Laboratories, Inc.:

     We have audited the accompanying consolidated balance sheets of Spatializer Audio Laboratories, Inc. and subsidiaries (The “Company”) as of December 31, 2004 and 2003 and the related consolidated statements of operations, shareholders’ equity, and cash flows for the years ended December 31, 2004, 2003 and 2002. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

     We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Spatializer Audio Laboratories, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of its operations and its cash flows for the years ended December 31, 2004, 2003 and 2002 in conformity with accounting principles generally accepted in the United States of America.

/s/ FARBER & HASS LLP

Camarillo, California
February 28, 2005

26

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	December 31,			December 31,
	2004			2003
ASSETS
Current Assets:
Cash and Cash Equivalents	$	871,155		$	589,797
Accounts Receivable		325,712			345,411
Prepaid Expenses and Other Current Assets		70,940			35,430
Total Current Assets		1,267,807			970,638
Property and Equipment, Net		29,527			42,022
Intangible Assets, Net		166,710			192,485
Other Assets		—			—
	$	1,464,044		$	1,205,145
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Notes Payable		66,252
Notes Payable to Related Party, Short Term		—			37,500
Accounts Payable		71,873			21,466
Accrued Wages and Benefits		50,446			36,973
Accrued Professional Fees		20,000			20,000
Accrued Commissions		32,182			33,856
Accrued Expenses		32,979			28,197
Deferred Income		391,395
Total Current Liabilities		665,127			177,992
Notes Payable to Related Party, Long Term		—			70,746
Commitments and Contingencies
Series B-1 Redeemable Convertible Preferred Shares, $0.01 par value: 1,000,000 shares authorized; 118,351 shares issued and outstanding at December 31, 2004 (liquidation preference of $1,183,510)		1,182			1,182
Stockholders’ Equity (Deficit):
Common shares, $0.01 par value; 65,000,000 shares authorized; 46,975,363 and 47,015,865 shares issued and outstanding at December 31, 2004 and 2003, respectively		469,754			470,159
Additional Paid-In Capital		46,428,866			46,428,461
Accumulated Deficit		(46,100,885	)		(45,943,395	)
Total Shareholders’ Equity		797,735			955,225
	$	1,464,044		$	1,205,145

See accompanying notes to consolidated financial statements

27

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

	Year Ended December 31,
	2004			2003			2002
Revenues:
Royalty Revenues	$	1,105,923		$	1,269,286		$	1,855,934
Cost of Revenues		111,395			122,417			130,516
		994,528			1,146,869			1,725,418
Operating Expenses:
General and Administrative		615,412			811,024			765,637
Research and Development		393,004			458,940			432,826
Sales and Marketing		137,889			360,692			512,727
		1,146,305			1,630,656			1,711,190
Operating Income (Loss)		(151,777	)		(483,787	)		14,228
Interest Income		4,982			7,201			12,432
Interest Expense		(10,295	)		(13,447	)		(14,493	)
Other Income (Expense), Net		0			0			25
		(5,313	)		(6,246	)		(2,036	)
Income (Loss) Before Income Taxes		(157,090	)		(490,033	)		12,192
Income Taxes		(400	)		(5,420	)		(6,100	)
Net Income (Loss)	$	(157,490	)	$	(495,453	)	$	18,292
Basic and Diluted Income (Loss) per Share:	$	(.00	)	$	(.01	)	$	.00
Weighted-Average Shares Outstanding		46,975,363			47,309,171			47,406,939

See accompanying notes to consolidated financial statements

28

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Year Ended December 31,
	2004			2003			2002
Cash Flows from Operating Activities:
Net Income (Loss)	$	(157,490	)	$	(495,453	)	$	18,292
Adjustments to Reconcile Net Income (Loss) to Net Cash Provided (Used) by Operating Activities:
Depreciation		11,942			30,591			54,737
Amortization		46,915			52,313			50,766
Stock and Options Issued for Services					12,000
Net Change in Assets and Liabilities:
Accounts Receivable		19,699			153,612			(56,460	)
Prepaid Expenses, Deposits and Other Assets		(35,510	)		55,960			43,370
Accounts Payable		50,407			(17,561	)		24,155
Accrued Expenses and Other Liabilities		16,581			(45,427	)		50,286
Deferred Revenue		391,395
Discontinued Operations								(100,000	)
Net Cash Provided (Used) by Operating Activities		343,939			(253,965	)		85,138
Cash Flows from Investing Activities:
Purchase of Property and Equipment		(4,007	)		(1,771	)		(74,993	)
Intangible Assets		(16,580	)		(18,938	)		(20,898	)
Net Cash Used by Investing Activities		(20,587	)		(20,709	)		(95,891	)
Cash Flows from Financing Activities:
Exercise of Options and Warrants					10,000
Notes Payable		66,252
Notes and Amounts Due to (from) Related Parties		(108,246	)		108,246
Repayments/Termination of Notes Payable					(112,500	)
Net Cash Provided (Used) by Financing Activities.		(41,994	)		5,746
Increase (Decrease) in Cash and Cash Equivalents.		281,358			(268,928	)		(10,753	)
Cash and Cash Equivalents, Beginning of Year		589,797			858,725			869,478
Cash and Cash Equivalents, End of Year	$	871,155		$	589,797		$	858,725
Supplemental Disclosure of Cash Flow Information:
Cash Paid During the Year for:
Interest	$	10,295		$	11,250		$	14,493
Income Taxes	$	400		$	4,800		$	2,400

See accompanying notes to consolidated financial statements

29

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

	10% Series B Convertible						Common
	Preferred Shares						Shares			Common Shares
													Additional						Total
	Number of			Par			Number of			Par			Paid-In-			Accumulated			Shareholders’
	Shares			Value			Shares			Value			Capital			Deficit			Equity
Balance, December 31, 2001		87,967		$	880			47,406,939		$	474,070		$	46,402,852		$	(45,466,234	)	$	1,411,568
Conversion of 10% Series B to Redeemable Series B-1		(87,867	)		(880	)														(880	)
Series B Pfd. Share dividend														(302	)					(302	)
Net Income																	18,292			18,292
Balance, December 31, 2002		-0-		$	-0-			47,406,939		$	474,070		$	46,402,550		$	(45,447,942	)	$	1,428,678
Options Exercised Warrants Exercised								166,666			1,667			8,333						10,000
Options Issued for Services														12,000						12,000
Cancellation of Unissued Performance Shares								(557,740	)		(5,578	)		5,578
Net Loss																	(495,453	)		(495,453	)
Balance, December 31, 2003		-0-		$	-0-			47,015,865		$	470,159		$	46,428,461		$	(45,943,395	)	$	955,225
Cancellation of Unissued Performance Shares								(40,500	)		(405	)		405
Net Loss																	(157,490	)		(157,490	)
Balance, December 31, 2004		-0-		$	-0-			46,975,365		$	469,754		$	46,428,866		$	(46,100,885	)	$	797,735

See accompanying notes to consolidated financial statements

30

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) Nature of Business

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

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

(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.

     Reclassification — Certain 2003 and 2002 amounts have been reclassified to conform with the current year presentation. In that regard, the Company has reflected the issuance of 15,384 shares of Class B-1 Convertible Preferred Stock that was originally recorded in Additional Paid-in Capital. This resulted in a reclassification of $154 to Convertible Preferred Stock from APIC.

     Revenue Recognition — The Company recognizes revenue from product sales upon shipment to the customer. License revenues are recognized when earned, in accordance with the contractual provisions. Royalty revenues are recognized upon shipment of products incorporating the related technology by the original equipment manufacturers (OEMs) and foundries. The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin 101.

     Concentration of Credit Risk — Financial instruments, which potentially subject the company to concentrations of credit risk, consist principally of cash, cash equivalents and trade accounts receivable. The Company places its temporary cash investments in certificates of deposit in excess of FDIC insurance limits, principally at Citibank FSB. At December 31, 2004 and 2003, substantially all cash and cash equivalents were on deposit at one financial institution.

     At December 31, 2004, three major customers, not presented in order of importance, each accounted for 10% or more of our total accounts receivable: Matsushita, Sharp and Toshiba Corporation, each of whom accounted for greater than 10% of our total 2004 accounts receivable. One customer accounted for 31.0%, another accounted for 27% and one accounted for 18% of our total accounts receivable at December 31, 2004. At December 31, 2003, one customer accounted for 42%, one customer accounted for 23% and one customer accounted for 16%.

     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 95%, 91% and 90% of total sales in the years ended December 31, 2004 and 2003 and 2002, respectively.

     Major Customers — During the year ended December 31, 2004, four customers accounted for 29%, 25%, 21% and 13%, respectively, of the Company’s net sales. During the year ended December 31, 2003, three customers accounted for 34%, 20%, and 20%, respectively, of the Company’s net sales.

31

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

     Advertising Costs — Costs incurred for producing and communicating advertising are expensed when incurred and included in selling, general and administrative expenses. Consolidated advertising expense amounted to $4,289, $2,960 and $4,087 in 2004, 2003 and 2002, respectively.

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

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

     Earnings Per Share — The Company determines earnings per share in accordance with Statement of Financial Accounting Standards No. 128, Earnings Per Share (“SFAS 128”). Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.

     Since the Company generated a net loss in 2004 and 2003, outstanding stock options and warrants would have been anti-dilutive and are not applicable to this calculation.

     The impact of Statement 128 on the calculation of earnings per share is as follows:

	Year Ended December 31,
	2002
BASIC:
Net Income (Loss) Available to Common Shareholders	$	18,292
Weighted Average Shares Outstanding		47,406,939
Basic Earnings(Loss) per Share	$	0.00
DILUTED:
Net Income (Loss) Available to Common Shareholders	$	18,292
Weighted Average Shares Outstanding		47,406,939
Net Effect of Dilutive Stock Options and Warrants Based on the Treasury Stock Method Using Average Market Price
Total Shares		47,406,939
Diluted Earnings per Share	$	0.0000
Average Market Price of Common Stock	$	.1234
Ending Market Price of Common Stock	$	.06

     The following table presents contingently issuable shares, options and warrants to purchase shares of common stock at December 31, 2002. Those that were outstanding during 2004 and 2003 were not included in the computation of diluted loss per share because the impact would have been anti-dilutive:

	2002
Options.		2,671,500
Warrants		-0-
Total		2,671,500

     Stock Option Plan —The Company determines the effect of stock based compensation in accordance with SFAS No. 123, Accounting for Stock-Based Compensation, as amended which permits entities to recognize as expense using the “fair-value” method over the

32

vesting period of all employee stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows entities to continue to utilize the “intrinsic value” method for equity instruments granted to employees and provide pro forma net income (loss) and pro forma earnings (loss) per share disclosures for employee stock option grants after 1994 as if the fair-value-based method defined in SFAS No. 123 has been applied. The Company has elected to continue to utilize the “intrinsic value” method for employee stock option grants and provide the pro forma disclosure provisions of SFAS No. 123 (Note 8).

     Impairment of Long-Lived Assets and Assets to be Disposed of - The Company adopted the provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of, on January 1, 1996. This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amounts of the assets exceed the fair value of the assets (see Notes 4). Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

     Segment Reporting - The Company adopted SFAS 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS No. 131”), in December 1997. MDT has been considered a discontinued operation since September 1998. As of December 31, 2002, the Company has only one operating segment, DPI, the Company’s Audio Signal Processing business.

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

     Recent Accounting Pronouncements - In January 2003 the FASB issued Interpretation 46 “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51”. This Interpretation requires a Company to consolidate the financial statements of a “Variable Interest Entity” (“VIE”), sometimes also known as a “special purpose entity”, even if the entity does not hold a majority equity interest in the VIE. The Interpretation requires that if a business enterprise has a “controlling financial interest” in a VIE, the assets, liabilities, and results of the activities of the VIE should be included in consolidated financial statements with those of the business enterprise, even if it holds a minority equity position. This Interpretation was effective immediately for all VIE’s created after January 31, 2003; for the first fiscal year or interim period beginning after June 15, 2003 for VIE’s in which a Company holds a variable interest that it acquired before February 1, 2003.

In May 2003 the FASB issued SFAS 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. This Statement establishes standards for how an issuer of debt or equity classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.

In December 2003, the FASB issued SFAS 132R “Employers’ Disclosures about Pensions and Other Postretirement Benefits—an amendment of FASB Statements No. 87, 88, and 106”. This Statement revises employers’ disclosures about pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those plans required by FASB Statements No. 87, Employers’Accounting for Pensions, No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, and No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions. This Statement retains the disclosure requirements contained in FASB Statement No. 132, Employers’ Disclosures about Pensions and Other Postretirement Benefits, which it replaces. It requires additional disclosures to those in the original Statement 132 about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The Company will adopt the provisions of SFAS 132R on January 1, 2004.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs-an amendment of ARB. No. 43, Chapter 4”. This Statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that “... under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges....” This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities.

In December 2004, the FASB issued SFAS No. 152, “Accounting for Real Estate Time-Sharing Transactions – an amendment of FASB statements no. 66 and 67”. This Statement amends FASB Statement No. 66, “Accounting for Sales of Real Estate”, to reference the financial accounting and reporting guidance for real estate time-sharing transactions that is provided in AICPA Statement of Position (SOP) 04-2, Accounting for Real Estate Time-Sharing Transactions. This Statement also amends FASB Statement No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects”, to state that the guidance for (a) incidental operations and (b) costs incurred to sell real estate projects does not apply to real estate time-sharing transactions. The accounting for those operations and costs is subject to the guidance in SOP 04-2.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary assets – an amendment of APB Opinion No. 29”. This Statement amends APB Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange.

In December 2004, the FASB issued SFAS No. 123R, “Share Based Payment”. This Statement is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation”. This Statement supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and its related implementation guidance. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. The Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement does not change the accounting guidance for share-based payment transactions with parties other than employees provided in Statement 123 as originally issued and EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” This Statement does not address the accounting for employee share ownership plans, which are subject to AICPA Statement of Position 93-6, “Employers’ Accounting for Employee Stock Ownership Plans”.

     The Company believes that the adoption of these pronouncements will not have a material effect on the Company’s financial position, results from operations or cash flows.

     Use of Estimates - Management of the Company has made a number of estimates and assumptions relating to the reporting of

33

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, 2004 and 2003 approximated fair value due to their short maturity or nature.

     The fair values of notes payable at December 31, 2004 and notes payable to a related party 2003 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, 2004 and 2003, consists of the following, net of a reserve for impairment loss in 1998 in accordance with application of SFAS 121:

	2004		2003
Office Computers, Software, Equipment and Furniture	$	331,867	$	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		602,727		564,862
Property and Equipment, Net	$	29,527	$	42,022

(4) Intangible Assets

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

	2004		2003
Capitalized Patent, Trademarks and Technology Costs	$	522,827	$	505,487
Less Accumulated Amortization		356,117		313,002
Intangible Assets, Net	$	166,710	$	192,485

     Estimated amortization is as follows:

2005	$	25,733
2006	$	16,702
2007	$	16,702
2008	$	16,702
Thereafter	$	90,871
	$	166,710

(5) Notes Payable to Related Parties

The Company was indebted to the Desper Family Trust, a related party, in the amount of $54,349 at December 31, 2004. In the fourth quarter of 2003, in response to the calling of the Note by the holder, we negotiated and completed the conversion of the $112,500 related party 10% demand note to a three- year 10% term note. Principal and interest of $5,191 are due monthly, which we pay on a current basis. Since the director who was an indirect beneficiary of the demand note retired from the Board of Directors in June 2003, the demand note is classified as a note payable at December 31, 2004. There are no installments due in more than twelve months as of December 31, 2004

34

(6) Shareholders’ Equity

During the year ended December 31, 2004, shares were issued or converted as follows:
Unissued Performance Shares held in escrow were cancelled.

Options to purchase common shares in exchange for services were issued with a value of $1,000.

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

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

Options to purchase common shares in exchange for services were issued with a value of $12,000.

Capitalization

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

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

Series B-1 Redeemable Convertible Preferred Stock: On November 6, 2002 the Board of Directors Designated a Series B-1 Preferred Stock. The series has a par value of $0.01 and a stated value of $10.00 per share US and is designated as a liquidation preference. The stock will rank prior to the Company’s common stock. No dividends will be paid on the Series B-1 Preferred Stock. Conversion rights vested on January 1, 2003 to convert the Series B-1 Preferred Stock to common at a certain formula based on an average closing share price, subject to a floor of $0.56 and a ceiling of $1.12. At December 29, 2005 certain mandatory conversion requirements exist subject to the above formula. The Series B-1 Preferred Stock has no voting power. Certain restrictions on trading exist based on date sensitive events based on the Company’s Insider Trading Policy. In December 2002, 87,967 shares of Series B-1 Preferred Stock were issued in exchange for the Series B Preferred Stock and 14,795 shares were issued in lieu of the adjusted accrued dividends on the Series B Preferred Stock. In 2004, the Company has reflected the issuance of 15,384 shares of Class B-1 Convertible Preferred Stock that was originally recorded in Additional Paid-in Capital. This resulted in a reclassification of $154 to Convertible Preferred Stock from APIC.

(7) 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, 4,697,536 as of December 31, 2004. Stock options are granted with an exercise price at the minimum equal to the stock’s fair market value at the date of grant. Stock options have five-year terms and vest and become fully exercisable up to three years from the date of grant.

     At December 31, 2004, there were 2,062,536 additional shares available for grant under the Plan. The per share weighted-average fair value of stock options granted during 2004, 2003 and 2002 was $0.09, $0.05 and $0.11, respectively, on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: 2004- expected dividend yield 0%, risk-free interest rate of 4.1%, expected volatility of 150% and an expected life of 5 years; 2003- expected dividend yield 0%, risk-free interest rate of 2.25%, expected volatility of 137% and an expected life of 5 years; 2002 — expected dividend yield 0%, risk-free interest rate of 6%, expected volatility of 427% and expected life of 5 years

     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

35

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			2003			2002
NET INCOME (LOSS):
As Reported	$	(157,490	)	$	(495,453	)	$	18,292
Pro Forma	$	(172,770	)	$	(538,368	)	$	(136,498	)
BASIC AND DILUTED LOSS:
As Reported	$	(0.00	)	$	(0.01	)	$	0.01
Pro Forma	$	(0.00	)	$	(0.01	)	$	(0.01	)

     Stock option activity during the periods indicated is as follows:

						Weighted-Average
	Exercisable		Number			Exercise Price
Options outstanding at December 31, 2001		1,529,132		1,872,299		$	0.45
Options granted				1,300,000		$	0.11
Options exercised				(0	)	$	0.00
Options forfeited				(500,799	)	$	2.29
Options outstanding at December 31, 2002		2,668,332		2,671,500
Options granted				1,200,000		$	0.05
Options exercised				(166,666	)	$	0.06
Options forfeited/expired				(669,834	)	$	0.18
Options outstanding at December 31, 2003		2,540,000		3,035,000		$	0.18
Options granted				200,000		$	0.09
Options exercised				—			—
Options forfeited				600,000		$	0.43
Options outstanding at December 31, 2004		2,381,666		2,635,000		$	0.11

(8) Warrants

     Warrant activity for the periods indicated below is as follows:

	Warrants			Warrant Price
Warrants outstanding at December 31, 2001		2,100,000		$	0.65
Warrants issued		0		$	0.00
Warrants exercised		0		$	0.00
Warrants expired		(2,100,000	)	$	0.65
Warrants outstanding at December 31, 2002		0		$	0.00
Warrants issued		0		$	0.00
Warrants exercised		0		$	0.00
Warrants expired		0		$	0.00
Warrants outstanding at December 31, 2003		0		$	0.00
Warrants issued		0		$	0.00
Warrants exercised		0		$	0.00
Warrants expired		0		$	0.00
Warrants outstanding at December 31, 2004		0		$	0.00

     All of the warrants were granted in 1999 and were issued in connection with private placements. At December 31, 2002, all such warrants had expired, without exercise.

36

(9) Income Taxes

     The Company files a consolidated return for U.S. income tax purposes. Income tax expense for the years ended December 31, 2004, 2003 and 2002 consisted of the following:

	2004			2003			2002
State franchise tax	$	400		$	4,800		$	2,400
Federal taxes		(0	)		(0	)		(0	)
Total	$	400		$	4,800		$	2,400

     Certain revenues received from customers in foreign countries are subject to withholding taxes that are deducted from outgoing funds at the time of payment. These taxes range from approximately 10% to 16.5% and are recorded as net royalty revenue.

     Income tax expense for the years ended December 31, 2004, 2003 and 2002 differed from the amounts computed by applying the U.S. federal income tax rate of 34 percent to loss before income taxes primarily due to the generation of additional net operating loss carry forwards for which no tax benefit has been provided.

     The tax effects of temporary differences that give rise to significant portions of the deferred tax assets at December 31, 2004 is composed primarily of the net loss carry forwards. The net change in the total valuation allowance for the year ended December 31, 2004 was insignificant. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable losses, management believes it is more likely than not the Company will not realize the benefits of these deductible differences and has established a valuation allowance to fully reserve the deferred tax assets at December 31, 2004. Additionally, the ultimate realizability of net operating losses may be limited by change of control provisions under Section 382 of the Internal Revenue Code.

     At December 31, 2004 and 2003, deferred income tax assets were primarily composed of:

Federal at 15% tax rate:

	2004			2003
Accrued Vacation		(6,048	)		(4,338	)
Net operating loss carryforward		1,550,763			1,533,605
Accum Amortization & depreciation		6,189			5,831
State deferred tax asset		(62,021	)		(92,751	)
R & D credit		314,971			288,450
Foreign Tax Credit		35,838			35,838
Deferred tax Asset		1,839,692			1,766,635
Less: Valuation Allowance		(1,839,692	)		(1,766,635	)
Net deferred tax asset		0			0

(10) Commitments and Contingencies

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

Operating Lease Commitments

     The Company is obligated under several non-cancelable operating leases. Future minimum rental payments for all operating leases of approximately $52,000 through December, 2006. Rent expense amounted to approximately $23,000, $ 83,000 and $78,000 for the years ended December 31, 2004, 2003 and 2002, 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. The amount charged to administrative expense for the Plan in 2004, 2003 and 2002 was approximately $2,000 per annum.

37

(12) Quarterly Financial Data (unaudited)

     The following is a summary of the quarterly results of operations for the years ended December 31, 2004 and 2003:

	Quarter Ended
2004	March 31			June 30			September 30			December 31
Net Revenues	$	170,679		$	234,860		$	205,324		$	495,060
Gross Margin	$	153,675		$	216,727		$	179,210		$	444,916
Net Income (Loss)	$	(123,796	)	$	(123,259	)	$	(80,576	)	$	170,141
Basic (Loss) Per Share	$	(0.00	)	$	(0.00	)	$	(0.00	)	$	0.00

	Quarter Ended
2003	March 31			June 30			September 30			December 31
Net Revenues	$	332,378		$	250,902		$	341,339		$	344,667
Gross Margin	$	296,436		$	228,405		$	306,192		$	315,836
Net Income (Loss)	$	(74,449	)	$	(212,461	)	$	(106,502	)	$	(102,041	)
Basic (Loss) Per Share	$	(0.00	)	$	(0.00	)	$	(0.00	)	$	(0.01	)

38

Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosure

     None.

Item 9A. Controls and Procedures

     We carried out an evaluation of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer had concluded that our disclosure controls and procedures as of the end of the period covered by this report were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission’s rules and forms. There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART III

Item 10. Directors and Executive Officers of the Registrant

     Information required for this item incorporated by reference to our Proxy Statement for the 2004 Annual Meeting of Stockholders.

     Code of Ethics

     We adopted a Code of Ethics that applies to all of our directors, officers and employees, including our Chief Executive Officer, our Chief Financial Officer and other senior financial officers. The Company will provide a copy of our code of ethics to any person, free of charge, upon written request sent to our principal executive office at 2625 Townsgate Road, Suite 330, Westlake Village, California 91361.

Item 11. Executive Compensation

     Information required for this item incorporated by reference to our Proxy Statement for the 2004 Annual Meeting of Stockholders.

Item 12. Security Ownership of Certain Beneficial Owners and Management

Equity Compensation Plan Information

							Number of securities
	Number of securities						remaining available for
	to be issued			Weighted-average			future issuance under
	upon exercise of			exercise price of			equity compensation plans
	outstanding options,			outstanding options,			(excluding securities
Plan category	warrants and rights			warrants and rights			reflected in column (a))
	(a)			(b)			(c)
Equity compensation plans approved by security holders		2,635,000	(1)	$	0.12	(1)		2,062,536
Equity compensation plans not approved by security holders.		0			0			0
Total		2,635,000						2,062,536

39

(1) Represents options to acquire the Company’s Common Stock under the Company’s 1995 Stock Option Plan and 1996 Incentive Plan approved by the Company’s stockholders in 1995 and 1996, respectively. The 1995 Plan authorizes grants of options to purchase authorized but unissued common stock in an amount of up to 10% of total common shares outstanding at each calendar quarter or 4,697,536 as at December 31, 2004. Stock options are granted with an exercise price equal to the stock’s fair market value at the date of grant. Stock options have five-year terms and vest and become fully exercisable as determined by the committee on date of grant. The 1996 Plan supplements the 1995 Plan by allowing for stock appreciation, incentive shares and similar accruals aggregating not more than the equivalent of 500,000 shares and the regrant of any Performance Shares that become available for regrant. See Note 2.

     The remaining information is required for this item is incorporated by reference to our Proxy Statement for the 2005 Annual Meeting of Stockholders.

Item 13. Certain Relationships and Related Transactions

     Information required for this item incorporated by reference to our Proxy Statement for the 2005 Annual Meeting of Stockholders.

Item 14. Principal Accounting Fees and Services

     Information required for this item incorporated by reference to our Proxy Statement for the 2005 Annual Meeting of Stockholders.

PART IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

     (a) Financial Statements

     See Item 8.

     (c) Exhibits

40

     The following Exhibits are filed as part of, or incorporated by reference into, this Report:

Exhibit
Number	Description
2.1*	Arrangement Agreement dated as of March 4, 1994 among Spatializer-Yukon, DPI and Spatializer-Delaware (Incorporated by reference to the Company’s Registration Statement on Form S-1,Registration No 33-90532, effective August 21, 1995.)
3.1*	Certificate of Incorporation of Spatializer-Delaware as filed February 28, 1994. (Incorporated by reference to the Company’sRegistration Statement on Form S-1, Registration No. 33-90532,effective August 21, 1995.)
3.2*	Amended and Restated Bylaws of Spatializer-Delaware. (Incorporated by reference to the Company’s Registration Statement on Form S-1,Registration No. 33-90532, effective August 21, 1995.)
3.3*	Certificate of Designation of Series B 10% Redeemable Convertible Preferred Stock of the Company as filed December 27, 1999(Incorporated by reference to the Company’s Annual Report on Form10-K, for the period ended December 31, 1999.)
3.4*	Certificate of Amendment of Certificate of Incorporation of the Company as filed on February 25, 2000 (Incorporated by reference to the Company’s Annual Report on Form 10-K, for the period ended December 31, 1999.)
3.5*	Certificate of Designation of Series B-1 Redeemable Convertible Preferred Stock as filed December 20, 2002 (Incorporated by reference to the Company’s Annual Report on Form 10-K, for the period ended December 31, 2002.)
3.6*	Certificate of Elimination of Series A Preferred Stock as filed December 26, 2002 (Incorporated by reference to the Company’s Annual Report on Form 10-K, for the period ended December 31,2002.)
3.7*	Certificate of Elimination of Series B Preferred Stock as filed December 26,2002 (Incorporated by reference to the Company’s Annual Report on Form 10-K, for the period ended December 31,2002.)
4.1*	Performance Share Escrow Agreements dated June 22, 1992 among Montreal Trust Company of Canada, Spatializer-Yukon and certain shareholders with respect to escrow of 2,181,048 common shares of Spatializer-Yukon. (Incorporated by reference to the Company’s Registration Statement on Form S-1, Registration No. 33-90532,effective August 21, 1995.)
4.2*	Modification Agreement for Escrowed Performance Shares. (Incorporated by reference to the Company’s Definitive Proxy Statement dated June 28, 1996 and previously filed with the Commission.)
4.3*	Form of Exchange Agreement effective December 26, 2002 entered into by holders of Series B Preferred Stock in connection with exchange of same for Series B-1 Preferred Stock (Incorporated by reference to the Company’s Annual Report on Form 10-K, for the period ended December 31, 2002.)
10.1*	Spatializer-Delaware Incentive Stock Option Plan (1995 Plan). (Incorporated by reference to the Company’s Registration Statement on Form S-1, Registration No. 33-90532, effective August 21,1995.)
10.2*	Spatializer-Delaware 1996 Incentive Plan. (Incorporated by reference to the Company’s Proxy Statement dated June 25, 1996 and previously filed with the Commission.)
10.3	Form of Stock Option Agreement

41

Exhibit
Number	Description
10.4*	License Agreement dated June 29, 1994 between DPI and MEC. (Incorporated by reference to the Company’s Registration Statement on Form S-1, Registration No. 33-90532, effective August 21,1995.)
10.5	Employment Agreement dated November 12, 2004, between the Company and Henry Mandell, as amended.
10.6	Related Party Promissory Note to the Successor Trustee of the Ira A. Desper Marital Trust dated November 1, 2003.
10.7	Lease for Office and Research Center in San Jose, CA.
10.8	License Agreement between Spatializer Audio Laboratories, Inc., Desper Products, Inc. and Samsung Electronics, effective August 22, 2004. (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004.)
21.1	Subsidiaries of the Company
23.1	Consent of Independent Auditors
31.1	Certificate of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certificate of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Certification will not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934)

* Previously filed.

42

SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: March 22, 2005
	SPATIALIZER AUDIO LABORATORIES, INC.
	(Registrant)
	/s/ Henry R. Mandell
	Henry R. Mandell
	Chief Executive Officer & Chief Financial Officer

     Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/ Carlo Civelli	Director	March 22, 2005
Carlo Civelli
/s/ James D. Pace	Director	March 22, 2005
James D. Pace
/s/ Gilbert N. Segel	Director	March 22, 2005
Gilbert N. Segel
/s/ Henry R. Mandell	Director	March 22, 2005
Henry R. Mandell

43

EX-10.3

EXHIBIT 10.3

SPATIALIZER AUDIO LABORATORIES, INC.
INCENTIVE STOCK OPTION AGREEMENT

               THIS INCENTIVE STOCK OPTION AGREEMENT (the “Agreement) is dated for reference as set forth on the signature page hereof and is between SPATIALIZER AUDIO LABORATORIES, INC. (the “Company”), and the person hereafter identified (the “Optionee”), with respect to an option (the “Option”) to purchase that number of common shares in the capital of the Company (the “Shares”) hereafter stated at an exercise price per share as hereafter stated.

     WHEREAS:

          A. The Company desires to grant an Option to the Optionee to purchase Shares as an incentive for Optionee’s continued performance as a director, officer or employee of the Company or its subsidiaries.

          B. The Board of Directors of the Company or an authorized committee thereof has authorized the grant of an Option to the Optionee to purchase the number of Shares hereafter set forth (the “Optioned Shares”) at the exercise price hereafter set forth (the “Exercise Price”).

               NOW THEREFORE in consideration of the premises and of the covenants and conditions hereinafter set forth, the parties hereto agree as follows:

     1. Grant of Option

               The Company hereby grants an Option, upon the terms and conditions set forth herein, as follows:

Optionee:

Number of Shares:

2. Effectiveness

               This grant shall be effective as of                                         . Such effective date is hereafter referred to as the “Date of Grant.”

          3. Exercise Price

               $                    per share

          4. Exercise

               The Option to purchase up to                                         shares shall vest as follows:

               Any Option granted under the Plan may be exercised by the Optionee or, if applicable, the legal representatives of an Optionee, giving notice to the Company specifying the number of Shares in respect of which such Option is being exercised and accompanied by payment (by cash or certified check payable to the Company) in an amount equal to the number of Shares in respect of which the Option is being exercised multiplied by the Exercise Price specified in this Agreement. Upon any such exercise of an Option the Company shall cause the transfer agent and registrar of Shares of the Company to promptly deliver to such Optionee or the legal representative of such Optionee, as the case may be, a Share Certificate in the name of such Optionee or the legal representative of such Optionee, as the case may be, representing the number of Shares specified in the notice.

          5. Option Not Transferable

               The Option is not transferable or assignable except by will or by the laws of descent and distribution.

          6. Investment Intent and Restrictions on Resale

               The Company may require, as a condition of exercising the Option, that the Optionee execute an undertaking in a form acceptable to the Company, that the Shares are being purchased as an investment and not with a view to distribution. The Optionee:

          a. agrees not to offer or sell or otherwise dispose of the Shares unless the Shares are subsequently registered under the United States Securities Act of 1933, as amended, or an exemption from registration is available;

          b. consents to the placing of a restrictive legend on any share certificates issued to the Optionee should such be necessary in order to comply with securities laws applicable to the Company; and

          c. acknowledges that securities laws applicable to the Company may require the Optionee to hold any Shares issued to Optionee for a certain period prior to resale

2

thereof.

          7. Termination of Options

               The Option shall terminate, to the extent not previously exercised, upon the occurrence of the first of the following events:

         a. Five years after the Date of Grant.

         b. Thirty (30) days after the Optionee’s cessation to act as a director, officer or employee of the Company or any of its subsidiaries for any reason (other than death);

         c. One year after the Optionee’s death; in such event, the Option may be exercised within such one year period by the person to whom the Optionee’s rights under the Option shall pass by the Optionee’s will or by the laws of descent and distribution to the extent that the Optionee was entitled to exercise the Option at his death.

          8. Representations of Optionee

     The Optionee hereby confirms and represents that:

           a. Optionee is a director, officer or employee of the Company or a subsidiary of the Company at the date hereof; and

          9. Adjustments in Shares

               The Option confers upon the Optionee the option to purchase Shares in the capital of the Company as constituted at the date hereof. If, prior to the exercise of the Option, at any time or from time to time, there shall be any reorganization of the capital stock of the Company, by way of consolidation, subdivision, merger, amalgamation or otherwise, or the payment of any stock dividends, then there shall automatically be an adjustment in either or both of the number of Shares of the Company which may be purchased pursuant hereto or the price at which such Shares may be purchased, by corresponding amounts, so that the Optionee’s rights hereunder shall thereafter be as reasonably as possible equivalent to the rights originally granted to the Optionee by the Option.

          10. Professional Advice

               The acceptance and exercise of the Option and the issuance of Optioned Shares may have consequences under federal, provincial and state tax and securities laws which may vary depending on the individual circumstances of the Optionee. Accordingly, the Optionee

3

acknowledges that he has been advised to consult his personal legal and tax advisor in connection with this Agreement and his dealings with respect to the Option or the Optioned Shares.

          11. Regulatory Approvals

               The Option shall be subject to any necessary approval of and acceptance by the Vancouver Stock Exchange and any other regulatory authority having jurisdiction over the securities of the Company.

          12. Shareholder’s Approvals

               If the approval of the shareholders of the Company to the Option or any amendment of this Agreement shall be required by the prevailing policies of the regulatory bodies having jurisdiction over the securities of the Company, then the Option or any amendment made to this Agreement, as the case may be, shall be subject to the approval of the shareholders of the Company.

          13. Tax Treatment

               Optionee acknowledges that the tax treatment of this option, Shares subject to this option or any events or transactions with respect thereto may be dependent upon various factors or events which are not determined by this agreement. Company makes no representations with respect to and hereby disclaims all responsibility as to such tax treatment.

          14. Withholding Tax

               If the exercise of any rights granted in this agreement or the disposition of shares following exercise of such rights results in Optionee’s realization of income which for U.S or Canadian income tax purposes is, in the opinion of Company, subject to withholding of tax, Optionee will pay to Company, if and when requested by Company, an amount equal to such withholding tax (or Company may withhold such amount from Optionee’s salary) prior to delivery of certificates evidencing the shares purchased.

          15. Entire Agreement

               This Agreement supersedes all prior and contemporaneous oral and written statements and representations and contains the entire agreement between the parties with respect to this Option.

4

          16. Governing Law

               This Agreement shall be construed and enforced in accordance with the laws of the State of California.

          17. Notices

               Any notice to be given hereunder shall be deemed to have been well and sufficiently given if mailed by prepaid registered or certified mail or delivered to the parties at the addresses specified herein or at such other address as each party may from time to time direct in writing. Any such notice shall be deemed to have been received if mailed, seven days after the time of mailing and if delivered, upon delivery. If normal mail service is interrupted by a mail dispute, slowdown, strike, force majeure, or other cause, notice sent by mail shall not be deemed to be received until actually received, and the party giving such notice shall use such other service as may be available to ensure prompt delivery or shall deliver such notice. The addresses of the parties are as follows:

Company	Optionee
Spatializer Audio Laboratories, Inc.
2025 Gateway Place, Suite 365
San Jose, CA 95110
(408) 453-4180 (Voice)
(408) 437-5787 (Fax)

5

IN WITNESS WHEREOF the parties have executed these presents as of the day and year set forth hereafter.

Dated:                                         

Company	Optionee
Spatializer Audio Laboratories, Inc.
By:

EX-10.5

EXHIBIT 10.5

SPATIALIZER AUDIO LABORATORIES, INC.
EMPLOYMENT AGREEMENT

     This Employment Agreement (this “Agreement”) sets out the terms and conditions of your employment by Spatializer Audio Laboratories, Inc., a Delaware corporation (the “Company”).

1. Period of Employment.

     A. Your employment by the Company under the terms of this Agreement is effective as of November 12, 1999 (the “Commencement Date”). Your employment will continue under the terms of this Agreement for a period of three years (3) years (the “Initial Term”) from the Commencement Date, and shall be automatically renewed thereafter for additional one year periods (“Successive Terms”), until terminated in accordance with the terms of this Agreement or until you are notified that the Agreement will not be automatically renewed. Such notification is to be provided to you no less than 6 months before the commencement of a Successive Term and if you elect to terminate your employment during the Initial Term or any Successive Term, you shall provide the Company with notice pursuant to Section 8(A)(1).

2. Job Description.

     A. You are to be employed as the Company’s Chief Executive Officer (“CEO”) and you shall continue to be employed as the Company’s Chief Financial Officer (“CFO”). As CEO, you shall be responsible for the general and active supervision and management over the business of the Company and over its officers, assistants, agents and employees. In your capacity as CFO, you shall have the general care and custody of the funds and securities of the Company, the bank and trust accounts of the Company and you shall exercise general supervision over expenditures and disbursements made by Company as well as the Company’s preparation of financial records and reports in connection therewith as may be necessary. If requested by the Board of Directors of the Company (the “Board”), your duties shall include performing services on behalf of the Company or to affiliates of the Company and in that regard, you agree to serve as the President and Treasurer of Desper Products, Inc (“DPI”). Finally, you agree to serve as a Director of DPI when so elected by the Company as sole shareholder of DPI. You shall devote your full professional time and energy, attention, skills and ability to the performance of your duties during your employment and shall faithfully and diligently endeavor to promote the business and best interests of the Company. You shall make available to the Board and the officers of the Company all knowledge possessed by you relating to any aspect of your duties and responsibilities hereunder. You agree that during your employment with the Company, you will not render or perform services for any other corporation, entity, person or firm actively involved with the Industry without the prior written consent of the Board. For purposes of this Agreement, the term the “Industry” shall consist of firms engaged in the development, licensing and marketing of digital audio signal processing technologies for the consumer electronics, personal computing, enterprise computing and entertainment industries, or those activities of a kind with which you were concerned or involved in the term of this Agreement. You hereby agree to appear and actively participate on behalf of the Company in the Industry and in the general promotion of its business.

1

     B. You further agree, during the course of your employment under this Agreement, to conduct yourself and all business on behalf of the Company in a manner intended to be in full compliance with all laws applicable to the duties undertaken by you during this Agreement.

3. Compensation.

     A. Salary. As compensation for the performance by you of your obligations hereunder, and provided that you satisfactorily perform your obligations hereunder, you will receive an annual salary of two hundred thousand dollars ($200,000) on the normal payroll schedule followed by the Company. On each anniversary of the Commencement Date, you will be eligible for a salary increase as approved by the Compensation Committee.

     B. Performance Shares. In addition to your salary, as set forth above, as November 12, 1999, those 168,628 performance shares held by the Company’s former CEO, Stephen D. Gershick directly, and those 674,516 performance shares held in escrow for him shall be transferred directly to you, to be released in accordance with the terms of that Escrow Agreement dated June 22, 1992. as amended (the “Escrow Agreement”). Other than due to your voluntary termination pursuant to Section 8(A)(1) or 8(B) or termination for Cause as defined in Section 8(A)(2), the Company will continue to distribute these performance shares to you under the schedule in the Escrow Agreement. If you complete the Initial Term of this Agreement, in all events, all remaining performance shares will be distributed to you in accordance with the schedule in the Escrow Agreement.

     C. Stock Options. Of the previously issued 500,000 options to acquire Company common stock, par value $.01 (“Common Stock”) held by you, all 500,000 of such options shall be treated as having been fully vested at November 12,1999 and shall be immediately exercisable by you from that date. Additionally, as November 12, 1999, you shall be granted options to acquire an additional 750,000 options to acquire Common Stock, of which 250,000 shares shall be exercisable at $.50 and immediately vested; 250,000 shares shall be exercisable at $.55 and will vest on November 12, 2000; and 250,000 shares shall be exercisable at $.75 and will vest on November 12, 2001.

     D. Annual Bonus. You shall be entitled to receive, in addition to your annual compensation set forth above, a bonus equal to 5% of the Company’s income after taxes each year, provided however, that in no case shall your bonus exceed $100,000 in any given year.

     E. Other Benefits:

(1)	During the term of this Agreement, you will be entitled, at Company expense, to such medical, disability, accident, life or other insurance or welfare plans, programs or arrangements as may be offered generally to the employees of the Company.
(2)	The Company shall pay or reimburse you for all reasonable and necessary business expenses incurred by you which relate to the business of the Company, as approved by the Board, with such payments or reimbursements

2

to be made monthly on the first scheduled payroll period in the month following that month in which such expenses were incurred, and upon presentation of receipts or other evidence of such expenses. These expenses include, but are not limited to the necessary reasonable and customary expenses associated with your work at the Company’s Santa Clara, California office, including an apartment of reasonable nature in the Santa Clara area, automobile use in the Santa Clara area, round-trip airfare and airport car service to and from the Santa Clara area and meals while working in the Santa Clara area.

(3)

A monthly automobile allowance of nine hundred ($900) dollars.

     F. The compensation provided to you pursuant to this Agreement shall be subject to any required federal, state, local and other governmental withholdings or other deductions that may be required from time to time under applicable tax laws.

4. Place of Work. Your principle place of work shall be at the Company’s business offices located at 20700 Ventura Boulevard, Suite 140, in Woodland Hills, California. You also agree to be available to travel and to work from time to time in such other places as may be requested by the Company for the reasonable performance of your duties. You have agreed that you will be available to work from the Company’s Santa Clara, California office on average of four (4) days per week but this commitment shall not apply in the event of any Change of Control (as defined below) and shall not, in any event, require you to relocate your principal residence to the Santa Clara, California area.

5. Authorizations. You agree to provide to the Company, as a condition precedent to your employment under this Agreement, all legally required proof of your authorization to work in the United States. You further agree to allow the Company to use your name, biography and likeness in connection with information that may be disseminated concerning the Company. You hereby warrant and represent that there are no existing or proposed agreements to which you are a party that may adversely affect your ability to your duties under this Agreement.

6. Vacations and Holidays.

     A. You will be entitled to take as vacation time all official Company holidays each year, as offered to all Company employees. You will also be entitled to three weeks of paid vacation each year.

     B. Holiday and vacation days accrued may be carried over from one year to the next as outlined in the Company’s employment manual or unless otherwise agreed in advance by the Board. Unused holiday days may be reimbursed to you as hours worked at your normal basic salary rate at the sole discretion of the Board.

     C. If you leave the Company before taking vacation days due to you, you will receive a pro-rata payment of your salary in respect to those vacation days you have not used during the year, in accordance with the Company’s policy then in effect for executive officers.

3

7. Sick Pay.

     A. The Company, subject to your compliance with the following procedures, will pay you your salary in respect of periods of absence through illness or injury for up to 14 days absence (in the aggregate) in any period of 12 months, or until the Company’s Short term Disability Plan begins payments. Unless otherwise required by law, sick leave is only to be used when, owing to health reasons, you are unable to work.

     B. Your unused sick leave is not carried forward from one year to the next and you will not be paid for unused sick leave.

8. Termination.

     A. Notice of Termination.

          (1) If you desire to terminate your employment with the Company, you must give the Company 30 days prior written notice; provided however, that if a Change of Control (as defined below) or a change in you place of work, as set forth in Section 4 above, is made, you may choose to terminate your employment by providing 10 days prior written notice to the Company. A “Change of Control” shall mean if and when (i) any person, as that term is used in Section 13(d) and 14(d)(2) of the Securities Exchange Act of 1934 (the “Exchange Act”), becomes or is discovered to be a beneficial owner (as defined in Rule 13d-3 under the Exchange Act as in effect on the date hereof) directly or indirectly of securities of the Company representing 20% or more of the combined voting power of the Company’s then outstanding securities (unless such person is known by you to already be a beneficial owner on the date of this Agreement); and (ii) the individuals who, as of the date hereof, constitute the Board of Directors of the Company cease for any reason to constitute at least a majority of the Board of Directors of the Company, unless such change is approved unanimously by the Board of Directors in office immediately prior to such cessation.

          (2) Except in the case of termination for “Cause” (as defined below), if the Company desires to terminate your employment, for any reason, the Company must give you 30 days written notice. Termination not for “Cause” is subject to the conditions set forth in Section 8(C)(2) below.

          (3) Any salary paid or owing to you from the Company upon termination shall be subject to any deductions for:

i.	Social Security, disability, unemployment or other taxes customarily paid by an employer and employee;
ii.	for any deductions in respect of any indebtedness that you may have to the Company; and
iii.	for any obligations the Company may have to any third party on your behalf.

4

          (4) The Company may, in its sole discretion, choose to pay your salary for the duration of the notice period set forth in Section 8(A)(3) in lieu of providing notice above or following such notice of termination of employment, require you to carry out none or only some of your duties at or away from the Company offices.

     B. For purposes of this Agreement, the following events shall constitute “Termination Events”:

          (1) Any termination of which notice is given under Section 8(A) above;

          (2) Termination of this Agreement by the Company for “Cause.” For purposes of this Agreement, the term “Cause,” when used in connection with the termination of this Agreement by the Company shall mean, and shall be limited to: (a) your commission of a felony; (b) your failure to act on behalf of the Company in its business or in the Industry in breach of this Agreement; (c) your participation actively in a Restricted Business in violation of Section 11 hereof, without the Board’s prior written consent; provided that the Company shall provide to you written notice of its belief that you are in breach pursuant to this section and that you shall have a period of 30 days from the date you receive such written notice of such event or breach to cure such event or breach. In the event of any termination for “Cause” the Company shall be entitled to immediately Terminate your employment with the Company; or

          (3) Your failure to substantially perform the duties required of you hereunder for a period of 30 consecutive days or for shorter periods aggregating 30 days in any 6 month period on account of a physical or mental disability or incapacity, as verified by a written statement from a physician mutually agreeable to you and the Company or your death.

     C. Upon the occurrence of a Termination Event, you shall be entitled to the following payments from the Company:

          (1) Payments in the Event of a Voluntary Termination or a Termination for Cause: Upon the termination of your employment as a result of a voluntary termination by you pursuant to Section 8(A)(1) or a termination for Cause by the Company, you shall be entitled to any Base Salary and accrued vacation pay if any, due and owing at the date of such termination, but not yet paid. You shall not be entitled to any other compensation or payments hereunder after the date of, or otherwise with respect to, such termination of your employment.

          (2) Payments Upon Termination not for Cause. Non-Renewal of Employment. Change of Control of the Company or Place of Work: Upon the termination of your employment not for Cause (including on account of your disability or death) or due to a Change in Control or a change in your place of work as set forth in Section 4 above, you shall be entitled to six months full salary and any accrued vacation, plus one year of Company medical and health benefits.

          (3) Timing of Payments: If you comply with the requirements of Section 13, the Company will pay all amounts payable to you under Section 8(D) no later than fifteen (15) business days after the Termination Event, and shall be paid in legal tender into such bank account as you (or

5

your legal representative) may designate; provided that the Company shall be entitled to withhold any amounts payable to you until you have fully complied with Section 13.

9. Confidentiality.

     A. You acknowledge that you may acquire the trade secrets and confidential information of the Company (“Confidential Information”) during the course of your employment and that the unauthorized disclosure of any such Confidential Information could cause serious harm and damage to the Company.

     B. For the purpose of avoiding such harm you agree that you must not make use of, divulge or communicate to any person (other than with proper authority) any Confidential Information of or relating to the Company or any of its customers or suppliers or any holding company or subsidiary of the Company including (but not limited to) such Confidential Information as: details of customers, potential customers, consultants, suppliers and potential suppliers, product details, prices, financial and accounting information, financial statements, discounts, specific product applications, product designs, product plans, manufacturing processes, computer programs, algorithms, future product developments, research reports, marketing plans, existing trade arrangements or terms of business, which you may receive or become aware of as a result of being in the employment of the Company. This obligation of confidentiality towards such Confidential Information shall continue to apply without limit in time after the termination (for whatever reason) of your employment but it shall not apply to information which is or is already disclosed into the public domain for reasons other than your fault or is required to be disclosed by law, but only to the extent that it is so disclosed.

10. Proprietary Property.

     A. Any proprietary rights whatsoever, including without limitation patents, copyrights and design rights, as a result of the development of, and the application of, all work produced by you during your employment under this Agreement, including (but not limited to) any invention, design, discovery or improvement, secret process, computer program, documentation, confidential information, copyright work or other material which you conceive, discover or create during or in consequence of your employment with the Company shall belong to the Company (“Proprietary Property”). You must promptly communicate to the Company all information concerning such Proprietary Property and if requested provide all such assistance at the Company’s expense as is necessary to secure the vesting of all rights to such Proprietary Property in the Company.

     B. You hereby irrevocably appoint the Company as your attorney-in-fact with full power in your name to execute and sign any document and do any other thing which the Company may consider to be desirable for the purposes of giving effect to this Section 10 and agree to notify and confirm whatever the Company may lawfully do as your attorney-in-fact.

11. Non-Solicitation.

     A. You shall not during employment, or for a period of 12 months after the Termination Date, either personally or by an agent and either on his own account or for or in association with any

6

other person directly or indirectly solicit, endeavor to entice away, induce to break their contract of employment or offer employment to any Restricted Person.

     B. For the purposes of this section the following words have the following meanings:

          i.   “Restricted Business” means any business in the Industry.

          ii.   “Restricted Person” means any person who has at any time in the period of twelve months prior to the Termination Date been employed by the Company or who is a consultant to the Company, who works in the Restricted Business and who was known to or worked with you during that period.

          iii.   “Termination Date” means the date on which your employment under this Agreement terminates.

12. Non-Interference with Suppliers. You shall not for a period of 12 months after the Termination Date either personally or by an agent and either on your own account or for or in association with any other person directly or indirectly interfere or seek to interfere or take such steps as may be likely to interfere with the continuance of supplies to the Company in respect of the Restricted Business and the Industry (or the terms relating to such supplies) from any supplier or seek to damage the relationship between any supplier and the Company who has supplied goods or services to the Company in the 12 month period immediately prior to the Termination Date.

13. Return of Documents, Materials and Equipment. You shall within 72 hours of a Termination Date, deliver to the Company, at the Company’s expense, and at any other time as the Company may request, all equipment owned or leased by the Company for your office use, and all documents, financial records, technology, software, source codes, object codes, hardware (and all copies thereof), all products, product samples, product designs or proto-types, or other items relating to the business of the Company, in whatever medium, that you possess or have under your control. For purposes hereof, any equipment, supplies or materials for which you received reimbursement from the Company shall be presumed to be owned by the Company.

14. Indemnification.

     A. You hereby agree to indemnify, defend and hold harmless the Company, and each of its officers, directors, shareholders, agents, employees and attorneys for the Company, their successors and assigns, from and against, and pay or reimburse each of them for, any and all claims, losses, damages, judgments, amounts paid in settlement, costs and legal, accounting or other expenses that any of them may sustain or incur as a result of any misrepresentation or any non-performance of any covenant or other obligation on the part of you contained in this Agreement.

     B. The Company agrees to indemnify, defend and hold harmless you from and against, and pay or reimburse you for any and all claims, losses, damages, judgments, amounts paid in settlement, costs and legal, accounting or other expenses that any of you may sustain or incur as a result of any misrepresentation or any non-performance of any covenant or other obligation on the part of the Company contained in this Agreement.

7

15. Entire Agreement. This Agreement constitutes the entire Agreement of the parties relating to the subject matter hereof. There are no terms, conditions or obligations other than those contained in this Agreement. This Agreement supersedes all prior communications, representations or agreements between the parties relating to the subject matter hereof. This Agreement may not be amended except in writing executed by you and the Company.

16. Separability of Provisions. The invalidity or unenforceability of any particular provision of this Agreement shall not effect the other provisions hereof; all of which shall remain enforceable in accordance with their terms. Should any of the obligations hereunder be found illegal or unenforceable, such obligations shall be enforceable within whatever terms a court of competent jurisdiction shall deem allowable by law.

17. Assignment. You may not assign, sell, subcontract, delegate or otherwise transfer your obligations under this Agreement, without the prior written consent of the Board, and any attempted assignment or delegation shall be void and without effect.

18. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the Delaware for agreements wholly negotiated, entered into and performed within the State of Delaware.

19. Injunctive Relief. You hereby acknowledge that the Company and its affiliated companies are new and evolving companies and that protection of Proprietary Property and Confidential Information are important to future prospects for growth and business development of the Company. You further acknowledge that the Company may not have an adequate remedy at law in the event of any breach or threatened breach by you of any provision of Sections 9,10,11,12 and 13, and that the Company may suffer irreparable damage and injury as a result. Accordingly, in the event of any such breach or threatened breach, you hereby consent to the application the Company for injunctive relief against you by any court of competent jurisdiction without the posting of any bond or security therefor.

20. Policies and procedures. You further agree to abide by the Company’s policies and procedures and any changes that may be made to them from time to time.

21. Counterparts. This Agreement may be executed simultaneously in one or more counterparts, each of which shall be deemed an original, but all of which, together, shall constitute One and the same instrument.

8

     WHEREAS, this Agreement is hereby entered to by the undersigned as of the date indicated below.

Dated:                                        

SPATIALIZER AUDIO LABORATORIES, INC.
By:	/s/ Stephen W. Desper
Name:	Stephen W. Desper
Title:	Director and designated signatory

9

AGREED AND ACCEPTED BY EMPLOYEE:

/s/ Henry R. Mandell

Henry R. Mandell

10

SPATIALIZER AUDIO LABORATORIES, INC.

February 5, 2002

Henry R. Mandell
5192 Pesto Way
Agoura Hills, CA 91301

Dear Henry:

     This letter agreement amends certain terms of the Employment Agreement (the “Agreement”) effective as of November 12, 1999 between you and Spatializer Audio Laboratories, Inc. (the “Company”) regarding: (i) your compensation and (ii) the terms of your severance in the event of “Change in Control” pursuant to the Agreement. We are pleased that you will be continuing with the Company for another year. For calendar year 2002, your base compensation will consist of a salary of $214,200, a monthly car allowance of $1,250 and the other executive benefits consistent with the Company’s current arrangements with you. In addition, in accordance with our discussions, we have agreed that the Agreement is hereby amended as follows:

“Compensation

     1. Performance Shares. Pursuant to Sections 3(b) of the Agreement, you were to be issued Performance Shares in the Company which are subject to the terms of that certain Escrow Agreement, dated as of June 22, 1992, as amended, by and among the Company and the signatories thereto.

     In November 2000, 168,632 performance shares were issued to you, but you declined to accept these shares (the “2000 Performance Shares”) and, in lieu thereof, in 2001 you were granted options to acquire 250,000 shares exercisable at $0.22 per share (“2001 Options”). In June of 2001, 252,944 of the 674,516 Performance Shares held in escrow for you (the “2001 Performance Shares”) were released, but you declined to accept the 2001 Performance Shares and now wish to decline the 2001 Options.

     In lieu of your decision to decline the 2001 Performance Shares and the 2001 Options, the Company has agreed to release to you from escrow 425,000 performance shares, therefore:

     Section 3(b) of the Agreement is amended to read as follows:

Henry R. Mandell
February 5, 2002
Page 2

     “B. Performance Shares. In addition to your salary, as set forth above, we agree that as of December 20, 2001, 425,000 performance shares including performance shares released to you in accordance with the terms of that Escrow Agreement dated June 22, 1992, as amended (the “Escrow Agreement”) and subsequently declined by you along with additional performance shares (previously returned to escrow when the holders left the employ of the Company) shall be and hereby are reallocated to your account as of January 2, 2002 and held for you along with the 252,942 performance shares previously allocated to and held in escrow for you pursuant to this Agreement. Other than due to your voluntary termination pursuant to Section 8(A)(1) or 8(B) or termination for Cause as defined in Section 8(A)(2), the Company will continue to distribute these performance shares to you under the schedule in the Escrow Agreement. If you complete the Initial Term of this Agreement, in all events, all remaining performance shares will be distributed to you in accordance with the schedule in the Escrow Agreement.”

     Section 3(c) of the Agreement is amended to read as follows:

     “C. Stock Options. Of the previously issued 500,000 options to acquire Company common stock, par value $.01 (“Common Stock”) held by you, all 500,000 of such options were fully vested at November 12, 1999 and were immediately exercisable by you from that date, including options to acquire 250,000 shares of Common Stock exercisable at $1.00. Additionally, as of November 12, 1999, you were granted options to acquire an additional 750,000 options to acquire Common Stock, of which 250,000 shares were exercisable at $.50 and immediately vested; 250,000 shares were exercisable at $.55 and vested on November 12, 2000; and the 250,000 shares vested on November 12, 2001 and were exercisable at $.75. The options to acquire 250,000 shares of Common Stock at an exercise price of $1.00 and options to acquire 250,000 shares of Common Stock at an exercise price of $.75 are terminated as of November 12, 2001. If you are an employee of the Company on the day following the Company’s 2002 Annual Shareholders Meeting, you will be granted on that date, in your capacity as an employee, options to purchase 500,000 shares of Common Stock which shall be fully vested and convertible at the Fair Market Value (as defined the Company’s 1996 Incentive Compensation Plan) of the Company’s Common Stock as of the date of grant.

SEVERANCE

     4. Section 8(C)(2) of the Agreement, is hereby amended to read as follows:

          “Upon the termination of your employment not for Cause (including on account of your disability or death) a change in your

Henry R. Mandell
February 5, 2002
Page 3

place of work as set forth in Section 4 above, you shall be entitled to six months full salary and any accrued vacation, plus one year of Company medical and health benefits. Upon termination of your employment in the event of a Change in Control, you shall be entitled to twelve months full salary, any accrued vacation and medical and health benefits.”

        Except as set forth herein, the Agreement shall remain in full force and effect and shall otherwise be unaffected hereby. If the foregoing accurately and completely sets forth the terms and understanding of our agreement, please indicate your acceptance by signing the enclosed copy of this letter in the indicated space below.

Very truly yours,
SPATIALIZER AUDIO LABORATORIES, INC.
By:	/s/ Gilbert N. Segel
	Gilbert N. Segel, for the Compensation
	Committee

ACCEPTED AND AGREED:

/s/ Henry R. Mandell

Henry R. Mandell

SPATIALIZER AUDIO LABORATORIES, INC.

February 21, 2005

Henry R. Mandell
2025 Gateway Place, Suite 365
San Jose, CA 95110

Dear Henry:

     This letter agreement, effective as of November 12, 2004, amends the following terms of the Employment Agreement (the “Agreement”) between you and Spatializer Audio Laboratories, Inc. (the “Company”) effective as of November 12, 1999, as amended on February 2, 2002 and amended hereby: (i) the extension of the term of the Agreement for an additional one-year period until November 12, 2006 and (ii) the grant of stock options to replace stock options previously issued to you which stock options have since expired unexercised. We are pleased that you will be continuing with the Company for another year. Your base compensation, consisting of a salary of $214,200 and all other executive benefits remain unchanged. In addition, in accordance with our discussions, we have agreed that the Agreement is hereby amended as follows:

     The following sentence shall be added to Section 3.C. of the Agreement:

          “As of February 21, 2005, you are hereby granted an option to purchase 500,000 shares of Common Stock at an exercise price of $0.10 per share. An option to purchase 250,000 shares of Common Stock is immediately vested as of February 21, 2005 and an option to purchase the remaining 250,000 shares of Common Stock shall vest on November 12, 2005 as long as you remain continuously employed by the Company or a subsidiary until such time.”

     Except as set forth herein, the Agreement shall remain in full force and effect and shall otherwise be unaffected hereby. If the foregoing accurately and completely sets forth the terms and understanding of our agreement, please indicate your acceptance by signing the enclosed copy of this letter in the indicated space below.

Very truly yours,
SPATIALIZER AUDIO LABORATORIES, INC.
By:	/s/ Gilbert N. Segel
	Gilbert N. Segel, for the Compensation
	Committee

ACCEPTED AND AGREED:

/s/ Henry R. Mandell

Henry R. Mandell

EX-10.6

EXHIBIT 10.6

PROMISSORY NOTE

$112,500.00 November 1, 2003

     FOR VALUE RECEIVED, the undersigned (the “Maker”) will pay to the order of the SUNTRUST BANK NATURE COAST, AS SUCCESSOR TRUSTEE OF THE IRA A. DESPER MARITAL TRUST (hereinafter together with any holder hereof, called “Holder”) at P.O. Box 1029, Crystal River, FL 34423, or at such other place as the Holder may from time to time designate in writing, the principal sum of One Hundred Twelve Thousand Five Hundred and 00/100 Dollars ($112,500.00), together with interest at the rate ten percent (10%) per annum on the unpaid principal balance from time to time outstanding, from the date hereof, payable as follows:

The first payment of $5,191.30 shall be due and payable on December 1, 2003, and continuing on the first day of each and every month thereafter until the entire balance of principal and interest is paid in full.

     This Note is, by mutual consent of the parties hereto, and for mutual considerations passing to each party hereto, receipt of which is hereby acknowledged by all parties hereto, a replacement of and in substitution of that certain obligation of maker hereof to Payee hereof in the principal sum of $112,500.00 and as is more particularly described in LOST INSTRUMENT BOND #5927420 wherein Sun Trust Bank is principal; Desper Products, Inc. and Spatializer Audio Laboratories, Inc. are Obligees; and Safeco Insurance Company of America is Surety; such obligation being also described in the Annual Report of Maker for the year 2002 as note [      ] on page [      ] thereof.

     Although Maker is executing this Note in California, this Note and its terms and provisions are to be governed and construed by and in accordance with the laws of the State of Florida. The Maker expressly consents to jurisdiction in Florida. Furthermore, exclusive venue for any dispute shall lie solely in Pirrellas County, Florida.

     This Note may be prepaid in whole or in part at any time without payment of premium or penalty. Any prepayments shall be applied to the last installments due hereunder.

     The Holder shall have the optional right to declare the amount of the total unpaid balance hereof to be due and forthwith payable in advance of the maturity date, as fixed herein, upon the Maker’s failure to remit any monthly payment when due. Upon exercise of this option by the Holder, the entire unpaid principal shall bear interest at the maximum contract rate permitted by law until paid. Forbearance to exercise this option with respect to any failure or breach of the undersigned shall not constitute a waiver of the right as to any continuing failure or breach or any subsequent failure or breach.

     Time is of the essence of this contract and, in the event of default, if this Note is collected by law or through an attorney at law, or under advice therefrom the undersigned agrees to pay all costs of collection, including reasonable attorneys’ fees. Such attorneys’

fees and costs shall include, but note be limited to, fees and costs incurred in all matters of collection and enforcement, construction and interpretation, before, during and after suit, trial, proceedings and appeals, as well as appearances in and connected with any bankruptcy proceedings or creditor’s reorganization or arrangement proceedings.

     No act of omission or commission of the Holder, including specifically any failure to exercise any right, remedy or recourse, shall be deemed to be a waiver or release of the same, such waiver or release to be effected only through a written document executed by the Holder and then only to the extent specifically recited therein. A waiver or release with reference to any one event shall not be construed as continuing, as a bar to, or as a waiver or release of, any subsequent right, remedy or recourse as to a subsequent event.

     The Maker, for itself, its legal representatives, successors and assigns, hereby: (a) for any default due to Maker’s failure to pay any amount due and owing under this Note, expressly waives presentment, demand for payment, notice of dishonor, protest, notice of non-payment or protest, and diligence in collection; (b) consents that the time of all payments or any part thereof may be extended, rearranged, renewed or postponed by the Holder hereof; and (c) agrees that the Holder, in order to enforce payment of this Note, shall not be required first to institute any suit or to exhaust any of its remedies against the undersigned.

     In this Note, whenever the context so requires, the neuter gender includes the feminine and/or masculine, as the case may be, and the singular number includes the plural.

     The undersigned is duly organized, validly existing and in good standing under the laws of the State of Delaware and has full power and authority to enter into this Note, and the undersigned corporate officer has full power and authority to execute this Note on behalf of the undersigned.

     The undersigned has executed this Note on the day and year first above written.

MAKER: SPATIALIZER AUDIO LABORATORIES INC. a Delaware Corporation
By:	/s/ HENRY MANDELL
	Its:  CEO                                        11/6/03

EX-10.7

EXHIBIT 10.7

OFFICE LEASE AGREEMENT

by and between

C.M. STRATPLAN, INC.,

a California corporation

(“Landlord”)

and

Spatializer Audio Laboratories, Inc.,

a Delaware corporation

(“Tenant”)

For approximately

1,288 rentable square feet

at San Jose Gateway

(“Premises”)

TABLE OF CONTENTS

1.	Parties	1
2.	Premises	1
3.	Definitions	1
4.	Lease Term	3
	A. Term	3
	B. Commencement Date	3
	C. Commencement Date Memorandum	3
	D. Tenant Delays	3
	E. Early Entry	3
	F. Termination	3
5	Rent	4
	A. Monthly Rent	4
	B. Prorations	4
	C. Periodic Adjustments	4
6.	Late Payment Charges	4
7.	Security Deposit	4
8.	Holding Over	4
9.	Tenant Improvements	5
10.	Condition of Premises	5
11.	Use of the Premises	5
	A. Tenant’s Use	5
	B. Compliance	5
	C. Toxic Material	6
	D. Transportation Systems Management	6
	E. Rules and Regulations	6
12.	Quiet Enjoyment	6
13.	Alterations	6
14.	Surrender of the Premises	7
15.	Operating Expenses	7
	A. Payment by Tenant	7
	B. Operating Expenses	7
	C. Adjustment	9
	D. Failure to Pay	9
16.	Taxes and Assessments	9
	A. Payment by Tenant	9
	B. Annual Assessments	9
	C. Taxes Levied Against Tenant’s Alterations and Personal Property	9
	D. Failure to Pay	10
17.	Utilities and Services	10
18.	Repair and Maintenance	10
	A. Premises, Building and Outside Area	10
	B Control and Reconfiguration	10
	C. Waiver	11
	D. Compliance with Governmental Regulations	11
	E. Repair Where Tenant at Fault	11
19.	Fixtures	11

i

20.	Liens	11
21.	Landlord’s Right to Enter the Premises	11
22.	Signs	11
23.	Insurance	11
	A. Indemnification	12
	B. Tenant’s Insurance	12
	C. All-Risk Insurance	12
	D. Evidence of Insurance	12
	E. Co-Insurer	12
	F. Insurance Requirements	12
	G. No Limitation of Liability	13
	H. Landlord’s Disclaimer	13
	I. Increased Coverage	13
24.	Waiver of Subrogation	13
25.	Damage or Destruction	13
	A. Partial Damage — Insured	13
	B. Partial Damage — Uninsured	13
	C. Total Destruction	13
	D. Landlord’s Obligations	14
	E. Damage Near End of Term	14
26.	Condemnation	14
	A. Total Taking — Termination	14
	B. Partial Taking	14
	C. No Apportionment of Award	14
	D. Temporary Taking	14
27.	Assignment and Subletting	14
	A. Landlord’s Consent	14
	B. Information to be Furnished	15
	C. Landlord’s Alternatives	15
	D. Proration	15
	E. Executed Counterpart	15
	F. Surrender of Lease	15
	G. No Mortgages	15
	H. Effect of Default	15
	I. Permitted Transfers	15
28.	Default	16
	A. Tenant’s Default	16
	B. Remedies	16
	C. Landlord’s Default	17
29.	Subordination	17
30.	Notices	18
31.	Attorneys’ Fees	18
32.	Estoppel Certificates	18
33.	Transfer of the Project by Landlord	18
34.	Landlord’s Right to Perform Tenant’s Covenants	18
35.	Tenant’s Remedy	19
36.	Mortgagee Protection	19
37.	Brokers	19
38.	Acceptance	19

ii

39.	Recording	19
40.	Modifications for Lender	19
41.	Parking	19
42.	Use of “San Jose Gateway” Prohibited	20
43.	Interest	20
44.	Quitclaim	20
45.	Relocation	20
46.	General	20
	A. Captions	20
	B. Executed Copy	20
	C. Time	20
	D. Severability	20
	E. Choice of Law	20
	F. Interpretation	20
	G. Effect of Remeasurement	20
	H. Binding Effect	20
	I. Waiver	21
	J. Entire Agreement	21
	K. Authority	21
	L. Exhibits	21
	M. Counterparts	21

iii

OFFICE LEASE AGREEMENT

INFORMATION SHEET

(“INFORMATION SHEET”)

A. PARTIES
1. Landlord:	C.M. STRATPLAN, INC., a California corporation.
2. Tenant:	Spatializer Audio Laboratories, Inc., a Delaware corporation
B. EFFECTIVE DATE	September 14, 2004
C. BASIC LEASE PROVISIONS
1. Premises:	San Jose Gateway
a. Address:	2025 Gateway Place
	San Jose, California 95110
b. Suite:	365
c. Floor:	Third
d. Total Building	One Hundred Fifty-Eight Thousand Three Hundred rentable area (approx.): Thirty-Two (158,332) rentable square feet
2. Rentable Area and Load Factor:
a. Rentable Area	One Thousand Two Hundred Eighty-Eight (1,288) rentable square feet
b. Load Factor (approx.)	14%
3. Term:	24 months
4. Estimated Commencement Date:	January 1, 2005. Landlord shall provide one (1) month and two (2) weeks of Early Occupancy.
5. Tenant’s Property Percentage:	0.81%
6. Base Rent:	Two Thousand One Hundred Twenty Five and 20/100 Dollars ($2,125.20) based on a rate of _One and 65/100 Dollars ($1.65) per rentable square foot per month for each of months one (1) through twelve (12) of the term; and
	Two Thousand One Hundred Eight Nine and 60/100 Dollars ($2,189.60) based on a rate of _One and 70/100 Dollars ($1.70) per rentable square foot per month for each of months thirteen (13) through twenty four (24) of the term.
7. Security Deposit:	$2,125.20
8. Operating Expense Base Year:	2005
9. Adjustments to Rent:	Refer to Paragraph C.6 above.

Initials:
Landlord	Tenant

-i-

10. Broker(s):	Dual Agency wherein Marne Michaels with Colliers International represents Tenant and Susan Gregory and Marne Michaels with of Colliers International represents Landlord.
11. Address for Notices:
Landlord:	C.M. Stratplan, Inc.
	c/o C. M. Capital Corporation
	525 University Avenue, Suite 1500
	Palo Alto, California 94301
	with a copy to:
	Property Manager Office
	2025 Gateway Place, Suite 100
	San Jose, California 95110
Tenant:	Spatializer Audio Laboratories, Inc.
	2025 Gateway Place, Suite 365
	San Jose, CA 95110

Initials:
Landlord	Tenant

-ii-

OFFICE LEASE AGREEMENT

     1. Parties. THIS OFFICE LEASE AGREEMENT (“Lease”), effective as of the date (“Effective Date”) set forth at B of the Office Lease Agreement Information Sheet (“Information Sheet”), is entered into by and between C.M. Stratplan, Inc., a California corporation (“Landlord”), and the entity set forth in the Information Sheet at A.2. (“Tenant”).

     2. Premises. Landlord hereby leases to Tenant, and Tenant hereby leases from Landlord, a portion of that certain Building (“Building”) in the City of San Jose, County of Santa Clara, State of California containing the total rentable floor area set forth in C.2. of the Information Sheet, as more particularly shown on EXHIBIT A (“Premises”), and located at the address, and in the suite and floor, designated on the Information Sheet at C.1 of the Information Sheet, together with a right in common to the Outside Area, as defined in Paragraph 3.K., of the Property, as defined in Paragraph 3.M. Tenant’s right to use the Outside Area shall be a right in common with other tenants of the Property and is subject to the reasonable rules and regulations and changes therein from time to time promulgated by Landlord governing the use of the Outside Area.

     3. Definitions. The following initially capitalized terms shall have the following meanings when used in this Lease:

          A. Alterations. Any alterations, additions or improvements made in, on or about the Building or the Premises after the Commencement Date, including, but not limited to, lighting, heating, ventilating, air conditioning, electrical, telecommunication cabling, partitioning, drapery and carpentry installations.

          B. Building. That certain building on the Property, commonly known as 2025 Gateway Place, San Jose, California 95110, containing an aggregate rentable area in the approximate amount set forth in the Information Sheet at C.1.d.

          C. CC&R’s. The Declaration of Covenants, Conditions, Restrictions and Easements dated May 25, 1972 established by Dillingham Development Company and recorded on June 2, 1972 in Book 9862 at page 57 et. Seq., of the official records of Santa Clara County, California, as they may be amended from time to time. Tenant hereby acknowledges that it has received and read a copy of the present CC&R’s.

          D. City. The City of San Jose, State of California.

          E. Commencement Date. The Commencement Date of this Lease shall be the first day of the Lease Term determined in accordance with Paragraph 4.B.

          F. County. The County of Santa Clara, State of California.

          G. HVAC. Heating, ventilating and air conditioning.

          H. Interest Rate. Interest Rate shall have the meaning set forth in Paragraph 43.

          I. Landlord’s Agents. Landlord’s authorized agents, together with any partners and any subsidiary, parent, and affiliate corporations of Landlord, and any directors, officers, shareholders and employees of Landlord or of any such agents, partners, or subsidiary, parent or affiliate corporations.

          J. Monthly Rent. The rent payable pursuant to Paragraph 5.A., as adjusted from time to time pursuant to the terms of this Lease.

          K. Outside Area. All areas and facilities within the Property, but outside the Building, as defined in Paragraph 3.M., provided and designated by Landlord for the general use and convenience of Tenant and other tenants and occupants of the Building, including, without limitation, the parking areas, access and perimeter roads, sidewalks, landscaped areas, service areas, trash disposal facilities, and similar areas and facilities, and the exterior walls and windows of the Building, subject to the reasonable rules and regulations and changes therein from time to time promulgated by Landlord governing the use of the Outside Area.

Initials:
Landlord	Tenant

          L. Project. The Property, Building (including the Premises), and Outside Area.

          M. Property. That certain real property, described in EXHIBIT B and consisting of approximately five and seven hundred and forty-four hundredths (5.744) acres, upon which is located the Building .

          N. Real Property Taxes. Any form of assessment, license, fee, rent tax, levy, interest or penalty (if a result of Tenant’s delinquency), or tax (other than net income, estate, succession, inheritance, transfer or franchise taxes), imposed by any authority having the direct or indirect power to tax, or by any city, county, state or federal government or any improvement or other district or division thereof, whether such tax is: (i) determined by the value or area of the Project or any part thereof (or any improvements now or hereafter made to the Project or any portion thereof by Landlord, Tenant or other tenants) or the rent and other sums payable hereunder by Tenant or by other tenants, including, but not limited to, any gross income or excise tax levied by any of the foregoing authorities with respect to receipt of such rent or other sums due under this Lease; (ii) upon any legal or equitable interest of Landlord in the Project or any part thereof; (iii) upon this transaction or any document to which Tenant is a party creating or transferring any interest in the Project; (iv) levied or assessed in lieu of, in substitution for, or in addition to, existing or additional taxes against the Project whether or not now customary or within the contemplation of the parties; (v) assessed for the purpose of constructing or maintaining or reimbursing the cost of construction of any streets, utilities or other public improvements; (vi) surcharged against the parking area; or (vii) levied upon any personal property of Landlord, Tenant or other tenants located on or used exclusively in connection with the operation of the Project.

          O. Rent. Monthly Rent plus any other amounts payable by Tenant under this Lease.

          P. Sublet. Any assignment or transfer of any estate or interest in this Lease; any subletting or parting with or sharing of the occupation, control, or possession of the Premises, or of any part thereof or any right or privilege appurtenant thereto; allowing anyone to conduct business at or from the Premises (whether as concessionaire, franchisee, licensee, permittee, subtenant or otherwise); if Tenant is a corporation, any transfer of the effective voting control of Tenant; if Tenant is a partnership, the resignation, death or the cessation of existence of a general partner; if Tenant is composed of more than one person or entity, any purported transfer from one to one or any more of the others composing Tenant or to any other person; any other transfer by voluntary or involuntary act or by operation of law (including by merger or consolidation); or any attempt to do any of the foregoing.

          Q. Subrent. Any consideration of any kind received, or to be received, by Tenant from a subtenant if such sums are related to Tenant’s interest in this Lease or in the Premises, including, but not limited to, bonus money and payments (in excess of fair market value) for Tenant’s assets including its trade fixtures, equipment and other personal property, goodwill, general intangibles, and any capital stock or other equity ownership of Tenant.

          R. Subtenant. The person or entity with whom a Sublet agreement is proposed to be or is made.

          S. Tenant Improvements. Those certain improvements to the Premises to be constructed by Landlord pursuant to EXHIBIT C.

          T. Tenant’s Agents. Tenant’s agents, employees, officers, directors, invitees or licensees.

          U. Tenant’s Property Percentage. The percentage determined by dividing the approximate rentable square footage of the Premises by the approximate total rentable square footage of the Building. Tenant’s Property Percentage is currently agreed to be the percentage set forth in C.5. of the Information Sheet, subject to adjustment as a result of a remeasurement of the Premises and/or the Building by Landlord pursuant to Paragraph 46.G.

          V. Tenant’s Personal Property. Tenant’s trade fixtures, furniture, equipment and other personal property in the Premises.

2

Initials:
Landlord	Tenant

          W. Term. The term of this Lease set forth in Paragraph 4.A., as it may be extended hereunder pursuant to any options to extend granted herein or by any written amendments to or extensions of this Lease.

     4. Lease Term.

          A. Term. The Term shall be a period set forth at C.3. of the Information Sheet, commencing on the Commencement Date, as defined below, and ending 5:00 p.m. on the last day of such period, unless the Term is sooner terminated as hereinafter provided.

          B. Commencement Date. Commencement Date shall be defined to mean the earliest to occur of the following, as determined by Landlord:

               (i) the date Tenant commences occupancy of any portion of the Premises; or

               (ii) the Estimated Commencement Date specified in the Information Sheet at C.4.

     If, for any reason, Landlord cannot deliver possession of the Premises to Tenant by the Estimated Commencement Date, Landlord shall not be subject to any liability therefor, nor shall such failure affect the validity of this Lease or the obligations of Tenant hereunder; but in such case, Tenant shall not be obligated to pay any Monthly Rent hereunder, subject to the provisions contained in Paragraph 4.D., until the date that Landlord gives Tenant notice that all work for the Tenant Improvements to be constructed or performed pursuant to EXHIBIT C has been substantially completed (which date shall then be deemed the Commencement Date).

          C. Commencement Date Memorandum. When the actual Commencement Date is determined, the parties shall execute a Commencement Date Memorandum, in the form attached hereto as EXHIBIT D, setting forth the date.

          D. Tenant Delays. If the Commencement Date of this Lease has not occurred on or before the Estimated Commencement Date, and if the cause of any delay in the occurrence of the Commencement Date is attributable to Tenant, then commencing on such date as the Commencement Date would have occurred but for any delay attributable to Tenant, and continuing on the first day of each calendar month thereafter until the Commencement Date, Tenant shall pay to Landlord the Monthly Rent set forth in Paragraph 5. Payments for any partial month shall be prorated on the basis of a thirty (30) day month. Delays attributable to Tenant shall include those caused by:

               (i) Tenant’s change requests in the space plan or the Plans for Tenant Improvements attached as EXHIBIT C-1 after their approval by Landlord;

               (ii) Tenant’s failure to complete any of its own improvement work to the extent Tenant delays completion by the City of its final inspection and approval of the Tenant Improvements described in EXHIBIT C;

               (iii) Tenant’s failure to approve cost estimates if such approvals are required pursuant to EXHIBIT C; or

               (iv) Interference with Landlord’s work caused by Tenant or by Tenant’s contractors or subcontractors.

          E. Early Entry. Landlord gives permission for Tenant to enter the Premises six weeks prior to the Commencement Date for the purpose of fixturing or any other purpose permitted by Landlord, such early entry shall be at Tenant’s sole risk and subject to all the terms and provisions hereof, except for the payment of Monthly Rent which shall commence on the date set forth in Paragraph 4.B. Landlord shall have the right to impose such additional conditions on Tenant’s early entry as Landlord shall deem appropriate.

          F. Termination. Either party, at its option, may terminate this Lease by giving written notice of its election to terminate to the other party if the Commencement Date has not occurred on or before one hundred twenty (120) days after the Estimated Commencement Date specified in the Information Sheet at C.4. through no fault of the terminating party.

3

Initials:
Landlord	Tenant

     5. Rent.

          A. Monthly Rent. In advance, on or before the first day of each calendar month, without prior notice or demand, deduction or offset, Tenant shall pay monthly rent (“Monthly Rent”) to Landlord, in lawful money of the United States at the Office of the Property Manager specified in the Information Sheet at C.11., or to such other place or person as Landlord may designate in the manner set forth in Paragraph 30. Monthly Rent shall consist of the sum of the following:

               (i) Base Rent. Base Rent (“Base Rent”) in the amount specified at C.6. of the Information Sheet (subject to adjustment as provided for at C.9 of the Information Sheet); and

               (ii) Monthly Operating Expense Reimbursement. Monthly Operating Expense Reimbursement (“Monthly Operating Expense Reimbursement”) equal to one twelfth (1/12) of Tenant’s Property Percentage of the amount by which Landlord’s estimate of the Operating Expenses for the relevant calendar year of the Term exceed the Base Year Operating Expenses, as such terms are defined in Paragraph 15.

          B. Prorations. If the Commencement Date is not the first (1st) day of a month, or if the termination date is not the last day of a month, a prorated monthly installment based on a thirty (30) day month shall be paid for the fractional month during which this Lease commences or terminates.

     6. Late Payment Charges. TENANT ACKNOWLEDGES THAT LATE PAYMENT BY TENANT TO LANDLORD OF RENT AND OTHER CHARGES PROVIDED FOR UNDER THIS LEASE WILL CAUSE LANDLORD TO INCUR COSTS NOT CONTEMPLATED BY THIS LEASE, THE EXACT AMOUNT OF SUCH COSTS BEING EXTREMELY DIFFICULT OR IMPRACTICABLE TO FIX. THEREFORE, IF ANY INSTALLMENT OF RENT OR ANY OTHER CHARGE DUE FROM TENANT IS NOT RECEIVED BY LANDLORD WITHIN FIVE DAYS OF THE DATE DUE, TENANT SHALL PAY TO LANDLORD AN ADDITIONAL SUM EQUAL TO FIVE PERCENT (5%) OF THE AMOUNT OVERDUE AS A LATE CHARGE. THE PARTIES AGREE THAT THIS LATE CHARGE REPRESENTS A FAIR AND REASONABLE ESTIMATE OF THE COSTS THAT LANDLORD WILL INCUR BY REASON OF THE LATE PAYMENT BY TENANT. SUCH LATE CHARGE SHALL BE IN ADDITION TO, AND NOT IN LIEU OF, ANY INTEREST THAT MAY ACCRUE ON ANY SUCH OVERDUE AMOUNT PURSUANT TO THE PROVISIONS OF PARAGRAPH 43.

Initials:
Landlord	Tenant

     7. Security Deposit. By execution hereof, Landlord acknowledges receipt of the sum set forth at C.7. of the Information Sheet from Tenant, as security for the faithful performance by Tenant of all of the terms and conditions of this Lease to be kept and performed by Tenant during the term hereof (“Security Deposit”). The Security Deposit shall secure Tenant’s obligations hereunder to pay rent and all other sums due to Landlord hereunder, to maintain the Premises and repair damages thereto as provided in this Lease, to surrender the Premises to Landlord in clean condition and good repair upon termination of this Lease and timely to discharge Tenant’s other obligations hereunder. Landlord may use and commingle the Security Deposit with other funds of Landlord. If Tenant fails to perform its obligations hereunder, then Landlord may, but without any obligation so to do, apply all or any portion of the Security Deposit toward fulfillment of Tenant’s unperformed obligations. If Landlord does so apply any portion of the Security Deposit, Tenant, upon demand by Landlord, shall immediately pay to Landlord a sufficient amount in cash to restore the Security Deposit to its full original amount. On termination of this Lease, if Tenant has then fully performed all its obligations hereunder, Landlord shall return the Security Deposit to Tenant. If Landlord, prior to the expiration of the term of this Lease, sells or otherwise transfers Landlord’s rights or interest under this Lease, Landlord may deliver the Security Deposit to the transferee, whereupon, Landlord shall have no further liability to Tenant concerning the Security Deposit.

     8. Holding Over. If Tenant remains in possession of all or any part of the Premises after the expiration of the Term, with the consent of Landlord, such tenancy shall be from month-to-month only and not a renewal hereof or any extension for any further term, and in such case, Base Rent shall be increased to an amount equal to one hundred fifty percent (150%) of the Base Rent paid during the last

4

Initials:
Landlord	Tenant

month of the Term and all other sums due hereunder shall be payable in the amount and at the time applicable at the time of expiration and at the time specified in this Lease and such month-to-month tenancy shall be subject to every other term, covenant and agreement of this Lease.

     9. Tenant Improvements. Landlord and Tenant agree to the terms and procedures for the planning, construction and funding of the construction of the Tenant Improvements as set forth in EXHIBIT C.

     10. Condition of Premises. Within ten (10) days after the Commencement Date, Tenant and Landlord shall conduct a walk- through inspection of the Premises with Landlord and jointly prepare and sign a final punch-list of items needing additional work by Landlord. Other than the items specified in the punch-list, by taking possession of the Premises, Tenant shall be deemed to have accepted the Premises in “As Is” condition as improved with the Tenant Improvements in good, clean and completed condition and repair, subject to all applicable laws, codes and ordinances. The punch-list to be prepared by Tenant shall not include any damage to the Premises caused by Tenant’s move-in, which damage shall be repaired or corrected by Tenant, at its expense. Tenant acknowledges that neither Landlord nor Landlord’s Agents have made any representations or warranties as to the suitability or fitness of the Premises or any other part of the Project (including, without limitation, the interbuilding network cabling) for the conduct of Tenant’s business or for any other purpose, nor has Landlord or Landlord’s Agents agreed to undertake any Alterations or construct any Tenant Improvements to the Premises except as expressly provided in this Lease. If Tenant fails to submit a punch-list to Landlord within the ten (10) day period, it shall be deemed that there are no items needing additional work or repair. Landlord’s contractor shall complete all reasonable punch-list items within thirty (30) days after the walk-through inspection or as soon as practicable thereafter. Upon Landlord or Landlord’s contractor’s indication to Tenant of the completion of such punch-list items, Tenant shall acknowledge the completion of such items in writing to Landlord. If Tenant fails either to so acknowledge the completion of such items within seven (7) days of such stated completion or within such seven day period to specify in writing to Landlord in reasonable detail any such previously listed punch-list items that remain uncompleted, all such items shall be deemed approved by Tenant.

     11. Use of the Premises.

          A. Tenant’s Use. Tenant shall use the Premises solely for general office purposes and shall not use the Premises for any other purpose without obtaining the prior written consent of Landlord. Tenant agrees that the Property is subject and this Lease is subordinate to the CC&R’s. Tenant acknowledges that it has read the CC&R’s and knows the contents thereof. Throughout the Term, Tenant shall faithfully and timely perform and comply with the CC&R’s and any modification or amendments thereof. Tenant shall comply with all duly adopted rules, regulations and restrictions as may be adopted from time to time by any committee established pursuant to the CC&Rs (“Association”). Any periodic or special dues or Outside Area assessments of the Association shall be included within the definition of Operating Expenses pursuant to Paragraph 15.B. and Tenant shall pay Tenant’s Property Percentage of such amounts over the Base Year amounts as further set forth in Paragraph 15. Tenant shall defend, indemnify and hold Landlord, and Landlord’s Agents free and harmless from and against any claim, loss, liability, expense or damage, including attorneys’ fees and costs, arising out of the actual or asserted failure of Tenant to perform or comply with the CC&R’s. Tenant shall not permit or make any use of the Premises which will increase the existing rate of insurance upon the Project, or cause the cancellation of any insurance policy covering the Project, or any part thereof. If the existing rate of insurance shall be increased or any insurance policy covering the Project canceled as a result of Tenant’s or Tenant’s Agent’s acts or omissions, then Landlord, in addition to such remedies as Landlord may have under this Lease or pursuant to law or equity, shall be entitled to reimbursement from Tenant upon written demand therefor for the entire amount of said increase or any additional amount which must be paid for a new insurance policy.

          B. Compliance. Tenant shall not use the Project or suffer or permit Tenant’s Agents to do anything in or about the Project in conflict with any law, statute, zoning restriction, ordinance or governmental law, rule, regulation or requirement of duly constituted public authorities now in force or which may hereafter be in force, or the requirements of the Board of Fire Underwriters or other similar body now or hereafter constituted relating to or affecting the condition, use or occupancy of the Project. Tenant shall continuously and uninterruptedly conduct its business in the Premises during the Term and shall not vacate or abandon the Premises. Tenant shall not commit any public or private nuisance or any other act or practice which might or would disturb the quiet enjoyment of any other tenant of Landlord or any occupant of nearby properties. Tenant shall place no loads upon the floors,

5

Initials:
Landlord	Tenant

walls or ceilings in excess of the maximum designed load determined by Landlord or which endanger the structure; nor place any harmful liquids in the drainage systems; nor dump or store waste materials or refuse or allow such to remain outside the Building proper, except in the enclosed trash areas provided. Tenant shall not store or permit to be stored or otherwise placed any material of any nature whatsoever outside the Building. If as a result of any use or change in use of the Premises by Tenant or any Alteration made to the Premises by or on behalf of Tenant, any alterations are required to the Premises, the Building or the Project (including, but not limited to, the Americans with Disabilities Act, and any state or local building, fire or safety codes, ordinances or regulations), Tenant shall be responsible for the same (or at the election of Landlord, for reimbursing Landlord for the cost of performing the same).

          C. Toxic Material. Tenant, at its sole cost, shall comply with and cause Tenant’s Agents to comply with all laws relating to the storage, use and disposal of hazardous, toxic or radioactive matter, including those materials identified in Sections 66680 through 66685 of Title 22 of the California Administrative Code, Division 4, Chapter 30 (“Title 22”) as they may be amended from time to time (collectively, “Toxic Materials”). If Tenant or Tenant’s Agents desire to store, use or dispose of any Toxic Materials in, on or about the Premises (other than the storage and use of reasonable quantities of customary office supplies), Tenant shall first request and obtain Landlord’s approval to such proposed storage, use or disposal in writing, which request must be made at least ten (10) days prior to the storage, use or disposal thereof in, on or about the Premises. Whether or not Landlord is aware or approves of the storage, use or disposal of any Toxic Material by Tenant or Tenant’s Agents, Tenant shall be solely responsible for and shall defend, indemnify and hold Landlord and Landlord’s Agents harmless from and against all claims, costs and liabilities, including attorneys’ fees and costs, arising out of or in connection with the storage, use, generation, transportation, disposal or release of Toxic Materials by Tenant or Tenant’s Agents, including without limitation, any such claims, costs, damages and liabilities (including attorneys’ fees and costs) arising out of or in connection with any investigation, testing, remediation, removal, clean-up and/or restoration services, work, materials and equipment necessary to return the Premises and any other property of whatever nature to their condition existing prior to the storage, use, generation, transportation, disposal or release of Toxic Materials by Tenant or Tenant’s Agents in, on or about the Premises or the Project, and to otherwise satisfactorily investigate and remediate the contamination arising therefrom to the satisfaction of Landlord and all governmental authorities. If at any time during or after the term of this Lease, as it may be extended, Tenant becomes aware of any injury, investigation, administrative proceeding, or judicial proceeding regarding the storage, use or disposition of any Toxic Materials by Tenant or Tenant’s Agents on or about the Premises or the Project, Tenant shall within five (5) days after first learning of such injury, investigation or proceeding give Landlord written notice advising Landlord of same.

          D. Transportation Systems Management. Tenant shall comply with the requirements of the City or County mandated parking or transportation systems management ordinances.

          E. Rules and Regulations. The Rules and Regulations for the Project in effect as of the Effective Date are attached hereto as EXHIBIT E. Landlord reserves the right to adopt or amend the Rules and Regulations from time to time in its reasonable discretion. Tenant agrees that Tenant, its employees and agents and, to the extent Tenant can require the same, its invitees and others over whom Tenant can reasonably be expected to exercise control, shall observe and perform the Rules and Regulations as they may be amended or adopted. A breach of the Rules and Regulations by Tenant or such persons shall constitute a default under this Lease as if the Rules or Regulations were contained in this Lease as covenants of the Tenant. Tenant acknowledges that Landlord has no obligation to enforce, and shall have no liability for non-enforcement of, the Rules and Regulations. The Rules and Regulations shall be consistent with the terms of the Lease.

     12. Quiet Enjoyment. Landlord covenants that Tenant, upon performing the terms, covenants and conditions of this Lease, shall have quiet and peaceful possession of the Premises as against any person claiming the same by, through or under Landlord.

     13. Alterations. Tenant shall not make or permit any Alterations in, on or about the Premises without the prior written consent of Landlord, and according to plans and specifications approved in writing by Landlord, which consent shall not be unreasonably withheld. Landlord, at its sole option, may, however, require as a condition to the granting of any such consent, that Tenant provide to Landlord, at Tenant’s sole cost and expense, a lien and completion bond in an amount equal to one and one-half (1¹/2) times any and all estimated costs of any intended improvements to the Premises, to insure Landlord against any liability for mechanics’ and materialmen’s liens and to insure completion of the work. Tenant shall, at its sole cost and expense, obtain all necessary permits and governmental

6

Initials:
Landlord	Tenant

inspections and approvals required in connection with any Alterations. All Alterations shall be installed at Tenant’s sole expense, in compliance with all applicable laws (including, but not limited to, The Americans With Disabilities Act, and any state or local building, fire or safety codes, ordinances or regulations), the Rules and Regulations and the CC&R’s, by a licensed contractor reasonably acceptable to Landlord, shall be done in a good and workmanlike manner conforming in quality and design with the Premises existing as of the Commencement Date, and shall not diminish the value of the Project. In the event that any Alteration made by Tenant necessitates the making of other alterations to the interior or exterior of the Building, the Outside Area or elsewhere within the Project for purposes of complying with applicable laws (including, but not limited to, The Americans With Disabilities Act, and any state or local building, fire or safety codes, ordinances or regulations), Tenant shall undertake such additional alterations at its sole cost and expense or shall, at Landlord’s option, reimburse Landlord for the cost and expenses incurred with respect to such additional alterations required for purposes of complying with applicable law as a result of Tenant’s Alterations. All Alterations made by Tenant shall be and become the property of Landlord upon installation and shall not be deemed Tenant’s Personal Property; provided, however, that Landlord may, at its option, require that Tenant, at Tenant’s expense, remove any or all Alterations installed by Tenant and return the Premises to their condition as of the Commencement Date of this Lease, normal wear and tear excepted and subject to the provisions of Paragraph 25. Notwithstanding any other provisions of this Lease, Tenant shall be solely responsible for the maintenance and repair of any and all Alterations made by it to the Premises. Tenant shall give Landlord written notice of Tenant’s intention to perform any work on the Premises at least twenty (20) days prior to the commencement of such work to enable Landlord to post and record an appropriate Notice of Nonresponsibility or other notice deemed proper before the commencement of any such work.

     14. Surrender of the Premises. Upon the expiration or earlier termination of the Term, Tenant shall surrender the Premises to Landlord in its condition existing as of the Commencement Date, normal wear and tear and fire or other insured casualty for which Tenant is not otherwise obligated under the provisions of Paragraph 18. to repair excepted, with all interior areas cleaned. Tenant shall prior to the expiration or termination of the Term remove from the Premises all of Tenant’s Alterations required to be removed pursuant to Paragraph 13., and all Tenant’s Personal Property and repair any damage and perform any restoration work caused or necessitated by any such removal. If Tenant fails to remove such Alterations and Tenant’s Personal Property, and such failure continues after the termination of this Lease, Landlord may retain such property and all rights of Tenant with respect to it shall cease, or Landlord may place all or any portion of such property in public storage for Tenant’s account. Tenant shall be liable to Landlord for costs of removal of any such Alterations and Tenant’s Personal Property and storage and transportation costs of same, and the cost of repairing and restoring the Premises, together with interest at the Interest Rate from the date of expenditure by Landlord until paid.

     15. Operating Expenses.

          A. Payment by Tenant. During the term of this Lease, Tenant shall pay to Landlord, as rent on a monthly basis as set forth in Paragraph 5.A., one-twelfth (1/12) of Tenant’s Property Percentage of the amount by which Landlord’s estimate of the Operating Expenses for each calendar year during the Term (after the Base Year) are estimated by Landlord to exceed the Operating Expenses incurred by Landlord for the Base Year, as such Base Year is specified at C.8. of the Information Sheet (“Base Year Operating Expenses”).

          B. Operating Expenses. The term “Operating Expenses” shall mean all expenses, costs and disbursements (but not capital investment items except as otherwise expressly provided below, or specific costs especially billed to and paid by specific tenants) of every kind and nature which Landlord shall pay or become obligated to pay because of or in connection with the ownership, maintenance, repair or operation of the Project and such additional building or Outside Area facilities in subsequent years as may be determined by Landlord to be necessary or appropriate. Operating Expenses shall include, but not be limited to, the following:

               (i) Wages and salaries of all employees engaged in the operation, maintenance and security of the Project, including taxes, insurance and benefits relating thereto; and the rental cost and overhead of any office and storage space used to provide such services;

               (ii) All supplies and materials used in operation, repair and maintenance of the Project;

7

Initials:
Landlord	Tenant

               (iii) Cost of all utilities, including surcharges, for the Project, including the cost of water, sewer, gas, power, heating, lighting, air conditioning and ventilating for the Project;

               (iv) Cost of all maintenance and service agreements for the Project and the equipment thereon, including but not limited to, security and energy management services, window cleaning, floor waxing, elevator maintenance, janitorial service, engineers, gardeners, and trash removal services;

               (v) Cost of all insurance which Landlord or Landlord’s lender deems necessary or appropriate for the Project such as the cost of “All-Risk” property insurance including, at Landlord’s option, earthquake and flood coverage, insurance against loss of rents on an “All-Risk” basis, and a lender’s loss payable endorsement in favor of any lenders with respect to the Project, and naming Landlord and such lenders as insureds; and casualty and liability insurance applicable to the Building, Property and Outside Area and Landlord’s personal property used in connection therewith, naming Landlord and Landlord’s Agents as named or additional insureds;

               (vi) Cost of repairs and general maintenance (excluding repairs and general maintenance to the extent then paid by proceeds of insurance or other third parties);

               (vii) A five percent (5%) management fee for the management of the Project (which management may be provided either by Landlord, affiliates of Landlord and/or by third parties) (the “Management Fee”);

               (viii) The costs of any additional services not provided to the Project at the Commencement Date but thereafter provided by Landlord in its management of the Building, Property or Outside Area;

               (ix) The cost of any capital improvements (including interest) made to the Project after September 1, 1997 that are intended to reduce other Operating Expenses or are required under any governmental law or regulation, or which enhance in any material respect the general appearance or use of the Project or any portion thereof, such cost thereof to be amortized with interest at a reasonable rate over the period Landlord reasonably determines to be the useful life of the capital improvement, consistent with applicable governmental requirements and generally accepted accounting principles;

               (x) Real property taxes, as that term is defined in Paragraph 16;

               (xi) Assessments, dues and other amounts payable pursuant to the CC&R’s, including any and all assessments and dues of the Association; provided, however, that Landlord may elect that Tenant pay directly any such assessments or dues relating to any particular uses of the Project made by Tenant or arising out of any actions of Tenant or Tenant’s Agents; and

               (xii) Maintenance and repair costs for interbuilding network cabling.

     The cost of additional or extraordinary services provided to Tenant and not paid or payable by Tenant pursuant to other provisions of this Lease shall be payable by Tenant and may be included by Landlord as part of the Operating Expenses payable by Tenant on a monthly basis or may be billed to Tenant separately, in a lump sum, as Landlord shall elect.

     Operating Expenses shall not include:

          (a) the cost of any additional or extraordinary services provided to other tenants of the Building;

          (b) costs paid for directly by Tenant;

          (c) principal and interest payments on loans secured by deeds of trust recorded against the Project;

          (d) real estate sales or leasing brokerage commissions; or

8

Initials:
Landlord	Tenant

          (e) executive salaries of off-site personnel employed by Landlord except for the charge (or pro rata share) of the manager of the Project (which manager’s salary is not included within the Management Fee).

          C. Adjustment.

               (i) Projected Increases. Prior to or at any time after the commencement of each calendar year during the Term following the Base Year, Landlord may provide Tenant with notice of Landlord’s estimate of the amount by which the then current year’s Operating Expenses are projected, if at all, to exceed the Base Year Operating Expenses (the “Projected Increase in Operating Expenses”). Tenant shall thereafter during such year pay adjusted Monthly Rent which shall include as the Monthly Operating Expense Reimbursement an amount equal to one-twelfth (1/12) of Tenant’s Property Percentage multiplied by any Projected Increase in Operating Expenses.

               (ii) Accounting. Within ninety (90) days (or as soon thereafter as possible) after the close of each calendar year after the Base Year, Landlord shall provide Tenant a statement of (a) such year’s actual Operating Expenses, (b) the Base Year Operating Expenses, (c) the amount, if any, by which the actual Operating Expenses exceed the Base Year Operating Expenses (the “Actual Increase in Operating Expenses”), (d) the amount equating to Tenant’s Property Percentage of any Actual Increase in Operating Expenses and (e) the sum of any amounts theretofore paid by Tenant as Monthly Operating Expense Reimbursements pursuant to Paragraph 5.A. with respect to such year. If the amount set forth in clause (d) above exceeds the amount set forth in clause (e) above, Tenant shall pay the amount of such excess to Landlord within ten (10) days of receipt of such statement, which obligation shall survive the expiration or earlier termination of its Term of the Lease. If the amount set forth in clause (e) above exceeds the amount set forth in clause (d) above, Landlord shall credit the amount of such excess against the next accruing payment(s) of Monthly Operating Expense Reimbursements or reimburse Tenant for same if this Lease has terminated prior to the date such determination is made.

               (iii) Proration. Tenant’s liability to pay Tenant’s Property Percentage of Operating Expenses in excess of Base Year Operating Expenses shall be prorated on the basis of a 365-day year to account for any fractional portion of a year included at the commencement or expiration of the term of this Lease.

               (iv) Not Fully Occupied. Notwithstanding any other provision to the contrary, it is agreed that if the Building, in total, is less than ninety-five percent (95%) occupied during all or any portion of any calendar year, an adjustment shall be made in calculating the Operating Expenses for the Project for such year so that Tenant’s Percentage of Operating Expenses in excess of the Base Year Operating Expenses shall be equivalent to the Operating Expenses calculated as though the Building, in total, had been ninety-five percent (95%) occupied during the entirety of such year.

               (v) Survival. Landlord and Tenant’s obligation to pay for or credit any increase or decrease in payments pursuant to this Paragraph shall survive the expiration or termination of the Term of this Lease.

          D. Failure to Pay. Failure of Tenant to pay any of the charges required to be paid under this Paragraph 15. shall constitute a breach of this Lease and Landlord’s remedies shall be as specified in Paragraph 28.B.

     16. Taxes and Assessments.

          A. Payment by Tenant. Except as provided for in Paragraph 16.C., Real Property Taxes for the Project shall be included within Operating Expenses pursuant to Paragraph 15.B.

          B. Annual Assessments. With respect to any taxes or assessments which may be levied against or upon the Project, or which under the laws then in force may be evidenced by improvement or other bonds or may be paid in annual installments, only the amount of such annual installment (with appropriate proration for any partial year) and interest due thereon shall be included within the computation of the annual taxes and assessments levied against the Project.

          C. Taxes Levied Against Tenant’s Alterations and Personal Property. In addition to Tenant’s obligation to pay its Property Percentage of Operating Expenses over Base Year Operating Expenses as provided in Paragraphs 15. and 16.A., (i) Tenant shall be responsible for and shall

9

Initials:
Landlord	Tenant

pay to the taxing authority prior to delinquency to the extent Tenant is billed directly, all Real Property Taxes assessed with respect to or against Tenant, or any Alterations, improvements, fixtures, equipment, facilities, furniture or other Personal Property owned by Tenant or placed, installed or located within, upon or about the Premises by Tenant or at Tenant’s direction (collectively “Personal Property Taxes”), and (ii) to the extent any Personal Property Taxes are billed to Landlord and Landlord elects not to include such Personal Property Taxes in Operating Expenses, Tenant shall be responsible for and shall pay to Landlord within ten (10) days after notice from Landlord, the amount of such Personal Property Taxes so billed to Landlord. Tenant shall provide Landlord with evidence of Tenant’s payment of the same upon Landlord’s request.

          D. Failure to Pay. Failure of Tenant to pay any of the charges required to be paid under this Paragraph 16. shall constitute a breach of this Lease and Landlord’s remedies shall be as specified in Paragraph 28.B.

     17. Utilities and Services. Landlord agrees to provide the utilities and services to the Premises on the terms more specifically set forth in EXHIBIT F. Landlord shall not be liable in damages or otherwise for any failure or interruption of any utility service or other service furnished to the Premises. Tenant shall be responsible for payment of all utility and other services provided during other than normal business hours for the Building, as reasonably determined by Landlord.

     18. Repair and Maintenance.

          A. Premises, Building and Outside Area.

               (i) Maintenance and Repair. Except as provided in this subparagraph (i), Tenant, at all times during the Term and at Tenant’s sole cost and expense, shall keep the Premises and every part thereof (including all fixtures and equipment located therein or exclusively servicing the Premises) in good condition and repair, normal wear and tear and damage for which Landlord is otherwise required to repair pursuant to Paragraph 25 of this Lease excepted. Landlord shall be responsible for maintaining and repairing (a) the structural parts of the Building, which structural parts include only the foundation, roof and subflooring of the Premises, the basic plumbing, heating, ventilating, air conditioning and electrical systems installed or furnished by Landlord, and (b) the Outside Area, except for any damage to Premises, Building or Outside Area caused by the negligence or willful acts or omissions of Tenant or of Tenant’s Agents, or by reason of the failure of Tenant to perform or comply with any terms, conditions or covenants in this Lease, or caused by Alterations made by Tenant or by Tenant’s Agents, which shall be Tenant’s responsibility. Except as otherwise provided in Paragraph 15.B., all costs of repair and maintenance of the Project shall be included in Operating Expenses.

               (ii) Notice of Repairs Needed. Landlord shall not be liable for any failure to make any of the repairs or to perform any maintenance unless the failure shall persist for an unreasonable time after written notice of the need of the repairs or maintenance is given to Landlord by Tenant.

               (iii) No Abatement. There shall be no abatement of rent and no liability of Landlord by reason of any injury to or interference with Tenant’s business arising from the making of any repairs, alterations or improvements in or to, or maintenance of, any portion of the Project, or any fixtures, appurtenances and equipment therein.

          B. Control and Reconfiguration. Landlord shall at all times have exclusive control of the Building (other than the Premises) and the Outside Area and may at any time temporarily close any part thereof and exclude and restrain anyone from any part thereof, and may change the design configuration or location of the Building or the Outside Area. In exercising any such rights, Landlord shall make a reasonable effort to minimize any disruption of Tenant’s business. Landlord shall have the right to reconfigure the parking area and ingress to and egress from the parking area, and to modify the directional flow of traffic in the parking area. Landlord shall further have the right to enter upon the Premises, upon the giving of the notice provided in Paragraph 21., for the purpose of installing, maintaining, repairing, adjusting and making connections to any utilities (including but not limited to plumbing, HVAC, electrical, telephone, cable TV, and computer wiring) serving the Premises or other spaces in the Building or for gaining access to the structural portions of the Building and making alterations thereto for the benefit of Tenant, Landlord or other occupants of the Building.

10

Initials:
Landlord	Tenant

          C. Waiver. Tenant waives the provisions of all laws, statutes or ordinances, including Sections 1932(1), 1932(2), 1933(4), 1941 and 1942 of the California Civil Code and any similar or successor law, which might now or at any time hereafter otherwise afford Tenant any right to make repairs and deduct the expenses of such repairs from the Rent due under this Lease.

          D. Compliance with Governmental Regulations. Tenant shall, at its cost comply with, including the making by Tenant of any Alteration to the Premises, all present and future regulations, rules, laws, ordinances, and requirements of all governmental authorities (including, state municipal, county and federal governments and their departments, bureaus, boards and officials) arising from the use or occupancy of, or applicable to, the Project or privileges appurtenant thereto (including, but not limited to, The Americans With Disabilities Act, and any state or local building, fire or safety codes, ordinances or regulations).

          E. Repair Where Tenant at Fault. If all or part of the Project or the Premises requires repair or becomes damaged or destroyed through any act or omission of Tenant or Tenant’s Agents, Landlord may effect the necessary alterations, replacements or repairs at Tenant’s cost.

     19. Fixtures. Tenant shall, at its own expense, provide, install and maintain in good condition all trade fixtures and equipment required in the conduct of its business in the Premises. All fixtures and improvements, other than Tenant’s trade fixtures and equipment, which are installed or constructed upon or attached to the Premises by either Landlord or Tenant shall become a part of the realty and belong to Landlord. If Tenant is not then in default, Tenant may, at the termination of this Lease, or at any other time, remove from the Premises all trade fixtures, equipment and other personal property not permanently affixed to the Premises. Upon removal, Tenant shall restore the Premises to its original condition at the time of occupancy, normal wear and tear excepted. Tenant shall place a floor mat of sufficient strength under each desk chair to protect the carpeting and shall be responsible for any damage to the carpet for failure to do so.

     20. Liens. Tenant shall keep the Project free from any liens arising out of any work performed, materials furnished or obligations incurred by or on behalf of Tenant and shall defend, indemnify and hold the Project, Landlord and Landlord’s Agents free and harmless from and against any lien, claim, cause of action, loss, liability, damage or expense, including attorneys’ fees and costs, in connection with or arising out of any such lien or claim of lien. Tenant shall cause any such lien imposed to be released of record by payment or posting of a proper bond acceptable to Landlord within ten (10) days after written request by Landlord. If Tenant fails to so remove any such lien within the prescribed ten (10) day period, then Landlord may do so and Tenant shall reimburse Landlord upon demand. Such reimbursement shall include all sums incurred by Landlord including Landlord’s reasonable attorneys’ fees, with interest thereon at the Interest Rate.

     21. Landlord’s Right to Enter the Premises. Tenant shall permit Landlord and its Agents to enter the Premises at all reasonable times to inspect the Premises, to post Notices of Nonresponsibility and similar notices, “For Sale” signs, to show the Premises to interested parties such as prospective lenders and purchasers, to make repairs or alterations to the Premises or the Building and any utility system located therein, to discharge Tenant’s obligations hereunder when Tenant has failed to do so within a reasonable time after written notice from Landlord, and at any reasonable time within one hundred eighty (180) days prior to the expiration of the Term, to place upon the Premises ordinary “For Lease” signs and to show the Premises to prospective tenants. The above rights are subject to reasonable security regulations of Tenant, and to the fact that Landlord shall seek to exercise its rights in a manner so as to minimize interference with Tenant’s business.

     22. Signs. Subject to receipt of the necessary approvals of the City, Landlord shall provide for Tenant a listing (to a maximum of four (4) lines) in the Building directory and a sign adjacent to the main entrance of the Premises within the Building. Except as provided in EXHIBIT C hereto, Tenant shall have no right to maintain Tenant identification signs in any other location in, on or about the Project and shall not display or erect any other Tenant identification sign, display or other advertising material that is visible from the exterior of the Building without Landlord’s prior written consent which may be withheld in Landlord’s sole discretion; all signage displayed, installed or erected by or on behalf of Tenant shall conform to all signage criteria, from time to time, adopted by Landlord.

     23. Insurance.

11

Initials:
Landlord	Tenant

          A. Indemnification. Tenant shall protect, defend, indemnify and hold Landlord and Landlord’s Agents free and harmless from and against any and all damage, loss, liability or expense including, without limitation, attorneys’ fees, expert witness fees and legal costs suffered directly or by reason of any claim, cause of action, suit or judgment brought by or in favor of any person or persons for damage, loss or expense due to, but not limited to, bodily injury and property damage sustained by such person or persons which arises out of, is occasioned by or in any way attributable to (i) injury or damage occurring upon the Premises, (ii) the use or occupancy of the Project or any part thereof and adjacent areas by the Tenant, (iii) the acts or omissions of the Tenant, its agents or employees or any contractors brought onto the Project by Tenant, except to the extent caused solely by the gross negligence or willful misconduct of Landlord or Landlord’s Agents. Tenant agrees that the indemnity obligations assumed herein and in other provisions of this Lease shall survive the expiration or earlier termination of the Term of this Lease.

          B. Tenant’s Insurance. Tenant shall maintain in full force and effect at all times during the Term (including any extension(s)), at its own expense, for the protection of Tenant and Landlord, as their interests may appear, policies of insurance issued by a responsible carrier or carriers, acceptable to Landlord, which afford the following coverages:

               (i) Worker’s Compensation — In accordance with state law.

               (ii) Commercial general liability insurance in an amount not less than Two Million and no/100ths Dollars ($2,000,000.00) combined single limit for both bodily injury and property damage which includes blanket contractual liability, broad form property damage, personal injury, completed operations, and products liability naming Landlord as an additional insured.

               (iii) “All Risk” property insurance (including, without limitation, vandalism, malicious mischief, inflation endorsement, and sprinkler leakage endorsement) on Tenant’s Personal Property located on or in the Premises together with any improvement or Alteration for which Landlord is not obligated to repair pursuant to Paragraph 25.D. Such insurance shall be in the full amount of the replacement cost, as the same may from time to time increase as a result of inflation or otherwise.

          C. All-Risk Insurance. During the Term Landlord shall maintain “All Risk” property insurance (including, at Landlord’s option, inflation endorsement, sprinkler leakage endorsement, and earthquake and flood coverage) on the Project, excluding coverage of all Tenant’s Personal Property located on or in the Premises, but including the Tenant Improvements. At Landlord’s option, the coverage shall also include insurance against loss of rents on an “All Risk” basis, including flood, in an amount equal to the Monthly Rent, and any other sums payable under the Lease, for a period of at least twelve (12) months commencing on the date of loss. Such insurance shall name Landlord as a named insured and may at Landlord’s option include Landlord’s Agents as named insureds and lender’s loss payable endorsement(s) in favor of lenders with respect to the Property. The insurance premiums, including the premiums resulting from increases in the valuation of the Project shall be included in Operating Expenses.

          D. Evidence of Insurance. Tenant shall deliver to Landlord, at least thirty (30) days prior to the time the insurance first is required to be carried by Tenant, written evidence of the insurance for the coverage specified in Paragraph 23.B., with the limits not less than those specified therein. The written evidence shall include a statement providing for written notification to Landlord by the insurer not less than thirty (30) days prior to cancellation or reduction of any required coverage.

          E. Co-Insurer. If, on account of the failure of Tenant to comply with the foregoing provisions, Landlord is adjudged a co-insurer by its insurance carrier, then, any loss or damage Landlord shall sustain by reason thereof, including attorneys’ fees and costs, shall be borne by Tenant and shall be immediately paid by Tenant upon receipt of a bill therefor and evidence of such loss.

          F. Insurance Requirements. All insurance shall be in a form satisfactory to Landlord. All policies required by Paragraph 23.B. shall be carried with companies that have a general policy holder’s rating of not less than “A” and a financial rating of not less than Class “X” in the most current edition of Best’s Insurance Reports. All policies required by Paragraph 23.B. shall provide that the policies shall not be subject to material alteration or cancellation except after at least thirty (30) days’ prior written notice to Landlord, and they shall be primary as to Landlord. If Tenant fails to procure and maintain the insurance required hereunder, Landlord may, but shall not be required to, order such insurance at Tenant’s expense and Tenant shall reimburse Landlord. Such reimbursement shall include

12

Initials:
Landlord	Tenant

all sums incurred by Landlord, including reasonable attorneys’ fees, with interest thereon at the Interest Rate.

          G. No Limitation of Liability. Landlord makes no representation that the limits of liability specified to be carried by Tenant under the terms of this Lease are adequate to protect Tenant or Landlord, and in the event Tenant believes that any such insurance coverage called for under this Lease is insufficient, Tenant shall provide, at its own expense, such additional insurance as Tenant deems adequate.

          H. Landlord’s Disclaimer. Landlord and Landlord’s Agents shall not be liable for any loss or damage to persons or property resulting from fire, explosion, falling plaster, glass, tile or sheetrock, steam, gas, electricity, water or rain which may leak from any part of the Project, or from the pipes, appliances or plumbing works therein or from the roof, street or subsurface or whatsoever, unless caused by or due to the gross negligence or willful misconduct of Landlord. Landlord and Landlord’s Agents shall not be liable for interference with the light, air, or any latent defect in the Project. In no event whatsoever shall Landlord be liable for losses attributable to interruption of telephone services. Tenant shall give prompt written notice to Landlord in the case of a casualty, accident or repair needed in the Project.

          I. Increased Coverage. Upon demand, Tenant shall provide Landlord, at Tenant’s expense, with such increased amount of existing insurance, and such other insurance as Landlord or Landlord’s lender may reasonably require, to afford Landlord and Landlord’s lender adequate protection.

     24. Waiver of Subrogation. Landlord and Tenant each hereby waive all rights of recovery against the other on account of loss and damage occasioned to such waiving party for its property or the property of others under its control to the extent that such loss or damage is insured against under any insurance policies which may be in force at the time of such loss or damage. Tenant and Landlord shall, upon obtaining policies of insurance required hereunder, give notice to the insurance carrier that the foregoing mutual waiver of subrogation is contained in this Lease and Tenant and Landlord shall cause each insurance policy obtained by such party to provide that the insurance company waives all right of recovery by way of subrogation against either Landlord or Tenant in connection with any damage covered by such policy.

     25. Damage or Destruction.

          A. Partial Damage — Insured. If the Premises are damaged by any casualty which is covered under the “All-Risk” insurance carried by Landlord pursuant to Paragraph 23.C., then Landlord shall restore the damage, provided insurance proceeds are available to pay the cost of restoration and provided such restoration can be completed within one hundred twenty (120) days after the commencement of the work in the opinion of Landlord. In such event this Lease shall continue in full force and effect, except that Tenant shall be entitled to a proportionate reduction of Monthly Rent while such restoration for which Landlord is obligated hereunder takes place, such proportionate reduction to be based upon the extent to which the damage and restoration efforts interfere with Tenant’s use of the Premises.

          B. Partial Damage — Uninsured. If the Premises or the Building is damaged by a risk not covered by Landlord’s insurance, or the available proceeds of insurance are less than the cost of restoration, or if the restoration cannot be completed within one hundred twenty (120) days after the commencement of work, in the opinion of Landlord, then Landlord shall have the option either to: (i) repair or restore such damage, this Lease continuing in full force and effect, but the Monthly Rent to be proportionately abated as provided in Paragraph 25.A.; or (ii) give notice to Tenant at any time within thirty (30) days after such damage terminating this Lease as of a date to be specified in such notice, which date shall be not less than thirty (30) nor more than sixty (60) days after giving such notice. If notice of termination is given, this Lease shall expire and all interest of Tenant in the Premises shall terminate on the date specified in the notice and the Monthly Rent shall be reduced in proportion to the extent, if any, to which the damage interferes with the use of the Premises by Tenant. All insurance proceeds for the Premises shall be payable solely to Landlord, and Tenant shall have no interest in the proceeds.

          C. Total Destruction. If the Premises or the Building is totally destroyed or the Premises or Building, as the case may be, cannot be restored as required herein under applicable laws and regulations or due to the presence of hazardous factors such as earthquake faults, chemical waste and

13

Initials:
Landlord	Tenant

similar dangers, notwithstanding the availability of insurance proceeds, this Lease shall be terminated effective the date of the damage.

          D. Landlord’s Obligations. Landlord shall not be required to insure against or repair any injury or damage by fire or other cause, or to make any restoration or replacement of any paneling, decorations, partitions, railings, floor coverings, office fixtures or other items which are Alterations or Personal Property installed in the Premises by Tenant or at the direct or indirect expense of Tenant. Tenant shall be required at Tenant’s sole cost and expense, separately to insure the same and promptly to restore or replace same in the event of damage. Except for any abatement of Monthly Rent relating to the plan of restoration of damage for which Landlord is obligated to repair hereunder, Tenant shall have no claim against Landlord for any damage suffered by reason of any such damage, destruction, repair or restoration; nor shall Tenant have the right to terminate this Lease as the result of any statutory provision now or hereafter in effect pertaining to the damage and destruction of the Premises, except as expressly provided herein.

          E. Damage Near End of Term. Anything herein to the contrary notwithstanding, if the Premises or the Building is destroyed or damaged during the last twelve (12) months of the Term, then Landlord may, at its option, cancel and terminate this Lease as of the date of the occurrence of the damage. If Landlord does not elect to terminate this Lease, the repair of the damage shall be governed by the other provisions of this Paragraph 25. If this Lease is terminated, Landlord may keep all the insurance proceeds resulting from the damage, except for the proceeds which specifically insured Tenant’s Personal Property.

     26. Condemnation.

          A. Total Taking — Termination. If title to all of the Premises or so much thereof is taken or appropriated for any public or quasi-public use under any statute or by right of eminent domain so that reconstruction of the Premises will not, in Landlord’s and Tenant’s mutual opinion, result in the Premises being reasonably suitable for Tenant’s continued occupancy for the uses and purposes permitted by this Lease, this Lease shall terminate as of the date that possession of the Premises or part thereof be taken. A sale by Landlord to any authority having the power of eminent domain, either under threat of condemnation or while condemnation proceedings are pending, shall be deemed a taking under the power of eminent domain for all purposes of this Paragraph.

          B. Partial Taking. If any part of the Premises or the Building is taken and the remaining part is reasonably suitable for Tenant’s continued occupancy for the purposes and uses permitted by this Lease, this Lease shall, as to the part so taken, terminate as of the date that possession of such part of the Premises or Building is taken. If the Premises is so partially taken the Rent and other sums payable hereunder shall be reduced in the same proportion that Tenant’s use and occupancy is reduced.

          C. No Apportionment of Award. No award for any partial or entire taking shall be apportioned. Tenant assigns to Landlord its interest in any award which may be made in such taking or condemnation, together with any and all rights of Tenant arising in or to the same or any part thereof. Nothing contained herein shall be deemed to give Landlord any interest in or require Tenant to assign to Landlord any separate award made to Tenant for the: taking of Tenant’s Personal Property, for the interruption to Tenant’s business, or its moving costs, or for the loss of its good will.

          D. Temporary Taking. No temporary taking of the Premises shall terminate this Lease or give Tenant any right to any abatement of Rent. Any award made to Tenant by reason of such temporary taking shall belong entirely to Tenant and Landlord shall not be entitled to share therein. Each party agrees to execute and deliver to the other all instruments that may be required to effectuate the provisions of this Paragraph.

     27. Assignment and Subletting.

          A. Landlord’s Consent. Tenant shall not enter into a Sublet without Landlord’s prior written consent, which consent shall not be unreasonably withheld. Any attempted or purported Sublet without Landlord’s prior written consent shall be void and confer no rights upon any third person and, at Landlord’s election, shall terminate this Lease. Each Subtenant shall agree in writing, for the benefit of Landlord, to assume, to be bound by, and to perform and observe the terms, covenants and conditions of this Lease to be performed and observed by Tenant. Every Sublet shall recite that it is and

14

Initials:
Landlord	Tenant

shall be subject and subordinate to the provisions of this Lease, and that the termination of this Lease shall constitute a termination (at the option of the Landlord) of every such Sublet. Notwithstanding anything contained herein, (i) Tenant shall not be released from personal liability for the performance of any of the terms, covenants and conditions of this Lease by reason of Landlord’s consent to a Sublet unless Landlord specifically grants such release in writing, and (ii) the parties agree that it shall be reasonable for Landlord to withhold its consent to any proposed Sublet when the proposed Subtenant is an occupant of the Property or is a third party which is already involved in negotiations with Landlord to lease space in the Project.

          B. Information to be Furnished. If Tenant desires at any time to Sublet the Premises or any portion thereof, it shall first notify Landlord of its desire to do so and shall submit in writing to Landlord: (i) the name of the proposed Subtenant; (ii) the nature of the proposed Subtenant’s business to be carried on in the Premises; (iii) the terms and provisions of the proposed Sublet and a copy of the proposed Sublet form containing a description of the subject premises; and (iv) such financial information, including financial statements, as Landlord may reasonably request concerning the proposed Subtenant. If Tenant requests Landlord’s consent to a proposed Sublet, Tenant shall pay to Landlord, whether or not consent is ultimately given, Landlord’s reasonable attorneys’ fees incurred in connection with such request.

          C. Landlord’s Alternatives. At any time within thirty (30) days after Landlord’s receipt of all the information specified in Paragraph 27.B., Landlord may, by written notice to Tenant, elect: (i) to lease for its own account the Premises or the portion thereof so proposed to be Sublet by Tenant, upon the same terms as those offered to the proposed Subtenant but on a form acceptable to Landlord; (ii) to terminate this Lease as it relates to the Premises or the portion thereof so proposed to be Sublet by Tenant as of the later of (x) the proposed effective date of such Sublet or (y) thirty (30) days after the date Landlord is in receipt of the information specified in Paragraph 27.B.; (iii) to consent to the Sublet by Tenant; or (iv) to refuse its consent to the Sublet.

     If Landlord consents to the Sublet, Tenant may thereafter enter a valid Sublet of the Premises or portion thereof, upon the terms and conditions and with the proposed Subtenant set forth in the information furnished by Tenant to Landlord pursuant to Paragraph 27.B., subject, however, to the condition that any excess of the Subrent over the Rent required to be paid by Tenant hereunder shall be split evenly between Landlord and Tenant as and when received by Tenant.

          D. Proration. If a portion of the Premises is Sublet, the pro rata share of the Rent attributable to such partial area of the Premises shall be determined by Landlord by dividing the Rent payable by Tenant hereunder by the total square footage of the Premises and multiplying the resulting quotient (the per square foot rent) by the number of square feet of the Premises which are Sublet.

          E. Executed Counterpart. No Sublet shall be valid nor shall any Subtenant take possession of the Premises until an executed counterpart of the Sublet agreement has been delivered to Landlord.

          F. Surrender of Lease. The voluntary or other surrender of this Lease by Tenant, or a mutual cancellation thereof, shall not work a merger, and shall, at the option of Landlord, terminate all or any existing Sublets, or may, at the option of Landlord, operate as an assignment to it of any or all such Sublets.

          G. No Mortgages. Tenant shall not pledge, hypothecate or encumber this Lease or Tenant’s interest herein or in the Premises in any manner, including without limitation, by means of any mortgage, deed of trust, security interest or assignment for security purposes, and any such attempted pledge, hypothecation or encumbrance shall be void and constitute a default under this Lease.

          H. Effect of Default. Notwithstanding any provision of this Paragraph 27 to the contrary, in the event of the occurrence of any uncured default by Tenant in the performance of any term or condition of this Lease, any right of Tenant at such time to seek to Sublet this Lease pursuant to this Paragraph 27 and any obligations of Landlord to review any proposed Sublet or exercise its rights under Paragraph 27.C above shall be suspended, and any applicable period for review or action by Landlord shall be tolled, until such default is cured of no force or effect.

          I. Permitted Transfers. Notwithstanding anything to the contrary contained in this Lease, Tenant, without Landlord’s prior written consent, may sublet the Premises or assign this

15

Initials:
Landlord	Tenant

Lease to: (i) a subsidiary, affiliate, division or corporation controlling, controlled by or under common control with Tenant; (ii) a successor corporation related to Tenant by merger, consolidation, nonbankruptcy reorganization or government action; or (iii) a purchaser of substantially all of Tenant’s assets located at the Premises (collectively “Permitted Transferees”); provided Tenant enters into such a transaction in good faith and not for the purpose of indirectly entering into a sublet or assignment of this Lease with a person or entity other than a Permitted Transferee through a step transaction or otherwise. For purposes of this Lease, a sale of Tenant’s capital stock through any public exchange shall not be deemed an assignment, subletting or other transfer of this Lease or the Premises requiring Landlord’s consent. Tenant shall not be required to obtain Landlord’s consent thereof, nor shall provisions of (ii) or (iv) of Paragraph 27.C hereof apply (but all other provisions of said Paragraph, including the second full grammatical paragraph thereof, shall apply); in no event shall such assignment or sublease release Tenant from any liability for the performance of the obligations under this Lease, unless Landlord shall have released Tenant in writing. Further, the requirements contained in the third and fourth sentences of Paragraph 27.A shall apply to all such transfers.

     28. Default.

          A. Tenant’s Default. A default under this Lease by Tenant shall exist if any of the following events shall occur:

               (i) If Tenant fails to pay Rent or any other sum required to be paid hereunder within five (5) days after the date when the same is due; or

               (ii) If Tenant fails to perform any term, covenant or condition of this Lease except those requiring the payment of money, and Tenant shall have failed to cure such breach within twenty (20) days after written notice from Landlord; provided, however, that when such failure could not reasonably be cured within the twenty (20) day period, then Tenant shall not be in default if Tenant promptly commences the performance of such cure within the twenty (20) day period and diligently thereafter prosecutes the same to completion; or

               (iii) If Tenant shall have failed to continuously and uninterruptedly conduct its business in the Premises, or shall have abandoned or vacated the Premise; or

               (iv) In the event of a general assignment by Tenant for the benefit of creditors; the filing of any voluntary petition in bankruptcy by Tenant or the filing of an involuntary petition by Tenant’s creditors, which involuntary petition remains undischarged for thirty (30) days; the employment of a receiver to take possession of substantially all of Tenant’s assets or any part of the Premises, if such receivership remains undissolved for ten business days after creation thereof; the attachment, execution or other judicial seizure of all or substantially all of Tenant’s assets or any part of the Premises, if such attachment or other seizure remains undismissed or undischarged for ten business days after the levy thereof; the admission by Tenant in writing of its inability to pay its debts as they become due; the filing by Tenant of a petition seeking any reorganization or arrangement, composition, readjustment, liquidation, dissolution or similar relief under any present or future statute, law or regulation; the filing by Tenant of an answer admitting or failing timely to contest a material allegation of a petition filed against Tenant in any such proceeding; or, if within thirty (30) days after the commencement of any proceeding against Tenant seeking any reorganization or arrangement, composition, readjustment, liquidation, dissolution or similar relief under any present or future statute, law or regulation, such proceeding shall not have been dismissed.

          B. Remedies. Upon a default, Landlord shall have the following remedies, in addition to all other rights and remedies provided by law or otherwise provided in this Lease, to which Landlord may resort cumulatively or in the alternative:

               (i) Landlord may continue this Lease in full force and effect, and this Lease shall continue in full force and effect as long as Landlord does not terminate this Lease, and Landlord shall have the right to collect Rent when due. During the period Tenant is in default, Landlord may enter the Premises and relet it, or any part of it, to third parties for Tenant’s account, provided that any rent in excess of the Monthly Rent due hereunder shall be payable to Landlord. Tenant shall be liable immediately to Landlord for all costs Landlord incurs in reletting the Premises or any part thereof, including, without limitation, broker’s commissions, expenses of cleaning and redecorating the Premises required by the reletting and like costs. Reletting may be for a period shorter or longer than the

16

Initials:
Landlord	Tenant

remaining Term of this Lease. No act by Landlord other than giving written notice to Tenant shall terminate this Lease.

               (ii) Landlord may by written notice terminate Tenant’s right to possession of the Premises at any time and relet the Premises or any part thereof. Acts of maintenance, efforts to relet the Premises or the appointment of a receiver on Landlord’s initiative to protect Landlord’s interest under this Lease shall not constitute a termination of Tenant’s right to possession. On termination, Landlord has the right to remove all Tenant’s Personal Property and store same at Tenant’s cost and to recover from Tenant:

          (a) the worth at the time of award of the unpaid Rent which had been earned at the time of termination including interest at the Interest Rate;

          (b) the worth at the time of award of the amount by which the unpaid Rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided, including interest at the Interest Rate;

          (c) the worth at the time of award of the amount by which unpaid Rent for the balance of the term after the time of award exceeds the amount of such rental loss for the same period that Tenant proves could be reasonably avoided, discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%);

          (d) any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant’s failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, including without limitation the following: (i) all expenses for repairing or restoring the Premises, (ii) all brokers’ fees, advertising costs and other expenses of repairing or restoring the Premises, (iii) all expenses in retaking possession of the Premises, and (iv) reasonable attorneys’ fees, expert witness fees and court costs; and

          (e) as used in subparagraphs (a) through (c) above, the term “time of award” shall mean the date of entry of a judgment or award against Tenant in an action or proceeding arising out of Tenant’s breach of this Lease.

     Tenant waives redemption or relief from forfeiture under California Code of Civil Procedure Sections 1174 and 1179, or under any other present or future law, in the event Tenant is evicted or Landlord takes possession of the Premises by reason of any default of Tenant hereunder.

               (iii) Landlord may, with or without terminating this Lease, re-enter the Premises and remove all persons and property from the Premises; such property may be removed and stored in a public warehouse or elsewhere at the cost of and for the account of Tenant. No re-entry or taking possession of the Premises by Landlord pursuant to this Paragraph shall be construed as an election to terminate this Lease unless a written notice of such intention is given to Tenant.

          C. Landlord’s Default. Landlord shall not be deemed to be in default in the performance of any obligation required to be performed by it hereunder unless and until it has failed to perform such obligation within twenty (20) days after receipt of written notice by Tenant to Landlord specifying the nature of such default; provided, however, that if the nature of Landlord’s obligation is such that more than twenty (20) days are required for its performance, then Landlord shall not be deemed to be in default if it shall commence such performance within such twenty (20) day period and thereafter diligently prosecute the same to completion.

     29. Subordination. This Lease is and shall automatically be subject and subordinate to all ground and underlying leases, mortgages, and deeds of trust (collectively, “Encumbrance”) which may now or hereafter affect the Premises, to the CC&R’s and to all renewals, modifications, consolidations, replacements and extensions thereof; provided, however, if the holder or holders of any such Encumbrance (“Holder”) shall require that this Lease be prior and superior thereto, then upon written notice from Holder to Tenant this Lease shall be automatically prior and superior to the lien of such Encumbrance without regard to the sequence of recordation. Within ten (10) days after Landlord or Holder’s written request, Tenant shall execute any and all documents requested by Landlord or Holder to further effectuate and evidence such subordination of this Lease to any lien of the Encumbrance or to evidence the Holder’s election that this Lease be prior and senior to the Encumbrance. Notwithstanding anything to the contrary set forth in this Paragraph, Tenant hereby attorns and agrees to attorn to the

17

Initials:
Landlord	Tenant

Holder and any person purchasing or otherwise acquiring the Premises at any sale or other proceeding or pursuant to the exercise of any other rights, powers or remedies under such Encumbrance, which obligation to attorn shall survive any foreclosure of any Encumbrance; and Tenant agrees within ten (10) days of request of Holder or any such other person to execute an attornment agreement recognizing Holder or such other person as Landlord under this Lease and acknowledging that this Lease is and shall remain in full force and effect and binding upon Tenant notwithstanding any foreclosure of such Encumbrance.

     30. Notices. Every notice to be given by any party to any other party with respect hereto, shall be in writing and shall not be effective for any purpose unless the same shall be delivered to the addressee personally, by a reputable express delivery service, a recognized overnight air courier service, or United States certified mail, return receipt requested, addressed to the respective parties at the addresses set forth at C.11. of the Information Sheet, or to such other address as either party may from time to time designate by notice to the other given in accordance with this Paragraph. All notices shall be effective (i) when delivered locally by hand or by a reputable express delivery service (ii) one business day after deposit with a recognized overnight air courier service or (iii) five business days after having been sent by certified mail, return receipt requested.

     31. Attorneys’ Fees. In the event Landlord engages an attorney to pursue the recovery of any Rent owed by Tenant hereunder (whether or not any action or legal proceeding is ultimately filed) or if either party brings any action or legal proceeding for damages for an alleged breach of any provision of this Lease, to recover Rent or other sums due, to terminate the tenancy of the Premises or to enforce, protect or establish any term, condition or covenant of this Lease or right of either party, the prevailing party shall be entitled to recover as a part of such action or proceedings, or in a separate action brought for that purpose, reasonable attorneys’ fees and costs, including expert witness fees (and without regard to whether or not such action or proceedings are pursued to judgment).

     32. Estoppel Certificates. Tenant shall within ten (10) days following written request by Landlord:

               (i) Execute and deliver to Landlord any documents, including estoppel certificates, in the form prepared by Landlord (a) certifying the date of commencement of this Lease, (b) certifying that this Lease is unmodified and in full force and effect or, if modified, stating the nature of such modification and certifying that this Lease, as so modified, is in full force and effect, (c) stating the dates to which Rent and any other amounts payable hereunder have been paid and the amount of any unforfeited security deposit then held by Landlord, and (d) acknowledging that there are not, to Tenant’s knowledge, any uncured defaults on the part of Landlord, or, if there are uncured defaults on the part of the Landlord, stating the nature of such uncured defaults, (e) acknowledging that Tenant does not have any claim or right of offset against Landlord (or if Tenant does have any such claim or right of offset, the nature of such claim or right of offset), and (f) setting forth such other matters as may reasonably be requested by Landlord. Tenant’s failure to deliver an estoppel certificate within ten (10) days after delivery of Landlord’s written request therefor shall be conclusive upon Tenant (a) that this Lease is in full force and effect, without modification except as may be represented by Landlord, (b) that there are now no uncured defaults in Landlord’s performance and (c) that no Rent has been paid in advance and no security deposit is held by Landlord, (d) that Tenant has no claims or rights of offset against Landlord and (e) that such other matters as were set forth in such estoppel certificate as prepared by Landlord are true and correct; provided, further, that such failure shall constitute a breach of this Lease and Landlord’s remedies shall be as specified in Paragraph 28.B.

               (ii) Deliver to Landlord the current financial statements of Tenant, and financial statements of the two (2) years prior to the current financial statements year, with an opinion of a certified public accountant, including a balance sheet and profit and loss statement for the most recent prior year, all prepared in accordance with generally accepted accounting principles consistently applied.

     33. Transfer of the Project by Landlord. In the event of any conveyance of the Project or the Building and assignment by Landlord of this Lease, Landlord shall be and is hereby entirely released from all liability under any and all of its covenants and obligations contained in or derived from this Lease occurring or accruing after the date of the conveyance and assignment, and Tenant agrees to attorn to such transferee.

     34. Landlord’s Right to Perform Tenant’s Covenants. If Tenant fails to make any payment or perform any other act on its part to be made or performed under this Lease, Landlord after

18

Initials:
Landlord	Tenant

fifteen (15) days’ written notice may, but shall not be obligated to, and without waiving or releasing Tenant from any obligation of Tenant under this Lease, make such payment or perform such other act to the extent Landlord may deem desirable, and in connection therewith, pay expenses and employ counsel. All sums so paid by Landlord and all penalties, interest and costs in connection therewith shall be due and payable by Tenant on the next day after any such payment by Landlord, together with interest thereon at the Interest Rate from such date to the date of payment by Tenant to Landlord, plus collection costs and attorneys’ fees. Landlord shall have the same rights and remedies for the nonpayment thereof as in the case of default in the payment of Rent.

     35. Tenant’s Remedy. The obligations of Landlord under this Lease do not and shall not constitute personal obligations of Landlord or any of Landlord’s Agents, and Tenant agrees that it shall look solely to the real estate that is the subject of this Lease and to no other assets of Landlord or Landlord’s Agents for satisfaction of any liability that may now or hereafter arise in respect of this Lease and will not seek recourse against Landlord or Landlord’s Agents or any of their personal assets for such satisfaction.

     36. Mortgagee Protection. If Landlord defaults under this Lease, Tenant shall, if earlier requested by Landlord or any lender with respect to the Project, notify by registered or certified mail to any beneficiary of a deed of trust or mortgagee of a mortgage covering the Premises and offer such beneficiary or mortgagee a reasonable opportunity to cure the default, including time to obtain possession of the Premises by power of sale or a judicial foreclosure, if such should prove necessary to effect a cure.

     37. Brokers. Tenant warrants and represents that it has had no dealings with any real estate broker or agent in connection with the negotiation of this Lease, except for the broker(s) specified at C.10. of the Information Sheet, and that it knows of no real estate broker or agent who is or might be entitled to a commission in connection with this Lease. Tenant agrees to defend, indemnify and hold Landlord and Landlord’s Agents free and harmless from and against any and all liabilities or expenses, including attorneys’ fees and costs, arising out of or in connection with claims made by any broker or individual for commissions or fees resulting from Tenant’s execution of this Lease.

     38. Acceptance. Delivery of this Lease, duly executed by Tenant, constitutes an offer to lease the Premises, and under no circumstances shall such delivery be deemed to create an option or reservation to lease the Premises for the benefit of Tenant. This Lease shall only become effective and binding upon full execution hereof by Landlord and delivery of a signed copy to Tenant.

     39. Recording. Neither party shall record this Lease nor a short form memorandum thereof.

     40. Modifications for Lender. If, in connection with obtaining financing for the Project, or any portion thereof, Landlord’s lender shall request reasonable modifications to this Lease as a condition to such financing, Tenant shall not unreasonably withhold, delay or defer its consent thereto, provided such modifications do not materially adversely affect Tenant’s rights hereunder.

     41. Parking. Tenant shall have the right to park in the Project’s parking facilities in common with other tenants of the Building upon terms and conditions, as may from time to time be established by Landlord and in accordance with any parking control or monitoring devices from time to time installed or implemented by Landlord. Tenant shall not overburden the parking facilities and shall not use more than one (1) parking space per three hundred thirty-three (333) rentable square feet of the Premises. Tenant also agrees to cooperate with Landlord and other tenants in the use of the parking facilities. Landlord reserves the right, in its discretion, to allocate and assign parking spaces among Tenant and the other tenants or to restrict the use of certain parking spaces for certain tenants and to install or otherwise implement parking control or monitoring devices for the parking facilities. In the event that parking control or monitoring devices for the parking facilities are installed, Landlord reserves the right to charge a reasonable fee for use of the parking facilities. Tenant shall establish and maintain during the Term hereof a program to encourage maximum use of public transportation by personnel of Tenant employed on the Premises, including without limitation, the distribution to such employees of written materials explaining the convenience and availability of public transportation facilities adjacent or proximate to the Building, staggering working hours of employees, and encouraging use of such facilities, all at Tenant’s sole reasonable cost and expense. Tenant agrees to comply with any lawful regulation or ordinance of the City of San Jose or the County of Santa Clara respecting transportation management in those jurisdictions, related to the conduct of Tenant’s business within the Premises.

19

Initials:
Landlord	Tenant

     42. Use of “San Jose Gateway” Prohibited. Tenant shall not employ the term “San Jose Gateway” in the name or title of its business or occupation without Landlord’s prior written consent.

     43. Interest. Any rent or other amount not paid by Tenant to Landlord when due hereunder shall bear interest at the lesser of (i) the rate of twelve percent (12%) per annum or (ii) the maximum rate permitted by applicable law (with such rate of interest sometimes referred to herein as the “Interest Rate”) from the date due until paid.

     44. Quitclaim. Upon any termination of this Lease, Tenant, at Landlord’s request, shall execute, have acknowledged and deliver to Landlord a quitclaim deed for all Tenant’s interest in the Project.

     45. Relocation. Landlord shall have the right, upon ninety (90) days’ prior written notice to Tenant, at any time and from time to time during the Term, to relocate Tenant from the Premises to any other premises (“Relocation Premises”) in the Project provided that the total rentable square footage of the Relocation Premises is reasonably comparable, as determined in Landlord’s sole discretion, to the total rentable square footage of the Premises. If, as a result of any such relocation, the total rentable square footage of Tenant’s premises is reduced, there shall be an appropriate adjustment in monthly Base Rent and an appropriate concomitant adjustment in Tenant’s Property Percentage. Landlord shall also provide tenant improvements in the Relocation Premises which are comparable to the then existing tenant improvements in the Premises. Except as provided in this Paragraph 45, none of the other terms of this Lease shall change in the event of any relocation of Tenant made pursuant to this Paragraph 45. Following any such relocation, the term “Premises” as used in this Lease shall mean the Relocation Premises. Any relocation will be at Landlord’s sole cost.

     46. General.

          A. Captions. The captions and headings used in this Lease are for the purpose of convenience only and shall not be construed to limit or extend the meaning of any part of this Lease.

          B. Executed Copy. Any fully executed copy of this Lease shall be deemed an original for all purposes.

          C. Time. Time is of the essence for the performance and observance of each term, covenant and condition of this Lease.

          D. Severability. If one or more of the provisions contained herein, except for the payment of Rent, is for any reason held to be invalid, illegal or unenforceable in any respect, such invalidity, illegality, or unenforceability shall not affect any other provision of this Lease, but this Lease shall be construed as if such invalid, illegal or unenforceable provision had not been contained herein.

          E. Choice of Law. This Lease shall be construed and enforced in accordance with the laws of the State of California. The language in all parts of this Lease shall in all cases be construed as a whole according to its fair meaning and not strictly for or against either Landlord or Tenant.

          F. Interpretation. When the context of this Lease requires, the neuter gender includes the masculine, the feminine, a partnership or corporation or joint venture, and the singular includes the plural. The term “including” shall be deemed to mean “including, but not by way of limitation” and the term “or” has the inclusive meaning represented by the term “and/or.”

          G. Effect of Remeasurement. The total rentable square feet of the Premises and of the Building is subject to remeasurement, at Landlord’s discretion, by an architect selected by Landlord using the standard of the Building Owners and Managers Association ANSI/BOMA-Z65.1-1996 or such other standard as then in effect and generally used by the Building Owners and Managers Association for such purposes. In the event the actual square footage for the Premises and/or the Building as determined by a remeasurement by Landlord differs from the square footage set forth in this Lease, there shall be an appropriate adjustment in monthly Base Rent and an appropriate concomitant adjustment in Tenant’s Property Percentage based on the square footage as determined by the remeasurement.

          H. Binding Effect. The covenants and agreement contained in this Lease shall be binding on the parties hereto and on their respective successors and assigns to the extent this Lease is assignable.

20

Initials:
Landlord	Tenant

          I. Waiver. The waiver by Landlord of any breach of any term, covenant or condition of this Lease shall not be deemed to be a waiver of such provision or any subsequent breach of the same or any other term, covenant or condition of this Lease. The subsequent acceptance of Rent hereunder by Landlord shall not be deemed to be a waiver of any preceding breach at the time of acceptance of such payment. No term, covenant or condition of this Lease shall be deemed to have been waived by Landlord unless the waiver is in writing signed by Landlord.

          J. Entire Agreement. This Lease, including the Information Sheet, is the entire agreement between the parties, and there are no agreements or representations between the parties except as expressed herein. Except as otherwise provided herein, no subsequent change or addition to this Lease shall be binding unless in writing and signed by the parties hereto.

          K. Authority. If Tenant is a corporation or a partnership, each individual executing this Lease on behalf of the corporation or partnership, as the case may be, represents and warrants that he is duly authorized to execute and deliver this Lease on behalf of the entity in accordance with its corporate bylaws, statement of partnership or certificate of limited partnership, as the case may be, and that this Lease is binding upon the entity in accordance with its terms. Landlord, at its option, may require a copy of such written authorization to enter this Lease. The failure of Tenant to deliver the same to Landlord within fifteen (15) days of Landlord’s request therefor shall be deemed a default under this Lease.

          L. Exhibits. All exhibits, amendments, riders and addenda attached hereto are hereby incorporated herein and made a part hereof.

          M. Counterparts. This Lease may be executed in counterparts, each of which shall be an original, but all counterparts shall constitute one (1) instrument.

     THIS LEASE, executed as of the date(s) set forth below, is effective as of the Effective Date set forth in B. of the Information Sheet.

Dated                     , 2004	TENANT:
	Spatializer Audio Laboratories, Inc. a Delaware corporation
	By:
	Its:
Dated                     , 2004	LANDLORD:
	C.M. STRATPLAN, INC., a California corporation
	By:
	Its:
	By:
	Its:

21

Initials:
Landlord	Tenant

EXHIBIT A

[to be attached when available]

1

EXHIBIT B

Legal Description:

The Property is located in the City of San Jose, County of Santa Clara, State of California:

All of Parcel C, as shown upon that certain Map entitled, “Parcel Map Being a Portion of Pueblo Tract No. 1”, which Map was filed for record in the office of the Recorder of the County of Santa Clara, State of California, on April 28, 1972 in Book 300 of Maps, at page 19.

1

EXHIBIT C

TENANT IMPROVEMENTS

1.	Landlord shall furnish and install within the Premises the tenant improvements described in the Space Plans attached hereto as EXHIBIT C-1 (“Tenant Improvements”) in accordance with the working drawings (“Working Drawings”) approved as provided in Section 3 below. Any additional work (“Tenant Extra Improvements”) requested by Tenant shall be subject to Landlord’s approval, and if approved shall be at Tenant’s expense.
2.	Tenant shall bear all costs of Tenant Extra Improvements. Any modifications requested by Tenant to Tenant Improvements shall constitute Tenant Extra Improvements as used herein.
3.	Landlord and Tenant will supply the information necessary for construction of Tenant Improvements pursuant to the following schedule:

A.	Tenant hereby approves the Space Plan (attached hereto as EXHIBIT C-1);
B.	Tenant shall sign off on approved finishes, built-in furniture plans, mechanical and electrical information and any then approved Tenant Extra Improvements prior to October 1, 2004;
C.	Tenant shall sign off on the Working Drawings for the Tenant Improvements and any approved Tenant Extra Improvements and the estimated cost thereof within two (2) days of receipt;
D.	Landlord shall exercise due diligence to cause the Tenant Improvements and any Tenant Extra Improvements approved by Landlord and Tenant in accordance with the terms hereof to be substantially completed on or before the Early Occupancy Date, which is November 15, 2004, provided that Tenant has not made changes in the scope of work or Working Drawings and has not requested special materials not available when needed for construction in accordance with the schedule. Any delays occasioned by the same or any delays occasioned by the construction of any Tenant Extra Improvements shall be deemed delays attributable to Tenant, and the provisions in Paragraph 4.D. of the Lease shall apply to such instances.

4.	If any changes are made by agreement of Landlord and Tenant in the Space Plan presently attached as EXHIBIT C-1, the revised Space Plan shall replace the present Space Plan.
5.	Landlord and Tenant shall diligently pursue the preparation of all Working Drawings for the Tenant Improvements and any approved Tenant Extra Improvements.
6.	After receipt and approval of the Working Drawings, Landlord shall cause the Tenant Improvements and any approved Tenant Extra Improvements to be constructed substantially in accordance with the Working Drawings, subject to any changes that may be required by any approving authority to comply with applicable law or relevant site conditions. In no event shall Landlord be required to install any Tenant Improvements or Tenant Extra Improvements which do not conform to the plans and specifications for the Project, or do not conform to any applicable regulations, laws, ordinances, codes and rules. Tenant shall not unreasonably withhold its approval of any changes to the Working Drawings required in order to obtain the necessary governmental approvals and permits.
7.	Tenant shall pay Landlord within ten (10) days of receipt any invoice for expenses related to making any Tenant Extra Improvements.

1

EXHIBIT C-1

APPROVED PLANS AND SPECIFICATIONS

[to be attached when available]

1

EXHIBIT D

COMMENCEMENT DATE MEMORANDUM

LANDLORD:
	C.M Stratplan, Inc.
	a California corporation
TENANT:	Spatializer Audio Laboratories, Inc.
	A Delaware corporation
LEASE DATE:	September 14, 2004
PREMISES:
	2025 Gateway Place
	Suite 365
	San Jose, California 95110

Pursuant to Paragraph 4.C. of the above-referenced Lease, the Commencement Date is hereby established as      , 200_

LANDLORD:

C.M. STRATPLAN, INC., a California corporation

By:

Its:

By:

Its:

TENANT:

Spatializer Audio Laboratories, Inc. a Delaware corporation

By:

Its:

1

EXHIBIT E

RULES AND REGULATIONS

1.	No sign, placard, picture, advertisement, name or notice shall be installed or displayed on any part of the outside or the inside of the Building without the prior written consent of Landlord. Landlord shall have the right to remove, at Tenant’s expense and without notice, any sign installed or displayed in violation of this rule. All approved signs or lettering on doors and walls shall be printed, painted, affixed or inscribed at the expense of Tenant by a person chosen by Landlord.
2.	The directory of the Building will be provided exclusively for the display of the name and location of tenants, and Landlord reserves the right to exclude any other names therefrom. Tenant shall pay Landlord’s standard charge for Tenant’s listing thereon and for any changes by Tenant.
3.	Except as consented to in writing by Landlord or in accordance with Building standard improvements, no draperies, curtains, blinds, shades, screens or other devices shall be hung at or used in connection with any window or exterior door or doors of the Premises. No awning shall be permitted on any part of the Premises. Tenant shall not place anything against or near glass partitions or doors or windows which may appear unsightly from outside the Premises.
4.	Tenant shall not obstruct any sidewalks, halls, lobbies, passages, exits, entrances, elevators or stairways of the Building. No tenant and no employee or invitee of any tenant shall go upon the roof of the Building or make any roof or terrace penetrations. Tenant shall not allow anything to be placed on the outside terraces or balconies without the prior written consent of Landlord.
5.	Tenant shall not have any right to enter into any telephone closet or room located in the Building, including, without limitation, any telephone closet or room serving the Premises, even if located within the Premises, except upon the prior written consent of Landlord. Tenant shall have no right to make any alterations to interbuilding network cabling.
6.	All cleaning and janitorial services for the Building shall be provided exclusively through Landlord, and, except with the written consent of Landlord, no person or persons other than those approved by Landlord shall be employed by Tenant or permitted to enter the Building for the purpose of cleaning. Tenant shall not cause any unnecessary labor by carelessness or indifference to the good order and cleanliness of the Premises. Landlord shall not in any way be responsible to any Tenant for any loss of property on the Premises, however occurring, or for any damage to any Tenant’s property by the janitor or any other employee or person.
7.	Landlord will furnish Tenant, free of charge, with two keys to Tenant’s suite entrance. Landlord may make a reasonable charge for any additional keys and for having any locks changed. Tenant shall not make or have made additional keys without Landlord’s prior written consent, and Tenant shall not alter any lock or install a new additional lock or bolt on any door of its Premises without Landlord’s prior written consent. Tenant shall deliver to Landlord, upon the termination of its tenancy, the keys to all locks for doors on the Premises, and in the event of loss of any keys furnished by Landlord, shall pay Landlord therefor.
8.	If Tenant requires telegraphic, telephonic, burglar alarm or similar services, it shall first obtain, and comply with, Landlord’s instructions for their installation.
9.	The elevators shall be available for use by all tenants in the Building, subject to reasonable scheduling as Landlord in its discretion shall deem appropriate. No equipment, materials, furniture, packages, supplies, merchandise or other property will be received in the Building or carried in the elevators except between the hours, and in the manner and in the elevators as may be designated by Landlord.
10.	Tenant shall not place a load upon any floor of the Premises which exceeds the maximum load per square foot which the floor was designed to carry and which is allowed by law. Tenant’s business machines and mechanical equipment which cause noise or vibration which may be transmitted to the structure of the Building or to any space therein, and which is objectionable to Landlord or to any tenants in the Building, shall be placed and maintained by Tenant, at Tenant’s expense, on vibration eliminators or other devices sufficient to eliminate noise or vibration.
11.	Tenant shall not use or keep on the Premises any toxic or hazardous materials or any kerosene, gasoline or inflammable or combustible fluid or material other than those limited quantities necessary for the operation or maintenance of office equipment. Tenant shall not use or permit

1

	to be used in the Premises any foul or noxious gas or substance, or permit or allow the Premises to be occupied or used in a manner offensive or objectionable to Landlord or other occupants of the Building by reason of noise, odors or vibrations. No animal, except seeing eye dogs when in the company of their master, may be brought into or kept in the Building.
12.	Tenant shall not use any method of heating or air-conditioning other than that supplied by Landlord, unless Tenant receives the prior written consent of Landlord.
13.	Tenant shall cooperate fully with Landlord to assure the most effective operation of the Building’s heating and air-conditioning and to comply with any governmental energy-saving rules, laws or regulations of which Tenant has actual notice. Tenant shall refrain from attempting to adjust controls other than room thermostats installed for Tenant’s use. Tenant shall keep corridor doors and sliding glass doors closed, and shall close window coverings at the end of each business day.
14.	Landlord reserves the right, exercisable without notice and without liability to Tenant, to change the name and street address of the Building.
15.	Landlord reserves the right to exclude any person from the Building between the hours of 6 p.m. and 7 a.m. the following day, or any other hours as may be established from time to time by Landlord, and on Saturdays, Sundays and legal holidays, unless that person is known to the person or employee in charge of the Building and has a pass or is properly identified. Tenant shall be responsible for all persons for whom it requests passes and shall be liable to Landlord for all acts of those persons. Landlord shall not be liable for damages for any error in admitting or excluding any person from the Building. Landlord reserves the right to prevent access to the Building by closing the doors or by other appropriate action in case of invasion, mob, riot, public excitement or other commotion.
16.	Tenant shall close and lock the doors of its Premises, shut off all water faucets or other water apparatus and turn off all lights and other equipment which is not required to be continuously run. Tenant shall be responsible for any damage or injuries sustained by other tenants or occupants of the Building or Landlord for noncompliance with this Rule.
17.	The toilet rooms, toilets, urinals, wash bowls and other apparatus shall not be used for any purpose other than that for which they were constructed, and no foreign substance of any kind whatsoever shall be placed therein. The expense of any breakage, stoppage or damage resulting from any violation of this rule shall be borne by the tenant who, or whose employees or invitees, shall have caused it.
18.	Tenant shall not install any radio or television antenna, loudspeaker or other device on the roof or exterior walls of the Building. Tenant shall not interfere with radio or television broadcasting or reception from or in the Building or elsewhere.
19.	Tenant shall not cut or bore holes for wires in the partitions, woodwork or plaster of the Premises. Tenant shall not affix any floor covering to the floor of the Premises in any manner except as approved by Landlord. Tenant shall repair, or be responsible for the cost of repair of any damage resulting from noncompliance with this Rule.
20.	Tenant shall not install, maintain or operate upon the Premises any vending machine without the prior written consent of Landlord.
21.	Canvassing, soliciting and distributing handbills or any other written material and peddling in the Building are prohibited, and each tenant shall cooperate to prevent these activities.
22.	Landlord reserves the right to exclude or expel from the Building any person who, in Landlord’s judgment, is intoxicated or under the influence of liquor or drugs or who is in violation of any of the Rules and Regulations of the Building.
23.	Tenant shall store all its trash and garbage within its Premises. Tenant shall not place in any trash box or receptacle any material which cannot be disposed of in the ordinary and customary manner of trash and garbage disposal within the Building. All garbage and refuse disposal shall be made in accordance with directions issued from time to time by Landlord.
24.	Use by Tenant of Underwriters’ Laboratory approved equipment for brewing coffee, tea, hot chocolate and similar beverages and microwaving food shall be permitted, provided that the equipment and use is in accordance with all applicable federal, state, county and city laws, codes, ordinances, rules and regulations.

2

25.	Tenant shall not use the name of the Building in connection with or in promoting or advertising the business of Tenant, except as Tenant’s address, without the written consent of Landlord.
26.	Tenant shall comply with all safety, fire protection and evacuation procedures and regulations established by Landlord or any governmental agency. Tenant shall be responsible for any increased insurance premiums attributable to Tenant’s use of the Premises, Building or Property.
27.	Tenant assumes any and all responsibility for protecting its Premises from theft and robbery, which responsibility includes keeping doors locked and other means of entry to the Premises closed.
28.	Tenant shall not use the Premises, or suffer or permit anything to be done on, in or about the Premises, which may result in an increase to Landlord in the cost of insurance maintained by Landlord on the Project.
29.	Tenant’s requests for assistance will be attended to only upon appropriate application to the office of the Building by an authorized individual. Employees of Landlord shall not perform any work or do anything outside of their regular duties unless under special instructions from Landlord, and no employee of Landlord will admit any person (Tenant or otherwise) to any office without specific instructions from Landlord.
30.	Tenant shall comply with all parking monitoring controls or devices from time to time installed or otherwise implemented by Landlord. Tenant shall not park its vehicles in any parking areas designated by Landlord as areas for parking by visitors to the Building or other reserved parking spaces. Tenant shall not leave vehicles in the Building parking areas overnight without the prior written consent of Landlord’s manager for the Property, nor park any vehicles in the Building parking areas other than automobiles, motorcycles, motor driven or non-motor driven bicycles or four-wheeled trucks. Tenant, its agents, employees and invitees shall not park any one (1) vehicle in more than one (1) parking space.
31.	The scheduling and manner of all Tenant move-ins and move-outs shall be subject to the discretion and approval of Landlord, and move-ins and move-outs shall take place only after 6 p.m. on weekdays, on weekends or at other times as Landlord may designate. Landlord shall have the right to approve or disapprove the movers or moving company employed by Tenant, and Tenant shall cause the movers to use only the entry doors and elevators designated by Landlord. If Tenant’s movers damage the elevator or any other part of the Property, Tenant shall pay to Landlord the amounts required to repair the damage.
32.	Landlord may waive any one or more of these Rules and Regulations for the benefit of Tenant or any other tenant, but no waiver by Landlord shall be construed as a waiver of the Rules and Regulations in favor of Tenant or any other tenant, nor prevent Landlord from thereafter enforcing the Rules and Regulations against any or all of the tenants of the Building.
33.	These Rules and Regulations are in addition to, and shall not be construed to in any way modify or amend, in whole or in part, the terms, covenants, agreements and conditions of any lease of premises in the Building.
34.	Landlord reserves the right to make other reasonable Rules and Regulations as, in its judgment, may from time to time be needed for safety and security, for care and cleanliness of the Building and for the preservation of good order therein. Tenant agrees to abide by all Rules and Regulations hereinabove stated and any additional rules and regulations which are adopted.
35.	Tenant shall be responsible for the observance of all of the foregoing rules by Tenant’s employees, agents, clients, customers, invitees and guests.

3

EXHIBIT F

UTILITIES AND SERVICES

     The standards set forth below for Utilities and Services are in effect. Landlord reserves the right to adopt nondiscriminatory modifications and additions hereto, which do not materially affect Tenant’s rights. Landlord shall give notice to Tenant, in accordance with provisions of the Lease, of material modification and additions.

     1. Provision by Landlord. As long as Tenant is not in default under any of the terms of this Lease, Landlord shall:

          a. Elevator. Provide unattended automatic elevator facilities Monday through Friday, except holidays, from 7:00 a.m. to 6:00 p.m., and have at least one elevator available at all other times.

          b. Ventilation. Ventilate the Premises and furnish air-conditioning or heating Monday through Friday, except holidays, from 7:00 a.m. to 6:00 p.m. (and at other times for the additional charges described in Paragraph 2) to the extent required for the comfortable occupancy of the Premises, subject to governmental regulation. The air-conditioning system achieves maximum cooling when the window coverings and sliding glass doors are closed. Landlord shall not be responsible for room temperatures if Tenant does not keep all sliding glass doors in the Premises closed whenever the system is in operation. Tenant shall cooperate to the best of its ability at all times with Landlord and shall abide by all reasonable regulations and requirements which Landlord may prescribe for the proper functioning and protection of the air-conditioning system. Tenant shall not connect any apparatus, device, conduit or pipe to the Building’s chilled and hot water air-conditioning supply lines. Tenant and Tenant’ servants, employees, agents, visitors, licensees or contractors shall not enter at any time the mechanical installations or facilities of the Building, or adjust, tamper with, touch or otherwise in any manner affect the installations or facilities. If any installation of partitions, equipment or fixtures by Tenant necessitates the rebalancing of the climate control equipment in the Premises, the rebalancing shall be performed by Landlord at Tenant’s expense.

          c. Electricity. Subject to government regulations (including, without limitation, applicable energy conservation requirements existing or enacted under any governmental regulation) and the provisions of Paragraph 2, furnish to the Premises electric current as required by the Building standard office lighting and fractional horsepower office business machines in the amount of approximately two and one-half (2.5) watts per square foot. If Tenant’s electrical installation or electrical consumption is in excess of the quantity described above, or extends beyond normal business hours, Tenant shall reimburse Landlord monthly for the measured consumption. Tenant shall not connect any apparatus or device with wires, conduits or pipes, or other means by which the services are supplied, for the purpose of using additional or unusual amounts of the services without the prior written consent of Landlord. At all times Tenant’s use of electric current shall not exceed the capacity of the feeders to the Building or the risers or wiring installation, except as provided in working drawings approved by Landlord.

          d. Water. Make water available in public areas for drinking and lavatory purposes only.

          e. Janitorial Service. Provide building standard janitorial service to the Premises, provided the Premises are used exclusively as offices, and are kept reasonably in order by Tenant. Tenant shall pay to Landlord any cost incurred by Landlord for janitorial services in excess of those generally provided for other tenants in the Building. Tenant shall pay to Landlord the cost of removal of any of Tenant’s refuse and rubbish.

     2. Additional Charges. Landlord may impose a reasonable charge for any utilities and services, including air-conditioning, electric current, water and janitorial service, required to be provided by Landlord by reason of (i) any use of the Premises at any time other than between the hours of 7:00 a.m. and 6:00 p.m. Monday through Friday, except holidays; (ii) any use beyond what Landlord agrees to furnish as described above; or (iii) special electrical, cooling and ventilating needs created in certain areas by hybrid telephone equipment, computers and other similar equipment or uses.

     3. Rules and Regulations. Tenant agrees to cooperate at all times with Landlord and to abide by all reasonable regulations and requirements which Landlord may prescribe for the use of the utilities and services. Any failure to pay any excess costs as described above with the next installment of Rent due after receipt of a statement for such services shall constitute a breach of the obligation to pay Rent under this Lease and shall entitle Landlord to the rights granted in this Lease for a breach.

1

     4. Stopping of Service. Landlord reserves the right to stop services of the elevator, plumbing, ventilation, air-conditioning and electric systems when necessary by reason of accident or emergency, or for repairs, alterations or improvements, in the judgment of Landlord desirable or necessary to be made, until the repairs, alterations or improvements have been completed. Landlord shall have no responsibility or liability for failure to supply elevator facilities, plumbing, ventilating, air-conditioning or electric service when prevented by strike or accident or by any cause beyond Landlord’s reasonable control, or by laws, rules, orders, ordinances, directions, regulations or requirements of any federal, state, county or municipal authority or failure of gas, oil or other suitable fuel supply or inability by exercise of reasonable diligence to obtain gas, oil or other suitable fuel. It is expressly understood and agreed that any covenants on Landlord’s part to furnish any service pursuant to any of the terms, covenants, conditions, provisions or agreements of this Lease, or to perform any act or thing for the benefit of Tenant, shall not be deemed breached if Landlord is unable to furnish or perform the same by virtue of a strike or labor trouble or any other cause whatsoever beyond Landlord’s reasonable control.

     5. Notice. To the extent practical, Landlord shall attempt to give Tenant notice of proposed shutdowns of services.

2

EX-21.1

EXHIBIT 21.1

SUBSIDIARY OF THE COMPANY

Name of Subsidiary	Percentage of Ownership	State of Incorporation
Desper Products, Inc.	100%	California

44

EX-23.1

EXHIBIT 23.1

CONSENT OF INDEPENDENT AUDITORS

     To the Board of Directors Of Spatializer Audio Laboratories, Inc.:

We consent to the incorporation by reference in the registration statements on Form S-8 (Nos. 333-27453 and 333-41170) of Spatializer Audio Laboratories, Inc. of our report dated March 6, 2004, related to the consolidated balance sheets of Spatializer Audio Laboratories, Inc. and subsidiaries as of December 31, 2003 and December 31, 2002, and the related consolidated statements of income, stockholders’ equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2003, which report appears in the annual report on Form 10-K of Spatializer Audio Laboratories, Inc. for the year ended December 31, 2003.

/s/ FARBER & HASS LLP

Oxnard, California

March 10, 2005

45

EX-31.1

EXHIBIT 31.1

CERTIFICATIONS

I, Henry R. Mandell certify that:

1. I have reviewed this annual report on Form 10-K 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: March 22, 2005
	/s/ Henry R. Mandell
	Henry R. Mandell
	Chief Executive Officer and Chief Financial Officer

46

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 Annual Report on Form 10-K of the Company for the year ended December 31, 2003 as filed with the Securities and Exchange Commission (the “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: March 22, 2005
	/s/ Henry R. Mandell
	Henry R. Mandell
	Chief Executive Officer and Chief Financial Officer

47