Enveric Biosciences, Inc. - Quarter Report: 2003 March (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

(Mark One)

OR

Commission File Number: 33-90532

SPATIALIZER AUDIO LABORATORIES, INC.

920 Hampshire Road, Suite A-34
Westlake Village, California 91361

(Address of principal executive offices)

900 Lafayette Street, Suite 710
Santa Clara, California 95050

(Address of principal corporate offices)

Telephone Number: (408) 296-0600

(Registrant’s telephone number, including area code)

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

As of May 9, 2003, there were 47,406,939 shares of the Registrant’s Common Stock outstanding.

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ITEM I. FINANCIAL STATEMENTS

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS

See accompanying notes to consolidated financial statements.

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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

See accompanying notes to consolidated financial statements.

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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)

See accompanying notes to consolidated financial statements.

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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(unaudited)

See accompanying notes to consolidated financial statements.

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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 Santa Clara, California.

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

     The Company’s wholly-owned subsidiary, MultiDisc Technologies, Inc. (“MDT”), was in the business of developing scaleable, modular compact disc and digital versatile disc (“DVD”) server technologies associated with a network based compact disc/DVD server for internet and intranet applications. Operations of MDT were discontinued in the fourth quarter of 1998 and the assets have been marketed for sale (see Note 9).

(2) Significant Accounting Policies

     Basis of Presentation — The interim consolidated financial statements of the Company are condensed and do not include some of the information necessary to obtain a complete understanding of the financial data. Management believes that all adjustments necessary for a fair presentation of results have been included in the unaudited consolidated Financial Statements for the interim periods presented. Operating results for the three-month period ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ended December 31, 2003. Accordingly, your attention is directed to footnote disclosures found in the December 31, 2002 Annual Report and particularly to Note 2 which includes a summary of significant accounting policies.

     Basis of Consolidation — The consolidated financial statements include the accounts of Spatializer Audio Laboratories, Inc. and its wholly-owned subsidiary, Desper Products, Inc. MultiDisc Technologies, Inc. has been presented as a discontinued operation (see Note 9). All significant intercompany balances and transactions have been eliminated in consolidation. Corporate administration is not allocated to subsidiaries.

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

     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 March 31, 2003 substantially all cash and cash equivalents were on deposit at two financial institutions.

     At March 31, 2003, five major customers, not presented in order of importance, each accounted for 10% or more of our total accounts receivable: Apple Computer, Inc., JVC, Samsung, Sanyo and Orion Corporation, each of whom accounted for greater than 10% of our total 2002 accounts receivable. One OEM accounted for 28.0%, another accounted for 22%, another accounted for 14.0%, another accounted for 13% and one accounted for 10% of our total accounts receivable at March 31, 2003.

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     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 77% and 66% of total sales in the year to date periods ended March 31, 2003 and 2002, respectively.

     Major Customers — During the quarter ended March 31, 2003, five customers accounted for 29%, 23%, 15%, 14% and 11%, respectively, of the Company’s net sales.

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

     Advertising Expenses — Advertising is expensed when incurred and included in selling, general and administrative expenses.

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

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

     Earnings Per Share — Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The following table presents contingently issuable shares, options and warrants to purchase shares of common stock that were outstanding during the three month periods ended March 31, 2003 and 2002 which were not included in the computation of diluted loss per share because the impact would have been antidilutive or less than $0.01 per share:

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During the three months ended March 31, 2003, no options were granted to officers and board members and 100,000 options had expired.

     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. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

     Segment Reporting - The Financial Accounting Standards Board issued Statement No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS No. 131”), in June 1997. SFAS No. 131 establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires enterprises to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. It replaces the “industry segment” concept of SFAS No. 14, Financial Reporting for Segments of a Business Enterprise, with a “management approach” concept as to basis for identifying reportable segments. SFAS 131 is effective for financial statements for fiscal years beginning after December 15, 1997. The Company adopted SFAS 131 in December 1997. MDT is considered a discontinued operation as of September 1998. As of March 31, 2003, the Company has only one operating segment, DPI, the Company’s Audio Signal Processing business.

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

     Recent Accounting Pronouncements - The FASB recently issued the following statements: FASB 146 - Accounting for Costs Associated with Exit or Disposal Activities, FASB 147 - Acquisitions of Certain Financial Institutions, FASB 148 - Accounting for Stock-Based Compensation. These FASB statements did not, or are not expected to, have a material impact on the Company’s financial position and results of operations.

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

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     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, 2002 and March 31, 2003 approximated fair value due to their short maturity or nature.

     The fair values of notes payable to a related party at December 31, 2002 and March 31, 2003 are materially consistent with the related carrying values based on current rates offered to the Company for instruments with similar maturities.

     Discontinued Operation - In September 1998, the Board of Directors approved a plan to refocus corporate activities on the Company’s core audio business, Desper Products, Inc. In conjunction to this strategic refocusing, the Company permanently suspended operations of MDT and placed the business and its related patent portfolio up for sale. The Company is accounting for the on-going operating and termination expenses of MDT as a discontinued operation (see Note 9).

(3) Property and Equipment

     Property and equipment, as of December 31, 2002 and March 31, 2003, consists of the following, net of a reserve for impairment loss in 1998 in accordance with application of SFAS 121:

(4) Intangible Assets

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

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     Estimated amortization is as follows:

(5) Notes Payable to Related Parties

     The Company was indebted to the Desper Family Trust, a related party, in the amount of $112,500 at March 31, 2003. This amount bears interest at a fixed rate of 10% annually and is due on demand.

(6) Shareholders’ Equity

     During the quarter ended March 31, 2003, no shares were issued or converted.

     During the year ended December 31, 2002, shares were issued or converted as follows:

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 exist on or after January 1, 2003 to convert the Series B-1 Preferred Stock to common at a certain formula. At December 29, 2005 certain mandatory conversion requirements exist subject to a certain formula. The Series B-1 Preferred Stock has no voting power. Certain restrictions on trading exist based on date sensitive events. In December 2002, 87,967 shares of Series B-1 Preferred Stock were issued in exchange for the Series B Preferred Stock and 14,795 shares were issued in lieu of the adjusted accrued dividends on the Series B Preferred Stock.

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(7) Escrowed Performance Shares

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

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

     All of the performance shares are included in the issued and outstanding shares. As of March 31, 2003, all performance shares under the escrow arrangement have been released.

(8) Stock Options

     In 1995, the Company adopted a stock option plan (the “Plan”) pursuant to which the Company’s Board of Directors may grant stock options to directors, officers and employees. The Plan which was approved by the stockholders authorizes grants of options to purchase authorized but unissued common stock up to 10% of total common shares outstanding at each calendar quarter, 4,740,694 as of March 31, 2003. Stock options are granted with an exercise price equal to the stock’s fair market value at the date of grant. Stock options have five-year terms and vest and become fully exercisable up to three years from the date of grant.

At March 31, 2003, there were 2,169,194 additional shares available for grant under the Plan.

(9) Discontinued Operation

     On September 25, 1998, the Board of Directors determined that it would be unable to raise the necessary capital required to properly commercialize the MDT technology. Therefore, the Company ceased funding the operations of MDT and is actively seeking to sell the assets and technology. All employees of MDT have been terminated and the Company has vacated the MDT facilities.

     Based on this action, the Company is treating MDT as a discontinued operation. Accordingly, the balance sheet and statement of operations of MDT are not consolidated in the continuing operations of the Company, but rather are disclosed as Net Liabilities of Discontinued Operation and Loss From Discontinued Operation, respectively. At December 31, 2002, after four years of inactivity and inability to sell the assets, the remaining balance of $71,045 was eliminated.

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(10) Commitments and Contingencies

     In connection with the downsizing of the Company in 1998, a number of employees were terminated and have filed, on various dates, employment and compensation related claims with the California State labor authorities. All but two of these claims have been settled. Two former officers and employees of MDT filed labor and employment termination related claims before the Labor Commissioner in 2000 seeking approximately $400,000 each which was allegedly due under each of their respective employment agreements, which claims, if resolved in favor of the claimants, could be material to the financial statements of the Company. The Labor Commissioner postponed those proceedings while other litigation proceeded in the Superior Court, Orange County seeking declaratory relief to bar the labor claims, as well as return of intellectual property and unspecified damages for breaches of the former officers’ and employees’ employment agreements. These employees, however, filed for personal bankruptcy and as a result, the state court proceeding was postponed and then dismissed primarily because of the bankruptcies. The claims became inactive. While bankruptcy for one employee has been dismissed the claims have not been reactivated. 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.

(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.

(12) Severe Acute Respiratory Syndrome (SARS)

     In recent months, we have become aware of the increasing threat of Severe Acute Respiratory Syndrome, or SARS. SARS is a contagious disease, which has been responsible for over 400 deaths worldwide, primarily in Asia. United States health officials have issued warnings as to the possible consequences if the outbreak is not contained. At this point, travel to Asia has been greatly restricted and the threat of the disease continues to spread.

     A few of our DSP partners perform software development, including the application of our algorithms into such software in Beijing and Shenzhen, People’s Republic of China. Illness or the threat of illness to their employees at these facilities may disrupt work schedules and delay completion of such projects. This could cause a delay or cancellation of the inclusion of our algorithms in our customer’s products. Any resulting delay in royalty streams or cancellation of new design wins may adversely affect our future operating results.

     In addition, while none of our employees have contracted the disease, we have suspended employee travel to Mainland China, Hong Kong and Taiwan as a precaution until the outbreak subsides. While these markets are currently not substantial to our overall business, this limits our ability to do business in these markets and to capitalize on these markets’ potential at the current time.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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. In consultation with our Board of Directors and Audit Committee, we have identified three accounting policies that we believe are key to an understanding of our financial statements. These are important accounting policies that require management’s most difficult, subjective judgments.

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

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

The third critical accounting policy relates to intangible assets. Our intangible assets consist primarily of patents. We capitalize all costs directly attributable to patents, consisting primarily of legal and filing fees, and amortize such costs over the remaining life of the patent (which range from 4 to 16 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.

The fourth critical accounting policy relates to the existence of the Audit Committee of our Board of Directors. This committee is directed to review the scope, cost and results of the independent audit of the Company’s books and records, the results of the annual audit with Management and the internal auditors and the adequacy of the Company’s accounting, financial, and operating controls; to recommend annually to the Board of Directors the selection of the independent auditors; to consider proposals made by the Company’s independent auditors for consulting work; and to report to the Board of Directors, when so requested, on any accounting of financial matters.

Revenues

     Revenues for the three months ended March 31, 2003 were $332,000, compared to revenues of $440,000 in the comparable period last year, a decrease of 25%. The decrease in revenues resulted primarily from the wind down and expiration of a license agreement with a major account and further reductions from a second account which began outsourcing manufacturing to third parties. These reductions were partially offset by increases in royalties from licensees added over the past several months, including a third party manufacturer of an existing customer. We expect royalty revenue to trend downward in the second quarter, as

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the full effect of these developments take hold. We expect that product launches of new design wins and growth from existing accounts, including third party manufacturers will greater offset these losses in the second half of fiscal 2003.

Gross Profit

Gross profit for the three months ended March 31, 2003 was $296,000 (89% of revenue) compared to gross profit of $412,000 (94% of revenue) in the comparable period last year, a decrease of 28%. Gross profit decreased due to the decrease in revenue, while gross margin declined due to a higher proportion of commission bearing foreign revenue.

Operating Expenses

Operating expenses in the three months ended March 31, 2003 were $368,000 (111% of revenue) compared to operating expenses of $389,000 (88% of revenue) in the comparable period last year, a decrease of 5%. The decrease in operating expenses for the three months ended March 31, 2003 resulted primarily from decreased use of outside consultants, partially offset by higher legal and accounting fees.

General and Administrative

General and administrative expenses in the three months ended March 31, 2003 were $156,000 (47% of revenue) compared to general and administrative expenses of $135,000 (31% of revenue) in the comparable period last year, an increase of 16%. The increase in general and administrative expense resulted primarily from higher legal and accounting expenses arising from the new regulatory requirements on public companies as a result of new legislation in 2002.

Research and Development

Research and development expenses in the three months ended March 31, 2003 were $109,000 (33% of revenue) compared to research and development expenses of $124,000 (28% of revenue) in the comparable period last year, a decrease of 12%. The decrease in such expenses resulted primarily from using more in-house resources as opposed to using more costly outside consultants for applications engineering than during the prior period.

Sales and Marketing

Sales and marketing expenses in the three months ended March 31, 2003 were $102,000 (31% of revenue) compared to sales and marketing expenses of $130,000 (30% of revenue) in the comparable period last year, a decrease of 22%. The sales and marketing expense resulted primarily from lower marketing support staff expense as compared with the comparable period last year.

Net Income (Loss)

     Net loss in the three months ended March 31, 2003 was $74,000, ($0.00) basic per share, compared with net income of $21,000 ($0.00) basic and fully diluted per share in the comparable period last year. The net loss resulted from decreased revenues, partially offset by slightly lower operating expenses.

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Liquidity and Capital Resources

     At March 31, 2003, we had $894,000 in cash and cash equivalents as compared to $859,000 at December 31, 2002. The increase in cash and cash equivalents is attributed to the decreases in accounts receivable. We had working capital of $1,076,000 at March 31, 2003 as compared with working capital of $1,125,000 at December 31, 2002. Our future cash flow will come primarily from the audio signal processing licensing, Original Equipment Manufacturers’ (“OEM”) royalties and from possible common stock issuances including warrants and options. We are actively engaged in negotiations for additional audio signal processing licensing arrangements which should generate additional cash flow without imposing any substantial costs on the Company. We anticipate that there will be a wind down of our licensing program in early 2003 with a large computer account as that entity completes its migration to its latest operating system. We added or expanded our relationships with JVC, Sanyo, Orion and Mediatech this past year. We believe that growth from these and other licensing arrangements including some that are pending but not announced or in negotiation, will substantially offset any revenue shortfalls from the computer account by the third quarter of fiscal 2003. Mediatech, in particular, has been successful in penetrating the DVD market and our relationship with them positions us well as the audio solutions provider of choice in these new accounts for 2003 and 2004. Further, by the second half of 2003, we expect to begin generating revenues from the Company’s new products that were introduced in 2002.

     Like other operating enterprises, the events of September 11, 2001 in the United States brought a degree of uncertainty to our operations and hindered our ability to plan and meet with our contractual partners outside the United States in this dynamic environment. 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, the Company 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. The Company has responded by offering additional products targeted to each price/quality segment of the market and continues to aggressively pursue new opportunities in emerging product categories and complements to our existing core business. In addition, our products have been positioned as a means for manufacturers to save money while delivering an enhanced audio experience. Nevertheless, these market conditions and competitive forces make it more challenging for the Company, and its rational commercial competitors, to enhance their operating results.

     To the extent the Company maintains or exceeds its projected revenues and is not required to fund contingencies, it expects to continue to retain its current cash reserves and therefore, maintain its liquidity position at a consistent level both on a short-term and long-term basis.

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To the extent that the Company does not achieve current operating levels or is required to fund contingencies, it will be required to use some of its cash reserves and this could impact its 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. To address these objectives, we retained Neveric Capital, a San Francisco based investment banking firm, to identify and evaluate strategic opportunities and to explore alternatives to enhance stockholder value and support the Company’s growth and overall strategy.

     In December 1999, we completed a set of financial transactions (the “1999 Transactions”) with certain existing holders of our equity and debt and with new institutional investors. The 1999 Transactions included the private placement of 1,884,254 additional shares of our Common Stock ($1.05 million in new capital or $0.56 per share), the issuance of warrants to acquire 2,100,000 shares of Common Stock exercisable for three years at an exercise price of $.67 per share), the cancellation of 500,000 warrants to acquire Common Stock issued in an earlier financing, the conversion of $1 million of short term debt into a new Series B Redeemable Convertible Preferred Stock (“Series B Preferred Stock”) and the conversion of $225,000 of secured debt into secured convertible debt.

     In the 1999 Transactions, $895,000 in short term loan advances from officers, directors and their affiliates and certain other securities holders, and accrued interest of $134,647, were restructured into the $1,000,000 in new Series B Preferred Stock. The Series B Preferred Stock, and any dividends therefrom not converted into cash, were convertible commencing in 2001 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 Company had an option to redeem with cash any Series B Preferred Stock not converted before the end of 2002 and to pay Series B Preferred Stock accrued and declared cumulative dividends of 10%. In November 2002, the Board of Directors and the holders of the Series B Preferred Stock, agreed to exchange the Series B Preferred Stock for a new Series B-1 Preferred Stock which had terms substantially the same as the Series B Preferred Stock, except that the conversion date was deferred to December 2005, no future dividends will accrue and dividends for prior periods on the Series B Preferred Stock were reset and recalculated to the LIBOR rate in effect on the first business day of each of 2000, 2001 and 2002, respectively and were paid through the issuance of the appropriate number of shares of Series B-1 Preferred Stock. The exchange was completed in December 2002. The 500,000 warrants issued in the 1999 Transactions expired, without exercise 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.

     As noted above, in the 1999 Transactions, $225,000 of secured debt, including accrued interest, was converted into secured long term convertible debt. The long term debt was repaid with interest in 2001. We currently have a related party obligation of $112,500 which bears interest of 10% per annum, which we pay on a current basis. The debt is due on demand.

     We eliminated Net Liabilities of Discontinued Operation since the statute of limitations for claims has been exceeded. We continue to maintain an accrual for unasserted claims or settlement costs related to the discontinuation of MDT in 1999. We do not expect any final liability to be in excess of this balance.

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     Funds generated by these financing activities as well as cash generated from our existing operations and customer base is expected to be sufficient for us to meet our operating obligations and the anticipated additional research and development for our audio technology business. The Company 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 the Company on terms that enhance shareholder value and support the Company’s business strategy.

     To the extent the Company maintains or exceeds its projected revenues and is not required to fund significant contingencies, it expects to continue to retain its current cash reserves and therefore, maintain its liquidity position at a consistent level both on a short-term and long-term basis. To the extent that the Company does not achieve current operating levels or is required to fund contingencies, it will be required to use some of its cash reserves and this could impact its longer term liquidity.

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PART I.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     We have not been exposed to material future earnings or cash flow fluctuations from changes in interest rates on our term investments at March 31, 2003. A hypothetical decrease of 100 basis points in interest rate (ten percent of our overall earnings rate) would not result in a material fluctuation in future earnings or cash flow. We have not entered into any derivative financial instruments to manage interest rate risk or for speculative purposes and we are not currently evaluating the future use of such financial instruments.

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ITEM 4. CONTROLS AND PROCEDURES

     Within 90 days prior to the filing of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Consistent with the Company’s policies adopted to accommodate a single person holding both designations, the evaluation was undertaken in the consultation with the Company’s audit committee and accounting personnel. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the 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 the Securities and Exchange Commission’s rules and forms.

     There were no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation.

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PART II.     OTHER INFORMATION

ITEM 1.   LEGAL PROCEEDINGS

     In connection with the downsizing of the Company in 1998, a number of employees were terminated and have filed, on various dates, employment and compensation related claims with California State labor authorities, all but two of which claims have been settled. Two former officers and employees of MDT filed labor and employment termination related claims before the Labor Commissioner in 2000 seeking approximately $400,000 each which was allegedly due under each of their employment agreements, which claims, if resolved in favor of the claimants, could be material to the financial statements of the Company. The Labor Commissioner postponed those proceedings while other litigations proceeded in the Superior Court, Orange County seeking declaratory relief to bar the labor claims, as well as return of intellectual property and unspecified damages for breaches of the former officers’ and employees’ employment agreements. These employees, however, filed for personal bankruptcy and, as a result, the state court claim was postponed and then dismissed primarily because of the bankruptcies. The labor claims became inactive while bankruptcy for one such employee had been dismissed and the state court claims have not been reactivated.

     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.

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ITEM 2.    CHANGES IN SECURITIES AND USE OF PROCEEDS

None

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

None

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

None

ITEM 5.    OTHER INFORMATION

None

ITEM 6.    EXHIBITS AND REPORTS ON FORM 8K

     Report on Form 8-K

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Exhibits

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CERTIFICATION

Pursuant to 18 U.S.C. Section 1350,

as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Henry R. Mandell, the Chief Executive Officer and Chief Financial Officer of Spatializer Audio Laboratories, Inc., certify that:

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

2.     Based on my knowledge, this quarterly 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 quarterly report;

3.     Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly report;

4.     I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

5.     I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

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6.     I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 9, 2003

/s/ Henry R. Mandell

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SIGNATURES

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

Dated: May 13, 2003