Enveric Biosciences, Inc. - Annual Report: 2006 (Form 10-K)

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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, 2006


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.)

2060 East Avenida de Los Arboles, # D190, Thousand Oaks, California 91362-1376
(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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes þ No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes þ No

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

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. þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o Accelerated Filer o Non-Accelerated Filer þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No

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 day of the registrant’s most recently completed second quarter (June 30, 2006) was approximately $731,000 and at February 25, 2007 was approximately $986,000.

As of February 25, 2007, there were 48,763,383 shares of the Registrant’s Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

None

TABLE OF CONTENTS


PART I
Item 1. Business
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF OPERATIONS
CONSOLIDATED STATEMENTS OF CASH FLOWS
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
PART III
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14. Principal Accountant Fees and Services
PART IV
Item 15. Exhibits and Financial Statement Schedules
SIGNATURES
EX-10.11 Amendment to Employment Agreement between the Company and Henry Mandell
EX-21.1 Subsidiaries of the Company
EX-23.1 Consent of Ramirez International Financial and Accounting Services, Inc.
EX-23.2 Consent of Farber Hass Hurley McEwen LLP (for 2004/2005 financials)
EX-31.1 Certificate pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
EX-32.1 Certificate pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
EXHIBIT 10.11
EXHIBIT 21.1
EXHIBIT 23.1
Exhibit 23.2
EXHIBIT 31.1
EXHIBIT 32.1

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 or that any potential transactions herein described will be realized or consummated. 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 Item 1A, Risk Factors, among other factors, could 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”) has been 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. We were incorporated in the State of Delaware in February 1994 and are the successor company in a Plan of Arrangement pursuant to which the outstanding shares of Spatializer, a publicly held Yukon, Canada corporation, were exchanged for an equal number of shares of our common stock. Our corporate office is located at 2060 East Avenida de Los Arboles, # D190, Thousand Oaks, California 91362-1376

The Company’s wholly-owned subsidiary, Desper Products, Inc. (“DPI” or “Desper Products”), has been 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. Desper Products is the owner of certain technology which DTS desires to acquire. Desper Products is a California corporation incorporated in June 1986.

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.

Background of the Sale of Assets and Dissolution

Spatializer has been under acute market pressure since 2002. In 2002, a personal computer account began migrating to a totally new operating system, which did not include any audio enhancements. The migration was completed in 2003 and the former licensee chose not to include any audio software enhancements, including those from Spatializer. This account had accounted for approximately 40% of Spatializer’s annual revenues.

In 2003, Spatializer experienced declining revenue from three major customers, primarily from the curtailment or cessation of use of its products by these customers. Two of these cases were in the DVD player market, where Spatializer historically had been strong. During 2003, the DVD player market became largely commoditized, resulting in intense pricing pressure and a steep decline in price and margins. Manufacturers were forced to strip out features, such as those offered by Spatializer, in order to compete. One of Spatializer’s accounts switched to outside sourcing and Spatializer was able to expand its relationship with their supplier to recapture

most of that revenue. However, a major new design win Spatializer was projecting for the DVD market was cancelled due to these cost constraints.

In 2004, the revenue mix by licensee platform was significantly different compared to the prior year. The decrease in revenue on the DVD and personal computer accounts previously discussed generated approximately 56% of total fiscal 2003 revenue, which was lost in 2004. These losses were partially offset by three new revenue sources in cellular phones, mobile audio semiconductors and personal computers and the expansion of an existing license relating to recordable DVD. Cellular phone, mobile audio and the personal computer markets had been targeted by Spatializer for replacing the losses in the DVD player category. Nevertheless, market pressures mounted and Spatializer was forced to substantially reduce overhead in order to remain liquid.

In response to increased market competitiveness and Spatializer’s difficulty competing in this environment, in November 2002, the board of directors created a Special Committee to review certain strategic opportunities as they arise and to obtain additional information regarding such opportunities for consideration and evaluation by the board of directors. Through December 19, 2005, the Special Committee consisted Gilbert Segel, James Pace and Henry Mandell. Messrs. Segel and Pace were independent directors of the Company. Spatializer hired an entity in late 2002 to provide investment banking services, paying such entity a $75,000 retainer fee. Over 100 companies were contacted on Spatializer’s behalf but, after examining the potential opportunities that resulted therefrom, Spatializer decided that no such opportunities were viable. Spatializer ended its relationship with such investment banking entity in the second half of 2003 as a result of the unsuccessful effort, with no future financial obligation to such entity.

In August 2005, Spatializer and Strategic Equity Group, Inc. (collectively, with its broker/dealer subsidiary, “SEG”) entered into a confidentiality agreement in connection with a possible investment banking services relationship.

In October 2005, Spatializer and SEG entered into an agreement for investment banking services. Under the terms of that agreement, Spatializer engaged SEG for a one year period, on an exclusive basis, to provide Spatializer with services, including the identification of possible strategic, financial and foreign partners or purchasers. Per the terms of such agreement, SEG received an upfront payment of a non-refundable retainer in the amount of $25,000 and is entitled to payment of a “success fee” payable upon consummation of a sale transaction in an amount equal to the greater of (a) $250,000 or (b) the sum of 5% of the first $2,000,000 of consideration, 4% of the second $2,000,000, 3% of the third $2,000,000 and 2% of any amount in excess of $6,000,000. SEG is also entitled to reimbursement for reasonable actual out-of-pocket expenses for travel and other incidentals in an amount not to exceed $25,000. Spatializer is required to indemnify SEG for liabilities that SEG may suffer which arise from the breach of any representations or warranties in the investment banking services agreement, the breach of any covenant of Spatializer in that agreement or any instrument contemplated by that agreement, any misrepresentations in any statement or certificate furnished by Spatializer pursuant to that agreement or in connection with any sale transaction contemplated by that agreement, any claims against, or liabilities or obligations of, Spatializer and any good faith acts of SEG undertaken in good faith and in furtherance of SEG’s performance under the agreement.

On December 19, 2005, at a regularly scheduled meeting, the board of directors of Spatializer discussed Spatializer’s current financial outlook. Management indicated to the board of directors that two customers, the revenues from which accounted for approximately 70% of Spatializer’s revenues during 2005, would not be sustainable in 2006. Based on management’s estimates, without new licensing revenue sources, management believed Spatializer would exhaust its available cash by the fourth quarter of 2006. The board of directors also discussed various strategic options for Spatializer, including potential suitors and the distribution by SEG of interest books to approximately 55 potential purchasers; competition in its niche; and other business matters. Following the presentation, Gilbert Segel and James Pace, two of the three independent directors of Spatializer, decided to resign from the board of directors in order to allow for other individuals more qualified and experienced in matters relating to the sale of Spatializer and other strategic alternatives for Spatializer, including liquidation, to fill the vacancies created. The board was reduced from four members to three authorized directors, leaving one vacancy thereon, which has not been filled to date. Henry R. Mandell then indicated his desire to resign as an officer of Spatializer, for personal reasons, effective January 6, 2006, which vacancy would result in a significant reduction in payroll expense, but also to remain as a director and Chairman of the Board and Secretary of Spatializer. Mr. Mandell offered to become a consultant to Spatializer on terms to be negotiated with Carlo Civelli, the remaining member of the Board. The board of directors then discussed plans for the future of Spatializer and measures for scaling back operations, while continuing to pursue a potential buyer through SEG, with a view to maximizing stockholder value.

On January 6, 2006, Henry R. Mandell’s resignation as the Chief Executive Officer and Chief Financial Officer became effective. Effective as of that date, Spatializer and Mr. Mandell entered into an agreement to continue his employment with Spatializer as Chairman and Secretary. Mr. Mandell agreed to continue to provide certain specified services to Spatializer, including

supervising the preparation of Spatializer’s financial statements and records; reviewing and authorizing day to day disbursements; supervising all of Spatializer’s licensing and business activities; handling stockholder communications; and serving as the contact person with SEG. He was permitted to accept other employment during the term of the agreement. As an incentive for Mr. Mandell to continue in Spatializer’s employ during the term of the agreement, and in consideration of foregoing certain severance pay to which he otherwise may have been entitled, Spatializer paid him a lump sum payment of $35,733.33, which amount was paid concurrently with the execution of the agreement. The agreement also provided for a monthly salary of $5,000, a bonus of $10,000 for Mr. Mandell’s assistance in the preparation of Spatializer’s Form 10-K for the fiscal year ended December 31, 2005 and a separate bonus of $5,000 each for his assistance on each Form 10-Q upon which he assists for any quarterly period ending after December 31, 2005 and each proxy. Additionally, if Spatializer is sold or enters into certain specified extraordinary transactions during the term of the agreement, Mr. Mandell may be entitled to an additional bonus in an amount equal to 3.5% of the total consideration, not to exceed $150,000. During the term of the agreement, he is entitled to employee benefits and reimbursement of reasonable, actual and necessary business expenses. The agreement contains certain non-competition, non-solicitation and confidentiality provisions. The agreement terminated certain provisions of Mr. Mandell’s then existing employment agreement (including without limitation the compensation and severance pay obligations thereunder) but continued certain other provisions thereof (such as the proprietary information, confidentiality and other similar provisions thereunder). The agreement was scheduled to expire on the earlier of (a) the consummation of certain extraordinary transactions, (b) the expiration, termination or non-renewal of the directors’ and officers’ insurance policy of Spatializer under which Mr. Mandell is covered as a director and officer of Spatializer and (c) June 30, 2006, but was extended for a period ending on the earlier of June 30, 2007 or the date of dissolution of Spatializer. Spatializer may terminate Mr. Mandell’s employment at any time during the term and Mr. Mandell may voluntarily resign his employment at any time during such term.

On January 10, 2006, Spatializer issued a press release regarding a potential auction, open to pre-qualified buyers, of the assets of Spatializer or the sale of an unlimited number of perpetual licenses of certain technology of Spatializer, all of which transactions would be subject to stockholder approval. Under the contemplated open auction process, potential buyers were invited to bid for the assets of Spatializer at a minimum bid of $2,000,000, such assets to be sold on an “as-is/where is” basis. Simultaneously, Spatializer offered all interested parties the opportunity to acquire non-exclusive, royalty-free, irrevocable, perpetual licenses for a one-time fee of $750,000 each, which licenses would be absent of any representations, warranties, or ongoing support by Spatializer. Bids were due by 11:59 P.M. Pacific Standard Time on February 15, 2006.

During a period commencing on or about January 12, 2006 through February 15, 2006, SEG sent out to more than 160 potential buyers materials relating to the announced auction. SEG followed up, or attempted to follow up, with such potential buyers through the close of the auction period.

At a meeting held on February 16, 2006, the board of directors of Spatializer discussed a proposed term sheet for the acquisition of Spatializer’s assets that had been delivered by DTS, Inc, a Delaware corporation and leading provider of entertainment technology products and services to the audio and image entertainment markets worldwide. The board of directors also discussed feedback that SEG had received from certain of the potential buyers that had been contacted during the auction period. As DTS’s offer did not specify a precise purchase price, such offer was deemed non-conforming to the guidelines established for the initial auction. Certain of the potential buyers had requested an extension of the auction period to perform additional due diligence. The board of directors again discussed what alternatives were available to Spatializer. The board of directors elected to extend the auction period until 11:59 P.M., Pacific Standard Time, on March 15, 2006 to provide bidders and other interested parties additional time to clarify their offers and perform further due diligence, as well as to permit Spatializer time to solicit additional offers. The board of directors, based on feedback received in the auction process, determined to simplify the auction process and eliminated the minimum bid requirements but reserved the right to reject any offers or bids in their discretion.

During the period from February 15, 2006 through March 15, 2006, SEG continued to follow up, or attempted to follow up, with the potential buyers to whom auction materials had been provided.

At the close of the extended auction period, Spatializer received a bid from DTS for the purchase of substantially all of the assets of Spatializer and Desper Products and bids from three other parties interested in buying a perpetual license. Management of Spatializer determined that the bids for the perpetual licenses were not sufficient in amount and decided that the bid for the assets of Spatializer received from DTS was the most attractive offer to pursue.

From March 16, 2006 through approximately April 10, 2006, Spatializer and DTS negotiated the terms of a non-binding letter of intent. Although Spatializer, in the course of such negotiations, requested that the transaction be structured as a stock sale or merger transaction, DTS was not willing to so structure the transaction. The letter of intent, requiring the transaction to be structured

as an asset sale, was executed on April 10, 2006. In connection with the execution of the letter of intent and as required by the terms thereof, DTS deposited $250,000 towards the purchase price of the assets, which deposit amount is being held in a trust account and will be disbursed to Spatializer contingent upon, among other things, approval of the transaction by the stockholders of Spatializer and satisfaction of the conditions to closing.

From January 25, 2006 through May 5, 2006, DTS performed various due diligence examinations relating to Spatializer. Preliminary discussions were held over the phone between DTS and SEG on January 25, 2006 and February 6, 2006. A technology demonstration was held at SEG’s office on February 10, 2006. A due diligence conference call including Spatializer was held on February 13, 2006. Counsel to DTS spent February 23, 2006, at SEG’s office analyzing contracts and various other due diligence items. Four due diligence conference calls were held in March 2006, as well as three additional conference calls in April 2006, and one in May 2006.

During the period from May 1, 2006 through mid-September 2006, legal counsel for DTS and for Spatializer prepared, and representatives of DTS and Spatializer negotiated, the Asset Purchase Agreement.

In July 2006, the board of directors of Spatializer was presented with and carefully considered a draft of the Asset Purchase Agreement. After due consideration of such draft, the board of directors of Spatializer approved, by unanimous written consent dated July 10, 2006, a form of the Asset Purchase Agreement. However, subsequent to that date, numerous changes and refinements were made to that draft based on the negotiations of the parties.

In July 2006, the board of directors of Desper Products was presented with and carefully considered a draft of the Asset Purchase Agreement. After due consideration of such draft, the board of directors of Desper Products approved, by a written consent of sole director dated July 10, 2006, a form of the Asset Purchase Agreement. However, subsequent to that date, numerous changes and refinements were made to that draft based on the negotiations of the parties.

In August 2006, the board of directors of Spatializer was presented with and carefully considered a revised draft of the Asset Purchase Agreement. After due consideration of all of the foregoing, the board of directors of Spatializer, by a unanimous written consent of directors dated August 28, 2006, authorized the execution and delivery on behalf of Spatializer of the Asset Purchase Agreement providing for the sale to DTS and its wholly owned subsidiary, DTS BVI, a British Virgin listed corporation, of all or substantially all of the assets of each of Spatializer and Desper Products, deemed the sale of all or substantially all of the assets of Spatializer and Desper Products for $1,000,000 in aggregate cash consideration to be expedient, advisable, and in the best interests of Spatializer. Furthermore, the board of directors of Spatializer deemed it advisable that, following the sale of the assets, Spatializer be dissolved. The board of directors also recommended that the stockholders of Spatializer vote in favor of both the sale of assets transaction and the dissolution of Spatializer. The board of directors called a meeting of the stockholders of Spatializer to consider the proposed sale of assets pursuant to the Asset Purchase Agreement and to take action upon the resolution of the board of directors to dissolve Spatializer.

Effective August 28, 2006, Spatializer, as the sole shareholder of Desper Products, executed a written consent of sole shareholder approving the principal terms of the sale of the assets of Desper Products.

On September 18, 2006, the parties executed and delivered the Asset Purchase Agreement. A special stockholders meeting was called for January 24, 2007 to approve sale of assets and to authorize the dissolution of the Company. Proxies were mailed on or about December 1, 2006. The meeting was adjourned without a final vote in the Board’s view of the best interest of the stockholders. The meeting was reconvened on February 21, 2007. The vote required to approve the asset sale and dissolution was a majority of the shares outstanding on the record date. The dissolution proposal was contingent upon approval of the asset sale. A total of 15,334,520 shares voted on the asset sale proposal, of which 14,407,084 shares were voted in favor, 823,182 shares voted against and 104,284 votes abstained. Although the votes cast on the proposal to sell the assets was overwhelmingly in favor thereof, the requisite vote was not obtained. As a result, the proposal was not approved and the Board is considering its options

Our financial statements, beginning on page 27 hereof, contain information relating to our revenues, loss and total assets for the fiscal year ended December 31, 2006.

Desper Products, Inc. — Virtual Audio Signal Processing Technologies

DPI 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.


Technology	Product Categories	Audio Enhancement
Spatializer^® 3-D Stereo	Stereo TV’s, Stereo Components and Systems, Car Audio, Laptop and Desktop Multimedia Computers, Set-top Boxes	Surround sound enhancement from an ordinary stereo (two-channel) signal
Spatializer ((environ))^TM	Cell Phones and Mobile Multimedia Players	Widens sound stage and improves stereo separation from two-channel ring tones, compressed audio, FM and TV broadcast and games.
Spatializer N-2-2 Ultra^TM	DVDP, DVDR, PVR, AV Receivers, Multimedia PCs, DTV,STB	Creation of spatially accurate home theater surround sound from two channel sources
Spatializer enCompass AV^TM	Products incorporating multi-channel audio sources like Dolby ProLogic II^®: AV Receivers	Creation of spatially accurate multi-speaker cinematic audio experience from two-channel audio information
Spatializer Audio Alchemy^TM	Computers and Recordable DVD utilizing DVD/MPEG and decoding, Cell phone handsets.	Static noise reduction combined with stabilization of dynamic audio range
Spatializer Vi.B.E.^TM	Mobile Multimedia Players, Cell Phones, DVD Players/Recorders, DTV, Stereo Components and Systems, Car Audio, Laptop and Desktop Multimedia PCs and Headphones.	Simulation of low frequency response from speakers with poor low frequency capability
Spatializer DRC^TM	Laptop and Desktop Multimedia Computers, Cell Phones and Portable Multimedia Players	Prevents over-driving speakers, headphones or ear buds while maximizing the dynamic audio output
Spatializer Natural Headphone^TM	Headphones, Mobile Phones, Mobile Multimedia Players	Creation of spatially accurate multi- speaker cinematic audio experience from headphones utilizing discrete multi-channel audio information
Spatializer PCE^TM	DTV, Mobile Phones, Mobile Multimedia Players, Multimedia PCs, Headphones	Creation of more recognizable and “cleaner” music or dialog from all media sources

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 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.		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 offered 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.

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 have signed an Asset purchase Agreement with DTS and have been attempting to secure stockholder approval of the sale, as outlined in the second paragraph of the Overview section above. Licensing activities are suspended

IC/DSP Foundry Licenses

The Company, through its wholly-owned subsidiary, Desper Products, Inc., entered into a major multi-technology licensing agreement with Samsung Electronics, Co. Ltd. on August 22, 2005.

As of December 31, 2006, 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, NEC 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, 2006, more than 50 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, 2006, 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 2006 two major customers, Sharp and Funai, not presented in order of importance, each accounted for 10% or more of our total revenues. One OEM accounted for 49% and one accounted for 20% of our royalty revenues during 2006. Four other accounts 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, 2006:

	•		Acer Labs

	•		Apple Computer

	•		Funai

	•		InterVideo

	•		JVC

	•		LG Electronics

	•		Logitech

	•		LSI

	•		Matsushita Electronics

	•		Micronas

	•		Mitsubishi Image and Information Works

	•		Motorola

	•		NEC

	•		Orion

	•		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 91% and 2% of our total revenues, respectively, in 2006; 62% and 34% of our total revenues, respectively, in 2005; and 70% and 25% of our total revenues, respectively, in 2004. 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 $334,000 in 2006, were derived almost entirely from Foundry and OEM license fees and royalties.

We have sought to maximize return on our intellectual property base by concentrating our efforts in higher margin licensing and software products and eliminating our hardware product operations. Licensing operations have been managed internally by our personnel and through use of an international sales representative force.

In 2006, revenues declined substantially as compared with the prior year. Revenues from Samsung and Matsushita wound down as contracts expired and the Company’s marketing activities were dormant. This was identified in late 2005, based on future third party product plans and discussions with these customers. It became apparent that revenues from these two accounts were not sustainable at current levels in the future. As a result, and due to the resignations of two directors and the CEO, our board of directors determined in late December 2005 to offer the Company’s assets for sale or to sell perpetual non-exclusive licenses of our intellectual property (with a subsequent sale of the residual assets) and to position the Company to exit the audio licensing business and to wind up and dissolve.

Competition

We competed 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 were unable to compete in this market, even though we offered a single source, complete suite of patented and proprietary 3D Stereo, interactive positional, virtual surround sound, headphone and speaker virtualization technologies. We lacked sufficient financial resources to compete, were closely dependent on third party licensee marketing plans which generally presented a longer or uncertain revenue stream than our cash resources could support and found the market less receptive to our value proposition than we had expected.

Research and Development

Our research and development expenditures in 2006, 2005 and 2004 were approximately 23%, 30% and 34% 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, 2006, we had no employees in our R&D group, based on our board of directors’ decision to offer our assets for sale. We discontinued our technology development in December 2005 and support efforts in May 2006 when the sole engineer resigned.

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. 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. 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 have experienced seasonal fluctuations in sales and earnings. In particular, we believe that there has been seasonality relating to the Christmas season in the third and fourth quarters, which generally are our strongest quarters, as well as the first quarter, which is generally our weakest quarter. We attempted to diversify 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.


	Period:	High (U.S. $)		Low (U.S. $)
2005
First Quarter		$	0.10	$	0.06
Second Quarter		$	0.09	$	0.05
Third Quarter		$	0.07	$	0.05
Fourth Quarter		$	0.07	$	0.03
2006
First Quarter		$	0.04	$	0.02
Second Quarter		$	0.03	$	0.02
Third Quarter		$	0.02	$	0.01
Fourth Quarter		$	0.02	$	0.02


	Fiscal Year Ended
	December 31, 2002			December 31, 2003			December 31, 2004			December 31, 2005			December 31, 2006
Consolidated Statement of Operations Data:
Revenues	$	1,856		$	1,269		$	1,106		$	1,192		$	333
Cost Of Revenues		(131	)		(122	)		(111	)		(106	)		(1	)

Gross Profit		1,725			1,147			995			1,086			332
Total Operating Expenses		(1,711	)		(1,631	)		(1,146	)		(1,177	)		(686	)
Other Income (Expense), Net		(2	)		(6	)		(5	)		8			6
Income taxes		(6	)		(5	)		(1	)		(1	)		(5	)

Net Income (Loss)	$	18		$	(495	)	$	(157	)	$	(82	)	$	(353	)

Basic Income (Loss) Per Share	$	0.00		$	(0.01	)	$	(0.00	)	$	(0.00	)	$	(0.01	)

Diluted Income (Loss) Per Share	$	0.00		$	(0.01	)	$	(0.00	)	$	(0.00	)	$	(0.01	)

Weighted Average Common Shares		47,406,939			47,309,171			46,975,363			46,990,059			48,763,383

Consolidated Balance Sheet Data
Cash and Cash Equivalents	$	859		$	590		$	871		$	551		$	229
Working Capital		1,125			793			603			560			242
Total Assets		1,746			1,205			1,464			897			464
Redeemable Preferred Stock		1			1			1			0			0
Advances From Related Parties		113			108			0			0			0
Total Shareholders’ Equity	$	1,429		$	955		$	798		$	717		$	377


	December 31,			December 31,
	2006			2005
ASSETS
Current Assets:
Cash and Cash Equivalents	$	228,940		$	550,633
Accounts Receivable		74,828			155,233
Prepaid Expenses and Other Current Assets		25,073			34,104

Total Current Assets		328,841			739,970
Property and Equipment, Net		3,477			18,403
Intangible Assets, Net Held for Sale		131,258			138,548


Total Assets	$	463,576		$	896,921


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Notes Payable		9,670			10,443
Accounts Payable		32,136			14,195
Accrued Wages and Benefits		3,169			48,095
Accrued Professional Fees		41,900			34,000
Accrued Commissions		200			31,917
Accrued Expenses		0			40,869

Total Current Liabilities		87,075			179,519


Commitments and Contingencies

Stockholders’ Equity (Deficit):

Common shares, $0.01 par value; 65,000,000 shares authorized; 48,763,383 shares issued and outstanding at December 31, 2006 and 2005, respectively		469,772			469,772
Additional Paid-In Capital		46,441,755			46,430,030
Accumulated Deficit		(46,535,026	)		(46,182,400	)

Total Stockholders’ Equity		376,501			717,402

Total Liabilities and Stockholders’ Equity	$	463,576		$	896,921


	Year Ended December 31,
	2006			2005			2004
Revenues:
Royalty Revenues	$	333,201		$	1,192,447		$	1,105,923
Cost of Revenues		897			106,062			111,395

		332,304			1,086,385			994,528

Operating Expenses:
General and Administrative		526,865			670,124			615,412
Research and Development		157,739			354,138			393,004
Sales and Marketing		1,241			152,473			137,889

		685,845			1,176,735			1,146,305

Operating Loss		(353,541	)		(90,350	)		(151,777	)

Interest Income		6,730			13,230			4,982
Interest Expense		(2,266	)		(5,269	)		(10,295	)
Other Income (Expense), Net		1,251			0			0

		5,715			7,961			(5,313	)

Loss Before Income Taxes		(347,826	)		(82,389	)		(157,090	)
Income Taxes		(4,800	)		874			(400	)

Net Loss	$	(352,626	)	$	(81,515	)	$	(157,490	)

Basic and Diluted Loss per Share:	$	(.01	)	$	(.00	)	$	(.00	)

Weighted-Average Shares Outstanding		48,763,385			46,990,059			46,975,363


	Year Ended December 31,
	2006			2005			2004
Cash Flows from Operating Activities:
Net Loss	$	(352,626	)	$	(81,515	)	$	(157,490	)
Adjustments to Reconcile Net Loss to Net Cash Provided (Used) by Operating Activities:
Depreciation		14,926			16,401			11,942
Amortization		22,303			31,030			46,915
Stock and Options Issued for Services					1,000
Net Compensation Expense on Vested Options		11,725
Net Change in Assets and Liabilities:
Accounts Receivable		80,405			170,479			19,699
Prepaid Expenses, Deposits and Other Assets		9,031			36,836			(35,510	)
Accounts Payable		17,941			(57,678	)		50,407
Accrued Expenses and Other Liabilities		(109,612	)		18,274			16,581
Deferred Revenue		0			(391,395	)		391,395

Net Cash Provided (Used) by Operating Activities		(305,907	)		(256,568	)		343,939

Cash Flows from Investing Activities:
Purchase of Property and Equipment		(0	)		(5,277	)		(4,007	)
Intangible Assets		(15,013	)		(2,868	)		(16,580	)

Net Cash Used by Investing Activities		(15,013	)		(8,145	)		(20,587	)

Cash Flows from Financing Activities:
Notes Payable		(773	)		(55,809	)		66,252
Notes and Amounts Due to (from) Related Parties		0			0			(108,246	)

Net Cash Used by Financing Activities.		(773	)		(55,809	)		(41,994	)

Increase (Decrease) in Cash and Cash Equivalents		(321,693	)		(320,522	)		281,358
Cash and Cash Equivalents, Beginning of Year		550,633			871,155			589,797

Cash and Cash Equivalents, End of Year	$	228,940		$	550,633		$	871,155

Supplemental Disclosure of Cash Flow Information:
Cash Paid During the Year for:
Interest	$	2,266		$	5,269		$	10,295
Income Taxes	$	4,800		$	0		$	400

	•		to provide a narrative explanation of a company’s financial statements “in plain English” that enables the average investor to see the company through the eyes of management;

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

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

	•		An understanding of our operating environment and its risks

	•		An outline of critical accounting policies

	•		A review of our corporate governance structure

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

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

	•		Disclosure on our internal controls and procedures

	•		Our Board of Directors has Determined it is in the Company’s and its Stockholders’ Interests to Sell the Company’s Assets

	•		We Are Unable to Achieve or Sustain Profitability in the Future or Obtain Future Financing and Our Business Operations Will Fail

	•		There is No Guarantee That There Will be Funds Available for Distribution to Stockholders if We Cannot Get Stockholder Approval for the Asset Sale, if the Approval is Untimely or if Claims Arise Post-Sale During the 275-Day Warranty Period

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


	10% Series B Convertible				Common
	Preferred Shares				Shares			Common Shares
											Additional					Total
	Number of		Par		Number of			Par			Paid-In-		Accumulated			Stockholders’
	Shares		Value		Shares			Value			Capital		Deficit			Equity
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

Conversion of Series B-1 Pfd to Common Shares						1,788,018			18			1,164					1,182

Net Loss														(81,515	)		(81,515	)

Balance, December 31, 2005		-0-	$	-0-		48,763,383		$	469,772		$	46,430,030	$	(46,182,400	)	$	717,402

Net Compensation Expense on Vested Options												11,725					11,725

Net Loss														(352,626	)		(352,626	)

Balance, December 31, 2006		-0-	$	-0-		48,763,383		$	469,772		$	46,441,755	$	(46,535,026	)	$	376,501


	2006		2005
Office Computers, Software, Equipment and Furniture	$	337,145	$	337,145
Test Equipment		73,300		73,300
Tooling Equipment		45,539		45,539
Trade Show Booth and Demonstration Equipment		174,548		174,548
Automobiles		7,000		7,000

Total Property and Equipment		637,531		637,531
Less Accumulated Depreciation and Amortization		634,054		619,128

Property and Equipment, Net	$	3,477	$	18,403


	2006		2005
Capitalized Patent, Trademarks and Technology Costs	$	540,708	$	525,695
Less Accumulated Amortization		409,450		387,147

Intangible Assets, Net	$	131,258	$	138,548


							Weighted-Average
	Exercisable			Number			Exercise Price
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
Options granted					500,000		$	0.10
Options exercised					(0	)	$	—
Options forfeited/expired					(325,000	)	$	0.31

Options outstanding at December 31, 2005		2,726,666			2,810,000		$	0.10

Options granted					(0	)	$	0.10
Options exercised					(0	)	$	—
Options forfeited/expired		(976,666	)		(1,060,000	)	$	0.10

Options outstanding at December 31, 2006		1,750,000			1,750,000		$	0.09


	2005			2004
NET INCOME (LOSS):
As Reported	$	(81,515	)	$	(157,490	)
Pro Forma	$	(89,715	)	$	(172,770	)
BASIC AND DILUTED LOSS:
As Reported	$	(0.00	)	$	(0.00	)
Pro Forma	$	(0.00	)	$	(0.00	)


	Quarter Ended
2006	March 31			June 30			September 30			December 31
Net Revenues	$	100,488		$	92,868		$	67,744		$	72,101
Gross Margin	$	90,299		$	83,580		$	60,970		$	97,455
Net Income (Loss)	$	(173,391	)	$	(62,989	)	$	(61,798	)	$	(54,448	)
Basic (Loss) Per Share	$	0.00		$	0.00		$	0.00		$	(0.00	)


							All Other
					Options		Compensation
Name and Principal Position	Year		Salary($)		Awards($)		($)			Total ($)
Henry R. Mandell, Chairman and Secretary		2006	$	90,000		—	$	19,000	(1)	$	109,000
		2005	$	214,200		8,000	$	16,000		$	238,200
		2004	$	214,200		3,820	$	14,000		$	232,020


2007	$	131,258
2008	$	0
2009	$	0
2010	$	0
Thereafter	$	0

	$	131,258


	AMOUNT AND NATURE OF		PERCENT OF
NAME OF BENEFICIAL OWNER	BENEFICIAL OWNERSHIP		CLASS
Jay Gottlieb(1)(2)		4,846,500		9.1	%

Carlo Civelli(1)(3)		5,763,780		11.75	%

Henry R. Mandell(1)(4)		2,162,875		4.4	%

All directors and executive officers as a group (2 persons)(1)(3)(4)		7,976,655		16.15	%


	SPATIALIZER AUDIO LABORATORIES, INC. (Registrant)
	/s/ Henry R. Mandell
	Henry R. Mandell
	Chairman & Secretary


(1)		The persons named in the table have sole voting and investment power with respect to all shares shown to be beneficially owned by them, subject to community property laws, where applicable, and the information contained in the footnotes to this table.

(2)		Based on Amendment No. 3 to the Schedule 13G filed by Mr. Gottlieb with the Securities and Exchange Commission on February 12, 2007. Mr. Gottlieb’s address is 27 Misty Brook Lane, New Fairfield, Connecticut 06812.

(3)		Carlo Civelli controls Clarion Finanz AG, a non-reporting investment company. Holdings of Mr. Civelli and Clarion Finanz AG are combined, and include all shares of Spatializer held of record or beneficially by them, and all additional shares over which he either currently exercises full or partial control, without duplication through attribution. Includes 300,000 options to acquire common stock held by Mr. Civelli, all of which are vested and currently exercisable. Mr. Civelli’s address is Gerberstrasse 5 8023, Zurich, Switzerland. (4) Includes 1,500,000 options held by Mr. Mandell, all of which are vested and are exercisable at various prices from $0.05 to $0.12. The options have varying expiration dates of which the final such expiration date is February 21, 2010.


(1)		Represents options to acquire the Company’s Common Stock under the Company’s 1995 Stock Option Plan and 1996 Incentive Plan approved by the Company’s stockholders in 1995 and 1996, respectively. The 1995 Plan authorizes grants of options to purchase authorized but unissued common stock in an amount of up to 10% of total common shares outstanding at each calendar quarter or 4,876,338 as at December 31, 2006. 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. Since the Plan expired in 2005, there can be no new issues of options.


(1)		Audit Fees are fees for professional services rendered for the annual audit, the reviews of the Company’s financial statements included in Form 10-Qs and services normally provided in connection with statutory and regulatory filings.

(2)		Audit Related Fees are for assurance and related services that are reasonably related to the performance of the fiscal 2005 audit and not reported under Audit Fees.

(3)		Tax Fees are fees for professional services rendered for tax compliance, tax planning and tax advice.


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.)

2.2		Asset Purchase Agreement dated as of September 18, 2006 among the Company, Desper Products, Inc., DTS, Inc. and DTS-BVI (incorporated by reference to Exhibit 10.9 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006.)

3.1		Certificate of Incorporation of Spatializer-Delaware as filed February 28, 1994. (Incorporated by reference to the Company’s Registration Statement on Form S-1, Registration No. 33-90532,effective August 21, 1995.)

3.2		Amended and Restated Bylaws of Spatializer-Delaware. (Incorporated by reference to the Company’s Registration Statement on Form S-1,Registration No. 33-90532, effective August 21, 1995.)

3.3		Certificate of Designation of Series B 10% Redeemable Convertible Preferred Stock of the Company as filed December 27, 1999 (Incorporated by reference to the Company’s Annual Report on 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.)


•		Filed Herewith.

*		Indicates management contracts or compensatory plans required to be filed as an exhibit to this report.


Signature	Title	Date
/s/ Carlo Civelli	Director	March 26, 2007

Carlo Civelli

/s/ Henry R. Mandell	Director, Chairman and Secretary (Principal executive	March 26, 2007

Henry R. Mandell	officer and principal financial officer)