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<SEC-DOCUMENT>0000950134-06-006223.txt : 20060330
<SEC-HEADER>0000950134-06-006223.hdr.sgml : 20060330
<ACCEPTANCE-DATETIME>20060330060451
ACCESSION NUMBER:		0000950134-06-006223
CONFORMED SUBMISSION TYPE:	10-K
PUBLIC DOCUMENT COUNT:		6
CONFORMED PERIOD OF REPORT:	20051231
FILED AS OF DATE:		20060330
DATE AS OF CHANGE:		20060330

FILER:

	COMPANY DATA:	
		COMPANY CONFORMED NAME:			SPATIALIZER AUDIO LABORATORIES INC
		CENTRAL INDEX KEY:			0000890821
		STANDARD INDUSTRIAL CLASSIFICATION:	SEMICONDUCTORS & RELATED DEVICES [3674]
		IRS NUMBER:				954484725
		STATE OF INCORPORATION:			DE
		FISCAL YEAR END:			1231

	FILING VALUES:
		FORM TYPE:		10-K
		SEC ACT:		1934 Act
		SEC FILE NUMBER:	000-26460
		FILM NUMBER:		06720527

	BUSINESS ADDRESS:	
		STREET 1:		2025 GATEWAY PLACE
		STREET 2:		SUITE 365
		CITY:			SAN JOSE
		STATE:			CA
		ZIP:			95110
		BUSINESS PHONE:		3102273370

	MAIL ADDRESS:	
		STREET 1:		2625 TOWNSGATE ROAD
		STREET 2:		SUITE 330
		CITY:			WESTLAKE VILLAGE
		STATE:			CA
		ZIP:			91361
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-K
<SEQUENCE>1
<FILENAME>v18918e10vk.htm
<DESCRIPTION>FORM 10-K
<TEXT>
<HTML>
<HEAD>
<TITLE>e10vk</TITLE>
</HEAD>
<BODY bgcolor="#FFFFFF">
<!-- PAGEBREAK -->
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>
<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV style="width: 100%; border-bottom: 2pt solid black; font-size: 1pt">&nbsp;</DIV>
<DIV style="width: 100%; border-bottom: 1pt solid black; font-size: 1pt">&nbsp;</DIV>






<DIV align="center" style="font-size: 14pt; margin-top: 12pt"><B>UNITED STATES SECURITIES AND EXCHANGE COMMISSION</B>
</DIV>

<DIV align="center" style="font-size: 12pt"><B>Washington, D.C. 20549</B>
</DIV>

<DIV align="center" style="font-size: 12pt"><B><DIV align="center"><DIV style="font-size: 3pt; margin-top: 16pt; width: 26%; border-top: 1px solid #000000">&nbsp;</DIV></DIV></B>
</DIV>

<DIV align="center" style="font-size: 18pt; margin-top: 12pt"><B>FORM 10-K</B>
</DIV>

<DIV align="center" style="font-size: 18pt; margin-top: 12pt"><B><DIV align="center"><DIV style="font-size: 3pt; margin-top: 16pt; width: 26%; border-top: 1px solid #000000">&nbsp;</DIV></DIV></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(Mark One)</B>
</DIV>

<DIV align="center">
<TABLE cellspacing="0" border="0" cellpadding="0" width="100%" style="font-size: 12pt">
<TR style="font-size: 6pt">
    <TD width="7%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="88%">&nbsp;</TD>
</TR>
<TR valign="top">
    <TD align="center"><FONT face="Wingdings">&#254;</FONT></TD>
    <TD>&nbsp;</TD>
    <TD><B>ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934</B></TD>
</TR>
</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 12%"><B><B>For the period ended: December&nbsp;31, 2005</B>
</B>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 12pt"><B>OR</B></DIV>

<DIV align="center">
<TABLE cellspacing="0" border="0" cellpadding="0" width="100%" style="font-size: 12pt">
<TR style="font-size: 12pt">
    <TD width="7%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="88%">&nbsp;</TD>
</TR>
<TR valign="top">
    <TD align="center"><FONT face="Wingdings">&#111;</FONT></TD>
    <TD>&nbsp;</TD>
    <TD><B>TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934</B></TD>
</TR>
</TABLE>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 12pt"><B>Commission File Number: 000-26460</B></DIV>

<DIV align="center" style="font-size: 20pt; margin-top: 12pt"><B>SPATIALIZER AUDIO LABORATORIES, INC.</B>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 0pt"><B>(Exact name of registrant as specified in its charter)</B></DIV>

<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="47%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="47%">&nbsp;</TD>
</TR>
<TR style="font-size: 10pt" valign="bottom">
    <TD nowrap align="center"><B>Delaware</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center"><B>95-4484725</B></TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD align="center" valign="top"><B>(State or other jurisdiction of<BR>
incorporation or organization)</B>
</TD>
    <TD>&nbsp;</TD>
    <TD align="center" valign="top"><B>(I.R.S. Employer<BR>
Identification No.)</B></TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 12pt"><B>2025 Gateway Place, Suite&nbsp;365<BR>
San Jose, California 95110</B><BR>
(Address of principal corporate offices)</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 12pt"><B>Telephone Number: (408)&nbsp;453-4180</B><BR>
(Registrant&#146;s telephone number, including area code)</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 12pt"><B>Securities registered pursuant to Section&nbsp;12(b) of the Act:<BR>
None</B></DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 12pt"><B>Securities registered pursuant to Section&nbsp;12(g) of the Act:<BR>
Common Stock, $0.01 par value</B></DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities Act. <FONT face="Wingdings">&#111;</FONT> Yes <FONT face="Wingdings">&#254;</FONT> No
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or Section 15(d) of the Act. <FONT face="Wingdings">&#111;</FONT> Yes <FONT face="Wingdings">&#254;</FONT> No
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Indicate by check mark whether the registrant (1)&nbsp;has filed all reports required to be filed
by Section&nbsp;13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12&nbsp;months (or
for such shorter period that the registrant was required to file such reports), and (2)&nbsp;has been
subject to such filing requirements for the past 90&nbsp;days: Yes <FONT face="Wingdings">&#254;</FONT> No <FONT face="Wingdings">&#111;</FONT>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Indicate by check mark if disclosure of delinquent filers pursuant to Item&nbsp;405 of Regulation
S-K is not contained herein, and will not be contained, to the best of the registrant&#146;s knowledge,
in definitive proxy or information statements incorporated by reference in Part&nbsp;III of this Form
10-K or any amendment to this Form 10-K. <FONT face="Wingdings">&#254;</FONT>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of &#147;accelerated filer and large accelerated
filer&#148; in Rule&nbsp;12b-2 of the Exchange Act.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Large Accelerated Filer <FONT face="Wingdings">&#111;</FONT> &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Accelerated Filer <FONT face="Wingdings">&#111;</FONT> &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Non-Accelerated Filer <FONT face="Wingdings">&#254;</FONT>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Indicate by check mark whether the registrant is a shell company (as defined in Rule&nbsp;12b-2 of
the Exchange Act). <FONT face="Wingdings">&#111;</FONT> Yes <FONT face="Wingdings">&#254;</FONT> No
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The aggregate market value of the voting stock held by non-affiliates of the registrant
computed by reference to the price at which the common equity was last sold as of the last business
of the registrant&#146;s most recently completed second quarter (June&nbsp;30, 2005) was approximately
$2,818,522 and at March&nbsp;1, 2006 was approximately $1,072,794. In addition, affiliates held
non-voting preferred stock valued at $1,183,510, at June&nbsp;30, 2005 and nil at March&nbsp;1, 2006.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As of March&nbsp;1, 2006, there were 48,763,385 shares of the Registrant&#146;s Common Stock
outstanding.
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>DOCUMENTS INCORPORATED BY REFERENCE</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Portions of the definitive proxy statement for the 2005 Annual Meeting are incorporated by
reference into Part&nbsp;III hereof.
</DIV>

<DIV style="width: 100%; border-bottom: 1pt solid black; margin-top: 10pt; font-size: 1pt">&nbsp;</DIV>
<DIV style="width: 100%; border-bottom: 2pt solid black; font-size: 1pt">&nbsp;</DIV>







<P align="center" style="font-size: 10pt">&nbsp;
</DIV>

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<P><HR noshade><P>
<H5 align="left" style="page-break-before:always">&nbsp;</H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">









<DIV align="left">
<!-- TOC -->
</DIV>
<DIV align="left">
<A name="tocpage"></A>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>TABLE OF CONTENTS</B>
</DIV>

<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="100%">&nbsp;</TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><A href="#101">PART I</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#102">Item&nbsp;1. Business</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#103">Item&nbsp;1A. Risk Factors</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#104">Item&nbsp;1B. Unresolved Staff Comments</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#105">Item&nbsp;2. Properties</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#106">Item&nbsp;3. Legal Proceedings</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#107">Item&nbsp;4. Submission of Matters to a Vote of Security Holders</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">PART II</DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#108">Item&nbsp;5. Market for Registrant&#146;s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#109">Item&nbsp;6. Selected Financial Data</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#110">Item&nbsp;7. Management&#146;s Discussion and Analysis of Financial Condition and Results of Operations</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#111">Item&nbsp;7A. Quantitative and Qualitative Disclosures About Market Risk</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#112">Item&nbsp;8. Financial Statements and Supplementary Data</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">INDEPENDENT AUDITORS&#146; REPORT</DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px"><A href="#113">CONSOLIDATED BALANCE SHEETS</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px"><A href="#114">CONSOLIDATED STATEMENTS OF OPERATIONS</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px"><A href="#115">CONSOLIDATED STATEMENTS OF CASH FLOWS</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px"><A href="#116">CONSOLIDATED STATEMENTS OF STOCKHOLDERS&#146; EQUITY (DEFICIT)</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px"><A href="#117">NOTES TO CONSOLIDATED FINANCIAL STATEMENTS</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#118">Item&nbsp;9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#119">Item&nbsp;9A. Controls and Procedures</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#120">Item&nbsp;9B. Other Information</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><A href="#121">PART III</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#122">Item&nbsp;10. Directors and Executive Officers of the Registrant</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#123">Item&nbsp;11. Executive Compensation</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#124">Item&nbsp;12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#125">Item&nbsp;13. Certain Relationships and Related Transactions</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#126">Item&nbsp;14. Principal Accountant Fees and Services</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><A href="#127">PART IV</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#128">Item&nbsp;15. Exhibits and Financial Statement Schedules</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><A href="#129">SIGNATURES</A></DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">EX-23.1</DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">EX-31.1</DIV></TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">EX-32.1</DIV></TD>
</TR>
<!-- End Table Body -->
<TR><TD colspan="9"><FONT size="2">&nbsp;<A HREF="v18918exv10w10.htm">EXHIBIT 10.10</A></FONT></TD></TR>
<TR><TD colspan="9"><FONT size="2">&nbsp;<A HREF="v18918exv21w1.htm">EXHIBIT 21.1</A></FONT></TD></TR>
<TR><TD colspan="9"><FONT size="2">&nbsp;<A HREF="v18918exv23w1.htm">EXHIBIT 23.1</A></FONT></TD></TR>
<TR><TD colspan="9"><FONT size="2">&nbsp;<A HREF="v18918exv31w1.htm">EXHIBIT 31.1</A></FONT></TD></TR>
<TR><TD colspan="9"><FONT size="2">&nbsp;<A HREF="v18918exv32w1.htm">EXHIBIT 32.1</A></FONT></TD></TR>
</TABLE>
</DIV>

<DIV align="left">
<!-- /TOC -->
</DIV>

<P align="center" style="font-size: 10pt">2
</DIV>

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<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">


<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;This Annual Report on Form 10-K contains forward-looking statements within the meaning of
Section&nbsp;21E of the Securities Exchange Act of 1934, as amended, and Section&nbsp;27A of the Securities
Act of 1933, as amended, reflecting management&#146;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, &#147;believes,&#148; &#147;anticipates,&#148; &#147;plans,&#148; &#147;expects&#148; and similar expressions are intended to
identify forward-looking statements. The important factors discussed under Item&nbsp;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&#146;s current expectations and are
inherently uncertain. Investors are warned that actual results may differ from management&#146;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.
</DIV>
<DIV align="left">
<A name="101"></A>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>PART I</B>
</DIV>

<DIV align="left">
<A name="102"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;1. </B><B><I>Business</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><B>Overview</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Spatializer Audio Laboratories, Inc. (&#147;Spatializer&#148; or &#147;Company&#148;) 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. Our
position as a developer of next generation technologies is based on our business relationships with
brand leaders, such as Toshiba, Samsung, Sanyo and Matsushita. We conduct our audio business
through our parent company and our wholly owned subsidiary, Desper Products, Inc. (&#147;DPI&#148;). DPI has
developed a full complement of patented and proprietary 3-D or virtual audio signal processing
technologies directed to the consumer electronics and multimedia PC markets. Our product offerings
are targeted to take advantage of the growing digital audio marketplace specifically for consumer
products like Digital Versatile Disc (&#147;DVD&#148;) players, portable mp3 players, digital televisions and
digital home, portable and cellular handset devices. As of December&nbsp;31, 2005, more than 49&nbsp;million
licensed units had been shipped covering all of these applications. DPI&#146;s virtual audio signal
processing technologies are currently incorporated in products offered by global brand leaders in
consumer electronics, PCs and cell phones including Toshiba, Matsushita, Samsung, Intervideo,
Sanyo, and Sharp.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;On January&nbsp;10, 2006, the Company announced that it would hold an open auction for the sale of
substantially all of its assets. The Board of Directors of the Company decided that it is in the
best interests of the stockholders to hold an open auction for the acquisition of the assets of the
Company or the granting of an unlimited amount of non-exclusive perpetual licenses for a one-time
fee and a subsequent auction of the residual assets. The consummation of any of such transactions
will be subject to approval by the stockholders of the Company. The Company received
non-conforming bids for such assets on the February&nbsp;15, 2006 deadline. The Board of Directors of
the company, in consultation with their financial and legal advisors, extended the auction period
to March&nbsp;10, 2006, to provide bidders and other interested parties additional time to clarify their
offers and perform due diligence, as well as to solicit additional offers. Negotiations continue
with auction participants who submitted bids by March&nbsp;10, 2006. The Company will announce its
decision upon completion of its evaluation of such bids.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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 Audio
Laboratories, Inc., a publicly held Yukon, Canada corporation, were exchanged for an equal number
of shares of our common stock. Our corporate office and research center is located at 2025 Gateway
Place, Suite&nbsp;365, San Jose, California 95110, Telephone (408)&nbsp;453-4180. We also maintain executive
offices at 2625 Townsgate Road, Suite&nbsp;330, Westlake Village, California 91361. We have a Website at
<I>www.spatializer.com</I>. 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 &#147;Company,&#148; &#147;we&#148; or &#147;our&#148; means Spatializer Audio Laboratories, Inc.
and its wholly-owned subsidiaries
</DIV>

<P align="center" style="font-size: 10pt">3
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our financial statements beginning on page 42 hereof contain information relating to our
revenues, loss and total assets for the fiscal year ended December&nbsp;31, 2005.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Desper Products, Inc. &#151; Virtual Audio Signal Processing Technologies</B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;DPI has developed a suite of proprietary advanced audio signal processing technologies for the
entire spectrum of applications falling under the general category of virtual audio. The objective
in each product category is to create or simulate the effect of a multi-speaker sonic environment
using two ordinary speakers (or headphones) for playback. The market for virtual audio is segmented
into six broad categories of technology as identified in the listing below. Each of these
technologies utilizes different underlying scientific principles in accomplishing its design
objectives and is targeted to a specific class of consumer electronics or multimedia computer
depending on the intended product use and functional capability of the product.
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="32%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="33%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="33%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="center" style="border-bottom: 1px solid #000000"><B>Technology</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" style="border-bottom: 1px solid #000000"><B>Product Categories</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" style="border-bottom: 1px solid #000000"><B>Audio Enhancement</B></TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Spatializer<SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP> 3-D Stereo
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Stereo TV&#146;s, Stereo
Components and
Systems, Car Audio,
Laptop and Desktop
Multimedia
Computers, Set-top
Boxes
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Surround sound
enhancement from an
ordinary stereo
(two-channel)
signal</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Spatializer ((environ))<SUP style="font-size: 85%; vertical-align: text-top">TM</SUP>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Cell Phones and
Mobile Multimedia
Players
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Widens sound stage
and improves stereo
separation from
two-channel ring
tones, compressed
audio, FM and TV
broadcast and
games.</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Spatializer N-2-2 Ultra<SUP style="font-size: 85%; vertical-align: text-top"> TM</SUP>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">DVDP, DVDR, PVR, AV
Receivers,
Multimedia PCs,
DTV,STB
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Creation of
spatially accurate
home theater
surround sound from
two channel sources</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Spatializer enCompass AV<SUP style="font-size: 85%; vertical-align: text-top"> TM</SUP>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Products
incorporating
multi-channel audio
sources like Dolby
ProLogic II<SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP>: AV
Receivers
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Creation of
spatially accurate
multi-speaker
cinematic audio
experience from
two-channel audio
information</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Spatializer Audio Alchemy<SUP style="font-size: 85%; vertical-align: text-top"> TM</SUP>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Computers and
Recordable DVD
utilizing DVD/MPEG
and decoding, Cell
phone handsets.
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Static noise
reduction combined
with stabilization
of dynamic audio
range</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Spatializer Vi.B.E.<SUP style="font-size: 85%; vertical-align: text-top"> TM</SUP>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Mobile Multimedia
Players, Cell
Phones, DVD
Players/Recorders,
DTV, Stereo
Components and
Systems, Car Audio,
Laptop and Desktop
Multimedia PCs and
Headphones.
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Simulation of low
frequency response
from speakers with
poor low frequency
capability</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Spatializer DRC<SUP style="font-size: 85%; vertical-align: text-top"> TM</SUP>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Laptop and Desktop
Multimedia
Computers, Cell
Phones and Portable
Multimedia Players
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Prevents
over-driving
speakers, headphones or ear
buds while
maximizing the
dynamic audio
output</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Spatializer Natural Headphone<SUP style="font-size: 85%; vertical-align: text-top">
TM</SUP>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Headphones, Mobile
Phones, Mobile
Multimedia Players
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Creation of
spatially accurate
<I>multi- speaker
cinematic audio</I>
experience from
headphones
utilizing discrete
multi-channel audio
information</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Spatializer PCE<SUP style="font-size: 85%; vertical-align: text-top"> TM</SUP>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">DTV, Mobile Phones,
Mobile Multimedia
Players, Multimedia
PCs, Headphones
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Creation of more
recognizable and
&#147;cleaner&#148; music or
dialog from all
media sources</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<P align="center" style="font-size: 10pt">4
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">


<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Licensed Products</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our current technology product applications are directed to (1)&nbsp;speaker enhancement, (2)
stereo surround sound enhancement, (3)&nbsp;mobile entertainment enhancement and (4)&nbsp;noise reduction.
</DIV>

<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>1.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Spatializer </B><B><I>3D Stereo. </I></B>Based upon proprietary methods of stereo signal processing, our
<I>Spatializer 3&#151;D Stereo </I>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&#153; (Double Detect and Protect&#153;) algorithm. DDP
continuously monitors the underlying stereo signal and dynamically optimizes spatial
processing, avoiding deleterious sonic artifacts common in other systems and provides &#147;set
and forget&#148; ease of use for consumers. First introduced in July&nbsp;1994 by DPI, in the form of
a 20 pin analog integrated circuit (IC)&nbsp;from Matsushita Electronics Corporation (&#147;MEC&#148;), 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 <I>Spatializer 3-D Stereo </I>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.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>2.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Spatializer </B><B><I>N-2-2 Ultra Digital Virtual Surround</I></B>. In September&nbsp;1996, DPI introduced
<I>Spatializer N-2-2, </I>which we consider a &#147;core&#148;, and &#147;enabling&#148; technology for Dolby
Digital-based home theater products and personal computers. In mid-2001, DPI introduced
<I>Spatializer N-2-2 Ultra </I>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<SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP> (AC-3) and MPEG-2) which carry up to eight (or more) discrete
(independent)&nbsp;channels of audio &#151; the front left and right channels, a center channel (for
vocal tracks), two rear surround channels and a Low Frequency Effects (LFE or &#147;sub-woofer&#148;)
channel for sound effects. The <I>Spatializer N-2-2Ultra </I>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. <I>Spatializer N-2-2Ultra </I>runs in real-time on general purpose Digital Signal
Processing (&#147;DSP&#148;) 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<SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP> Pentium<SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP> 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. <I>Spatializer N-2-2Ultra </I>has been approved by Dolby Laboratories and
qualifies Spatializer licensees to use the newly created Dolby Digital VIRTUAL&#153; trademark on
products incorporating the technology. We believe our <I>Spatializer N-2-2 </I>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.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>3.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Spatializer </B><B><I>Vi.B.E</I></B><B>. </B>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.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>4.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Spatializer </B><B><I>VSP-11 </I></B>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<I><SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP> </I>Media Player, Real Player<I><SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP></I>, Real Jukebox<I><SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP></I>, WinAmp<I><SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP></I>,
WinDVD<I><SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP></I>, PowerDVD<I><SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP></I>, among others, without any special modification. It will run in
conjunction with any sound card, as well as with USB audio.</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">5
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">


<DIV style="margin-top: 6pt"><TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">


<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>5.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Spatializer </B><B><I>Natural Headphone </I></B>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.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>6.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Spatializer </B><B><I>PCE</I></B>, introduced in October&nbsp;2001, makes high frequencies clearer, crisper and
more brilliant while low frequencies are more dramatic, tighter and have more impact.
Spatializer<SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP> 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 &#147;naturalness&#148;,
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.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>7.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Spatializer </B><B><I>enCompass AV </I></B>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.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>8.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Spatializer </B><B><I>VirtuaLFE </I></B>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.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>9.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Spatializer </B><B><I>Audio Alchemy </I></B>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.</TD>
</TR>

</TABLE>
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">In addition, we offer three whole product solutions with multiple Spatializer technologies that
comprehensively address the unique audio delivery challenges inherent in each targeted platform.
The Spatializer HD Class is comprised of three new products specifically targeted at home audio,
cellular telephones and other mobile applications and personal computers. The Spatializer
technologies in each package operate in a complementary fashion, such that the concurrent
technologies deliver a more powerful and effective audio experience than that possible from a
single solution. Further, each technology has been optimized and customized for the targeted
application and is designed to overcome the audio challenges presented by small form factor,
transducer limitations and even cost constraints.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Spatializer UltraMobile HD&#153; 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.
</DIV>


<P align="center" style="font-size: 10pt">6
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Spatializer UltraTV HD&#153; 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&#146;s speaker
set<B>.</B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Spatializer UltraPC HD&#153; 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&#153; 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&#146;s specific speaker set.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Licensing Activities</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Until 2000, we licensed our technologies primarily through semiconductor manufacturing and
distribution licenses (&#147;Foundry Licenses&#148;) 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).
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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&nbsp;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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;OEMs who desire to incorporate these DSPs or ICs into their products are required to enter
into a license (&#147;OEM Licenses&#148;) 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 (&#147;Licensed
Products&#148;) payable in the quarter following shipment by the OEM of its Licensed Products.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We are currently offering these assets for sale or for perpetual license, as outlined in the
second paragraph of the Overview section above.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<I>IC/DSP Foundry Licenses</I>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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&nbsp;22, 2004.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As of December&nbsp;31, 2005, we have entered into non-exclusive Foundry Licenses for our Virtual
Audio Signal Processing technologies with Matsushita Electronics Corporation (&#147;MEC&#148;), Samsung
Electronics, Sigmatel, ESS Technology, Inc. (&#147;ESS&#148;), OnChip Systems, Inc. (&#147;OnChip&#148;), LSI Logic,
Inc. (&#147;LSI&#148;), Acer Labs, Inc. (&#147;Ali&#148;), 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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As of December&nbsp;31, 2005, more than 49&nbsp;million ICs, programmable processors and DSPs
incorporating Spatializer audio signal
</DIV>

<P align="center" style="font-size: 10pt">7
</DIV>

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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">processing technology had been manufactured and sold.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>OEM Licensees and Customers</I>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As of December&nbsp;31, 2005, 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 (&#147;LUA&#148;) 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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In 2005 three major customers, not presented in order of importance, each accounted for 10% or
more of our total revenues: Matsushita, Sharp and Samsung, each of whom accounted for greater than
10% of our total 2005 revenues. One OEM accounted for 33%, one accounted for 28% each and one
accounted for 16% of our royalty revenues during 2005. One other account comprised more than 5%,
but less than 10% of revenues. All other OEM&#146;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&nbsp;31, 2005:
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="30%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="35%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="30%">&nbsp;</TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px"><B>&#149; </B><I>Acer Labs</I>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>MediaTek</I>
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Sanyo Corp.</I></TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px"><B>&#149; </B><I>Apple Computer</I>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Micronas</I>
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Sharp Corp.</I></TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px"><B>&#149; </B><I>Cirrus Logic</I>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Mitsubishi Image and Information Works</I>
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Sigmatel</I></TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px"><B>&#149; </B><I>InterVideo</I>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Motorola</I>
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Texas Instruments</I></TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px"><B>&#149; </B><I>JVC</I>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>NEC</I>
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Theta Digital</I></TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px"><B>&#149; </B><I>LG Electronics</I>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Panasonic Car Audio</I>
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Toshiba DVD</I></TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px"><B>&#149; </B><I>Logitech</I>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Panasonic TV</I>
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Toshiba TV</I></TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px"><B>&#149; </B><I>LSI</I>
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Samsung</I>
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>&#149; </B><I>Zoran</I></TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We have extensive relationships with OEM licensees and customers outside the United States.
Japanese and Korean based entities accounted for 62% and 34% of our total revenues, respectively,
in 2005, 70% and 25% of our total revenues, respectively, in 2004, and 71% and 20% of our total
revenues, respectively, in 2003. 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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<I>Customers, Revenues and Expenses</I>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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&#146; applications. Our revenues, which totaled $1,192,000 in 2005, were derived almost
entirely from Foundry and OEM license fees and royalties.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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 2005 three major customers, not presented in order
of importance, each accounted for 10% or more of our total revenues: Matsushita, Sharp and Samsung,
each of whom accounted for greater than 10% of our total revenues. One OEM accounted for 33%, one
accounted for 28% each and one accounted for 16% of our royalty revenues during 2005. One other
account comprised more than 5%, but less than 10% of revenues. All other OEM&#146;s accounted for less
than 5% of royalty revenues individually.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In 2005, revenues were stagnant as compared with the prior year. Revenues from Toshiba and
Mitsubishi wound down as the devices with our technology reached end of life and new models did not
include our technology. This revenue was replaced by higher revenue from Samsung and Matsushita.
However, 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 with a degree of certainty. As a result, and due to the resignations of two
directors and the CEO, our board of directors determined in late December&nbsp;2005 to offer the
Company&#146;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.
</DIV>

<P align="center" style="font-size: 10pt">8
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Competition</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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<SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP>, Dolby ProLogic<SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP>, and DTS<SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP>), as well as other
technologies designed to create an enhanced stereo image from two or more speakers.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Research and Development</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our research and development expenditures in 2005, 2004 and 2003 were approximately 30%, 34%
and 28% 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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As of December&nbsp;31, 2005, we had one employee in our R&#038;D group representing 33% of our total
human resources. In addition and not included above, we had the availability of three dedicated
engineers at an outside consulting company in India for applications engineering. Our software,
hardware and application engineers had focused on developing intellectual property, technology
solutions and consumer products. In 2004, we established a relationship with an engineering
services firm in Bangalore, India for the substantial transfer to such firm of our applications
engineering work. In addition to substantially lowering costs for consulting services as compared
to costs associated with using domestic contractors, project completion dates were reliable and
throughput expanded due to such firm&#146;s relatively large engineering staff. Thus, multiple projects
were completed simultaneously and within lower cost and time parameters. Despite the foregoing,
based on our board of directors&#146; decision to offer our assets for sale, we discontinued our
technology development efforts in December&nbsp;2005.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Intellectual Property and Proprietary Information</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We rely on a variety of intellectual property protections for our products and services,
including patent, copyright, trademark and trade secret laws, and contractual obligations. Our core
signal processing technology is covered by U.S. patent 6,307,941. On March&nbsp;20, 1998, we filed a
patent application on our enCompass V 2.0 technology with the United States Patent &#038; Trademark
Office (&#147;USPTO&#148;) covering our enCompass 2.0 positional audio gaming technology. In June&nbsp;2000, we
filed an additional patent application for our reduced cost/higher performance 3-D Stereo circuit
design. In late 2002, we filed a patent application covering our Spatializer PCE technology. In
2003, we filed a patent application for Spatializer Audio Alchemy. Much of our intellectual
property consists of trade secrets. In 2002, patent 6,307,941 was issued by the USPTO covering our
Spatializer N-2-2 technology. We possess copyright protection for its principal software
applications and has U.S. and foreign trademark protection for its key product names and logo
marks.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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
</DIV>

<P align="center" style="font-size: 10pt">9
</DIV>

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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Seasonality</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Employees</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We began 2005 with three full-time and five part-time employees and sales representatives and
decreased our staff to two full time and five part-time employees, consultants and sales
representatives by December&nbsp;31, 2005. At year-end, there was one full-time employee engaged in
research and development. In addition, we utilized an engineering firm with three dedicated
engineers to our projects on an as-needed basis. We have employed the services of outside
professional consultants, particularly in the audio engineering area, due to the costly and tight
labor market for such professionals in Silicon Valley as well as the need for specialized expertise
in the course of our business. None of our employees are represented by a labor union or are
subject to a collective bargaining agreement. We consider our relations with our employees and
consultants to be satisfactory.
</DIV>
<DIV align="left">
<A name="103"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;1A. </B><B><I>Risk Factors</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;This Annual Report on Form 10-K contains forward-looking statements within the meaning of
Section&nbsp;21E of the Securities Exchange Act of 1934, as amended, and Section&nbsp;27A of the Securities
Act of 1933, as amended, reflecting management&#146;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 any transactions described herein will be realized. Such
forward-looking statements involve known and unknown risks, uncertainties and other factors that
may cause our actual results, performance or achievements, or industry results, to be materially
different from any future results, performance or achievements expressed or implied by such
forward-looking statements. Numerous factors may affect our actual results and may cause results to
differ materially from those expressed in forward-looking statements made by or on behalf of our
company. For this purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words,
&#147;believes,&#148; &#147;anticipates,&#148; &#147;plans,&#148; &#147;expects&#148; and similar expressions are intended to identify
forward-looking statements. The important factors discussed under the caption &#147;Factors That May
Affect Future Results&#148; in Item&nbsp;7. Management&#146;s Discussion and Analysis of Financial Condition and
Results of Operations, herein, among others, would cause actual results to differ materially from
those indicated by forward-looking statements made herein and represent management&#146;s current
expectations and are inherently uncertain. Investors are warned that actual results may differ from
management&#146;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.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Our Board of Directors has Determined it is in the Company&#146;s and its Stockholders Best Interests to
Attempt to Sell the Company&#146;s Assets.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We have experienced a loss from operations in four of the last five fiscal years. In December
2005 our revenues were stagnant, with those from certain of our major customers winding down.
Revenues from certain of our other customers appear not to be sustainable in the future. In
December&nbsp;2005, two of our three independent directors resigned and the Chairman of the Board, Chief
Executive Officer, Chief Financial Officer and Secretary resigned from all positions held with the
Company other than as a director, Chairman and Secretary. For these and other reasons, and after
exploring other exit strategies and opportunities, our Board of Directors concluded in December
2005 to attempt to sell the Company either through a sale of assets or a sale of multiple,
non-exclusive perpetual licenses with a subsequent sale of the residual assets and engaged
Strategic Equity Group to assist us in this endeavor. Following such transaction, it is
anticipated that the Company would be wound up and dissolved. The consummation of any such
transaction and the determination to wind up and dissolve is subject to stockholder approval.
There is no assurance that the Company will be able to negotiate an agreement for the sale of
assets. There is no assurance that, if such an agreement is successfully negotiated, that such
transaction will be approved by stockholders or consummated. Further, even if such transaction is
consummated, there is no assurance that there will be any funds available for distribution to
stockholders. If such sale and subsequent wind up and
</DIV>

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</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">dissolution is not approved, the Board of Directors will be required to explore other alternatives
for the Company and its business.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Our Operating Results Fluctuate, We Are Unable to Achieve or Sustain Profitability in the Future
or Obtain Future Financing and Our Business Operations Will Fail</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We have experienced a loss from operations in four of the last five years. We experienced
losses in the last two years. While our objective and full effort has been on managing a profitable
business, due to the market conditions and factors outlined in this Annual Report on Form 10-K and
their impact on fluctuations in operating expenses and revenues, we no longer believe that we will
be able to generate a positive profit position in any given future period, nor do we believe that
is feasible. We cannot guarantee that we will increase sales of our products and technologies, or
that we will successfully develop and market any additional products, or achieve or sustain future
profitability. We cannot, because of market and business conditions, rely on the sale of shares or
on debt financings in the future. Further, we do not believe that debt or equity financing will be
available as required and as such, have decided to try to sell the assets of the Company.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Because The Market In Which We Operate Is Highly Competitive, We Face Significant Pricing Pressure
and Competition.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The PC and consumer electronics markets are under intense pressure, primarily from retailers,
to reduce selling prices, with resultant pressure to reduce costs. In addition, certain of our
competitors appear to be pursuing a business plan that disregards commercially reasonable pricing
to achieve a larger market penetration even if the penetration will not provide for viable margins
or returns. Cost reductions are driven by lower cost sourcing, often in China, design
simplification and reduction in or substitution of features. Therefore, we have been seeking
commercial acceptance of our products in highly competitive markets. We responded by offering
additional products targeted to each price and quality segment of the market, more aggressively
priced and feature enriched our products and entered new segments, such as cell phones, with
different competitive pressure. Our value proposition that stressed the cost reducing capabilities
of our audio solutions through improved performance from lower cost components as well as product
differentiation that Spatializer technology can deliver, failed to resonate with our targeted
customers in this highly competitive environment. The result was the elimination of features,
including ours, to reduce cost. There is no assurance that our present or contemplated future
products or a repositioned value proposition will achieve or maintain sufficient commercial
acceptance, or if they do, that functionally equivalent products will not be developed by current
or future competitors or customers who had access to significantly greater resources or which are
willing to &#147;give away&#148; their products.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Because Our Relative Size and Power Is Small Compared To That of Our Customers, Our Business
Leverage With Some Customers Is Generally Weak and Communication Not Always Transparent</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We deal with some of the largest global consumer electronics makers in the world, the vast
majority of which are in Asia. Spatializer is a small company and there are other options for
manufacturers, including those from our competitors, their chip suppliers, or eliminating the use
of audio enhancement technology altogether. As such, our leverage with our customers is generally
weak. This imbalance made it very difficult for the Company to be viewed as a worthy or reliable
partner and made negotiations in general imbalanced against us. In addition, the culture in our
local markets may not dictate clear, direct and transparent communication of business plans or
technology usage as is the culture in our home country. When this occurs, we have received very
short notice of discontinued use of our technology and revenues from such an account would
typically begin a steep decline in the subsequent quarter, resulting in period-to-period
fluctuation. This also results in limited visibility with regard to future revenues and its impact
on our operating results. Our response has been to strengthen our business relationships with more
onsite visits, increase our understanding of cultural differences and focus more intently on
service. We also emphasize to our overseas sales representatives the need for close customer
support, with the objective that both new opportunities and possible difficulties are brought to
light as soon as possible.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>We Rely on the Schedules and Cooperation of Chip Makers or Other Third Parties to Deliver Our
Technology in Consumer Products. These Third Parties Have Their Own Priorities and Alliances That
May Delay or Thwart our Sales Efforts to Potential Customers.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Spatializer does not develop or market semiconductors. That is why we carry no inventory or
have order backlogs that typically are good indicators of near term performance. Rather, we develop
audio algorithms that are embedded on third party processors or semiconductors used by our
customers. While our algorithms are implemented on a wide array of processors, often times a
customer uses a processor where there is no such implementation, or where a competing solution has
been implemented. In this case, our customers request that our algorithm be implemented. While
these requests are typically honored, processor
</DIV>

<P align="center" style="font-size: 10pt">11
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">manufacturers must schedule such implementation as their resources or corporate strategies allow.
Therefore, the supply-chain is often quite long and complicated, which potentially can result in
delays or deadlines that may not always coincide with our customer&#146;s requirements and which are
beyond the control of our company<B>. </B>In addition, standards may be adopted by cell phone system
operators or manufacturers that may impede or prevent the penetration of non-standard technology
onto their platforms. Lastly, customer implementation delays have put off expected cash flow into
the future, beyond the time frame of operations based on our available cash resources.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>If New Product Development Is Delayed, We Will Experience Delays In Revenues And Competitive
Products May Reach The Market Before Our Products.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Since our inception, we have experienced delays in bringing new products to market and
commercial application as a result of delays inherent in technology development, financial resource
limits and industry responses and maturity. These delays have resulted in delays in the timing of
revenues and product introduction. In the future, delays in new product development or technology
introduction on behalf of us, our original equipment manufacturers of consumer electronics and
multimedia computer products (OEMs), integrated circuit (IC)&nbsp;foundries or our software producers
and marketers could result in further delays in revenues and could allow competitors to reach the
market with products before us. In view of the emerging nature of the technology involved, and the
rapidly changing character of the entire media, internet and computer markets, our expansion into
other technology areas and the uncertainties concerning the ability of our current products and new
products to achieve meaningful commercial acceptance, there is no likelihood of achieving or
sustaining profitability.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Manufacturer&#146;s design-in cycles for our technology range from four to twelve months, from the
decision to adopt our technology to cash flow. These schedules are also prone to delays at the
manufacturer level and in some cases, manufacturer&#146;s new products may be cancelled due to market
testing or resource allocation. Since these events are beyond our control, it is difficult to
absolutely project when new deals will begin generating revenues or if signed deals will generate
financial results. For this reason, we do not typically announce new deals until the target product
is being introduced. The delays experienced on one of these deals made it impossible for the
Company to sustain operations until the new cash flow, which was not assured, might be realized.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>We Expect That We Will Continue to be Dependent upon a Limited Number of OEMs for a Significant
Portion of Our Net Sales in Future Periods</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Although no OEM is presently obligated either to purchase a specified amount of products or to
provide us with binding forecasts of product purchases for any period, we anticipate being
dependent upon a limited number of OEMs for a large port of our net sales. Our three largest
customers as of December&nbsp;31, 2005 accounted for 33%, 28% and 16% of our net sales. The loss of any
one of our major customers or licensees would significantly reduce our revenues and harm our
ability to achieve or sustain acceptable levels of operating results. The loss, or signing of a
similarly sized account or accounts would have a material short term impact on our operations and
there is no assurance that we will not lose all or some of the revenues from one or more of these
accounts. In late December&nbsp;2005, management and the Board of Directors concluded that revenues from
two of the three largest accounts would be significantly reduced in 2006, putting the liquidity of
the Company in jeopardy as it operated through 2006.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt">&nbsp;&nbsp; <I>Demand for Our Products is Subject to Risks Beyond Our Control.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our products are typically one of many related products used by consumer electronic users. As
a result, demand for our products is therefore subject to many risks beyond our control, including,
among others:
</DIV>

<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>competition faced by our OEM customers in their particular end markets;</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>the technical, sales and marketing and management capabilities of our OEM customers;</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>the pressure faced by our OEM customers to reduce cost</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;There can be no assurance that we will not lose sales in the future as a result of the
pressure to reduce costs faced by our customers. In late December&nbsp;2005, management and the Board
of Directors concluded that revenues from two of the three largest accounts would be significantly
reduced in 2006, putting the liquidity of the Company in jeopardy by subjecting us to adverse
revenue fluctuations.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Because The Technology Environment In Which We Operate Is Rapidly Changing, We May Not Be
Successful In Establishing And</I>
</DIV>

<P align="center" style="font-size: 10pt">12
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><I>Maintaining The Technological Superiority Of Our Products Over Those Of Our Competitors.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We operate in a technology environment which is competitive and rapidly changing. While our
software applications deliver what we, and most manufacturers who listen to it, believe is a
significantly superior audio experience, the competitive market forces that pressure manufacturers
to reduce their costs may create some resistance to new technology adoption or use. Our future
success was dependent on establishing and maintaining the technological superiority of our products
over those of competitors, our ability to successfully identify and bring other compatible
technologies and products to market and a recognition by the market of product value. We compete
with a number of entities that produce various stereo audio enhancement processes, technologies and
products in both traditional two-speaker environments such as consumer electronics and multimedia
computing, and in multi-channel, multi-speaker applications such as Home Theater. In the field of
3-D or &#147;virtual audio&#148;, our principal competitors are SRS Labs, Inc., QSound Labs, Inc. and Dolby
Laboratories or technologies and products developed by other companies, including entities that
have business relationships with us. There can be no assurance that we would be able to favorably
compete in this market in the future, even if we had adequate liquidity.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>If We Are Unable To Attract And Retain Our Key Personnel, We May Not Be Able To Successfully
Operate Our Business.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our future success primarily depends on the abilities and efforts of a small number of
individuals, with particular management obligations and technical expertise. Loss of the services
of any of these persons could adversely affect our business prospects. There is no assurance that
we will be able to retain this group or successfully recruit other personnel, as needed. Our CEO
resigned in January&nbsp;2006, as did our two outside directors, in December&nbsp;2005. We compete with other
enterprises with stronger financial resources and larger staffs that may offer employment
opportunities to our staff which are more desirable than those which we are able to offer. Failure
to maintain skilled personnel with the software and engineering skills critical to our business had
an adverse impact upon our business, the results of our operations and our prospects.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><I>The Market For Our Stock May Be Not Remain Liquid And The Stock Price May Be Subject To Volatility</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our stock is quoted on the OTC Bulletin Board, where low trading volume and high volatility is
often experienced. While a few firms make a market in our stock, the historically low trading
volume and relatively few market makers of our stock makes it more likely that a severe fluctuation
in volume, either up or down, will significantly impact the stock price. There can be no assurance
that these market makers will continue to quote our stock and a reduction in such market makers
would negatively impact trading liquidity. Further, with our constrained resources and increased
cost and time associated with implementation of Sarbanes-Oxley, it may not be possible for us to
remain listed on the OTC Bulletin Board in the future as a fully reporting company. This and the
existing limited market and volume in the trading of our stock, may result in our shareholders
having difficulty selling our common stock. The trading price of our Common Stock has been, and
will likely continue to be, subject to wide fluctuations in response to quarterly variations in our
operating results, announcements of new products or technological innovations by the Company or our
competitors, strategic alliances between us and third parties, general market fluctuations and
other events and factors, some of which may be beyond our control.
</DIV>
<DIV align="left">
<A name="104"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;1B. </B><B><I>Unresolved Staff Comments</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Not applicable.
</DIV>
<DIV align="left">
<A name="105"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;2</B>. <B><I>Properties</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our corporate office and research center in San Jose, California, is the primary location for
our audio technology division, Desper Products, Inc. (&#147;DPI&#148;). We occupy approximately 1,300 square
feet with an annual rent on a full service basis of approximately $25,500 in calendar 2005 and
$26,275 in calendar 2006. The lease expires on December&nbsp;30, 2006 and is renewable at market rates
thereafter. We lease our space at rental rates and on terms which management believes are
consistent with those available for similar space in the applicable local area. Such property is
well maintained and we believe is adequate to support our current requirements. Based on the
decision to try to sell the Company&#146;s assets, it is unlikely the lease will be renewed.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our executive office was located in Westlake Village, California, where we occupied
approximately 100 square feet with an annual rent of approximately $5,300. The lease term on this
space expired on June&nbsp;30, 2005 and was renewable on a month to month basis thereafter. This space
in the Los Angeles area was used to facilitate business and contacts with the entertainment
community as well as with our accountants, lawyers and directors. This space was vacated and the
month to month lease terminated in February
</DIV>

<P align="center" style="font-size: 10pt">13
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">2006.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We leased an apartment in San Jose, California for use by the chief executive officer when
away from the executive office. The annual rent on this apartment was approximately $16,800. The
lease was on a month-to-month basis and was terminated in January&nbsp;2006.
</DIV>
<DIV align="left">
<A name="106"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;3. </B><B><I>Legal Proceedings</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;From time to time we may be involved in various disputes and litigation matters arising in the
normal course of business. As of the date of this Annual Report on Form 10-K, we are not involved
in any legal proceedings that are expected to have a material adverse effect on our consolidated
financial position, results of operations or cash flows. However, litigation is subject to inherent
uncertainties. Were an unfavorable ruling to occur, there exists the possibility of a material
adverse impact on our results of operations of the period in which the ruling occurs. Our estimate
of the potential impact on our financial position or overall results of operations for the above
legal proceedings could change in the future. At present, there are no active legal proceedings.
</DIV>
<DIV align="left">
<A name="107"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;4. </B><B><I>Submission of Matters to a Vote of Security Holders</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;There were no matters submitted to a vote of our security holders either through solicitation
of proxies or otherwise in the fourth quarter of the fiscal year ended December&nbsp;31, 2005.
</DIV>
<DIV align="left">
<A name="108"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;5. </B><B><I>Market for Registrant&#146;s Common Equity and Related Stockholder Matters</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our Common Stock was listed and commenced trading on the NASDAQ SmallCap market on August&nbsp;21,
1995 under the symbol &#147;SPAZ&#148;. In January&nbsp;1999, the Common Stock was delisted by the NASDAQ SmallCap
Market due to our inability to maintain listing requirements. Our Common Stock immediately
commenced trading on the OTC Bulletin Board under the same symbol. The following table sets forth
the high and low bid price of our Common Stock as reported on the OTC Bulletin Board for fiscal
years 2004 and 2005. The quotations listed below reflect interim dealer prices without retail
mark-up, mark-down or commission and may not represent actual transactions.
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="76%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="center" style="border-bottom: 1px solid #000000"><B>Period:</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>High (U.S. $)</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>Low (U.S. $)</B></TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">2004</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">First Quarter</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.22</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.11</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Second Quarter</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.14</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.06</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Third Quarter</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.10</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.05</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Fourth Quarter</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.09</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.05</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">2005</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">First Quarter</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.10</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.06</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Second Quarter</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.09</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.05</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Third Quarter</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.07</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.05</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Fourth Quarter</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.07</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.03</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;On March&nbsp;1, 2006, the closing price reported by the OTC Bulletin Board was U.S. $0.021.
Stockholders are urged to obtain current market prices for our Common Stock. Computershare Investor
Services, LLC is our transfer agent and registrar.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;There were no sales of unregistered securities by the Company during the year ended December
31, 2004. In December&nbsp;2005, we issued shares of our Common Stock in connection with the mandatory
conversion of our Series&nbsp;B-1 Redeemable Convertible Preferred Stock, par value $.01 per share,
which transaction was previously described and included in our Form 8-K filed with the SEC on
December&nbsp;30, 2005 (with date of earliest event reported of December&nbsp;29, 2005).
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;To our knowledge, there were approximately 200 holders of record of the stock of the Company
as of March&nbsp;1, 2006. Our transfer agent has indicated that beneficial ownership is in excess of
4,000 stockholders.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We have not paid any cash dividends on our Common Stock and have no present intention of paying any
dividends. Our current
</DIV>

<P align="center" style="font-size: 10pt">14
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">policy is to retain earnings, if any, for use in operations and in the development of our business. Our future dividend policy will be determined from time to time by the Board of Directors.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company did not repurchase any of its equity securities during the fourth quarter of the fiscal year ended December&nbsp;31, 2005.
</DIV>


<P align="center" style="font-size: 10pt">15
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">


<DIV align="left">
<A name="109"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;6. </B><B><I>Selected Financial Data</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The following selected consolidated financial data should be read in conjunction with our
Consolidated Financial Statements and related Notes and with &#147;Management&#146;s Discussion and Analysis
of Financial Condition and Results of Operations&#148;, included in Item&nbsp;7. The selected financial data
for the years ended December&nbsp;31, 2005, 2004, 2003, 2002 and 2001 are derived from our consolidated
financial statements that have been audited by Farber &#038; Hass LLP, independent certified public
accountants. The consolidated statements of operation and cash flows for the years ended December
31, 2003, 2004 and 2005 and the report thereon are included elsewhere in this Report.
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="40%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="18" style="border-bottom: 1px solid #000000"><B>Fiscal Year Ended</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>December 31, 2001</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>December 31, 2002</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>December 31, 2003</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>December 31, 2004</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>December 31, 2005</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><B>Consolidated
Statement of Operations
Data:</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Revenues</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,604</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,856</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,269</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,106</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,192</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Cost Of Revenues</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(97</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(131</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(122</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(111</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(106</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Gross Profit</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,507</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,725</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,147</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">995</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,086</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Total Operating Expenses</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1,823</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1,711</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1,631</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1,146</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1,177</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Other Income (Expense),
Net</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">73</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(2</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(6</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(5</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">8</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Income taxes</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">3</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(6</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(5</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net Income (Loss)</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(240</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">18</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(495</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(157</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(82</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Basic Income (Loss) Per
Share</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.01</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">0.00</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.01</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.00</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.00</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Diluted Income (Loss) Per
Share</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.01</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">0.00</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.01</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.00</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.00</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Weighted Average Common
Shares</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">47,388,235</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">47,406,939</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">47,309,171</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">46,975,363</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">46,990,059</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><B>Consolidated Balance
Sheet Data</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Cash and Cash Equivalents</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">869</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">859</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">590</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">871</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">551</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Working Capital</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,124</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,125</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">793</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">603</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">560</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Total Assets</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,753</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,746</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,205</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,464</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">897</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Redeemable Preferred Stock</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Advances From Related
Parties</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">113</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">113</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">108</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Total Shareholders&#146; Equity</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,411</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,429</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">955</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">798</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">717</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>

<DIV align="left">
<A name="110"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;7. </B><B><I>Management&#146;s Discussion and Analysis of Financial Condition and Results of Operations</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><B>Executive Overview</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Revenues increased to $1,192,000 for the year ended December&nbsp;31, 2005 compared to $1,106,000
for the year ended December&nbsp;31, 2004, an increase of 8%. Revenues are almost entirely comprised of
royalties pertaining to the licensing of Spatializer<SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP> audio signal processing algorithms. A key
issue discussed is the difficulty in obtaining revenue traction when traditional revenue sources
are eroding, while being replaced by new revenue sources at a lower rate.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Net loss was $82,000 for the year ended December&nbsp;31, 2005; ($0.00) basic per share, compared
to net loss of $157,000, ($0.00) per share basic and diluted, for the year ended December&nbsp;31, 2004.
Net loss for the current period is primarily the result of lower revenue, partially offset by lower
overhead. A key issue discussed is management&#146;s efforts to reduce overhead in view of declining
revenue, while maintaining competitiveness.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Net cash used by operating activities was $256,568 for the year ended December&nbsp;31, 2005, as
compared to net cash provided by operating activities was $343,939 for the year ended December&nbsp;31,
2004 and net cash used in operating activities of $253,965 for the year ended December&nbsp;31, 2003.
The decrease in cash flows from operations for the year ended December&nbsp;31, 2005 was primarily a
</DIV>

<P align="center" style="font-size: 10pt">16
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">result of the decrease in deferred income, the net loss, a decrease in accounts payable and a
decrease in notes payable, partially offset
by a decrease in accounts receivable. Deferred income decreased due to full revenue
realization of a prior year licensing prepayment and accounts receivable decreased due to reduced
year over year revenue. A key issue is the Company&#146;s ability to generate continued positive cash
flow to continue operations.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The business environment in which we operate is highly competitive and is offers substantial
risk. These risks should be studied and understood, as outlined in Risk Factors under Item&nbsp;1A
above.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Approach to MD&#038;A</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;An important demonstration of our commitment to our stockholders is a clear explanation of the
Company&#146;s operating results, risks and opportunities. The purpose of MD&#038;A is to provide our
shareholders and other interested parties with information necessary to gain an understanding of
our financial condition, changes in financial condition and results of operations. As such, we seek
to satisfy three principal objectives:
</DIV>

<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>to provide a narrative explanation of a company&#146;s financial statements &#147;in plain English&#148;
that enables the average investor to see the company through the eyes of management;</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>to enhance the overall financial disclosure and provide the context within which
financial information should be analyzed; and</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>to provide information about the quality of, and potential variability of, a company&#146;s
earnings and cash flow, so that investors can ascertain the likelihood and relationship of
past performance being indicative of future performance.</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We believe the best way to achieve this is to give the reader:
</DIV>

<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>An understanding of our operating environment and its risks</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>An outline of critical accounting policies</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>A review of our corporate governance structure</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>A review of the key components of the financial statements and our cash position and capital
resources</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>A review of the important trends in the financial statements and our cash flow</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Disclosure on our internal controls and procedures</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Operating Environment</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We operate in a very competitive business environment. This environment impacts us in the
following ways, further discussed in greater detail under Item&nbsp;1A above.
</DIV>

<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Our Board of Directors has Determined it is in the Company&#146;s and it&#146;s Stockholders&#146;
Interests to Attempt to Sell the Company&#146;s Assets</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>We Face Significant Pricing Pressure and Competition that has Resulted in Our Technology
Being Designed Out Within a Short Time Frame, and Impeded Efforts to Secure New Design Wins</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>New Customer Product Development Has been Delayed. This Resulted in Delays In Revenues.
Further, Where our Products are Delayed, Competitive Products May Reach The Market Before,
or Replace Our Products.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>We Rely on the Schedules and Cooperation of Chip Makers or Other Third Parties to Deliver
Our Technology in Consumer Products. These Third parties Have Their Own Priorities and
Alliances that Delayed or Could Thwart our Sales Efforts to Potential Customers.</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">17
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">


<DIV style="margin-top: 6pt"><TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">



</TABLE>
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">We have experienced a loss from operations in four of the last five fiscal years. In December&nbsp;2005
our revenues were stagnant, with
those from certain of our major customers to decrease significantly in
2006. Revenues from certain of our other
customers appear not to be sustainable in the future. In December&nbsp;2005, two of our three
independent directors resigned and the Chairman of the Board, Chief Executive Officer, Chief
Financial Officer and Secretary resigned from all positions held with the Company other than as a
director, Chairman and Secretary. For these and other reasons, and after exploring other exit
strategies and opportunities, our Board of Directors concluded in December&nbsp;2005 to attempt to sell
the Company either through a sale of assets or a sale of multiple, non-exclusive perpetual licenses
with a subsequent sale of the residual assets and engaged Strategic Equity Group to assist us in
this endeavor. Following such transaction, it is anticipated that the Company would be wound up and
dissolved. The consummation of any such transaction and the determination to wind up and dissolve
is subject to stockholder approval. There is no assurance that the Company will be able to
negotiate an agreement for the sale of assets. There is no assurance that, if such an agreement is
successfully negotiated, that such transaction will be approved by stockholders or consummated.
Further, even if such transaction is consummated, there is no assurance that there will be any
funds available for distribution to stockholders. If such sale and subsequent wind up and
dissolution is not approved, the Board of Directors will be required to explore other alternatives
for the Company and its business.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">We have experienced a loss from operations in four of the last five years. We experienced losses in
the last two years. While our objective and full effort has been on managing a profitable business,
due to the market conditions and factors outlined in this Annual Report on Form 10-K and their
impact on fluctuations in operating expenses and revenues, we no longer believe that we will be
able to generate a positive profit position in any given future period, nor do we believe that is
feasible. We cannot guarantee that we will increase sales of our products and technologies, or that
we will successfully develop and market any additional products, or achieve or sustain future
profitability. We cannot, because of market and business conditions, rely on the sale of shares or
on debt financings in the future. Further, we do not believe that debt or equity financing will be
available as required and as such, have decided to try to sell the assets of the Company.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">The PC and consumer electronics markets are under intense pressure, primarily from retailers, to
reduce selling prices, with resultant pressure to reduce costs. In addition, certain of our
competitors appear to be pursuing a business plan that disregards commercially reasonable pricing
to achieve a larger market penetration even if the penetration will not provide for viable margins
or returns. Cost reductions are driven by lower cost sourcing, often in China, design
simplification and reduction in or substitution of features. Therefore, we have been seeking
commercial acceptance of our products in highly competitive markets. We responded by offering
additional products targeted to each price and quality segment of the market, more aggressively
priced and feature enriched our products and entered new segments, such as cell phones, with
different competitive pressure. Our value proposition that stressed the cost reducing capabilities
of our audio solutions through improved performance from lower cost components as well as product
differentiation that Spatializer technology can deliver, failed to resonate with our targeted
customers in this highly competitive environment. The result was the elimination of features,
including ours, to reduce cost. There is no assurance that our present or contemplated future
products or a repositioned value proposition will achieve or maintain sufficient commercial
acceptance, or if they do, that functionally equivalent products will not be developed by current
or future competitors or customers who had access to significantly greater resources or which are
willing to &#147;give away&#148; their products.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Spatializer does not develop or market semiconductors. That is why we carry no inventory or have
order backlogs that typically are good indicators of near term performance. Rather, we develop
audio algorithms that are embedded on third party processors or semiconductors used by our
customers. While our algorithms are implemented on a wide array of processors, often times a
customer uses a processor where there is no such implementation, or where a competing solution has
been implemented. In this case, our customers request that our algorithm be implemented. While
these requests are typically honored, processor manufacturers must schedule such implementation as
their resources or corporate strategies allow. Therefore, the supply-chain is often quite long and
complicated, which potentially can result in delays or deadlines that may not always coincide with
our customer&#146;s requirements and which are beyond the control of our company<B>. </B>In addition, standards
may be adopted by cell phone system operators or manufacturers that may impede or prevent the
penetration of non-standard technology onto their platforms. Lastly, customer implementation delays
have put off expected cash flow into the future, beyond the time frame of operations based on our
available cash resources.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Therefore, when reviewing the operating results or drawing conclusions with regard to future
performance, these competitive forces and uncertainties must be taken into consideration. Though
there is no absolute long-term visibility, it is likely that our operations would fail if we
attempted to continue long-term in this environment. Hence, the Company&#146;s Board of Directors has
decided to attempt to sell the assets of the Company and liquidate the business, subject to
stockholders&#146; approval.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Critical Accounting Policies</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our discussion and analysis of our financial condition and results of operations are based
upon our consolidated statements, which
</DIV>

<P align="center" style="font-size: 10pt">18
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these
financial statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses based on historical experience and various
other factors that are believed to be reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions. In consultation with our Board of
Directors and Audit Committee, we have identified three accounting policies that we believe are
critical to an understanding of our financial statements. These are important accounting policies
that require management&#146;s most difficult, subjective judgments.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The first critical accounting policy relates to revenue recognition. We recognize revenue from
product sales upon shipment to the customer. License revenues are recognized when earned, in
accordance with the contractual provisions. Royalty revenues are recognized upon shipment of
products incorporating the related technology by the original equipment manufacturers (OEMs) and
foundries. These revenues are reported to us by our Licensees in formal, written royalty reports,
which serve as the basis for our quarterly revenue accruals. Infrequently, certain written reports
are received after our required reporting deadlines, sometimes due to contractual requirements. In
such cases, management tries to obtain verbal reports or informal reports from the Licensee. In the
absence of such information, management may utilize conservative estimates based on information
received or historical trends. In such isolated cases, management strives to under-estimate such
revenues to err on the side of caution. In the event such estimates are used, the revenue for the
following quarter is adjusted based on receipt of the written report. In addition, any error in
Licensee reporting, which is very infrequent, is adjusted in the subsequent quarter when agreed by
both parties as correct.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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&#146;s specific product. There are no
production costs to capitalize as defined in Statement on Financial Accounting Standards No.&nbsp;86.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The third critical accounting policy relates to intangible assets. Our intangible assets
consist primarily of patents. We capitalize all costs directly attributable to patents and
trademarks, consisting primarily of legal and filing fees, and amortize such costs over the
remaining life of the asset (which range from 3 to 20&nbsp;years) using the straight-line method. In
accordance with SFAS 142, &#147;Goodwill and Other Intangible Assets&#148;, only intangible assets with
definite lives are amortized. Non-amortized intangible assets are instead subject to annual
impairment testing.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Corporate Governance</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<I>Audit Committee</I>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;This committee is directed to review the scope, cost and results of the independent audit of
our books and records, the results of the annual audit with management and the internal auditors
and the adequacy of our accounting, financial, and operating controls; to recommend annually to the
Board of Directors the selection of the independent auditors; to approve proposals made by our
independent auditors for consulting work; and to report to the Board of Directors, when so
requested, on any accounting of financial matters. Gilbert Segel was the only independent director
on this committee. Mr.&nbsp;Segel resigned from our Board of Directors in December&nbsp;2005. Mr.&nbsp;Mandell,
Chairman of the Board and Secretary of the Company, served as ex-officio member of the Audit
Committee during fiscal year 2005. Mr.&nbsp;Mandell resigned his employment with Company effective
January&nbsp;6, 2006. There were no members of the committee upon the resignation of Mr.&nbsp;Segel.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<I>Compensation and Stock Committee</I>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our Compensation and Stock Option Committee (the &#147;Compensation Committee&#148;) consisted of
Messrs.&nbsp;Pace and Segel, each of whom was a non-employee director of the Company and a
&#147;disinterested person&#148; with respect to the plans administered by such committee, as such term is
defined in Rule&nbsp;16b-3 adopted under the Securities Exchange Act of 1934, as amended, and the rules
and regulations thereunder (collectively, the &#147;Exchange Act&#148;). The Compensation Committee reviews
and approves annual salaries, bonuses and other forms and items of compensation for our senior
officers and employees. Except for plans that are, in accordance with their terms or as required by
law, administered by the Board of Directors or another particularly designated group, the
Compensation Committee also administers and implements all of our stock option and other
stock-based and equity-based benefit plans (including performance-based plans), recommends changes
or additions to those plans or awards under the plans. Messrs.&nbsp;Pace and Segel resigned as directors
in December&nbsp;2005.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Our Audit Committee and Compensation and Stock Committee charters are available in print to any
stockholder upon request in
</DIV>

<P align="center" style="font-size: 10pt">19
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">writing to our principal corporate office at 2025 Gateway place, Suite
365, San Jose, California 95110.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Key Components of the Financial Statements and Important Trends</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The financial statements, including the Consolidated Balance Sheets, the Consolidated
Statements of Cash Flows and the Consolidated Statements of Stockholders&#146; Equity, should be read in
conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this
report. MD&#038;A explains the key components of each of these financial statements, key trends and
reasons for reporting period-to-period fluctuations.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Consolidated Balance Sheet provides a snapshot view of our financial condition at the end
of our fiscal year. A balance sheet helps management and our stockholders understand the financial
strength and capabilities of our business. Balance sheets can help identify and analyze trends,
particularly in the area of receivables and payables. A review of cash compared to the comparable
year and in relation to ongoing profit or loss can show the ability of the Company to withstand
business variations. The relationship between Current Assets and Current Liabilities Working
capital (current assets less current liabilities) measures how much in liquid assets a company has
available to build its business. The presence of Deferred Revenue indicates cash received
on revenue to be earned over the next twelve months. Receivables that are substantially higher than
revenue for the quarter may indicate a slowdown of collections, with an impact on future cash
position. This is addressed further in MD&#038;A under <I>Liquidity and Capital Resources.</I>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Consolidated Statement of Operations tells the reader whether the Company had a profit or
loss. It shows key sources of revenue and major expense categories. It is important to note
period-to-period comparisons of each line item of this statement, reasons for any fluctuation and
how costs are managed in relation to the overall revenue trend of the business. These statements
are prepared using accrual accounting under generally accepted accounting standards in the United
States. This is addressed further in MD&#038;A under Revenues and Expenses.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Consolidated Statement of Cash Flows explains the actual sources and uses of cash. Some
expenses of the Company, such as depreciation and amortization do not result in a cash outflow in
the current period, since the underlying patent expenditure or asset purchase was made years
earlier. New capital expenditures, on the other hand, result in a disbursement of cash, but will be
expensed in the Consolidated Statement of Operations over its useful life. Fluctuations in
receivables and payables also explain why the net change in cash is not equal to the loss reported
on the Statement of Operations. Therefore, it is possible that the impact of a net loss on cash is
less or more than the actual amount of the loss. This is discussed further in MD&#038;A under <I>Liquidity
and Capital Resources.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Consolidated Statement of Changes in Stockholders&#146; Equity shows the impact of the
operating results on the Company&#146;s equity. In addition, this statement shows new equity brought
into the Company through stock sales or stock option exercise. This is discussed further in MD&#038;A
under <I>Liquidity and Capital Resources.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Results of Operations</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The following discussion and analysis relates to our financial condition and results of
operations for the year ended December&nbsp;31, 2005 compared to the year ended December&nbsp;31, 2004, and
the year ended December&nbsp;31, 2004 compared to the year ended December&nbsp;31, 2003. The following
discussion of the financial condition and results of operations should be read in conjunction with
the Consolidated Financial Statements and Notes thereto included elsewhere in this report.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>For the Year Ended December&nbsp;31, 2005, Compared to the Year Ended December&nbsp;31, 2004</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>Revenues</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Revenues increased to $1,192,000 for the year ended December&nbsp;31, 2005 compared to $1,106,000
for the year ended December&nbsp;31, 2004, an increase of 8%. Revenues are almost entirely comprised of
royalties pertaining to the licensing of Spatializer<SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP> audio signal processing algorithms.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The increase in revenue resulted from a greater recognition of deferred revenue in the current
year, as compared to the prior year, in which a royalty advance was received. In addition, revenues
increased from royalties on a third party semiconductor used in cellular phones, as compared to the
prior year. This was partially offset by declining revenues from two accounts whose products using
our technology reached end of life. Their new models do not utilize our technology.
</DIV>

<P align="center" style="font-size: 10pt">20
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>Gross Profit</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Gross profit increased to $1,086,000 for the year ended December&nbsp;31, 2005 compared to $995,000
in the comparable period last year, an increase of 9%. Gross margin was 91% of revenue in the year
ended December&nbsp;31, 2005 compared with 90% of revenue for the comparable period last year. The
increase in gross profit resulted from higher revenues in fiscal 2005. We maintain a high margin
since revenues are from licensing and royalty activities, which have little or no associated direct
manufacturing or selling costs other than commissions paid to our independent representatives that
solicit and oversee the particular accounts. All development costs are expensed as engineering and
development expenses in the period they are incurred.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>Operating Expenses</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Operating expenses for the year ended December&nbsp;31, 2005 increased to $1,177,000 (99% of sales)
from $1,146,000 (105% of sales) for the year ended December&nbsp;31, 2004, an increase of 3%. The
increase in operating expenses resulted primarily from increases in general and administrative
expense and sales and marketing expense. General and Administrative expenses increased due to
higher legal and audit expenses. Sales and marketing expenses increased due to higher travel
expenses resulting from more overseas licensing trips.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>General and Administrative</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;General and administrative expense increased to $670,000 for the year ended December&nbsp;31, 2005
from $615,000 for the year ended December&nbsp;31, 2004, an increase of 9%. The increase is primarily
due to increased legal and accounting expenses related to public filings, in part in response to
the additional requirements imposed on public companies by the Sarbanes-Oxley Act, and to increased
travel costs by the CEO. General operating costs include rent, telephone, legal, public filing,
office supplies and stationery, postage, depreciation and similar costs.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>Research and Development</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Research and Development costs decreased to $354,000 for the year ended December&nbsp;31, 2005,
compared to $393,000 for the year ended December&nbsp;31, 2003, a decrease of 10%. The decrease in
research and development expense was due to the commencement of the use of lower cost applications
engineering consultants in India in the second half of 2004 and the elimination of an in-house
applications engineering position in early 2005. The number of projects completed by the Indian
engineering firm were higher in 2005 as compared to 2004, partially offsetting the savings from the
eliminated in-house engineering staff position.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We continued efforts to identify, validate, and develop new product ideas at DPI. Specific
engineering efforts were directed toward the launch of Spatializer ((environ)) 3G and applications
engineering to port our technology to leading processor platforms.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>Sales and Marketing</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Sales and Marketing costs increased to $152,000 for the year ended December&nbsp;31, 2005, compared
to $138,000 for the year ended December&nbsp;31, 2004, an increase of 10%. The increase in such expenses
resulted from higher international travel in search of new licensing arrangements.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>Net Income (Loss)</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Net loss was $81,000 for the year ended December&nbsp;31, 2005; ($0.00) basic per share, compared
to net loss of $157,000, ($0.00) per share basic and diluted, for the year ended December&nbsp;31, 2004.
The reduction in net loss for the current period is primarily the result of higher revenue,
partially offset by higher overhead.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>For the Year Ended December&nbsp;31, 2004, Compared to the Year Ended December&nbsp;31, 2003</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>Revenues</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Revenues decreased to $1,106,000 for the year ended December&nbsp;31, 2004 compared to $1,269,000
for the year ended December&nbsp;31, 2003, a decrease of 13%. Revenues are almost entirely comprised of
royalties pertaining to the licensing of Spatializer<SUP style="font-size: 85%; vertical-align: text-top">&#174;</SUP> audio
</DIV>

<P align="center" style="font-size: 10pt">21
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">signal processing algorithms.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;While the overall decrease was relatively modest, the revenue mix by licensee platform was
significantly different year over year. The decrease in revenues is attributed primarily to the
loss or reduction at three key DVD player accounts and one PC account which in aggregate, generated
approximately 56% of total fiscal 2003 revenue. In each case, these licensees decided to use no
licensed virtual surround solution or opted for a free solution from their chip supplier, driven
primarily by cost reduction pressure. These losses were partially offset by three new revenue
sources in cellular phones, mobile audio semiconductors and PCs, and the expansion of an existing
license relating to recordable DVD.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>Gross Profit</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Gross profit decreased to $995,000 for the year ended December&nbsp;31, 2004 compared to $1,147,000
in the comparable period last year, a decrease of 13%. Gross margin held steady at 90% of revenue
in the year ended December&nbsp;31, 2004 compared with 90% of revenue for the comparable period last
year. The decrease in gross profit results from lower revenues in the current year We maintain a
high margin since revenues are from licensing and royalty activities, which have little or no
associated direct manufacturing or selling costs other than commissions paid to our independent
representatives that solicit and oversee the particular accounts. All development costs are
expensed as engineering and development expenses in the period they are incurred.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>Operating Expenses</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Operating expenses for the year ended December&nbsp;31, 2004 decreased to $1,146,000 (105% of
sales) from $1,631,000 (128% of sales) for the year ended December&nbsp;31, 2003, a decrease of 30%. The
decrease in operating expenses results primarily from reductions in general and administrative
expense and sales and marketing expense. General and Administrative expenses declined due to the
relocation to smaller and less expensive offices in December&nbsp;2003 and lower occupancy-related
expenses. Sales and marketing expenses declined due to the elimination of a marketing and business
development executive position and related travel in the fourth quarter of 2003 and the
restructuring of our Japan sales operation. These responsibilities were transferred to another
executive and to a new commissioned representative firm in Japan.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>General and Administrative</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;General and administrative expense decreased to $615,000 for the year ended December&nbsp;31, 2004
from $811,000 for the year ended December&nbsp;31, 2003, a decrease of 24%. The decrease is primarily
due to the relocation of our offices to smaller and lower cost facilities in December&nbsp;2003, upon
expiration of an existing lease, lower occupancy related expenses, partially offset by increased
legal and accounting expenses related to public filings, in part in response to the additional
requirements imposed on public companies by the Sarbanes-Oxley Act and increased travel by the CEO.
General operating costs include rent, telephone, legal, public filing, office supplies and
stationery, postage, depreciation and similar costs.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>Research and Development</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Research and Development costs decreased to $393,000 for the year ended December&nbsp;31, 2004,
compared to $459,000 for the year ended December&nbsp;31, 2003, a decrease of 14%. The decrease in
research and development expense was due to the commencement of the use of lower cost specialist
consultants in India in the second half of 2004.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We continued efforts to identify, validate, and develop new product ideas at DPI. Specific
engineering efforts were directed toward the launch of Spatializer Audio Alchemy, refinement of
Spatializer Natural Headphone, development of new cell phone solutions and applications engineering
to port our technology to leading processor platforms.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>Sales and Marketing</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Sales and Marketing costs decreased to $138,000 for the year ended December&nbsp;31, 2004, compared
to $361,000 for the year ended December&nbsp;31, 2003, a decrease of 62%. The reduction in such expenses
resulted from the elimination of a sales consultant position, the elimination of a sales executive
position in the third quarter of 2003 and fewer trade show participations.
</DIV>


<P align="center" style="font-size: 10pt">22
</DIV>


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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B><I>Net Income (Loss)</I></B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Net loss was $157,000 for the year ended December&nbsp;31, 2004; ($0.00) basic per share, compared
to net loss of $495,000, ($0.01) per share basic and diluted, for the year ended December&nbsp;31, 2003.
Net loss for the current period is primarily the result of lower revenue, partially offset by lower
overhead.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Liquidity and Capital Resources</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;At December&nbsp;31, 2005, we had $551,000 in cash and cash equivalents as compared to $871,000 at
December&nbsp;31, 2004. The decrease in cash resulted from full recognition of deferred income, the net
loss, a decrease in accounts payable and a decrease in notes payable, partially offset by a
decrease in accounts receivable. Deferred income decreased due to full revenue realization of a
prior year licensing prepayment and accounts receivable decreased due to reduced year over year
revenue. We had working capital of $560,000 at December&nbsp;31, 2005 as compared with working capital
of $586,000 at December&nbsp;31, 2004.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Net cash used by operating activities was $256,568 for the year ended December&nbsp;31, 2005, as
compared to net cash provided by operating activities of $343,939 for the year ended December&nbsp;31,
2004 and net cash used by operating activities of $253,965 for the year ended December&nbsp;31, 2003.
The decrease in cash flows from operations for the year ended December&nbsp;31, 2005 was primarily a
result of the decrease in deferred income, the net loss, a decrease in accounts payable and notes
payable, partially offset by a decrease in accounts receivable.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We use cash in investing activities primarily to secure patent and trademark protection for
our proprietary technology and brand name, and to purchase short-term investments such as bank
certificates of deposit. Cash used in investing activities totaled $8,145, $20,587 and $20,709,
respectively, in the years ended December&nbsp;31, 2005, 2004, and 2003. All expenditures for on-going
research and development are expenses and therefore included in the Net Loss.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Net cash flows used in financing activities totaled $55,809 and $41,994 for the year ended
December&nbsp;31, 2005 and 2004, respectively. Cash provided by financing activities totaled $5,746 for
the years ended December&nbsp;31, 2003.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In December&nbsp;2005, the Company, as stipulated by the related Subscription Agreement, forced the
conversion of all outstanding Series&nbsp;B-1 Preferred Stock, into Restricted Common Stock at the
minimum conversion price of $.56 per share. This resulted in the issuance of 1,788,018 Common Stock
shares, worth approximately $100,000 at market value at issuance. This issuance diluted existing
common stockholders by approximately 4%, but eliminated $1.1&nbsp;million in liquidation preference
shares.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In the fourth quarter of 2003, we negotiated and completed the conversion of a $112,500
related party 10% demand note to a three-year 10% term note. Principal and interest of $5,191 is
paid monthly, which we pay on a current basis. Since the director who was an indirect beneficiary
of the demand note retired from the Board of Directors in June&nbsp;2003, the demand note is classified
as a note payable at December&nbsp;31, 2004. There are no installments due in more than twelve months
as of December&nbsp;31, 2004.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Future payments due under operating lease obligations as of December&nbsp;31, 2005 are described
below:
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="40%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="19" style="border-bottom: 1px solid #000000"><B>Payments due by period</B></TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3"><B>Less than</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3"><B>More than</B></TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="center" style="border-bottom: 1px solid #000000"><B>Contractual obligations</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>Total</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>1 year</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>1-3 years</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>3-5 years</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>5 years</B></TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Long-Term Debt Obligations</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Capital Lease Obligations</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Operating Lease Obligations</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">26,900</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">26,700</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">200</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Purchase Obligations</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Total</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">26,900</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">26,700</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">200</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In the event the Company is to be would up and dissolved the Company would attempt to settle
these amounts, negotiate early termination, or pay the remaining obligation if cash resources
permitted.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our future cash flow will come primarily from the audio signal processing licensing and OEM
royalties until or if our efforts to sell the assets of the company, with stockholders approval, is consummated and in that case
from any net proceeds from the sale of
</DIV>

<P align="center" style="font-size: 10pt">23
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">assets or perpetual licenses. The Board of Directors will,
with the approval of the stockholders, decide on the dispensation of such proceeds.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The fluid, competitive and dynamic nature of the market continues a high degree of uncertainty
to our operations. The operations of our business, and those of our competitors, are also 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. In addition, the commoditization of
many consumer electronics segments, our lack of resources and the departure of key employee and
directors has made it unfeasible to continue to compete.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Based on current and projected operating levels, we no longer believe that we can maintain our
liquidity position at a consistent level both on a short-term and long-term basis. As such, we do
not believe our current cash reserves and cash generated from our existing operations and customer
base are sufficient for us to meet our operating obligations and the anticipated additional
research and development for our audio technology business for at least the next 12&nbsp;months.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;On January&nbsp;10, 2006, the Company announced that it would hold an open auction for the sale of
substantially all of its assets. The Board of Directors of the Company decided that it is in the
best interests of the stockholders to hold an open auction for the acquisition of the assets of the
Company or the granting of an unlimited amount of non-exclusive perpetual licenses for a one-time
fee and a subsequent auction of the residual assets. The consummation of any of such transactions
will be subject to approval by the stockholders of the Company. The Company received
non-conforming bids for such assets on the February&nbsp;15, 2006 deadline. The Board of Directors of
the company, in consultation with their financial and legal advisors, extended the auction period
to March&nbsp;10, 2006, to provide bidders and other interested parties additional time to clarify their
offers and perform due diligence, as well as to solicit additional offers. Negotiations continue
with auction participants who submitted bids by March&nbsp;10, 2006 and will announce its decision upon
completion of its evaluation of such bids.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Net Operating Loss Carry forwards</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;At December&nbsp;31, 2005, we had net operating loss carry forwards for Federal income tax purposes
of approximately $26,500,000 which are available to offset future Federal taxable income, if any,
through 2014. Approximately $21,700,000 of these net operating loss carry forwards is subject to an
annual limitation of approximately $1,000,000.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Recently Issued Accounting Pronouncements</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In December&nbsp;2004, the Financial Accounting Standards Board (&#147;FASB&#148;) issued SFAS No.&nbsp;123R,
&#147;Share Based Payment&#148;. This Statement is a revision of FASB Statement No.&nbsp;123, &#147;Accounting for
Stock-Based Compensation&#148;. This Statement supersedes APB Opinion No.&nbsp;25, &#147;Accounting for Stock
Issued to Employees&#148; and its related implementation guidance. This Statement establishes standards
for the accounting for transactions in which an entity exchanges its equity instruments for goods
or services. It also addresses transactions in which an entity incurs liabilities in exchange for
goods or services that are based on the fair value of the entity&#146;s equity instruments or that may
be settled by the issuance of those equity instruments. The Statement focuses primarily on
accounting for transactions in which an entity obtains employee services in share-based payment
transactions. This Statement does not change the accounting guidance for share-based payment
transactions with parties other than employees provided in Statement 123 as originally issued and
EITF Issue No.&nbsp;96-18, &#147;Accounting for Equity Instruments That Are Issued to Other Than Employees
for Acquiring, or in Conjunction with Selling, Goods or Services.&#148; This Statement does not address
the accounting for employee share ownership plans, which are subject to AICPA Statement of Position
93-6, &#147;Employers&#146; Accounting for Employee Stock Ownership Plans&#148;. The Securities and Exchange
Commission has delayed the adoption requirement of SFAS No.&nbsp;123R until the first annual reporting
period beginning after December&nbsp;15, 2005. We adopted SFAS No.&nbsp;123R as of January&nbsp;1, 2006 as
required.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">In May&nbsp;2005 the FASB issued SFAS 154 &#147;Accounting Changes and Error Corrections&#148;. This Statement
replaces APB Opinion No.&nbsp;20, &#147;Accounting Changes&#148;, and FASB Statement No.&nbsp;3, &#147;Reporting Accounting
Changes in Interim Financial Statements&#148;, and changes the requirements for the accounting for and
reporting of a change in accounting principle and also corrections of error in previously issued
financial statements. This Statement harmonizes US accounting standards with existing international
accounting standards by requiring companies to report voluntary changes in accounting principles
via a retrospective application, unless impracticable. Also, the reporting of an error correction
involves adjustments to previously issued financial statements similar to those generally
applicable to reporting an accounting change retrospectively. This pronouncement is effective for
accounting changes and corrections of errors made in fiscal years beginning after December&nbsp;15, 2005
</DIV>
<DIV align="left">
<A name="111"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;7A. </B><B><I>Quantitative and Qualitative Disclosures About Market Risk</I></B>
</DIV>


<P align="center" style="font-size: 10pt">24
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">We have not been exposed to material future earnings or cash flow fluctuations from changes in
interest rates on our short-term investments at December&nbsp;31, 2005. 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.
</DIV>


<P align="center" style="font-size: 10pt">25
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left">
<A name="112"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;8. </B><B><I>Financial Statements and Supplementary Data</I></B>
</DIV>


<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>REPORT of REGISTERED PUBIC ACCOUNTING FIRM</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>To the Board of Directors of Spatializer Audio Laboratories, Inc.:</B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We have audited the accompanying consolidated balance sheets of Spatializer Audio
Laboratories, Inc. and subsidiaries (The &#147;Company&#148;) as of December&nbsp;31, 2005 and 2004 and the
related consolidated statements of operations, shareholders&#146; equity, and cash flows for the years
ended December&nbsp;31, 2005, 2004 and 2003. These consolidated financial statements are the
responsibility of the Company&#146;s management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. The Company is not required to, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of internal control
over financial reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of the
Company&#146;s internal control over financial reporting. Accordingly we express no such opinion. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Spatializer Audio Laboratories, Inc. and subsidiaries
as of December&nbsp;31, 2005 and 2004, and the results of its operations and its cash flows for the
years ended December&nbsp;31, 2005, 2004 and 2003 in conformity with accounting principles generally
accepted in the United States of America.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The accompanying financial statements have been prepared assuming that the Company will
continue as a going concern. As discussed in Note 2 to the financial statements, the Company&#146;s
significant operating losses raise substantial doubt about its ability to continue as a going
concern. The financial statements do not include any adjustments that might result from the outcome
of this uncertainty.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">/s/ FARBER HASS HURLEY &#038; MCEWEN LLP

</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Camarillo, California<BR>
February&nbsp;24, 2006

</DIV>

<P align="center" style="font-size: 10pt">26
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>SPATIALIZER AUDIO LABORATORIES, INC.<BR>
AND SUBSIDIARIES</B>
</DIV>

<DIV align="left">
<A name="113"></A>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 6pt"><B>CONSOLIDATED BALANCE SHEETS</B></DIV>


<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="76%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>December 31,</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>December 31,</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2005</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2004</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:105px; text-indent:-15px">ASSETS</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Current Assets:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Cash and Cash Equivalents</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">550,633</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">871,155</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Accounts Receivable</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">155,233</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">325,712</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Prepaid Expenses and Other Current Assets</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">34,104</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">70,940</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:60px; text-indent:-15px">Total Current Assets</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">739,970</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,267,807</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Property and Equipment, Net</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">18,403</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">29,527</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Intangible Assets, Net</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">138,548</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">166,710</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">TOTAL ASSETS</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">896,921</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,464,044</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">LIABILITIES AND STOCKHOLDERS&#146; EQUITY</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Current Liabilities:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Notes Payable</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">10,443</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">66,252</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Accounts Payable</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">14,195</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">71,873</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Accrued Wages and Benefits</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">48,095</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">50,446</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Accrued Professional Fees</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">34,000</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">20,000</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Accrued Commissions</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">31,917</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">32,182</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Accrued Expenses</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">40,869</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">32,979</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Deferred Income</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">391,395</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD colspan="7" align="left" style="border-top: 1px solid #000000">&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:60px; text-indent:-15px">Total Current Liabilities</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">179,519</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">665,127</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Commitments and Contingencies</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Series&nbsp;B-1 Redeemable Convertible Preferred Shares, $0.01 par value:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">1,000,000 shares authorized; 118,351 shares issued and outstanding
at December&nbsp;31, 2004 (liquidation preference of $1,183,510)</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,182</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Stockholders&#146; Equity (Deficit):</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:75px; text-indent:-15px">Common shares, $0.01 par value; 65,000,000 shares authorized;
48,763,383 and 46,975,363 shares issued and outstanding at
December&nbsp;31, 2005 and 2004, respectively</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">469,772</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">469,754</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:75px; text-indent:-15px">Additional Paid-In Capital</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">46,430,030</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">46,428,866</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:75px; text-indent:-15px">Accumulated Deficit</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(46,182,400</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(46,100,885</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:90px; text-indent:-15px">Total Shareholders&#146; Equity</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">717,402</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">797,735</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Total Liabilities and Shareholders&#146; Equity</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">896,921</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,464,044</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="center" style="font-size: 10pt; margin-top: 18pt">See accompanying notes to consolidated financial statements
</DIV>


<P align="center" style="font-size: 10pt">27
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">




<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>SPATIALIZER AUDIO LABORATORIES, INC.<BR>
AND SUBSIDIARIES</B>
</DIV>

<DIV align="left">
<A name="114"></A>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 6pt"><B>CONSOLIDATED STATEMENTS OF OPERATIONS</B></DIV>


<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="64%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="10" style="border-bottom: 1px solid #000000"><B>Year Ended December 31,</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2005</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2004</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2003</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Revenues:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Royalty Revenues</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,192,447</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,105,923</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,269,286</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Cost of Revenues</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">106,062</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">111,395</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">122,417</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,086,385</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">994,528</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,146,869</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Operating Expenses:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">General and Administrative</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">670,124</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">615,412</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">811,024</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Research and Development</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">354,138</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">393,004</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">458,940</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Sales and Marketing</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">152,473</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">137,889</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">360,692</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,176,735</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,146,305</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,630,656</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Operating Income (Loss)</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(90,350</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(151,777</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(483,787</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Interest Income</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">13,230</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">4,982</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">7,201</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Interest Expense</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(5,269</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(10,295</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(13,447</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">7,961</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(5,313</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(6,246</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Income (Loss) Before Income Taxes</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(82,389</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(157,090</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(490,033</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Income Taxes</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">874</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(400</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(5,420</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Net Income (Loss)</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(81,515</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(157,490</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(495,453</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Basic and Diluted Income (Loss) per Share:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(.00</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(.00</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(.01</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Weighted-Average Shares Outstanding</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">46,990,059</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">46,975,363</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">47,309,171</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="center" style="font-size: 10pt; margin-top: 18pt">See accompanying notes to consolidated financial statements
</DIV>


<P align="center" style="font-size: 10pt">28
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">




<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>SPATIALIZER AUDIO LABORATORIES, INC.<BR>
AND SUBSIDIARIES</B>
</DIV>
<DIV align="left">
<A name="115"></A>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 6pt"><B>CONSOLIDATED STATEMENTS OF CASH FLOWS</B>
</DIV>

<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="64%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="10" style="border-bottom: 1px solid #000000"><B>Year Ended December 31,</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2005</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2004</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2003</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Cash Flows from Operating Activities:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Net Income (Loss)</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(81,515</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(157,490</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(495,453</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Adjustments to Reconcile Net Income (Loss) to
Net Cash Provided (Used) by Operating
Activities:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Depreciation</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">16,401</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">11,942</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">30,591</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Amortization</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">31,030</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">46,915</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">52,313</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Stock and Options Issued for Services</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,000</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">12,000</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Net Change in Assets and Liabilities:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Accounts Receivable</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">170,479</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">19,699</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">153,612</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Prepaid Expenses, Deposits and Other Assets</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">36,836</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(35,510</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">55,960</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Accounts Payable</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(57,678</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">50,407</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(17,561</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Accrued Expenses and Other Liabilities</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">18,274</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">16,581</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(45,427</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Deferred Revenue</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(391,395</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">391,395</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
</TR>


<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>

<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net Cash Provided (Used) by Operating Activities</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(256,568</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">343,939</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(253,965</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Cash Flows from Investing Activities:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Purchase of Property and Equipment</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(5,277</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(4,007</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1,771</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Intangible Assets</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(2,868</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(16,580</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(18,938</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net Cash Used by Investing Activities</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(8,145</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(20,587</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(20,709</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Cash Flows from Financing Activities:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Conversion of B-1 Pfd to Common Stock</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">10,000</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Notes Payable</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(55,809</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">66,252</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Notes and Amounts Due to (from)&nbsp;Related Parties</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(108,246</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">108,246</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Repayments/Termination of Notes Payable</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(112,500</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net Cash Provided (Used) by Financing Activities</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(55,809</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(41,994</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">5,746</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Increase (Decrease) in Cash and Cash Equivalents</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(320,522</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">281,358</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(268,928</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Cash and Cash Equivalents, Beginning of Year</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">871,155</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">589,797</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">858,725</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Cash and Cash Equivalents, End of Year</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">550,633</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">871,155</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">589,797</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Supplemental Disclosure of Cash Flow Information</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Cash Paid During the Year for:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Interest</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">5,269</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">10,295</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">11,250</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Income Taxes</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">400</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">4,800</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="center" style="font-size: 10pt; margin-top: 18pt">See accompanying notes to consolidated financial statements
</DIV>


<P align="center" style="font-size: 10pt">29
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">




<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>SPATIALIZER AUDIO LABORATORIES, INC.<BR>
AND SUBSIDIARIES</B>
</DIV>
<DIV align="left">
<A name="116"></A>
</DIV>


<DIV align="center" style="font-size: 10pt; margin-top: 6pt"><B>CONSOLIDATED STATEMENTS OF STOCKHOLDERS&#146; EQUITY (DEFICIT)</B>
</DIV>

<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="23%">&nbsp;</TD>
    <TD width="4%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="4%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="4%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="4%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="4%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="4%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="4%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="6"><B>10% Series B Convertible</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>Common</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="6">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="6" style="border-bottom: 1px solid #000000"><B>Preferred Shares</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>Shares</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="6" style="border-bottom: 1px solid #000000"><B>Common Shares</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>Additional</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>Total</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>Number of</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>Par</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>Number of</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>Par</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>Paid-In-</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>Accumulated</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>Shareholders&#146;</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>Shares</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>Value</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>Shares</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>Value</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>Capital</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>Deficit</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>Equity</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Balance, December&nbsp;31, 2002</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">-0-</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD nowrap align="right">-0-</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">47,406,939</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">474,070</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">46,402,550</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(45,447,942</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,428,678</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options Exercised Warrants
Exercised</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">166,666</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,667</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">8,333</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">10,000</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options Issued for Services</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">12,000</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">12,000</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Cancellation of Unissued
Performance Shares</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(557,740</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(5,578</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">5,578</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net Loss</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(495,453</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(495,453</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>

    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Balance, December&nbsp;31, 2003</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">-0-</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD nowrap align="right">-0-</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">47,015,865</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">470,159</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">46,428,461</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(45,943,395</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">955,225</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Cancellation of Unissued
Performance Shares</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(40,500</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(405</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">405</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net Loss</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(157,490</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(157,490</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>

    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>

<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Balance, December&nbsp;31, 2004</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">-0-</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD nowrap align="right">-0-</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">46,975,365</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">469,754</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">46,428,866</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(46,100,885</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">797,735</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Conversion of Series&nbsp;B-1 Pfd
to Common Shares</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,788,018</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">18</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,164</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,182</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net Loss</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(81,515</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(81,515</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD colspan="27" nowrap align="left" style="border-top: 1px solid #000000">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Balance, December&nbsp;31, 2005</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">-0-</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD nowrap align="right">-0-</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">48,763,383</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">469,772</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">46,430,030</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(46,182,400</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">717,402</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000; border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000; border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000; border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000; border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000; border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD colspan="7" align="left" style="border-top: 1px solid #000000">&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="center" style="font-size: 10pt; margin-top: 18pt">See accompanying notes to consolidated financial statements
</DIV>


<P align="center" style="font-size: 10pt">30
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">




<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>SPATIALIZER AUDIO LABORATORIES, INC.<BR>
AND SUBSIDIARIES</B>
</DIV>

<DIV align="left">
<A name="117"></A>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 6pt"><B>NOTES TO CONSOLIDATED FINANCIAL STATEMENTS</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(1)&nbsp;Nature of Business</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Spatializer Audio Laboratories, Inc. and subsidiaries (the &#147;Company&#148;) is in the business of
developing and licensing technology. The Company sales, research and subsidiary administration are
conducted out of facilities in San Jose, California.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company&#146;s wholly-owned subsidiary, Desper Products, Inc. (&#147;DPI&#148;), 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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(2)&nbsp;Significant Accounting Policies</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Basis of Consolidation &#151; </B>The consolidated financial statements include the accounts of
Spatializer Audio Laboratories, Inc. and its wholly-owned subsidiary, Desper Products, Inc. All
significant intercompany balances and transactions have been eliminated in consolidation. Corporate
administration expenses are not allocated to subsidiaries.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Reclassification &#151; </B>Certain 2003 amounts have been reclassified to conform with the 2004 and
2005 presentation. In that regard, the Company has reflected the issuance of 15,384 shares of Class
B-1 Convertible Preferred Stock that was originally recorded in Additional Paid in Capital. This
resulted in a reclassification of $154 to Convertible Preferred Stock from APIC.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Going Concern </B>&#150; The Company has incurred substantial operating losses in four of the last five
years. Also, license contracts with two of the Company&#146;s largest customers will expire on terms in
2006. Those customers have informed the Company that the contracts will not be renewed nor replaced
with other licenses.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Revenue Recognition &#151; </B>The Company recognizes revenue from product sales upon shipment to the
customer. License revenues are recognized when earned, in accordance with the contractual
provisions. Royalty revenues are recognized upon shipment of products incorporating the related
technology by the original equipment manufacturers (OEMs) and foundries. The Company recognizes
revenue in accordance with SEC Staff Accounting Bulletin 104.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Concentration of Credit Risk &#151; </B>Financial instruments, which potentially subject the company to
concentrations of credit risk, consist principally of cash, cash equivalents and trade accounts
receivable. The Company places its temporary cash investments in certificates of deposit in excess
of FDIC insurance limits, principally at Citibank FSB. At December&nbsp;31, 2005 and 2004, substantially
all cash and cash equivalents were on deposit at one financial institution.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;At December&nbsp;31, 2005, three major customers, not presented in order of importance, each
accounted for 10% or more of our total accounts receivable: Matsushita, Sharp and Funai
Corporation, each of whom accounted for greater than 10% of our total 2005 accounts receivable. One
customer accounted for 52.0%, another accounted for 22% and one accounted for 14% of our total
accounts receivable at December&nbsp;31, 2005. At December&nbsp;31, 2004, three major customers, not
presented in order of importance, each accounted for 10% or more of our total accounts receivable:
Matsushita, Sharp and Toshiba Corporation, each of whom accounted for greater than 10% of our total
2004 accounts receivable. One customer accounted for 31.0%, another accounted for 27% and one
accounted for 18% of our total accounts receivable at December&nbsp;31, 2004.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company does not apply interest charges to past due accounts receivable.
</DIV>

<P align="center" style="font-size: 10pt">31
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Cash and Cash Equivalents &#151; </B>Cash equivalents consist of highly liquid investments with
original maturities of three months or less.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Customers Outside of the U.S.- </B>Sales to foreign customers were 95%, 95% and 91% of total sales
in the years ended December&nbsp;31, 2005 and 2004 and 2003, respectively.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Major Customers &#151; </B>During the year ended December&nbsp;31, 2005, three customers accounted for 42%,
23% and 12%, respectively, of the Company&#146;s net sales. During the year ended December&nbsp;31, 2004,
four customers accounted for 29%, 25%, 21% and 13%, respectively, of the Company&#146;s net sales.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Research and Development Costs &#151; </B>The Company expenses research and development costs as
incurred, which is presented as a separate line on the statement of operations.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Advertising Costs &#151; </B>Costs incurred for producing and communicating advertising are expensed
when incurred and included in selling, general and administrative expenses. Consolidated
advertising expense amounted to $18,931, $4,289 and $2,960 in 2005, 2004 and 2003, respectively.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Property and Equipment &#151; </B>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&nbsp;years to 5&nbsp;years under the straight line method.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Intangible Assets &#151; </B>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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Earnings Per Share &#151; </B>The Company determines earnings per share in accordance with Statement of
Financial Accounting Standards No.&nbsp;128, <I>Earnings Per Share </I>(&#147;SFAS 128&#148;). Basic earnings (loss)&nbsp;per
share is computed by dividing net income (loss)&nbsp;available to common shareholders by the weighted
average number of common shares outstanding during the period. Diluted earnings (loss)&nbsp;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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Since the Company generated a net loss in 2005, 2004 and 2003, outstanding stock options and
warrants would have been anti-dilutive and are not applicable to this calculation.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Stock Option Plan &#151;</B>The Company determines the effect of stock based compensation in accordance
with SFAS No.&nbsp;123, <I>Accounting for Stock-Based Compensation ,as amended </I>which permits entities to
recognize as expense using the &#147;fair-value&#148; method over the vesting period of all employee
stock-based awards on the date of grant. Alternatively, SFAS No.&nbsp;123 allows entities to continue to
utilize the &#147;intrinsic value&#148; method for equity instruments granted to employees and provide pro
forma net income (loss)&nbsp;and pro forma earnings (loss)&nbsp;per share disclosures for employee stock
option grants after 1994 as if the fair-value-based method defined in SFAS No.&nbsp;123 has been
applied. The Company has elected to continue to utilize the &#147;intrinsic value&#148; method for employee
stock option grants and provide the pro forma disclosure provisions of SFAS No.&nbsp;123 (Note 8).
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Impairment
of Long-Lived Assets and Assets to be Disposed of </B>&#151; The Company adopted the
provisions of SFAS No.&nbsp;121, <I>Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed of, </I>on January&nbsp;1, 1996. This Statement requires that long-lived assets and
certain identifiable intangibles be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability
of assets to be held and used is measured by a comparison of the carrying amount of an asset to
future net cash flows expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured as the amount by which the carrying amounts
of the assets exceed the fair value of the assets (see Notes 4). Assets to be disposed of are
reported at the lower of the carrying amount or fair value less costs to sell.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Segment Reporting </B>- The Company adopted SFAS 131, <I>Disclosures about Segments of an Enterprise
and Related Information </I>(&#147;SFAS No.&nbsp;131&#148;), in December&nbsp;1997. MDT has been considered a discontinued
operation since September&nbsp;1998. As of December&nbsp;31, 2002, the Company has only one operating
segment, DPI, the Company&#146;s Audio Signal Processing business.
</DIV>

<P align="center" style="font-size: 10pt">32
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Income Taxes </B>&#151; 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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Recent
Accounting Pronouncements </B>&#151; In December&nbsp;2004, the Financial Accounting Standards Board
(&#147;FASB&#148;) issued SFAS No.&nbsp;123R, &#147;Share Based Payment&#148;. This Statement is a revision of FASB
Statement No.&nbsp;123, &#147;Accounting for Stock-Based Compensation&#148;. This Statement supersedes APB
Opinion No.&nbsp;25, &#147;Accounting for Stock Issued to Employees&#148; and its related implementation guidance.
This Statement establishes standards for the accounting for transactions in which an entity
exchanges its equity instruments for goods or services. It also addresses transactions in which an
entity incurs liabilities in exchange for goods or services that are based on the fair value of the
entity&#146;s equity instruments or that may be settled by the issuance of those equity instruments. The
Statement focuses primarily on accounting for transactions in which an entity obtains employee
services in share-based payment transactions. This Statement does not change the accounting
guidance for share-based payment transactions with parties other than employees provided in
Statement 123 as originally issued and EITF Issue No.&nbsp;96-18, &#147;Accounting for Equity Instruments
That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services.&#148; This Statement does not address the accounting for employee share ownership plans, which
are subject to AICPA Statement of Position 93-6, &#147;Employers&#146; Accounting for Employee Stock
Ownership Plans&#148;. The Securities and Exchange Commission has delayed the adoption requirement of
SFAS No.&nbsp;123R until the first annual period beginning after December&nbsp;15, 2005. We adopted SFAS No.
123R as of January&nbsp;1, 2006 as required.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">In May&nbsp;2005 the FASB issued SFAS 154 &#147;Accounting Changes and Error Corrections&#148;. This Statement
replaces APB Opinion No.&nbsp;20, &#147;Accounting Changes&#148;, and FASB Statement No.&nbsp;3, &#147;Reporting Accounting
Changes in Interim Financial Statements&#148;, and changes the requirements for the accounting for and
reporting of a change in accounting principle and also corrections of error in previously issued
financial statements. This Statement harmonizes US accounting standards with existing international
accounting standards by requiring companies to report voluntary changes in accounting principles
via a retrospective application, unless impracticable. Also, the reporting of an error correction
involves adjustments to previously issued financial statements similar to those generally
applicable to reporting an accounting change retrospectively. This pronouncement is effective for
accounting changes and corrections of errors made in fiscal years beginning after December&nbsp;15,
2005.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company believes that the adoption of these pronouncements may not have a material effect
on the Company&#146;s financial position, results from operations or cash flows. This impact cannot be
determined at this time, as future option grants are indeterminable.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Use of Estimates </B>&#151; 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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Fair Value of Financial Instruments </B>&#151; 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&nbsp;31, 2004 and 2003 approximated fair
value due to their short maturity or nature.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The fair value of notes payable at December&nbsp;31, 2005 is materially consistent with the related
carrying values based on current rates offered to the Company for instruments with similar
maturities.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(3)&nbsp;Property and Equipment</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Property and equipment, as of December&nbsp;31, 2005 and 2004, consists of the following, net of a
reserve for impairment loss in 1998 in accordance with application of SFAS 121:
</DIV>

<P align="center" style="font-size: 10pt">33
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="76%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2005</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2004</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Office Computers, Software, Equipment and Furniture</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">337,145</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">331,867</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Test Equipment</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">73,300</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">73,300</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Tooling Equipment</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">45,539</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">45,539</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Trade Show Booth and Demonstration Equipment</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">174,548</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">174,548</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Automobiles</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">7,000</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">7,000</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Total Property and Equipment</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">637,531</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">632,253</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Less Accumulated Depreciation and Amortization</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">619,128</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">602,727</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Property and Equipment, Net</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">18,403</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">29,527</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(4)&nbsp;Intangible Assets</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Intangible assets, as of December&nbsp;31, 2005 and 2004 consist of the following:
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="76%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2005</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2004</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Capitalized Patent, Trademarks and Technology Costs</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">525,695</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">522,827</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Less Accumulated Amortization</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">387,147</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">356,117</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Intangible Assets, Net</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">138,548</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">166,710</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Estimated amortization is as follows:
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="88%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">2006</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">16,702</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">2007</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">16,702</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">2008</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">16,702</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">2009</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">16,702</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Thereafter</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">71,740</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">138,548</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
Management estimates that the recorded net book value of intangible
assets would be realized through a sale of assets.
</DIV>



<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(5)&nbsp;Notes Payable to Related Parties</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company was indebted to the Premium Finance, Inc., an unrelated insurance premium finance
company, in the amount of $10,443 at December&nbsp;31, 2005. This note finances the Company&#146;s annual
Directors&#146; and Officers&#146; Liability Insurance. This amount bears interest at a fixed rate of 10%
annually, is paid in monthly installments of $5,221 that commenced on June&nbsp;1, 2005 and continues
for nine months until the entire balance of principal and interest is paid in full.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company was indebted to the Desper Family Trust, through November&nbsp;30, 2005, when the note
was paid in full. The Desper Family Trust&#146;s principal beneficiary is the mother of a former
director of the Company. This director&#146;s term expired in June&nbsp;2003 and as such, is not a related
party. This note bore interest at a fixed rate of 10% annually, was paid in monthly installments
of $5,191 that commenced on December&nbsp;1, 2003 and continued for twenty-four months until the entire
balance of principal and interest was paid in full.
</DIV>

<P align="center" style="font-size: 10pt">34
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(6)&nbsp;Shareholders&#146; Equity</B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>During the year ended December&nbsp;31, 2005, shares were issued or converted as follows:</I>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">In December&nbsp;2005, the Company, as stipulated by the related Subscription Agreement, forced the
conversion of all outstanding Series&nbsp;B-1 Preferred Stock, into Restricted Common Stock at the
minimum conversion price of $.56 per share. This resulted in the issuance of 1,788,018 Common Stock
shares.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Options to purchase 75,000 and 100,000 shares of common stock previously granted to an employee, at
exercise prices of $0.27 and $0.05, respectively, were cancelled upon his resignation from the
Company.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Options to purchase a total of 500,000 shares of common stock were granted to the CEO related to
the extension of his employment agreement. These options vested half on issuance and half in
November, 2005, if the executive is in the employ of the Company. These options may be exercised at
a price of $0.10 per share through February, 2010. These options had no value at December&nbsp;31, 2005.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>During the year ended December&nbsp;31, 2004, shares were issued or converted as follows:</I><BR>
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Unissued Performance Shares held in escrow were cancelled.</I>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Options to purchase common shares in exchange for services were issued with a value of $1,000.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Capitalization</B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><B>Series&nbsp;B-1 Redeemable Convertible Preferred Stock: </B>On November&nbsp;6, 2002 the Board of Directors
Designated a Series&nbsp;B-1 Preferred Stock. The series had a par value of $0.01 and a stated value of
$10.00 per share US and was designated as a liquidation preference. The stock ranked prior to the
Company&#146;s common stock. No dividends were to be paid on the Series&nbsp;B-1 Preferred Stock. Conversion
rights vested on January&nbsp;1, 2003 to convert the Series&nbsp;B-1 Preferred Stock to common at a certain
formula based on an average closing share price, subject to a floor of $0.56 and a ceiling of
$1.12. The Series&nbsp;B-1 Preferred Stock has no voting power. Certain restrictions on trading existed
based on date sensitive events based on the Company&#146;s Insider Trading Policy. In December&nbsp;2002,
87,967 shares of Series&nbsp;B-1 Preferred Stock were issued in exchange for the Series&nbsp;B Preferred
Stock and 14,795 shares were issued in lieu of the adjusted accrued dividends on the Series&nbsp;B
Preferred Stock. In 2004, the Company reflected the issuance of 15,384 shares of Series&nbsp;B-1
Convertible Preferred Stock that was originally recorded in Additional Paid in Capital. This
resulted in a reclassification of $154 to Convertible Preferred Stock from APIC. In December&nbsp;2005,
the Company, as stipulated by the related Subscription Agreement, forced the conversion of all
outstanding Series&nbsp;B-1 Preferred Stock, into Restricted Common Stock at the minimum conversion
price of $.56 per share. This resulted in the issuance of 1,788,018 Common Stock shares.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(7)&nbsp;Stock Options</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In 1995, the Company adopted a stock option plan (the &#147;Plan&#148;) pursuant to which the Company&#146;s
Board of Directors may grant stock options to directors, officers and employees. The Plan which was
approved by the stockholders authorizes grants of options to purchase authorized but unissued
common stock up to 10% of total common shares outstanding at each calendar quarter, 4,697,537 as of
September&nbsp;30, 2005. Stock options were granted under the Plan with an exercise price equal to the
stock&#146;s fair market value at the date of grant. Outstanding stock options under the Plan have
five-year terms and vest and become fully exercisable up to three years from the date of grant. The
Plan expired in February&nbsp;2005. To date, the Company has not adopted a new stock option plan.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;There were 500,000 options granted in the quarter ended March&nbsp;31, 2005 to the CEO in
connection with the extension of his employment agreement. These options vested half on issuance
and half in November, 2005. These options may be exercised at a price of $0.10 per share through
February, 2010. The Company cancelled 175,000 options previously granted to an employee, upon his
resignation in January&nbsp;2005. Options to purchase 150,000 shares of common stock expired in the
quarter ended December&nbsp;31, 2005.
</DIV>

<P align="center" style="font-size: 10pt">35
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">At December&nbsp;31, 2004, there were 2,066,339 additional shares available for grant under the Plan.
The per share weighted-average fair value of stock options granted during 2005, 2004 and 2003 was
$0.02, $0.09 and $0.05, respectively, on the date of grant using the Black-Scholes option-pricing
model with the following weighted-average assumptions: 2005- expected dividend yield 0%, risk-free
interest rate of 4.5%, expected volatility of 150% and an expected life of 5&nbsp;years 2004- expected
dividend yield 0%, risk-free interest rate of 4.1%, expected volatility of 150% and an expected
life of 5&nbsp;years; 2003- expected dividend yield 0%, risk-free interest rate of 2.25%, expected
volatility of 137% and an expected life of 5&nbsp;years;
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company applies APB Opinion No.&nbsp;25 in accounting for its Plan and, accordingly, no
compensation cost has been recognized for the fair value of its stock options in the consolidated
financial statements. Had the Company determined compensation cost based on the fair value at the
grant date for its stock options under SFAS No.&nbsp;123, the Company&#146;s net income (loss)&nbsp;would have
been increased to the pro forma amounts indicated below:
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="64%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2005</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2004</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2003</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">NET INCOME (LOSS):</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">As Reported</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(81,515</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(157,490</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(495,453</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Pro Forma</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(89,715</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(172,770</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(538,368</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">BASIC AND DILUTED LOSS:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">As Reported</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.00</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.00</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.01</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Pro Forma</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.00</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.00</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.01</TD>
    <TD nowrap>)</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Stock option activity during the periods indicated is as follows:
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="64%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3"><B>Weighted-Average</B></TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>Exercisable</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>Number</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>Exercise Price</B></TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options outstanding at December&nbsp;31, 2002</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,668,332</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,671,500</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options granted</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,200,000</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.05</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options exercised</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">&nbsp;</TD>
    <TD align="right">(166,666</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.06</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options forfeited/expired</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">&nbsp;</TD>
    <TD align="right">(669,834</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.18</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options outstanding at December&nbsp;31, 2003</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,540,000</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">3,035,000</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.18</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options granted</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">200,000</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.09</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options exercised</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options forfeited</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">&nbsp;</TD>
    <TD align="right">(600,000</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.43</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options outstanding at December&nbsp;31, 2004</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,381,666</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,635,000</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.11</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options granted</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">500,000</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.10</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options exercised</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">&nbsp;</TD>
    <TD align="right">(0</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options forfeited/expired</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">&nbsp;</TD>
    <TD align="right">(325,000</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.31</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD colspan="7" align="left" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Options outstanding at December&nbsp;31, 2005</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,726,666</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,810,000</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.10</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;At December&nbsp;31, 2005, the number of options exercisable was 2,726,666 and the weighted-average
exercise price of those options was $0.10.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(8)&nbsp;Warrants</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Warrant activity for the periods indicated below is as follows:
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">There were no warrants issued and outstanding during the last three years.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(9)&nbsp;Income Taxes</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company files a consolidated return for U.S. income tax purposes. Income tax expense for
the years ended December&nbsp;31, 2005, 2004 and 2003 consisted of the following:
</DIV>

<P align="center" style="font-size: 10pt">36
</DIV>

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<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="64%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2005</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2004</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2003</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">State franchise tax</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">400</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">400</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">4,800</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Federal taxes</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1,274</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(0</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(0</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Total</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">(874</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">400</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">4,800</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Certain revenues received from customers in foreign countries are subject to withholding taxes
that are deducted from outgoing funds at the time of payment. These taxes range from approximately
10% to 16.5% and are recorded as net royalty revenue.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Income tax expense for the years ended December&nbsp;31, 2005, 2004 and 2003 differed from the
amounts computed by applying the U.S. federal income tax rate of 34&nbsp;percent to loss before income
taxes primarily due to the generation of additional net operating loss carry forwards for which no
tax benefit has been provided.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The tax effects of temporary differences that give rise to significant portions of the
deferred tax assets at December&nbsp;31, 2005 is composed primarily of the net loss carry forwards. The
net change in the total valuation allowance for the year ended December&nbsp;31, 2005 was insignificant.
In assessing the realizability of deferred tax assets, management considers whether it is more
likely than not that some portion or all of the deferred tax assets will not be realized. The
ultimate realization of deferred tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become deductible. Management
considers projected future taxable income and tax planning strategies in making this assessment.
Based upon the level of historical taxable losses, management believes it is more likely than not
the Company will not realize the benefits of these deductible differences and has established a
valuation allowance to fully reserve the deferred tax assets at December&nbsp;31, 2005. Additionally,
the ultimate realizability of net operating losses may be limited by change of control provisions
under Section&nbsp;382 of the Internal Revenue Code.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;At December&nbsp;31, 2005, the Company had net operating loss carry forwards for Federal income tax
purposes of approximately $26,500,000 which are available to offset future Federal taxable income,
if any, through 2014. Approximately $21,700,000 of these net operating loss carry forwards are
subject to an annual limitation of approximately $1,000,000.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(10)&nbsp;Commitments and Contingencies</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;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.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><I>Operating Lease Commitments</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company is obligated under several non-cancelable operating leases. Future minimum rental
payments for all operating leases of approximately $27,000 through December, 2006. Rent expense
amounted to approximately $25,000, $23,000 and $ 83,000 for the years ended December&nbsp;31, 2005, 2004
and 2003, respectively.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(11)&nbsp;Profit Sharing Plan</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company has a 401(k) profit sharing plan covering substantially all employees, subject to
certain participation and vesting requirements. The Company may elect to make discretionary
contributions to the Plan, but has never done so over the life of the Plan. The amount charged to
administrative expense for the Plan in 2005, 2004 and 2003 was approximately $2,000 per annum.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(12)&nbsp;Quarterly Financial Data (unaudited)</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The following is a summary of the quarterly results of operations for the years ended December
31, 2005 and 2004:
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="52%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="15" style="border-bottom: 1px solid #000000"><B>Quarter Ended</B></TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="center" style="border-bottom: 1px solid #000000"> <B>2005</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>March 31</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>June 30</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>September 30</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>December 31</B></TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net Revenues</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">331,950</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">428,912</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">270,914</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">160,670</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Gross Margin</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">298,078</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">386,022</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">258,162</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">144,122</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net Income (Loss)</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">10,014</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">57,566</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">36,545</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">$</TD>
    <TD align="right">(186,514</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Basic (Loss) Per Share</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.00</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.00</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.00</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">$</TD>
    <TD align="right">(0.00</TD>
    <TD nowrap>)</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<P align="center" style="font-size: 10pt">37
</DIV>

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<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="52%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="15" style="border-bottom: 1px solid #000000"><B>Quarter Ended</B></TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="center" style="border-bottom: 1px solid #000000"> <B>2004</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>March 31</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>June 30</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>September 30</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>December 31</B></TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net Revenues</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">170,679</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">234,860</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">205,324</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">495,060</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Gross Margin</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">153,675</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">216,727</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">179,210</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">444,916</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net Income (Loss)</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">$</TD>
    <TD align="right">(123,796</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">$</TD>
    <TD align="right">(123,259</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">$</TD>
    <TD align="right">(80,576</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">170,141</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Basic (Loss) Per Share</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">$</TD>
    <TD align="right">(0.00</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">$</TD>
    <TD align="right">(0.00</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="right">$</TD>
    <TD align="right">(0.00</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="right">$</TD>
    <TD align="right">0.00</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(13)&nbsp;Subsequent Events and Management Plans (unaudited)</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;On January&nbsp;10, 2006, the Company announced that it would hold an open auction for the sale of
substantially all of its assets. The Board of Directors of the Company decided that it is in the
best interests of the stockholders to hold an open auction for the acquisition of the assets of the
Company or the granting of an unlimited amount of non-exclusive perpetual licenses for a one-time
fee and a subsequent auction of the residual assets. The consummation of any of such transactions
will be subject to approval by the stockholders of the Company. The Company received
non-conforming bids for such assets on the February&nbsp;15, 2006 auction close deadline. The Board of
Directors of the company, in consultation with their financial and legal advisors, extended the
auction period to March&nbsp;10, 2006, to provide bidders and other interested parties additional time
to clarify their offers and perform due diligence, as well as to solicit additional offers.
Negotiations continue with auction participants who submitted bids by March&nbsp;10, 2006. The Company
will announce its decision and recommendation to the stockholders upon finalization of bids and
completion of its evaluation of such bids.
</DIV>

<P align="center" style="font-size: 10pt">38
</DIV>

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<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left">
<A name="118"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;9. </B><B><I>Change in and Disagreements with Accountants on Accounting and Financial Disclosure</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;None.
</DIV>
<DIV align="left">
<A name="119"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;9A. </B><B><I>Controls and Procedures</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We carried out an evaluation of the effectiveness of our disclosure controls and procedures,
as defined in Rules&nbsp;13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934. Based on
that evaluation, the Chief Executive Officer and Chief Financial Officer had concluded that our
disclosure controls and procedures as of the end of the period covered by this report were
effective to ensure that information required to be disclosed by the Company in reports that it
files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in Securities and Exchange Commission&#146;s rules and forms.
There were no changes in our internal control over financial reporting that occurred during the
quarter ended December&nbsp;31, 2005 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
</DIV>
<DIV align="left">
<A name="120"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;9B. </B><B><I>Other Information</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Not applicable.
</DIV>
<DIV align="left">
<A name="121"></A>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>PART III</B>
</DIV>

<DIV align="left">
<A name="122"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;10. </B><B><I>Directors and Executive Officers of the Registrant</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Information required for this item incorporated by reference to our Proxy Statement for the
2006 Annual Meeting of Stockholders.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Code of Ethics</B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We adopted a Code of Ethics that applies to all of our directors, officers and employees,
including our Chief Executive Officer, our Chief Financial Officer and other senior financial
officers. The Company will provide a copy of our code of ethics to any person, free of charge,
upon written request sent to our principal corporate office at 2025 Gateway Place, Suite&nbsp;365, San
Jose, California 95110.
</DIV>
<DIV align="left">
<A name="123"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;11. </B><B><I>Executive Compensation</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Information required for this item incorporated by reference to our Proxy Statement for the
2006 Annual Meeting of Stockholders.
</DIV>
<DIV align="left">
<A name="124"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>Item&nbsp;12. </B><B><I>Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters</I></B>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>Equity Compensation Plan Information</B>
</DIV>

<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="64%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>Number of securities</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>Number of securities</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>remaining available for</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>to be issued</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>Weighted-average</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>future issuance under</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>upon exercise of</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>exercise price of</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>equity compensation plans</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>outstanding options,</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>outstanding options,</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>(excluding securities</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="center" style="border-bottom: 1px solid #000000"><B>Plan category</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>warrants and rights</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>warrants and rights</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>reflected in column (a))</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>(a)</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>(b)</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>(c)</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Equity
compensation plans
approved by security
holders</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">2,810,000 </TD>
    <TD nowrap>(1)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">0.10 </TD>
    <TD nowrap>(1)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,066,339</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Equity compensation
plans not approved by
security holders</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">0</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Total</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,810,000</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">0.10</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,066,339</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<P align="center" style="font-size: 10pt">39
</DIV>

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<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left">
<DIV style="font-size: 3pt; margin-top: 16pt; width: 18%; border-top: 1px solid #000000">&nbsp;</DIV>
</DIV>

<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">
<TR>
    <TD width="3%"></TD>
    <TD width="1%"></TD>
    <TD width="96"></TD>
</TR>

<TR valign="top">
    <TD nowrap align="left">(1)</TD>
    <TD>&nbsp;</TD>
    <TD>Represents options to acquire the Company&#146;s Common Stock under the Company&#146;s 1995 Stock Option
Plan and 1996 Incentive Plan approved by the Company&#146;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 4,876,339 as at
December&nbsp;31, 2005. Stock options are granted with an exercise price equal to the stock&#146;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.</TD>
</TR>

</TABLE>



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The remaining information is required for this item is incorporated by reference to our Proxy
Statement for the 2005 Annual Meeting of Stockholders.
</DIV>
<DIV align="left">
<A name="125"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;13. </B><B><I>Certain Relationships and Related Transactions</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Information required for this item incorporated by reference to our Proxy Statement for the
2006 Annual Meeting of Stockholders.
</DIV>
<DIV align="left">
<A name="126"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;14. </B><B><I>Principal Accountant Fees and Services</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Information required for this item incorporated by reference to our Proxy Statement for the
2006 Annual Meeting of Stockholders.
</DIV>
<DIV align="left">
<A name="127"></A>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>PART IV</B>
</DIV>

<DIV align="left">
<A name="128"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;15. </B><B><I>Exhibits and Financial Statement Schedules</I></B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(a)&nbsp;Financial Statements
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;See Item&nbsp;8.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(b)&nbsp;Exhibits
</DIV>

<P align="center" style="font-size: 10pt">40
</DIV>

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<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The following Exhibits are filed as part of, or incorporated by reference into, this Report:
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="92%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="left"><B>Exhibit</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="left" style="border-bottom: 1px solid #000000"><B>Number</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" style="border-bottom: 1px solid #000000"><B>Description</B></TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">2.1
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Arrangement Agreement dated as of March&nbsp;4, 1994 among
Spatializer-Yukon, DPI and Spatializer-Delaware (Incorporated by
reference to the Company&#146;s Registration Statement on Form
S-1,Registration No 33-90532, effective August&nbsp;21, 1995.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">3.1
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Certificate of Incorporation of Spatializer-Delaware as filed
February&nbsp;28, 1994. (Incorporated by reference to the Company&#146;s
Registration Statement on Form&nbsp;S-1, Registration No.
33-90532,effective August&nbsp;21, 1995.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">3.2
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Amended and Restated Bylaws of Spatializer-Delaware. (Incorporated
by reference to the Company&#146;s Registration Statement on Form
S-1,Registration No.&nbsp;33-90532, effective August&nbsp;21, 1995.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">3.3
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Certificate of Designation of Series&nbsp;B 10% Redeemable Convertible
Preferred Stock of the Company as filed December&nbsp;27, 1999
(Incorporated by reference to the Company&#146;s Annual Report on
Form 10-K, for the period ended December&nbsp;31, 1999.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">3.4
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Certificate of Amendment of Certificate of Incorporation of the
Company as filed on February&nbsp;25, 2000 (Incorporated by reference to
the Company&#146;s Annual Report on Form&nbsp;10-K, for the period ended
December&nbsp;31, 1999.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">3.5
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Certificate of Designation of Series&nbsp;B-1 Redeemable Convertible
Preferred Stock as filed December&nbsp;20, 2002 (Incorporated by
reference to the Company&#146;s Annual Report on Form&nbsp;10-K, for the
period ended December&nbsp;31, 2002.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">3.6
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Certificate of Elimination of Series&nbsp;A Preferred Stock as filed
December&nbsp;26, 2002 (Incorporated by reference to the Company&#146;s Annual
Report on Form&nbsp;10-K, for the period ended December&nbsp;31,2002.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">3.7
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Certificate of Elimination of Series&nbsp;B Preferred Stock as filed
December&nbsp;26,2002 (Incorporated by reference to the Company&#146;s Annual
Report on Form&nbsp;10-K, for the period ended December&nbsp;31,2002.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">4.1
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Performance Share Escrow Agreements dated June&nbsp;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&#146;s
Registration Statement on Form&nbsp;S-1, Registration No.
33-90532,effective August&nbsp;21, 1995.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">4.2
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Modification Agreement for Escrowed Performance Shares.
(Incorporated by reference to the Company&#146;s Definitive Proxy
Statement dated June&nbsp;28, 1996 and previously filed with the
Commission.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">4.3
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Form of Exchange Agreement effective December&nbsp;26, 2002 entered into
by holders of Series&nbsp;B Preferred Stock in connection with exchange
of same for Series&nbsp;B-1 Preferred Stock (Incorporated by reference to
the Company&#146;s Annual Report on Form&nbsp;10-K, for the period ended
December&nbsp;31, 2002.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">10.1*
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Spatializer-Delaware Incentive Stock Option Plan (1995 Plan).
(Incorporated by reference to the Company&#146;s Registration Statement
on Form&nbsp;S-1, Registration No.&nbsp;33-90532, effective August&nbsp;21,1995.)</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<P align="center" style="font-size: 10pt">41

</DIV>

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<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="5%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="92%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="left"><B>Exhibit</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="left" style="border-bottom: 1px solid #000000"><B>Number</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" style="border-bottom: 1px solid #000000"><B>Description</B></TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">10.2*
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Spatializer-Delaware 1996 Incentive Plan. (Incorporated by reference
to the Company&#146;s Proxy Statement dated June&nbsp;25, 1996 and previously
filed with the Commission.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">10.3*
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Form of Stock Option Agreement (Incorporated by reference to Exhibit
10.3 to the Company&#146;s Annual Report on Form&nbsp;10-K for the period
ended December&nbsp;31, 2004.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">10.4
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">License Agreement dated June&nbsp;29, 1994 between DPI and MEC.
(Incorporated by reference to the Company&#146;s Registration Statement
on Form&nbsp;S-1, Registration No.&nbsp;33-90532, effective August&nbsp;21,1995.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">10.5*
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Employment Agreement dated November&nbsp;12, 2004, between the Company
and Henry Mandell, as amended. (Incorporated by reference to Exhibit
10.5 to the Company&#146;s Annual Report on Form&nbsp;10-K for the period
ended December&nbsp;31, 2004.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">10.6
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Related Party Promissory Note to the Successor Trustee of the Ira A.
Desper Marital Trust dated November&nbsp;1, 2003. (Incorporated by
reference to Exhibit&nbsp;10.6 to the Company&#146;s Annual Report on Form
10-K, for the period ended December&nbsp;31, 2004.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">10.7
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Lease for Office and Research Center in San Jose, CA.</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">10.8
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Lease for Executive Office in Westlake Village, CA.</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">10.9
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">License Agreement between Spatializer Audio Laboratories, Inc.,
Desper Products, Inc. and Samsung Electronics, effective August&nbsp;22,
2004. (Incorporated by reference to the Company&#146;s Quarterly Report
on Form&nbsp;10-Q for the period ended September&nbsp;30, 2004.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">10.10
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Employment Agreement dated January 6, 2006, between the Company and
Henry Mandell. (Incorporated by reference to Exhibit&nbsp;10.10 to the
Company&#146;s Annual Report on Form&nbsp;10-K for the period ended December
31, 2005.)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">21.1
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Subsidiaries of the Company</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">23.1
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Consent of Independent Auditors</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">31.1
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Certificate pursuant to Section&nbsp;302 of the Sarbanes-Oxley Act of 2002</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">32.1
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Certificate pursuant to Section&nbsp;906 of the Sarbanes-Oxley Act of
2002 (Certification will not be deemed &#147;filed&#148; for purposes of
Section 18 of the Securities Exchange Act of 1934, as amended)</TD>
</TR>
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</TABLE>
</DIV>



<DIV align="left">
<DIV style="font-size: 3pt; margin-top: 16pt; width: 18%; border-top: 1px solid #000000">&nbsp;</DIV>
</DIV>

<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">
<TR>
    <TD width="3%"></TD>
    <TD width="1%"></TD>
    <TD width="96"></TD>
</TR>

<TR valign="top">
    <TD nowrap align="left">*</TD>
    <TD>&nbsp;</TD>
    <TD>Previously filed.</TD>
</TR>

</TABLE>


<P align="center" style="font-size: 10pt">42
</DIV>

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<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">





<DIV align="left">
<A name="129"></A>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>SIGNATURES</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Pursuant to the requirements of Section&nbsp;13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="30%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="70%">&nbsp;</TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Dated: March&nbsp;27, 2006</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">SPATIALIZER AUDIO LABORATORIES, INC.</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">(Registrant)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">/s/ Henry R. Mandell</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Henry R. Mandell</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><I>Chairman &#038; Secretary</I></TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities and on the
dates indicated.
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="40%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="25%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="25%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="center" style="border-bottom: 1px solid #000000"> <B>Signature</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" style="border-bottom: 1px solid #000000"><B>Title</B></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" style="border-bottom: 1px solid #000000"><B>Date</B></TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">/s/ Carlo Civelli
<DIV style="font-size: 1pt; border-top: 1px solid #000000">&nbsp;</DIV>
Carlo Civelli
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Director&nbsp;
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">March&nbsp;27, 2006</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">/s/ Henry R. Mandell
<DIV style="font-size: 1pt; border-top: 1px solid #000000">&nbsp;</DIV>
Henry R. Mandell
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Director&nbsp;
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">March&nbsp;27, 2006</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>



<P align="center" style="font-size: 10pt">43
</DIV>


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<DOCUMENT>
<TYPE>EX-10.10
<SEQUENCE>2
<FILENAME>v18918exv10w10.htm
<DESCRIPTION>EXHIBIT 10.10
<TEXT>
<HTML>
<HEAD>
<TITLE>exv10w10</TITLE>
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<BODY bgcolor="#FFFFFF">
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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="right" style="font-size: 10pt; margin-top: 12pt"><B>Exhibit 10.10</B>
</DIV>


<DIV align="center" style="font-size: 14pt; margin-top: 18pt"><FONT style="font-variant: SMALL-CAPS">Spatializer Audio Laboratories, Inc.</FONT>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 0pt"><FONT style="font-variant: SMALL-CAPS">Corporate Headquarters</FONT><BR>
<FONT style="font-variant: SMALL-CAPS">2025 Gateway Place, Suite&nbsp;365 West Wing &#149; San Jose, CA 95110</FONT><BR>
<FONT style="font-variant: SMALL-CAPS">Tel 408.453.4180 &#149; Fax 408.437.5787 </FONT>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 6pt">January&nbsp;6, 2006
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Henry R. Mandell<BR>
14216 Huron Court<BR>
Moorpark, California 93021

</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Dear Henry:

</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As you know, Spatializer Audio Laboratories, Inc. (the &#147;Company&#148;) has engaged Strategic Equity
Group to explore a possible sale, or strategic alliance that may result in the sale, of the assets
and/or the stock of the Company. Although you had indicated your desire to leave the employ of the
Company, the Company very much wants you to continue to render services to the Company to assist
the Company in its transition. The purpose of this letter is to set forth the terms of the
agreement we have reached with respect to your continued employment with the Company. That
agreement is as follows:
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;1.&nbsp;You shall be employed by the Company, on the terms and conditions herein contained, from
the date hereof and continuing for a period not to exceed the first to occur of (a)&nbsp;the date of
consummation of a Sale of the Business (as hereinafter defined); (b)&nbsp;the expiration, termination or
non-renewal of the directors&#146; and officers&#146; insurance policy of the Company under which you are
covered as a director and officer of the Company; and (c)&nbsp;June&nbsp;30, 2006 (the &#147;Term&#148;).
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;2.&nbsp;During the Term, you will continue as Secretary and Chairman of the Board of Directors of
the Company and as an employee thereof; provided, however, that the services to be rendered by you
during the Term shall include only the following (the &#147;Services&#148;): assisting in a Sale of the
Business (including a sale of the stock or assets of the Company) or entering into a strategic
alliance or other extraordinary transaction between the Company and a third party; coordinating due
diligence and documentary activities in connection with the foregoing; supervising preparation of
financial statements and records; reviewing and authorizing day to day disbursements; reviewing and
responding to certain Company mail, correspondence or emails; supervising all of the Company&#146;s
licensing and business activities; handling stockholder communications; eliminating redundant
and/or unnecessary expenses or commitments; conferring with the Company&#146;s principal engineer by
telephone on any matters of concern; and taking such other customary actions on behalf of the
Company that you deem reasonably necessary to advance the interests of the Company and its
stockholders. The Company agrees that you may provide the Services in person, by telephone, email
or otherwise as you see fit, whether during, before or after normal business hours and/or on
weekends. The Company understands and agrees that you may be employed by another person or entity
during the Term and that the Services to be provided hereunder shall not be of a nature or duration
so as to interfere with said employment or to unduly burden you during normal business hours.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;3.&nbsp;During the Term, the Company shall provide you with the following compensation, subject in
all cases to payroll tax and other applicable withholding, and benefits.
</DIV>

<P align="center" style="font-size: 10pt">&nbsp;
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(a)&nbsp;During the Term, in payment for your Services, the Company will pay you the following
compensation at the following times:
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(i)&nbsp;a one time lump sum incentive payment of $35,733.33, which payment is being paid
concurrently herewith, receipt of which is hereby acknowledged by you, which payment is being paid
in lieu of severance pay, if any, to which you otherwise may have been entitled, it being
understood that you shall not be entitled to any severance pay upon termination of your employment
on or after the date hereof;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(ii)&nbsp;a monthly salary of $5,000 per month, such salary to be paid in accordance with the
normal payroll practices of the Company, such salary to commence with January&nbsp;2006 and to continue
through the termination of your employment as herein provided;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(iii)&nbsp;for assisting in the preparation of the Company&#146;s Annual Report on Form 10-K to be filed
with the Securities and Exchange Commission (the &#147;Commission&#148;) with respect to the fiscal year
ended December&nbsp;31, 2005, a bonus of $10,000, such bonus to be due upon the filing of such Form 10-K
(provided such assistance has been provided, such amount shall be due to you regardless of whether
the Form 10-K is filed before or after termination your employment);
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(iv)&nbsp;for assisting in the preparation of any of the Company&#146;s Quarterly Reports on Form 10-Q
to be filed with the Commission with respect to any fiscal quarter ending after December&nbsp;31, 2005,
a bonus of $5,000 for each such Quarterly Report on Form 10-Q upon which you so assist, such bonus
to be due upon the filing of such each such Form 10-Q (provided such assistance has been provided,
such amount shall be due to you regardless of whether any such Form 10-Q is filed before or after
termination your employment); and
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(v)&nbsp;in the event that the Company consummates any one or more Sales of the Business (including
for these purposes a sale of the stock of the Company, regardless of whether of not the assets of
the Company are sold prior thereto or in connection therewith), a bonus in an amount equal to three
and one-half percent (3.5%) of the gross proceeds from such Sale of the Business, but in no event
shall such bonus exceed $150,000 in the aggregate, such bonus to be paid concurrently with the
consummation of such Sale of the Business (or, to the extent any portion of the consideration
payable in the Sale of the Business transaction is contingent upon any future events or is
deferred, then the portion of the bonus based on such contingent or deferred consideration shall be
paid when such contingent or deferred consideration is actually paid to the Company or its
stockholders or other parties, regardless of whether such amount is actually paid before or after
termination of your employment). Notwithstanding anything else to the contrary in this Agreement,
it is the intention of the parties that regardless of the earlier termination of your employment or
the expiration of this Agreement, the Company shall continue to be obligated to pay you the bonus
provided for in this clause (v)&nbsp;if a Sale of the Business occurs, or a definitive agreement or a
letter of intent with respect to a Sale of the Business in entered into which subsequently results
in a Sale of the Business, on or prior to December&nbsp;31, 2006 with or to any of the persons or
entities introduced to the Company or any agent thereof by you on or prior to the expiration of the
Term of this Agreement or the termination of your employment by the Company. This Section&nbsp;3(a)(v)
shall survive expiration of the Term of this Agreement or the termination of your employment by the
Company.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(b)&nbsp;For purposes of this Agreement, &#147;Sale of the Business&#148; shall have the same meaning as a
&#147;Sale&#148; as defined in that certain agreement between the Company and Strategic Equity Growth, dated
as of October&nbsp;12, 2005, and, in addition thereto shall include any sale of the Company as a &#147;shell
public company&#148; whether before, after or in connection with any
</DIV>

<P align="center" style="font-size: 10pt">-2-
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">disposition of all or substantially all of the assets of the Company, or any new perpetual
license of the Company technologies to one or more parties in conjunction with Sale of the
Business.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(c)&nbsp;From the date here and while employed by the Company, you will be entitled to participate
in such employee benefit plans or programs, including health insurance coverage, as may be made
available by the Company from time to time subject to the eligibility rules and regulations
applicable to each benefit plan or program. The Company retains sole discretion to change,
eliminate, or expand any employee benefit plans and programs offered.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(d)&nbsp;Subject to approval of classes or categories of reimbursable expenses and Company policies
regarding same, as established by the Company from time to time, the Company will reimburse you for
all reasonable, actual and necessary business expenses that are incurred directly for the benefit
of the Company while providing services to it. Reimbursement will be made after presentation of
documentation in a form sufficient to permit the Company to determine the necessity and
reasonableness of the expense, to comply with all governmental reporting requirements, and to
substantiate the Company&#146;s right to claim income tax deductions for such expenses.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;4.&nbsp;During the Term and notwithstanding Section&nbsp;1 above, the Company may terminate your
employment for any reason provided that, if such termination is not in accordance with Section&nbsp;1
above, then concurrently with and upon the effective date of such termination, the Company pays
you, in one lump sum payment, any portion of the salary and other amounts earned but are unpaid
through the effective date of such termination and thereafter pays such amounts, if any, as may
subsequently become due and payable under Sections&nbsp;3(a)(iii), (iv)&nbsp;and (v)&nbsp;of this Agreement. You
may resign your employment with the Company at any time, and upon such resignation the Company
shall pay you all sums then due and owing under this Agreement, including amounts subsequently due
and payable under Sections&nbsp;3(a)(iii), (iv)&nbsp;and (v)&nbsp;of this Agreement. This Section&nbsp;4 shall survive
expiration of the Term of this Agreement or the termination of your employment by the Company.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;5.&nbsp;You acknowledge that this Agreement and the duties to be performed under it do not violate
any contract to which you are a party or the policies of any other employer by whom you may be
employed during the Term.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;6.&nbsp;During the Term:
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(a)&nbsp;Except as may be required in carrying out your duties under this Agreement, you shall not,
directly or indirectly, within the geographic areas in which the Company currently conducts its
business, carry on or engage in any business that is directly competitive with the business of the
Company, either individually or with any other person, whether as a proprietor, partner, member,
joint venturer, employee, agent, independent contractor, officer, director, shareholder (other than
as a holder of less than ten percent (10%) of the voting stock or other securities of a publicly
traded company), investor, or lender. Notwithstanding the provisions of the preceding sentence,
you shall not be prohibited by this Agreement from engaging in any business that is not directly
competitive with the business of the Company as conducted by the Company as of the date hereof; and
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(b) Without first obtaining the consent of the Company, which consent may be withheld by the
Company in its reasonable discretion, you shall not (i)&nbsp;for yourself or for any entity with which
you are affiliated, solicit or entice, or attempt to solicit or entice, any employee of the Company
to leave the employment of the Company or hire any employee of the Company who has voluntarily left
employment with the Company; or (ii)&nbsp;except as requested by the Company pursuant hereto, solicit
(for yourself or for any person or entity with whom you are affiliated) any business that would be
competitive with the business of the Company from any
</DIV>

<P align="center" style="font-size: 10pt">-3-
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">present customer or any person or entity who becomes a customer of the Company prior to the
termination of your employment hereunder or request any such customer to curtail or cancel its
business relationship with the Company (except as may be required in the carrying out of your
duties hereunder)..
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;7.&nbsp;The parties agree that:
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(a)&nbsp;Your employment by the Company is such that you had and will continue to have access to
Confidential Information (as defined below). You will not divulge or communicate to any person
(except in performing his duties under this Agreement) or use for your own purpose any Confidential
Information. All documents and objects embodying Confidential Information made, compiled,
received, held or used by you while employed by the Company in connection with the business of the
Company will be and remain the Company&#146;s property and will be delivered by you to the Company upon
the termination of your employment or at any earlier time requested in writing by the Company. The
term &#147;Confidential Information&#148; means manufacturing and marketing data, trade secrets, customer
lists and lists of customer sources and any other information marked &#147;confidential&#148;; provided,
however, that &#147;Confidential Information&#148; shall not include information that (i)&nbsp;is or becomes
generally available to the public other than as a result of disclosure by you, (ii)&nbsp;is generally
known in the industry in which the Company transacts business, (iii)&nbsp;must be disclosed under
federal or state securities laws or regulations, or (iv)&nbsp;must be disclosed, upon advice of counsel,
in order to comply with other applicable laws or regulations or with any requirements imposed by
judicial or administrative process, provided, in this latter case, you shall give the Company two
days&#146; notice prior to making such disclosure.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(b)&nbsp;Any breach or threatened breach by you of any obligation set forth in subparagraph (a)&nbsp;of
this Section&nbsp;7 would cause great and irreparable harm to the Company for which there would be no
adequate remedy at law. Therefore, in addition to any other rights or remedies the Company may
have, the parties agree that if you breach or threaten to breach any obligation set forth in such
subparagraph, the Company will be entitled to temporary and permanent injunctive relief without the
necessity of proving actual damages, posting a bond or making any undertaking.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(c)&nbsp;Nothing herein is intended to supersede, modify or amend any confidentiality agreement,
proprietary information and/or other similar agreement between you and the Company (including such
provisions as are set forth in the Employment Agreement, as hereinafter defined) to the extent that
the provisions hereof are less restrictive than those set in such agreements, each of which
agreements is, subject to Section&nbsp;14 hereof, hereby confirmed in all respects and shall remain in
full force and effect in accordance with its respective terms.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;8.&nbsp;This Agreement shall be binding upon and shall inure to the benefit of the Company and you
and your respective heirs, legal representatives, successors and assigns, provided, that, neither
you nor the Company may make any assignments of this Agreement or any interest herein, by operation
of law or otherwise, without the prior written consent of the other party hereto.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;9.&nbsp;This Agreement, and the agreements referred to in Section 7(c) above, contain the entire
understanding between the Company and you with respect to the matters referenced herein and
supersedes any and all agreements, either oral or in writing, between the parties hereto with
respect to such matters. You and the Company each acknowledge that no representations,
inducements, promises, or agreements, orally or otherwise, have been made by any party, or anyone
acting on behalf of any party, which is not embodied herein.
</DIV>

<P align="center" style="font-size: 10pt">-4-
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;10.&nbsp;This Agreement cannot be modified or changed except by an instrument in writing, signed by
both parties to the Agreement.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;11.&nbsp;This Agreement is entered into in the State of California and shall be construed and
interpreted in accordance with its law. The language of all parts of this Agreement shall in all
cases be construed as a whole, according to its fair meaning, and not strictly for or against any
of the parties. Paragraph headings contained in this Agreement are for convenience only and shall
not be considered for any purpose in construing the Agreement.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;12.&nbsp;The waiver by either party hereto of any breach or violation of any provision of this
Agreement by the other party shall not operate as or be construed to be a waiver of any subsequent
breach by such waiving party.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;13.&nbsp;In the event of invalidity or unenforceability of any one or more provisions of this
Agreement, such invalidity or unenforceability shall not affect the validity or enforceability of
the other provisions hereof and such other provisions shall be deemed to remain in full force and
effect.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;14.&nbsp;We hereby agree that Sections&nbsp;1 through 4 and Sections&nbsp;6 through 8 of that certain
Employment Agreement, effective as of November&nbsp;12, 1999, between you and the Company, as such
Sections of, and the Employment Agreement itself, have been amended to date (such Employment
Agreement, as amended to date, is referred to herein as the &#147;Employment Agreement&#148;) are hereby
terminated and of no further force and effect as of the date hereof (which sections include, among
other things, provisions relating to your compensation, benefits and severance pay) but we hereby
confirm that Section&nbsp;5 and Sections&nbsp;9 through 21 of the Employment Agreement are not being amended
or terminated hereby and shall remain in full force and effect in accordance with the terms
thereof.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;If the foregoing accurately sets forth your understandings of our agreement, please sign and
return to me the enclosed copy of this Agreement.
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="50%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="2%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="46%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="46%">&nbsp;</TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD colspan="5" valign="top" align="left">Spatializer Audio Laboratories, Inc.</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">By:
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">/s/ CarloCivelli</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="40%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="59%">&nbsp;</TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Acknowledge and Agreed as of January&nbsp;6, 2006:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">/s/ Henry R. Mandell
<DIV style="font-size: 1pt; border-top: 1px solid #000000">&nbsp;</DIV>
Henry R. Mandell
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>



<P align="center" style="font-size: 10pt">-5-
</DIV>


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</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-21.1
<SEQUENCE>3
<FILENAME>v18918exv21w1.htm
<DESCRIPTION>EXHIBIT 21.1
<TEXT>
<HTML>
<HEAD>
<TITLE>exv21w1</TITLE>
</HEAD>
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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="right" style="font-size: 10pt; margin-top: 12pt"><B>EXHIBIT 21.1</B>
</DIV>


<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>SUBSIDIARY OF THE COMPANY</B>
</DIV>

<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="30%">&nbsp;</TD>
    <TD width="2%">&nbsp;</TD>
    <TD width="28%">&nbsp;</TD>
    <TD width="2%">&nbsp;</TD>
    <TD width="28%">&nbsp;</TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Name of Subsidiary
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Percentage of Ownership
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">State of Incorporation</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Desper Products, Inc.
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">100%
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">California</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<P align="center" style="font-size: 10pt">
</DIV>

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</HTML>
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-23.1
<SEQUENCE>4
<FILENAME>v18918exv23w1.htm
<DESCRIPTION>EXHIBIT 23.1
<TEXT>
<HTML>
<HEAD>
<TITLE>exv23w1</TITLE>
</HEAD>
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<DIV style="font-family: 'Times New Roman',Times,serif">


<DIV align="right" style="font-size: 10pt; margin-top: 12pt"><B>EXHIBIT 23.1</B>
</DIV>


<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>CONSENT OF INDEPENDENT AUDITORS</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>To the Board of Directors Of Spatializer Audio Laboratories, Inc.:</B>
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">We consent to the incorporation by reference in the registration statements on Form&nbsp;S-8 (Nos.
333-27453 and 333-41170) of Spatializer Audio Laboratories, Inc. of
our report dated February 24,
2006, related to the consolidated balance sheets of Spatializer Audio Laboratories, Inc. and
subsidiaries as of December&nbsp;31, 2005 and December&nbsp;31, 2004, and the related consolidated statements
of income, stockholders&#146; equity and comprehensive income and cash flows for each of the years in
the three-year period ended December&nbsp;31, 2005, which report appears in the annual report on Form
10-K of Spatializer Audio Laboratories, Inc. for the year ended December&nbsp;31, 2005.<U> </U>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">/s/ FARBER
HASS HURLEY &#038; MCEWEN LLP

</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Camarillo, California

</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt">February 24, 2006
</DIV>


<P align="center" style="font-size: 10pt">
</DIV>

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</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-31.1
<SEQUENCE>5
<FILENAME>v18918exv31w1.htm
<DESCRIPTION>EXHIBIT 31.1
<TEXT>
<HTML>
<HEAD>
<TITLE>exv31w1</TITLE>
</HEAD>
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<DIV style="font-family: 'Times New Roman',Times,serif">




<DIV align="right" style="font-size: 10pt; margin-top: 12pt"><B>EXHIBIT 31.1</B>
</DIV>


<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>CERTIFICATIONS</B>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">I, Henry R. Mandell certify that:
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">1. I have reviewed this annual report on Form 10-K of Spatializer Audio Laboratories, Inc.;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">2. Based on my knowledge, this report does not contain any untrue statement of a material fact or
omit to state a material fact necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to the period covered by this
report;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">3. Based on my knowledge, the financial statements, and other financial information included in
this report, fairly present in all material respects the financial condition, results of operations
and cash flows of the registrant as of, and for, the periods presented in this report;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">4. The registrant&#146;s other certifying officer(s) and I are responsible for establishing and
maintaining disclosure controls and procedures (as defined in Exchange Act Rules&nbsp;13a-15(e) and
15d-15(e)) for the registrant and have:
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">b) Evaluated the effectiveness of the registrant&#146;s disclosure controls and procedures and presented
in this report our conclusions about the effectiveness of the disclosure controls and procedures,
as of the end of the period covered by this report based on such evaluation; and
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">c) Disclosed in this report any change in the registrant&#146;s internal control over financial
reporting that occurred during the registrant&#146;s most recent fiscal quarter (the registrant&#146;s fourth
fiscal quarter in the case of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant&#146;s internal control over financial reporting; and
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">5. The registrant&#146;s other certifying officer(s) and I have disclosed, based on our most recent
evaluation of internal control over financial reporting, to the registrant&#146;s auditors and the audit
committee of the registrant&#146;s board of directors (or persons performing the equivalent functions):
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">a) All significant deficiencies and material weaknesses in the design or operation of internal
control over financial reporting which are reasonably likely to adversely affect the registrant&#146;s
ability to record, process, summarize and report financial information; and
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant&#146;s internal control over financial reporting.
</DIV>

<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="5%">&nbsp;</TD>
    <TD width="2%">&nbsp;</TD>
    <TD width="20%">&nbsp;</TD>
    <TD width="2%">&nbsp;</TD>
    <TD width="30%">&nbsp;</TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Date: March 27, 2006</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">/s/ Henry R. Mandell</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Henry R. Mandell</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Chairman of the Board and Secretary</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<P align="center" style="font-size: 10pt">
</DIV>

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</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-32.1
<SEQUENCE>6
<FILENAME>v18918exv32w1.htm
<DESCRIPTION>EXHIBIT 32.1
<TEXT>
<HTML>
<HEAD>
<TITLE>exv32w1</TITLE>
</HEAD>
<BODY bgcolor="#FFFFFF">
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<H5 align="left" style="page-break-before:always">&nbsp;</H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">


<DIV align="right" style="font-size: 10pt; margin-top: 12pt"><B>EXHIBIT 32.1</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<B>CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (SUBSECTIONS (a)&nbsp;AND
(b)&nbsp;OF SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE)</B>
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a)&nbsp;and (b)&nbsp;of section
1350, chapter 63 of Title 18, United States Code), the undersigned officer of Spatializer Audio
Laboratories, Inc. (the &#147;Company&#148;) hereby certifies with respect to the Annual Report on Form
10-K of the Company for the year ended December&nbsp;31, 2005 as filed with the Securities and
Exchange Commission (the &#147;Report&#148;) that to his knowledge:
</DIV>


<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">1)</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Report fully complies with the requirements of Section 13(a) or 15(d) of the
Securities and Exchange Act of 1934; and</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">2)</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The information contained in the Report fairly presents, in all material respects, the
financial condition and results of operations of the Company.</TD>
</TR>

</TABLE>
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="5%">&nbsp;</TD>
    <TD width="2%">&nbsp;</TD>
    <TD width="20%">&nbsp;</TD>
    <TD width="2%">&nbsp;</TD>
    <TD width="30%">&nbsp;</TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Date: March&nbsp;27, 2006</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">/s/ Henry R. Mandell</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Henry R. Mandell</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Chairman of the Board and Secretary</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>



<P align="center" style="font-size: 10pt">
</DIV>


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