e10vq

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


þ		Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the period ended: June 30, 2006


o		Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 000-26460

SPATIALIZER AUDIO LABORATORIES, INC.

(Exact name of registrant as specified in its charter)


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

2025 Gateway Place, Suite 365
San Jose, California 95110

(Address of principal corporate offices)

Telephone Number: (408) 453-4180

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o accelerated filer o non-accelerated filerþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yeso Noþ

As of August 6, 2006, there were 48,763,383 shares of the Registrant’s Common Stock outstanding.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
	ITEM I. FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
PART II. OTHER INFORMATION
	ITEM 1. LEGAL PROCEEDINGS
	ITEM 1A. RISK FACTORS
	ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
	ITEM 3. DEFAULTS UPON SENIOR SECURITIES
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
	ITEM 5. OTHER INFORMATION
	ITEM 6. EXHIBITS
SIGNATURES
EXHIBIT 31
EXHIBIT 32

PART I. FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS


	June 30,			December 31,
	2006			2005
	(unaudited)
ASSETS

Current Assets:
Cash and Cash Equivalents	$	297,247		$	550,633
Accounts Receivable, net		84,020			155,233
Prepaid Expenses and Deposits		61,936			34,104

Total Current Assets		443,203			739,970

Property and Equipment, net		10,271			18,403
Intangible Assets, net		142,410			138,548

Total Assets	$	595,884		$	896,921


LIABILITIES AND SHAREHOLDERS’ EQUITY

Current Liabilities:
Note Payable		33,846			10,443
Accounts Payable		25,158			14,195
Accrued Wages and Benefits		3,706			48,095
Accrued Professional Fees		10,000			34,000
Accrued Commissions		35,428			31,917
Accrued Expenses		6,724			40,869

Total Current Liabilties		114,862			179,519

Commitments and Contingencies

Shareholders’ Equity:
Common shares, $.01 par value, 65,000,000 shares authorized, 48,763,383 shares issued and outstanding at June 30, 2006 and December 31, 2005		469,772			469,772
Additional Paid-In Capital		46,430,030			46,430,030
Accumulated Deficit		(46,418,780	)		(46,182,400	)

Total Shareholders’ Equity		481,022			717,402

	$	595,884		$	896,921

See notes to consolidated financial statements

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)


	For the Three Month Period Ended						For the Six Month Period Ended
	June 30,			June 30,			June 30,			June 30,
	2006			2005			2006			2005
Revenues:
Royalty Revenues	$	92,868		$	428,912		$	193,356		$	760,863
Cost of Revenues		9,288			42,890			19,477			76,762

Gross Profit		83,580			386,022			173,879			684,101
Operating Expenses:
General and Administrative		130,766			189,723			249,133			340,924
Research and Development		12,839			83,358			157,740			182,649
Sales and Marketing		—			56,201			1,241			95,454

		143,605			329,282			408,114			619,027

Operating Income (Loss)		(60,025	)		56,740			(234,235	)		65,074
Interest and Other Income		1,702			3,696			4,921			6,616
Interest and Other Expense		(2,266	)		(2,870	)		(2,266	)		(4,110	)

		(564	)		826			2,655			2,506

Income (Loss) Before Income Taxes		(60,589	)		57,566			(231,580	)		67,580

Income Taxes		(2,400	)		—			(4,800	)		—


Net Income (Loss)	$	(62,989	)	$	57,566		$	(236,380	)	$	67,580


Basic and Diluted Earnings Per Share	$	(0.00	)	$	0.00		$	(0.00	)	$	0.00


Weighted Average Shares Outstanding		48,763,383			46,975,365			48,763,383			46,975,365

See notes to consolidated financial statements

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


	Six Months Ended
	June 30,
	2006			2005
Cash Flows from Operating Activities:
Net Income (Loss)	$	(236,380	)	$	67,580
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and Amortization		19,283			28,603
Net Change in Assets and Liabilities:
Accounts Receivable and Employee Advances		71,213			145,327
Prepaid Expenses and Deposits		(27,832	)		4,219
Accounts Payable		10,963			(47,427	)
Accrued Wages and Benefits		(44,389	)		(10,519	)
Accrued Professional Fees		(24,000	)		(10,000	)
Accrued Commissions		3,511			(2,847	)
Accrued Expenses		(34,145	)		1,000
Deferred Revenue		—			(313,116	)

Net Cash Provided By (Used In) Operating Activities		(261,776	)		(137,180	)

Cash Flows from Investing Activities:
Purchase of Property and Equipment		—			(5,477	)
Increase in Capitalized Patent and Technology Costs		(15,013	)		—

Net Cash Provided By (Used in) Investing Activities		(15,013	)		(5,477	)

Cash flows from Financing Activities:
Issuance (Repayment) of Notes Payable		23,403			838

Net Cash Provided by Financing Activities		23,403			838

Increase (Decrease) in Cash and Cash Equivalents		(253,386	)		(141,819	)

Cash and Cash Equivalents, Beginning of Period		550,633			871,155


Cash and Cash Equivalents, End of Period	$	297,247		$	729,336


Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest	$	—		$	6,766
Income Taxes		4,800			—

See notes to consolidated financial statements

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

1) Nature of Business

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

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

On January 10, 2006, Spatializer Audio Laboratories, Inc. announced that it will hold an open auction for the sale of substantially all of the assets, subject to stockholder approval. The Board of Directors of the Company decided that it is in the best interest of the stockholders to hold an open auction for the sale 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 foregoing interim financial information is unaudited and has been prepared from the books and records of the Company. The financial information reflects all adjustments necessary for a fair presentation of the financial condition, results of operations and cash flows of the Company in conformity with U.S. generally accepted accounting principles. All such adjustments were of a normal recurring nature for interim financial reporting. Operating results for the three and nine months ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. Accordingly, your attention is directed to footnote disclosures found in the December 31, 2005 Annual Report and particularly to Note 1, which includes a summary of significant accounting policies.

(2) Significant Accounting Policies

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

Revenue Recognition — The Company recognizes royalty revenue upon reporting of such royalties by licensees. License revenues are recognized when earned, in accordance with the contractual provisions, typically upon our delivery of contracted services or delivery and contractual availability of licensed product. Royalty revenues are recognized upon shipment of products incorporating the related technology by the original equipment manufacturers (OEMs) and foundries, as reported by quarterly royalty statements. The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin (SAB) 104.

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

Concentration of Credit Risk — Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash, cash equivalents and trade accounts receivable. The Company places its temporary cash investments in certificates of deposit in excess of FDIC insurance limits, principally at CitiBank FSB. At June 30, 2006 substantially all cash and cash equivalents were on deposit at two financial institutions.

At June 30, 2006, three customers, not presented in the order of importance, Orion, Sharp and Funai, accounted for 40%, 20% and 12% respectively of our accounts receivable. At June 30, 2005, three major customers, not presented in order of importance, each accounted for 10% or more of our total accounts receivable: Matsushita, Intervideo and Sharp. One OEM accounted for 48%, one accounted for 18% and one accounted for 11% of our total accounts receivable The Company performs ongoing credit evaluations of its customers and normally does not require collateral to support accounts receivable. Due to the contractual nature of sales agreements and historical trends, no allowance for doubtful accounts has been provided.

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

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

Customers Outside of the U.S. — Sales to foreign customers were 100% and 89% of total sales in the year to date periods ended June 30, 2006 and 2005, respectively. Approximately 100% of sales were generated in Japan in the six months ended June 30, 2006.

Major Customers — During the quarter ended June 30, 2006, three customers, Sharp, Funai and Orion, not presented in order of importance, accounted for 36%, 18% and 14% of the Company’s revenue in the quarter ended June 30. 2006. During the quarter ended June 30, 2005, two customers, Samsung and Matsushita, not presented in order of importance, accounted for 44% and 37% of the Company’s net sales.

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

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

Intangible Assets — Intangible assets consist of patent costs and trademarks which are amortized on a straight-line basis over the estimated useful lives of the patents which range from five to twenty years. The weighted average useful life of patents was approximately 11 years. All of our Intangible Assets have finite lives as defined by Statement of Financial Accounting Standard (SFAS) 142.

Earnings Per Share — Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The following table presents contingently issuable shares, options and warrants to purchase shares of common stock that were outstanding during the three month periods ended June 30, 2006 and 2005 which were not included in the computation of diluted loss per share because the impact would have been antidilutive or less than $0.01 per share:


	2006		2005
Options		2,000,000		2,960,000
Warrants		0		0

		2,000,000		2,960,000

Stock Option Plan — On January 1, 2006 the Company adopted SFAS 123R “Share Based Payments. No options were granted in the quarter ended June 30, 2006.

Impairment of Long-Lived Assets and Assets to be Disposed of - The Company adopted the provisions of SFAS No. 144, Accounting for the Impairment of Long-Lived Assets, on January 1, 2002. This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amounts of the assets exceed the fair value of the assets.

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

Income Taxes - Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and

liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Recent Accounting Pronouncements -

In May 2005 the FASB issued SFAS 154 “Accounting Changes and Error Corrections”. This Statement replaces APB Opinion No. 20, “Accounting Changes”, and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”, 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. The Company adopted this Statement as required on January 1, 2006.

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

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

Fair Value of Financial Instruments - The fair and carrying values of cash equivalents, accounts receivable, accounts payable, short-term debt to a related party and accrued liabilities and those potentially subject to valuation risk at December 31, 2005 and June 30, 2006 approximated fair value due to their short maturity or nature.

(3) Property and Equipment

Property and equipment, as of December 31, 2005 and June 30, 2006, consists of the following in accordance with application of SFAS 144:


			December 31,
	June 30, 2006		2005
Office Computers, Software, Equipment and Furniture	$	337,144	$	337,145
Test Equipment		73,300		73,300
Tooling Equipment		45,539		45,539
Trade Show Booth and Demonstration Equipment		174,548		174,548
Automobiles		0		7,000

Total Property and Equipment		630,531		637,531
Less Accumulated Depreciation and Amortization		620,260		619,128

Property and Equipment, Net	$	10,271	$	18,403

(4) Intangible Assets

Intangible assets, as of December 31, 2005 and June 30, 2006 consist of the following:


	June 30,		December 31,
	2006		2005
Capitalized Patent, Trademarks and Technology Costs	$	540,709	$	525,695
Less Accumulated Amortization		398,299		387,147

Intangible Assets, Net	$	142,410	$	138,548

Estimated amortization is as follows:


2006	$	16,702
2007	$	16,702
2008	$	16,702
2009	$	16,702
Thereafter	$	66,164

(5) Notes Payable

The Company was indebted to the Premium Finance, Inc., an unrelated insurance premium finance company. This note finances the Company’s annual Directors’ and Officers’ Liability Insurance. This amount bears interest at a fixed rate of 13% annually, is paid in monthly installments of $4,835 that commenced on June 1, 2006 and continues for eight months until the entire balance of principal and interest is paid in full.

(6) Shareholders’ Equity

During the quarter ended June 30, 2006, shares were issued, cancelled or converted as follows:

Options to purchase 160,000 shares of common stock previously granted to two directors and two employees, at an exercise price of $0.30 expired.

Options to purchase 650,000 shares of common stock were cancelled in the quarter ended June 30, 2006 to two former directors as a result of their resignation form the Board of Directors, per the Plan requirements.

Capitalization

Series B-1 Redeemable Convertible Preferred Stock: On November 6, 2002 the Board

of Directors Designated a Series 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’s common stock. No dividends were to be paid on the Series B-1 Preferred Stock. Conversion rights vested on January 1, 2003 to convert the Series B-1 Preferred Stock to common at a certain formula based on an average closing share price, subject to a floor of $0.56 and a ceiling of $1.12. The Series B-1 Preferred Stock has no voting power. Certain restrictions on trading existed based on date sensitive events based on the Company’s Insider Trading Policy. In December 2002, 87,967 shares of Series B-1 Preferred Stock were issued in exchange for the Series B Preferred Stock and 14,795 shares were issued in lieu of the adjusted accrued dividends on the Series B Preferred Stock. In 2004, the Company reflected the issuance of 15,384 shares of Series 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 2005, the Company, as stipulated by the related Subscription Agreement, forced the conversion of all outstanding Series B-1 Preferred Stock into Common Stock at the minimum conversion price of $.56 per share. This resulted in the issuance of 1,788,018 Common Stock shares.

(7) Stock Options

In 1995, the Company adopted a stock option plan (the “Plan”) pursuant to which the Company’s Board of Directors may grant stock options to directors, officers and employees. The Plan which was approved by the stockholders authorizes grants of options to purchase authorized but unissued common stock up to 10% of total common shares outstanding at each calendar quarter, 4,876,339 as of June 30, 2006. Stock options were granted under the Plan with an exercise price equal to the stock’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 2005. To date, the Company has not adopted a new stock option plan.


						*WEIGHTED-AVERAGE*
	Exercisable		Number			Exercise Price
Options outstanding at December 31, 2003		2,540,000		3,035,000		$	0.18
Options granted				200,000		$	0.09
Options exercised				—			—
Options forfeited				(600,000	)	$	0.43

Options outstanding at December 31, 2004		2,381,666		2,635,000		$	0.11
Options granted				500,000		$	0.10
Options exercised				(0	)	$	—
Options forfeited/expired				(325,000	)	$	0.31

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

Options granted				(0	)	$	0.10
Options exercised				(0	)	$	—
Options forfeited/expired				(810,000	)	$	0.14

Options outstanding at June 30, 2006		2,076,666		2,000,000		$	0.09

The per share weighted-average fair value of stock options granted during 2005 was $0.04, on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: expected dividend yield 0%, risk-free interest rate of 4.5%, expected volatility of 100% and an expected life of 5 years.

At June 30, 2006, the number of options exercisable was 2,000,000 and the weighted-average exercise price of those options was $0.09.

There were no warrants outstanding at December 31, 2005 or June 30, 2006.

(8) Commitments and Contingencies

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

Operating Lease Commitments

The Company is obligated under several non-cancelable operating leases. Future minimum rental payments at June 30, 2006 for all operating leases were approximately $13,000 through December 2006. There is no continuing lease obligation after that date. Rent expense amounted to approximately $9,000 and $8,000 for the quarters ended June 30, 2006 and 2005, respectively.

(9) Profit Sharing Plan

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

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

This information should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, the audited consolidated financial statements and the notes thereto included in the Form 10-K and the unaudited interim consolidated financial statements and notes thereto included in this report.

Executive Overview

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 2005, two of our three independent directors resigned and Henry Mandell, our 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 an investment banking firm to assist us in this endeavor.

On January 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 decided that it is in the best interests of the stockholders to hold an open auction for the sale 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. Following such transaction, it is currently anticipated that the Company would be wound up and dissolved.

The Company received non-conforming bids for such assets on the February 15, 2006 deadline. The Board of Directors extended the auction period to March 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. To date, negotiations have continued with auction participants who submitted bids by March 10, 2006, but the Company has not entered into any definitive agreements with any bidder for such a sale.

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.

Revenues for the three months ended June 30, 2006 were $93,000, compared to revenues of $429,000 in the comparable period last year, a decrease of 78%. Revenues are almost entirely comprised of royalties pertaining to the licensing of Spatializer^® audio signal processing algorithms. A key issue discussed below is our ability to obtain revenue traction

when traditional revenue sources are eroding, during the period in which the Company is attempting to sell its assets.

Net loss in the three months ended June 30, 2006 was $63,000, $0.00 basic per share, compared with net income of $58,000, $0.00 basic and diluted per share, in the comparable period last year. A key issue discussed is management’s unsuccessful efforts to increase revenues while managing overhead and maintaining competitiveness during revenue source transition to new markets for the Company.

At June 30, 2006, we had $297,000 in cash and cash equivalents as compared to $551,000 at December 31, 2005. The decrease in cash resulted primarily from the net loss. We had working capital of $328,000 at June 30, 2006 as compared with working capital of $560,000 at December 31, 2005.

A key issue is the Company’s ability to generate positive cash flow, or if needed, raise additional capital to fund its business. Such funding has proven to be unattainable.

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

Approach to MD&A

An important demonstration of our commitment to our stockholders is a clear explanation of the Company’s operating results, risks and opportunities. The purpose of MD&A is to provide our shareholders and other interested parties with information necessary to gain an understanding of our financial condition, changes in financial condition and results of operations. As such, we seek to satisfy three principal objectives:

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

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

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

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

	•		An understanding of our operating environment and its risks

	•		An outline of critical accounting policies

	•		A review of our corporate governance structure

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

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

	•		Disclosure on our internal controls and procedures

Operating Environment

We operate in a very competitive business environment. This environment impacts us in various ways, some of which are discussed below which such items are further discussed in greater detail in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

	•		Our Board of Directors has determined it is in the Company’s and it’s Stockholders’ interests to attempt to sell the Company’s assets

	•		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

	•		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.

	•		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.

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 Quarterly Report on Form 10-Q 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.

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 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 “give away” their products.

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

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’s Board of Directors decided to attempt to sell the assets of the Company and liquidate the business, subject to stockholders’ approval.

Critical Accounting Policies

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

The first critical accounting policy relates to revenue recognition. Royalty revenues are recognized upon shipment of products incorporating the related technology by the original equipment manufacturers (OEMs) and foundries. These revenues are reported to us by our Licensees in formal, written royalty reports, which serve as the basis for our quarterly

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

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

The third critical accounting policy relates to our long-lived assets. The Company continually reviews the recoverability of the carrying value of long-lived assets using the methodology prescribed in Statement of Financial Accounting Standards (SFAS) 144, “Accounting for the Impairment and Disposal of Long-Lived Assets.” The Company also reviews long-lived assets and the related intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Upon such an occurrence, recoverability of these assets is determined by comparing the forecasted undiscounted net cash flows to which the assets relate, to the carrying amount. If the asset is determined to be unable to recover its carrying value, then intangible assets, if any, are written down first, followed by the other long-lived assets to fair value. Fair value is determined based on discounted cash flows, appraised values or management’s estimates, depending on the nature of the assets. Our intangible assets consist primarily of patents. We capitalize all costs directly attributable to patents and trademarks, consisting primarily of legal and filing fees, and amortize such costs over the remaining life of the asset (which range from 3 to 20 years) using the straight-line method. In accordance with SFAS 142, “Goodwill and Other Intangible Assets”, only intangible assets with definite lives are amortized. Non-amortized intangible assets are instead subject to annual impairment testing. Management believes based on the preliminary results of its auction bids that the net carrying value of its assets exceeds the current carrying value.

Corporate Governance

Audit Committee

This committee is directed to review the scope, cost and results of the independent audit of our books and records, the results of the annual audit with management and the internal auditors and the adequacy of our accounting, financial, and operating controls; to recommend annually to the Board of Directors the selection of the independent auditors; to approve proposals made by our independent auditors for consulting work; and to report to the Board of Directors, when so requested, on any accounting of financial matters. Gilbert Segel was the only independent director on this committee. Mr. Segel resigned from our Board of Directors in December 2005. Mr. Mandell, Chairman of the Board and Secretary of the

Company, served as ex-officio member of the Audit Committee during fiscal year 2005. Mr. Mandell resigned his employment with Company effective January 6, 2006. There were no members of the committee upon the resignation of Mr. Segel.

Compensation and Stock Committee

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

Our Audit Committee and Compensation and Stock Committee charters are available in print to any stockholder upon request in writing to our principal corporate office at 2025 Gateway place, Suite 365, San Jose, California 95110.

Key Components of the Financial Statements and Important Trends

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

The 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&A under Liquidity and Capital Resources.

The Consolidated Statement of Operations tells the reader whether the Company had a profit or loss. It shows key sources of revenue and major expense categories. It is important to note period-to-period comparisons of each line item of this statement, reasons for any fluctuation and how costs are managed in relation to the overall revenue trend of the

business. These statements are prepared using accrual accounting under generally accepted accounting standards in the United States. This is addressed further in MD&A under Revenues and Expenses.

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&A under Liquidity and Capital Resources.

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

Results of Operations

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

Revenues

Revenues decreased to $93,000 for the quarter ended June 30, 2006 compared to $429,000 for the quarter ended June 30, 2005, a decrease of 78%. Revenues in the six months ended June 30, 2006 were $193,000, compared to revenues of $761,000 in the comparable period last year, a decrease of 75%. Revenues in the three and six months ended June 30, 2006 decreased due to end of life of a mobile telephone license and the recognition, in the prior year, of deferred revenue on a royalty prepayment received in the third quarter of 2004 and the suspension of day-to-day operations during the process of attempting to sell the assets of the company, including cessation of ongoing sales activities.

Gross Profit

Gross profit for the three months ended June 30, 2006 was $83,000 (90% of revenue) compared to gross profit of $386,000 (90% of revenue) in the comparable period last year, a decrease of 78%. Gross profit for the six months ended June 30, 2006 were $174,000 (90% of revenue) compared to $684,000 (90% of revenue) in the comparable period last year. Gross profit in the three and six-month periods decreased due to decreased revenue. Gross margins held steady in both periods, reflecting the standard 10% commission to international representatives on all royalty receipts

Operating Expenses

Operating expenses in the three months ended June 30, 2006 were $144,000 (155% of revenue) compared to operating expenses of $329,000 (77% of revenue) in the comparable period last year, a decrease of 56%. Operating expenses in the six months ended June 30,

2006 were $408,000 (211% of revenue) compared to $619,000 (81% of revenue) in the comparable six-month period last year. The decrease in operating expenses for the three and six months ended June 30, 2006 resulted primarily from personnel and operating reductions resulting from the suspension of day-to-day operations during the process of attempting to sell the assets of the Company, with the goal of conserving cash.

General and Administrative

General and administrative expenses in the three months ended June 30, 2006 were $131,000 (141% of revenue) compared to general and administrative expenses of $190,000 (44% of revenue) in the comparable period last year, a decrease of 31%. General and administrative expenses in the six months ended June 30, 2006 were $249,000 (268% of revenue) compared to $341,000 (45% of revenue) in the comparable six month period last year. The decrease in general and administrative expense for the three and six month periods resulted primarily from the elimination of the CEO position and related corporate travel expenses and the suspension of day-to-day operations during the process of attempting to sell the assets of the Company .

Research and Development

Research and Development expenses in the three months ended June 30, 2006 were $13,000 (14% of revenue) compared to research and development expenses of $83,000 (19% of revenue) in the comparable period last year, a decrease of 84%. The decrease in the current period results from the resignation of the principal engineer in the quarter and suspension of all development work. Research and Development expenses for the six months ended June 30, 2006 were $158,000 (82% of revenue) compared to $183,000 (24% of revenue) in the comparable six month period last year. The decrease in the six month research and development expenses resulted from the elimination of an in-house applications engineering position, the resignation of the principal engineer in May 2006 and the suspension of day-to-day operations during the process of attempting to sell the assets of the Company.

Sales and Marketing

Sales and Marketing expenses in the three months ended June 30, 2005 were nil (0% of revenue) compared to sales and marketing expenses of $56,000 (13% of revenue) in the comparable period last year. Sales and Marketing expenses for the six months ended June 30, 2006 were $1,000 (1% of revenue) compared to $95,000 (12% of revenue) in the comparable six month period last year. The decrease in sales and marketing expense in the three and six month periods resulted from the suspension of all travel and selling activities during the process of attempting to sell the assets of the Company, with the resignation of the CEO who performed this function as among his duties.

Net Income (Loss)

Net loss in the three months ended June 30, 2006 was ($63,000), ($0.00) basic per share, compared with net income of $58,000, $0.00 basic per share in the comparable period last year. Net loss in the six months ended June 30, 2006 was ($236,000), ($0.00) basic per share, compared with net loss of $68,000, $0.00 basic per share in the comparable period last year. Net Income resulted from increased revenues.

Liquidity and Capital Resources

At June 30, 2006, we had $297,000 in cash and cash equivalents as compared to $551,000 at December 31, 2005. The decrease in cash and cash equivalents results primarily from the net loss. We had working capital of $328,000 at June 30, 2006 as compared with working capital of $560,000 at December 31, 2005. Working capital decreased due to the funding of net operating losses.

In December 2005, the Company, as stipulated by the related Subscription Agreement, forced the conversion of all outstanding Series 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 million in liquidation preference shares.

Future payments due under operating lease obligations as of June 30, 2006 are described below:

Payments due by period

Less than

More than

Contractual obligations

Total

1 year

1-3 years

3-5 years

5 years

Long-Term Debt Obligations

Capital Lease Obligations

Operating Lease Obligations

13,000

Purchase Obligations

Total

13,000

In the event the Company is to be wound up and dissolved the Company would attempt to settle these amounts, negotiate early termination, or pay the remaining obligation if cash resources permitted.

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 assets or perpetual licenses. The Board of Directors will, with the approval of the stockholders, decide on the dispensation of such proceeds.

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. 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. 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.

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 months.

Net Operating Loss Carry forwards

At June 30, 2006, 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.

Recently Issued Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share Based Payment”. This Statement is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation”. This Statement supersedes APB Opinion

No. 25, “Accounting for Stock Issued to Employees” and its related implementation guidance. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. The Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement does not change the accounting guidance for share-based payment transactions with parties other than employees provided in Statement 123 as originally issued and EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” This Statement does not address the accounting for employee share ownership plans, which are subject to AICPA Statement of Position 93-6, “Employers’ Accounting for Employee Stock Ownership Plans”. The Securities and Exchange Commission has delayed the adoption requirement of SFAS No. 123R until the first annual reporting period beginning after December 15, 2005. We adopted SFAS No. 123R as of January 1, 2006 as required.

In May 2005 the FASB issued SFAS 154 “Accounting Changes and Error Corrections”. This Statement replaces APB Opinion No. 20, “Accounting Changes”, and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”, 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 15, 2005

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We have not been exposed to material future earnings or cash flow fluctuations from changes in interest rates on our short-term investments at June 30, 2006. A hypothetical decrease of 100 basis points in interest rate (ten percent of our overall earnings rate) would not result in a material fluctuation in future earnings or cash flow. We have not entered into any derivative financial instruments to manage interest rate risk or for speculative purposes and we are not currently evaluating the future use of such financial instruments.

Item 4. Controls and Procedures

The Company carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934. Based on that evaluation, the Chairman of the Board, in performing the functions of the principal executive and principal financial officers of the Company, concluded that the Company’s disclosure controls and procedures as of June 30, 2006 were effective to ensure that information required to be disclosed by the Company in reports which it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure .

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time we may be involved in various disputes and litigation matters arising in the normal course of business. As of August 6, 2006 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, given the size of our company, there exists the possibility of a material adverse impact on our results of operations of the period in which the ruling occurs. Our estimate of the potential impact on our financial position or overall results of operations for new legal proceedings could change in the future.

ITEM 1A. RISK FACTORS

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

As discussed above, 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 an investment banking firm to assist us in this endeavor. 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. 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, including liquidation and dissolution.

Further, Even if Such Transaction is Consummated, There is no Assurance that There will be Any Funds Available for Distribution to Stockholders.

If we were to liquidate and dissolve, we cannot predict when or if we would be able to make a distribution to our stockholders. Any distributions after dissolution would be reduced by cash expenditures during the staged wind-down of our business, by expenses incurred in pursuing the sale transaction and other strategic alternatives, and by the ultimate amounts paid in settlement of our liabilities. Before authorizing any distribution to stockholders after dissolution, our Board of Directors would be required to make adequate provision to satisfy known and unknown claims against us, and our liability for those claims may extend for a substantial period of time in the future. As a result, there can be no assurance that we would have sufficient cash available to make any distributions to stockholders after dissolution. If we were to have sufficient remaining cash to make distributions, a substantial period may elapse after dissolution before we would be able to make any such distribution to stockholders, and such distribution, if any, may be made in more than one installment over an extended period of time. Difficulties efficiently implementing our staged wind-down of business operations could reduce the amount of our remaining corporate assets.

We May Continue to Incur the Expense of Complying with Public Company Reporting Requirements.

We have an obligation to continue to comply with the applicable reporting requirements of the Securities Exchange Act of 1934 even though compliance with such reporting requirements is economically burdensome. If such a sale transaction is not completed and we were to liquidate and dissolve, then in order to curtail such expenses, after filing our certificate of dissolution upon stockholder approval of a plan of liquidation, we might seek relief from the SEC for a substantial portion of the periodic reporting requirements under that Act. There can be no assurance that we would be able to obtain such relief.

We have Suspended Our Day-to-Day Business Operations.

We currently have extremely limited personnel resources. The Chairman is the sole employee and serves on a limited part time basis, conducting Company business outside of normal business hours, as he is employed full-time elsewhere. We currently have zero employees and one bookkeeping consultant, and rely on our Chairman of the Board to represent the Company in asset sale and due diligence discussions, review recurring expenditures, disburse checks prepared by the outside consultant, financial statement preparation and meeting federal regulatory reporting requirements . If a sale transaction is not completed, it may be difficult for us to efficiently implement the staged wind-down of our business.

We do not Currently Maintain an Independent Audit Committee or Compensation Committee.

In December 2005, two of our three non-executive 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. From such time, we have had no members of our Audit Committee or Compensation Committee, with such functions being fulfilled by the remaining Board of Directors. The listing standards of the national securities exchanges and automated quotation systems require audit committees and compensation committees of the board of directors consist of independent members. However, we are not subject to the listing requirements of any national securities exchange or quotation system and therefore exempt from such requirements.

Mr. Mandell’s consulting arrangement was previously approved by the remaining member of the Board, with Mr. Mandell abstaining. In reviewing the consulting arrangement, the Board determined that the arrangement was fair to the corporation.

Although we are exempt from regulations mandating an independent audit committee and compensation committee, and although all Board members have fiduciary obligations in fulfilling their duties, our shareholders may perceive a potential conflict of interest because of our lack of an independent audit committee.

In addition to the other information set forth in this Quarterly Report, stockholders should also carefully consider the factors discussed in Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

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

There were no unregistered sales of equity securities or repurchases during the period covered by this report.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

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

None

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS


2.1*		Arrangement Agreement dated as of March 4, 1994 among Spatializer-Yukon, DPI and Spatializer-Delaware (Incorporated by reference to the Company’s Registration Statement on Form S-1,Registration No 33-90532, effective August 21, 1995.)

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

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

3.3*		Certificate of Designation of Series B 10% Redeemable Convertible Preferred Stock of the Company as filed December 27, 1999(Incorporated by reference to the Company’s Annual Report on Form10-K, for the period ended December 31, 1999.)

3.4*		Certificate of Amendment of Certificate of Incorporation of the Company as filed on February 25, 2000 (Incorporated by reference to the Company’s Annual Report on Form 10-K, for the period ended December 31, 1999.)

3.5*		Certificate of Designation of Series B-1 Redeemable Convertible Preferred Stock as filed December 20, 2002 (Incorporated by reference to the Company’s Annual Report on Form 10-K, for the period ended December 31, 2002.)

3.6*		Certificate of Elimination of Series A Preferred Stock as filed December 26, 2002 (Incorporated by reference to the Company’s Annual Report on Form 10-K, for the period ended December 31, 2002.)

3.7*		Certificate of Elimination of Series B Preferred Stock as filed December 26,2002 (Incorporated by reference to the Company’s Annual Report on Form 10-K, for the period ended December 31, 2002.)

10.1*		Spatializer-Delaware Incentive Stock Option Plan (1995 Plan). (Incorporated by reference to the Company’s Registration Statement on Form S-1, Registration No. 33-90532, effective August 21, 1995.)


10.2*		Spatializer-Delaware 1996 Incentive Plan. (Incorporated by reference to the Company’s Proxy Statement dated June 25, 1996 and previously filed with the Commission.)

10.3*		Form of Stock Option Agreement

10.4*		License Agreement dated June 29, 1994 between DPI and MEC. (Incorporated by reference to the Company’s Registration Statement on Form S-1, Registration No. 33-90532, effective August 21,1995.)

10.5*		Employment Agreement dated November 12, 2004, between the Company and Henry Mandell, as amended. (Incorporated by reference to the Company’s Annual Report on Form 10-K, for the period ended December 31, 2004.)

10.6*		Related Party Promissory Note to the Successor Trustee of the Ira A. Desper Marital Trust dated November 1, 2003. (Incorporated by reference to the Company’s Annual Report on Form 10-K, for the period ended December 31, 2004.)

10.7*		Lease for Office and Research Center in San Jose, CA. (Incorporated by reference to the Company’s Annual Report on Form 10-K, for the period ended December 31, 2004.)

10.8*		License Agreement between Spatializer Audio Laboratories, Inc., Desper Products, Inc. and Samsung Electronics, effective August 22, 2004. (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004.)

31		Section 302 Certifications

32**		Section 1350 Certification


*		Previously filed

**		Certification will not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934.


	SPATIALIZER AUDIO LABORATORIES, INC. (Registrant)
	/s/ Henry R. Mandell
	Henry R. Mandell
	Chairman of the Board and Secretary (Principal Executive, Financial and Accounting Officer)

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	Common Shares									Total
	Number of				Additional		Accumulated			Shareholders'
	shares		Par value		paid-in-capital		Deficit			Equity
Balance, December 31, 2005		48,763,383	$	469,772	$	46,430,030	$	(46,182,400	)	$	717,402

Net (Loss)		—		—		—		(173,391	)		(173,391	)


Balance, March 31, 2006		48,763,383	$	469,772	$	46,430,030	$	(46,355,791	)	$	544,011


Net (Loss)								(62,989	)	$	(62,989	)


Balance, June 30, 2006		48,763,383	$	469,772	$	46,430,030	$	(46,418,780	)	$	481,022