10-Q

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: September 30, 2006

OR

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

Commission File Number: 000-26460

SPATIALIZER AUDIO LABORATORIES, INC.

(Exact name of registrant as specified in its charter)

Delaware	95-4484725
(State or other jurisdiction of	(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 of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o       accelerated filer o       non-accelerated filer þ

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

Yes o      No þ

As of October 26, 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 10.9
EXHIBIT 31
EXHIBIT 32

PART I. FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	September 30,			December 31,
	2006			2005
	(unaudited)
ASSETS
Current Assets:
Cash and Cash Equivalents	$	272,985		$	550,633
Accounts Receivable, net		69,572			155,233
Prepaid Expenses and Deposits		46,937			34,104
Total Current Assets		389,494			739,970
Property and Equipment, net		6,205			18,403
Intangible Assets, net		136,833			138,548
Total Assets	$	532,532		$	896,921
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Note Payable		24,176			10,443
Accounts Payable		18,367			14,195
Accrued Wages and Benefits		2,341			48,095
Accrued Professional Fees		22,500			34,000
Accrued Commissions		42,202			31,917
Accrued Expenses		2,998			40,869
Total Current Liabilities		112,584			179,519
Commitments and Contingencies
Shareholders’ Equity:
Common shares, $.01 par value, 65,000,000 shares authorized, 46,975,365 shares issued and outstanding at September 30, 2006 and December 31, 2005		469,772			469,772
Additional Paid-In Capital		46,430,030			46,430,030
Accumulated Deficit		(46,479,854	)		(46,182,400	)
Total Shareholders’ Equity		419,948			717,402
	$	532,532		$	896,921

See notes to consolidated financial statements

2

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

	For the Three Month Period Ended						For the Nine Month Period Ended
	September 30,			September 30,			September 30,			September 30,
	2006			2005			2006			2005
Revenues:
Royalty Revenues	$	67,744		$	270,914		$	261,100		$	1,031,777
		67,744			270,914			261,100			1,031,777
Cost of Revenues		6,774			12,752			26,251			89,514
Gross Profit		60,970			258,162			234,849			942,263
Operating Expenses:
General and Administrative		122,210			116,539			371,343			457,463
Research and Development		—			62,068			157,740			244,717
Sales and Marketing		—			45,356			1,241			140,810
		122,210			223,963			530,324			842,990
Operating (Loss)		(61,240	)		34,199			(295,475	)		99,273
Interest and Other Income		1,442			3,376			7,087			9,992
Interest and Other Expense		(2,000	)		(1,030	)		(4,266	)		(5,140	)
		(558	)		2,346			2,821			4,852
Income (Loss) Before Income Taxes		(61,798	)		36,545			(292,654	)		104,125
Income Taxes		—			—			(4,800	)		—
Net Income (Loss)	$	(61,798	)	$	36,545		$	(297,454	)	$	104,125
Basic and Diluted Earnings Per Share	$	(0.00	)	$	0.00		$	(0.01	)	$	0.00
Weighted Average Shares Outstanding		48,763,383			46,975,365			48,763,383			46,975,365

See notes to consolidated financial statements

3

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

	Nine Months Ended
	September 30,
	2006			2005
Cash Flows from Operating Activities:
Net Income (Loss)	$	(297,454	)	$	104,125
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and Amortization		28,926			37,789
Net Change in Assets and Liabilities:
Accounts Receivable and Employee Advances		85,661			138,359
Prepaid Expenses and Deposits		(12,833	)		28,660
Accounts Payable		4,172			(46,170	)
Accrued Wages and Benefits		(45,754	)		(5,506	)
Accrued Professional Fees		(11,500	)		2,500
Accrued Commissions		9,561			2,073
Accrued Expenses		(37,147	)		(31,995	)
Deferred Revenue					(391,395	)
Net Cash Provided By (Used In) Operating Activities		(276,368	)		(161,560	)
Cash Flows from Investing Activities:
Purchase/Disp of Property and Equipment		—			(5,277	)
Increase in Capitalized Patent and Technology Costs		(15,013	)		—
Net Cash Provided By (Used in) Investing Activities		(15,013	)		(5,277	)
Cash flows from Financing Activities:
Issuance (Repayment) of Notes Payable		13,733			(29,891	)
Net Cash Provided by Financing Activities		13,733			(29,891	)
Increase (Decrease) in Cash and Cash Equivalents		(277,648	)		(196,728	)
Cash and Cash Equivalents, Beginning of Period		550,633			871,155
Cash and Cash Equivalents, End of Period	$	272,985		$	674,427
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest	$	4,266		$	5,140
Income Taxes		4,800

See notes to consolidated financial statements

4

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

	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)		—		—		—		(172,667	)		(172,667	)
Balance, March 31, 2006		48,763,383	$	469,772	$	46,430,030	$	(46,355,066	)	$	544,735
Net (Loss)								(62,989	)	$	(62,989	)
Balance, June 30, 2006		48,763,383		469,772		46,430,030		(46,418,055	)		481,746
Net (Loss)								(61,798	)	$	(61,798	)
Balance, September 30, 2006		48,763,383		469,772		46,430,030		(46,479,854	)		419,948

See notes to consolidated financial statements

5

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

1) Sale of All or Substantially All of the Assets of Spatializer Audio Laboratories, Inc. and Desper Products, Inc. and Dissolution of Spatializer

     Spatializer has been a developer, licensor and marketer of next generation technologies for the consumer electronics, personal computing, entertainment and cellular telephone markets. Our technology is incorporated into products offered by our licensees and customers on various economic and business terms. We were incorporated in the State of Delaware in February 1994 and are the successor company in a Plan of Arrangement pursuant to which the outstanding shares of Spatializer Audio Laboratories, Inc., a publicly held Yukon, Canada corporation, were exchanged for an equal number of shares of our common stock. Our corporate office is located at 2025 Gateway Place, Suite 365 West Wing, San Jose, California 95110.

The Company’s wholly-owned subsidiary, Desper Products, Inc. (“DPI”), has been in the business of developing proprietary advanced audio signal processing technologies and products for consumer electronics, entertainment, and multimedia computing. All Company revenues are generated from this subsidiary. Desper Products is the owner of certain technology which DTS desires to acquire. Desper Products is a California corporation incorporated in June 1986.

DTS, Inc. is a Delaware corporation and a leading provider of entertainment technology, products and services to the audio and image entertainment markets worldwide. DTS BVI is a British Virgin Island corporation and a wholly owned subsidiary of DTS.

          Background of the Sale of Assets and Dissolution

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

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

          In 2004, the revenue mix by licensee platform was significantly different compared to the prior year. The decrease in revenue on the DVD and personal computer accounts

6

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

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

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

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

     On December 19, 2005, at a regularly scheduled board of directors meeting, the board of directors of Spatializer discussed Spatializer’s current financial outlook. Management indicated to the board of directors that two customers, the revenues from which accounted for approximately 70% of Spatializer’s income during 2005, would not be sustainable in 2006. Based on management’s estimates, without new licensing revenue sources, management believed Spatializer would exhaust its available cash by the fourth quarter of 2006. The board of directors also discussed various strategic options for Spatializer, including potential

7

suitors and the distribution by SEG of interest books to approximately 55 potential purchasers, competition in its niche, and other business matters. Following the presentation, Gilbert Segel and James Pace, two of the three independent directors of Spatializer, decided to resign from the board of directors in order to allow for other individuals more qualified and experienced in matters relating to the sale of Spatializer and other strategic alternatives for Spatializer, including liquidation, to fill the vacancies created. The board was reduced from four members to three authorized directors leaving one vacancy thereon, which has not been filled to date. Henry R. Mandell then indicated his desire to resign as an officer of Spatializer, for personal reasons, effective January 6, 2006, which vacancy would result in a significant reduction in payroll expense, but would stay as a director and Chairman of the Board and Secretary of Spatializer. Mr. Mandell offered to become a consultant to Spatializer on terms to be negotiated with Carlo Civelli, the remaining member of the Board. The board of directors then discussed plans for the future of Spatializer and measures for scaling back operations, while continuing to pursue a potential buyer through SEG, with a view to maximizing stockholder value.

     On January 6, 2006, Henry R. Mandell’s resignation as the Chief Executive Officer and Chief Financial Officer became effective. Effective as of that date, Spatializer and Mr. Mandell entered into an agreement to continue his employment with Spatializer as Chairman and Secretary. In that agreement, Mr. Mandell agreed to continue to provide certain specified services to Spatializer, including supervising the preparation of Spatializer’s financial statements and records, reviewing and authorizing day to day disbursements, supervising all of Spatializer’s licensing and business activities, handling stockholder communications and serving as the contact person with SEG. He was permitted to accept other employment during the term of that agreement. As an incentive for Mr. Mandell to continue in Spatializer’s employ during the term of that agreement, and in consideration for the foregoing of certain severance pay to which he otherwise may have been entitled, Spatializer paid him a lump sum payment of $35,733.33, which amount was paid concurrently with the execution of that agreement. That agreement also provided for a monthly salary of $5,000, a bonus of $10,000 for Mr. Mandell’s assistance in the preparation of Spatializer’s Form 10-K for the fiscal year ended December 31, 2005 and a separate bonus of $5,000 each for his assistance on each Form 10-Q upon which he assists for any quarterly period ending after December 31, 2005 and each proxy. Additionally, if Spatializer is sold or enters into certain specified extraordinary transactions during the term of that agreement, Mr. Mandell may be entitled to an additional bonus in an amount equal to 3.5% of the total consideration, not to exceed $150,000. During the term of that agreement, he is entitled to employee benefits and reimbursement of reasonable, actual and necessary business expenses. That agreement contains certain non-competition, non-solicitation and confidentiality provisions. That agreement terminated certain provisions of Mr. Mandell’s then existing employment agreement (including without limitation the compensation and severance pay obligations thereunder) but continued certain other provisions thereof (such as the proprietary information, confidentiality and other similar provisions thereunder). While that agreement was to expire on the earlier of (a) the consummation of certain extraordinary transactions, (b) the expiration, termination or non-renewal of the directors’ and officers’ insurance policy of Spatializer under which Mr. Mandell is covered as a director and officer of Spatializer and (c) June 30, 2006, that agreement was extended for a period ending on the earlier of June 30, 2007 or the date of dissolution of Spatializer. Spatializer may terminate Mr. Mandell’s employment at any time during the term and Mr. Mandell may voluntarily resign his employment at any time during such term.

8

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

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

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

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

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

     From March 16, 2006 through approximately April 10, 2006, Spatializer and DTS negotiated the terms of a non-binding letter of intent. Although Spatializer, in the course of such negotiations, requested that the transaction be structured as a stock sale or merger transaction, DTS was not willing to so structure the transaction. The letter of intent, requiring the transaction to be structured as an asset sale, was executed on April 10, 2006. In connection with the execution of the letter of intent and as required by the terms thereof, DTS deposited $250,000 towards the purchase price of the assets, which deposit amount is being held in a trust account and will be disbursed to Spatializer contingent upon, among other things, approval of the transaction by the stockholders of Spatializer and satisfaction of the conditions to closing.

9

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

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

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

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

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

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

     On September 18, 2006, the parties executed and delivered the Asset Purchase Agreement. It is anticipated that a meeting of Stockholders will be held in January, 2007 to vote on the approval of this Agreement.

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     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 generally accepted accounting principles. All such adjustments were of a normal recurring nature for interim financial reporting. Operating results for the three months ended September 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 September 30, 2006 substantially all cash and cash equivalents were on deposit at two financial institutions.

     At September 30, 2006, two customers, not presented in the order of importance, Sharp and Funai, accounted for 57% and 14% respectively of our. accounts receivable. At September 30, 2005, three customers, not presented in the order of importance, Matsushita, Sharp and Funai, accounted for 42%, 21% and 20% respectively of our. 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.

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     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 100% of total sales in the year to date periods ended September 30, 2006 and 2005, respectively. Approximately 95% and 5% of sales were generated in Japan and Korea, respectively, in the nine months ended September 30, 2006.

     Major Customers — During the quarter ended September 30, 2006, two customers, Sharp and Funai, not presented in order of importance, accounted for 57% and 14% of the Company’s revenue. In the nine months ended September 30, 2006, two customers, Funai, Sharp, not presented in order of importance, accounted for 41% and 25% of the Company’s revenue.

     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 and nine month periods ended September 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:

12

	2006		2005
Options		1,750,000		2,960,000
Warrants		0		0
		1,750,000		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 September 30, 2006. Options to purchase 250,000 common shares expired in the quarter ended September 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.

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     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 September 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 September 30, 2006, consists of the following in accordance with application of SFAS 144:

	September 30,		December 31,
	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		624,326		619,128
Property and Equipment, Net	$	6,205	$	18,403

(4) Intangible Assets

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

	September		December 31,
	30, 2006		2005
Capitalized Patent, Trademarks and Technology Costs	$	540,709	$	525,695
Less Accumulated Amortization		403,876		387,147
Intangible Assets, Net	$	136,833	$	138,548

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     Estimated amortization is as follows:

2006	$	8,351
2007	$	134,059
2008	$	0
2009	$	0
Thereafter	$	0

     It is anticipated that the intangible assets will be written off upon completion of the sale of assets, subject to stockholder approval, in January, 2007.

(5) Notes Payable

     The Company is 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 September 30, 2006, shares were issued, cancelled or converted as follows:

Options to purchase 250,000 shares of common stock previously granted to one employee, at an exercise price of $0.05 were cancelled after the resignation of the employee per terms of the option agreement.

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 Restricted Common Stock at the minimum conversion price of $.56 per share. This resulted in the issuance of 1,788,018 Common Stock shares.

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(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 September 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		(976,666	)		(1,060,000	)	$	0.10
Options outstanding at September 30, 2006		1,750,000			1,750,000		$	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 September 30, 2006, the number of options exercisable was 1,750,000 and the weighted-average exercise price of those options was $0.09.

     There were no warrants outstanding at December 31, 2005 or September 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 September 30, 2006 for all operating leases were approximately $7,000 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 September 30, 2006 and 2005, respectively.

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(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.

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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.

     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.

Executive Overview

     Revenues decreased to $68,000 for the quarter ended September 30, 2006 compared to $271,000 for the quarter ended September 30, 2005, a decrease of 75%. Revenues were comprised of royalties pertaining to the licensing of Spatializer^® audio signal processing algorithms and circuit designs. A key issue discussed is our ability to obtain and maintain revenue traction when traditional revenue sources are eroding, while being replaced by new revenue sources.

     Net Loss was $62,000 for the quarter ended September 30, 2006; $0.00 basic and diluted per share, compared to net income of $37,000, ($0.00) per share basic, for the quarter ended September 30, 2005. The increased net loss for the current period is primarily the result of lower revenue, partially offset by lower overhead. A key issue discussed is management’s unsuccessful efforts to increase revenues while managing overhead and maintaining competitiveness during revenue source transition to new markets for the Company.

     At September 30, 2006, we had $273,000 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 $277,000 at September 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. We do not believe this is attainable.

     The business environment in which we operate is very difficult and the industry, we believe, is unattractive from a competitive strategy perspective. We face substantial risk as a result. 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

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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 difficult 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 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

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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.

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 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 dissolution is not approved, the Board of Directors will be required to explore other alternatives for the Company and its business.

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 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

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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 has decided to recommend to and seek the approval of stockholders for the sale of the assets of the Company and liquidate the business.

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

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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 as CEO with Company effective January 6, 2006, though he remained as Chairman to assist in the search and closing of a sale transaction. There were no members of the committee upon the resignation of Mr. Segel.

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     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.

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          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

Revenues

     Revenues decreased to $68,000 for the quarter ended September 30, 2006 compared to $271,000 for the quarter ended September 30, 2005, a decrease of 75%. Revenues were comprised of royalties pertaining to the licensing of Spatializer audio signal processing algorithms and circuit designs. Revenues in the nine months ended September 30, 2006 were $261,000, compared to revenues of $1,032,000 in the comparable period last year, a decrease of 75%. Revenues in the three and nine months ended September 30, 2006 decreased due to end of life of a mobile telephone license and the recognition, earlier in 2005, of deferred revenue on a royalty prepayment received in the third quarter of 2004.

Gross Profit

     Gross profit for the three months ended September 30, 2006 was $61,000 (90% of revenue) compared to gross profit of $258,000 (95% of revenue) in the comparable period last year, a decrease of 76%. Gross profit for the nine months ended September 30, 2006 were $235,000 (90% of revenue) compared to $942,000 (91% of revenue) in the comparable period last year. Gross profit in the three and nine-month periods decreased due to decreased revenue.

Operating Expenses

     Operating expenses in the three months ended September 30, 2006 were $122,000 (180% of revenue) compared to operating expenses of 224,000 (83% of revenue) in the comparable period last year, a decrease of 46%. Operating expenses in the nine months ended September 30, 2006 were $530,000 (203% of revenue) compared to $843,000 (82% of revenue) in the comparable nine-month period last year. The decrease in operating expenses for the three and nine months ended September 30, 2006 resulted primarily from personnel and operating reductions resulting from the suspension of day-to-day operations during the asset auction process, with the goal of conserving cash.

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General and Administrative

     General and administrative expenses in the three months ended September 30, 2006 were $122,000 (180% of revenue) compared to general and administrative expenses of $117,000 (43% of revenue) in the comparable period last year, an increase of 4%. General and administrative expenses in the nine months ended September 30, 2006 were $371,000 (142% of revenue) compared to $457,000 (44% of revenue) in the comparable nine month period last year. The increase in general and administrative expense for the three month period results primarily from higher legal expenses arising from the proposed sale of assets. The decrease in general and administrative expense for the nine month period resulted primarily from the elimination of the CEO position and related corporate travel expenses.

Research and Development

     Research and Development expenses in the three months ended September 30, 2006 were $0 (0% of revenue) compared to research and development expenses of $62,000 (23% of revenue) in the comparable period last year, a decrease of 100%. Research and Development expenses for the nine months ended September 30, 2006 were $158,000 (61% of revenue) compared to $245,000 (25% of revenue) in the comparable nine month period last year. There were no engineering activities in the third quarter. The decrease in the nine month research and development expenses resulted from the elimination of an in-house applications engineering position and the resignation of the principal engineer in May 2006.

Sales and Marketing

     Sales and Marketing expenses in the three months ended September 30, 2006 were $0 (0% of revenue) compared to sales and marketing expenses of $45,000 (17% of revenue) in the comparable period last year, an decrease of 100%. Sales and Marketing expenses for the nine months ended September 30, 2006 were $1,000 (1% of revenue) compared to $141,000 (14% of revenue) in the comparable nine month period last year. The decrease in sales and marketing expense in the three and nine month periods resulted from the suspension of all travel and selling activities, with the resignation of the CEO who performed this function as among his duties.

Net Income (Loss)

     Net Loss was ($62,000) for the quarter ended September 30, 2006, $0.00 basic per share, compared to net income of $37,000, $0.00 basic and diluted per share, for the quarter ended September 30, 2005. Net loss in the nine months ended September 30, 2006 was ($297,000), ($0.01) basic per share, compared with net income of $104,000, $0.00 basic and diluted per share in the comparable period last year. The net loss in the three month and nine month periods resulted from decreased revenues and a general wind down of operations.

     At September 30, 2006, we had $273,000 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 $277,000 at September 30, 2006 as compared with working capital of $560,000 at December 31, 2005.

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     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 September 30, 2006 are described below:

	Payment due by period
			Less than				More than
Contractual obligations	Total		1 year		1-3 years	3-5 years	5 years
Operating Lease Obligations	$	7,000	$	7,000
Total	$	7,000	$	7,000

     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.

     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.

     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 months.

     On January 10, 2006, the Company announced that it would hold an open auction for the

26

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 15, 2006 deadline. The Board of Directors of the company, in consultation with their financial and legal advisors, extended the auction period to March 15, 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.

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

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

     On September 18, 2006, the parties executed and delivered the Asset Purchase Agreement. It is anticipated that a meeting of Stockholders will be held in January, 2007 to vote on the approval of this Agreement.

Net Operating Loss Carry forwards

     At December 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 2013. Approximately $21,700,000 of these net operating loss carry forwards are subject to an annual limitation of approximately $1,000,000. Based on the suspension of operations and the pending sale of assets, these net operating loss carry forwards will not be utilized.

Recently Issued Accounting Pronouncements

27

     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 September 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 September 30, 2006 were effective to ensure that information required to be disclosed by the Company in reports

28

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 . There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

29

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 October 29, 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

     In addition to the other information set forth in this Quarterly Report, stockholders should 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

10.9 Asset Purchase Agreement, dated as of September 18, 2006, by and among DTS, Inc., a Delaware corporation (“Purchaser”), DTS BVI Limited, a corporation organized under the laws of the British Virgin Islands and a subsidiary of Purchaser (“Purchaser Subsidiary”), Spatializer Audio Laboratories, Inc., a Delaware corporation (“Seller”), and Desper Products, Inc., a California corporation which is a wholly

30

	owned subsidiary of Seller (“Seller Subsidiary”).
31	Rule 13a-14(a)/15d-14(a) Certification
32*	Section 1350 Certification

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

SIGNATURES

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

Dated: November 14, 2006

SPATIALIZER AUDIO LABORATORIES, INC.

(Registrant)

/s/ Henry R. Mandell

Henry R. Mandell

Chairman of the Board and Secretary

(Principal Executive, Financial and Accounting Officer)

31

EX-10.9

Exhibit 10.9

EXECUTION COPY

ASSET PURCHASE AGREEMENT

by and among

DTS, INC.,

DTS BVI LIMITED,

SPATIALIZER AUDIO LABORATORIES, INC.

and

DESPER PRODUCTS, INC.

dated as of

September 18, 2006

TABLE OF CONTENTS

	Page(s)
ARTICLE I PURCHASE AND SALE OF ASSETS		1
Section 1.1 Sale and Transfer of Assets		1
Section 1.2 Assumption of Liabilities		2
Section 1.3 Excluded Liabilities		2
Section 1.4 The Purchase Price		3
Section 1.5 Allocation of Purchase Price; Tax Filings		3
ARTICLE II THE CLOSING		4
Section 2.1 The Closing		4
Section 2.2 Deliveries by Seller and Seller Subsidiary		4
Section 2.3 Deliveries by Purchaser		5
ARTICLE III REPRESENTATIONS AND WARRANTIES OF SELLER AND SELLER SUBSIDIARY		5
Section 3.1 Authorization		5
Section 3.2 Binding Agreement		6
Section 3.3 Good Title Conveyed		6
Section 3.4 Organization; Qualification of Seller		6
Section 3.5 Subsidiaries and Affiliates		6
Section 3.6 Consents and Approvals; No Violations		6
Section 3.7 SEC Reports and Financial Statements		7
Section 3.8 Property Held by Others		8
Section 3.9 Absence of Certain Changes		8
Section 3.10 Title to Properties; Encumbrances		8
Section 3.11 Environmental Matters		8
Section 3.12 Contracts and Commitments		8
Section 3.13 Customers		9
Section 3.14 Litigation		9
Section 3.15 Compliance with Laws		9
Section 3.16 Employee Benefit Plans		9
Section 3.17 Tax Matters		9
Section 3.18 Intellectual Property		10
Section 3.19 Solvency		12
Section 3.20 Brokers or Finders		12
Section 3.21 Full Disclosure		12
Section 3.22 Proxy Statement		13

	Page(s)
ARTICLE IV REPRESENTATIONS AND WARRANTIES OF PURCHASER		13
Section 4.1 Organization		13
Section 4.2 Authorization; Validity of Agreement; Necessary Action		13
Section 4.3 Consents and Approvals; No Violations		13
Section 4.4 Brokers or Finders		14
Section 4.5 Information Supplied		14
ARTICLE V COVENANTS		14
Section 5.1 Interim Operations of Seller and Seller Subsidiary		14
Section 5.2 Access; Confidentiality		15
Section 5.3 Stockholder Meeting		15
Section 5.4 Proxy Statement		16
Section 5.5 Efforts and Actions to Cause Closing to Occur		16
Section 5.6 Notification of Certain Matters		17
Section 5.7 No Solicitation of Competing Transaction		18
Section 5.8 No Assumption of Labor Liabilities		18
Section 5.9 Subsequent Actions		19
Section 5.10 Publicity		19
Section 5.11 Mail Received After Closing		19
Section 5.12 Access to Books and Records		19
Section 5.13 Waiver of Bulk Sales Requirement		19
Section 5.14 Accounts Receivable		20
Section 5.15 Proxy Solicitation Efforts		20
Section 5.16 Post-Closing Assignment		20
ARTICLE VI CONDITIONS		21
Section 6.1 Conditions to Each Party’s Obligation to Effect the Closing		21
Section 6.2 Conditions to Obligations of Purchaser to Effect the Closing		21
Section 6.3 Conditions to Obligations of Seller to Effect the Closing		22
ARTICLE VII TERMINATION		23
Section 7.1 Termination		23
Section 7.2 Effect of Termination		24
ARTICLE VIII INDEMNIFICATION		24
Section 8.1 Indemnification; Remedies		24
Section 8.2 Limitations		24
Section 8.3 Notice of Claim; Defense		25
Section 8.4 Survival of Indemnification Claims		25
Section 8.5 Tax Effect of Indemnification Payments		25

	Page(s)
Section 8.6 Survival of Covenants, Representations and Warranties		25
ARTICLE IX DEFINITIONS AND INTERPRETATION		26
Section 9.1 Definitions		26
Section 9.2 Interpretation		30
ARTICLE X MISCELLANEOUS		31
Section 10.1 Fees and Expenses		31
Section 10.2 Amendment and Modification		31
Section 10.3 Notices		31
Section 10.4 Counterparts		32
Section 10.5 Entire Agreement; No Third Party Beneficiaries		32
Section 10.6 Severability		33
Section 10.7 Governing Law		33
Section 10.8 Enforcement; Venue		33
Section 10.9 Time of Essence		33
Section 10.10 Extension; Waiver		33
Section 10.11 Election of Remedies		33
Section 10.12 Assignment		34

EXHIBITS

Exhibit A – Form Of Assumption Agreement
Exhibit B – Purchase Price Allocation
Exhibit C – Form Of Bill Of Sale And Assignment
Exhibit D – Schedule Of Liens
Exhibit E – Assumed Contracts

ASSET PURCHASE AGREEMENT

     Asset Purchase Agreement, dated as of September 18, 2006, by and among DTS, Inc., a Delaware corporation (“Purchaser”), DTS BVI Limited, a corporation organized under the laws of the British Virgin Islands and a subsidiary of Purchaser (“Purchaser Subsidiary”), Spatializer Audio Laboratories, Inc., a Delaware corporation (“Seller”), and Desper Products, Inc., a California corporation which is a wholly owned subsidiary of Seller (“Seller Subsidiary”). Certain capitalized terms used in this Agreement have the meanings assigned to them in ARTICLE IX.

     WHEREAS, the Boards of Directors of each of Purchaser, Purchaser Subsidiary, Seller and Seller Subsidiary has approved, and deems it advisable and in the best interests of its respective stockholders to consummate the acquisition of the Purchased Assets by Purchaser, which acquisition is to be effected by the sale of the Purchased Assets to Purchaser or Purchaser Subsidiary, as determined by Purchaser, by Seller and Seller Subsidiary, subject to only those liabilities expressly assumed by Purchaser or Purchaser Subsidiary pursuant hereto, and otherwise upon the terms and subject to the conditions set forth herein; and

     WHEREAS, Purchaser and Purchaser Subsidiary intend to co-develop the Purchased Assets and allocate them among each of them such that all tangible Purchased Assets and all other domestic Purchased Assets be transferred to Purchaser and all foreign Purchased Assets be transferred to Purchaser Subsidiary, each at the Closing as contemplated hereby.

     NOW, THEREFORE, in consideration of the foregoing and the representations, warranties, covenants and agreements set forth herein, intending to be legally bound hereby, the parties hereto agree as follows:

ARTICLE I

PURCHASE AND SALE OF ASSETS

     Section 1.1 Sale and Transfer of Assets. Subject to the terms and conditions of this Agreement, at the Closing Seller and Seller Subsidiary shall sell, convey, assign, transfer and deliver to Purchaser or Purchaser Subsidiary as specified by Purchaser the Purchased Assets, and Purchaser or Purchaser Subsidiary, as applicable, agrees to purchase and accept from Seller and Seller Subsidiary the Purchased Assets, free and clear of all Encumbrances, except for the Encumbrances specifically to be assumed by Purchaser or Purchaser Subsidiary pursuant to the Assumption Agreement in the form of Exhibit A hereto (the “Assumption Agreement”). The term “Purchased Assets” means all of Seller’s and Seller Subsidiary’s right, title and interest in and to all property and assets, real, personal or mixed, tangible or intangible, of every kind and description, wherever located, used in the conduct of the Business, and shall include but not be limited to:

     (a) all Seller Intellectual Property;

     (b) all Assumed Contracts;

     (c) all accounts receivable and royalties originating from the Assumed Contracts, subject to Purchaser’s obligation pursuant to Section 5.14; and

     (d) all records, reports and databases related to outbound licenses of Seller Intellectual Property;

provided, that, (x) cash and cash equivalents and (y) accounts receivable not originating from the Assumed Contracts are not Purchased Assets.

     Section 1.2 Assumption of Liabilities. Except for obligations specifically to be assumed by Purchaser or Purchaser Subsidiary pursuant to the Assumption Agreement, neither Purchaser nor Purchaser Subsidiary shall assume nor shall be deemed to have assumed or agreed to be responsible for any Liabilities of Seller, Seller Subsidiary or any of either of their Affiliates, whether or not arising out of the ownership and operation of the Purchased Assets or the Business. Upon the terms and subject to the conditions of this Agreement and the Assumption Agreement, Purchaser or Purchaser Subsidiary, as determined by Purchaser, shall assume on the Closing Date, effective as of the time of the Closing, and pay, perform and discharge when due all liabilities, obligations and commitments under the Assumed Contracts, to the extent arising or relating to performance by Seller or Seller Subsidiary after the Closing Date, other than any Liabilities, arising due to any breach of any such Assumed Contract by Seller or Seller Subsidiary (collectively, the “Assumed Liabilities”).

     Section 1.3 Excluded Liabilities. Notwithstanding any provision in this Agreement, Purchaser or Purchaser Subsidiary, as applicable, is assuming only the Assumed Liabilities and is not assuming any other Liability of Seller, Seller Subsidiary or any of either of their Affiliates whether or not arising out of the ownership and operation of the Purchased Assets or the Business (all Liabilities of Seller, Seller Subsidiary and either of their Affiliates not expressly assumed by Purchaser or Purchaser Subsidiary shall be retained by Seller, Seller Subsidiary and their Affiliates and are referred to as the “Excluded Liabilities”). Without limiting the generality of the preceding sentence, the Excluded Liabilities include:

     (a) all Liabilities relating to the operations of Seller or Seller Subsidiary or the Business, except as set forth in Section 1.2;

     (b) all Liabilities related to any accounts payable or any indebtedness of Seller or Seller Subsidiary, except those Liabilities first arising after the Effective Time under the Assumed Contracts;

     (c) all Liabilities relating to any products manufactured or licensed by Seller or Seller Subsidiary prior to the Effective Time, including warranty obligations and product liabilities and intellectual property indemnities irrespective of the legal theory asserted;

     (d) all Liabilities related to any Assumed Contract that arise prior to the Effective Time;

     (e) all Liabilities related to any Assumed Contract that arise subsequent to the Effective Time but that arise out of or relate to any breach that occurred prior to the Effective Time;

     (f) all Liabilities with respect to Taxes relating to the Business, the Seller or Seller Subsidiary;

     (g) subject to Purchaser’s limited obligation pursuant to Section 10.1, all Liabilities with respect to Taxes arising out of or relating to the sale of the Purchased Assets or assumption of the Assumed Liabilities;

     (h) all Liabilities with respect to Taxes relating to the ownership or use of the Purchased Assets prior to the Effective Time;

     (i) all Liabilities, obligations and commitments relating to any Environmental Claim;

     (j) all Liabilities relating to any employee benefits or employee plans provided to any employee or consultant of Seller or Seller Subsidiary;

     (k) all Liabilities relating to employment, severance or termination agreements with any employee or consultant of Seller or Seller Subsidiary;

     (l) all Liabilities relating to any violation of law by Seller or Seller Subsidiary or any litigation against Seller or Seller Subsidiary; and

     (m) all Liabilities relating to brokers fees or success fees with respect to the Transaction.

     Section 1.4 The Purchase Price. Subject to the terms and conditions of this Agreement, in consideration of the aforesaid sale, conveyance, assignment, transfer and delivery to Purchaser and Purchaser Subsidiary of the Purchased Assets, at the Closing Purchaser shall (i) pay or cause to be paid to Seller an amount of cash equal to One Million Dollars ($1,000,000) U.S. and (ii) Purchaser or Purchaser Subsidiary, as determined by Purchaser, shall assume the Assumed Liabilities.

     Section 1.5 Allocation of Purchase Price; Tax Filings. The Purchase Price shall be allocated among the Purchased Assets as set forth in Exhibit B hereto, which has been arrived at by arm’s length negotiation, in compliance with Section 1060 of the Code and the regulations promulgated thereunder. Each of Purchaser, Purchaser Subsidiary, Seller and Seller Subsidiary shall (i) timely file all forms (including Internal Revenue Service Form 8594) and Tax Returns required to be filed in connection with such allocation, (ii) be bound by such allocation for purposes of determining Taxes, (iii) prepare and file, and cause its Affiliates to prepare and file, its Tax Returns on a basis consistent with such allocation and (iv) take no position, and cause its Affiliates to take no position, inconsistent with such allocation on any applicable Tax Return, in any audit or proceeding before any taxing authority, in any report made for Tax, financial accounting or any other purposes, or otherwise. In the event that the Allocation set forth on Exhibit B hereto is disputed by any taxing authority, the party receiving notice of such dispute shall promptly notify the other party hereto concerning the existence and resolution of such dispute.

ARTICLE II

THE CLOSING

     Section 2.1 The Closing. The sale and transfer of the Purchased Assets by Seller and Seller Subsidiary to Purchaser and Purchaser Subsidiary shall take place at the offices of Purchaser, 5171 Clareton Drive, Agoura Hills, CA 91301, at 10:00 a.m., local time, on a day mutually agreed to by Seller and Purchaser which day shall be not later than ten Business Days following the satisfaction or waiver of all conditions to closing set forth in ARTICLE VI (other than conditions which can be satisfied only by the delivery of certificates, opinions or other documents at the Closing), unless another date or place is agreed in writing by each of the parties hereto.

     Section 2.2 Deliveries by Seller and Seller Subsidiary. At the Closing, Seller and Seller Subsidiary shall deliver or cause to be delivered to Purchaser and Purchaser Subsidiary:

     (a) a duly executed Bill of Sale and Assignment in the form annexed hereto as Exhibit C;

     (b) all documents of title and instruments of conveyance necessary to transfer and record beneficial and record ownership to Purchaser or Purchaser Subsidiary, as applicable, of all Purchased Assets;

     (c) assignments of all Patents, Trademarks, trade names, domain names, ideas, assumed names and Copyrights and all applications and disclosures therefor and all other Intellectual Property included among the Purchased Assets;

     (d) duly executed copies of all required consents;

     (e) all documents containing or relating to “know-how” to be acquired by Purchaser or Purchaser Subsidiary pursuant hereto;

     (f) all of the books, records and customer data and reports of Seller or Seller Subsidiary relating to the Purchased Assets;

     (g) the officers’ certificate referred to in Section 6.2(c) hereof;

     (h) all such other deeds, endorsements, assignments and other instruments as, in the opinion of Purchaser’s counsel, are necessary to vest in Purchaser or Purchaser Subsidiary, as applicable, good and marketable title to the Purchased Assets free and clear of all Encumbrances;

     (i) evidence of the satisfaction of all obligations and release of all liens encumbering the Purchased Assets, including without limitation those items specified on Exhibit D hereto ; and

     (j) all other previously undelivered documents required to be delivered by Seller or Seller Subsidiary to Purchaser or Purchaser Subsidiary at or prior to the Closing in connection with the Transactions.

     Seller and Seller Subsidiary shall take all actions reasonably requested by Purchaser to deliver physical possession of the Purchased Assets to Purchaser or Purchaser Subsidiary at the Closing at such location in southern California as is specified by Purchaser; provided, that, all out of pocket costs related to delivery of the Purchased Assets that are either arranged for by Purchaser, or arranged for by Seller with Purchaser’s written pre-approval, shall be paid or reimbursed, as applicable, by Purchaser.

     Section 2.3 Deliveries by Purchaser. At the Closing, Purchaser shall deliver or cause to be delivered to Seller:

     (a) immediately available funds in the amount of One Million Dollars ($1,000,000) (U.S.);

     (b) the Assumption Agreement, duly executed by Purchaser or Purchaser Subsidiary, as applicable;

     (c) the officer’s certificate referred to in Section 6.3 hereof; and

     (d) such other documents as are required to be delivered by Purchaser or Purchaser Subsidiary to Seller at or prior to the Closing pursuant to this Agreement.

ARTICLE III

REPRESENTATIONS AND WARRANTIES
OF SELLER AND SELLER SUBSIDIARY

     Except as specifically set forth in the Disclosure Schedule prepared by Seller and delivered to Purchaser simultaneously with the execution hereof, each of Seller and Seller Subsidiary represent and warrant to Purchaser and Purchaser Subsidiary that all of the statements contained in this Article III are true and complete as of the date of this Agreement (or, if made as of a specified date, as of such date), and will be true and complete in all material respects (without giving effect to any materiality qualifier therein) as of the Closing Date as though made on the Closing Date. Each exception set forth in the Disclosure Schedule and each other response to this Agreement set forth in the Disclosure Schedule is identified by reference to, or has been grouped under a heading referring to, a specific individual section or subsection, as applicable, of this Agreement and, relates only to such section or subsection, as applicable and to another section or subsection of this Agreement only to the extent the applicability of such disclosure thereto is readily apparent.

     Section 3.1 Authorization. Each of Seller and Seller Subsidiary has full corporate power and authority to execute and deliver this Agreement and to consummate the Transactions. The execution, delivery and performance by Seller and Seller Subsidiary of this Agreement and the consummation by each of them of the Transactions have been duly authorized by Seller’s and Seller Subsidiary’s Boards of Directors and by the sole shareholder of Seller Subsidiary, and no other corporate action on the part of Seller or Seller Subsidiary is necessary to authorize the execution and delivery by Seller of this Agreement or the consummation by it of the Transactions, subject only to the approval of this Agreement and the Transactions (including

without limitation the sale of the Purchased Assets) by the holders of a majority of the outstanding shares of Seller Common Stock (“Stockholder Approval”).

     Section 3.2 Binding Agreement. This Agreement has been duly executed and delivered by each of Seller and Seller Subsidiary and, assuming due and valid authorization, execution and delivery thereof by Purchaser, this Agreement is a valid and binding obligation of Seller and Seller Subsidiary enforceable against Seller and Seller Subsidiary in accordance with its terms, except (i) as limited by applicable bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance and other similar laws of general application affecting enforcement of creditors’ rights generally and (ii) the availability of the remedy of specific performance or injunctive or other forms of equitable relief may be subject to equitable defenses and would be subject to the discretion of the court before which any proceeding therefor may be brought.

     Section 3.3 Good Title Conveyed. The bill of sale and the deeds, endorsements, assignments and other instruments to be executed and delivered by Seller and Seller Subsidiary to Purchaser and Purchaser Subsidiary at the Closing will be valid and binding obligations of Seller and Seller Subsidiary, enforceable in accordance with their respective terms, and will effectively vest in Purchaser or Purchaser Subsidiary, as applicable, good, valid and marketable title to all the assets to be transferred to Purchaser pursuant to and as contemplated by this Agreement free and clear of all Encumbrances, except Encumbrances to be assumed by Purchaser or Purchaser Subsidiary pursuant to the Assumption Agreement.

     Section 3.4 Organization; Qualification of Seller. Each of Seller and Seller Subsidiary (i) is a corporation duly organized, validly existing and in good standing under the laws of its state of incorporation; (ii) has full corporate power and authority to carry on its business and to own those Purchased Assets to be transferred by it to Purchaser; and (iii) is duly qualified or licensed to do business as a foreign corporation in good standing in every jurisdiction in which the conduct of its business or the character of its assets requires such qualification, except where the failure to be so qualified or licensed as a foreign corporation could not, individually or in the aggregate, reasonably be expected to have a material adverse effect on Seller and Seller Subsidiary, taken as a whole, or on the Purchased Assets.

     Section 3.5 Subsidiaries and Affiliates. The Disclosure Schedule sets forth the name, jurisdiction of incorporation and authorized and outstanding capital of each Subsidiary of Seller. All the outstanding capital stock of each Subsidiary of Seller is owned directly by Seller, and there are no outstanding options, rights or agreements of any kind relating to the issuance, sale or transfer of any capital stock or other equity securities of any such Subsidiary. Seller has heretofore delivered to Purchaser complete and correct copies of the certificate of incorporation and by-laws of Seller and Seller Subsidiary, as presently in effect.

     Section 3.6 Consents and Approvals; No Violations. Except for the filing with the SEC of (x) a proxy statement relating to the approval by the stockholders of Seller of the principal terms of this Agreement and the Transactions (the “Proxy Statement”) and (y) such reports under the Exchange Act as may be required in connection with this Agreement and the Transactions, none of the execution, delivery or performance of this Agreement by Seller or Seller Subsidiary, the consummation by Seller or Seller Subsidiary of the Transactions or compliance by Seller or Seller Subsidiary with any of the provisions hereof will (i) conflict with

or result in any breach of any provision of the certificate of incorporation, the by-laws or similar organizational documents of Seller or Seller Subsidiary, (ii) require any filing with, or permit, authorization, consent or approval of, any Governmental Entity or other Person (including, without limitation, consents from parties to loans, contracts, leases, licenses and other agreements to which Seller or Seller Subsidiary is a party) other than documents to record record ownership of registered Seller Intellectual Property, (iii) require any consent, approval or notice under, or result in a violation or breach of, or constitute (with or without due notice or the passage of time or both) a default (or give rise to any right of termination, amendment, cancellation or acceleration) under, any of the terms, conditions or provisions of any agreement to which Seller or Seller Subsidiary is a party or by which the Purchased Assets are bound, or (iv) violate any order, writ, injunction, decree, statute, rule or regulation applicable to Seller, the Purchased Assets, Seller Subsidiary or any of their properties or assets, excluding from the foregoing clauses (ii), (iii) and (iv) such violations, breaches or defaults could not, individually or in the aggregate, reasonably be expected to have a material adverse effect on Seller and Seller Subsidiary, taken as a whole, or on the Purchased Assets.

     Section 3.7 SEC Reports and Financial Statements.

     (a) Seller has filed, or furnished, as applicable, with the SEC all forms, reports, schedules, statements and other documents required to be filed by it since January 1, 2004 (together with all exhibits and schedules thereto and all information incorporated therein by reference, the “Seller SEC Documents”). The Seller SEC Documents, as of their respective dates or, if amended, as of the date of the last such amendment, (i) did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading and (ii) complied in all material respects with the applicable requirements of the Exchange Act, Securities Act and the Sarbanes-Oxley Act of 2002 and the rules and regulations promulgated under such acts and the applicable rules and regulations of the SEC thereunder. No Subsidiary of Seller is separately required to make any filings with the SEC.

     (b) The consolidated financial statements of Seller included or incorporated by reference in the Seller SEC Documents complied in all material respects with applicable accounting requirements and with the published rules and regulations of the SEC with respect thereto, were prepared in accordance with GAAP applied on a consistent basis during the periods indicated (except as may be indicated in the notes thereto or, in the case of unaudited interim financial statements, as may be permitted by the SEC on Form 10-Q under the Exchange Act) and fairly presented the consolidated financial position of Seller and its consolidated Subsidiaries as of the dates thereof and the consolidated results of their operations and cash flows for the periods then ended, except that the unaudited interim financial statements were or are subject to normal and recurring year-end adjustments which were not material in amount. Since January 1, 2004, there has been no material change in Seller’s accounting methods or principles that would be required to be disclosed in Seller’s financial statements in accordance with GAAP, except as required by applicable law and described in the notes to such financial statements. Except (a) as disclosed in such financial statements and (b) for liabilities and obligations incurred in the ordinary course of business and consistent with past practice since the Balance Sheet Date that are immaterial in the aggregate, neither Seller nor Seller Subsidiary has any Liability that has, or

could reasonably be expected to have, a material adverse effect on Seller and Seller Subsidiary, taken as a whole, or on Purchaser’s ability to exploit the Purchased Assets.

     Section 3.8 Property Held by Others. The Disclosure Schedule lists all property owned by Seller or Seller Subsidiary and included within the Purchased Assets which is not in the possession of Seller, if any, together, in each case, with the name, address and telephone number of each Person who holds such property.

     Section 3.9 Absence of Certain Changes. Since the Balance Sheet Date, neither Seller nor Seller Subsidiary has:

     (a) permitted or allowed any of the Purchased Assets to be subjected to any Encumbrance;

     (b) sold, transferred, licensed or otherwise disposed of any Purchased Asset; or permitted to lapse any rights to the use of any Seller Intellectual Property, or disposed of or disclosed to any Person other than representatives of Purchaser any trade secret, formula, process, know-how or other Intellectual Property not theretofore a matter of public knowledge; or

     (c) agreed, whether in writing or otherwise, to take any action described in this section.

     Section 3.10 Title to Properties; Encumbrances. Each of Seller and Seller Subsidiary has good, valid and marketable title to all the Purchased Assets free and clear of all Encumbrances.

     Section 3.11 Environmental Matters. Each of Seller and Seller Subsidiary is in material compliance with all Environmental Laws. There is no Environmental Claim by any Person that is pending or, to the knowledge of Seller, threatened against Seller, or Seller Subsidiary, or against any Person whose liability for any Environmental Claim Seller or Seller Subsidiary has retained or assumed either contractually or by operation of law.

     Section 3.12 Contracts and Commitments.

     (a) The Disclosure Schedule sets forth each outbound license of Seller Intellectual Property. Except for the outbound licenses of Seller Intellectual Property specified in the Disclosure Schedule, neither Seller nor Seller Subsidiary has any agreements, contracts, commitments or restrictions which are material to the Business.

     (b) Except as set forth in the Disclosure Schedule, neither Seller nor Seller Subsidiary has any outstanding contracts with agents, consultants, advisors, salesmen, sales representatives, distributors or dealers.

     (c) Neither Seller nor Seller Subsidiary is in default under or in violation of, nor is there any valid basis for any claim of default under or violation of, any contract required to be set forth in the Disclosure Schedule pursuant to Section 3.12(a) or 3.12(b).

     (d) Neither Seller nor Seller Subsidiary is restricted by agreement from carrying on its business anywhere in the world.

     (e) Seller has provided Purchaser with a correct and complete copy of each contract identified in the Disclosure Schedules and all amendments thereto and waivers thereunder.

     (f) Except for the contracts set forth in Section 3.12(a) of the Disclosure Schedule for which Seller has provided Purchaser a correct and complete copy (including all amendments thereto and waivers thereunder), no Person has been granted a royalty-free license to any Seller Intellectual Property.

     (g) Except for the contracts set forth in Section 3.12(a) of the Disclosure Schedule for which Seller has provided Purchaser a correct and complete copy (including all amendments thereto and waivers thereunder), no outbound license of Seller Intellectual Property permits the licensee to sublicense or assign such license.

     Section 3.13 Customers. To Seller’s knowledge, there has not been any material adverse change in the business relationship of Seller or Seller Subsidiary with any customer who accounted for more than 5% of its consolidated sales for the year ended December 31, 2005.

     Section 3.14 Litigation. There is no action, suit, inquiry, proceeding or investigation by or before any court or governmental or other regulatory or administrative agency or commission pending or, to the knowledge of Seller, threatened, against or involving the Seller or Seller Subsidiary, or which questions or challenges the validity of this Agreement or any action taken or to be taken by Seller or Seller Subsidiary pursuant to this Agreement or in connection with the Transactions; and there is no valid basis for any such action, proceeding or investigation. Neither Seller nor Seller Subsidiary is subject to any judgment, order or decree.

     Section 3.15 Compliance with Laws. Each of Seller and Seller Subsidiary has complied in all respects with all laws, rules and regulations, ordinances, judgments, decrees, orders, writs and injunctions of all United States federal, state, local, foreign governments and agencies thereof that affect their business, properties or assets and no notice, charge, claim, action or assertion has been received by Seller or Seller Subsidiary or has been filed, commenced or threatened against Seller or Seller Subsidiary alleging any violation of any of the foregoing, in each case, except as could not, individually or in the aggregate, reasonably be expected to have a material adverse effect on Seller and Seller Subsidiary, taken as a whole, or on the Purchased Assets.

     Section 3.16 Employee Benefit Plans. Neither Seller or Seller Subsidiary currently has or has ever had in place, any Plans or is or has been subject to any multi-employer plan.

     Section 3.17 Tax Matters. Seller and Seller Subsidiary has each timely filed, or caused to be filed (taking into account any valid extensions of due dates), all Tax Returns, including information returns and returns for estimated taxes, required by any taxing jurisdiction with respect to Taxes and all Taxes shown on said returns to be due and all other Taxes due and owing (whether or not shown on any return) have been paid in full or are being contested in good faith as described in the Disclosure Schedule, which Tax Returns are complete and accurate in all material respects. Seller and Seller Subsidiary has each withheld all amounts required to be

withheld on account of Taxes from amounts paid to employees, former employees, directors, officers, members, residents and non-residents and has remitted or will remit the same to the appropriate taxing authorities within the prescribed time periods. None of the Tax Returns filed by Seller or Seller Subsidiary has been audited by any taxing authority and, to Seller’s knowledge, there is no such examination currently in progress. No deficiency in the payment of Taxes for any period has been asserted in writing by any taxing authority and remains unsettled. Neither Seller nor Seller Subsidiary has entered into any agreement, waiver or other arrangement providing for any extension of time with respect to the assessment or collection of any Taxes.

     Section 3.18 Intellectual Property.

     (a) The Disclosure Schedule sets forth a true and complete list of all Patents and Patent applications, Trademark registrations and applications, service mark registrations and applications, Software, Copyright registrations and applications, material unregistered Trademarks, service marks, Copyrights and Internet domain names used or held for use by Seller or Seller Subsidiary, together with all licenses related to the foregoing, whether Seller or Seller Subsidiary is the licensee or licensor thereunder.

     (b) Seller or Seller Subsidiary is the sole and exclusive owner of all Seller Intellectual Property, free and clear of all Encumbrances, except for that Intellectual Property indicated in the Disclosure Schedule as being licensed to Seller or Seller Subsidiary, under which Seller or Seller Subsidiary has a valid license, free and clear of all Encumbrances.

     (c) Except as indicated in the Disclosure Schedule, all Patents, registrations and applications for Intellectual Property that are owned by Seller or Seller Subsidiary (i) are valid, subsisting, in proper form and enforceable, and have been duly maintained, including the submission of all necessary filings and fees in accordance with the legal and administrative requirements of the appropriate jurisdictions and (ii) have not lapsed, expired or been abandoned, and no patent, registration or application therefor is the subject of any opposition, interference, cancellation proceeding or other legal or governmental proceeding before any Governmental Entity in any jurisdiction.

     (d) Seller or Seller Subsidiary owns or has the valid right to use all of the Intellectual Property used by it or held for use by it in connection with its business. There are no conflicts with or infringements of any Seller Intellectual Property by any third party. The conduct of the businesses of Seller and Seller Subsidiary does not conflict with or infringe in any way on any proprietary right of any third party. There is no claim, suit, action or proceeding pending or, to the knowledge of Seller, threatened against Seller or Seller Subsidiary (i) alleging any such conflict or infringement with any third party’s proprietary rights or (ii) challenging the ownership, use, validity or enforceability of the Seller Intellectual Property.

     (e) The Disclosure Schedule lists all algorithms related to the Business. There is no Software currently or previously, or contemplated to be, licensed, sublicensed or sold to or by Seller or Seller Subsidiary. “Software” means any and all (i) computer programs, including any and all software implementations of algorithms, models and methodologies, whether in source code or object code, (ii) computer databases and computer compilations, including any and all data and collections of data, whether machine readable or otherwise, (iii) descriptions, flow-

charts and other work product used to design, plan, organize and develop any of the foregoing, (iv) any Domain Names and the technology supporting and content contained on any Internet site(s), and (v) all documentation, including user manuals and training materials, relating to any of the foregoing.

     (f) Each item of Software listed in the Disclosure Schedule is either (i) owned by Seller or Seller Subsidiary, or (ii) currently in the public domain or otherwise available to Seller or Seller Subsidiary without the license, lease or consent of any third party. With respect to the Software set forth in the Disclosure Schedule which Seller or Seller Subsidiary purports to own, such Software was either developed by (x) employees of Seller or Seller Subsidiary within the scope of their employment; or (y) independent contractors who have assigned their rights to Seller or Seller Subsidiary and waived any moral rights in favor of Seller or Seller Subsidiary pursuant to written agreements. The Seller Software generally functions in the manner intended, free of any significant bugs or programming errors.

     (g) Except pursuant to the outbound licenses of Seller Intellectual Property set forth in Section 3.12(a) of the Disclosure Schedule, neither Seller nor Seller Subsidiary has ever distributed to any third party any of the Seller Software and, except as contemplated hereby, no such distribution is presently contemplated. Each of Seller and Seller Subsidiary has taken all actions customary in the software industry to document the Seller Software and its operation, such that the Seller Software, including the source code and documentation, have been written in a clear and professional manner so that they may be understood, modified and maintained in an efficient manner by reasonably competent programmers. The Seller Software is free of any undisclosed program routine, device, or other feature, including, without limitation, a time bomb, software lock, drop-dead device, or malicious logic or, as of the time of each delivery, any virus, worm or Trojan horse, that is designed to delete, disable, deactivate, interfere with, or otherwise harm them (a “Disabling Code”), and any virus or other intentionally created, undocumented contaminant (a “Contaminant”), that may, or may be used to, access, modify, delete, damage or disable any hardware, system or data or that may result in damage thereto. The components obtained from third party suppliers are free of any Disabling Codes or Contaminants that may, or may be used to, access, modify, delete, damage or disable any hardware, system or data or that might result in damage thereto.

     (h) All employees and consultants of Seller or Seller Subsidiary, whether former or current, have entered into valid and binding agreements with Seller or Seller Subsidiary sufficient to vest title in Seller or Seller Subsidiary of all rights in any Intellectual Property created by such employee or consultant in the scope of his or her services or employment for Seller or Seller Subsidiary, as the case may be.

     (i) Each of Seller and Seller Subsidiary takes and has taken reasonable measures to protect the confidentiality of its trade secrets, know-how or other confidential information material to its business as currently operated or planned to be operated (together, “Trade Secrets”). No material or significant Trade Secret has been disclosed or authorized to be disclosed to any third party, including any employee, agent, contractor or other person, other than pursuant to a written non-disclosure agreement (or other written agreement or employment policy imposing non-disclosure obligations) that adequately protects Seller’s or Seller Subsidiary’s proprietary interests in and to such Trade Secrets. No party to any non-disclosure

agreement relating to any Trade Secrets is in breach thereof. All nonpublic information provided by or on behalf of Seller or Seller Subsidiary to third parties (other than Purchaser) has been returned to Seller or destroyed.

     (j) All consents, filings, and authorizations by or with Governmental Entities or third parties necessary with respect to the consummation of the Transactions, as they may affect the Intellectual Property, have been obtained.

     (k) Neither Seller nor Seller Subsidiary has entered into any consent, indemnification, forbearance to sue, settlement agreement or cross-licensing arrangement with any Person relating to the Seller Intellectual Property or the Intellectual Property of any third party, except as contained in any license agreements listed in the Disclosure Schedule.

     (l) Neither Seller, Seller Subsidiary, nor Purchaser is, nor will be as a result of the execution and delivery of this Agreement, the other Documents or the performance of its obligations under this Agreement or the other Documents, in breach of any license, sublicense or other agreement relating to the Seller Intellectual Property.

     Section 3.19 Solvency. Neither Seller nor Seller Subsidiary is insolvent and will not be rendered insolvent by the Transactions. As used in this section “insolvent” means that the sum of the debts and other Liabilities of a party exceeds the present fair saleable value of such party’s assets. Immediately after giving effect to the Transactions, the cash available to Seller and Seller Subsidiary, after taking into account all other anticipated uses of the cash, will be sufficient to pay all Liabilities of Seller and Seller Subsidiary. Neither Seller nor Seller Subsidiary intends to file for reorganization or liquidation under the bankruptcy or reorganization laws of any jurisdiction within one year from the Closing Date. Seller has conducted an auction process with respect to the sale of the Purchased Assets, and based on among other things, the offers of participants in the process, has concluded that it is receiving reasonably equivalent value from Purchaser for the Purchased Assets.

     Section 3.20 Brokers or Finders. No agent, broker, investment banker, financial advisor or other firm or Person is or will be entitled to any broker’s or finder’s fee or any other commission or similar fee in connection with any of the Transactions except for Strategic Equity Group and its assignee Edgewater Capital, LLC, whose fees and expenses shall be paid by Seller. True and complete copies of all agreements between Seller and Strategic Equity Group or Edgewater Capital LLC, including, without limitation, any fee arrangements have been furnished to Purchaser.

     Section 3.21 Full Disclosure. To the knowledge of Seller, Seller has not failed to disclose to Purchaser any facts material to the Purchased Assets. No representation or warranty by Seller or Seller Subsidiary contained in this Agreement and no statement contained in any document (including, without limitation, financial statements and the Disclosure Schedule), certificate, or other writing furnished or to be furnished by Seller or Seller Subsidiary to Purchaser or any of its representatives pursuant to the provisions hereof or in connection with the Transactions, contains or will contain any untrue statement of material fact or omits or will omit to state any material fact necessary, in light of the circumstances under which it was made, in order to make the statements herein or therein not misleading.

     Section 3.22 Proxy Statement. The Proxy Statement will not, at the date it is first mailed to the stockholders of Seller and at the time of the Stockholders’ Meeting, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading, except that no representation or warranty is made by Seller with respect to statements made or incorporated by reference therein based on information supplied by or on behalf of Purchaser specifically for inclusion or incorporation by reference in the Proxy Statement. The Proxy Statement will comply as to form in all material respects with the requirements of the Exchange Act.

ARTICLE IV

REPRESENTATIONS AND WARRANTIES

OF PURCHASER AND PURCHASER SUBSIDIARY

     Purchaser represents and warrants to Seller that:

     Section 4.1 Organization. Each of Purchaser and Purchaser Subsidiary is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation and has all requisite corporate power and authority to own, lease and operate its properties and to carry on its business as now being conducted, except where the failure to be so organized, existing and in good standing or to have such power, authority, and governmental approvals would not have, individually or in the aggregate, a material adverse effect on the ability of Purchaser or Purchaser Subsidiary to consummate the Transactions.

     Section 4.2 Authorization; Validity of Agreement; Necessary Action. Each of Purchaser and Purchaser Subsidiary has all requisite corporate power and authority to execute and deliver this Agreement and to consummate the Transactions. The execution, delivery and performance by Purchaser and Purchaser Subsidiary of this Agreement and the consummation of the Transactions have been duly authorized by the Board of Directors of Purchaser and Purchaser Subsidiary, and no other corporate action on the part of Purchaser or Purchaser Subsidiary is necessary to authorize the execution and delivery by Purchaser or Purchaser Subsidiary of this Agreement or the consummation of the Transactions. This Agreement has been duly executed and delivered by Purchaser and Purchaser Subsidiary, and, assuming due and valid authorization, execution and delivery hereof by Seller and Seller Subsidiary, is a valid and binding obligation of Purchaser, enforceable against Purchaser and Purchaser Subsidiary in accordance with its terms except (i) as limited by applicable bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance and other similar laws of general application affecting enforcement of creditors’ rights generally and (ii) the availability of the remedy of specific performance or injunctive or other forms of equitable relief may be subject to equitable defenses and would be subject to the discretion of the court before which any proceeding therefor may be brought.

     Section 4.3 Consents and Approvals; No Violations. None of the execution, delivery or performance of this Agreement by Purchaser or Purchaser Subsidiary, the consummation by Purchaser or Purchaser Subsidiary of the Transactions or compliance by Purchaser or Purchaser Subsidiary with any of the provisions hereof will (i) conflict with or result in any breach of any provision of the certificate of incorporation or by-laws of Purchaser or Purchaser Subsidiary, (ii)

require any filing with, or permit, authorization, consent or approval of, any Governmental Entity, (iii) result in a violation or breach of, or constitute (with or without due notice or lapse of time or both) a default (or give rise to any right of termination, cancellation or acceleration) under, any of the terms, conditions or provisions of any note, bond, mortgage, indenture, lease, license, contract, agreement or other instrument or obligation to which Purchaser or Purchaser Subsidiary is a party or by which any of its properties or assets may be bound, or (iv) violate any order, writ, injunction, decree, statute, rule or regulation applicable to Purchaser or Purchaser Subsidiary or any of their properties or assets, excluding from the foregoing clauses (ii), (iii) and (iv) such violations, breaches or defaults which would not, individually or in the aggregate, have a material adverse effect on the ability of Purchaser or Purchaser Subsidiary to consummate the Transactions.

     Section 4.4 Brokers or Finders. Neither Purchaser nor Purchaser Subsidiary has entered into any agreement or arrangement entitling any agent, broker, investment banker, financial advisor or other firm or Person to any broker’s or finder’s fee or any other commission or similar fee in connection with any of the Transactions.

     Section 4.5 Information Supplied. None of the information to be supplied by or on behalf of Purchaser or Purchaser Subsidiary in writing specifically for inclusion or incorporation by reference in the Proxy Statement will, at the date it is first mailed to the stockholders of Seller and at the time of the Stockholders’ Meeting, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading.

ARTICLE V

COVENANTS

     Section 5.1 Interim Operations of Seller and Seller Subsidiary. Each of Seller and Seller Subsidiary shall procure that, and each of Seller and Seller Subsidiary covenants and agrees that, after the date hereof and prior to the Closing Date, except (i) as expressly provided in this Agreement, (ii) as set forth in the Disclosure Schedule or (iii) as may be agreed in writing by Purchaser in its sole discretion:

     (a) neither Seller nor Seller Subsidiary shall (i) modify, amend or terminate any contract identified on Schedule E hereto or any material contract or waive, release or assign any material rights or claims, (ii) enter into, terminate or amend any contract identified on Schedule E hereto or any material contract, (iii) incur any material liability, (iv) permit the Purchased Assets to become subject to any Encumbrance or (v) sell, transfer, lease, license or otherwise dispose of any of the Purchased Assets or Seller Intellectual Property;

     (b) neither Seller nor Seller Subsidiary shall adopt a plan of complete or partial liquidation or dissolution; provided, that, Seller may adopt a plan of dissolution in accordance with the DGCL if and only if (x) such plan provides for the consummation of the Transactions in accordance with the terms of this Agreement; (y) such plan is adopted in accordance with the DGCL; and (z) Seller does not adopt a plan of distribution or make any distribution on or prior to the 213^th day after the Closing Date;

     (c) neither Seller nor Seller Subsidiary shall adopt a plan of complete or partial merger, consolidation, restructuring, recapitalization or other reorganization; provided, that, Seller may adopt a plan of merger for the sole purpose of the sale of Seller as a corporate shell and without any of the Purchased Assets if and only if such plan includes the consummation of the Transactions in accordance with the terms of this Agreement and Seller demonstrates that such plan will not delay either the solicitation of proxies in favor of the Transactions or the consummation of the Transactions;

     (d) each of Seller and Seller Subsidiary shall file, on a timely basis, with appropriate taxing authorities all Tax Returns required to be filed prior to the Closing Date and timely pay all Taxes related thereto;

     (e) neither Seller nor Seller Subsidiary shall take, or agree to or commit to take, any action that would or is reasonably likely to result in any of the conditions to the Closing set forth in ARTICLE VI not being satisfied, or would make any representation or warranty of Seller or Seller Subsidiary contained herein inaccurate in any respect at, or as of any time prior to, the Closing Date, or that would materially impair the ability of Seller, Purchaser or Seller Subsidiary to consummate the Closing in accordance with the terms hereof or materially delay such consummation; and

     (f) neither Seller nor Seller Subsidiary shall enter into any agreement, contract, commitment or arrangement to do any of the foregoing, or authorize, recommend, propose or announce an intention to do, any of the foregoing.

     Section 5.2 Access; Confidentiality. Seller and Seller Subsidiary shall use its best efforts to preserve the organization of their book, records and customer data and reports in the same manner and format as previously made available to Purchaser. Between the date of this Agreement and the Closing, Seller and Seller Subsidiary shall (i) afford Purchaser and its authorized representatives reasonable access to all offices and other facilities and to all books and records, (ii) permit Purchaser to make such inspections and to make copies of such books and records as it may reasonably require and (iii) furnish Purchaser with such financial and operating data and other information as Purchaser may from time to time reasonably request. Purchaser and its authorized representatives shall conduct all such inspections in a manner that will minimize disruptions to the business and operations of Seller.

     Section 5.3 Stockholder Meeting. Seller shall, as promptly as practicable following the execution of this Agreement, establish a record date for, duly call, give notice of, convene and hold a meeting of its stockholders to approve the principal terms of this Agreement and the Transactions (the “Stockholder Meeting”). Seller shall, through its Board of Directors, recommend to its stockholders approval of the principal terms of this Agreement and the Transactions and shall include such recommendation in the Proxy Statement. Without limiting the generality of the foregoing, Seller’s obligations pursuant to the first sentence of this Section 5.3 shall not be affected by the commencement, public proposal, public disclosure or communication of any Acquisition Proposal. Seller shall not withdraw or modify such approval or recommendation of this Agreement or the Transactions.

     Section 5.4 Proxy Statement. As promptly as practicable after the execution of this Agreement, Seller shall prepare and file with the SEC the Proxy Statement. Seller shall use its reasonable best efforts to (i) respond to any comments on the Proxy Statement or requests for additional information from the SEC as soon as practicable after receipt of any such comments or requests and (ii) cause the Proxy Statement to be mailed to its stockholders as promptly as practicable. Seller shall promptly (i) notify Purchaser upon the receipt of any such comments or requests and (ii) provide Purchaser with copies of all correspondence between Seller and its representatives, on the one hand, and the SEC and its staff, on the other hand, with respect to the Proxy Statement. Prior to responding to any such comments or requests or the filing or mailing of the Proxy Statement, (i) Seller shall provide Purchaser with a reasonable opportunity to review and comment on any drafts of the Proxy Statement and related correspondence and filings, (ii) Seller shall include in such drafts, correspondence and filings all comments reasonably proposed by Purchaser and (iii) to the extent practicable, Seller and its outside counsel shall permit Purchaser and its outside counsel to participate in all communications with the SEC and its staff (including all meetings and telephone conferences) relating to the Proxy Statement, this Agreement or any of the Transactions. If at any time prior to the Stockholders Meeting any event shall occur, or fact or information shall be discovered that should be set forth in an amendment of or a supplement to the Proxy Statement, Seller shall, in accordance with the foregoing procedures, prepare and file with the SEC such amendment or supplement as soon thereafter as is reasonably practicable and to the extent required by applicable law, cause such amendment or supplement to be distributed to the stockholders of Seller. Each of Purchaser and Purchaser Subsidiary shall cooperate with Seller in connection with the preparation of the Proxy Statement and shall provide in a timely fashion all information requested by Seller concerning Purchaser and Purchaser Subsidiary that is required to be included in the Proxy Statement.

     Section 5.5 Efforts and Actions to Cause Closing to Occur.

     (a) Prior to the Closing, upon the terms and subject to the conditions of this Agreement, Purchaser, Purchaser Subsidiary, Seller and Seller Subsidiary shall use their respective reasonable best efforts to take, or cause to be taken, all actions, and to do, or cause to be done and cooperate with each other in order to do, all things necessary, proper or advisable (subject to any applicable laws) to consummate the Closing and the other Transactions as promptly as practicable including, but not limited to the preparation and filing of all forms, registrations and notices required to be filed to consummate the Closing and the other Transactions and the taking of such actions as are necessary to obtain any requisite approvals, authorizations, consents, orders, licenses, permits, qualifications, exemptions or waivers by any third party or Governmental Entity. In addition, no party hereto shall take any action after the date hereof that could reasonably be expected to materially delay the obtaining of, or result in not obtaining, any permission, approval or consent from any Governmental Entity or other Person required to be obtained prior to Closing.

     (b) Prior to the Closing, each party shall promptly consult with the other parties hereto with respect to, provide any necessary information with respect to, and provide the other parties (or their respective counsel) with copies of, all filings made by such party with any Governmental Entity or any other information supplied by such party to a Governmental Entity in connection with this Agreement and the Transactions. Each party hereto shall promptly

provide the other parties with copies of any communication received by such party from any Governmental Entity regarding any of the Transactions.

     (c) Seller shall use its best efforts to obtain the release of the liens and judgments described in Section 3.3 of the Disclosure Schedule (other than tax liens, which shall be discharged in accordance with (i) below) and otherwise shall obtain, prior to the Closing, (i) the unconditional release of each Person holding a tax or other lien (other than those liens, excepting tax liens, and judgments described in Section 3.3 of the Disclosure Schedule) on property owned or leased by Seller or Seller Subsidiary and (ii) the unconditional consent to the Closing and the other Transactions of each other party to each material contract with Seller or Seller Subsidiary. All such releases and consents, to the extent obtained, shall be in writing and executed counterparts thereof shall be delivered to Purchaser at or prior to the Closing.

     Section 5.6 Notification of Certain Matters.

     (a) From time to time prior to the Closing, Seller and Seller Subsidiary shall promptly supplement or amend the Disclosure Schedule with respect to any matter existing or occurring as of or prior to the date of this Agreement that was required to be set forth or described in the Disclosure Schedule in order to make any representation or warranty in the Agreement true and complete. No supplement or amendment of the Disclosure Schedule made after the execution hereof by Seller or Seller Subsidiary pursuant to this section 5.6(a) or otherwise shall, except as set forth in Section 5.6(b), be deemed to cure any breach of any representation of or warranty made pursuant to this Agreement.

     (b) From time to time prior to the Closing, Seller and Seller Subsidiary shall promptly supplement or amend the Disclosure Schedule with respect to any matter arising after the date of this Agreement that, if existing at, or occurring on, the date of this Agreement, would have been required to be set forth or described in the Disclosure Schedule in order to make any representation or warranty in the Agreement true and correct. Should Seller or Seller Subsidiary supplement the Disclosure Schedule in respect of circumstances set forth in this Section 5.6(b), Purchaser shall have the right in its sole discretion to terminate this Agreement. Should Purchaser elect not to terminate this Agreement under these circumstances but rather to consummate the Transactions, then, unless Purchaser and Seller agree otherwise in writing, Purchaser shall be deemed to have waived the breach to the extent disclosure was required and made pursuant to this Section 5.6(b).

     (c) Seller and Seller Subsidiary shall give notice to Purchaser promptly after becoming aware of (i) the occurrence or non-occurrence of any event whose occurrence or non-occurrence would be likely to cause either (A) any representation or warranty contained in this Agreement to be untrue or inaccurate in any material respect at any time from the date hereof to the Closing Date or (B) any condition set forth in ARTICLE VI to be unsatisfied in any material respect at any time from the date hereof to the Closing Date and (ii) any failure of Seller and Seller Subsidiary or any officer, director, employee or agent thereof, to comply with or satisfy any covenant, condition or agreement to be complied with or satisfied by it hereunder; provided, however, that the delivery of any notice pursuant to this section shall not limit or otherwise affect the remedies available hereunder to the party receiving such notice.

     Section 5.7 No Solicitation of Competing Transaction.

     (a) Neither Seller, Seller Subsidiary nor any Affiliate thereof shall (and Seller shall cause the officers, directors, employees, representatives and agents of Seller, Seller Subsidiary and each Affiliate thereof, including investment bankers, attorneys and accountants, not to), directly or indirectly, encourage, solicit, participate in or initiate discussions or negotiations with, or provide any information to, any Person or group (other than Purchaser, any of its Affiliates or representatives) concerning any Acquisition Proposal. Seller shall not approve or recommend, or propose to approve or recommend any Acquisition Proposal, or enter into any agreement with respect to any Acquisition Proposal. Upon execution of this Agreement, Seller and Seller Subsidiary and their representatives shall immediately cease any existing activities, discussions or negotiations with any parties conducted heretofore with respect to any of the foregoing and Seller and Seller Subsidiary shall request (or if Seller or Seller Subsidiary has the contractual right to do so, demand) the return of all documents, analyses, financial statements, projections, descriptions and other data previous furnished to others in connection with efforts to sell the Purchased Assets, Seller or Seller Subsidiary. Seller shall immediately notify Purchaser of the existence of any proposal or inquiry received by Seller, Seller Subsidiary or their representatives and Seller shall immediately communicate to Purchaser the terms of any proposal or inquiry which may be received (and shall immediately provide to Purchaser copies of any written materials received by Seller in connection with such proposal, discussion, negotiation or inquiry) and the identity of the party making such proposal or inquiry.

     (b) Neither Seller’s Board of Directors nor Seller Subsidiary’s Board of Directors shall (i) withdraw or modify, or propose to withdraw or modify, in a manner adverse to Purchaser, the approval by such Boards of Directors of this Agreement or the Transactions or recommendation to their stockholders, (ii) approve or recommend or propose to approve or recommend, any Acquisition Proposal or (iii) authorize Seller or Seller Subsidiary to enter into any agreement (other than pursuant to this Agreement) with respect to any Acquisition Proposal.

     (c) Notwithstanding the foregoing clauses (a) and (b), Seller may engage in discussions with third parties for the sole purpose of the sale of Seller as a corporate shell and without any of the Purchased Assets if and only if the terms would include the consummation of the Transactions in accordance with the terms of this Agreement and Seller demonstrates that such transaction will not delay either the solicitation of proxies in favor of the Transactions or the consummation of the Transactions.

     Section 5.8 No Assumption of Labor Liabilities. Neither Purchaser nor Purchaser Subsidiary shall assume any labor agreements or any liabilities thereunder or the fringe benefit plans or any other liabilities which Seller or Seller Subsidiary may have with respect to any union or employees (including former employees) either on the date hereof or the date of the Closing, including liabilities of Seller or Seller Subsidiary with respect to payment of wages or pensions which may have accrued, vested or been earned prior to the Closing and liabilities of Seller or Seller Subsidiary to contribute to pension or other fringe benefit plans with respect to or on account of service prior to the Closing, and/or any other term or condition of employment.

     Section 5.9 Subsequent Actions.

     (a) If at any time after the Closing but prior to the dissolution of Seller, Purchaser will consider or be advised that any deeds, bills of sale, instruments of conveyance, assignments, assurances or any other actions or things are necessary or desirable to vest, perfect or confirm ownership (of record or otherwise) in Purchaser or Purchaser Subsidiary, its right, title or interest in, to or under any or all of the Purchased Assets or otherwise to carry out this Agreement, Seller and Seller Subsidiary shall execute and deliver all deeds, bills of sale, instruments of conveyance, powers of attorney, assignments and assurances and take and do all such other actions and things as may be requested by Purchaser in order to vest, perfect or confirm any and all right, title and interest in, to and under such rights, properties or assets in Purchaser or Purchaser Subsidiary or otherwise to carry out this Agreement.

     (b) In case at any time after the Closing Date any further action is necessary, proper or advisable to carry out the purposes of this Agreement, as soon as reasonably practicable, each party hereto shall take, or cause its proper officers or directors to take, all such necessary, proper or advisable actions.

     Section 5.10 Publicity. Seller’s and Seller Subsidiary’s initial press release with respect to the execution of this Agreement shall be subject to Purchaser’s prior review, opportunity for comment, and approval, which shall not be unreasonably withheld. Thereafter, until the Closing, or the date the Transactions are terminated or abandoned pursuant to ARTICLE VII, neither Seller, Seller Subsidiary nor any of their respective Affiliates shall issue or cause the publication of any press release or other public announcement with respect to this Agreement or the other Transactions without prior review, opportunity for comment, and approval by Purchaser, which shall not be unreasonably withheld, except as may be required by law or by any listing agreement. In the event that Seller or Seller Subsidiary is required by applicable law or listing agreement to issue or cause the publication of any press release or other public announcement with respect to this Agreement or the other Transactions, it shall promptly notify Purchaser in advance of any such disclosure, and provide Purchaser with the text of any disclosure language, statement or announcement and will reasonably cooperate with Purchaser to the extent it may seek to limit such disclosure or comment on the form or substance of such disclosure.

     Section 5.11 Mail Received After Closing. Seller and Seller Subsidiary shall, promptly upon the Closing, file with the United States Postal Service a change of address notification to direct all mail sent to Seller or Seller Subsidiary to Purchaser.

     Section 5.12 Access to Books and Records. On and after the Closing and until dissolution of Seller, during normal business hours, Seller and Seller Subsidiary will permit Purchaser and its auditors, through their authorized representatives, to have access to and examine and make copies of all books and records relating to the Purchased Assets which are not delivered to Purchaser pursuant hereto.

     Section 5.13 Waiver of Bulk Sales Requirement. Each of the parties waives compliance with any applicable bulk sales laws, including without limitation the Uniform Commercial Code Bulk Transfer provisions. Seller and Seller Subsidiary agree to pay and discharge in due course and will indemnify and save harmless Purchaser, from and against all

claims made by creditors of Seller and Seller Subsidiary, including expenses and attorneys’ fees incurred by Purchaser in defending against such claims.

     Section 5.14 Accounts Receivable. In its attempt to collect royalties or accounts receivable, Seller shall not, and shall cause its agents not to, take any action that could reasonably be expected to negatively affect Purchaser’s relationship with any licensee of Seller Intellectual Property. Notwithstanding that the accounts receivable are included among the Purchased Assets, Purchaser shall pay to Seller on or prior to the 70^th day after the end of the calendar quarter during which the Closing occurs, the Closing Quarter Royalty Payment. The “Closing Quarter Royalty Payment” shall be an amount equal to the product of (X) the total amount of self reported royalties actually received by Purchaser on or prior to the 60^th day after the end of the calendar quarter during which the Closing occurs earned under the Assumed Contracts in respect of such quarter multiplied by (Y) a fraction, the numerator of which is the actual number of days elapsed during such quarter prior to the Closing Date and the denominator of which is the total number of days in such quarter. Subject to Purchaser’s obligation in respect of the Closing Quarter Royalty Payment, Seller and Seller Subsidiary shall promptly remit to Purchaser all royalty payments received in respect of the Assumed Contracts after the Closing.

     Section 5.15 Proxy Solicitation Efforts. Seller shall (x) engage the services of Georgeson Shareholder Services or another Person reasonably acceptable to Purchaser to act as a proxy solicitation agent to solicit proxies voting in favor of the Transactions; (y) make presentations explaining Seller’s rationale for the Transactions and explaining why the Transactions are in the best interests of Seller and its stockholders to any Person which will potentially issue a recommendation as to how Seller’s stockholders should vote at the Stockholders Meeting; and (z) otherwise use its best efforts to secure Stockholder Approval for the Transactions.

     Section 5.16 Post-Closing Assignment. Should Seller or Seller Subsidiary identify after the Closing Date a contract or License related to the Seller Intellectual Property, it shall give prompt written notice of such fact to Purchaser and, at the written request of Purchaser, assign any contract or License relating to the Seller Intellectual Property to Purchaser or Purchaser Subsidiary as Purchaser may request in its sole discretion.

     Section 5.17 Pre-Closing Delivery. Immediately prior to the Closing, Seller shall make available to Purchaser at Purchaser’s offices the hard drive resident in Phil Brown’s computer located at 2025 Gateway Place, Suite 365, San Jose, California 95110 as of April 13, 2006 and the DVDs containing the source code for the algorithms, development platforms and Software specified in the Disclosure Schedules together with the passwords and other information necessary to access the data on such mediums. It shall be a condition precedent to Purchaser’s obligation to effect the Closing that it is capable of accessing the data on such mediums and is able to confirm that such data conforms in all material respects to the data thereon examined by Purchaser during its site visit to Seller’s San Jose offices on April 13, 2006.

ARTICLE VI

CONDITIONS

     Section 6.1 Conditions to Each Party’s Obligation to Effect the Closing. The respective obligation of each party to effect the Closing shall be subject to the satisfaction at or prior to the Closing Date of each of the following conditions:

     (a) Statutes; Court Orders. No statute, rule or regulation shall have been enacted or promulgated by any governmental authority which prohibits the consummation of the Closing; and there shall be no order or injunction of a court of competent jurisdiction in effect precluding consummation of the Closing; and

     (b) Stockholder Approval. Stockholder Approval shall have been obtained.

     Section 6.2 Conditions to Obligations of Purchaser and Purchaser Subsidiary to Effect the Closing. The obligations of Purchaser and Purchaser Subsidiary to consummate the Closing shall be subject to the satisfaction on or prior to the Closing Date of each of the following conditions:

     (a) Government Action. There shall not be threatened or pending any suit, action or proceeding by any Governmental Entity affecting Purchaser’s or Purchaser Subsidiary’s ability to exploit the Purchased Assets or seeking to preclude consummation of the Transaction;

     (b) Intentionally Omitted.

     (c) Officer’s Certificate. Seller and Seller Subsidiary shall have delivered to Purchaser and Purchaser Subsidiary at the Closing a certificate signed by the chief executive officer of Seller and Seller Subsidiary, dated the Closing Date, in form and substance satisfactory to Purchaser, to the effect that, as of the Closing Date, (w) all of the representations and warranties of Seller set forth in this Agreement that are qualified as to materiality are true and complete, (x) all such representations and warranties that are not so qualified are true and complete in all material respects, (y) there has not occurred any material adverse change (or any development that, insofar as reasonably can be foreseen, is reasonably likely to result in any material adverse change) in the consolidated financial condition, businesses, results of operations or prospects of Seller and Seller Subsidiary, taken as a whole, or on the Purchased Assets and (z) Seller and Seller Subsidiary have performed all obligations required under this Agreement to be performed by it at or prior to the Closing;

     (d) Consents Obtained. All consents and approvals of any Person necessary to the consummation of the Closing and the other Transactions, including consents and approvals from parties to loans, contracts, leases, licenses or other agreements and consents and approvals from governmental agencies, whether federal, state or local shall have been obtained, and a copy of each such consent or approval shall have been provided to Purchaser at or prior to the Closing;

     (e) Material Adverse Change. There shall not have occurred any material adverse change (or any development that, insofar as reasonably can be foreseen, is reasonably likely to result in any material adverse change) in the consolidated financial condition, businesses, results

of operations or prospects of Seller and Seller Subsidiary taken as a whole or on Purchaser’s or Purchaser Subsidiary’s ability to exploit the Purchased Assets;

     (f) Intentionally Omitted.

     (g) Material Liabilities. No facts or circumstances shall exist which, in the good faith but sole and exclusive judgment of Purchaser, could result in Purchaser or Purchaser Subsidiary becoming liable for any Liabilities of Seller or Seller Subsidiary other than those to be assumed pursuant to the Assumption Agreement.

     (h) Representations and Warranties. All of the representations and warranties of Seller set forth in this Agreement that are qualified as to materiality shall be true and complete in all respects and any such representations and warranties that are not so qualified shall be true and complete in all material respects, in each case as of the date of this Agreement and as of the Closing Date;

     (i) Confirming Inspection. Seller shall have made available to Purchaser at Purchaser’s offices, immediately prior to the Closing the hard drive resident in Phil Brown’s computer located at 2025 Gateway Place, Suite 365, San Jose, California 95110 as of April 13, 2006 and the DVDs containing the source code for the algorithms, development platforms and Software specified in the Disclosure Schedules together with the passwords and other information necessary to access the data on such mediums and Purchaser shall be capable of accessing the data on such mediums and be able to confirm that such data conforms in all material respects to the data thereon examined by Purchaser during its site visit to Seller’s San Jose offices on April 13, 2006.

     (j) Breach. Neither Seller nor Seller Subsidiary shall have failed to perform in any material respect any material obligation or to comply in any material respect with any agreement or covenant of Seller or Seller Subsidiary to be performed or complied with by it under this Agreement.

     The foregoing conditions are for the sole benefit of Purchaser and may be waived by Purchaser, in whole or in part, at any time and from time to time in the sole discretion of Purchaser.

     Section 6.3 Conditions to Obligations of Seller to Effect the Closing. The obligations of Seller to consummate the Closing shall be subject to the satisfaction on or prior to the Closing Date of each of the following conditions:

     (a) Representations and Warranties. All of the representations and warranties of Purchaser set forth in this Agreement that are qualified as to materiality shall be true and complete in all respects and any such representations and warranties that are not so qualified shall be true and complete in all material respects, in each case as of the date of this Agreement and as of the Closing Date;

     (b) Breach. Purchaser shall not have failed to perform in any material respect any material obligation or to comply in any material respect with any agreement or covenant of Purchaser to be performed or complied with by it under this Agreement; and

     (c) Officer’s Certificate. Purchaser shall have delivered to Seller at the Closing a certificate signed by the chief executive officer of Purchaser, dated the Closing Date, in form and substance satisfactory to Seller, to the effect that, as of the Closing Date, (x) all of the representations and warranties of Purchaser set forth in this Agreement that are qualified as to materiality are true and complete, (y) all such representations and warranties that are not so qualified are true and complete in all material respects, and (z) Purchaser has performed all obligations required under this Agreement to be performed by it at or prior to the Closing.

     The foregoing conditions are for the sole benefit of Seller and may be waived by Seller, in whole or in part, at any time and from time to time in the sole discretion of Seller.

ARTICLE VII

TERMINATION

     Section 7.1 Termination. The Transactions may be terminated or abandoned at any time prior to the Closing Date:

     (a) By the mutual written consent of Purchaser and Seller;

     (b) By either Purchaser or Seller if any Governmental Entity shall have issued an order, decree or ruling or taken any other action (which order, decree, ruling or other action the parties hereto shall use their reasonable efforts to lift), which permanently restrains, enjoins or otherwise prohibits the Transactions and such order, decree, ruling or other action shall have become final and non-appealable;

     (c) By Seller:

          if Purchaser or Purchaser Subsidiary shall have breached in any material respect any of its representations, warranties, covenants or other agreements contained in this Agreement, which breach cannot be or has not been cured within 30 days after the giving of written notice by Seller to Purchaser specifying such breach; or

          on or after June 30, 2007, if the Closing shall not have theretofore occurred and if the failure of the Closing to occur is not the result of a breach of a representation, warranty or covenant by Seller or Seller Subsidiary;

     (d) By Purchaser:

          if Seller or Seller Subsidiary shall have breached any representation, warranty, covenant or other agreement contained in this Agreement, which breach cannot be or has not been cured within 30 days after the giving of written notice by Purchaser to Seller specifying such breach; or

          on or after June 30, 2007, if the Closing shall not have theretofore occurred and if the failure of the Closing to occur is not the result of a breach of a representation, warranty or covenant by Purchaser.

     Section 7.2 Effect of Termination. In the event of the termination or abandonment of the Transactions by any party hereto pursuant to the terms of this Agreement, written notice thereof shall forthwith be given to the other party or parties specifying the provision hereof pursuant to which such termination or abandonment of the Transactions is made, and there shall be no liability or obligation thereafter on the part of Purchaser, Purchaser Subsidiary, Seller or Seller Subsidiary except (A) for fraud, (B) for breach of this Agreement prior to such termination or abandonment of the Transactions and (C) as set forth in Section 10.1; provided, that, if this Agreement is terminated subsequent to the Stockholders Meeting and Stockholder Approval is not obtained thereat, then, unless Seller shall have complied in all respects with its obligations pursuant to Section 5.15, Seller shall reimburse Purchaser for all out-of-pocket expenses incurred by Purchaser in connection with the Transactions.

ARTICLE VIII

INDEMNIFICATION

     Section 8.1 Indemnification; Remedies.

     (a) Seller and Seller Subsidiary shall jointly and severally indemnify, defend and hold harmless the Purchaser Indemnified Persons from and against and in respect of all Losses that arise out of any breach by Seller or Seller Subsidiary of its representations and warranties contained in or made pursuant to this Agreement; and

     (b) Seller and Seller Subsidiary shall jointly and severally indemnify, defend and hold harmless the Purchaser Indemnified Persons from and against and in respect of all Losses that arise out of any breach by Seller or Seller Subsidiary of its covenants or agreements contained in or made pursuant to this Agreement;

     (c) Seller and Seller Subsidiary shall jointly and severally indemnify, defend and hold harmless the Purchaser Indemnified Persons from and against and in respect of all Losses related to Excluded Liabilities; and

     (d) Seller and Seller Subsidiary shall jointly and severally indemnify, defend and hold harmless the Purchaser Indemnified Persons from and against and in respect of all Losses that arise from the failure to obtain any required consent (with respect to the assignment of the Assumed Contracts) in connection with the Transactions.

     Section 8.2 Limitations.

     (a) No claim for the recovery of any Losses pursuant to section 8.1(a) may be asserted by any Purchaser Indemnified Person more than 183 days after the Closing Date; provided, however, that claims first asserted in writing by any Purchaser Indemnified Person with reasonable specificity prior to such date shall not thereafter be barred by the expiration of such indemnification period.

     (b) Seller shall have no liability for indemnification until the total of all Losses exceeds $50,000 U.S., but once such amount has been exceeded, Seller shall be liable for all Losses in excess of the first $15,000 U.S. of Losses.

     Section 8.3 Notice of Claim; Defense. Purchaser shall give Seller prompt (and in any event within 183 days after the Closing Date for a claim made pursuant to Section 8.1(a) above) notice of any third-party claim that may give rise to any indemnification obligation under this Article VIII, together with the estimated amount of such claim, and Seller shall, with the approval of Purchaser which shall not be unreasonably withheld, have the right to assume the defense at Seller’s expense of any such claim through counsel of Seller’ own choosing by so notifying Purchaser within 30 days of the first receipt by Seller of such notice from Purchaser; provided, however, that any such counsel shall be reasonably satisfactory to Purchaser. Failure to give such notice shall not affect the indemnification obligations hereunder in the absence of, and then only to the extent of, actual and material prejudice. If, under applicable standards of professional conduct, a conflict with respect to any significant issue between any Purchaser Indemnified Person and Seller exists in respect of such third-party claim, Seller shall pay the reasonable fees and expenses of such additional counsel as may be required to be retained in order to eliminate such conflict. Seller shall be liable for the fees and expenses of counsel employed by Purchaser for any period during which Seller has not assumed the defense of any such third-party claim (other than during any period in which Purchaser will have failed to give notice of the third-party claim as provided above). If Seller assumes such defense, Purchaser shall have the right to participate in the defense thereof and to employ counsel, at its own expense, separate from the counsel employed by Seller, it being understood that Seller shall control such defense. If Seller chooses to defend or prosecute any third-party claim, Purchaser shall agree to any reasonable settlement, compromise or discharge of such third-party claim that Seller may recommend and that, by its terms, discharges Purchaser and the Purchaser Indemnified Persons from the full amount of liability in connection with such third-party claim; provided, however, that, Seller shall not consent to, and Purchaser shall not be required to agree to, the entry of any judgment or enter into any settlement that (i) provides for injunctive or other non-monetary relief affecting Purchaser or any Affiliate of Purchaser or (ii) does not include as an unconditional term thereof the giving of a release from all liability with respect to such claim by each claimant or plaintiff to each Purchaser Indemnified Person that is the subject of such third-party claim.

     Section 8.4 Survival of Indemnification Claims. The indemnification obligations set forth in this Article VIII shall survive the Closing.

     Section 8.5 Tax Effect of Indemnification Payments. All indemnity payments made by Seller or Seller Subsidiary to Purchaser Indemnified Persons pursuant to this Agreement shall be treated for all Tax purposes as adjustments to the Purchase Price.

     Section 8.6 Survival of Covenants, Representations and Warranties. Each of the covenants, representations and warranties of Seller in this Agreement or in any schedule, instrument or other document delivered pursuant to this Agreement shall survive the Closing Date and shall continue in force thereafter except as limited by Section 8.2(a); provided, that, the covenants in Section 5.9, Section 5.12 and Section 5.16 shall terminate on the 275^th day following the Closing Date; and provided further, that, notwithstanding the termination of any covenant, Seller and Seller Subsidiary shall remain liable for any breach thereof that occurred prior to such termination.

ARTICLE IX

DEFINITIONS AND INTERPRETATION

     Section 9.1 Definitions. For all purposes of this Agreement, except as otherwise expressly provided or unless the context clearly requires otherwise:

     “Acquisition Proposal” shall mean any proposal or offer made by any Person other than Purchaser to acquire all or any portion of the Purchased Assets or any capital stock of Seller or Seller Subsidiary, whether by merger, tender offer, exchange offer, sale of assets, license or similar transactions involving the Seller or Seller Subsidiary.

     “Affiliate” shall have the meaning set forth in Rule 12b-2 promulgated under the Exchange Act.

     “Agreement” or “this Agreement” shall mean this Asset Purchase Agreement, together with the Exhibits hereto and the Disclosure Schedule.

     “Associate” shall have the meaning set forth in Rule 12b-2 promulgated under the Exchange Act.

     “Assumed Contracts” shall mean (x) all contracts, Licenses and other agreements of Seller or Seller Subsidiary set forth on Exhibit E (as may be supplemented from time to time by Purchaser in its sole discretion prior to the Closing solely to add additional contracts, Licenses and other agreements), (y) such additional contracts or licenses of Seller or Seller Subsidiary as are selected by Purchaser by written notice to Seller and (z) such additional contracts, Licenses and other agreements as are assigned to Purchaser pursuant to Section 5.16.

     “Assumed Liabilities” shall have the meaning ascribed thereto in Section 1.2.

     “Assumption Agreement” shall have the meaning ascribed thereto in Section 1.1.

     “Balance Sheet” shall mean the most recent audited balance sheet of the Seller and Seller Subsidiary in the Seller SEC Documents.

     “Balance Sheet Date” shall mean December 31, 2005.

     “Business” shall mean the research, development, marketing, sale, service and licensing of audio and optical disc technologies, products and services.

     “Closing” shall mean the closing referred to in Section 2.1.

     “Closing Date” shall mean the date on which the Closing occurs.

     “Closing Quarter Royalty Payment” shall have the meaning ascribed thereto in Section 5.14.

     “Code” shall mean the Internal Revenue Code of 1986, as amended.

     “Copyrights” shall mean U.S. and foreign registered and unregistered copyrights (including those in computer software and databases), rights of publicity and all registrations and applications to register the same.

     “DGCL” shall mean the Delaware General Corporation Law.

     “Disclosure Schedule” shall mean the disclosure schedule of even date herewith prepared and signed by the Seller and delivered to Purchaser simultaneously with the execution hereof.

     “Effective Time” shall mean 10:00 a.m. local time on the Closing Date.

     “Encumbrances” shall mean any and all liens, charges, security interests, options, claims, mortgages, pledges, proxies, voting trusts or agreements, obligations, understandings or arrangements or other restrictions on title, transfer or use of any nature whatsoever other than liens for taxes, assessments or other governmental charges which were incurred in the ordinary course of business and are not due and payable.

     “Environmental Claim” shall mean any claim, action, cause of action, investigation or notice (written or oral) by any Person alleging actual or potential liability for investigatory, cleanup or governmental response costs, or natural resources or property damages, or personal injuries, attorney’s fees or penalties relating to (i) the presence, or release into the environment, of any Materials of Environmental Concern at any location owned or operated by the Seller or Seller Subsidiary, now or in the past, or (ii) circumstances forming the basis of any violation, or alleged violation, of any Environmental Law.

     “Environmental Law” shall mean each federal, state, local and foreign law and regulation relating to pollution, protection or preservation of human health or the environment including ambient air, surface water, ground water, land surface or subsurface strata, and natural resources, and including each law and regulation relating to emissions, discharges, releases or threatened releases of Materials of Environmental Concern, or otherwise relating to the manufacturing, processing, distribution, use, treatment, generation, storage, containment (whether above ground or underground), disposal, transport or handling of Materials of Environmental Concern, or the preservation of the environment or mitigation of adverse effects thereon and each law and regulation with regard to record keeping, notification, disclosure and reporting requirements respecting Materials of Environmental Concern.

     “ERISA” shall mean the Employee Retirement Income Security Act of 1974, as amended.

     “Exchange Act” shall mean the Securities Exchange Act of 1934, as amended.

     “Excluded Liabilities” shall have the meaning ascribed thereto in Section 1.3.

     “GAAP” shall mean United States generally accepted accounting principles.

     “Governmental Entity” shall mean a court, arbitral tribunal, administrative agency or commission or other governmental or other regulatory authority or agency.

     “Intellectual Property” shall mean all of the following: Trademarks, Patents, ideas, Copyrights, domain names, Trade Secrets, know-how and Licenses.

     “Liabilities” shall mean all liabilities and obligations, secured or unsecured, whether absolute, accrued, contingent, fixed or otherwise, whether known or unknown and whether or not due.

     “Licenses” shall mean all licenses and agreements pursuant to which Seller or Seller Subsidiary has acquired rights in or to any Trademarks, Patents or Copyrights used by or for the benefit of Seller or Seller Subsidiary, or licenses and agreements pursuant to which Seller or Seller Subsidiary has licensed or transferred the right to use any Trademark, Patent or Copyright.

     “Losses” shall mean any and all losses, Liabilities, claims, diminution of value, damages, judgments, settlements and expenses (including interest and penalties recovered by a third party with respect thereto and reasonable attorneys’ fees and expenses and reasonable accountants’ fees and expenses incurred in the investigation or defense of any of the same or in asserting, preserving or enforcing any of the rights of Purchaser arising under ARTICLE VIII) incurred by any of the Purchaser Indemnified Persons.

     “Materials of Environmental Concern” shall mean chemicals; pollutants; contaminants; wastes; toxic or hazardous substances, materials and wastes; petroleum and petroleum products; asbestos and asbestos-containing materials; polychlorinated biphenyls; lead and lead-based paints and materials; and radon.

     “Patents” shall mean issued U.S. and foreign patents and pending patent applications, patent disclosures, and any and all divisions, continuations, continuations-in-part, reissues, reexaminations, and extension thereof, any counterparts claiming priority there from, utility models, patents of importation/confirmation, certificates of invention and like statutory rights.

     “Person” shall mean a natural person, partnership, corporation, limited liability company, business trust, joint stock company, trust, unincorporated association, joint venture, Governmental Entity or other entity or organization.

     “Plan” shall have the meaning set forth in ERISA Section 3(3).

     “Proxy Statement” shall have the meaning ascribed thereto in Section 3.6.

     “Purchased Assets” shall have the meaning ascribed thereto in Section 1.1.

     “Purchaser” shall have the meaning ascribed thereto in the Preamble.

     “Purchaser Subsidiary” shall have the meaning ascribed thereto in the Preamble.

     “Purchaser Indemnified Persons” shall mean Purchaser, Purchaser Subsidiary, each of their Affiliates and each of their officers, directors, employees, agents and representatives.

     “Securities Act” shall mean the Securities Act of 1933, as amended.

     “SEC” shall mean the United States Securities and Exchange Commission.

     “Seller” shall have the meaning ascribed thereto in the Preamble.

     “Seller Common Stock” shall mean the common stock of Seller.

     “Seller Intellectual Property” shall mean all Intellectual Property of Seller or Seller Subsidiary or used in connection with the Business.

     “Seller Software” means all material computer programs and computer databases, other than off-the-shelf applications, which are owned or otherwise used by Seller or Seller Subsidiary.

     “Seller SEC Documents” shall have the meaning ascribed thereto in Section 3.7.

     “Seller Subsidiary” shall have the meaning ascribed thereto in the Preamble.

     “Stockholder Approval” shall have the meaning ascribed thereto in Section 3.1.

     “Subsidiary” shall mean, with respect to any Person, any corporation or other organization, whether incorporated or unincorporated, of which (a) at least a majority of the securities or other interests having by their terms ordinary voting power to elect a majority of the Board of Directors or others performing similar functions with respect to such corporation or other organization is directly or indirectly owned or controlled by such Person or by any one or more of its Subsidiaries, or by such Person and one or more of its Subsidiaries or (b) such Person or any other Subsidiary of such Person is a general partner (excluding any such partnership where such Person or any Subsidiary of such party does not have a majority of the voting interest in such partnership).

     “Tax” or “Taxes” shall mean all taxes, charges, fees, duties, levies, penalties or other assessments imposed by any federal, state, local or foreign governmental authority, including income, gross receipts, excise, property, sales, gain, use, license, custom duty, unemployment, capital stock, transfer, franchise, payroll, withholding, social security, minimum estimated, profit, gift, severance, value added, disability, premium, recapture, credit, occupation, service, leasing, employment, stamp and other taxes, and shall include interest, penalties or additions attributable thereto or attributable to any failure to comply with any requirement regarding Tax Returns.

     “Tax Return” shall mean any return, declaration, report, claim for refund, or information return or statement relating to Taxes, including any such document prepared on a consolidated, combined or unitary basis and also including any schedule or attachment thereto, and including any amendment thereof.

     “Trademarks” shall mean U.S. and foreign registered and unregistered trademarks, trade dress, service marks, logos, trade names, corporate names and all registrations and applications to register the same including all common law rights and common law rights therein.

     “Trade Secrets” shall have the meaning ascribed thereto in Section 3.18.

     “Transactions” shall mean all the transactions provided for or contemplated by this Agreement.

     “Transfer Taxes” shall mean all sales (including, without limitation, bulk sales), use, transfer, recording, ad valorem, privilege, documentary, gains, gross receipts, registration, conveyance, excise, license, stamp, duties or similar Taxes and fees.

     “Transfer Tax Payor” shall mean the party which has primary legal responsibility for the payment of any particular Transfer Tax.

     Section 9.2 Interpretation.

     (a) When a reference is made in this Agreement to a section or article, such reference shall be to a section or article of this Agreement unless otherwise clearly indicated to the contrary.

     (b) Whenever the words “include”, “includes” or “including” are used in this Agreement they shall be deemed to be followed by the words “without limitation.”

     (c) The words “hereof”, “herein” and “herewith” and words of similar import shall, unless otherwise stated, be construed to refer to this Agreement as a whole and not to any particular provision of this Agreement, and article, section, paragraph, exhibit and schedule references are to the articles, sections, paragraphs, exhibits and schedules of this Agreement unless otherwise specified.

     (d) The meaning assigned to each term defined herein shall be equally applicable to both the singular and the plural forms of such term, and words denoting any gender shall include all genders. Where a word or phrase is defined herein, each of its other grammatical forms shall have a corresponding meaning.

     (e) A reference to any party to this Agreement or any other agreement or document shall include such party’s successors and permitted assigns.

     (f) A reference to any legislation or to any provision of any legislation shall include any amendment to, and any modification or re-enactment thereof, any legislative provision substituted therefor and all regulations and statutory instruments issued thereunder or pursuant thereto.

     (g) The parties have participated jointly in the negotiation and drafting of this Agreement. In the event an ambiguity or question of intent or interpretation arises, this Agreement shall be construed as if drafted jointly by the parties, and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any provisions of this Agreement.

ARTICLE X

MISCELLANEOUS

     Section 10.1 Fees and Expenses. All costs and expenses incurred in connection with this Agreement and the consummation of the Transactions shall be paid by the party incurring such expenses, except as specifically provided to the contrary in this Agreement (including in the proviso of Section 2.2 and in Section 7.2) and except that all Transfer Taxes arising out of, in connection with or attributable to the transactions effected pursuant to this Agreement shall be borne and paid by Seller. The Transfer Tax Payor shall prepare and timely file all relevant Tax Returns required to be filed in respect of such Transfer Tax, pay the Transfer Tax shown on such Tax Return, and notify the other parties in writing of the Transfer Tax shown on such Tax Return and how such Transfer Tax was calculated, and if the Transfer Tax Payor is Purchaser or its Affiliates, Seller shall, except as set forth in the following sentence, reimburse the Transfer Tax Payor for the amount of such Transfer Tax in immediately available funds within ten (10) business days of receipt of such notice. Notwithstanding the preceding sentence, Purchaser shall be responsible for Transfer Taxes incurred with respect to the transfer by Seller to Purchaser of tangible personal property having a fair market value of up to $20,000 U.S. and, to the extent Transfer Taxes with respect to the transfer by Seller to Purchaser of tangible personal property having a fair market value of up to $20,000 U.S. are paid by Seller, Purchaser shall reimburse Seller in respect of such Transfer Taxes by wire transfer of immediately available funds within ten (10) business days of receipt of notice and proof of payment from Seller.

     Section 10.2 Amendment and Modification. Subject to the revision of Schedule E by Purchaser as contemplated by the definition of “Assumed Contracts,” this Agreement may be amended, modified and supplemented in any and all respects, but only by a written instrument signed by all of the parties hereto expressly stating that such instrument is intended to amend, modify or supplement this Agreement.

     Section 10.3 Notices. All notices and other communications hereunder shall be in writing and shall be deemed given when mailed, delivered personally, telecopied (which is confirmed) or sent by an overnight courier service, such as Federal Express, to the parties at the following addresses (or at such other address for a party as shall be specified by such party by like notice):

if to Purchaser or Purchaser
Subsidiary, to:

DTS, Inc.
5171 Clareton Drive
Agoura Hills, CA 91301

Attention: General Counsel
Telephone: (818) 706-3525
Telecopy: (818) 824-2470

with a copy to:

Heller Ehrman
4350 La Jolla Village
Seventh Floor
San Diego, CA 92122

Attention: Kirt Shuldberg, Esq.
Telephone: (858) 450-5766
Telecopy: (858) 587-5928

And

if to Seller or Seller
Subsidiary, to:

Spatializer Audio Laboratories, Inc.
4215 Tierra Rejada Rd.
PMB 159
Moorpark, CA 93021
Attention: Henry Mandell, CEO
Telephone:
Telecopy:

With a copy to:
Reed Smith LLP
1901 Avenue of the Stars
Suite 700
Los Angeles, California 90062
Attention: John Iino, Esq.
Telephone: (310) 734-5200
Telecopy: (310) 734-5299

     Section 10.4 Counterparts. This Agreement may be executed in one or more counterparts, all of which shall be considered one and the same agreement and shall become effective when two or more counterparts have been signed by each of the parties and delivered to the other parties.

     Section 10.5 Entire Agreement; No Third Party Beneficiaries. This Agreement (a) constitutes the entire agreement and supersede all prior agreements and understandings, both written and oral, among the parties with respect to the subject matter hereof and thereof and (b) are not intended to confer upon any Person other than the parties hereto and the Purchaser Indemnified Persons any rights or remedies hereunder.

     Section 10.6 Severability. Any term or provision of this Agreement that is held by a court of competent jurisdiction or other authority to be invalid, void or unenforceable in any situation in any jurisdiction shall not affect the validity or enforceability of the remaining terms and provisions hereof or the validity or enforceability of the offending term or provision in any other situation or in any other jurisdiction. If the final judgment of a court of competent jurisdiction or other authority declares that any term or provision hereof is invalid, void or unenforceable, the parties agree that the court making such determination shall have the power to reduce the scope, duration, area or applicability of the term or provision, to delete specific words or phrases, or to replace any invalid, void or unenforceable term or provision with a term or provision that is valid and enforceable and that comes closest to expressing the intention of the invalid or unenforceable term or provision.

     Section 10.7 Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of California without giving effect to the principles of conflicts of law thereof; provided, that, the General Corporation Law of the State of Delaware shall apply to the extent applicable.

     Section 10.8 Enforcement; Venue. The parties agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that the parties shall be entitled to an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the terms and provisions of this Agreement in any court of the United States located in the State of California or in California state court, this being in addition to any other remedy to which they are entitled at law or in equity. In addition, each of the parties hereto (a) consents to submit itself to the personal jurisdiction of any Federal or state court located in the County of Los Angeles, California in the event any dispute arises out of this Agreement or any of the Transactions, (b) agrees that it shall not attempt to deny or defeat such personal jurisdiction by motion or other request for leave from any such court and (c) agrees that it shall not bring any action relating to this Agreement or any of the Transactions in any court other than a Federal or state court sitting in the County of Los Angeles, California.

     Section 10.9 Time of Essence. Each of the parties hereto hereby agrees that, with regard to all dates and time periods set forth or referred to in this Agreement, time is of the essence.

     Section 10.10 Extension; Waiver. At any time prior to the Closing Date, the parties may (a) extend the time for the performance of any of the obligations or other acts of the other parties, (b) waive any inaccuracies in the representations and warranties of the other parties contained in this Agreement or in any document delivered pursuant to this Agreement or (c) waive compliance by the other parties with any of the agreements or conditions contained in this Agreement. Any agreement on the part of a party to any such extension or waiver shall be valid only if set forth in an instrument in writing signed on behalf of such party. The failure of any party to this Agreement to assert any of its rights under this Agreement or otherwise shall not constitute a waiver of those rights.

     Section 10.11 Election of Remedies. Neither the exercise of nor the failure to exercise a right or to give notice of a claim under this Agreement will constitute an election of remedies or

limit Purchaser or any of the Purchaser Indemnified Persons in any manner in the enforcement of any other remedies that may be available to any of them, whether at law or in equity.

     Section 10.12 Assignment. Neither this Agreement not any of the rights, interests or obligations hereunder shall be assigned by any of the parties hereto (whether by operation of law or otherwise) without the prior written content of the other parties, except that Purchaser may assign, in its sole discretion, any or all of its rights and interests hereunder to any direct or indirect wholly owned Subsidiary of Purchaser. Subject to the preceding sentence, this Agreement shall be binding upon, inure to the benefit of and be enforceable by the parties and their respective successors and assigns.

     Section 10.13 Joint and Several Liability. Purchaser and Purchaser Subsidiary shall be jointly and severally liable for all obligations of Purchaser Subsidiary hereunder or under any agreement executed by Purchaser Subsidiary and delivered to Seller at the Closing, including without limitation the Assumption Agreement.

     IN WITNESS WHEREOF, Purchaser, Purchaser Subsidiary, Seller and Seller Subsidiary have executed this Agreement or caused this Agreement to be executed by their respective officers thereunto duly authorized as of the date first written above.

DTS, INC.
By:	/s/ JON E. KIRCHNER
	Name:	Jon Kirchner
	Title:	President & Chief Executive Officer
DTS BVI LIMITED
By:	/s/ JON E. KIRCHNER
	Name:	Jon E. Kirchner
	Title:	Chairman
SPATIALIZER AUDIO LABORATORIES, INC.
By:	/s/ HENRY R. MANDELL
	Name:	Henry R. Mandell
	Title:	Chairman
DESPER PRODUCTS, INC.
By:	/s/ HENRY R. MANDELL
	Name:	Henry R. Mandell
	Title:	President

EX-31

Exhibit 31

RULE 13a-14(a)/15d-14(a) CERTIFICATION

I, Henry R. Mandell certify that:

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

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 14, 2006

/s/ Henry R. Mandell

Henry R. Mandell
Chairman of the Board
(performing the functions of principal executive officer and principal financial officer)

EX-32

Exhibit 32

SECTION 1350 CERTIFICATION

Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of Title 18, United States Code), the undersigned officer of Spatializer Audio Laboratories, Inc. (the “Company”) hereby certifies with respect to the Quarterly Report on Form 10-Q of the Company for the quarter ended September 30, 2006 as filed with the Securities and Exchange Commission (the “10-Q Report”) that to his knowledge:

1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities and Exchange Act of 1934; and

2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: November 10, 2006

/s/ Henry R. Mandell

Henry R. Mandell
Chairman of the Board
(performing the functions of principal executive officer and principal financial officer)