<PAGE>   1
 
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------
 
                                   FORM 10-K
                            ------------------------
 
(MARK ONE)
 
     [X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
        THE SECURITIES EXCHANGE ACT OF 1934
 
                    FOR THE PERIOD ENDED: DECEMBER 31, 1998
 
                                       OR
 
     [ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
        THE SECURITIES EXCHANGE ACT OF 1934
 
                        COMMISSION FILE NUMBER: 33-90532
 
                      SPATIALIZER AUDIO LABORATORIES, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                            <C>
                   DELAWARE                                      95-4484725
       (STATE OR OTHER JURISDICTION OF                        (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                      IDENTIFICATION NO.)
</TABLE>
 
                       20700 VENTURA BOULEVARD, SUITE 140
                     WOODLAND HILLS, CALIFORNIA 91364-2357
                    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
 
                        TELEPHONE NUMBER: (818) 227-3370
              (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 [X]  No [ ]
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.  [X]
 
     The aggregate market value of the voting stock held by non-affiliates of
the registrant at April 2, 1999 was approximately $1,726,647.66.
 
     As of April 2, 1999 there were 27,414,148 shares of the Registrant's Common
Stock outstanding.
 
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>   2
 
                                     PART I
 
ITEM 1. BUSINESS
 
OVERVIEW
 
     Spatializer Audio Laboratories, Inc. (the "Company") is a leading
developer, licensor and marketer of next generation technologies for the
consumer electronics, personal computing, enterprise computing and entertainment
industries. The Company has two business units (100% wholly owned subsidiaries),
Desper Products, Inc. ("DPI") and MultiDisc Technologies, Inc. ("MDT"), both of
which are in the business of technology development and licensing. DPI has
developed a full complement of patented and proprietary 3-D or virtual audio
signal processing technologies directed to the consumer electronics and
multimedia PC markets. The Company continues to expand its product offerings to
take advantage of the emerging digital audio marketplace specifically for
consumer products like Digital Versatile Disc (DVD) for personal computers, and
home entertainment; and interactive positional audio for PC gaming on the
Windows 95/98(TM) platforms. As of December 31, 1998 more than 13 million
licensed units had been shipped. DPI's 3-D audio signal processing technologies
have been incorporated in over 400 products offered by global brand leaders
including in consumer electronics, Toshiba, Panasonic, JVC, Hitachi, Phillips
and Sharp, and in the PC multimedia marketplace, Dell, Gateway, Micron, Fujitsu,
NEC and Sony, among others. In addition to continuing the Company's objective of
broadening recognition for the Spatializer brand name through association with
these and other globally recognized consumer electronics and multimedia computer
brand leaders, the Company has also placed a high priority on broadening its
technology base to position itself for continued growth. The Company believes
that with the accelerating growth in the digital audio/video marketplace, the
market for virtual audio technologies, and therefore for the Company's products
is entering a new phase of acceptance.
 
     MultiDisc Technologies, Inc. was formed in June 1996 when the Company
acquired development stage optical disc storage and robotics assets and
technologies from Home Theater Products, International, Inc. ("HTP"), a debtor
in possession (the "MultiDisc transaction"). MDT is currently a development
stage enterprise creating a new product category, the MultiDisc Modular
Stackable Storage Library ("MSSL"), of 12 cm CD/DVD based scaleable optical disc
storage devices, a technology uniquely designed to combine the speed and
performance of CD/DVD server arrays, the low cost, flexibility and capacity of
CD Jukebox designs and next generation high speed, high volume robotics. The
target markets for the MDT technology currently include Internet and Intranet
enterprise networking and backup/archiving, image and document storage, and
specialized vertical market applications including medical information
technology, data warehousing and video-on-demand.
 
     On September 25, 1998, the Company announced its plan to refocus its
business on the exploitation of its core audio technologies, suspend research
and development at MDT and to properly position the MultiDisc assets for sale.
Therefore, MDT has been accounted for as a discontinued operation. This
repositioning strategy recognized that the capital investment required to
properly commercialize the MDT technology was beyond the Company's current
capacity. Management believes this strategy and the victory in the QSound patent
litigation provides a better opportunity to further solidify its position as a
leading provider of virtual audio solutions, based on available capital
resources
 
     The Company's executive offices are located at 20700 Ventura Boulevard,
Suite 140, Woodland Hills, California 91364, Telephone (818) 227-3370. World
Wide Web sites (http://www.spatializer.com), (http://www.multidisc.com).
 
DESPER PRODUCTS, INC. -- 3-D AUDIO SIGNAL PROCESSING TECHNOLOGIES
 
     DPI has developed a suite of proprietary advanced audio signal processing
technologies for the entire spectrum of applications falling under the general
category of "3-D" or virtual audio. The objective in each product category is to
create or simulate the effect of a multi-speaker sonic environment using two
ordinary speakers (or headphones) for playback. The market for 3-D audio is
segmented into three broad categories of
 
                                        1
<PAGE>   3
 
technology as identified in the listing below. Each of these technologies
utilizes different underlying scientific principles in accomplishing its design
objectives and is targeted to a specific class of consumer electronics or
multimedia computer depending on the intended product use and functional
capability of the product. DPI currently has other audio signal processing
technologies under development which will serve to expand its market scope and
partner product capabilities.
 
<TABLE>
<S>                           <C>                              <C>
----------------------------------------------------------------------------------------------
CATEGORY OF TECHNOLOGY        PRODUCT CATEGORIES               3-D AUDIO ENHANCEMENT
----------------------------------------------------------------------------------------------
 3-D Stereo                   Consumer electronics products    Surround Sound enhancement from
 (Spatializer(R) 3-D Stereo)  providing stereo                 an ordinary stereo signal
                              playback -- DVD Players, Stereo
                              TV's, VCR's, Stereo Components
                              and Systems, Car Audio, Laptop
                              and Desktop Multimedia
                              Computers, Set-top Boxes
----------------------------------------------------------------------------------------------
 Positional Audio             Interactive Gaming for           Simulation of immersive,
 (Spatializer enCompass(TM)   Multimedia Computers under       interactive sonic environments
 V2.0)                        Windows '95/'97, Virtual         including sound objects that
                              Reality Applications.            move in real time with related
                                                               graphics objects or changes in
                                                               game player position or
                                                               perspective.
----------------------------------------------------------------------------------------------
 Two-Speaker Virtualization   Products incorporating multi-    Creation of spatially accurate
 (Spatializer N-2-2(TM))      channel audio sources like       multi-speaker cinematic audio
 Digital Virtual Surround     Dolby Digital(R) (AC-3), Dolby   experience from two speakers,
                              ProLogic(R) or MPEG-2. Home      and headphones utilizing
                              Theater, DVD-Video, Multimedia   discrete multi-channel audio
                              Computers utilizing DVD/MPEG     information.
                              and decoding.
----------------------------------------------------------------------------------------------
</TABLE>
 
LICENSED PRODUCTS
 
     The Company's current technology product applications are directed to (1)
stereo enhancement in consumer electronics products and multimedia PCs, (2)
interactive positional audio for PC gaming, and (3) two-speaker and headphone
virtualization of multi-channel audio for DVD based multimedia computer and home
theater applications.
 
     1. SPATIALIZER(R) 3D STEREO. Based upon proprietary and patented methods of
stereo signal processing, the Company's Spatializer(R) 3-D Stereo technology is
designed to create a vivid and expansive three-dimensional surround sound
listening experience from any stereo source input using only two ordinary
speakers. Along with professional audio quality and coherent stable sonic
imaging, the technology includes the Company's unique DDP(TM) (Double Detect and
Protect(TM)) algorithm. DDP(TM) continuously monitors the underlying stereo
signal and dynamically optimizes spatial processing, avoiding deleterious sonic
artifacts common in other systems and provides "set and forget" ease of use for
consumers. First introduced in July 1994, in the form of a 20 pin analog
integrated circuit (IC) from Matsushita Electronics Corporation ("MEC"), the
technology is now incorporated into low-cost, standard process ICs by four chip
foundries (Matsushita, ESS Technologies, Inc., OnChip Systems and Luxsonor) for
easy and inexpensive implementation in any consumer electronics or computer
products utilizing stereo audio. Matsushita and ESS introduced new Spatializer
IC designs in 1997. In addition, the Company has developed reduced cost
(Spatializer VBX(TM)) and improved performance analog and DSP software designs,
which it introduced during the first quarter of 1997. In 1998, the Company
continued development of lower cost 3-D Stereo technology in response to such a
need in the marketplace.
 
                                        2
<PAGE>   4
 
     2. SPATIALIZER(R) ENCOMPASS(TM) V2.0 In March 1998, the Company introduced
Spatializer(R) enCOMPASS(TM) V2.0, a real-time software-only positional 3-D
audio engine based upon the Company's proprietary implementation of HRTF (head
related transfer functions) algorithms, and Interaural Intensity and Interaural
Time differences. Version 2.0 has variable radiation pattern models for greater
sound functionality, variable frequency dependent propagation and distance
modeling to provide greater depiction of sound in relation to the player, and a
choice of rendering quality levels to address different processing requirements
between PC CPUs. Spatializer(R) enCOMPASS(TM) permits PC game developers to
easily create immersive and interactive audio environments under the Windows '95
DirectSound 3-D audio API where sound objects move in real time in response to
changes in the location or the perspective of the player in the game. This
provides the game designer the ability of developing under the industry standard
Microsoft DirectSound 5.0 open API, rather than under proprietary systems. The
system supports playback over speakers or through headphones. On December 23,
1998, the Company signed its first license of Spatializer(R) enCOMPASS(TM) with
Apple Computer, Inc.
 
     3. SPATIALIZER(R) N-2-2(TM) DIGITAL VIRTUAL SURROUND. In September 1996,
DPI introduced Spatializer N-2-2, which the Company considers a "core", and
"enabling" technology for DVD based personal computer and home theater products.
DVD is considered by many to be the single most important and potentially most
widely adopted consumer audio/computer technology ever introduced. The audio
standards for DVD (based upon geographic region) are multi-channel audio formats
(Dolby Digital(R) (AC-3) and MPEG-2) which carry six (or more) discrete
(independent) channels of audio -- the front left and right channels, a center
channel (for vocal tracks), two rear surround channels and a Low Frequency
Effects (LFE or "sub-woofer") channel for sound effects. The Spatializer N-2-2
software-based algorithms permit spatially accurate reproduction of this
multi-channel audio over any ordinary stereo system using two rather than the
five or six speakers normally required in traditional home theater setups.
Spatializer N-2-2 runs in real-time on general purpose Digital Signal Processing
("DSP") hardware platforms like those offered by Motorola, C-Cube, Medianix and
Zoran; may be integrated with host based software-only MPEG-2 or DVD decoders
(like SoftDVD and DVDExpress, offered by CompCore Multimedia and Mediamatics,
respectively, for the Intel(R) Pentium(R) microprocessor); and can be ported to
any of the principal audio codecs or media processor/accelerator platforms
performing Dolby Digital (AC-3) or MPEG-2 audio decoding. N-2-2 has been
approved by Dolby Laboratories and qualifies Spatializer licensees to use the
newly created Dolby Digital VIRTUAL(TM) trademark on products incorporating the
technology. The Company believes its Spatializer N-2-2 process will serve to
widen and accelerate the market for DVD acceptance, because it delivers the full
cinematic audio experience to ordinary consumers without the additional expense
and complication of multi-speaker home theater playback systems. The Spatializer
N-2-2 technology is also available for use over headphones, which accurately
renders a spatially accurate 5 speaker position simulating the typical home
theater arrangement.
 
LICENSING ACTIVITIES
 
     The Company has traditionally licensed its technologies through
semiconductor manufacturing and distribution licenses ("Foundry Licenses") with
semiconductor foundries ("Foundries"). In turn, these Foundries manufacture and
distribute integrated circuits ("ICs") incorporating Spatializer technology to
manufacturers of consumer electronics and multimedia computer products ("OEMs").
 
     The terms of the Foundry Licenses are negotiated on an individual basis
requiring the payment of a per unit running royalty according to sliding scales
based upon cumulative volume. Certain of the licenses call for the payment of an
up-front license issuance fee either in lieu of, or in addition to the running
royalty. Per unit royalties are payable in the quarter following shipment from
the Foundry to the OEM.
 
     OEMs who desire to incorporate these ICs into their products are required
to enter into a license ("OEM Licenses") with the Company before they may
purchase the ICs in quantity. Foundry Licenses generally have limited the sale
of Spatializer ICs to OEMs who have entered into an OEM License with the
Company. OEM licenses generally provide for the payment of a further per unit
royalty by the OEM for OEM products incorporating a Spatializer IC ("Licensed
Products") payable in the quarter following shipment by the OEM of its Licensed
Products.
                                        3
<PAGE>   5
 
     In mid-1996, the Company modified its licensing program to ease the
licensing process and accelerate cash flow by offering Foundries an alternative
"Bundled Royalty" arrangement which permits the IC foundry to make a traditional
component IC sale to an OEM without requiring the OEM to negotiate a separate
royalty license agreement with the Company. In these situations, the IC Foundry
is authorized to sell Spatializer ICs to OEMs, which enter into a simplified
Logo Usage Agreement ("LUA"), or to be authorized customers in consideration for
a higher ("bundled") per unit royalty from the IC Foundry. This license
structure has relieved much of the licensing burden from the IC foundries and
has resulted in an increase in License signings.
 
     Because the Spatializer N-2-2 technology may be fully implemented in
software to run in host based (Intel Pentium(R)) or general purpose DSP
(Motorola, Zoran, C-Cube and Medianix) environments, no IC Foundry may be
involved. In these situations, the Company will enter into royalty bearing
licenses directly with the OEM. However, the Company may still pursue bundled
agreements with DSP providers, if appropriate.
 
     The Company is currently negotiating new IC Foundry and OEM licenses for
its N-2-2, enCOMPASS V2.0, and 3-D stereo technologies.
 
  IC Foundry Licenses
 
     As of December 31, 1998, the Company has entered into six non-exclusive
Foundry Licenses for its 3-D Audio Signal Processing technologies with
Matsushita Electronics Corporation ("MEC"), ESS Technology, Inc. ("ESS"), OnChip
Systems, Inc. ("OnChip"), C-Cube Technologies, Inc. ("C-Cube"), Luxsonor and
Medianix. Foundry Licenses generally require the payment of per unit running
royalties based upon a sliding scale computed on the number of Spatializer ICs
sold.
 
     MEC currently manufactures and sells three 3-D Stereo IC's incorporating
Spatializer audio signal processing and has several more ICs in design. ESS
currently manufactures and sells the ES1869 and 1879 Spatializer(R) ICs, two of
its highest volume multifunction AudioDrive(R) ICs, which are primarily used for
multimedia and notebook applications. OnChip currently manufactures two versions
of the 3-D Stereo Spatializer(R) IC. C-Cube currently incorporates N-2-2 on
their Ziva-3 DSP.
 
     In June of 1998, C-Cube Technology, Inc. entered into a Foundry License for
Spatializer N-2-2. Additionally, in 1998, the Company entered into a
non-exclusive Foundry license for 3D Stereo and N-2-2 V1.0 with Medianix
Corporation.
 
     As of December 31, 1998, more than 13 million ICs incorporating Spatializer
3-D audio signal processing technology had been manufactured and sold.
 
  OEM Licensees and Customers
 
     As of December 31, 1998, the Company technology had been incorporated in
products offered by over 80 separate OEM Licensees and customers on various
economic and business terms. Some of these OEM Licenses required a license
issuance fee and/or a separate per unit royalty, while others were licensed
under the LUA or were authorized customers under bundled royalty licenses with
the IC foundries. The OEM licensees and customers offer a wide range of
products, which include DVDs, car stereo systems, direct view TVs, wide screen
and projection TVs, VCRs, powered speakers, portable audio systems
("Boomboxes"), HiFi stereo systems and components, computer sound cards and
graphics accelerator cards, multimedia desktop personal computers, notebook
computers, LCD projectors, multimedia computer monitors, and arcade pinball and
video games.
 
                                        4
<PAGE>   6
 
     The following table is a partial list of the OEM Licensees and authorized
customers as of December 31, 1998:
 
<TABLE>
<S>                                           <C>  <C>
---------------------------------------------      ---------------------------------------------
PARTIAL LIST OF OEM LICENSEES OR CUSTOMERS         LISTING -- CONTINUED
---------------------------------------------      ---------------------------------------------
 Apple Computer, Inc.                              Panasonic TV & VCR (Matsushita
 Dell Computer Corp.                                 Kotobuki Electronics Industries, Ltd.)
 Digital Technology Systems Of California,          Panasonic Car Audio (Matsushita
 Inc.                                                Communications Industrial Co., Ltd.
 Fujitsu Computer Corp.                             Proton Electronic Industrial Co., Ltd.
 Hewlett Packard                                    Samsung Information Systems, America
 Hitachi, Ltd.                                      Seiko Epson Corp.
 Iiyama Electric Co., Ltd.                          Sanyo Corp.
 Gateway Computer Corp.                             Sharp Corp.
 Golden Regent                                      Toshiba DVD
 JVC                                                Toshiba TV
 Labtec Enterprises, Inc.                           Taisei Electric, Inc.
 Mag Monitors                                       Taiyo Electric Company, Ltd.
 Micron Computer Corp.                              Texas Instruments
 NEC                                                Theta Digital
---------------------------------------------      ---------------------------------------------
</TABLE>
 
HARDWARE PRODUCTS
 
     Sales of the Company's professional and consumer hardware products to date
have not generated significant revenues and the Company does not plan to
manufacture these products in the future. The Company is focusing its attention
on licensing these product designs to third parties and concentrating on
software-only products and "plug-ins" for the principal products of digital
audio workstation ("DAW") providers on both the MacIntosh(TM) and PC platforms.
 
MULTIDISC TECHNOLOGIES, INC. -- NETWORK BASED MODULAR, SCALEABLE COMPACT
DISC/DVD SERVERS
 
     As its first effort to broaden the Company's technology portfolio and
capitalize on the Company's strong relationships with manufacturers of consumer
electronics and personal computer peripheral products, the Company acquired
certain developmental stage technologies and assets from Home Theatre Products
("HTP"), for approximately $1,062,000 in June 1996 to form its subsidiary,
MultiDisc Technologies, Inc. ("MDT"). The MultiDisc transaction, which was
implemented through a court-approved sale in the HTP bankruptcy proceeding,
included an array of compact disc server robotics and software technologies in
various stages of completion. The MultiDisc transaction was undertaken to
position the Company for long term growth in a significant new market. The
Company expected to license this technology or enter into third party
manufacturing arrangements for sale of MDT CD/DVD changer products to OEMs.
 
     The MultiDisc transaction brought to the Company a unique combination of
proprietary electromechanical designs, robotics, operating software, firmware,
intellectual property, and engineering know-how. The core intellectual property
is reflected in five patent applications acquired by the Company in the asset
acquisition, four of which have been issued. The Company has added an additional
fifty patent applications filed with the United States Patent & Trademark Office
("USPTO") to bring the total to fifty-five patent applications filed.
 
     On September 25, 1998, the Company announced a plan to refocus its business
on the exploitation of its core audio technologies, suspend research and
development of MDT and to properly position the MultiDisc assets for sale.
Therefore, MDT has been accounted for as a discontinued operation. The
repositioning strategy recognizes that the capital investment required to
properly commercialize the MDT technology is beyond the Company's current
capacity. As a result, all research and development activities were suspended.
The Company continues to explore the sale of the business or the patent
portfolio with interested parties.
 
                                        5
<PAGE>   7
 
REVENUES AND EXPENSES
 
     The Company generates revenues in its audio business from royalties
pursuant to its Foundry, OEM, and other licenses, and from the sale and
distribution of its consumer and professional hardware products. The Company's
revenues, which totaled $1,679,715 in 1998, were derived substantially from
Foundry and OEM license fees and royalties.
 
     The Company limits its inventory, capital cost, personnel and overhead cost
exposure in connection with its hardware products by entering into third-party
manufacturing and distribution arrangements. The Company is seeking to maximize
return on its intellectual property base by concentrating its efforts in very
high margin licensing and software products and has curtailed its hardware
product operations. Licensing operations have been managed internally by Company
personnel. Sales of professional audio products are accomplished through a
worldwide network of professional audio dealers and managed by Company
personnel.
 
     The Company had two major customers Matsushita Electronics Corp. (MEC) and
ESS Technology, Inc. (ESS) in 1998, each of whom accounted for greater than 10%
of the Company's total 1998 revenues. One OEM accounted for 56% and another
accounted for 18% of the Company's royalty revenues during 1998. All other OEM's
accounted for less than 10% of royalty revenues individually.
 
     On September 18, 1998, the U.S. Court of Appeals upheld U.S. District Court
Judge William D. Keller's decision of August 29, 1996 in which the District
Court had granted the Company's summary judgment motion in its entirety and
denied the motion by QSound in the patent infringement litigation between the
Company and QSound. The decision affirmed the District Court's ruling in all
aspects and confirmed that Spatializer is entitled to distribute its products
free of any infringement claim by QSound. The Company is not pursuing its
counterclaims for damages and for a decision that the QSound patent is invalid
at the present time. (See ITEM 3 -- LEGAL PROCEEDINGS, Page 7, for further
detail). The uncertainties caused by the patent litigation had hindered the
performance of the Company, particularly since licensing revenue depends upon
OEM unit shipments, which follow three to four quarter production cycles.
 
     During 1996, the Company recorded three one-time (non-recurring) charges
aggregating $21,147,000, which represented approximately 83% of the net loss
reported for the year. These charges were:
 
          (a) The Company recorded a one-time non-cash financial statement
     charge to earnings of $20,218,000 in the fourth quarter of 1996 upon final
     consent by the British Columbia Securities Commission ("BCSC") and the
     Company's acceptance to the modification of the Company's performance share
     escrow arrangement as approved by the Company's shareholders in August
     1996. Under the revised arrangement the Company's 5,776,700 "Performance
     Shares" became subject to a new escrow arrangement under which the shares
     will be released over a six-year period of time.
 
          (b) The Company recorded a one-time charge to earnings in June 1996,
     in the amount of $680,000 as "In Process Research & Development" in
     connection with its MultiDisc Technologies CD/DVD robotics system
     technology acquisition.
 
          (c) In connection with the liquidation of its Canadian predecessor,
     the Company incurred and paid Canadian income taxes in the amount of
     $249,000.
 
     In September 1998, the Company implemented cost cutting measures in
conjunction with the suspension of its research and development activities at
MDT and to further rationalize the overhead of Desper Products and the corporate
office in response to lower levels of operating performance. The objective of
these initiatives was to reduce future operating costs from 1998 levels.
 
COMPETITION
 
     3-D AUDIO SIGNAL PROCESSING MARKETPLACE
 
     The Company competes with a number of entities that produce various audio
enhancement processes, technologies and products, some utilizing traditional
two-speaker playback, others utilizing multiple speakers, and others restricted
to headphone listening. These include the consumer versions of multiple
speakers, matrix
 
                                        6
<PAGE>   8
 
and discrete digital technologies developed for theatrical motion picture
exhibition (like Dolby Digital(R), Dolby ProLogic(R), and DTS(R)), as well as
other technologies designed to create an enhanced stereo image from two or more
speakers.
 
     The Company's principal competitors in the field of 3-D audio are QSound
Labs, Inc. ("QSound"), SRS Labs, Inc., Aureal Semi-conductor, Inc., CRL and
Harman International. In the future, the Company's products and technologies
also may compete with audio technologies and product applications developed by
other companies including entities that have business relationships with the
Company.
 
     The Company believes that it will favorably compete in this market because
it offers a single source, complete suite of patented and proprietary 3D Stereo,
interactive positional, and speaker virtualization technologies, and because of
its superior engineering and OEM support, the strength of its IC Foundry and OEM
relationships, and the Spatializer brand name recognition in the industry.
 
PATENTS, TRADEMARKS AND COPYRIGHTS
 
     The Company's core Spatializer audio signal processing technology is
covered by its U.S. patent 5,412,731, issued May 2, 1995. On July 15, 1997, the
Company filed a patent on its N-2-2(TM) intellectual property with the U.S.
Patent Office. On March 20, 1998, the Company filed a patent on its enCompass V
2.0 technology with the U.S. Patent Office covering the Company's enCompass 2.0
positional audio gaming technology. Additional patent applications for the
Company's reduced cost/higher performance 3-D Stereo designs and other
technologies are currently in process. Much of the Company's intellectual
property consists of trade secrets. The Company possesses copyright protection
for its principal software applications and has U.S. and foreign trademark
protection for its key product names and logo marks.
 
     The core MDT data storage technology is covered by U.S. patents 5,774,431,
5,822,283, 5,886,960 and 5,886,974. As of December 31, 1998, MDT had fifty-one
patent applications on file with the USPTO covering software, mechanical
techniques, implementations and mixed technology designs. The Company has
recently been notified by the USPTO that formal notice of allowance is
forthcoming on five patent applications. The Company has applied for U.S.
trademark protection for its principal product names and logo marks.
 
EMPLOYEES
 
     The Company began 1998 with twenty-eight full-time and two part-time
employees and reduced its staff to fifteen full-time employees by December 31,
1998. At year-end, there were nine employees engaged in research and development
with seven of those employees involved with the development effort at the
Company's audio subsidiary, Desper Products. From time to time the Company also
employs the services of outside professional consultants. None of the Company's
employees are represented by a labor union or are subject to a collective
bargaining agreement. The Company considers its relations with its employees and
consultants to be satisfactory.
 
                                        7
<PAGE>   9
 
                                    PART II
 
ITEM 2. PROPERTIES
 
     The Company's executive office is located in Woodland Hills, California
where it occupies approximately 4,300 square feet with an annual rent of
approximately $85,000. The lease term on this space expires March 30, 2000. On
March 4, 1999, the Company entered into a new lease and reduced its space to
approximately 800 square feet at a rent expense of approximately $1,800 per
month. Terms are on a month-to-month basis. During 1998, the Company also leased
facilities in Mountain View, CA, Newbury Park, CA, and Huntington Beach, CA. In
an effort to consolidate offices by division and control costs, the Company
closed both the Newbury Park, CA and Huntington Beach offices during the third
and fourth quarters of the fiscal year ended December 31, 1998, respectively.
Rent expenses of approximately $99,000 associated with these two facilities are
included in the 1998 operating expenses. The Company incurred lease termination
costs of $17,582 in connection with the closing of the Huntington Beach office.
 
     The Company's regional office in Mountain View, CA, is the primary location
for the Company's audio technology division, Desper Products, Inc. ("DPI"). The
Company occupies approximately 4,200 square feet in this location and the annual
rent for these premises is approximately $52,000, with the lease term expiring
February 22, 1999. This lease has been extended for an additional six month term
at a cost of $6,930 per month.
 
     The Company's regional office in Huntington Beach, CA, was the primary
location for the Company's multi-disc server technology division, MultiDisc
Technologies, Inc. ("MDT"). The Company occupied approximately 4,000 square feet
of office in this location and the annual rent for these premises is
approximately $50,000, with the lease term expiring July 31, 1999. The Company
vacated this space in November, 1998 and forfeited all rent deposits.
 
     The Company leases its space at rental rates and on terms which management
believes are consistent with those available for similar space in the applicable
local area. The Company's properties are well maintained, considered adequate
and are being utilized for their intended purposes.
 
ITEM 3. LEGAL PROCEEDINGS
 
     In the Fall of 1994, QSound Labs, Inc. ("QSound") advised MEC that, in its
view, the Spatializer technology infringed certain U.S. patents held by QSound.
In October 1994 the Company and DPI initiated a proceeding against QSound
seeking a determination that the technology did not infringe on Qsound's patents
and other relief.
 
     On August 29, 1996 the Court granted the Company's summary judgment motion
of non-infringement in its entirety and denied the motion by QSound in the
pending patent infringement litigation between the Company and QSound. In
September, 1998, the U.S. Court of Appeals for the Federal Court upheld the U.S.
District Court's ruling of August 1996, finding in favor of DPI and the Company
on all aspects of the appeal.
 
     In granting the Company's summary judgment motion, the Court found that the
Company's IC (Integrated Circuit) does not infringe the QSound patent and denied
QSound's motion with respect to infringement. The Company's claim that the
QSound patent is invalid was not decided and, since the issues which the Court
would need to consider on the patent invalidity claim are similar to certain
issues considered in the infringement claim, QSound was granted the right to
immediately appeal the denial of its motion and trial on the invalidity issue
was deferred until after that appeal. In substance, the Court's finding confirms
the Company's position that there is no infringement by the Company's IC of any
patent held by QSound and that the claims by QSound were without merit. Qsound
has not appealed and the Company is not pursuing its other claims at the present
time.
 
     In December 1998, a complaint was filed in the United States District Court
for the Northern District of New York, by Alexander, Wescott & Co., Inc.,
against the Company alleging breach of contract and seeking fees from the
Company based on its claim that the amounts were due for arranging a financing.
The action
 
                                        8
<PAGE>   10
 
also seeks attorneys' fees, interest and the costs of suit. The Company has
filed a motion to dismiss the action. The motion is pending.
 
     In February 1999, a complaint was filed in the Superior Court of Los
Angeles County, Northwest District, by I.N. Associates, Inc., against the
Company's wholly owned subsidiary, MultiDisc Technologies, Inc. ("MDT"),
alleging breach of contract and fraud, and claiming $499,953.94 in damages,
attorneys fees, interest and the costs of suit. MDT has answered and denied the
claims.
 
     In connection with the downsizing of the Company, a number of employees
have been terminated and have filed various employment and compensation related
claims with the various State labor authorities which claims are pending
resolution and funding as Company resources allow. The Company also anticipates
that, from time to time, it may be named as a party to other legal proceedings
that may arise in the ordinary course of its business.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     There were no matters submitted to a vote of the security holders of the
Company either through solicitation of proxies or otherwise in the fourth
quarter of the fiscal year ended December 31, 1998.
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
     The Company's Common Stock was listed and commenced trading on the small
capital market of NASDAQ on August 21, 1995 under the symbol "SPAZ". On December
31, 1998, the Company informed NASDAQ that it would be unable to comply with the
requirements for continued listing on the NASDAQ SmallCap Market. On January 5,
1999, the Company's stock was delisted from the NASDAQ SmallCap Market and, on
the same day, commenced trading on the NASD Bulletin Board under the symbol
"SPAZ". The following table sets forth the high and low sales price of the
Company's Common Stock on its principal market for fiscal years 1997 and 1998:
 
<TABLE>
<CAPTION>
                     PERIOD:                        HIGH (U.S. $)    LOW (U.S. $)
                     -------                        -------------    ------------
<S>                                                 <C>              <C>
1997
  First Quarter...................................      $3.75           $1.06
  Second Quarter..................................      $2.00           $0.75
  Third Quarter...................................      $2.56           $1.13
  Fourth Quarter..................................      $3.44           $1.31
1998
  First Quarter...................................      $2.88           $1.00
  Second Quarter..................................      $1.56           $0.56
  Third Quarter...................................      $0.75           $0.19
  Fourth Quarter..................................      $0.25           $0.06
</TABLE>
 
     On April 2, 1999, the closing price reported by NASDAQ was U.S. $0.09.
Stockholders are urged to obtain current market prices for the Company's Common
Stock. Montreal Trust Company of Canada, Vancouver, B.C., was the transfer agent
and registrar for the Company's Common Stock until March 31, 1997. Beginning
April 1, 1997, Harris Trust Company of California became the Company's new
transfer agent.
 
RECORD HOLDERS
 
     To the Company's knowledge there were approximately 125 holders of record
of the stock of the Company as of April 2, 1999. However, the Company's transfer
agent has indicated that beneficial ownership is in excess of 1,700
shareholders.
 
                                        9
<PAGE>   11
 
DIVIDENDS
 
     The Company has not paid any cash dividends on its Common Stock and has no
present intention of paying any dividends. The current policy of the Company is
to retain earnings, if any, for use in operations and in the development of its
business. The future dividend policy of the Company will be determined from time
to time by the Board of Directors.
 
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
 
     The following selected consolidated financial data should be read in
conjunction with the Company's Consolidated Financial Statements and related
Notes and with "Management's Discussion and Analysis of Financial Condition and
Results of Operations", included in Item 7. The selected data presented below
under the headings "Consolidated Statement of Operations Data" and "Consolidated
Balance Sheet Data" as of and for the years ended December 31, 1998, 1997 and
1996, as of and for the four-month period ended December 31, 1994, and the year
ended August 31, 1994, are derived from the consolidated financial statements of
Spatializer Audio Laboratories, Inc. and subsidiaries, which consolidated
balance sheets have been audited by KPMG Peat Marwick LLP, independent certified
public accountants through December 31, 1997 (The Company did not obtain an
updated report in connection with this filing.) and by Farber & Hass LLP,
Certified Public Accountants, for the year ended December 31, 1998. The
consolidated financial statements as of December 31, 1998 and 1997, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for the years ended December 31, 1998, 1997 and 1996, and the report
thereon, are included elsewhere in this Report.
 
<TABLE>
<CAPTION>
                              FISCAL
                               YEAR       FOUR MONTH                         FISCAL YEAR ENDED
                              ENDED      PERIOD ENDED   -----------------------------------------------------------
                            AUGUST 31,   DECEMBER 31,   DECEMBER 31,   DECEMBER 31,     DECEMBER 31,   DECEMBER 31,
                             1994(1)      1994(1&2)       1995(1)          1996             1997           1998
                            ----------   ------------   ------------   ------------     ------------   ------------
<S>                         <C>          <C>            <C>            <C>              <C>            <C>
CONSOLIDATED STATEMENT OF
  OPERATIONS DATA:
Revenues..................  $      140    $      187    $     1,230    $     2,024      $     2,781    $     1,680
Cost of Revenues..........         (61)          (25)           (79)          (186)            (230)          (134)
                            ----------    ----------    -----------    -----------      -----------    -----------
Gross Profit..............          79           162          1,151          1,838            2,551          1,546
         Total Operating
           Expenses.......      (1,808)       (1,339)        (4,403)       (27,042)(3)       (7,236)        (3,490)
Other Income (Expense),
  Net.....................         (79)          (16)            74            118               27           (108)
Loss from Discontinued
  Ops.....................                                                                                  (3,702)
Income Taxes..............                                      (63)          (310)(4)          (60)           (38)
                            ----------    ----------    -----------    -----------      -----------    -----------
Net Loss..................  $   (1,806)   $   (1,193)   $    (3,241)   $   (25,395)     $      (310)   $    (5,792)
                            ==========    ==========    ===========    ===========      ===========    ===========
Basic/Diluted Loss Per
  Share:
    Continuing
      Operations(5).......  $    (0.28)   $    (0.14)   $     (0.32)   $     (2.01)     $     (0.23)   $     (0.12)
                            ==========    ==========    ===========    ===========      ===========    ===========
         Total............  $    (0.28)   $    (0.14)   $     (0.32)   $     (2.01)     $     (0.23)   $     (0.29)
                            ==========    ==========    ===========    ===========      ===========    ===========
Weighted Average Common
  Shares..................   6,891,546     8,552,535     10,156,816     12,844,751       20,804,095     22,180,180
                            ==========    ==========    ===========    ===========      ===========    ===========
CONSOLIDATED BALANCE SHEET
  DATA:
Cash and Cash
  Equivalents.............  $    1,779    $    1,540    $     3,113    $     1,587      $       577    $       264
Working Capital...........           6           982          3,159          2,092              283         (1,975)
         Total Assets.....       2,676         2,318          4,420          4,141            3,165            893
Advances From Related
  Parties.................         539           517            325            113              113            857
Total Shareholders' Equity
  (Deficit)...............  $      288    $    1,367    $     3,697    $     3,268      $     1,525    $    (1,553)
</TABLE>
 
---------------
(1) A Plan of Arrangement was completed on July 27, 1994 whereby the situs of
    the Company was moved to Delaware. Spatializer Audio Laboratories, Inc., a
    Delaware corporation, became the parent company for
 
                                       10
<PAGE>   12
 
    Spatializer-Yukon and DPI. The financial statements for this fiscal year
    reflect the consolidation of all three entities.
 
(2) Not comparative.
 
(3) Includes two one-time significant changes. Compensation Expense of
    $20,218,450 was recorded associated with the transfer of the Company's
    performance shares from Canadian Escrow into a new escrow arrangement which
    will provide for the release of the performance shares over the next six
    years. Based on the revised escrow arrangement, which primarily converts the
    escrow shares release from performance criteria to time-based criteria, the
    Company recorded compensation expense on the date the new escrow arrangement
    terms were accepted by the Company. Additionally, In-Process Research &
    Development ("IPR&D") expense of $679,684 related to the allocation of costs
    was incurred as a result of the MultiDisc Technologies, Inc. ("MDT") asset
    acquisition in June 1996.
 
(4) The Company incurred and paid Canadian income taxes in the amount of
    $249,000 during the year associated with the liquidation of
    Spatializer-Yukon, the Company's Canadian predecessor.
 
(5) Loss per share has been calculated based on the weighted average number of
    common shares outstanding including escrowed performance shares, which are
    factored into the calculation as of December 30, 1996, the date on which the
    British Columbia Securities Commission ("BCSC") issued its consent to the
    Company's revised escrow arrangement
 
                                       11
<PAGE>   13
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
     The following discussion and analysis relates to the financial condition
and results of operations of Spatializer Audio Laboratories, Inc. and
subsidiaries (the "Company") for the year ended December 31, 1998 compared to
the year ended December 31, 1997, and the year ended December 31, 1997, compared
with the year ended December 31, 1996.
 
RESULTS OF OPERATIONS
 
     FOR THE YEAR ENDED DECEMBER 31, 1998, COMPARED TO THE YEAR ENDED DECEMBER
31, 1997
 
REVENUES
 
     Revenues declined to $1,680,000 for the year ended December 31, 1998
compared to $2,781,000 for the year ended December 31, 1997, a decline of 40%.
Revenues include license issuance fees and royalties pertaining to the licensing
of Spatializer(R) audio signal processing designs and the sales of professional
recording systems and consumer products.
 
     The decrease in revenues is attributed primarily to decreases in recurring
royalties for the licensing of Spatializer audio technology reflecting
competitive market pricing pressure, the discontinuation of consumer product
sales, the signing in late 1997 of a flat fee license agreement for which there
was no comparable license agreement in the current fiscal year and weakness in
the Asian market.
 
     Gross profit was unchanged at 92% in the year ended December 31, 1998
compared with 92% for the comparable period. This reflects the impact of the
discontinuation of lower margin consumer products sales offset by inventory
write-downs ($86,000) on the remaining consumer products inventory to market.
The Company maintains a high margin as the majority of revenues are from
licensing and royalty activities, which have little or no associated direct
costs.
 
OPERATING EXPENSES
 
     Operating expenses from continuing operations for the year ended December
31, 1998 decreased to $3,490,000 from $7,238,000 for the year ended December 31,
1997, a decrease of 51%. The decrease in operating expenses result primarily
from the reclassification of certain MDT expenses as discontinued operation and
higher technology demonstrator development expense in 1997.
 
     Based on the corporate strategic refocusing, MDT is being treated as a
discontinued operation. Operating expenses of MDT of approximately $2,800,000
have been excluded from operating expenses and presented separately as a
discontinued operation. Total operating expenses of MDT for the year ended
December 31, 1997 were $3,791,000.
 
GENERAL AND ADMINISTRATIVE
 
     General and administrative costs decreased to $1,732,000 for the year ended
December 31, 1998 from $2,174,000 for the year ended December 31, 1997, a
decrease of 20%. The decrease is primarily due to the reclassification of MDT
expenses of $511,000 to discontinued operations, partially offset by a provision
of $100,000 for corporate restructuring. General operating costs include rent,
telephone, office supplies, legal, accounting, postage, depreciation and similar
costs.
 
RESEARCH AND DEVELOPMENT
 
     Research and Development costs decreased to $756,000 for the year ended
December 31, 1998, compared to $3,708,000 for the year ended December 31, 1997,
a decrease of 79%. The decrease in research and development expense was due to
the suspension of MDT's research and development activity in late September,
1998 and the reclassification of such expenses of $1,771,000 to discontinued
operations. In addition, MDT research and development expenses incurred in 1998
were lower than the comparable period last year due to substantially lower
($1,000,000) technology demonstrator development expense. Total
 
                                       12
<PAGE>   14
 
research and development costs for MDT were $3,013,000 of the $3,708,000 expense
for the year ended December 31, 1997.
 
     In addition, the Company continued efforts to identify, validate, and
develop new product ideas at DPI. Specific engineering efforts were directed
toward porting support of N-2-2(TM) -- Digital Virtual Surround technologies to
current and potential licensees during the year, simplified low cost 3-D stereo
solutions and toward enCompass, a true interactive, real-time 3-D audio
positioning technology.
 
SALES AND MARKETING
 
     Sales and marketing costs decreased to $1,002,000 for the year ended
December 31, 1998, compared to $1,356,000 for the year ended December 31, 1997,
a decrease of 26%. The decrease is primarily due to the reclassification of MDT
expenses of $531,000 to discontinued operations, partially offset by an
expansion in DPI sales personnel, travel and international sales representatives
expenses.
 
LOSS ON DISCONTINUED OPERATION
 
     Loss on discontinued operation was $3,702,000 for the year ended December
31, 1998. There was no comparable loss in the prior year. Loss on discontinued
operation is comprised of the reclassification of $2,847,000 of net MDT expenses
and valuation adjustments of $855,000. The net expense represents primarily
general and administrative, sales and marketing and research and development
expenses for the period January 1 through September 30, 1998. The Board of
Directors announced the discontinued operation of MDT on September 25, 1998 and
had preliminary indications from its banker and potential buyers that the sale
of MDT's assets would not result in a loss to the Company. However, since no
transaction has been consummated for the MDT assets as of this filing date, the
Company has elected to reserve for this contingency.
 
NET LOSS
 
     The net loss increased to $5,792,000 for the year ended December 31, 1998,
compared to $4,720,000 for the year ended December 31, 1997, an increase of 22%.
The increased net loss for the period is primarily the result of wind down costs
for the Company's discontinued operation, MDT and lower revenues of DPI,
partially offset by significantly lower MDT technology demonstrator development
compared with the prior year.
 
     FOR THE YEAR ENDED DECEMBER 31, 1997, COMPARED TO THE YEAR ENDED DECEMBER
31, 1996
 
REVENUES
 
     The Company reported an increase in revenues of 37% or $757,000, reaching
$2,781,000 for the year ended December 31, 1997 compared to $2,024,000 for the
year ended December 31, 1996. Revenues include license issuance fees and
royalties pertaining to the licensing of Spatializer(R) audio signal processing
designs and the sales of professional recording systems and consumer products.
 
     The increase in revenues is attributed primarily to $880,000 of license
fees received in 1997. The Company further solidified its market position in
multimedia computing with the signing during the year of a multi-year,
multi-technology license agreement with one of the Company's IC Foundries.
 
     The decrease in product sales in 1997 is expected to be offset by increased
licensing revenues and running royalties. Revenues from hardware product sales
have not been substantial in recent periods, and since the margins on these
revenues have not been significant, the impact on the Company's results of
operations as a result of the termination of the manufacture of hardware
products is expected to be minimal.
 
     Gross profit remained relatively flat at 92% for the year ended December
31, 1997 as compared with 91% for the same period in 1996. The Company maintains
a high margin as the majority of revenues are from licensing and royalty
activities, which have little or no associated direct costs.
 
                                       13
<PAGE>   15
 
OPERATING EXPENSES
 
     The operating expenses for the year period ended December 31, 1997
increased by approximately 18% or $1,094,000 to $7,238,000 compared to
$6,144,000 for the year ended December 31, 1996 after excluding the effects of
one time charges of $20,898,000 in fiscal 1996 for compensation expense and
in-process research and development. A one-time charge for compensation expense
of $20,218,000 was recorded in 1996 associated with the transfer of the
Company's performance shares from Canadian Escrow into a new escrow arrangement
which will provide for the release of the performance shares for a period up to
six years. The increase in operating costs is a direct result of the expansion
of the Company's Research and Development department and related activities due
to the prototype development undertaken by MDT, the Company's server technology
business.
 
GENERAL AND ADMINISTRATIVE
 
     General and administrative costs decreased approximately 7% or $156,000, to
$2,174,000 for the year period ended December 31, 1997 as compared with
$2,330,000 for the same period in 1996. The decrease is primarily due to cost
savings in professional service fees and general operating costs partially
offset by increased payroll and payroll-related costs as the Company
transitioned consulting and temporary help to permanent positions in 1996.
General operating costs include rent, telephone, office supplies and stationery,
postage, depreciation and similar costs.
 
RESEARCH AND DEVELOPMENT
 
     Research and Development costs increased by approximately 99% or
$1,848,000, to $3,708,000 for the year period ended December 31, 1997, compared
to $1,860,000 for the same period in 1996. The increase in research and
development expense was due to the increased cost of MDT's research and
development activity of technology demonstrators for the MultiDisc eXpandable
Network Server, XNS(TM), with technology expenses partially offset by savings in
the DPI subsidiary of the Company.
 
     MDT, which began operations on June 24, 1996, represented approximately 81%
or $3,013,000 of the total research and development costs of $3,708,000 for the
year ended December 31, 1997 and 45% or $843,000 of the total research and
development costs of $1,860,000 for the year ended December 31, 1996.
 
     In addition, the Company continued efforts to identify, validate, and
develop new product ideas through DPI. Specific engineering efforts were
directed toward porting support of N-2-2(TM) -- Digital Virtual Surround
technologies to current and potential licensees during the year and toward
enCompass, a true interactive, real-time 3-D audio positioning technology.
 
     A one-time charge for In Process Research and Development of $679,684 was
recorded related to the MDT asset acquisition in June 1996. This one-time cost
is not included in research and development department costs for purposes of a
more accurate comparison of actual and on-going research and development costs
of the Company.
 
SALES AND MARKETING
 
     Sales and marketing costs decreased approximately 31%, or $599,000 for a
total of $1,356,000 for the year ended December 31, 1997, compared to $1,955,000
for the same period in 1996. The decrease is attributed to cost containment
efforts which began in the fourth quarter of 1996 along with a reduction in 1997
trade show and trade show related costs and advertising costs associated with
the 1996 launch of the Company's subsequently discontinued consumer product, the
HTMS-2510.
 
NET LOSS
 
     The net loss for the year ended December 31, 1997 increased approximately
11% or $472,000, for a total net loss of $4,720,000 compared to $4,248,000 after
excluding the effects of one time charges of $20,218,000 of Compensation Expense
and $680,000 in process research and development expense and $249,000 of income
tax expense incurred upon liquidation of the Company's Canadian predecessor
during year ended
                                       14
<PAGE>   16
 
December 31, 1996. The increased net loss for the period is primarily a result
of increased research and development efforts at the Company's subsidiary, MDT,
partially offset by the cost savings realized by the continuation of the
Company's cost cutting measures which began in the fourth quarter of 1996.
 
     In 1997, the Company granted 100,000 warrants as consideration for
consulting services rendered during the year. The fair value of the services
received ($100,000) was determined to be more reliably measurable and used to
value the warrants, consistent with the provisions of SFAS 123 paragraph 8.
There were no other compensatory arrangements with third parties in 1997. The
pro forma net loss, as disclosed in footnote 13 of the accompanying financial
statements, is significantly higher than historical net loss as a result of the
Company granting 1,495,000 options to employees and directors during 1996 and
1997
 
LIQUIDITY AND CAPITAL RESOURCES
 
     At December 31, 1998, the Company had $264,000 in cash and cash equivalents
as compared to $577,000 at December 31, 1997. The decrease in cash and cash
equivalents is attributed to: (i) cash used for research and development at MDT
on the Modular Scalable Storage Library, (ii) the repayment of $400,000 of
borrowings on a bank line of credit and (iii) cash used in other operating
activities. This was partially offset by net proceeds of $2,612,000 from the
sale of preferred stock on April 14, 1998 and proceeds from $745,000 related
party notes payable. The Company had negative working capital of $1,975,000 at
December 31, 1998 as compared with working capital of $283,000 at December 31,
1997. The Company's future cash flows are expected to come primarily from audio
signal processing licensing, Foundry and Original Equipment Manufacturers'
("OEM") royalties, debt issuances, common and/or preferred stock issuances
including warrant and option exercises or through venture and/or strategic
investors. At December 31, 1998 the Company had six Foundry licensees,
seventy-three OEM Licensees and eight authorized customers for its audio signal
processing business as compared with five Foundry licensees and sixty-two OEM
Licensees and fourteen authorized customers at December 31, 1997. The Company is
actively engaged in negotiations for additional audio signal processing
licensing arrangements, equity and debt financing, which should generate
additional cash flow without imposing any substantial costs on the Company.
 
     The Company continues to have no material long-term obligations and has no
present commitments or agreements that would require any long-term debt or
obligations to be incurred. The Company owed $857,500 to related parties as of
December 31, 1998 and $112,500 at December 31, 1997.
 
     On October 30, 1998, the Compensation Committee of the Board of Directors
re-priced qualified stock options to purchase 121,000 shares of common stock
granted to various employees beginning in June 1995. The exercise price for
these options was adjusted to $0.1875 per share (the closing market price on
October 30, 1998) reducing grant date exercise prices ranging from $0.72 to
$2.34 per share. Also, on November 12, 1998, the Compensation Committee of the
Board of Directors re-priced qualified stock options to purchase 100,000 shares
of common stock granted to an employee in March 1998. The exercise price for
these options was adjusted to $0.125 per share (the closing market price on
November 12, 1998) reducing the grant date exercise price from $1.18 per share.
The vesting schedules and expiration dates for these options were not modified.
 
     On April 14, 1998, the Company entered into a private placement for up to
$5 million of which $3 million was funded at September 30, 1998. In connection
with the private placement, the Company authorized 100,000 shares of a new
Series A, 7% Convertible Preferred Stock at a stated price of $50 per share and
issued 60,000 shares for $3 million. In connection with the April funding, the
Company issued purchase warrants, exercisable for three years and entitling the
holders to acquire one share of the Company's common stock for each warrant. Of
the warrants, 450,000 were issued and 150,000 warrants were issued to placement
agents. The investor warrants are exercisable at 140% and the placement warrants
are exercisable at 120%, respectively, of the average closing bid price of the
Company's common stock for the 10 days preceding the closing. In addition, cash
placement fees of 10% were paid. A related party of the Company received 50,000
of the placement agent warrants and $100,000 of the placement agent cash fee for
arranging $1 million of the $3 million investment. As of December 31, 1998, $1
million of the remaining $2 million of the funding was due but had not yet been
received.
 
                                       15
<PAGE>   17
 
     Holders of the Series A Preferred Stock have a right to convert their
shares, at their option on the earlier of (x) ninety (90) days after issuance or
(y) on the effective date of this Registration (the "Conversion Date") with such
conversion to be based on a per share conversion price ("Conversion Price")
equal to the lesser of a price that reflects a discount (the "Conversion
Discount") to the average of any three (3) consecutive closing bid prices for
the Company's Common Stock within twenty (20) trading days immediately prior to
the conversion date (the "Floating Conversion Price") or a price which is equal
to one hundred thirty percent (130%) of the closing bid prices of the Company's
Common Stock for the ten (10) trading days immediately preceding the date of
issuance (the "Fixed Conversion Price") provided that in determining the
Conversion Price, the holder shall not count any day on which its sales account
for greater than twenty percent (20%) of the volume of the Company's Common
Stock and on which the holder has sales in the last hour of trading. The
Conversion Discount shall be equal to fifteen percent (15%) if the Conversion
Rights are exercised within one hundred twenty (120) days of first issuance of
the Series A Preferred Stock, shall be equal to seventeen and one-half percent
(17.5%) if the Conversion Rights are exercised after one hundred (120) days and
prior to one hundred forty-nine (149) days of first issuance of the Series A
Preferred Stock. The applicable Conversion Discount increases by five percent
(5%) if the Company is de-listed on NASDAQ. In addition, the percentage of
shares that can be converted at any one time is limited during such time periods
and the holders cannot own more than 4.99% of the equity of the Company after
the Conversion.
 
     The beneficial conversion feature of the Series A Preferred Stock will be
recorded as a dividend using the most favorable conversion terms available to
the shareholder to calculate the dividend in accordance with EITF Topic D-60.
Since the Company has an accumulated deficit and, under Delaware Law, must
charge dividends against additional paid in capital, the net impact of recording
the beneficial conversion feature is zero since both sides of the entry are
recorded in additional paid in capital. At December 31, 1998, dividends in
arrears were $148,750.
 
     In the private placement, the participants were granted certain rights to
participate in the separate financing of approximately $6 million which had been
pursued by the Company to fund the commercial introduction of its MultiDisc
CD/DVD server technology. However, as reported by the Company on September 25,
1998, the Company has decided to refocus on the core audio technologies and to
properly position the MultiDisc assets for sale. Therefore this financing is not
currently being pursued actively.
 
     On September 25, 1998, the Company announced that its Board of Directors
was refocusing the Company's business on the exploitation of its audio
technologies, and, as noted above, to properly position the MultiDisc assets for
sale. In reaching this decision, the Board of Directors noted that the September
18, 1998 decision by the U.S. Court of Appeals confirming the District Court's
grant of a Summary Judgment in favor of the Company and against Qsound was
expected to eliminate the negative market perceptions faced by the Company over
the last four years. Currently the Company is actively pursuing licensing
opportunities, including possible strategic alliances and capital funding
opportunities based on its core audio technologies. In reaching its decision of
September 25, 1998, the Company indicated that while it recognized the prospects
of MultiDisc, the capital investment required to properly commercialize the
technology was beyond its current capacity and, therefore, it had made the
decision to seek a sale transaction. Effective as of that date, Steven D.
Gershick resigned as chief executive officer of the Company and as president of
MultiDisc Technologies, Inc., but continues to serve as chairman of the board of
the Company. Henry R. Mandell, who joined the Company in March, 1998 as senior
vice president finance was designated as interim chief executive officer to
oversee all of the corporate activities. Michael Bolcerek resigned as president
of Desper Products, Inc.
 
     Funds generated from the financing business activities and capital
transactions described above, as well as cash generated from the Company's
existing operations and the cost reductions being undertaken, may not be
sufficient for the Company to meet its operation obligations during the next
twelve months. In addition, if the refocus on the audio technologies strategy is
not successful, if a strategic alliance including capital funding is not
concluded, or if an appropriate transaction is not undertaken with respect to
the MultiDisc activities, the ability of the Company to meet its operating needs
will be materially adversely affected. As of December 31, 1998, the company had
a negative working capital of $1,975,000 and, absent continued and improved
revenues and successful funding activities, the Company may not be in a position
to resolve this deficit. The financial
                                       16
<PAGE>   18
 
statements and the opinion expressed by the Company's independent accountants
disclose that the financial statements have been prepared assuming the Company
will continue to operate as a going concern which contemplates the realization
of assets and the settlement of liabilities in the normal course of business.
 
     The Company has responded to inquiries from NASDAQ and attended a hearing
with respect to its continued listing on October 29, 1998 at which time it
outlined its strategy for continued listing. In November, 1998, NASDAQ provided
the Company with an extension and conditional listing until December 31, 1998 to
provide evidence of compliance with all requirements for continued listing. On
December 31, 1998, the Company informed NASDAQ that it would be unable to comply
with these requirements. On January 5, 1999, the Company's stock was delisted
from the NASDAQ SmallCap Market and, on the same day, commenced trading on the
NASD Bulletin Board under the symbol "SPAZ".
 
     On October 31, 1997, the Company entered into a line of credit agreement
with Silicon Valley Bank to provide up to $750,000 in short term financing based
upon the Company's accounts receivable base. The line of credit expired on
October 23, 1998. As of December 31, 1998 and March 31, 1999, no borrowings were
outstanding.
 
NET OPERATING LOSS CARRYFORWARDS
 
     At December 31, 1998, the Company had net operating loss carryforwards of
approximately $25,000,000 for income tax purposes. The Company's ability to
utilize approximately $900,000 of these tax losses which accrued during 1994
against future income may be restricted as a result of the change in year-ends
to December 31, 1994. The net operating loss carryforwards expire through 2013.
 
INFLATION
 
     The Company believes that the moderate inflation rate of the 1990's has not
impacted its operations.
 
YEAR 2000
 
     The Company is aware that many computer software programs may not currently
be designed to properly handle the system date change after December 31, 1999.
The Company has addressed this contingency with its computer consultants and
upgraded its software programs in 1998, at a cost of approximately $15,000.
 
THE ASIAN ECONOMIC CRISIS
 
     The Company believes that the deterioration of Asian markets and economies
has had a moderately negative impact on its revenues and profitability.
Approximately 25% of the Company's revenues for the year ended December 31, 1998
were derived from foundries and OEM's based in Japan and other Asian countries.
In addition, some US-based customers do business globally, including Asia, and
have been impacted negatively. The Company continues to work with its Asian
customers in developing products and related pricing to help them remain
competitive with regard to the Company's products.
 
COMPREHENSIVE INCOME
 
     The Financial Accounting Standards Board issued Statement No. 130,
Reporting Comprehensive Income ("SFAS 130"), in June 1997. FAS 130 establishes
standards for reporting and display of comprehensive income and its components
in financial statements. The Company adopted FAS No. 130 in the first quarter of
fiscal year ended December 31, 1998. There was no impact on the 1998 and 1997
financial statements.
 
ITEM 8. FINANCIAL STATEMENTS
 
                                       17
<PAGE>   19
 
                          INDEPENDENT AUDITORS' REPORT
 
The Board of Directors
Spatializer Audio Laboratories, Inc.
 
     We have audited the accompanying consolidated balance sheet of Spatializer
Audio Laboratories, Inc. and subsidiaries as of December 31, 1998 and the
related consolidated statements of operations, shareholders' equity (deficit),
and cash flows for the year ended December 31, 1998. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
 
     We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
 
     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Spatializer
Audio Laboratories, Inc. and subsidiaries as of December 31, 1998, and the
results of their operations and their cash flows for the year then ended in
conformity with generally accepted accounting principles.
 
     The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered significant losses from
operations and has a net capital deficiency that raise substantial doubt about
the Company's ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 17. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
 
                                          /s/ FARBER & HASS LLP
Oxnard, California
April 10, 1999
 
                                       18
<PAGE>   20
 
ITEM 8. FINANCIAL STATEMENTS
 
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
                          CONSOLIDATED BALANCE SHEETS
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                              DECEMBER 31,    DECEMBER 31,
                                                                  1998            1997
                                                              ------------    ------------
<S>                                                           <C>             <C>
Current Assets:
  Cash and Cash Equivalents.................................  $    264,054    $    577,413
  Accounts Receivable, net of allowance for doubtful
  accounts of $190,000 at December 31, 1997.................       134,633         911,505
  Employee Advances.........................................                        59,086
  Inventory.................................................         7,993          93,250
  Prepaid Expenses and Deposits.............................        65,718         135,702
  Deferred Transaction Costs................................                       146,529
                                                              ------------    ------------
          Total Current Assets..............................       472,398       1,923,485
Property and Equipment, Net.................................       184,140         586,961
Intangible Assets, Net......................................       236,913         654,668
                                                              ------------    ------------
                                                              $    893,451    $  3,165,114
                                                              ============    ============
 
                      LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
  Bank Line of Credit Payable...............................                  $    400,000
  Notes Payable.............................................  $     14,795          64,272
  Notes Payable to Related Parties..........................       857,500         112,500
  Accounts Payable..........................................       335,784         651,376
  Accrued Wages and Benefits................................        84,423         332,713
  Accrued Expenses..........................................       370,548          79,140
  Deferred Income...........................................       250,000
  Net Liabilities of Discontinued Operation.................       533,891
                                                              ------------    ------------
                                                                 2,446,941       1,640,001
                                                              ------------    ------------
Commitments and Contingencies
Shareholders' Equity (Deficit):
  Series A 7% Convertible Preferred shares, 100,000 shares
     authorized, 52,900 shares issued and outstanding.......           529
  Preferred shares, $.01 par value, 1,000,000
     shares -- authorized, no shares issued or
     outstanding............................................
Common shares, $.01 par value, 50,000,000 shares authorized,
  25,841,867 and 21,410,012 shares issued and outstanding at
  December 31, 1998 and 1997, respectively..................       258,418         214,100
Additional Paid-In Capital..................................    44,150,501      41,481,890
Accumulated Deficit.........................................   (45,962,938)    (40,170,877)
                                                              ------------    ------------
          Total Shareholders' Equity (Deficit)..............    (1,553,490)      1,525,113
                                                              ------------    ------------
                                                              $    893,451    $  3,165,114
                                                              ============    ============
</TABLE>
 
          See accompanying notes to consolidated financial statements.
                                       19
<PAGE>   21
 
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31,
                                                     ------------------------------------------
                                                        1998           1997            1996
                                                     -----------    -----------    ------------
<S>                                                  <C>            <C>            <C>
Revenues:
  Product Revenues, net............................  $    39,496    $   336,703    $    336,849
  Licensing Revenues...............................      663,522        880,000
  Royalty Revenues.................................      976,697      1,564,530       1,687,338
                                                     -----------    -----------    ------------
                                                       1,679,715      2,781,233       2,024,187
     Cost of Revenues..............................      134,190        229,736         185,540
                                                     -----------    -----------    ------------
                                                       1,545,525      2,551,497       1,838,647
                                                     -----------    -----------    ------------
Operating Expenses:
  General and Administrative.......................    1,732,097      2,173,717       2,329,333
  Research and Development.........................      755,899      3,707,995       1,860,400
  Sales and Marketing..............................    1,001,747      1,356,196       1,954,527
  Compensation Expense.............................                                  20,218,450
  In-Process Research and Development..............                                     679,684
                                                     -----------    -----------    ------------
                                                       3,489,743      7,237,908      27,042,394
                                                     -----------    -----------    ------------
     Operating Loss................................   (1,944,218)    (4,686,411)    (25,203,747)
Interest Income....................................       27,672         57,305         123,643
Interest Expense...................................      (84,723)       (21,063)        (14,571)
Other Income (Expense), net........................      (50,955)        (8,949)         10,042
                                                     -----------    -----------    ------------
                                                        (108,006)        27,293         119,114
                                                     -----------    -----------    ------------
  Loss From Continuing Operations..................   (2,052,224)    (4,659,118)    (25,084,633)
  Loss From Discontinued Operation.................   (3,701,599)
                                                     -----------    -----------    ------------
  Loss Before Income Taxes.........................   (5,753,823)    (4,659,118)    (25,084,633)
  Income Taxes.....................................      (38,238)       (60,703)       (310,537)
                                                     -----------    -----------    ------------
  Net Loss.........................................  $(5,792,061)   $(4,719,821)   $(25,395,170)
                                                     ===========    ===========    ============
  Basic and Diluted Loss Per Share:
     Continuing Operations.........................  $      (.12)   $      (.23)   $      (2.01)
     Discontinued Operation........................  $      (.17)
                                                     -----------    -----------    ------------
  Net Loss.........................................         (.29)   $      (.23)   $      (2.01)
                                                     ===========    ===========    ============
  Weighted-average shares outstanding..............   22,180,180     20,604,095      12,644,751
                                                     ===========    ===========    ============
</TABLE>
 
          See accompanying notes to consolidated financial statements.
                                       20
<PAGE>   22
 
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31,
                                                     ------------------------------------------
                                                        1998           1997            1996
                                                     -----------    -----------    ------------
<S>                                                  <C>            <C>            <C>
Cash Flows from Operating Activities:
  Net Loss.........................................  $(5,792,061)   $(4,719,821)   $(25,395,170)
  Adjustments to reconcile net loss to net cash
     used in operating activities:
     Depreciation and Amortization.................      126,334        407,238         130,057
     Discontinued Operation........................      962,060
     Deferred Transaction Costs....................      146,529
     Loss on Disposal of Property and Equipment....       50,308         14,281
     Provision for Doubtful Accounts...............                     100,000          90,000
     Options and Warrants Issued for Services......       56,030        100,000
     Compensation Expense..........................                                  20,218,450
     In-Process Research and Development...........                                     679,684
  Net Change in Assets and Liabilities:
     Accounts Receivable and Employee Advances.....      798,675       (249,806)       (498,846)
     Inventory.....................................       85,257        203,289         (34,408)
     Prepaid Expenses and Other Assets.............       31,112        121,147        (267,748)
     Accounts Payable..............................      102,737        247,506         223,824
     Accrued Expenses and Other Liabilities........      503,007         78,701         129,622
     Changes in Discontinued Operation.............      (66,796)
                                                     -----------    -----------    ------------
Net Cash Used in Operating Activities..............   (2,996,808)    (3,697,465)     (4,724,535)
                                                     -----------    -----------    ------------
Cash Flows from Investing Activities:
     Purchase of Property and Equipment............      (43,079)      (187,485)       (229,780)
     Proceeds from Disposal........................       20,400
     Increase in Intangible Assets.................      (34,350)      (237,036)        (43,118)
     Deferred Transaction Costs....................                    (146,529)
     MDT Asset Acquisition.........................                                  (1,062,156)
     Discontinued Operation........................     (238,025)
                                                     -----------    -----------    ------------
Net Cash Used in Investing Activities..............     (295,054)      (571,050)     (1,335,054)
                                                     -----------    -----------    ------------
Cash Flows from Financing Activities:
     Issuance of Common and Preferred Shares,
       net.........................................    2,611,474      1,966,144       2,649,000
     Exercise of Options and Warrants..............       45,954        910,917       2,098,122
     Notes and Amounts Due to Related Parties......      745,000                       (212,561)
     Proceeds from Issuance of Notes Payable.......                                      15,273
     Proceeds (Repayment) from Bank on Line of
       Credit......................................     (400,000)       400,000
     Discontinued Operation........................      (20,501)
     Repayments of Notes Payable...................       (3,424)       (18,528)        (15,907)
                                                     -----------    -----------    ------------
Net Cash Provided by Financing Activities..........    2,978,503      3,258,533       4,533,927
                                                     -----------    -----------    ------------
Decrease in Cash and Cash Equivalents..............     (313,359)    (1,009,982)     (1,525,662)
                                                     -----------    -----------    ------------
Cash and Cash Equivalents, Beginning of Year.......      577,413      1,587,395       3,113,057
                                                     ===========    ===========    ============
Cash and Cash Equivalents, End of Year.............  $   264,054    $   577,413    $  1,587,395
                                                     ===========    ===========    ============
Supplemental Schedule of Non-Cash Investing and
  Financing Activities:
     Capital Expenditures Financed by Lease
       Obligations and Notes Payable...............  $         0    $    59,000    $     10,940
                                                     -----------    -----------    ------------
Supplemental Disclosure of Cash Flow Information:
     Cash Paid During the Year For:
     Interest......................................  $    26,370    $    21,063    $     13,771
Income Taxes.......................................  $    35,838    $    60,703    $    310,729
                                                     ===========    ===========    ============
</TABLE>
 
          See accompanying notes to consolidated financial statements.
                                       21
<PAGE>   23
 
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
                 CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                             SERIES A, 7%
                              CONVERTIBLE
                               PREFERRED
                                SHARES               COMMON SHARES                                             TOTAL
                         ---------------------   ----------------------                                    SHAREHOLDERS'
                          NUMBER                 NUMBER OF                  ADDITIONAL      ACCUMULATED       EQUITY
                         OF SHARES   PAR VALUE     SHARES     PAR VALUE   PAID-IN CAPITAL     DEFICIT        (DEFICIT)
                         ---------   ---------   ----------   ---------   ---------------   ------------   -------------
<S>                      <C>         <C>         <C>          <C>         <C>               <C>            <C>
Balance, December 31,
  1995.................       --       $ --      17,457,531   $174,575      $13,578,782     $(10,055,886)  $  3,697,471
Options Exercised......       --         --         363,033      3,630          383,905               --        387,535
Warrants Exercised.....       --         --         646,000      6,460        1,704,127               --      1,710,587
Private Placements,
  Net..................       --         --         648,865      6,489        2,642,511               --      2,649,000
Performance Shares.....       --         --              --         --       20,218,450               --     20,218,450
Net Loss...............       --         --              --         --                       (25,395,170)   (25,395,170)
                          ------       ----      ----------   --------      -----------     ------------   ------------
Balance, December 31,
  1996.................       --       $ --      19,115,429   $191,154      $38,527,775     $(35,451,056)  $  3,267,873
Options Exercised......       --         --         339,833      3,399          404,954               --        408,352
Warrants Exercised.....       --         --         287,250      2,872          499,693               --        502,565
Private Placements,
  Net..................       --         --       1,667,500     16,675        1,949,468               --      1,966,144
Warrants Issued for
  Services.............       --         --              --         --          100,000               --        100,000
Net Loss...............       --         --              --         --               --       (4,719,821)    (4,719,821)
                          ------       ----      ----------   --------      -----------     ------------   ------------
Balance, December 31,
  1997.................       --       $ --      21,410,012   $214,100      $41,481,890     $(40,170,877)  $  1,525,113
Issuance of Preferred
  Shares, Net..........   60,000        600              --         --        2,610,874               --      2,611,474
Options Exercised......       --         --          13,333        133           12,571               --         12,704
Warrants Exercised.....       --         --          19,000        190           33,060               --         33,250
Options Issued for
  Services.............       --         --              --         --           56,030               --         56,030
Conversion of Preferred
  Shares...............   (7,100)       (71)      4,399,522     43,995          (43,924)              --             --
Net Loss...............       --         --              --         --               --       (5,792,061)    (5,792,061)
                          ------       ----      ----------   --------      -----------     ------------   ------------
Balance, December 31,
  1998.................   52,900       $529      25,841,867   $258,418      $44,150,501     $(45,962,938)  $ (1,553,490)
                          ======       ====      ==========   ========      ===========     ============   ============
</TABLE>
 
          See accompanying notes to consolidated financial statements.
                                       22
<PAGE>   24
 
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(1) NATURE OF BUSINESS
 
     Spatializer Audio Laboratories, Inc. and subsidiaries (the "Company") is in
the business of developing and licensing technology.
 
     The Company's wholly owned subsidiary Desper Products, Inc. ("DPI") is in
the business of developing proprietary advanced audio signal processing
technologies and products for consumer electronics, entertainment, and
multimedia computing.
 
     The Company's wholly owned subsidiary, MultiDisc Technologies, Inc. ("MDT")
was in the business of developing scaleable, modular compact disc and digital
versatile disc ("DVD") server technologies associated with a network based
compact disc/DVD server for internet and intranet applications. Operations of
MDT were discontinued in the fourth quarter of 1998 and the assets are being
marketed for sale (see Note 14).
 
     On December 5, 1995, the Board of Directors of the Company authorized the
liquidation of Spatializer Audio Laboratories, Inc. -- Yukon pursuant to S.213
of the Business Corporations Act (Yukon). This action was taken to minimize the
tax consequences to the Company. The liquidation was completed during the first
quarter of 1996.
 
     The Company has experienced significant operating losses for the three
years ended December 31, 1998. In addition, the Company has a negative working
capital of $1,975,000 and shareholder's deficit of $1,553,490 at December 31,
1998. The financial statements have been prepared assuming the Company will
continue to operate as a going concern which contemplates the realization of
assets and the settlement of liabilities in the normal course of business. No
adjustment has been made to the recorded amount of assets or the recorded amount
or classification of liabilities which would be required if the Company were
unable to continue its operations. See Management's Plans at Note 17.
 
(2) SIGNIFICANT ACCOUNTING POLICIES
 
  Basis of Consolidation
 
     The consolidated financial statements include the accounts of Spatializer
Audio Laboratories, Inc. and its wholly owned subsidiary, Desper Products, Inc.
MultiDisc Technologies, Inc. has been presented as a discontinued operation (see
Note 14). All significant intercompany balances and transactions have been
eliminated in consolidation.
 
  Revenue Recognition
 
     The Company recognizes revenue from product sales upon shipment to the
customer. License revenues are recognized when earned, in accordance with the
contractual provisions. Royalty revenues are recognized upon shipment of
products incorporating the related technology by the original equipment
manufacturers (OEM's) and foundries.
 
  Cash and Cash Equivalents
 
     Cash equivalents consist of highly liquid investments with original
maturities of three months or less. Restricted cash balances of $10,000 and
$71,500 at December 31, 1998 and 1997, respectively, related to leasehold
improvement and credit card guarantees are included in cash and cash equivalents
in the accompanying consolidated financial statements.
 
                                       23
<PAGE>   25
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
  Inventory
 
     Inventory, which consists primarily of finished goods, is stated at the
lower of cost (first-in, first-out) or market.
 
  Research and Development Costs
 
     The Company expenses research and development costs as incurred.
 
  Property and Equipment
 
     Property and equipment are stated at cost. Property and equipment under
capital leases are stated at the present value of minimum lease payments.
Property and equipment are depreciated over three to five years using
accelerated-depreciation methods, which approximates 150% declining balance.
Leasehold improvements are amortized over the shorter of the useful life of the
asset or lease term.
 
  Intangible Assets
 
     Intangible assets consist of patent costs which are amortized on a
straight-line basis over the estimated useful lives of the patents which range
from five to ten years.
 
  Valuation Accounts
 
     The Company had reserves for doubtful accounts recorded in the accompanying
consolidated financial statements which are summarized as follows:
 
<TABLE>
<CAPTION>
                                                                ALLOWANCE FOR
                                                              DOUBTFUL ACCOUNTS
                                                              -----------------
<S>                                                           <C>
Balance at January 1, 1996..................................      $      --
  Charged to expense........................................         90,000
  Deductions................................................             --
                                                                  ---------
Balance at December 31, 1996................................         90,000
  Charged to expense........................................        100,000
  Deductions................................................             --
                                                                  ---------
Balance at December 31, 1997................................        190,000
  Charged to expense........................................             --
  Deductions................................................       (190,000)
                                                                  ---------
Balance at December 31, 1998................................      $       0
                                                                  =========
</TABLE>
 
  Loss per Share
 
     On December 31, 1997, the Company retroactively adopted the provisions of
Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS
128") which replaces the presentation of primary and fully diluted earnings
(loss) per share with a presentation of basic and diluted earnings (loss) 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. Diluted
earnings (loss) per share is computed similarly to fully diluted earnings (loss)
per share pursuant to the Accounting Principles Board ("APB") Opinion No. 15.
The following table presents contingently issuable shares, options and warrants
to purchase shares of common
 
                                       24
<PAGE>   26
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
stock that were outstanding during 1998, 1997, and 1996 which were not included
in the computation of diluted loss per share because the impact would have been
antidilutive:
 
<TABLE>
<CAPTION>
                                              1998         1997         1996
                                            ---------    ---------    ---------
<S>                                         <C>          <C>          <C>
Performance Shares........................         --                 5,746,047
Options...................................  1,972,300    1,855,070    1,701,732
Warrants..................................    732,000      934,750      174,000
                                            ---------    ---------    ---------
                                            2,704,300    2,789,820    7,621,779
                                            =========    =========    =========
</TABLE>
 
     Adoption of SFAS 128 did not have an impact on loss per share for the year
ended December 31, 1996 as previously reported.
 
     The loss per share for the year ended December 31, 1998 includes the effect
of approximately $371,000 of the beneficial conversion feature of the Series A,
7% Convertible Preferred Stock as well as dividends in arrears of approximately
$149,000 related to this Preferred Stock.
 
  Stock Option Plan
 
     Prior to January 1, 1996 the Company accounted for its stock option plan in
accordance with the provisions of APB Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations. As such, compensation expense
would be recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. On January 1, 1996, the Company
adopted SFAS No. 123, Accounting for Stock-Based Compensation, which permits
entities to recognize as expense using the fair value based method over the
vesting period the fair value of all employee stock-based awards on the date of
grant. Alternatively, SFAS No. 123 allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income (loss) and pro
forma earnings (loss) per share disclosures for employee stock option grants
made in 1995 and future years as if the fair-value-based method defined in SFAS
No. 123 has been applied. The Company has elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions
of SFAS No. 123 (Note 13).
 
  Impairment of Long-Lived Assets and Assets to be Disposed of
 
     The Company adopted the provisions of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of, on
January 1, 1996. This Statement requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured as the amount by which the carrying
amounts of the assets exceed the fair value of the assets (see Note 14). Assets
to be disposed of are reported at the lower of the carrying amount or fair value
less costs to sell.
 
  Segment Reporting
 
     The Financial Accounting Standards Board issued Statement No. 131,
Disclosures about Segments of an Enterprise and Related Information ("SFAS No.
131"), in June 1997. SFAS No. 131 establishes standards for the way public
business enterprises are to report information about operating segments in
annual financial statements and requires enterprises to report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. It replaces the
"industry segment" concept of SFAS No. 14,
 
                                       25
<PAGE>   27
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Financial Reporting for Segments of a Business Enterprise, with a "management
approach" concept as to basis for identifying reportable segments. SFAS 131 is
effective for financial statements for fiscal years beginning after December 15,
1997. The Company adopted SFAS 131 in December 1997. MDT is considered a
discontinued operation as of September 1998. As of December 31, 1998, the
Company has only one operating segment, DPI, the Company's 3-D Audio Signal
Processing business.
 
  Comprehensive Income
 
     The Financial Accounting Standards Board issued Statement No. 130,
Reporting Comprehensive Income ("SFAS 130"), in June 1997. SFAS 130 establishes
standards for reporting and display of comprehensive income and its components
in financial statements. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997. The Company adopted SFAS No. 130 January 1, 1998.
Comprehensive income (loss) is the change in equity of a business enterprise
during a period from transactions and all other events and circumstances from
nonowner sources. Other comprehensive income (loss) includes foreign currency
items, minimum pension liability adjustments, and unrealized gains and losses on
certain investments in debt and equity securities. The Company did not have
components of other comprehensive income (loss) during the years ended December
31, 1998 and 1997. As a result, comprehensive loss is the same as the net loss
for the years ended December 31, 1998 and 1997.
 
  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 carryforwards. 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.
 
  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.
 
  Financial Instruments
 
     The carrying values of cash and cash equivalents, accounts receivable,
accounts payable and accrued liabilities at December 31, 1998 and 1997
approximated fair value due to the short maturity of those investments.
 
     The fair value of the amounts from related parties could not be estimated
due to the nature of the borrowings.
 
     The fair values of notes payable at December 31, 1998 and 1997 are
materially consistent with the related carrying values based on current rates
offered to the Company for instruments with similar maturities.
 
                                       26
<PAGE>   28
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
  Sales of Common Stock of Subsidiaries
 
     At the time a subsidiary or equity affiliate sells existing or newly issued
common stock to unrelated parties at a price in excess of its book value, the
company records a gain reflecting its share of the change in the subsidiary's
shareholders equity resulting from the sale.
 
  Discontinued Operation
 
     In September, 1998, the Board of Directors approved a plan to refocus
corporate activities on the Company's core audio business, Desper Products, Inc.
In conjunction to this strategic refocusing, the Company permanently suspended
operations of MDT and placed the business and its related patent portfolio up
for sale. The Company is accounting for the on-going operating and termination
expenses of MDT as a discontinued operation (see Note 14).
 
  Reclassification
 
     Certain 1997 and 1996 amounts have been reclassified in order to conform
with 1998 classifications.
 
(3) DEFERRED TRANSACTION COSTS
 
     On November 5, 1997, the Board of Directors adopted a plan in which MDT
would be spun-off into a newly formed and separately financed corporation. Costs
relating to this transaction for legal, accounting, valuation, and consulting
were deferred until the completion of the transaction. Under the plan, the
company was, upon closing, to receive majority interest in this new company.
Based on the decision by the Board of Directors to discontinue operations of
MDT, these costs were written off in the fourth quarter of 1998.
 
(4) PROPERTY AND EQUIPMENT
 
     Property and equipment, as of December 31, 1998 and 1997 consists of the
following:
 
<TABLE>
<CAPTION>
                                                                1998         1997
                                                              --------    ----------
<S>                                                           <C>         <C>
Office Computers, Software, Equipment and Furniture.........  $225,907    $  788,392
Test Equipment..............................................    60,647       114,225
Tooling Equipment...........................................    44,136        44,136
Trade Show Booth and Demonstration Equipment................   122,768       137,158
Leasehold Improvements......................................    22,122        48,783
                                                              --------    ----------
                                                               475,580     1,132,694
Less Accumulated Depreciation and Amortization..............   291,440       545,733
                                                              --------    ----------
                                                              $184,140    $  586,961
                                                              ========    ==========
</TABLE>
 
(5) INTANGIBLE ASSETS
 
     Intangible assets, as of December 31, 1998 and 1997 consist of the
following:
 
<TABLE>
<CAPTION>
                                                                1998        1997
                                                              --------    --------
<S>                                                           <C>         <C>
Capitalized patent and technology costs.....................  $365,637    $546,260
Capitalized patent costs in association with MDT Asset
  Acquisition...............................................               200,000
                                                              --------    --------
                                                               365,637     746,260
Less Accumulated Amortization...............................   128,724      91,592
                                                              --------    --------
                                                              $236,913    $654,668
                                                              ========    ========
</TABLE>
 
                                       27
<PAGE>   29
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
(6) FINANCING ARRANGEMENTS
 
  Bank Credit Agreement
 
     The Company had an accounts receivable-based working capital bank line of
credit which provided for borrowings up to $750,000 of the Company's qualified
and eligible gross domestic accounts receivable at an interest rate of 1.5% of
the average gross daily factoring account balance. The line of credit expired on
October 23, 1998 and has not been renewed.
 
  Notes Payable
 
     Notes payable at December 31, 1998 and 1997 consist of the following:
 
<TABLE>
<CAPTION>
                                                               1998       1997
                                                              -------    -------
<S>                                                           <C>        <C>
Notes payable, secured by equipment, interest at 11.5% to
  22%, payable in monthly installments
May 2002....................................................  $14,795    $19,781
Capital lease obligations, payable in monthly installments
  through
  February 2000.............................................              44,491
                                                              -------    -------
                                                              $14,795    $64,272
                                                              =======    =======
</TABLE>
 
     The notes payable balances as of December 31, 1998 and 1997 have been
classified as current liabilities since the long-term portion of the debt is not
material to the accompanying consolidated balance sheet. Capital lease
obligations totalling $25,552 at December 31, 1998 are included in the Net
Liabilities of Discontinued Operations.
 
(7) NOTES PAYABLE TO RELATED PARTIES
 
     The Company was indebted to certain related parties for an amount totaling
$112,500 at December 31, 1998 and 1997. This amount bears interest at a fixed
rate of 10% annually and is due on demand.
 
     At December 31, 1998, the Company was indebted to four of its directors and
one of its executives for an amount totaling $745,000. This amount bears
interest at a fixed rate of 10% annually. Of this amount, $650,000 was due on
December 31, 1998, and is currently in default. The remaining $95,000 is due on
November 30, 1999, or upon the sale of the MDT assets. The Company granted
95,000 warrants to purchase common stock at $0.20 per share in connection with
the $95,000 of indebtedness.
 
(8) SHAREHOLDERS' EQUITY
 
  During the year ended December 31, 1998, shares were issued or converted as
follows:
 
     On April 14, 1998, the Company entered into a private placement for up to
$5 million of which $3 million was funded at December 31, 1998. In connection
with the private placement, the Company authorized 100,000 shares of a new
Series A, 7% Convertible Preferred Stock at a stated price of $50 per share and
issued 60,000 shares for the $3 million. In connection with the April funding,
the Company issued purchase warrants, exercisable for three years and entitling
the holders to acquire one share of the Company's common stock for each warrant.
Of the warrants, 450,000 were issued and 150,000 warrants were issued to
placement agents. The investor warrants are exercisable at 140% and the
placement warrants are exercisable at 120%, respectively, of the average closing
bid price of the Company's common stock for the 10 days preceding the closing.
In addition, cash placement fees of 10% were paid. A related party of the
Company received 50,000 of the placement agent warrants and $100,000 of the
placement agent cash fee for arranging $1 million of the
 
                                       28
<PAGE>   30
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
$3 million investment. As of December 31, 1998, $1 million of the remaining $2
million of the funding was due but had not yet been received.
 
     Holders of the Series A Preferred Stock have a right to convert their
shares, at their option on the earlier of (x) ninety (90) days after issuance or
(y) on the effective date of a Form S-3 Registration Statement (the "Conversion
Date") with such conversion to be based on a per share conversion price
("Conversion Price") equal to the lesser of a price that reflects a discount
(the "Conversion Discount") to the average of any three (3) consecutive closing
bid prices for the Company's Common Stock within twenty (20) trading days
immediately prior to the conversion date (the "Floating Conversion Price") or a
price which is equal to one hundred thirty percent (130%) of the closing bid
prices of the Company's Common Stock for the ten (10) trading days immediately
preceding the date of issuance (the "Fixed Conversion Price") provided that in
determining the Conversion Price, the holder shall not count any day on which
its sales account for greater than twenty percent (20%) of the volume of the
Company's Common Stock and on which the holder has sales in the last hour of
trading. The Conversion Discount shall be equal to fifteen percent (15%) if the
Conversion Rights are exercised within one hundred twenty (120) days of first
issuance of the Series A Preferred Stock and shall be equal to seventeen and
one-half percent (17.5%) if the Conversion Rights are exercised after one
hundred (120) days and prior to one hundred forty-nine (149) days of first
issuance of the Series A Preferred Stock. The applicable Conversion Discount
increases by five percent (5%) if the Company is de-listed on NASDAQ. In
addition, the percentage of shares that can be converted at any one time is
limited during such time periods and the holders cannot own more than 4.99% of
the equity of the Company after the Conversion.
 
     At December 31, 1998, 7,100 shares of the Series A Convertible Preferred
Stock had been converted into a total of 4,399,522 shares of the Company's
Common Stock.
 
     The beneficial conversion feature of the Series A Preferred Stock will be
recorded as a dividend using the most favorable conversion terms available to
the shareholder to calculate the dividend in accordance with FASB (Emerging
Issues Task Force) Topic D-60. Since the Company has an accumulated deficit and,
under Delaware Law, must charge dividends against additional paid in capital,
the net impact of recording the beneficial conversion feature is zero since both
sides of the entry are recorded in additional paid in capital. At December 31,
1998, dividends in arrears were $148,750.
 
     In the private placement, the participants were granted certain rights to
participate in the separate financing of approximately $6 million which was
being pursued by the Company to fund the commercial introduction of its
MultiDisc CD/DVD server technology. However, as reported by the Company on
September 25, 1998, the Company has decided to refocus on the core audio
technologies and to properly position the MultiDisc assets for sale. Therefore
this financing is not currently being pursued actively.
 
  During the year ended December 31, 1997, shares were issued or converted as
follows:
 
     In March 1997, the Company completed a private placement of 1,600,000 units
at a price of $1.25 per unit, each unit comprised of one common share and
one-half of one non-transferable share purchase warrant. One warrant entitles
the holder to purchase one additional share at a price of $1.75 on or before
April 7, 1998. Stock issuance costs consisted of 67,500 shares of common stock,
12,000 warrants to purchase an equivalent number of shares of common stock at
1.50 per share and $33,856 cash.
 
  During the year ended December 31, 1996, shares were issued or converted as
follows:
 
     In May 1996, the Company completed a private placement of 200,000 units at
a price of $4.25 per unit, each unit comprised of one common share and
one-quarter of one non-transferable share purchase warrant. One warrant entitles
the holder to purchase one additional share at a price of $4.75 on or before May
9, 1997. Regulatory approval was received in July 1996 from the Vancouver Stock
Exchange ("VSE").
 
                                       29
<PAGE>   31
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     Also in May 1996, the Company completed a private placement of 280,000
units at a price of $4.25 per unit, each unit comprised of one common share and
one-quarter of one non-transferable share purchase warrant. One warrant entitles
the holder to purchase one additional share at a price of $4.75 on or before May
31, 1997. Regulatory approval was received in July 1996 from the VSE.
 
     In June 1996, the Company completed a private placement of 140,000 units at
a price of $4.35 per unit, each unit comprised of one common share and
one-quarter of one non-transferable share purchase warrant. One warrant entitles
the holder to purchase one additional share at a price of $5.12 on or before
June 17, 1997. Regulatory approval was received in August 1996 from the VSE.
 
     In relation to the private placements of the Company's stock during 1996,
finder's fees for such placements were paid through the issuance of 28,865
shares of stock.
 
(9) ESCROWED PERFORMANCE SHARES
 
     In December 1996, the Company accepted the terms outlined by the British
Columbia Securities Commissions ("BCSC") for the release of the Company's
5,776,700 escrowed "Performance Shares" from Canadian Escrow into a new escrow
arrangement with the Company. The overall modification was approved by the
Company's shareholders in August 1996. Under the revised arrangement, the
performance shares will be released automatically as follows: 10% on June 22,
1999; 20% on June 22, 2000; 30% on June 22, 2001; and 30% on June 22, 2002. In
addition to the automatic releases, performance shares can be released based on
the cash flow release criteria contained in the original June 22, 1992 escrow
agreement although, to maintain a stable market in the Company's stock, in any
year not more than 30% of the shares will be released, based on the cash flow
criteria.
 
     Under the revised escrow arrangement, the performance shares will vest
provided the individual has not voluntarily terminated his/her relationship with
the Company prior to applicable vesting dates.
 
     Based on the revised escrow arrangement, which primarily converts the
escrow shares release from performance criteria to a time-based criteria, the
Company recorded as compensation expense the excess of the fair market value of
the 5,776,700 performance shares on the date the Company accepted the terms of
the new escrow arrangement over the purchase price of such escrow shares.
 
     All of the performance shares are included in the issued and outstanding
shares for the years ended December 31, 1998, 1997, and 1996. However, the
shares were not reflected in the calculation of loss per common share until
earned by and released to the holders on December 30, 1996, the date on which
the Company and the BCSC accepted and entered into the terms of the current
escrowed agreement as discussed above.
 
(10) 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 authorizes grants of options to purchase
authorized but unissued common stock up to 10% of total common shares
outstanding at each calendar quarter, 2,584,187 as of December 31, 1998. Stock
options are granted with an exercise price equal to the stock's fair market
value at the date of grant. Stock options have five-year terms and vest and
become fully exercisable up to three years from the date of grant.
 
     At December 31, 1998, there were 611,887 additional shares available for
grant under the Plan. The per share weighted-average fair value of stock options
granted during 1998, 1997 and 1996 was $0.25, $1.44, and $3.24, respectively, on
the date of grant using the Black-Scholes option-pricing model with the
following weighted -average assumptions: 1998 -- expected dividend yield 0%,
risk-free interest rate of 9.0%, expected
 
                                       30
<PAGE>   32
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
volatility of 95% and an expected life of 3 years; 1997 -- expected dividend
yield 0%, risk-free interest rate of 6.50%, expected volatility of 147% and an
expected life of 5 years; 1996 -- expected dividend yield 0%, risk-free interest
rate of 6.41%, expected volatility of 147% and an expected life of 5 years.
 
     The Company applies APB Opinion No. 25 in accounting for its Plan and,
accordingly, no compensation cost has been recognized for the fair value of its
stock options in the consolidated financial statements. Had the Company
determined compensation cost based on the fair value at the grant date for its
stock options under SFAS No. 123, the Company's net loss would have been
increased to the pro forma amounts indicated below:
 
<TABLE>
<CAPTION>
                                                1998           1997            1996
                                             -----------    -----------    ------------
<S>                                          <C>            <C>            <C>
Net loss -- as reported....................  $(5,792,061)   $(4,719,821)   $(25,395,170)
         -- pro forma......................   (5,792,061)    (6,408,547)    (25,954,816)
                                             ===========    ===========    ============
Basic and diluted loss per share
         -- as reported....................  $      (.29)   $      (.23)   $      (2.01)
         -- pro forma......................  $      (.29)          (.31)          (2.05)
                                             ===========    ===========    ============
</TABLE>
 
     Pro forma net loss reflects only options granted since December 31, 1994.
Therefore, the full impact of calculating compensation cost for stock options
under SFAS No. 123 is not reflected in the pro forma net loss amounts presented
above because compensation cost is reflected over the options' vesting period
and compensation cost for options granted prior to January 1, 1995 is not
considered.
 
     Stock option activity during the periods indicated is as follows:
 
<TABLE>
<CAPTION>
                                                                        WEIGHTED AVERAGE
                                                            NUMBER       EXERCISE PRICE
                                                           ---------    ----------------
<S>                                                        <C>          <C>
Options Outstanding at January 1, 1996...................  1,426,432        $ 0.864
Options Granted..........................................    715,000        $ 3.506
Options Exercised........................................   (363,033)       $ 1.070
Options Expired..........................................    (76,667)       $ 3.506
                                                           ---------
Options Outstanding at December 31, 1996.................  1,701,732        $ 2.737
Options Granted..........................................    780,000        $ 1.560
Options Exercised........................................   (339,833)       $ 1.182
Options Forfeited........................................   (286,829)       $ 3.208
                                                           ---------
Options Outstanding at December 31, 1997.................  1,855,070        $ 1.897
Options Granted..........................................    646,000        $ 0.728
Options Exercised........................................    (13,333)       $ 0.953
Options Forfeited........................................   (515,437)       $ 1.763
                                                           ---------
Options Outstanding at December 31, 1998.................  1,972,300        $ 1.515
                                                           =========
</TABLE>
 
     At December 31, 1998, the exercise prices of the outstanding options ranged
from $.1875 per share to $3.26 per share, and the remaining contractual life of
outstanding options ranged from 14 months to 58 months.
 
     At December 31, 1998 and 1997, the number of options exercisable was
1,269,633 and 1,233,403, respectively, and the weighted-average exercise price
of those options was $1.937 and $2.059, respectively.
 
     On October 30, 1998, the Compensation Committee of the Board of Directors
re-priced qualified stock options to purchase 121,000 shares of common stock
granted to various employees beginning in June 1995. The exercise price for
these options was adjusted to $.01875 per share (the closing market price on
 
                                       31
<PAGE>   33
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
October 30, 1998) reducing grant date exercise prices ranging from $0.72 to
$2.34 per share. Also, on November 12, 1998, the Compensation Committee of the
Board of Directors re-priced qualified stock options to purchase 100,000 shares
of common stock granted to an employee in March 1998. The exercise price for
these options was adjusted to $0.125 per share (the closing market price on
November 12, 1998) reducing the grant date exercise price from $1.18 per share.
The vesting schedules and expiration dates for these options were not modified.
 
(11) WARRANTS
 
     Warrant activity for the periods indicated below is as follows:
 
<TABLE>
<CAPTION>
                                                              WARRANTS     WARRANT PRICE
                                                              ---------    -------------
<S>                                                           <C>          <C>
Warrants Outstanding at January 1, 1996.....................    780,000       $2.536
Warrants Issued.............................................    155,000       $3.553
Warrants Exercised..........................................   (646,000)      $2.645
Warrants Expired............................................   (115,000)      $3.700
                                                              ---------
Warrants Outstanding at December 31, 1996...................    174,000       $3.790
Warrants Issued.............................................  1,067,000       $1.455
Warrants Exercised..........................................   (287,250)      $1.750
Warrants Expired............................................    (19,000)      $3.800
                                                              ---------
Warrants Outstanding at December 31, 1997...................    934,750       $1.704
Warrants Issued.............................................    720,000       $1.455
Warrants Exercised..........................................    (19,000)      $1.750
Warrants Expired............................................   (903,750)      $1.706
                                                              ---------
Warrants Outstanding at December 31, 1998...................    732,000       $1.118
                                                              ---------
</TABLE>
 
     All of the warrants granted in 1998, 1997 and 1996 were issued in
connection with private placements except for the following: 100,000 warrants
were granted in 1997 as consideration for consulting services rendered during
1997; 25,000 warrants were granted in 1998 as consideration for consulting
services rendered during 1998; and 95,000 warrants were granted in 1998 in
connection with a debt financing with the Company's directors. For those
warrants granted as consideration for consulting services, the fair value of the
consulting services was included in research and development costs in the
accompanying consolidated statement of operations for the year ended December
31, 1998. At December 31, 1998 and 1997, the number of warrants exercisable was
732,000 and 934,750, respectively.
 
(12) INCOME TAXES
 
     The Company files a consolidated return for U.S. income tax purposes.
Income tax expense for the years ended December 31, 1998, 1997 and 1996
consisted of the following:
 
<TABLE>
<CAPTION>
                                                        1998       1997        1996
                                                       -------    -------    --------
<S>                                                    <C>        <C>        <C>
State franchise tax..................................  $ 2,400    $ 2,856    $ 58,331
Foreign taxes........................................   35,838     57,847     252,206
                                                       -------    -------    --------
                                                       $38,238    $60,703    $310,537
                                                       =======    =======    ========
</TABLE>
 
     Certain revenues received from customers in foreign countries are subject
to withholding taxes that are deducted from outgoing funds at the time of
payment. These taxes range from approximately 8.5% to 15% and are recorded as
foreign tax expense when incurred. In early 1996, the Company completed the
liquidation of
 
                                       32
<PAGE>   34
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Spatializer -- Yukon, a Canadian subsidiary. The liquidation resulted in a
Canadian tax liability of approximately $249,000 and approximately $3,000 in
minimum state taxes in 1996.
 
     Income tax expense for the years ended December 31, 1998, 1997 and 1996
differed from the amounts computed by applying the U.S. federal income tax rate
of 34 percent to loss before income taxes primarily due to the generation of
additional net operating loss carryforwards for which no tax benefit has been
provided.
 
     The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1998 and 1997 are presented below.
 
<TABLE>
<CAPTION>
                                                               1998           1997
                                                           ------------    -----------
<S>                                                        <C>             <C>
Deferred tax assets:
  Net operating loss carryforwards.......................  $  9,475,000    $ 7,515,000
  In-process research and development costs..............       272,000        272,000
  Asset reserves.........................................       313,000         96,000
  Accrued liabilities....................................        32,000        104,000
  Property and equipment, principally due to differences
     in depreciation and capitalized interest............        20,000         25,000
  Other..................................................                       26,000
                                                           ------------    -----------
Total gross deferred tax assets..........................    10,112,000      8,038,000
Less valuation allowance.................................   (10,112,000)    (8,038,000)
                                                           ------------    -----------
Net deferred tax assets..................................  $         --    $        --
                                                           ============    ===========
</TABLE>
 
     The net change in the total valuation allowance for the years ended
December 31, 1998 and 1997 was an increase of $2,074,000 and $1,800,000,
respectively. In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers projected future taxable income and tax planning strategies in making
this assessment. Based upon the level of historical taxable losses, management
believes it is more likely than not the Company will not realize the benefits of
these deductible differences and has established a valuation allowance to fully
reserve the deferred tax assets at December 31, 1998 and 1997. Additionally, the
ultimate realizability of net operating losses may be limited by change of
control provisions under section 382 of the Internal Revenue Code.
 
     At December 31, 1998, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $25,000,000 which are available to
offset future federal taxable income, if any, through 2013. In addition, the
Company has foreign tax and general business credit carryforwards of $179,000
and $188,000 respectively.
 
                                       33
<PAGE>   35
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
(13) SEGMENT REPORTING
 
     The following table presents information about reported segment losses and
segment assets as of and for the years ended December 31, 1997 and 1996:
 
<TABLE>
<CAPTION>
                                        1997                                     1996
                       --------------------------------------   ---------------------------------------
                                                    SEGMENT                                   SEGMENT
                          DPI           MDT          TOTAL          DPI           MDT          TOTAL
                       ----------   -----------   -----------   -----------   -----------   -----------
<S>                    <C>          <C>           <C>           <C>           <C>           <C>
Revenues from
  External
  Customers..........  $2,781,233   $        --   $ 2,781,233   $ 2,024,187   $        --   $ 2,024,187
Interest Income......         758         3,145         3,904         3,271         3,056         6,327
Interest Expense.....     (12,483)       (5,353)      (17,836)      (13,282)         (208)      (13,490)
Depreciation and
  Amortization.......     134,905       154,730       289,635       134,720        44,034       178,754
In Process Research
  and Development....          --            --            --            --       679,684       679,684
Segment Profit.......    (645,412)   (3,793,522)   (4,438,934)   (2,233,252)   (1,648,059)   (3,881,311)
Segment Assets.......     616,563       780,189     1,396,752     1,698,660       607,850     2,306,510
Expenditures for
  Segment Assets.....      34,819       317,808       352,627        80,577       143,382       223,959
                       ----------   -----------   -----------   -----------   -----------   -----------
</TABLE>
 
     The following is a reconciliation of reportable segment loss and assets, to
the Company's consolidated totals.
 
<TABLE>
<CAPTION>
                                                              1997            1996
                                                           -----------    ------------
<S>                                                        <C>            <C>
LOSS:
Total loss for reportable segments.......................  $(4,438,934)   $ (3,881,311)
Compensation Expense (Note 9)............................                  (20,218,450)
Other Corporate Expenses.................................     (280,887)     (1,295,409)
                                                           -----------    ------------
Total Net Loss...........................................  $(4,719,821)   $(25,395,170)
                                                           ===========    ============
ASSETS:
Total assets for reportable segments.....................  $ 1,396,752    $  2,306,510
Corporate assets.........................................    1,768,362       1,834,685
                                                           -----------    ------------
Consolidated Total.......................................  $ 3,165,114    $  4,141,195
                                                           ===========    ============
</TABLE>
 
     The revenues for the year ended December 31, 1998 include revenues from two
major customers each of whom represent 56% and 18%, respectively, of total
revenues. The revenues for the year ended December 31, 1997 include revenues
from two major customers, each of whom represent 58% and 16%, respectively, of
total revenues. The revenues for the year ended December 31, 1996 include
revenues from four major customers, each of whom represent 25%, 24%, 14% and
12%, respectively, of total revenues.
 
(14) DISCONTINUED OPERATION
 
     On September 25, 1998, the Board of Directors determined that it would be
unable to raise the necessary capital required to properly commercialize the MDT
technology. Therefore, the Company ceased funding the operations of MDT and is
actively seeking to sell the assets and technology. All employees of MDT have
been terminated and the Company has vacated the MDT facilities.
 
     Based on this action, the Company is treating MDT as a discontinued
operation. Accordingly, the balance sheet and statement of operations of MDT are
not consolidated in the continuing operations of the
 
                                       34
<PAGE>   36
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Company, but rather are disclosed as Net Liabilities of Discontinued Operation
and Loss From Discontinued Operation, respectively.
 
     The Net Liabilities of Discontinued Operation at December 31, 1998 are
comprised of the following:
 
<TABLE>
<S>                                                           <C>
Current assets..............................................  $  23,052
Property and equipment, net.................................    122,698
Patents.....................................................    637,388
Accounts payable............................................   (277,696)
Accrued expenses............................................   (230,643)
Notes payable...............................................    (25,552)
                                                              ---------
                                                                249,247
Valuation adjustments.......................................   (783,138)
                                                              ---------
Net liabilities of discontinued operations..................  $(533,891)
                                                              =========
</TABLE>
 
     Summary of operating results of the discontinued operation was as follows:
 
<TABLE>
<CAPTION>
                                                       1998           1997
                                                    -----------    -----------
<S>                                                 <C>            <C>
License revenue...................................  $    50,000    $       -0-
Costs and expenses................................   (2,177,396)    (3,799,150)
                                                    -----------    -----------
Loss from discontinued operation before loss on
  disposal........................................   (2,127,396)    (3,799,150)
Loss on disposal..................................   (1,574,203)
                                                    -----------    -----------
Loss from discontinued operation..................  $(3,701,599)   $(3,799,150)
                                                    ===========    ===========
</TABLE>
 
(15) COMMITMENTS AND CONTINGENCIES
 
  Legal
 
     In the Fall of 1994, QSound Labs, Inc. ("QSound") advised MEC that, in its
view, the Spatializer technology infringed certain U.S. patents held by QSound.
In October 1994 the Company and DPI initiated a proceeding against QSound
seeking a determination that the technology did not infringe on Qsound's patents
and other relief.
 
     On August 29, 1996 the Court granted the Company's summary judgment motion
of non-infringement in its entirety and denied the motion by QSound in the
pending patent infringement litigation between the Company and QSound. In
September, 1998, the U.S. Court of Appeals for the Federal Court upheld the U.S.
District Court's ruling of August 1996, finding in favor of DPI and the Company
on all aspects of the appeal.
 
     In granting the Company's summary judgment motion, the Court found that the
Company's IC (Integrated Circuit) does not infringe the QSound patent and denied
QSound's motion with respect to infringement. The Company's claim that the
QSound patent is invalid was not decided and, since the issues which the Court
would need to consider on the patent invalidity claim are similar to certain
issues considered in the infringement claim, QSound was granted the right to
immediately appeal the denial of its motion and trial on the invalidity issue
was deferred until after that appeal. In substance, the Court's finding confirms
the Company's position that there is no infringement by the Company's IC of any
patent held by QSound and that the claims by QSound were without merit. Qsound
has not appealed and the Company is not pursuing its other claims at the present
time.
 
     In December 1998, a complaint was filed in the United States District Court
for the Northern District of New York, by Alexander, Wescott & Co., Inc.,
against the Company alleging breach of contract and seeking fees from the
Company based on its claim that the amounts were due for arranging a financing.
The action
 
                                       35
<PAGE>   37
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
also seeks attorneys' fees, interest and the costs of suit. The Company has
filed a motion to dismiss the action. The motion is pending.
 
     In February 1999, a complaint was filed in the Superior Court of Los
Angeles County, Northwest District, by I.N. Associates, Inc., against the
Company's wholly owned subsidiary, MultiDisc Technologies, Inc. ("MDT"),
alleging breach of contract and fraud, and claiming $499,953.94 in damages,
attorneys fees, interest and the costs of suit. MDT has answered and denied the
claims.
 
     In connection with the downsizing of the Company, a number of employees
have been terminated and have filed various employment and compensation related
claims with the various State labor authorities which claims are pending
resolution and funding if Company resources allow. The Company also anticipates
that, from time to time, it may be named as a party to other legal proceedings
that may arise in the ordinary course of its business.
 
  Operating Lease Commitments
 
     The Company is obligated for future minimum rental payments for all
operating leases of approximately $105,000 during the year ended December 31,
1999. Rent expense amounted to approximately $251,000, $238,000 and $197,000 for
years ended December 31, 1998, 1997 and 1996 respectively.
 
(16) FOURTH QUARTER ADJUSTMENTS
 
     During the quarter ended December 31, 1998, the Company recorded
non-recurring adjustments which reduced net assets and increased the net loss by
approximately $1,323,000. These adjustments relate to reflecting MDT as a
discontinued operation ($855,000), the write-off of deferred transaction costs
($218,000) and restructuring costs ($250,000).
 
(17) MANAGEMENT PLANS
 
     The Company has implemented significant cost reductions in its continuing
operations. Management believes that the proceeds from the sale of MDT, new
contracts in 1999 and continuing royalty revenues may not be adequate to finance
the 1999 cash flow requirements. Additional debt or equity financing will be
required. Management has developed plans which include, but are not limited to,
merging with another company and obtaining additional debt or equity financing.
 
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE -- NONE
 
                                       36
<PAGE>   38
 
                                    PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
     The following table sets forth certain information with respect to both the
directors and executive officers of the Company:
 
<TABLE>
<CAPTION>
               NAME                  AGE                         POSITION
               ----                  ---                         --------
<S>                                  <C>  <C>
NOMINEES FOR TERMS ENDING IN 2001:
James D. Pace......................  43   Director -- 2/95 to date.
                                          Member of Compensation Committee -- 2/95 to date.
Gilbert N. Segel...................  66   Director -- 5/95 to date.
                                          Member of Audit Committee -- 5/95 to date.
                                          Member of Compensation Committee -- 5/95 to date.
 
NOMINEES FOR TERMS ENDING IN 2000:
Jerold H. Rubinstein...............  60   Director -- 8/91 to date.
                                          Member of Audit Committee -- 8/91 to date.
Stephen W. Desper..................  56   Director -- 7/92 to date.
                                          Chairman of the Board -- 7/92 to 12/95.
                                          Vice Chairman of the Board -- 12/95 to date.
                                          Principal Holder.
Steven D. Gershick.................  44   Director -- 7/92 to date.
                                          Chairman of the Board -- 12/95 to date.
                                          President and Chief Executive Officer -- 7/92 to 9/98.
                                          President of Operating Subsidiary Desper Products,
                                          Inc. ("DPI") -- 3/97 to 1/98.
                                          Chief Executive Officer of DPI -- 10/91 to 9/98.
                                          President of Operating Subsidiary MultiDisc
                                          Technologies, Inc. ("MDT") -- 9/97 to 9/98.
                                          Chief Executive Officer of MDT -- 6/96 to 9/98.
 
NOMINEES FOR TERMS ENDING IN 1999:
Carlo Civelli......................  50   Director -- 3/93 to date.
                                          Vice President Finance, Europe -- 8/91 to 3/95.
                                          Principal Holder.
Scot E. Land.......................  44   Director
 
EXECUTIVE OFFICERS:
Michael Bolcerek...................  35   President of Operating Subsidiary Desper Products,
                                          Inc. ("DPI") -- 1/98 to 9/98.
                                          Chief Financial Officer/V.P. Finance -- 6/97 to 3/98.
Henry R. Mandell...................  42   Interim Chief Executive Officer -- 9/98 to date Chief
                                          Financial Officer -- 3/98 to date.
</TABLE>
 
     JAMES D. PACE. Director since February 1995. Director of DPI since July
1992. For more than the last twelve years, Mr. Pace has specialized in the
introduction and distribution of new technologies into the professional
recording and film industries. He is an electronics engineer with broad
experience in recording and live sound reinforcement.
 
     GILBERT N. SEGEL. Director since May 1995. Mr. Segel has spent more than
thirty (30) years as an independent business manager representing musical
artists, film actors and entertainment industry entrepreneurs. Since 1985, he
has concentrated on his personal investments and serves as a director of various
private business and charitable enterprises. Mr. Segel is the brother-in law of
Mr. Rubinstein.
 
     JEROLD H. RUBINSTEIN. Director since August 1991. Chairman and Chief
Executive Officer of XTRA Music. Formerly Chairman and Chief Executive Officer
DMX, Inc. (previously International Cablecasting Technologies, Inc.). Prior to
that, co-owner and chairman of United Artists Records; chairman of ABC Records,
Inc.; co-founder and chairman of Bel-Air Savings and Loan of Los Angeles; and
co-founder and
 
                                       37
<PAGE>   39
 
partner of JRC Oil, a Colorado oil and gas exploration company. Attorney and
certified public accountant, California. Mr. Rubinstein is the brother-in law of
Mr. Segel.
 
     STEPHEN W. DESPER. Vice Chairman of the Board, Inventor. Devoted his full
time for a number of years to developing and refining Spatializer(R) technology.
Recording engineer, over twenty (20) years experience; Director of Engineering
for The Beach Boys Organization. Acoustician, Acoustic Design and Noise Control
Engineer. December, 1991 to December, 1995, Chairman of Spatializer Audio
Laboratories, Inc. Since December, 1995 Vice Chairman of Spatializer Audio
Laboratories, Inc. Inventor and President of Desper Products; Inc. ("DPI")
 -- June 1986 to October, 1991. Vice President and Director of Research, DPI --
October 1991 to December 1996.
 
     STEVEN D. GERSHICK. Chairman of the Board, President and Chief Executive
Officer. Director since July 1992. Resigned all positions except Chairman of the
Board, September 1998. Since December 1995, Chairman of Spatializer Audio
Laboratories, Inc. Certified Public Accountant, KPMG Peat Marwick from May 1977
through June, 1980. From 1981 through September, 1991, the principal of a
Certified Public Accounting firm specializing in business consulting and
entertainment business management. Since October 1, 1991, CEO of DPI. From
October, 1991 to June, 1996, President of DPI. From March 1997 to January 1998,
resumed role as President of DPI. Since June 1996, CEO of MDT. President of MDT
since September 1997. Since December 1991, President and CEO of Spatializer
Audio Laboratories, Inc. Practicing C.P.A. to October 1991.
 
     CARLO CIVELLI. Director since March 1993. VP Finance -- Europe from August
1991 to March 1995. Has extensive experience in financing emerging public
companies. Managing director of Clarion Finanz AG, Zurich, Switzerland, for more
than the last five years. Director and Financial Consultant to Clarion Finanz
AG.
 
     SCOT E. LAND. Director since April 1997, resigned March 1999. Managing
Director of EnCompass Group, Inc. 1997 to date. Senior Technology Analyst with
Microsoft Corporation 1994 to 1997. From 1993 to 1994, Mr. Land was Vice
President of First Marathon Securities, Toronto, Canada with responsibilities in
Research and Investment Banking, specializing in High Technology. During this
same time, Mr. Land was an advisor to Microsoft Corporation on matters related
to strategic planning and competitive product assessment. From 1988 to 1993, Mr.
Land was President and CEO of InVision Technologies, Foster City, California.
Mr. Land is on the Board of Directors of several private technology companies
and non-profit organizations.
 
     MICHAEL BOLCEREK. President of DPI since January, 1998, resigned September
1998 Chief Financial Officer and Vice President of Finance June 1997 to March
1998. Controller of Nokia Display Products, Inc. 1995 to 1996. Treasurer and
Acting Chief Financial Officer for Axil Computer, Inc. 1994 to 1995. Assistant
Treasurer for NeXT Computer, Inc. 1992 to 1993. Manager of U.S. Treasury
Operations for NeXT Computer, Inc. 1991 to 1992. Previously worked for Oracle
Corporation in various management positions from 1987 to 1991.
 
     HENRY R. MANDELL. Interim Chief Executive Officer since September 1998.
Chief Financial Officer and Senior Vice President, Finance since March 1998.
Executive Vice President and Chief Financial Officer of The Sirena Apparel
Group, Inc. from November 1990 to January, 1998. Senior Vice President of
Finance and Administration for Media Home Entertainment, Inc. from April 1985 to
November 1990. Director of Finance and Accounting for Oak Media Corporation from
June 1982 to April 1985. Senior Corporate Auditor for Twentieth Century Fox Film
Corporation from June 1981 to June 1982. Senior Auditor for Arthur Young and
Company from August 1978 to June 1981, where he qualified as a Certified Public
Accountant.
 
                                       38
<PAGE>   40
 
ITEM 11. EXECUTIVE COMPENSATION
 
     The following table sets forth separately, for the last three complete
fiscal years, each component of compensation paid or awarded to, or earned by,
the Chief Executive Officer ("CEO") of the Company and each of the other most
highly compensated executive officers who were serving as executive officers at
the end of the last fiscal year (collectively, the "Named Executive Officers").
 
                           SUMMARY COMPENSATION TABLE
 
<TABLE>
<CAPTION>
                                                                               LONG TERM COMPENSATION
                                                                         -----------------------------------
                                                                                  AWARDS             PAYOUTS
                                                                         ------------------------    -------
                                                                         SECURITIES
                                                                           UNDER
                                                                          OPTIONS/     RESTRICTED
                                            ANNUAL COMPENSATION             SARS         STOCK
                                      -------------------------------     GRANTED        AWARDS       LTIP
NAME AND PRINCIPAL POSITION  YEAR      SALARY      BONUS       OTHER        (#)           ($)        PAYOUTS
---------------------------  -----    --------    --------    -------    ----------    ----------    -------
<S>                          <C>      <C>         <C>         <C>        <C>           <C>           <C>
Henry R. Mandell(1)........  12/98    $105,833    $     --    $ 6,750     500,000         N/A         N/A
Interim Chief Executive
Officer
Steven D. Gershick(1)......  12/98    $211,635    $ 12,000    $ 6,923         N/A         N/A         N/A
Chairman of the Board,       12/97    $175,000    $ 44,250    $ 9,000      50,000         N/A         N/A
President and CEO            12/96    $150,000    $ 37,500    $ 8,607      50,000      See note 6     N/A
Eric Rene Bos(2)...........  12/98    $120,000    $ 75,000        N/A         N/A         N/A         N/A
Vice President, Product      12/97    $120,000    $136,500    N/A10,000       N/A(5)      N/A         N/A
Development for MDT          12/96    $ 60,000    $ 26,500    $            25,000         N/A         N/A
Robert L. Montelius(2).....  12/98    $120,000    $ 75,000        N/A         N/A         N/A         N/A
Vice President, Engineering  12/97    $120,000    $136,500        N/A         N/A(5)      N/A         N/A
for MDT                      12/96    $ 60,000    $ 26,500    $10,000      25,000         N/A         N/A
Theodore C. Tanner(3)......  12/98    $122,427    $     --    $ 4,800      50,000         N/A         N/A
Vice President,              12/97    $ 98,770    $ 13,000    $ 6,000      15,000(4)      N/A         N/A
Engineering for DPI          12/96    $ 64,675    $ 15,500        N/A      45,000(4)   See note 6     N/A
Peter S. Birch.............  12/98    $129,654    $     --    $ 5,400      30,000         N/A         N/A
Sr. Vice President, Sales
and Marketing for DPI
</TABLE>
 
---------------
(1) Mr. Mandell became an employee of the Company in March, 1998. He became
    Interim Chief Executive Officer of the Company on September 25, 1998,
    concurrent with the effective date of Mr. Gershick's resignation as
    President and Chief Executive Officer.
 
(2) Mssrs. Bos and Montelius became employees upon the Company's acquisition of
    MultiDisc Technologies, Inc. in June, 1996.
 
(3) Mr. Tanner became an employee of DPI in March, 1996.
 
(4) The exercise price for these options was adjusted to the closing market
    price on July 18, 1997.
 
(5) The exercise price for these options was adjusted to the closing market
    price on December 12, 1997.
 
(6) On September 2, 1996, Steven D. Gershick and Theodore Tanner received
    performance shares which were transferred from prior holders based on a
    previous understanding that those shares were held for their benefit. Based
    on the market closing price of $4.25 on September 2, 1996, the value of the
    shares they received was $636,405 for Mr. Gershick and $63,640 for Mr.
    Tanner. On June 22, 1997, 5% of the 5,776,700 originally issued performance
    shares were released from escrow in accordance with the escrow arrangement.
    On June 22, 1998 another 5% of the 5,776,700 originally issued performance
    shares were released from escrow in accordance with the escrow arrangement.
    As a result, as of December 31, 1998, 5,104,530 of the originally issued
    performance shares remained outstanding which, based on the $0.125 year end
    closing price of the stock, were valued at $638,066. Unless released earlier
    based on cumulative positive cash flow of $.6285 Cdn. per share, the
    remainder of these shares will vest based on the following schedule: 10%
    June, 1999; 20% June, 2000; 30% June 2001; and, 30% June, 2002.
 
                                       39
<PAGE>   41
 
           OPTION/STOCK APPRECIATION RIGHT ("SAR") GRANTS DURING THE
                     MOST RECENTLY COMPLETED FINANCIAL YEAR
 
     The following table presented in accordance with the Securities Exchange
Act of 1934, as amended ("the Exchange Act") and the Regulations thereunder sets
forth stock options granted under the Company's Stock Option Plan ("the Stock
Option Plan") during the most recently completed financial year to each of the
Named Executive Officers:
 
<TABLE>
<CAPTION>
                                                                                                                  ALTERNATIVE
                                                                                                                      TO
                                                                                                                  REALIZABLE
                                                INDIVIDUAL GRANTS                                                    VALUE:
                      ---------------------------------------------------------------------                          GRANT  
                                     % OF                          MARKET                         POTENTIAL          VALUE
                                     TOTAL                        VALUE OF                       REALIZABLE           TO     
                                   OPTIONS/                      SECURITIES                   VALUE AT ASSUMED    REALIZABLE
                                     SARS                        UNDERLYING                     ANNUAL RATES         DATE
                      SECURITIES    GRANTED                       OPTIONS/                     OF STOCK PRICE     -----------
                        UNDER         TO                          SARS ON                     APPRECIATION FOR       GRANT
                       OPTIONS/    EMPLOYEES   EXERCISE OR        DATE OF                        OPTION TERM         DATE
                         SARS      IN FISCAL    BASE PRICE         GRANT         EXPIRATION   -----------------     PRESENT
                       GRANTED       YEAR      ($/SECURITY)     ($/SECURITY)        DATE       5%($)    10%($)      VALUE $
                      ----------   ---------   ------------     ------------     ----------   -------   -------   -----------
<S>                   <C>          <C>         <C>              <C>              <C>          <C>       <C>       <C>
Henry R. Mandell.....  100,000       15.5%     $ 0.125/shr(1)   $ 0.125/shr(1)    3/23/03     $   625   $ 1,250       $ 0
                       150,000       23.2%     $  0.50/shr      $ 0.125/shr      11/12/03     $ 3,750   $ 7,500       $ 0
                       250,000       38.7%     $  1.00/shr      $ 0.125/shr      11/12/03     $12,500   $25,000       $ 0
Steven D. Gershick...      N/A        N/A              N/A              N/A         N/A           N/A       N/A       N/A
Eric Rene Bos........      N/A        N/A              N/A              N/A         N/A           N/A       N/A       N/A
Robert L.
  Montelius..........      N/A        N/A              N/A              N/A         N/A           N/A       N/A       N/A
Theodore C. Tanner...   50,000        7.7%     $  2.13/shr      $  2.13/shr       2/02/03     $ 5,325   $10,650       $ 0
Peter S. Birch.......   20,000        3.1%     $0.1875/shr(2)   $0.1875/shr(2)    1/16/03     $   188   $   375       $ 0
                        10,000        1.5%     $0.1875/shr      $0.1875/shr      10/30/03     $    94   $   188       $ 0
</TABLE>
 
---------------
(1) Repriced from $1.18 per share effective November 12, 1998.
 
(2) Repriced from $1.62 per share effective October 30, 1998.
 
            AGGREGATED OPTIONS/SAR EXERCISES IN LAST FINANCIAL YEAR
                    AND FINANCIAL YEAR-END OPTION/SAR VALUES
 
     The following table (presented in accordance with the Exchange Act and the
Regulations) sets forth details of all exercises of stock options/SARs during
the most recently completed financial year by each of the Named Executive
Officers and the financial year-end value of unexercised options/SARs on an
aggregated basis:
 
<TABLE>
<CAPTION>
                                                                                   VALUE OF UNEXERCISED
                               SECURITIES     AGGREGATE       UNEXERCISED        IN-THE-MONEY OPTIONS/SARS
                                ACQUIRED        VALUE         OPTIONS/SARS         AT FISCAL YEAR-END($)
            NAME               ON EXERCISE    REALIZED     AT FISCAL YEAR-END    EXERCISABLE/UNEXERCISABLE
            ----               -----------    ---------    ------------------    -------------------------
<S>                            <C>            <C>          <C>                   <C>
Henry R. Mandell.............      N/A         N/A              500,000                    $0/$0
Steven D. Gershick...........      N/A         N/A              333,000                    $0/$0
Eric Rene Bos................      N/A         N/A               25,000                    $0/$0
Robert L. Montelius..........      N/A         N/A               25,000                    $0/$0
Theodore C. Tanner...........      N/A         N/A              110,000                    $0/$0
Peter S. Birch...............      N/A         N/A               30,000                    $0/$0
</TABLE>
 
                                       40
<PAGE>   42
 
                         TEN-YEAR OPTION/SAR REPRICINGS
 
     The following table (presented in accordance with the Exchange Act and the
Regulations) sets forth details of all repricings of stock options/SARs during
the most recently completed financial year by each of the Named Executive
Officers:
 
<TABLE>
<CAPTION>
                                          NUMBER OF        MARKET                                  LENGTH OF
                                          SECURITIES      PRICE OF       EXERCISE                ORIGINAL TERM
                                          UNDERLYING      STOCK AT       PRICE AT                REMAINING AT
                                         OPTIONS/SARS     TIME OF        TIME OF        NEW         DATE OF
                                         REPRICED OR    REPRICING OR   REPRICING OR   EXERCISE   REPRICING OR
            NAME                DATE       AMENDED       AMENDMENT      AMENDMENT      PRICE       AMENDMENT
            ----              --------   ------------   ------------   ------------   --------   -------------
<S>                           <C>        <C>            <C>            <C>            <C>        <C>
Henry R. Mandell............  11/12/98     100,000        $ 0.125         $1.18       $ 0.125    4 yrs 4 mths
Steven D. Gershick..........       N/A         N/A            N/A           N/A           N/A        N/A
Eric Rene Bos...............       N/A         N/A            N/A           N/A           N/A        N/A
Robert L. Montelius.........       N/A         N/A            N/A           N/A           N/A        N/A
Theodore C. Tanner..........       N/A         N/A            N/A           N/A           N/A        N/A
Peter S. Birch..............  10/30/98      20,000        $0.1875         $1.62       $0.1875    4 yrs 2 mths
</TABLE>
 
     The above referenced stock option repricings were effected to bring the
exercise prices down to reflect the current market price in order to properly
incentivize the option holders. The modifications to the exercise prices
effected on October 30, 1998 were generally applied to all Spatializer and DPI
employees whose option exercise prices were above the then current market price.
The modifications to the exercise prices effected on November 12, 1998 were
generally applied to the interim chief executive officer whose option exercise
prices were above the then current market price.
 
EMPLOYMENT AGREEMENTS
 
     Effective October 1991, DPI entered into a two-year employment agreement
(which continues thereafter from year to year unless terminated) with Steven
Gershick pursuant to which Mr. Gershick was designated as President and Chief
Executive Officer, at an annual salary of $125,000. Under his agreement, he
serves full time and may terminate his employment on 90-days written notice. The
Company may terminate the agreement for cause or at the end of the original or
any extended term on 90 days prior written notice. In the event of termination,
he is entitled to payment of six months to one year's salary, depending on the
term remaining on the date of any termination. The employment agreement provides
Mr. Gershick with the employee benefits generally available to other employees
of the Company and, in addition, entitles him to life insurance, disability
insurance and automobile allowance. He is entitled to bonuses at the discretion
of the Board of Directors. His agreement contains confidentiality, nondisclosure
and invention provisions typical in the industry.
 
     As of January 1, 1995, the annual salary for Steven D. Gershick was
increased to $150,000. As of January 1, 1997, the annual salary for Mr. Gershick
was again increased to $175,000. As of January 1, 1998 the annual salary for Mr.
Gershick was decreased to $65,000, with an additional annual salary of $175,000
to be paid to Mr. Gershick directly from MultiDisc Technologies, Inc. Mr.
Gershick resigned as President and Chief Executive Officer in September 1998.
 
     Effective June 1996, MDT entered into employment agreements through
December 1997 (which were automatically extended for one additional year unless
written notice was given by either party by June 1) with Eric Rene Bos and
Robert Montelius pursuant to which Mr. Bos was designated as Vice President of
Product Development and Mr. Montelius was designated as Vice President of
Engineering, at annual salaries of $120,000 each. Under their agreements, they
serve full time and may terminate their employment on 90-days written notice.
The Company may terminate their agreements for cause or at the end of the
original or any extended term with or without written notice. In the event of
termination, they are each entitled to one years base salary, payable in equal
quarterly installments, in addition to lump-sum payments equal to their base
salary through the termination date of their agreement. The employment agreement
provides Mssrs. Bos and Montelius with the employee benefits generally available
to other employees of the Company and, in addition, entitles them to life
insurance, disability insurance and automobile allowance. In addition to being
entitled to
 
                                       41
<PAGE>   43
 
bonuses at the discretion of the Board of Directors, they are each entitled to a
$5,000 bonus for each new patent application which MDT or the Company chooses to
prosecute in which they are an inventor. Their agreements contain
confidentiality, nondisclosure and invention provisions typical in the industry.
 
     In May 1997, the Company notified Mssrs. Bos and Montelius that it did not
intend to renew their agreements beyond December 1997. In September 1997, the
Company notified both parties that it would extend their agreements through June
1998.
 
     Effective October 1996, DPI entered into an employment agreement through
December 1997 (which, by its terms, has been extended through December 1998 with
Theodore Tanner pursuant to which he was designated as Vice President of
Engineering, at an annual salary of $85,000. Under his agreement, he serves full
time and may terminate his employment on 45-days written notice. The Company may
terminate the agreement for cause or at the end of the original or any extended
term with or without written notice. In the event of termination, he is entitled
to a lump-sum payment equal to his base salary through the termination date of
his agreement. The employment agreement provides Mr. Tanner with the employee
benefits generally available to other employees of the Company and, in addition,
entitles him to life insurance, disability insurance and automobile allowance.
In addition to being entitled to bonuses at the discretion of the Board of
Directors, he is entitled to a $5,000 bonus for each new patent application
which DPI or the Company chooses to prosecute in which he is an inventor. His
agreement contains confidentiality, nondisclosure and invention provisions
typical in the industry.
 
     As of May 16, 1997, the annual salary for Mr. Tanner was increased to
$100,000. As of July 1, 1997, the annual salary for Mr. Tanner was again
increased to $110,000. As of July 31, 1998, Mr. Tanner's annual salary was
increased to $130,000.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     The following table sets forth information (except as otherwise indicated
by footnote) as to shares of Common Stock owned as of March 31, 1999 by, or
which can be acquired in sixty days, (i) each person known by management to
beneficially own more than five percent (5%) of the Company's outstanding Common
Stock, (ii) each of the Company's directors and nominees for election as
directors, and (iii) all executive officers, directors and nominees for election
as directors as a group:
 
<TABLE>
<CAPTION>
                                                               AMOUNT AND NATURE
         NAME AND ADDRESS OF BENEFICIAL OWNER(1)            OF BENEFICIAL OWNERSHIP    PERCENT OF CLASS
         ---------------------------------------            -----------------------    ----------------
<S>                                                         <C>                        <C>
DIRECTORS
Carlo Civelli(2)(5).......................................         4,070,958                 13.8%
Stephen W. Desper(3)(5)...................................         1,976,128                  6.7%
Steven D. Gershick(5).....................................         1,176,144                  4.0%
James D. Pace(4)(5).......................................           326,997                  1.1%
Jerold H. Rubinstein(5)...................................           250,000                    *
Gilbert N. Segel(5).......................................           220,000                    *
Scot E. Land..............................................            63,947                    *
 
NAMED EXECUTIVE OFFICERS
Henry R. Mandell..........................................            33,333                    *
Eric Rene Bos.............................................            16,667                    *
Robert Montelius..........................................            16,667                    *
Theodore Tanner(5)........................................            71,667                    *
Peter S. Birch............................................             6,667
All directors and executive officers as a group (12                8,229,174                 27.9%
  persons)(5)(6)..........................................
</TABLE>
 
---------------
 *  Indicates that the percentage of shares beneficially owned does not exceed
    one percent (1%) of the class.
 
(1) Each of the persons named can be reached at the Company's offices at 20700
    Ventura Boulevard, Suite 140, Woodland Hills, California, 91364, except for
    Carlo Civelli, whose address is Seefeld-
 
                                       42
<PAGE>   44
 
    strasse 214, 8034 Zurich, Switzerland. The persons named in the table have
    sole voting and investment power with respect to all shares shown to be
    beneficially owned by them, subject to community property laws where
    applicable and the information contained in the footnotes to this table.
 
(2) Carlo Civelli controls Clarion Finanz AG, a non-reporting investment
    company. Holdings of Mr. Civelli and Clarion Finanz AG are combined, and
    include all shares of the Company held of record or beneficially by either,
    and all additional shares over which he either currently exercises full or
    partial control, without duplication through attribution.
 
(3) Does not include 37,853 shares held by Sparkle Co. on behalf of the Estate
    of Stephen Desper's deceased father, Ira Desper, as to which Mr. Desper
    disclaims any direct or indirect beneficial interest or control.
 
(4) Does not include 134,497 shares held by Jeffrey C. Evans, a director of DPI,
    and co-owner with Mr. Pace of Audio Intervisual Design and Developing
    Technologies Distributors. Mr. Pace disclaims any direct or indirect
    beneficial interest or control of Mr. Evans' shares.
 
(5) Includes an aggregate of 4,109,127 escrowed performance shares held as of
    March 31, 1999 as follows: Carlo Civelli, 1,251,792 shares; Jerold H.
    Rubinstein, 135,000 shares; Stephen W. Desper, 1,736,708 shares; Steven D.
    Gershick, 758,830 shares; James D. Pace, 114,297 shares; Gilbert N. Segel,
    99,000 shares; Theodore Tanner, 13,500 shares.
 
(6) Includes options to purchase 1,116,800 shares exercisable at various prices
    from $0.125 to $3.26 per share, and expiring on various dates from February,
    2000 to March, 2003.
 
(7) Included in the denominator of this percent of class calculation are 732,000
    warrants and 1,344,633 options which are exercisable as of March 31, 1999,
    or within 60 days subsequent to March 31, 1999, but are not in-the-money as
    of March 31, 1999.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
TRANSACTIONS WITH MANAGEMENT AND OTHERS
 
     Except for severance paid to Mr. Desper for a six month period following
his resignation from Director of Research in December, 1996 no insider and no
security holder who is known to the Company to own more than five percent (5%)
of the Common Stock and no member of the immediate family of any of the officers
or directors has or has had any material interest, direct or indirect, in any
transaction in which the amount involved exceeds U.S. $60,000 since the
commencement of the Company's last completed financial year or in any proposed
transaction which in either such case has materially affected or will materially
affect the Company.
 
     At the 1996 Annual Meeting the stockholders approved, subject to regulatory
consent, a proposal to modify the terms of the performance share escrow
arrangements for certain founders, officers and directors. On December 30, 1996,
the Company received final consent from the British Columbia Securities
Commission ("BCSC") to a modification arrangement which was less favorable to
the holders of performance shares than the proposal approved by the
stockholders. The Company has implemented the modification as consented to by
the BCSC.
 
     Under the revised arrangement, 5% of the performance shares were released
June 22, 1997 and the remainder are scheduled to be released automatically as
follows: 10% on June 22, 1999; 20% on June 22, 2000; 30% on June 22, 2001; and
30% on June 22, 2002. In addition to the automatic releases, performance shares
can be released based on the cash flow release criteria contained in the
original June 22, 1992 escrow agreement although, to maintain a stable market in
the Company's stock, in any year not more than 30% of the shares will be
released, based on the cash flow criteria.
 
     In addition, under the revised arrangement the performance shares will vest
if the individual holder has not voluntarily terminated his or her service to
the Company prior to the applicable vesting dates. Any individual who is
involuntarily terminated by the Company will be entitled to an automatic
acceleration of the unvested performance shares. The Board, in its discretion,
may allow an individual who has voluntarily terminated his or her services to
the Company to retain a portion or all of any unvested performance shares.
 
                                       43
<PAGE>   45
 
     The Company's only indebtedness to related parties is a loan payable to the
estate of Stephen Desper's deceased father, Ira A. Desper. The amount payable to
the estate at December 31, 1997 was U.S. $112,500.
 
     At December 31, 1998, the Company was indebted to four of its directors and
one of its executives for an amount totaling $745,000. This amount bears
interest at a fixed rate of 10% annually. Of this amount, $650,000 was due on
December 31, 1998, and is currently in default. The remaining $95,000 is due on
November 30, 1999, or upon the sale of the MDT assets. The Company granted
95,000 warrants to purchase common stock at $0.20 per share in connection with
the $95,000 of indebtedness.
 
     None of the directors or officers of the Company have been involved in any
securities transactions in the last fiscal year (excluding grants and exercises
of Employee and Director Incentive Options as described below).
 
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
 
     The Company is not aware of any officer, director, or beneficial owner of
more than 10% of its common stock that has failed to file on a timely basis, as
disclosed in such forms, the reports required by Section 16(a) of the Securities
Exchange Act during the most recent fiscal year. The Company became a reporting
person under the Securities Exchange Act in August of 1995.
 
                                       44
<PAGE>   46
 
                                    PART IV
 
ITEM 14. EXHIBITS
 
<TABLE>
<CAPTION>
EXHIBIT NO.                           DESCRIPTION
-----------                           -----------
<C>           <S>
   2.1*       Desper-Spatializer Reorganization Agreement dated January
              29, 1992. (Incorporated by reference to the Company's
              Registration Statement on Form S-1, Registration No.
              33-90532, effective August 21, 1995.)
   2.2*       Arrangement Agreement dated as of March 4, 1994 among
              Spatializer-Yukon, DPI and Spatializer-Delaware.
              (Incorporated by reference to the Company's Registration
              Statement on Form S-1, Registration No. 33-90532, effective
              August 21, 1995.)
   3.1*       Certificate of Incorporation of Spatializer-Delaware as
              filed February 28, 1994. (Incorporated by reference to the
              Company's Registration Statement on Form S-1, Registration
              No. 33-90532, effective August 21, 1995.)
   3.2*       Amended and Restated Bylaws of Spatializer-Delaware.
              (Incorporated by reference to the Company's Registration
              Statement on Form S-1, Registration No. 33-90532, effective
              August 21, 1995.)
   4.1*       Form of Subscription Agreement for August 1994 Private
              Placement. (Incorporated by reference to the Company's
              Registration Statement on Form S-1, Registration No.
              33-90532, effective August 21, 1995.)
   4.2*       Form of Subscription Agreement for November 1994 Private
              Placement. (Incorporated by reference to the Company's
              Registration Statement on Form S-1, Registration No.
              33-90532, effective August 21, 1995.)
   4.3*       Form of Spatializer-Yukon Incentive Stock Option Agreement.
              (Incorporated by reference to the Company's Registration
              Statement on Form S-1, Registration No. 33-90532, effective
              August 21, 1995.)
   4.4*       Spatializer-Delaware Incentive Stock Option Plan (1995
              Plan). (Incorporated by reference to the Company's
              Registration Statement on Form S-1, Registration No.
              33-90532, effective August 21, 1995.)
   4.5*       Performance Share Escrow Agreements dated June 22, 1992
              among Montreal Trust Company of Canada, Spatializer-Yukon
              and certain shareholders with respect to escrow of 2,181,048
              common shares of Spatializer-Yukon. (Incorporated by
              reference to the Company's Registration Statement on Form
              S-1, Registration No. 33-90532, effective August 21, 1995.)
   4.6*       Spatializer-Delaware 1996 Incentive Plan (Incorporated by
              reference to the Company's Proxy Statement dated June 25,
              1996 and previously filed with the Commission.)
   4.7*       Form of Subscription Agreement for 1995 Private Placements.
              (Incorporated by reference to the Company's Registration
              Statement on Form S-1, Registration No. 33-90532, effective
              August 21, 1995.)
   4.8*       Form of Subscription Agreement and Warrant Agreement for
              March 7, 1997 Private Placement. (Incorporated by reference
              to the Company's Annual Report on Form 10-K for the year
              ended December 31, 1997.)
   4.9*       Modification Agreement for Escrowed Performance Shares.
              (Incorporated by reference to the Company's Definitive Proxy
              Statement dated June 28, 1996 and previously filed with the
              Commission.)
   4.10*      Subscription Agreement for April 1998 Private Placement.
              (Incorporated by reference to the Company's Registration
              Statement on Form S-3, Registrations No. 333-52863, filed
              May 15, 1998.)
</TABLE>
 
                                       45
<PAGE>   47
 
<TABLE>
<CAPTION>
EXHIBIT NO.                           DESCRIPTION
-----------                           -----------
<C>           <S>
  10.1***     License Agreement dated June 29, 1994 between DPI and MEC.
              (Incorporated by reference to the Company's Registration
              Statement on Form S-1, Registration No. 33-90532, effective
              August 21, 1995.)
  10.2***     License Agreement dated November 11, 1994 between DPI and
              ESS. (Incorporated by reference to the Company's
              Registration Statement on Form S-1, Registration No.
              33-90532, effective August 21, 1995.)
  10.3*       License Agreement dated June 10, 1994 between Joel Cohen and
              DPI. (Incorporated by reference to the Company's
              Registration Statement on Form S-1, Registration No.
              33-90532, effective August 21, 1995.)
  11.1        Statement re: computation of per share earnings.
  21.1        Schedule of Subsidiaries of the Company.
</TABLE>
 
---------------
*   Previously filed.
 
**  To be filed by amendment.
 
*** Portions subject to request for confidential treatment. The confidential
    portions omitted have been filed separately with the Commission.
 
    [All schedules have been omitted because they are not applicable, not
    required, or the information is included elsewhere in the statements or
    notes thereto. The Registrant filed no reports on Form 8-K for the fiscal
    quarter ended December 31, 1998.]
 
                                       46
<PAGE>   48
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
 
Dated: April 14, 1999
 
                                          SPATIALIZER AUDIO LABORATORIES, INC.
                                          (Registrant)
 
                                          /s/ HENRY R. MANDELL
                                          --------------------------------------
                                          Henry R. Mandell
                                          Interim Chief Executive Officer &
                                          Chief Financial Officer
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated
 
<TABLE>
<CAPTION>
                    NAME                                       TITLE                         DATE
                    ----                                       -----                         ----
<S>                                            <C>                                      <C>
           /s/ STEVEN D. GERSHICK                      Chairman of the Board            April 14, 1999
---------------------------------------------
             Steven D. Gershick
 
              /s/ CARLO CIVELLI                              Director                   April 14, 1999
---------------------------------------------
                Carlo Civelli
 
            /s/ STEPHEN W. DESPER                            Director                   April 14, 1999
---------------------------------------------
              Stephen W. Desper
 
              /s/ JAMES D. PACE                              Director                   April 14, 1999
---------------------------------------------
                James D. Pace
 
          /s/ JEROLD H. RUBINSTEIN                           Director                   April 14, 1999
---------------------------------------------
            Jerold H. Rubinstein
 
            /s/ GILBERT N. SEGEL                             Director                   April 14, 1999
---------------------------------------------
              Gilbert N. Segel
</TABLE>
 
                                       47