<PAGE>   1

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                                 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, 1999

                                       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 March 24, 2000 was approximately $83,669,000.

     As of March 24, 2000, there were 46,174,970 shares of the Registrant's
Common Stock outstanding.

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<PAGE>   2

                                     PART I

ITEM 1. BUSINESS

Overview

     Spatializer Audio Laboratories, Inc. ("The Company" or "we") is a leading
developer, licensor and marketer of next generation technologies for the
consumer electronics, personal computing, enterprise computing and entertainment
industries. Our position as a leading developer of next generation technologies
is based on our strong relationships with brand leaders, such as Apple, Toshiba
and Hitachi. We conduct our audio business through our parent company and our
wholly owned subsidiary, Desper Products, Inc. ("DPI"). 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. We
continue to expand our 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, 1999, more than 17 million licensed units had been shipped
covering all of these applications. DPI's 3-D audio signal processing
technologies have been incorporated in over 380 products offered by global brand
leaders including in consumer electronics, Toshiba, Panasonic, JVC, Hitachi,
Mitsubishi, Samsung, Sanyo, Goldstar, Emerson, Zenith and Proton, in the PC
multimedia marketplace, Apple, Compaq, Dell, Gateway, Hewlett Packard, Sony,
Micron, Fujitsu, NEC, Seiko-Epson and Labtec, among others, and on the Internet
through software plug-ins for the WinAmp and Xing MP3 players. We are focused on
broadening recognition for the Spatializer brand name through association with
these and other globally recognized consumer electronics and multimedia computer
brand leaders, and on broadening our audio technology and software base to
position ourselves for continued growth. We believe that with the accelerating
growth in the digital audio/video marketplace, the market for virtual audio
technologies, and therefore for our products, is entering a new phase of
opportunity.

     Our other wholly owned subsidiary, MultiDisc Technologies, Inc., ("MDT")
formed in June 1996 when we acquired development stage optical disc storage and
robotics assets and technologies from Home Theater Products, International,
Inc., a debtor in possession, is now inactive. In September 1998, we announced
our plan to refocus our business on the exploitation of our 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. Since 1998 we have been unsuccessful in identifying a
purchaser for this technology. This repositioning strategy recognized that the
capital investment required to properly commercialize the MDT technology was
beyond our current capacity. We believe this strategy provides a better
opportunity to further solidify our position as a leading provider of virtual
audio solutions, based on available capital resources.

     In December 1999, we completed the placement of $1 million of Common Stock,
at no discount from market, the conversion of $1 million of short-term debt to
new Series B Redeemable Convertible Preferred Stock and the restatement of
$225,000 of existing secured debt to secured long-term debt (the "December
Transactions"). The December Transactions significantly strengthen our balance
sheet and restore working capital and shareholder's equity. The resulting
liquidity will allow us to emerge from turnaround mode and to pursue growth.

     Our executive offices are located at 20700 Ventura Boulevard, Suite 140,
Woodland Hills, California 91364, Telephone (818) 227-3370. We maintain a
Website at www.spatializer.com. We were incorporated in the State of Delaware in
February, 1994.

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<PAGE>   3

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 five broad categories of technology as identified in the listing
below. Each of these technologies utilizes different underlying scientific
principles in accomplishing its design objectives and is targeted to a specific
class of consumer electronics or multimedia computer depending on the intended
product use and functional capability of the product. DPI currently has other
audio signal processing technologies under development which will serve to
expand its market scope and partner product capabilities.

<TABLE>
<CAPTION>
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      CATEGORY OF TECHNOLOGY                PRODUCT CATEGORIES                3-D AUDIO ENHANCEMENT
----------------------------------------------------------------------------------------------------------
<S>                                 <C>                                 <C>
 3-D Stereo                         Consumer electronics products       Surround Sound enhancement from an
 (Spatializer(R) 3-D Stereo)        providing stereo playback -- DVD    ordinary stereo signal
                                    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 Multimedia   Simulation of immersive,
 (Spatializer enCompass(TM) V2.0)   Computers under Windows '95/'98,    interactive sonic environments
                                    Virtual Reality Applications.       including sound objects that move
                                                                        in real time with related graphics
                                                                        objects or changes in game player
                                                                        position or perspective.
----------------------------------------------------------------------------------------------------------
 Two-Speaker Virtualization         Products incorporating              Creation of spatially accurate
 (Spatializer N-2-2(TM)) Digital    multi-channel audio sources like    multi- speaker cinematic audio
 Virtual Surround                   Dolby Digital(R) (AC-3), Dolby      experience from two speakers, and
                                    ProLogic(R) or MPEG-2. Home         headphones utilizing discrete
                                    Theater, DVD-Video, Multimedia      multi-channel audio information.
                                    Computers utilizing DVD/MPEG and
                                    decoding.
----------------------------------------------------------------------------------------------------------
 Bass Enhancement                   Consumer electronics products       Simulation of lower frequency
 (Vi.B.E.(TM))                      providing stereo playback -- DVD    response from speakers with
                                    Players, Stereo TV's, VCR's,        relatively high low frequency
                                    Stereo Components and Systems, Car  capability
                                    Audio, Laptop and Desktop
                                    Multimedia Computers and Speakers
----------------------------------------------------------------------------------------------------------
 Internet Audio Enhancement         Laptop and Desktop Multimedia       Surround Sound and bass
 (Spatializer(R) StreamFX(TM))      Computers and portable music        enhancement to playback of
                                    devices running MP3 media player    ordinary MP3 files
                                    software
----------------------------------------------------------------------------------------------------------
</TABLE>

LICENSED PRODUCTS

     Our 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

                                        3
<PAGE>   4

        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. The technology is currently
        available in both analog and digital formats. Matsushita introduced a
        new Spatializer IC design in 1999, offering the Spatializer 3-D Stereo
        effect in a simplified, lower cost package.

     2. SPATIALIZER(R)ENCOMPASS(TM) V2.0. In March 1998, we introduced
        Spatializer(R) enCOMPASS(TM) V2.0, a real-time software-only positional
        3-D audio engine based upon our 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
        enCOMPASS 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., which
        released the technology in its products in October 1999.

     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 C-Cube, Acer Labs, Inc., Motorola, 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) microprocessors); and can be
        ported to any of the principal audio codecs or media
        processor/accelerator platforms performing Dolby Digital (AC-3) or
        MPEG-2 audio decoding. 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. We
        believe our 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. In the third quarter
        1999, we licensed Spatializer N-2-2 to Acer Labs, Inc.

     4. SPATIALIZER(R)VI.B.E. In early 1999, DPI introduced Spatializer Vi.B.E.,
        a virtual bass enhancement technology. Spatializer Vi.B.E. produces a
        dynamic bass response from even the lowest-end speakers or headphones.
        Spatializer Vi.B.E. uses proprietary technology to generate realistic
        bass frequencies that are unaffected by speaker system frequency
        response.

     5. SPATIALIZER(R)STREAMFX. Spatializer StreamFX creates a dramatic and
        enveloping sound experience out of any pair of regular speakers or
        headphones when playing MP3 music files. Spatializer StreamFX utilizes
        Spatializer 3-D Stereo and is a long-time favorite of both movie and
        sound studios
                                        4
<PAGE>   5

        in addition to numerous audio product manufacturers. Combined with
        Vi.B.E., this product widens and deepens the soundfield to surround the
        listener with rich and ambient enhanced audio. A headphone option
        generates the same equally immersive experience over headphones creating
        a dramatic audio experience.

       LICENSING ACTIVITIES

     We have traditionally licensed our 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 us 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 us. OEM licenses generally
provide for the payment of a further per unit royalty by the OEM for OEM
products incorporating a Spatializer IC ("Licensed Products") payable in the
quarter following shipment by the OEM of its Licensed Products.

     In mid-1996, we modified our 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 (C-Cube,
Motorola, Zoran, and Acer Labs) environments, no IC Foundry may be involved, as
is the licensing arrangement with Apple Computer, Inc. In these situations, we
will enter into royalty bearing licenses directly with the OEM. However, we may
still pursue bundled agreements with DSP providers, if appropriate.

     We are currently negotiating new IC/DSP Foundry and OEM licenses for its
N-2-2, enCOMPASS V2.0, and 3-D stereo technologies.

IC Foundry Licenses

     In October 1999, Acer Labs, Inc. entered into a Foundry License for
Spatializer N-2-2.

     As of December 31, 1999, we have 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") Acer Labs, Inc. ("Ali") and
Luxsonor. Foundry Licenses generally require the payment of per unit running
royalties based upon a sliding scale computed on the number of Spatializer ICs
or DSPs sold.

     MEC currently manufactures and sells four 3-D Stereo IC's incorporating
Spatializer audio signal processing and has several more ICs in design. ESS
currently manufactures and sells two Spatializer(R) ICs, which are primarily
used for multimedia and notebook applications. OnChip currently manufactures
three versions of the 3-D Stereo Spatializer(R) IC. C-Cube currently
incorporates N-2-2 on their Ziva-3 DSP and Ali incorporates N-2-2 into their
M3321 DSP.

                                        5
<PAGE>   6

     As of December 31, 1999, more than 17 million ICs and DSPs incorporating
Spatializer 3-D audio signal processing and N-2-2 digital virtual surround sound
technology had been manufactured and sold.

OEM Licensees and Customers

     As of December 31, 1999, our technology has been incorporated in products
offered by over 90 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.

     The following table is a partial list of the OEM Licensees and authorized
customers as of December 31, 1999:

<TABLE>
<CAPTION>
---------------------------------------------  ---------------------------------------------
PARTIAL LIST OF OEM LICENSEES OR CUSTOMERS     LISTING -- CONTINUED
<S>                                            <C>
---------------------------------------------  ---------------------------------------------
 Apple, Computer Inc.                          NEC
 Compaq Computer Corp.                         Panasonic TV & VCR (Matsushita Kotobuki
 Dell Computer Corp.                           Electronics Industries, Ltd.)
 Digital Technology Systems Of California,     Panasonic Car Audio (Matsushita
 Inc.                                          Communications Industrial Co., Ltd.)
 Emerson                                       Proton Electronic Industrial Co., Ltd.
 Fujitsu Computer Corp.                        Samsung
 Hewlett Packard                               Seiko Epson Corp.
 Hitachi, Ltd.                                 Sanyo Corp.
 Iiyama Electric Co., Ltd.                     Sharp Corp.
 Gateway Computer Corp.                        Toshiba DVD
 Golden Regent                                 Toshiba TV
 LG Electronics                                Taisei Electric, Inc.
 JVC                                           Taiyo Electric Company, Ltd.
 Labtec Enterprises, Inc.                      Texas Instruments
 Mag Monitors                                  Theta Digital
 Marantz                                       VM Labs, Inc.
 Micron Computer Corp                          Zenith
 Mitsubishi Image and Information Works
---------------------------------------------  ---------------------------------------------
</TABLE>

HARDWARE PRODUCTS

     Sales of our professional and consumer hardware products to date have not
generated significant revenues and we do not plan to manufacture these products
in the future. Instead, we are focusing our attention on licensing these product
designs to third parties and concentrating on software-only products and
"plug-ins" for use with MP3 players for PC platforms and portable audio devices.

MultiDisc Technologies, Inc. -- Network Based Modular, Scaleable Compact
Disc/DVD Servers

     As its first effort to broaden our technology portfolio and capitalize on
our 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 and formed a subsidiary, 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
intended to position the Company for long term growth in a significant new
market. The Company expects to license this technology or enter into third party
manufacturing arrangements for sale of MDT CD/DVD changer products to OEMs.

                                        6
<PAGE>   7

     The MultiDisc transaction brought a unique combination of proprietary
electromechanical designs, robotics, operating software, firmware, intellectual
property, and engineering know-how and five patent applications acquired in the
asset acquisition. MDT added an additional forty-seven patent applications filed
with the United States Patent & Trademark Office ("USPTO") to bring the total to
fifty-two patent applications filed.

     On September 25, 1998, we announced our plan to refocus our business on the
exploitation of its core audio technologies and to properly position the
MultiDisc assets for sale. The repositioning strategy recognized that the
capital investment required to properly commercialize the MDT technology was
beyond the Company's capacity. As a result, all research and development
activities were suspended and the Company has accounted for MDT as a
discontinued operation. The Company has explored the sale of the business or the
patent portfolio with interested parties, but to date, no transaction has been
consummated.

Revenues and Expenses

     We generate revenues in its audio business from royalties pursuant to its
Foundry, OEM, and other licenses, and from non-recurring engineering fees to
port our technologies to specific licencees' applications. The Company's
revenues, which totaled $1,660,371 in 1999, were derived substantially from
Foundry and OEM license fees and royalties.

     We seek to maximize return on our intellectual property base by
concentrating its efforts in very high margin licensing and software products
and has eliminated its hardware product operations. Licensing operations have
been managed internally by our personnel and through use of an international
sales rep force.

     We had four major customers, C-Cube Technologies, Inc., Apple Computer,
Inc., Matsushita Electronics Corp. (MEC) and Toshiba Corporation in 1999, each
of whom accounted for greater than 10% of our total 1999 revenues. One OEM
accounted for 30%, another accounted for 26% and two accounted for between 10%
and 15% of our royalty revenues during 1999. All other OEM's accounted for less
than 10% of royalty revenues individually.

     In September, 1998, the U.S. Court of Appeals for the Federal Court upheld
the U.S District Court's ruling of August 1996, in which we prevailed in a
22-month legal battle over its 3-D Stereo intellectual property when the U.S.
District Court granted the Company's motion for summary judgment against a
competitor's assertions of patent infringement.. (See ITEM 3 -- LEGAL
PROCEEDINGS, Page 8, for further detail). The uncertainties caused by the patent
litigation had hindered our corporate results, particularly since licensing
revenue depends upon OEM unit shipments, which follow three to four quarter
production cycles. The resolution of this litigation contributed to the
Company's ability to attract new licensing and financing arrangements and to
reposition the Company for positive growth in profitability.

     In September 1998, we implemented cost cutting measures in conjunction with
the suspension of our 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 result of these initiatives was to
reduce 1999 operating costs from 1998 levels, which enabled the Company to
achieve profitable operating results in 1999.

Competition

  3-D AUDIO SIGNAL PROCESSING MARKETPLACE

     We compete with a number of entities that produce various audio enhancement
processes, technologies and products, some utilizing traditional two-speaker
playback, others utilizing multiple speakers, and others restricted to headphone
listening. These include the consumer versions of multiple speakers, matrix and
discrete digital technologies developed for theatrical motion picture exhibition
(like Dolby Digital(R), Dolby ProLogic(R), and DTS(R)), as well as other
technologies designed to create an enhanced stereo image from two or more
speakers.

                                        7
<PAGE>   8

     Our 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, our 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.

     We believe that we will favorably compete in this market because we offer a
single source, complete suite of patented and proprietary 3D Stereo, interactive
positional, and speaker virtualization technologies, and because of our superior
engineering and OEM support, the strength of our IC Foundry and OEM
relationships, and the Spatializer brand name recognition in the industry.

Patents, Trademarks and Copyrights

     Our core Spatializer audio signal processing technology is covered by our
U.S. patent 5,412,731, issued May 2, 1995. On July 15, 1997, the Company filed a
patent in the U.S. Patent office on our N-2-2(TM) intellectual property with the
U.S. Patent Office. On March 20, 1998, we filed a patent on our 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 our
reduced cost/higher performance 3-D Stereo designs and other technologies are
currently in process. Much of our intellectual property consists of trade
secrets. We 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 MultiDisc transaction brought a unique combination of proprietary
electromechanical designs, robotics, operating software, firmware, intellectual
property, and engineering know-how and five patent applications acquired in the
asset acquisition. MDT added an additional forty-seven patent applications filed
with the United States Patent & Trademark Office ("USPTO") to bring the total to
fifty-two patent applications filed. However, due to the suspension of all
operating activities of MDT, we are not pursuing these applications and some
applications have lapsed. 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. We have either
obtained or applied for U.S. trademark protection for its principal product
names and logo marks.

     On September 25, 1998, we announced our plan to refocus our business on the
exploitation of its core audio technologies and to properly position the
MultiDisc assets for sale. The repositioning strategy recognized that the
capital investment required to properly commercialize the MDT technology was
beyond our capacity. As a result, all research and development activities were
suspended and we have accounted for MDT as a discontinued operation.

Employees

     We began 1999 with thirteen full-time and five part-time employees and
sales representatives and reduced our staff to five full-time and six part-time
employees by December 31, 1999. At year-end, there were two employees engaged in
research and development. From time to time, we also employ the services of
outside professional consultants. None of our employees are represented by a
labor union or are subject to a collective bargaining agreement. We consider our
relations with our employees and consultants to be satisfactory.

                                        8
<PAGE>   9

                                    PART II

ITEM 2. PROPERTIES

     Our executive office is located in Woodland Hills, California where we
occupy approximately 900 square feet with an annual rent of approximately
$32,000. The lease term on this space is month to month. During 1999, we also
had leased facilities in Mountain View, CA, and Santa Clara, CA.

     Our regional office in Mountain View, CA, was the primary location for our
audio technology division, ("DPI"). We occupied approximately 4,200 square feet
in this location and the annual rent on a triple net basis for these premises
was approximately $101,000, with the lease term expiring December 31, 1999. This
lease has not been renewed. On November 16, 1999, we entered into a lease for
approximately 2,700 square feet of office space in Santa Clara, CA for DPI, and
relocated our DPI office from Mountain View on December 12, 1999. The annual
rent for this facility on a full service basis is approximately $75,000, with
the lease expiring on November 30, 2002.

     Our regional office in Huntington Beach, CA, was the primary location for
MDT. MDT occupied approximately 4,000 square feet of office in this location and
the annual rent for these premises was approximately $50,000, with the lease
term expiring July 31, 1999. In connection with the suspension of MDT
operations, this space was vacated in November 1998. Rent deposits were
forfeited in connection with a full settlement and termination of the lease.

     We lease our space at rental rates and on terms which management believes
are consistent with those available for similar space in the applicable local
area. Our 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 also sought attorneys' fees, interest and the costs of suit. The
Company filed a motion to dismiss the action. On July 20, 1999, the Court found
in favor of the Company and dismissed the complaint.

     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,

                                        9
<PAGE>   10

interest and the costs of suit. MDT has answered and denied the claims. The
matter was subject to a mediation preceding in March 2000, and settlement is
currently being documented. If the current settlement is finalized, the matter
will be resolved without any cost to the Company and I.N. will be entitled to a
cashless exercise of warrants for the 125,000 shares originally issued to them
in 1997 and 1998.

     In October, 1999, a complaint was filed in the Superior Court of Orange
County, California, by Bentall U.S. LLC, against the Company alleging breach of
contract, and claiming $18,630.73 in damages, attorneys fees, interest and costs
of the suit. This claim was settled and the complaint dismissed in November
1999.

     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 have either been
settled or are pending resolution and funding if Company resources allow. In
September, 1999, an entry of judgement in the Municipal Court of Santa Clara
County, California was entered on behalf of one claimant in the amount of
$8,307.30. In February, 2000, an appeal was heard in the Superior Court of
Orange County, California, relating to a claim filed by a former employee of MDT
for back vacation pay and penalties. In March 2000, both parties agreed to
dismiss the action as part of a settlement.

     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, 1999.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     Our Common Stock was listed and commenced trading on the NASDAQ SmallCap
market on August 21, 1995 under the symbol "SPAZ". In January 1999, the shares
were delisted by the NASDAQ SmallCap Market due to our inability to maintain
listing requirements. Our Common Stock immediately commenced trading on the OTC
Bulletin Board under the same symbol. The following table sets forth the high
and low sales price of our Common Stock on its principal market for fiscal years
1998 and 1999:

<TABLE>
<CAPTION>
                      PERIOD:                         HIGH (U.S. $)   LOW (U.S. $)
                      -------                         -------------   ------------
<S>                                                   <C>             <C>
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
1999
  First Quarter.....................................      $0.44          $0.08
  Second Quarter....................................      $0.36          $0.08
  Third Quarter.....................................      $0.90          $0.20
  Fourth Quarter....................................      $0.96          $0.26
</TABLE>

     On March 24, 2000, the closing price reported by NASDAQ was U.S. $1.81.
Stockholders are urged to obtain current market prices for our Common Stock.
Beginning April 1, 1997, Harris Trust Company of California has been our
transfer agent.

RECORD HOLDERS

     To our knowledge there were approximately 125 holders of record of the
stock of the Company as of March 24, 2000. However, our transfer agent has
indicated that beneficial ownership is in excess of 3,300 shareholders.

                                       10
<PAGE>   11

DIVIDENDS

     We have not paid any cash dividends on its Common Stock and has no present
intention of paying any dividends. Our current policy is to retain earnings, if
any, for use in operations and in the development of its business. Our future
dividend policy 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, 1997, 1996 and
1995, 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. The selected financial data for the years ended December 31, 1999
and 1998 are derived from the Company's consolidated financial statements which
have been audited by Farber & Hass LLP, independent public accountants. The
consolidated statements of operation and cashflows for the year ended December
31, 1997 and the report thereon are included elsewhere in this Report.

<TABLE>
<CAPTION>
                                                           FISCAL YEAR ENDED
                              ---------------------------------------------------------------------------
                              DECEMBER 31,   DECEMBER 31,      DECEMBER 31,   DECEMBER 31,   DECEMBER 31,
                                1995(1)          1996              1997           1998           1999
                              ------------   ------------      ------------   ------------   ------------
<S>                           <C>            <C>               <C>            <C>            <C>
CONSOLIDATED STATEMENT OF
  OPERATIONS DATA:
Revenues....................  $     1,230     $    2,024       $     2,781    $     1,680    $     1,660
Cost Of Revenues............          (79)          (186)             (230)          (134)           (49)
                              -----------     ----------       -----------    -----------    -----------
Gross Profit................        1,151          1,838             2,551          1,546          1,611
Total Operating Expenses....       (4,403)       (27,042)(3)        (7,238)        (3,490)        (1,156)
Other Income (Expense),
  Net.......................           74            119                27           (108)           (94)
Loss from Discontinued
  Operations................                                                       (3,702)
Income taxes................          (63)          (310)              (60)           (38)            (6)
                              -----------     ----------       -----------    -----------    -----------
Net Income (Loss)...........  $    (3,241)    $  (25,395)(4)   $    (4,720)   $    (5,792)   $       355
                              -----------     ----------       -----------    -----------    -----------
Basic Income (Loss) Per
  Share(5)..................  $     (0.32)    $    (2.01)      $     (0.23)   $     (0.29    $      0.01
                              ===========     ==========       ===========    ===========    ===========
Diluted Income (Loss) Per
  Share(5)..................  $     (0.32)    $    (2.01)      $     (0.23)   $     (0.29)   $      0.01
                              ===========     ==========       ===========    ===========    ===========
Weighted Average Common
  Shares....................   10,156,816     12,644,751        20,604,095     22,180,180     33,805,512
                              ===========     ==========       ===========    ===========    ===========
CONSOLIDATED BALANCE SHEET
  DATA:
Cash and Cash Equivalents...  $     3,113     $    1,587       $       577    $       264    $     1,022
Working Capital (Deficit)...        3,159          2,092                83         (1,975)           395
Total Assets................        4,420          4,141             3,165            893          2,118
Advances From Related
  Parties...................          325            113               113            857            337
Shareholders' Note
  Payable...................           --             --                --
Total Shareholders' Equity
  (Deficit).................  $     3,697     $    3,268       $     1,525    $    (1,553)   $       768
</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

                                       11
<PAGE>   12

Spatializer-Yukon and DPI. The financial statements for this fiscal year reflect
the consolidation of all three entities.

(2) Not used.

(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.

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, 1999 compared to
the year ended December 31, 1998, and the year ended December 31, 1998, compared
with the year ended December 31, 1997.

RESULTS OF OPERATIONS

FOR THE YEAR ENDED DECEMBER 31, 1999, COMPARED TO THE YEAR ENDED DECEMBER 31,
1998

REVENUES

     Revenues declined to $1,660,000 for the year ended December 31, 1999
compared to $1,680,000 for the year ended December 31, 1998, a decline of 1%.
Revenues include license issuance fees and royalties pertaining to the licensing
of Spatializer(R) audio signal processing designs and non-recurring engineering
fees.

     The decrease in revenues is attributed primarily to the settlement in early
1998 of royalty claims from a licensee for which there was no comparable license
settlement in the current fiscal year, competitive market pricing pressure and
decreases in recurring royalties for the licensing of Spatializer audio
technology reflecting weakness in the Japanese 3-D audio market. This was
substantially offset by increases in royalties derived from DSP foundries and
OEMs for the Company's N-2-2 technology and royalty and engineering fees from a
new licensee in 1999.

     Gross profit increased to 98% in the year ended December 31, 1999 compared
with 92% for the comparable period last year. This increase reflects the impact
of the discontinuation of lower margin consumer products sales, and inventory
write-downs on the remaining consumer products inventory to market in 1998, for
which there was no comparable adjustment in 1999. 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 for the year ended December 31, 1999 decreased to
$1,156,000 from $3,490,000 for the year ended December 31, 1998, a decrease of
67%. The decrease in operating expenses result from the rationalization of
overhead, particularly with regard to the corporate office, implemented in late
September 1998, as part of the Company's strategic repositioning to focus
exclusively on its core audio business.

                                       12
<PAGE>   13

     Based on this strategic refocusing, MultiDisc Technologies, Inc. is being
treated as a discontinued operation for accounting purposes. Operating
expenditures in 1999 were minimal and were accrued in the year ending December
31, 1998. Operating and wind down expenses of MultiDisc Technologies, Inc
totaling $3,000,000 were excluded from 1998 operating expenses and presented
separately as a discontinued operation. Total operating expenses of MultiDisc
Technologies, Inc. for the year ended December 31, 1997 were $3,791,000.

  GENERAL AND ADMINISTRATIVE

     General and administrative costs decreased to $516,000 for the year ended
December 31, 1999 from $1,732,000 for the year ended December 31, 1998, a
decrease of 70%. The decrease is primarily due decreased payroll and
payroll-related costs primarily related to the downsizing of the corporate
office as a result of overhead rationalizations implemented beginning in
September 1998. General operating costs include rent, telephone, office supplies
and stationery, postage, depreciation and similar costs.

  RESEARCH AND DEVELOPMENT

     Research and Development costs decreased to $383,000 for the year ended
December 31, 1999, compared to $756,000 for the year ended December 31,1998, a
decrease of 49%. The decrease in research and development expense was due to
headcount attrition and a delay in efforts to fill open positions until
additional working capital became available through the December Transactions.

     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 and toward development of
StreamFX, an Internet audio enhancement product and Vi.B.E., a virtual bass
enhancement technology.

  SALES AND MARKETING

     Sales and marketing costs decreased to $257,000 for the year ended December
31, 1999, compared to $1,002,000 for the year ended December 31, 1998, a
decrease of 73%. The decrease results from headcount reductions effected in
September 1998 and suspension of public relations, formal trade show
participation and advertising efforts until the additional working capital
became available through the December Transactions.

  LOSS ON DISCONTINUED OPERATION

     There was no loss on discontinued operation in the year ended December 31,
1999. Compared to a loss on discontinued operation of $3,702,000 for the year
ended December 31, 1998. Expenditures for MDT were minimal in fiscal 1999 and
were accrued in the year ended December 31, 1998. Loss on discontinued operation
was comprised of the reclassification of $2,847,000 of the net MDT expenses and
valuation adjustments of $855,000. The net expense primarily represented 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 had been consummated for the MDT assets as of the date on which the
Company filed its annual report Form 10-K in April 1999, the Company elected to
reserve for the contingency.

  NET INCOME (LOSS)

     Net Income increased to $355,000 for the year ended December 31, 1999,
compared to a net loss of $5,792,000 for the year ended December 31, 1998, an
increase of 103%. The improvement for the period is primarily the result of
overhead rationalization and corporate refocusing which began its implementation
in September 1998 and the wind down costs of MDT in 1998, for which there were
no such expenses in the current fiscal year.

                                       13
<PAGE>   14

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, as well as 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 increase reflects the impact
of the discontinuation of lower margin consumer products sales, partially 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 and stationery, 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
headcount attrition and a delay in efforts to fill open positions until the
additional working capital became available through the December Transactions.

     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 representative
expenses.

                                       14
<PAGE>   15

  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 the 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 decreased 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
at the Company's discontinued operation, MDT and lower revenues of DPI,
partially offset by significantly lower technology demonstrator development
compared with the prior year.

  LIQUIDITY AND CAPITAL RESOURCES

     At December 31, 1999, we had $1,022,000 in cash and cash equivalents as
compared to $264,000 at December 31, 1998. The increase in cash and cash
equivalents is attributed to cash provided by the issuance of 1,884,254
additional shares of Common Stock ($1.05 million in new capital from the
December Transaction), and cash provided by other operating activities. We had
working capital of $395,000 at December 31, 1999 as compared with a working
capital deficit of $1,975,000 at December 31, 1998. Our future cash flow will
come primarily from the audio signal processing licensing business' Foundry and
Original Equipment Manufacturers' ("OEM") royalties and common stock issuances
including warrant and option exercises. At December 31, 1999 we had six Foundry
licensees, seventy-six OEM Licensees and fourteen authorized customers for its
audio signal processing business as compared with six Foundry licensees and
seventy-three OEM Licensees and eight authorized customers at December 31, 1998.
We are actively engaged in negotiations for additional audio signal processing
licensing arrangements which will generate additional cash flow without imposing
any substantial costs on the Company.

     We have related party obligations of $225,000, convertible into Common
Stock at our or Debtee's option. The obligation matures in June 2001. The
Company owed $337,500 to related parties as of December 31, 1999 and $857,500 at
December 31, 1998.

     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. 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, we entered into a private placement for up to $5 million
of which $3 million was funded. 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, we 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 our common stock for the
10 days preceding the closing. In addition, cash placement fees of 10% were
paid. A
                                       15
<PAGE>   16

related party 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. We do not expect any additional investment above the initial $3
million to be received under this placement. At December 31, 1999, 60,000 shares
of Series A Convertible Preferred Stock, representing the entire placement had
been converted into a total of 30,517,943 shares of our Common Stock, some of
which are covered by Form S-3 and the balance of which were issued as restricted
shares.

     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 our 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 our
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 our 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 increased by five percent (5%) when we were
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 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 September 30,
1999, dividends in arrears were approximately $150,000.

     On September 25, 1998, we announced that our Board of Directors was
refocusing our business on the exploitation of its audio technologies, and, as
noted above, to properly position the MultiDisc assets for sale. Currently we
are 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, we indicated that
while we recognized the prospects of MultiDisc, the capital investment required
to properly commercialize the technology was beyond our capacity and, therefore,
we 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 continued to serve as chairman of
the board and director of the Company until February 10, 2000. 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, reporting to the Board of Directors, and continues in that capacity.
Michael Bolcerek resigned as president of Desper Products, Inc. Mr. Mandell was
elected as a director by the stockholders on February 10, 2000 and also was
designated chief executive officer and chairman of the board.

     We 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 us 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, we
informed NASDAQ that we would be unable to comply with these requirements. On
January 5, 1999, our common stock was delisted from the NASDAQ SmallCap Market
and, on the same day, commenced trading on the NASD Bulletin Board under the
symbol "SPAZ".

                                       16
<PAGE>   17

     In December 1999, we completed a set of financial transactions (the
"December Transactions") with certain existing holders of our equity and debt
and with new institutional investors. The December Transactions included the
private placement of 1,884,254 additional shares of our Common Stock ($1.05
million in new capital or $0.55725 per share), the issuance of warrants to
acquire 2,100,000 shares of Common Stock exercisable for three years at an
exercise price of $.67 per share), the cancellation of 500,000 warrants to
acquire Common Stock issued in that earlier financing, the conversion of $1
million of short term debt into a new Series B Redeemable Convertible Preferred
Stock ("Series B Preferred Stock") and the conversion of $225,000 of secured
debt into secured convertible debt.

     In the December Transactions, $895,000 in short term loan advances from
officers, directors and their affiliates and certain other securities holders,
and accrued interest of $134,647, were restructured into the $1,000,000 in new
Series B Preferred Stock. The Series B Preferred Stock, and any dividends
therefrom not converted into cash, are convertible commencing in 2001 into
restricted Common Stock at a 10% discount, based on the 10 day average closing
bid price prior to the conversion, but subject to a minimum conversion of $.56
per share and a maximum of $1.12 per share. We have a three year option to
redeem any Series B Preferred Stock, not sooner converted, in whole or in part,
in cash.

     In the December Transactions, $225,000 of secured debt, including accrued
interest, was converted into secured long term convertible debt. The long term
debt is held by existing institutional investors and is secured by essentially
all of our assets. The debt, and accrued interest, is convertible at our or the
holder's options into registered Common Stock at a conversion price equal to the
average 10 day closing bid price prior to conversion but subject to the same
minimum and maximum conversion prices set for the Series B Preferred Stock.

     Funds generated by these financing activities as well as cash generated
from the Company's existing operations is expected to be sufficient for us to
meet our operating obligations and the anticipated additional research and
development for its audio technology business.

  NET OPERATING LOSS CARRYFORWARDS

     At December 31, 1999, we had net operating loss carryforwards of
$26,000,000 for income tax purposes. Our 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 2012.

  INFLATION

     We believe that the moderate inflation rate of the 1990's has not impacted
our operations.

  YEAR 2000

     We are aware that many computer software programs may not currently be
designed to properly handle the system date change after December 31, 1999. We
have addressed this contingency with its computer consultants and has upgraded
our software programs in 1998, the cost of which was approximately $15,000. The
Company has not experienced any Year 2000 problems as of this filing date.

  THE ASIAN ECONOMIC CRISIS

     Approximately 51% of our revenues for the year ended December 31, 1999 were
derived from foundries and OEM's based in Japan and other Asian countries. We
believe that the relatively moderate level of the Company's Asian business, and
the concentration of this Asian business with Matsushita Electronics
Corporation, Toshiba Corporation, Samsung and LG Electronics which comprised 85%
of revenues generated from Asian customers, has resulted in some impact on
revenues and profitability.

                                       17
<PAGE>   18

  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. FAS No. 130 is effective for fiscal years beginning
after December 15, 1997. The Company will adopt FAS No. 130 in the first quarter
of fiscal year ended December 31, 1998.

                                       18
<PAGE>   19

                          INDEPENDENT AUDITORS' REPORT

To the Board of Directors
of Spatializer Audit Laboratories, Inc.:

     We have audited the accompanying consolidated balance sheets of Spatializer
Audio Laboratories, Inc. and subsidiaries as of December 31, 1999 and 1998 and
the related consolidated statements of operations, shareholders' equity
(deficit), and cash flows for the years ended December 31, 1999 and 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 audits.

     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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 audits provide 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, 1999 and 1998, and
the results of their operations and their cash flow for the years then ended in
conformity with generally accepted accounting principles.

/s/  FARBER & HASS LLP

Oxnard, California
March 10, 2000

                                       19
<PAGE>   20

                          INDEPENDENT AUDITORS' REPORT

The Board of Directors
Spatializer Audio Laboratories, Inc.

     We have audited the accompanying consolidated balance sheets of Spatializer
Audio Laboratories, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of operations, shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1997. 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 audits.

     We conducted our audits 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 audits provide 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, 1997 and 1996, and
the results of their operations and their cash flow for each of the years in the
three-year period ended December 31, 1997 in conformity with generally accepted
accounting principles.

                                          /s/  KPMG PEAT MARWICK LLP

Los Angeles, California
March 6, 1998, except for note 19, which is
as of April 15, 1998

                                       20
<PAGE>   21

ITEM 8. FINANCIAL STATEMENTS

                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS

                                     ASSETS

<TABLE>
<CAPTION>
                                                              DECEMBER 31,    DECEMBER 31,
                                                                  1999            1998
                                                              ------------    ------------
<S>                                                           <C>             <C>
Current Assets:
  Cash and Cash Equivalents.................................  $  1,021,998    $    264,054
  Accounts Receivable.......................................       687,595         134,633
  Inventory.................................................        12,993           7,993
  Prepaid Expenses and Deposits.............................        22,640          65,718
                                                              ------------    ------------
          Total Current Assets..............................     1,745,226         472,398
Property and Equipment, Net.................................       132,803         184,140
Intangible Assets, Net......................................       207,793         236,913
Other Assets................................................        32,177
                                                              ------------    ------------
                                                              $  2,117,999    $    893,451
                                                              ============    ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
  Notes Payable.............................................  $     14,149    $     14,795
  Notes Payable to Related Party............................       337,742         857,500
  Accounts Payable..........................................       234,117         335,784
  Accrued Wages and Benefits................................        53,136          84,423
  Accrued Expenses..........................................       291,117         370,548
  Deferred Income...........................................                       250,000
  Net Liabilities of Discontinued Operation.................       419,600         533,891
                                                              ------------    ------------
          Total Current Liabilities.........................     1,349,861       2,446,941
                                                              ------------    ------------
  Commitments and Contingencies
Stockholders' Equity (Deficit):
  7% Series A Convertible Preferred shares, $0.01 par value;
     100,000 shares authorized; no shares and 52,900 shares
     issued and outstanding at December 31, 1999 and 1998,
     respectively...........................................                           529
  10% Series B Convertible Redeemable Preferred shares,
     $0.01 par value; 1,000,000 shares authorized; 102,967
     shares and no shares issued and outstanding at December
     31, 1999 and 1998, respectively........................         1,030
  Common shares, $0.01 par value; 50,000,000 shares
     authorized; 46,174,970 and 25,841,867 shares issued and
     outstanding at December 31, 1999 and 1998,
     respectively...........................................       461,750         258,418
  Additional Paid-In Capital................................    45,913,503      44,150,501
  Accumulated Deficit.......................................   (45,608,146)    (45,962,938)
                                                              ------------    ------------
          Total Shareholders' Equity (Deficit)..............       768,137      (1,553,490)
                                                              ------------    ------------
                                                              $  2,117,999    $    893,451
                                                              ============    ============
</TABLE>

          See accompanying notes to consolidated financial statements
                                       21
<PAGE>   22

                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                               YEAR ENDED DECEMBER 31,
                                                      -----------------------------------------
                                                         1999           1998           1997
                                                      -----------    -----------    -----------
<S>                                                   <C>            <C>            <C>
Revenues:
  Product Revenues, Net.............................                 $    39,496    $   336,703
  Licensing Revenues................................                     663,522        880,000
  Royalty Revenues..................................  $ 1,660,371        976,697      1,564,530
                                                      -----------    -----------    -----------
                                                        1,660,371      1,679,715      2,781,233
     Cost of Revenues...............................       48,780        134,190        229,736
                                                      -----------    -----------    -----------
                                                        1,611,591      1,545,525      2,551,497
                                                      -----------    -----------    -----------
Operating Expenses:
  General and Administrative........................      515,843      1,732,097      2,173,717
  Research and Development..........................      383,176        755,899      3,707,995
  Sales and Marketing...............................      257,017      1,001,747      1,356,196
                                                      -----------    -----------    -----------
                                                        1,156,036      3,489,743      7,237,908
                                                      -----------    -----------    -----------
     Operating Income (Loss)........................      455,555     (1,944,218)    (4,686,411)
                                                      -----------    -----------    -----------
Interest Income.....................................        3,401         27,672         57,305
Interest Expense....................................     (102,468)       (84,723)       (21,063)
Other Income (Expense), Net.........................        4,804        (50,955)        (8,949)
                                                      -----------    -----------    -----------
                                                          (94,263)      (108,006)        27,293
                                                      -----------    -----------    -----------
       Income (Loss) from Continuing Operations.....      361,292     (2,052,224)    (4,659,118)
       Loss from Discontinued Operations............                  (3,701,599)
                                                      -----------    -----------    -----------
     Income (Loss) Before Income Taxes..............      361,292     (5,753,823)    (4,659,118)
     Income Taxes...................................       (6,500)       (38,238)       (60,703)
                                                      -----------    -----------    -----------
     Net Income (Loss)..............................  $   354,792    $(5,792,061)   $(4,719,821)
                                                      ===========    ===========    ===========
     Basic and Diluted Income (Loss) per Share:
       Continued Operations.........................  $       .01    $      (.12)   $      (.23)
       Discontinued Operations......................                        (.17)
                                                      -----------    -----------    -----------
                                                      $       .01    $      (.29)   $      (.23)
                                                      ===========    ===========    ===========
       Weighted-Average Shares Outstanding..........   33,805,512     22,180,180     20,604,095
                                                      ===========    ===========    ===========
</TABLE>

          See accompanying notes to consolidated financial statements
                                       22
<PAGE>   23

                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                               YEAR ENDED DECEMBER 31,
                                                       ----------------------------------------
                                                          1999          1998           1997
                                                       ----------    -----------    -----------
<S>                                                    <C>           <C>            <C>
Cash Flows from Operating Activities:
  Net Income (Loss)..................................  $  354,793    $(5,792,061)   $(4,719,821)
  Adjustments to Reconcile Net Income (Loss) to Net
     Cash Used by Operating Activities:
     Depreciation and Amortization...................     103,564        126,334        407,283
     Discontinued Operations.........................                    962,060
     Deferred Transaction Costs......................                    146,529
     Loss on Disposal of Property and Equipment......                     50,308         14,281
     Provision for Doubtful Accounts.................                                   100,000
     Options and Warrants Issued for Services........                     56,030        100,000
  Net Change in Assets and Liabilities:
     Accounts Receivable and Employee Advances.......    (558,583)       798,675       (249,806)
     Inventory.......................................      (5,000)        85,257        203,289
     Prepaid Expenses and Deposits...................      16,521         31,112        125,282
     Other Assets....................................                                    (4,135)
     Accounts Payable................................    (101,667)       102,737        247,506
     Accrued Expenses and Other Liabilities..........    (360,718)       503,007         78,701
     Discontinued Operations.........................    (114,291)       (66,796)
                                                       ----------    -----------    -----------
Net Cash Used by Operating Activities................    (665,382)    (2,996,808)    (3,697,465)
                                                       ----------    -----------    -----------
Cash Flows from Investing Activities:
     Purchase of Property and Equipment..............     (16,365)       (43,079)      (187,485)
     Proceeds from Disposal..........................                     20,400
     Intangible Assets...............................      (6,740)       (34,350)      (237,036)
     Deferred Transaction Costs......................                                  (146,529)
     Discontinued Operations.........................                   (238,025)
                                                       ----------    -----------    -----------
Net Cash Used by Investing Activities................     (23,105)      (295,054)      (571,050)
                                                       ----------    -----------    -----------
Cash Flows from Financing Activities:
  Issuance of Common and Preferred Shares, Net.......   1,959,627      2,611,474      1,966,144
  Exercise of Options and Warrants...................       7,208         45,954        910,917
  Notes and Amounts Due to (from) Related Parties....    (519,757)       745,000
  Proceeds (Repayments) on Line of Credit............                   (400,000)       400,000
  Discontinued Operations............................                    (20,501)
  Repayments of Notes Payable........................        (647)        (3,424)       (18,528)
                                                       ----------    -----------    -----------
Net Cash Provided by Financing Activities............   1,446,431      2,978,503      3,258,533
                                                       ----------    -----------    -----------
Increase (Decrease) in Cash and Cash Equivalents.....     757,944       (313,359)    (1,009,982)
Cash and Cash Equivalents, Beginning of Year.........     264,054        577,413      1,587,395
                                                       ----------    -----------    -----------
Cash and Cash Equivalents, End of Year...............  $1,021,998    $   264,054    $   577,413
                                                       ==========    ===========    ===========
Supplemental Disclosure of Cash Flow Information:
  Cash Paid During the Year for:
     Interest........................................  $   11,250    $    26,370    $    21,063
     Income Taxes....................................  $    6,500    $    35,838    $    60,703
</TABLE>

          See accompanying notes to consolidated financial statements
                                       23
<PAGE>   24

                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
                        SERIES A, 7% CONVERTIBLE    SERIES B, 10% CONVERTIBLE
                            PREFERRED SHARES            PREFERRED SHARES                       COMMON SHARES
                        -------------------------   -------------------------   --------------------------------------------
                         NUMBER OF                   NUMBER OF                  NUMBER OF                      ADDITIONAL
                          SHARES       PAR VALUE      SHARES       PAR VALUE      SHARES       PAR VALUE     PAID-IN-CAPITAL
                        -----------   -----------   -----------   -----------   ----------   -------------   ---------------
<S>                     <C>           <C>           <C>           <C>           <C>          <C>             <C>
Balance, January 1,
  1998................                                                          21,410,012     $214,100        $41,481,890
Issuance of Preferred
  Shares, Net.........     60,000        $ 600                                                                   2,610,874
Options Issued for
  Services............                                                              13,333          133             12,571
Options Exercised.....                                                              19,000          190             33,060
Warrants Exercised....
Conversion of
  Preferred Shares....     (7,100)         (71)                                  4,399,522       43,995            (43,924)
Net Loss..............                                                                  --           --                 --
                          -------        -----        -------        ------     ----------     --------        -----------
Balance, December 31,
  1998................     52,900          529                                  25,841,867      258,418         44,150,501
Issuance of Preferred
  Shares, Net.........                                102,967        $1,030                                      1,028,617
Issuance of Common
  Shares, Net.........                                                           1,884,254       18,843            911,137
Options Exercised.....                                                              59,998          600              6,608
Conversion of
  Preferred Shares....    (52,900)        (529)                                 18,388,851      183,889           (183,360)
Net Income............                                                                  --           --                 --
                          -------        -----        -------        ------     ----------     --------        -----------
Balance, December 31,
  1999................          0        $   0        102,967        $1,030     46,174,970     $461,750        $45,913,503
                          =======        =====        =======        ======     ==========     ========        ===========

<CAPTION>

                                           TOTAL
                        ACCUMULATED    SHAREHOLDERS'
                          DEFICIT         EQUITY
                        ------------   -------------
<S>                     <C>            <C>
Balance, January 1,
  1998................  $(40,170,877)   $ 1,525,113
Issuance of Preferred
  Shares, Net.........                    2,611,474
Options Issued for
  Services............                       12,704
Options Exercised.....                       33,250
Warrants Exercised....
Conversion of
  Preferred Shares....
Net Loss..............    (5,792,061)    (5,792,061)
                        ------------    -----------
Balance, December 31,
  1998................   (45,962,938)    (1,553,490)
Issuance of Preferred
  Shares, Net.........                    1,029,647
Issuance of Common
  Shares, Net.........                      929,980
Options Exercised.....                        7,208
Conversion of
  Preferred Shares....
Net Income............       354,792        354,792
                        ------------    -----------
Balance, December 31,
  1999................  $(45,608,146)   $   768,137
                        ============    ===========
</TABLE>

          See accompanying notes to consolidated financial statements
                                       24
<PAGE>   25

                      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 12).

(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 12). 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 (OEMs) and foundries.

     CONCENTRATION OF CREDIT RISK -- Financial instruments which potentially
subject the company to concentrations of credit risk consist principally of cash
and trade accounts receivable.

     At December 31, 1999, four customers accounted for 48%, 16%, 12% and 12%,
respectively, of the Company's trade receivables. The Company performs ongoing
credit evaluations of its customers and normally does not require collateral to
support accounts receivable.

     CASH AND CASH EQUIVALENTS -- Cash equivalents consist of highly liquid
investments with original maturities of three months or less.

     MAJOR CUSTOMERS -- During the year ended December 31, 1999, four customers
accounts for 30%, 26%, 15% and 10%, respectively, of the Company's net sales.

     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.

                                       25
<PAGE>   26
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     VALUATION ACCOUNTS -- The Company had reserves for doubtful accounts
recorded in the accompanying consolidated financial statements which are
summarized as follows:

<TABLE>
<S>                                                        <C>
BALANCE AT JANUARY 1, 1998...............................  $ 190,000
Charged to Expense.......................................          0
Deductions...............................................   (190,000)
                                                           ---------
BALANCE AT DECEMBER 31, 1998.............................          0
BALANCE AT DECEMBER 31, 1999.............................  $       0
                                                           =========
</TABLE>

     EARNINGS 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 impact of Statement 128 on the calculation of earnings per share is as
follows:

<TABLE>
<CAPTION>
                                                     YEAR ENDED DECEMBER 31,
                                                    --------------------------
                                                       1999           1998
                                                    -----------    -----------
<S>                                                 <C>            <C>
BASIC:
Net Income (Loss) Available to Common
  Shareholders....................................  $   354,792    $(5,792,061)
Weighted Average Shares Outstanding...............   33,805,512     22,180,180
Basic Earnings per Share..........................  $      0.01    $     (0.29)
DILUTED:
Net Income (Loss) Available to Common
  Shareholders....................................  $   354,792    $(5,792,061)
Weighted Average Shares Outstanding...............   33,805,512     22,180,180
Net Effect of Dilutive Stock Options and Warrants
  Based on the Treasury Stock Method Using Average
  Market Price....................................    1,859,519            N/A
Total Shares......................................   35,665,031
Diluted Earnings per Share........................  $    0.0100            N/A
Average Market Price of Common Stock..............  $    0.4700            N/A
Ending Market Price of Common Stock...............  $    0.9375            N/A
</TABLE>

     The following table presents contingently issuable shares, options and
warrants to purchase shares of common stock that were outstanding during 1998
and 1997 which were not included in the computation of diluted loss per share
because the impact would have been antidilutive:

<TABLE>
<CAPTION>
                                              1999         1998         1997
                                            ---------    ---------    ---------
<S>                                         <C>          <C>          <C>
Options...................................  1,252,500    1,972,300    1,855,070
Warrants..................................  2,730,000      732,000      934,750
                                            ---------    ---------    ---------
Total.....................................  3,982,500    2,704,300    2,789,820
                                            =========    =========    =========
</TABLE>

     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", 72 Convertible Preferred Stock as well as dividends in arrears of
approximately $149,000 related to this Preferred Stock.

                                       26
<PAGE>   27
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     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 9).

     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 Notes 4). 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, 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 non-owner 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, 1999, 1998 and 1997. As a result, comprehensive income
(loss) is the same as the net income (loss) for the years ended December 31,
1999, 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

                                       27
<PAGE>   28
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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,
1999 and 1998 approximated fair value due to the short maturity of those
investments.

     The fair value of the advances from related parties could not be estimated
due to the nature of the borrowings.

     The fair values of notes payable at December 31, 1999 and 1998 are
materially consistent with the related carrying values based on current rates
offered to the Company for instruments with similar maturities.

     DISCONTINUED OPERATIONS -- 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
12).

(3) PROPERTY AND EQUIPMENT

     Property and equipment, as of December 31, 1999 and 1998, consists of the
following, net of a reserve for impairment loss in 1998 in accordance with
application of SFAS 121:

<TABLE>
<CAPTION>
                                                           1999        1998
                                                         --------    --------
<S>                                                      <C>         <C>
Office Computers, Software, Equipment and Furniture....  $242,272    $225,907
Test Equipment.........................................    60,647      60,647
Tooling Equipment......................................    44,136      44,136
Trade Show Booth and Demonstration Equipment...........   122,768     122,768
Leasehold Improvements.................................    22,122      22,122
                                                         --------    --------
Total Property and Equipment...........................   491,945     475,580
Less Accumulated Depreciation and Amortization.........   359,142     291,440
                                                         --------    --------
Property and Equipment, Net............................  $132,803    $184,140
                                                         ========    ========
</TABLE>

(4) INTANGIBLE ASSETS

     Intangible assets, as of December 31, 1999 and 1998 consist of the
following:

<TABLE>
<CAPTION>
                                                           1999        1998
                                                         --------    --------
<S>                                                      <C>         <C>
Capitalized Patent and Technology Costs................  $373,677    $365,637
Less Accumulated Amortization..........................   165,884     128,724
                                                         --------    --------
Intangible Assets, Net.................................  $207,793    $236,913
                                                         ========    ========
</TABLE>

                                       28
<PAGE>   29
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(5) FINANCING ARRANGEMENTS

     NOTES PAYABLE -- Notes payable at December 31, 1999 and 1998 consist of the
following:

<TABLE>
<CAPTION>
                                                            1999       1998
                                                           -------    -------
<S>                                                        <C>        <C>
Notes payable, secured by equipment, interest at 11.5% to
  22%, payable in monthly installments through May
  2002...................................................  $14,149    $14,795
                                                           =======    =======
</TABLE>

     The notes payable balances as of December 31, 1999 and 1998 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, 1999 are included in the Net
Liabilities of Discontinued Operations.

(6) NOTES PAYABLE TO RELATED PARTIES

     The Company was indebted to certain related parties for an amount totaling
$337,742 at December 31, 1999. This amount bears interest at a fixed rate of 10%
annually and is due on demand. It is convertible into shares of common stock
based on the 10 day average closing bid price immediately prior to notice of
conversion.

     At December 31, 1998, the Company was indebted to four of its directors and
one of its executives for an amount totalling $745,000. This amount bears
interest at a fixed rate of 10% annually. Of this amount, $650,000 was due on
December 31, 1998. The remaining $95,000 was 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.
This debt was converted into Series B preferred stock in December 1999 (see Note
7).

(7) SHAREHOLDERS' EQUITY

  During the year ended December 31, 1999, shares were issued or converted as
follows:

     In December 1999, the Company completed a set of financial transactions
(the "December Transactions") with certain existing holders of the Company's
equity and debt and with new institutional investors. The December Transactions
included the private placement of 1,884,254 additional shares of our common
stock ($1.05 million in new capital or $0.55725 per share), the issuance of
warrants to acquire 2,100,000 shares of common stock exercisable for three years
at an exercise price of $.67 per share), the cancellation of 500,000 warrants to
acquire common stock issued in an earlier financing, the conversion of $1
million of short-term debt into a new Series B Convertible Redeemable Preferred
Stock ("Series B Preferred Stock") and the conversion of $225,000 of secured
debt into secured long-term convertible debt.

     In the December Transactions, $895,000 in short-term loan advances from
officers, directors and their affiliates and certain other securities holders,
and accrued interest of $134,647, were restructured into $1,000,000 in new
Series B Preferred Stock. The Series B Preferred Stock, and any dividends
therefrom not converted into cash, are convertible commencing in 2001 into
restricted common stock at a 10% discount, based on the 10-day average closing
bid price prior to the conversion, but subject to a minimum conversion of $56
per share and a maximum of $1.12 per share. The Company has a three-year option
to redeem any Series B Preferred Stock, not sooner converted, in whole or in
part, in cash.

     In the December Transactions, $225,000 of secured debt, including accrued
interest, was converted into secured long-term convertible debt. The long-term
debt is held by existing institutional investors and is secured by essentially
all of the Company's assets. The debt, and accrued interest, is convertible at
the Company's or the holder's options into registered common stock at a
conversion price equal to the average

                                       29
<PAGE>   30
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

10-day closing bid price prior to conversion but subject to the same minimum and
maximum conversion prices set for the Series B Preferred Stock.

     Also, concurrently with the December Transactions, 55,000 shares were
allocated to the Company's outside legal counsel in payment of a portion of its
legal fees for this transaction.

  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 $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 twenty (120) days and prior to one hundred forty-nine (149) days of
first issuance of the Series A Preferred Stock. The applicable Conversion
Discount increased by five percent (5%) when the Company was delisted 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 Convertible Preferred Series A
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 $131,148.

                                       30
<PAGE>   31
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     In the private placement, the participants were granted certain rights to
participate in the separate financing of approximately $6 million currently
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.

(8) 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: 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, 1999, 1998 and 1997. 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.

(9) 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, 4,617,497 as of December 31, 1999. 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, 1999, there were 1,758,030 additional shares available for
grant under the Plan. The per share weighted-average fair value of stock options
granted during 1999, 1998 and 1997 was $0.32, $0.25, and $1.44, respectively, on
the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions: 1999 and 1998 -- expected dividend yield
0%, risk-free interest rate of 9.0%,
                                       31
<PAGE>   32
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

expected 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.

     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>
                                                  1999         1998           1997
                                                --------    -----------    -----------
<S>                                             <C>         <C>            <C>
NET INCOME (LOSS):
As Reported...................................  $354,792    $(5,792,061)   $(4,719,821)
Pro Forma.....................................  $(49,978)   $(5,792,061)   $(6,408,547)
BASIC AND DILUTED LOSS:
As Reported...................................  $   0.01    $      (.29)   $      (.23)
Pro Forma.....................................  $  (0.01)   $      (.29)   $      (.31)
</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, 1997...........  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
Options granted..................................  1,280,000         $0.316
Options exercised................................    (59,998)        $1.242
Options forfeited................................   (332,835)        $1.131
                                                   ---------
Options outstanding at December 31, 1999.........  2,859,467         $1.271
                                                   =========
</TABLE>

     At December 31, 1999, the number of options exercisable was 2,401,300, and
the weighted-average exercise price of those options was $1.48.

     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
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

                                       32
<PAGE>   33
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

grant date exercise price from $1.18 per share. The vesting schedules and
expiration dates for these options were not modified.

(10) WARRANTS

     Warrant activity for the periods indicated below is as follows:

<TABLE>
<CAPTION>
                                                      WARRANTS     WARRANT PRICE
                                                      ---------    -------------
<S>                                                   <C>          <C>
Warrants outstanding at January 1, 1997.............    174,000        $3.79
Warrants issued.....................................  1,067,000        $1.45
Warrants exercised..................................   (287,250)       $1.75
Warrants expired....................................    (19,000)       $3.80
                                                      ---------
Warrants outstanding at December 31, 1997...........    934,750        $1.70
Warrants issued.....................................    720,000        $1.45
Warrants exercised..................................    (19,000)       $1.75
Warrants expired....................................   (903,750)       $1.70
                                                      ---------
Warrants outstanding at December 31, 1998...........    732,000        $1.11
Warrants issued.....................................  2,410,000        $0.60
Warrants exercised..................................          0
Warrants expired....................................    412,000        $1.26
                                                      ---------
Warrants outstanding at December 31, 1999...........  2,730,000        $0.67
                                                      =========
</TABLE>

     All of the warrants granted in 1999, 1998 and 1997 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 years ended December
31, 1998 and 1997. At December 31, 1999 and 1998, the number of warrants
exercisable was 2,730,000 and 732,000, respectively.

(11) INCOME TAXES

     The Company files a consolidated return for U.S. income tax purposes.
Income tax expense for the years ended December 31, 1999, 1998 and 1997
consisted of the following:

<TABLE>
<CAPTION>
                                                  1999      1998       1997
                                                 ------    -------    -------
<S>                                              <C>       <C>        <C>
State franchise tax............................  $  800    $ 2,400    $ 2,856
Foreign taxes..................................   5,700     35,838     57,847
                                                 ------    -------    -------
Total..........................................  $6,500    $38,238    $60,703
                                                 ======    =======    =======
</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.

     Income tax expense for the years ended December 31, 1999, 1998 and 1997
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.

                                       33
<PAGE>   34
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1999 and 1998 are presented below.

<TABLE>
<CAPTION>
                                                      1999            1998
                                                   -----------    ------------
<S>                                                <C>            <C>
DEFERRED TAX ASSETS:
Net Operating Loss Carryforwards.................  $ 9,854,000    $  9,475,000
In-Process Research and Development Costs........                      272,000
Asset Reserves...................................                      313,000
Accrued Liabilities..............................       19,000          32,000
Property and Equipment, Principally Due to
  Differences in Depreciation and Capitalized
  Interest.......................................       23,000          20,000
                                                   -----------    ------------
Total Gross Deferred Tax Assets..................    9,896,000      10,112,000
Less Valuation Allowance.........................   (9,896,000)    (10,112,000)
                                                   -----------    ------------
Net Deferred Tax Assets..........................  $         0    $          0
                                                   ===========    ============
</TABLE>

     The net change in the total valuation allowance for the years ended
December 31, 1999 and 1998 was a change of $(216,000) and $2,074,000,
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, 1999 and 1998. 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, 1999, the Company had net operating loss carryforwards for
Federal income tax purposes of approximately $26,000,000 which are available to
offset future Federal taxable income, if any, through 2013.

(12) 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 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, 1999 are
comprised of the following:

<TABLE>
<S>                                                        <C>
Accounts payable.........................................  $(260,364)
Accrued expenses.........................................   (133,684)
Notes payable............................................    (25,552)
                                                           ---------
Net liabilities of discontinued operations...............  $(419,600)
                                                           =========
</TABLE>

                                       34
<PAGE>   35
                      SPATIALIZER AUDIO LABORATORIES, INC.
                                AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(13) COMMITMENTS AND CONTINGENCIES

     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. The matter was subject to a mediation preceding in March 2000, and
settlement is currently being documented. If the current settlement is
finalized, the matter will be resolved without any cost to the Company and I.N.
will be entitled to a cashless exercise of warrants for the 125,000 shares
originally issued to them in 1997 and 1998.

  Operating Lease Commitments

     The Company is obligated for future minimum rental payments for all
operating leases of approximately $75,000 per year through November 2002. Rent
expense amounted to approximately $140,000, $251,000 and $238,000 for the years
ended December 31, 1999, 1998 and 1997, respectively.

                                       35
<PAGE>   36

ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE

     None.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     Information required for this item incorporated by reference to the
Definitive Proxy filed on January 12, 2000.

ITEM 11. EXECUTIVE COMPENSATION

     Information required for this item incorporated by reference to the
Definitive Proxy filed on January 12, 2000.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     Information required for this item incorporated by reference to the
Definitive Proxy filed on January 12, 2000.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Information required for this item incorporated by reference to the
Definitive Proxy filed on January 12, 2000.

                                    PART IV

ITEM 14. EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                             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.)
 3.3       Certificate of Designation of Series B 10% Redeemable
           Convertible Preferred Stock of the Company as filed December
           27, 1999.
 3.4       Certificate of Amendment of Certificate of Incorporation of
           the Company as filed on February 25, 2000.
 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.)
</TABLE>

                                       36
<PAGE>   37

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                             DESCRIPTION
-------                            -----------
<C>        <S>
 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.)
 4.11      Common Stock Purchase Agreement dated as of December 29,
           1999 among the Company, CPR (USA) Inc., LibertyView Funds,
           L.P., LibertyView Fund, LLC.
 4.12      Stock Purchase Warrant, dated as of December 29, 1999 issued
           by the Company to CPR (USA) Inc.
 4.13      Stock Purchase Warrant, dated as of December 29, 1999 issued
           by the Company to LibertyView Funds, L.P.
 4.14      Stock Purchase Warrant, dated as of December 29, 1999 issued
           by the Company to LibertyView Fund, LLC.
 4.15      Registration Rights Agreement dated as of December 29, 1999
           among the Company and CPR (USA) Inc., LibertyView Funds,
           L.P. and LibertyView Fund, LLC.
 4.16      Secured Non-Negotiable Convertible Promissory Note dated as
           of December 29, 1999 issued by the Company to CPR (USA) Inc.
 4.17      Secured Non-Negotiable Convertible Promissory Note dated as
           of December 29, 1999 issued by the Company to LibertyView
           Funds, L.P.
 4.18      Secured Non-Negotiable Convertible Promissory Note dated as
           of December 29, 1999 issued by the Company to LibertyView
           Fund LLC.
 4.19      Registration Rights Agreement dated as of December 29, 1999
           among the Company and CPR (USA) Inc., LibertyView Funds,
           L.P. and LibertyView Fund, LLC.
</TABLE>

                                       37
<PAGE>   38

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                             DESCRIPTION
-------                            -----------
<C>        <S>
 4.20      Agreement Regarding Cancellation of Warrants, dated as of
           December 29, 1999 among CPR (USA), Inc., LibertyView Funds,
           L.P. and LibertyView Fund, LLC.
 4.21      Common Stock Subscription Agreement dated as of December 29,
           1999 between the Company and Lufeng Investments (as assignee
           of Arab Commerce Bank).
 4.22      Stock Purchase Warrant, dated as of December 29, 1999 issued
           by the Company to Lufeng Investments (as assignee of Arab
           Commerce Bank).
 4.23      Registration Rights Agreement dated as of December 29, 1999
           between the Company and Lufeng Investments (as assignee of
           Arab Commerce Bank).
 4.24      Common Stock Subscription Agreement dated as of December 29,
           1999 between the Company and Bank Insinger de Beaufort.
 4.25      Stock Purchase Warrant, dated as of December 29, 1999 issued
           by the Company to Bank Insinger de Beaufort.
 4.26      Registration Rights Agreement dated as of December 29, 1999
           between the Company and Bank Insinger de Beaufort.
 4.27      Common Stock Subscription Agreement dated as of December 29,
           1999 between the Company and Romofin, A.G.
 4.28      Stock Purchase Warrant, dated as of December 29, 1999 issued
           by the Company to Romofin, A.G.
 4.29      Registration Rights Agreement dated as of December 29, 1999
           between the Company and Romofin, A.G.
 4.30      10% Convertible Preferred Stock Subscription Agreement dated
           as of December 29, 1999 between the Company and Clarion
           Finanz, A.G. Carlo Civelli, Henry R. Mandell, James D. Pace,
           Jerold H. Rubinstein, Gilbert N. Segel, Aton Select Fund
           Ltd. and Romofin A.G.
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.)
10.4       Agreement Regarding Indebtedness dated as of December 29,
           1999 among the Company and CPR (USA) Inc., LibertyView
           Funds, L.P. and LibertyView Fund, LLC.
10.5       Security Agreement dated as of December 29, 1999 among the
           Company and CPR (USA) Inc., LibertyView Funds, L.P. and
           LibertyView Fund, LLC.
10.6       Finder's Fee Agreement dated as of December 27, 1999 between
           the Company and Bristol Capital, L.L.C.
21.1       Schedule of Subsidiaries of the Company.
27         Financial Data Schedule.
</TABLE>

---------------
  * Previously filed.

 ** To be filed by amendment.

*** Previously filed and portions subject to request for confidential treatment.
    The confidential portions omitted have been filed separately with the
    Commission.

                                       38
<PAGE>   39

                                   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: March 30, 2000                     SPATIALIZER AUDIO LABORATORIES, INC.
                                          (Registrant)

                                          /s/ HENRY R. MANDELL
                                          --------------------------------------
                                          Henry R. Mandell
                                          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>
                  SIGNATURE                                    TITLE                        DATE
                  ---------                                    -----                        ----
<S>                                            <C>                                     <C>

/s/ CARLO CIVELLI                                             Director                 March 30, 2000
---------------------------------------------
Carlo Civelli

/s/ STEPHEN W. DESPER                                         Director                 March 30, 2000
---------------------------------------------
Stephen W. Desper

/s/ JAMES D. PACE                                             Director                 March 30, 2000
---------------------------------------------
James D. Pace

/s/ GILBERT N. SEGEL                                          Director                 March 30, 2000
---------------------------------------------
Gilbert N. Segel
</TABLE>

                                       39
<PAGE>   40

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                             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.)
 3.3       Certificate of Designation of Series B 10% Redeemable
           Convertible Preferred Stock of the Company as filed December
           27, 1999.
 3.4       Certificate of Amendment of Certificate of Incorporation of
           the Company as filed on February 25, 2000.
 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>

                                       40
<PAGE>   41

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                             DESCRIPTION
-------                            -----------
<C>        <S>
 4.11      Common Stock Purchase Agreement dated as of December 29,
           1999 among the Company, CPR (USA) Inc., LibertyView Funds,
           L.P., LibertyView Fund, LLC.
 4.12      Stock Purchase Warrant, dated as of December 29, 1999 issued
           by the Company to CPR (USA) Inc.
 4.13      Stock Purchase Warrant, dated as of December 29, 1999 issued
           by the Company to LibertyView Funds, L.P.
 4.14      Stock Purchase Warrant, dated as of December 29, 1999 issued
           by the Company to LibertyView Fund, LLC.
 4.15      Registration Rights Agreement dated as of December 29, 1999
           among the Company and CPR (USA) Inc., LibertyView Funds,
           L.P. and LibertyView Fund, LLC.
 4.16      Secured Non-Negotiable Convertible Promissory Note dated as
           of December 29, 1999 issued by the Company to CPR (USA) Inc.
 4.17      Secured Non-Negotiable Convertible Promissory Note dated as
           of December 29, 1999 issued by the Company to LibertyView
           Funds, L.P.
 4.18      Secured Non-Negotiable Convertible Promissory Note dated as
           of December 29, 1999 issued by the Company to LibertyView
           Fund LLC.
 4.19      Registration Rights Agreement dated as of December 29, 1999
           among the Company and CPR (USA) Inc., LibertyView Funds,
           L.P. and LibertyView Fund, LLC.
 4.20      Agreement Regarding Cancellation of Warrants, dated as of
           December 29, 1999 among CPR (USA), Inc., LibertyView Funds,
           L.P. and LibertyView Fund, LLC.
 4.21      Common Stock Subscription Agreement dated as of December 29,
           1999 between the Company and Lufeng Investments (as assignee
           of Arab Commerce Bank).
 4.22      Stock Purchase Warrant, dated as of December 29, 1999 issued
           by the Company to Lufeng Investments (as assignee of Arab
           Commerce Bank).
 4.23      Registration Rights Agreement dated as of December 29, 1999
           between the Company and Lufeng Investments (as assignee of
           Arab Commerce Bank).
 4.24      Common Stock Subscription Agreement dated as of December 29,
           1999 between the Company and Bank Insinger de Beaufort.
 4.25      Stock Purchase Warrant, dated as of December 29, 1999 issued
           by the Company to Bank Insinger de Beaufort.
 4.26      Registration Rights Agreement dated as of December 29, 1999
           between the Company and Bank Insinger de Beaufort.
 4.27      Common Stock Subscription Agreement dated as of December 29,
           1999 between the Company and Romofin, A.G.
 4.28      Stock Purchase Warrant, dated as of December 29, 1999 issued
           by the Company to Romofin, A.G.
 4.29      Registration Rights Agreement dated as of December 29, 1999
           between the Company and Romofin, A.G.
 4.30      10% Convertible Preferred Stock Subscription Agreement dated
           as of December 29, 1999 between the Company and Clarion
           Finanz, A.G. Carlo Civelli, Henry R. Mandell, James D. Pace,
           Jerold H. Rubinstein, Gilbert N. Segel, Aton Select Fund
           Ltd. and Romofin A.G.
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.)
</TABLE>

                                       41
<PAGE>   42

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                             DESCRIPTION
-------                            -----------
<C>        <S>
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.)
10.4       Agreement Regarding Indebtedness dated as of December 29,
           1999 among the Company and CPR (USA) Inc., LibertyView
           Funds, L.P. and LibertyView Fund, LLC.
10.5       Security Agreement dated as of December 29, 1999 among the
           Company and CPR (USA) Inc., LibertyView Funds, L.P. and
           LibertyView Fund, LLC.
10.6       Finder's Fee Agreement dated as of December 27, 1999 between
           the Company and Bristol Capital, L.L.C.
21.1       Schedule of Subsidiaries of the Company.
27         Financial Data Schedule.
</TABLE>

---------------
  * Previously filed.

 ** To be filed by amendment.

*** Previously filed and portions subject to request for confidential treatment.
    The confidential portions omitted have been filed separately with the
    Commission.

                                       42