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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



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(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, 2001

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)

|                                                                        |  |                                                
|----------------------------------------------------------------------- |  | -----------------------------------------------
|Delaware
(State or other jurisdiction of
incorporation or organization) |  | 95-4484725
(I.R.S. Employer
Identification No.)

920 Hampshire Road, Suite A-34
Westlake Village, California 91361

(Address of principal executive offices)

900 Lafayette Street, Suite 710
Santa Clara, California 95050

(Address of principal corporate offices)

Telephone Number: (408) 296-0600

(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 20, 2002 was approximately $9,400,000.

As of March 20, 2002, there were 47,406,939 shares of the Registrants
Common Stock outstanding.



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TABLE OF CONTENTS



|             |                                                                                               |                                                           |  |  |  |  |  | 
|------------ | --------------------------------------------------------------------------------------------- | --------------------------------------------------------- |  |  |  |  |  | 
|PART I      
|             | Item 1. Business                                                                             
|PART II     
|             | Item 2. Properties                                                                           
|             | Item 3. Legal Proceedings                                                                    
|             | Item 4. Submission of Matters to a Vote of Security Holders                                  
|             | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                
|             | Item 6. Selected Consolidated Financial Data                                                 
|             | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
|             | Item 8. Financial Statements                                                                 
|             |                                                                                               | CONSOLIDATED BALANCE SHEETS                              
|             |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS                    
|             |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS                    
|             |                                                                                               | CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)
|             |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS               
|             | Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosure  
|PART III    
|             | Item 10. Directors and Executive Officers of the Registrant                                  
|             | Item 11. Executive Compensation                                                              
|             | Item 12. Security Ownership of Certain Beneficial Owners and Management                      
|             | Item 13. Certain Relationships and Related Transactions                                      
|PART IV     
|             | Item 14. Exhibits                                                                            
|SIGNATURES  
|EXHIBIT 21.1



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PART I




Item 1.Business

Overview

Spatializer Audio Laboratories, Inc. (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 business relationships with brand
leaders, such as Apple, Toshiba and Matsushita. 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) players,
portable mp3 players, digital televisions and digital home, portable and auto
entertainment devices. As of December 31, 2001, more than 35 million licensed
units had been shipped covering all of these applications. DPIs virtual audio
signal processing technologies are currently incorporated in products offered
by global brand leaders including in consumer electronics, Toshiba, Panasonic,
JVC, Hitachi, Samsung, Sanyo, LG Electronics, Zenith and Sharp, in the PC
multimedia marketplace by Apple Computer, among others, and on the Internet
through our VSP-11 universal sound processor and in software plug-ins for the
WinAmp and Linux-based XMMS MP3 players. We are focused on broadening
recognition of 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 MDT assets for sale. Therefore, MDT has been accounted for as a
discontinued operation. Since 1998, we have been unsuccessful in identifying a
purchaser for the MDT assets or technology. Our repositioning in 1998
recognized that the capital investment required to properly commercialize the
MDT technology was beyond our capacity. We believe this strategy provides a
better opportunity to further solidify our position as a leading provider of
virtual audio solutions, based on our 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 strengthened our
balance sheet and restored our working capital and shareholders equity. The
resulting liquidity allowed us to emerge from a turnaround mode and to pursue
growth and operating stability in 2000.

Our executive offices are located at 920 Hampshire Road, Suite A-34,
Westlake Village, California 91361. Our corporate office and research center is
located at 900 Lafayette Street, Suite 710, Santa Clara, California 95050,
Telephone (408) 296-0600. We maintain a Website at www.spatializer.com.We were
incorporated in the State of Delaware in February, 1994.

Desper Products, Inc.  Virtual 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 virtual audio. The objective in each product category is to create
or simulate the effect of a multi-speaker sonic environment using two ordinary
speakers (or headphones) for playback. The market for virtual audio is
segmented into six broad categories of technology as identified in the listing
below. Each of these technologies utilizes different underlying scientific
principles in accomplishing its design objectives and is targeted to a specific
class of consumer electronics or multimedia computer depending on the intended
product use and functional capability of the product. DPI currently has other
audio signal processing technologies under development which will serve to
expand its market scope and partner product capabilities.

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|                                                                                  |  |                                                                                                                                                                                                        |  |                                                                                                                                                               
|--------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|Category of Technology                                                            |  | Product Categories                                                                                                                                                                                     |  | Virtual Audio Enhancement                                                                                                                                     
|                                                                                  |  |                                                                                                                                                                                                        |  |                                                                                                                                                               
|3-D Stereo(Spatializer® 3-D
Stereo)
Spatializer VirtualSurround VBX              |  | Consumer electronics products
providing stereo playback  DVD
Players, Stereo TVs, VCRs,
Stereo Components and Systems, Car
Audio, Laptop and Desktop
Multimedia Computers, Set-top
Boxes            |  | Surround Sound enhancement from an ordinary stereo (two-channel) signal                                                                                       
|Two-Speaker Virtualization(Spatializer N-2-2,
Spatializer N-2-2 Ultra)          |  | Products incorporating
multi-channel audio sources like
Dolby Digital® (AC-3), Dolby
ProLogic® or MPEG-2. Home
Theater, DVD-Video, Multimedia                                                          |  | Creation of spatially accurate
multi- speaker cinematic audio
experience from two speakers, and
headphones utilizing discrete
multi-channel audio information.
|Digital Virtual Surround Sound                                                    |  | Computers utilizing DVD/MPEG and
decoding.                                                                                                                                                             |  |                                                                                                                                                               
|Bass Enhancement
(Vi.B.E.)                                                       |  | Consumer electronics products
providing stereo playback  DVD
Players, Stereo TVs, VCRs,
Stereo Components and Systems, Car
Audio, Laptop and Desktop
Multimedia Computers and Speakers              |  | Simulation of lower frequency
response from speakers with
relatively high low frequency
capability                                                            
|Internet Audio Enhancement(Spatializer®VSP-11,
StreamFX)                         |  | Laptop and Desktop Multimedia
Computers and portable music
devices running digital media player
Software                                                                                               |  | Surround Sound and bass
enhancement to playback of
ordinary internet audio files                                                                              
|Headphone Virtualization(Spatializer Natural Headphone)
Digital Virtual Surround |  | Products incorporating
multi-channel audio sources like
Dolby Digital® (AC-3), Dolby
ProLogic®, MPEG-2 or stereo. Home
Theater, DVD-Video, Multimedia
Computers utilizing DVD/MPEG
Decoding or stereo. |  | Creation of spatially accurate
multi- speaker cinematic audio
experience from
headphones utilizing discrete
multi-channel audio information.                  
|Phase Corrected Equalization
(Spatializer PCE)                                   |  | All audio products with one or more
speakers                                                                                                                                                           |  | Creation of more recognizable and
cleaner music or dialog from
broadcast or media sources                                                                   

Licensed Products

Our current technology product applications are directed to (1)
two-speaker and headphone virtualization of multi-channel audio for DVD players
and home theater applications, (2) stereo and bass enhancement in consumer
electronics products and multimedia PCs, and (3) downloadable software,
purchased directly by consumers, delivering audio enhancement applications for
PCs.



| | 1. |  | Spatializer® 3D Stereo.Based upon proprietary and patented methods
of stereo signal processing, the Companys Spatializer® 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 (Double Detect and Protect) algorithm. DDP
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 by DPI, in the form of a 20 pin
analog integrated circuit (IC) from Matsushita Electronics Corporation
(MEC), the technology is now incorporated into low-cost, standard
process ICs by four chip foundries (Matsushita, ESS Technologies, Inc.,
OnChip Systems and Luxsonor) for easy and inexpensive implementation in
any consumer electronics or computer products utilizing stereo audio.
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 Stereoeffect in a simplified, lower cost
package. In early 2002, we introduced a new algorithm-based technology
which provides a virtual surround sound effect from a two channel input
for DSP-based environments.
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | 2. |  | Spatializer® N-2-2Digital Virtual Surround. In September 1996, DPI
introduced Spatializer N-2-2,which the Company considers a core, and
enabling technology for DVD based home theater products and personal
computers. In mid-2001, DPI introduced Spatializer N-2-2 Ultraas the
latest generation of this core audio technology. Through outstanding
performance and continuous enhancement, Spatializer N-2-2 has emerged as
the de facto standard for branded virtual surround sound as measured
by most brand adoptions, cumulative shipments and market share of such
brands in the DVD player market. DVD is considered by many to be the
single most important and fastest adopted consumer audio/computer
technology ever introduced. The audio standards for DVD (based upon
geographic region) are multi-channel audio formats (Dolby Digital®
(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-2-2software- 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-2-2runs in real-time on general
purpose Digital Signal Processing (DSP) hardware platforms like those
offered by LSI, Acer Labs, Inc., Motorola, VM Labs and Zoran; may be
integrated with host based software-only MPEG-2 or DVD decoders (like
WinDVD and PowerDVD, offered by InterVideo and Cyberlink, respectively,
for the Intel® Pentium® series of microprocessors); and can be ported to
any of the principal audio codecs or media processor/accelerator
platforms performing Dolby Digital (AC-3) or MPEG-2 audio decoding.
Spatializer N-2-2has been approved by Dolby Laboratories and qualifies
Spatializer licensees to use the newly created Dolby Digital VIRTUAL
trademark on products incorporating the technology. We believe our
Spatializer N-2-2process has helped to widen and accelerate the market
for DVD acceptance, because it delivers the full cinematic audio
experience to ordinary consumers without the additional expense and
complication of multi-speaker home theater playback systems.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 3. |  | Spatializer® 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. This is particularly important in enhancing the audio of all
forms of portable digital audio devices. Spatializer Vi.B.E. uses
proprietary technology to generate the perception of realistic bass
frequencies that are unaffected by actual speaker system frequency
response capability.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| | 4. |  | Spatializer® VSP-11. First introduced by DPI in early 2002,
Spatializer® VSP-11 (Virtual Sound Processor 11) is a stand-alone
application program for Microsoft Windows 95, 98, ME, 2000 and XP
platforms that utilizes Spatializers proprietary psychoacoustic
techniques to allow consumers to enjoy the benefits of the renowned
Spatializer audio enhancement technologies on all leading media players,
soft DVD players and file sharing programs. This means that Spatializer
VSP-11 is truly a universal audio enhancement software package that will
enhance output from the Microsoft®Media Player, Real Player®, Real
Jukebox®, WinAmp®, WinDVD®, PowerDVD®, among others, without any special
modification. It will run in conjunction with any sound card, as well as
with USB audio.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| | 5. |  | Spatializer® Natural Headphone Spatializer Natural Headphone,
introduced by DPI in March 2001, renders spatially accurate multiple
speaker positions simulating the typical home theater or stereo
arrangement through a headphone. The headphone algorithm delivers a high
performance simulated surround sound experience, using a reasonable
amount of processing power at a reasonable cost. Thus, this solution is
equally practical and effective for both low-power portable devices and
home theater applications. Unlike typical virtual surround sound
headphone solutions, which rely heavily on reverberation which can sound
unnatural, Spatializer Natural Headphone utilizes a combination of
techniques to provide an expanded, yet natural sound field.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| | 6. |  | Spatializer® PCE Spatializer PCE, introduced in October 2001,
makes high frequencies clearer, crisper and more brilliant while low
frequencies are more dramatic, tighter and have more impact.
Spatializer® PCE gives the manufacturer an inexpensive way to
dramatically improve the sound of low-end loudspeakers, such as the kind
found in televisions, boom boxes and computers. Spatializer PCE is also
ideal for improving the quality of Internet audio, which can sound
rather lackluster and dull due to compression or low bit rates. It can
be applied prior to encoding audio streams, and can just as easily
enhance the playback of the decompressed audio. It can improve the
clarity, intelligibility and impact of both dialog and music.
Spatializer PCE works by both modifying and smoothing non-linear phase
response and by creating psycho-acoustic cues. Typical equalization
techniques cause phase distortion (non-zero group delay) due to
non-linear phase response. Spatializer PCE has a nearly-linear phase
response, which results in a near-zero group delay. This improves the
naturalness, or transparency of the dialog or music by not adding to
phase distortion already present in many playback systems.. Spatializer
PCE can be custom tailored for two or an array of speaker
configurations. Indeed, the technology, without a surround sound effect,
can enhance single speaker applications as well.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

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In addition to these technologies, we offer a series of products
introduced by DPI under the Spatializer DigitalFX brand, first introduced in
early 2000. The Spatializer DigitalFX series is a comprehensive audio
enhancement software solution based on the Companys Spatializer N-2-2 virtual
surround sound technology, Spatializer Vi.B.E and Spatializer PCE, combined
with additional audio effects tailored and optimized for specific product
applications. This powerful combination of technologies in a single product
targeted for specific product applications provides a highly efficient and cost
effective solution for the television, portable digital music, PDA, AV
Receiver, PC and car audio markets.

Spatializer Digital TVFX is a customized application of Spatializer
technology optimized for digital and analog televisions with an on board
digital signal processor. Spatializer integrates its original, patented 3D
Stereo and N-2-2 technologies with speaker-compensation and Vi.B.E. bass
enhancement algorithms. The digital processing of the stereo signal provides a
striking and immersive audio experience while the virtual bass enhancement
creates apparently deeper bass response from the small speakers utilized by
most televisions. Optional reverb and equalizer features further enhance the
audio experience. The result is a dramatic improvement to the overall audio
sound field provided by the television. Spatializer Digital TVFX is 100%
digital, and applicable to any TV system with an embedded DSP.

Spatializer Digital OntheGoFX is targeted specifically for portable
digital music players and Personal Data Assistants (PDAs). According to
industry analysts, the portable digital player market is expected to grow
significantly once the music industry establishes economically feasible, secure
and convenient modes of electronic music distribution. Spatializer Digital
OntheGoFX shares the same core 3D stereo technology as other members of the
Spatializer DigitalFX series, but includes a highly effective headphone
algorithm which produces an expanded headphone audio experience. In addition,
the included Vi.B.E technology is particularly effective in improving the
limited bass response of inexpensive lightweight stereo headphones often
incorporated into these devices. The algorithms are highly efficient, utilizing
a minimal amount of MIPS any standard embedded DSP.

Spatializer Digital PCFX combines the entire suite of respected
Spatializer audio technologies into a single, comprehensive and cost effective
software audio solution for the Wintel platform. Since the product runs on the
host CPU, with minimal CPU utilization, no discrete chip is required.
Spatializer Digital PCFX provides Spatializer 3-D stereo, Spatializer N-2-2
virtual surround sound for DVD playback, Vi.B.E virtual bass enhancement and
enCompass , Spatializers positional audio technology for computer games
utilizing the Microsoft DirectX API. Apple Computer began utilizing
Spatializer technology across their product platforms in October 1999.

Spatializer Digital AVFX is tailored for AV Receivers equipped with a
Dolby Digital decoder.. Spatializer Digital AVFX provides Spatializer 3-D
stereo, Spatializer N-2-2 virtual surround sound for DVD audio or video
playback, Vi.B.E virtual bass enhancement and in the future, extensive room
modeling and customized effects.

Spatializer Digital AutoFX enhances the audio performance of DSP-based
car stereo systems by delivering Spatializers acclaimed 3-D stereo, bass
enhancement, equalizer and reverb technology in a single solution. Optional
positional audio voice cues for on board GPS and navigation systems, virtual
surround sound for on board DVD player systems and space modeling will be
offered on an optional and customized basis based on specific customer need.

Licensing Activities

Until 2000, we licensed our technologies primarily through semiconductor
manufacturing and distribution licenses (Foundry Licenses) with semiconductor
foundries (Foundries). In turn, these Foundries manufacture and distribute
integrated circuits (ICs) or digital signal processors (DSPs) incorporating
Spatializer technology to manufacturers of consumer electronics and multimedia
computer products (OEMs).

In 2000, we began offering Foundries the option of entering into a
non-royalty bearing distribution agreement with us. Under this business model,
the foundry offers Spatializer technology as an optional feature, promotes our
technology in their sales materials and cooperates with the Spatializer sales
force in closing license agreements for Spatializer technology with the OEM
customer. This business model provides the foundry with an additional selling
feature at no additional cost to the foundry. The OEM can obtain use of the
technology directly from Spatializer without any additional mark-up from the
foundry.

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The terms of all of our licenses are negotiated on an individual basis
requiring the payment of a per unit running royalty according to sliding scales
based upon cumulative volume. Some of our licenses call for the payment of an
up-front license issuance fee either in lieu of, or in addition to the running
royalty. Other agreements require the OEM customer, rather than the foundry, to
pay the royalty. Per unit royalties are generally reportable and payable 45
days after the end of the quarter following shipment from the Foundry to the
OEM or, in the case of a distribution agreement, by the OEM to its accounts.

OEMs who desire to incorporate these DSPs or 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 DSPs or ICs with Spatializer technology to OEMs who have entered into an
OEM License with us. OEM licenses generally provide for the payment of a
further per unit royalty by the OEM for OEM products incorporating a
Spatializer IC (Licensed Products) payable in the quarter following shipment
by the OEM of its Licensed Products.

In early 2001, we reached an agreement with C-Cube Semiconductor II (now
LSI Logic Corporation) to unbundle the royalty on their DSPs in order to
facilitate the licensing of multiple technologies to OEM manufacturers and to
help ensure that their products remained highly competitive in the market. As
such, effective April 1, 2001, C-Cubes customers using Spatializer technology
have entered into direct licenses with us.

We are currently negotiating new IC/DSP Foundry and OEM licenses with
potential customers for Spatializer N-2-2, Spatializer Vi.B.E., Spatializer 3-D
stereo , Spatializer VSP-11, Spatializer PCEand combinations and optimizations
of these technologies under the Spatializer DigitalFX series.

IC/DSP Foundry Licenses

In 2000 and early 2001, VM Labs, Inc., MIPS Technologies, New Japan Radio
Corporation (NJRC), Tvia, Inc. and Link Up Systems entered into Foundry
License or Distibution Agreements for Spatializer N-2-2 and or DigitalFX. All
but the NJRC agreements were non-royalty bearing distribution agreements, with
per unit royalties to be paid by the OEM customer.

In 2001, we entered into license or distribution agreements with Texas
Instruments, Cirrus Logic, Sanyo, Sharp and Kenwood, among others.

As of December 31, 2001, we have entered into thirteen non-exclusive
Foundry Licenses for our Virtual 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), Luxsonor, VM Labs, Inc., MIPS Technologies, NJRC, Tvia,
Inc., Texas Instruments, Cirrus Logic and Link Up Systems. 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.

As of December 31, 2001, more than 35 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, 2001, our technology has been incorporated in products
offered by more than 95 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, 2001:

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|                                               |  |                                                                      
|---------------------------------------------- |  | ---------------------------------------------------------------------
|Partial List of OEM Licensees or Customers     |  |                                                                      
|                                               |  |                                                                      
|Apple, Computer Inc.                           |  | NEC                                                                  
|Cirrus Logic                                   |  | Panasonic TV & VCR (Matsushita Kotobuki Electronics Industries, Ltd.)
|Dell Computer Corp.                            |  | Panasonic Car Audio (Matsushita Communications Industrial Co., Ltd.) 
|Digital Technology Systems Of California, Inc. |  | Proton Electronic Industrial Co., Ltd.                               
|Emerson                                        |  | Samsung                                                              
|Fujitsu Computer Corp.                         |  | Seiko Epson Corp.                                                    
|Hewlett Packard                                |  | Sanyo Corp.                                                          
|Hitachi, Ltd.                                  |  | Sharp Corp.                                                          
|Iiyama Electric Co., Ltd.                      |  | Toshiba DVD                                                          
|Gateway Computer Corp.                         |  | Toshiba TV                                                           
|Golden Regent                                  |  | Taisei Electric, Inc.                                                
|LG Electronics                                 |  | Taiyo Electric Company, Ltd.                                         
|JVC                                            |  | Texas Instruments                                                    
|Labtec Enterprises, Inc.                       |  | Theta Digital                                                        
|Mag Monitors                                   |  | VM Labs, Inc.                                                        
|Marantz                                        |  | Zenith                                                               
|Micron Computer Corp                           |  |                                                                      
|Mitsubishi Image and Information Works         |  |                                                                      

Hardware Products

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, we 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 MDT 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 MDT transaction was intended
to position us for long term growth in a significant new market. Our intention
was to license this technology or enter into third party manufacturing
arrangements for sale of MDT CD/DVD changer products to OEMs.

The MDT transaction brought a 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 our core audio technologies and to properly position the
MDT 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 operations, including 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 our audio business from royalties pursuant to our
Foundry, OEM, and other licenses, and from non-recurring engineering fees to
port our technologies to specific licensees applications. The Companys
revenues, which totaled $1,604,000 in 2001, were derived almost entirely from
Foundry and OEM license fees and royalties.

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

In 2001, four major customers, not presented in order of importance, each
accounted for 10% or more of our total revenues: Apple Computer, Inc., LSI,
Samsung and Toshiba Corporation in 2001, each of whom accounted for greater
than 10% of our total 2001 revenues. One OEM accounted for 40%, another
accounted for 23%, another accounted for 15% and one accounted for 14% of our
royalty revenues during 2001. One other account comprised 7% of total 2001
revenues. All other OEMs accounted for less than 1% of royalty revenues
individually.

The Company achieved profitable operating results in 1999 and 2000 as a
result of overhead reductions combined with the strong growth of DVD-related
revenues. In 2001, we began expanding our headcount, primarily in the
engineering area in anticipation of

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continued growth. At midyear, in light of a weakening in market conditions
and lower than anticipated royalties from a key Asian account, expenditures
were once again curtailed in order to bring overhead levels more in line with
current revenues. Declining revenues were experienced from three major
customers resulting from sluggish sales of their products and the cessation of
use of our products by the smaller of these customers. In addition, while
overhead reductions were implemented at mid-year, profitability was further
impacted by either the delay or cancellation of anticipated products using our
technology in light of weak market conditions. As a result, we were not
profitable in 2001.

Competition

Virtual 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®, Dolby ProLogic®, and DTS®), as
well as other technologies designed to create an enhanced stereo image from two
or more speakers.

Our principal competitors in the field of virtual audio are SRS Labs, Inc.
and Qsound Labs, Inc. In addition, some DSP foundries and OEMs have
proprietary virtual audio technologies that they regularly offer to OEMs at no
cost. Pressure on OEMs to reduce their costs, particularly in the DVD market is
intense. The marketplace is also susceptible to undisciplined competitors who,
from time to time, may offer below market prices in a desperate attempt to
generate short term revenue. 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, virtual surround sound, headphone and speaker
virtualization technologies. By virtue of our specialized engineering and OEM
support, we can offer a turn-key audio solution to OEMs who do not possess
this expertise internally. We also have developed new products that address our
customers need for a low cost solution. In addition, the strength of our IC
Foundry and OEM relationships and the Spatializer brand name recognition in the
industry are other key differentiators between both our branded and unbranded
competition. Lastly, we continue to explore new and alternative business models
that we believe serve the interests of both our customers and our shareholders.

Patents, Trademarks and Copyrights

Our core signal processing technology is covered by U.S. patents
5,412,731, 5,896,456 and 6,307,941. On March 20, 1998, we filed a patent on our
enCompass V 2.0 technology with the USPTO covering the Companys enCompass 2.0
positional audio gaming technology. In June 2000, we filed an additional patent
application for our reduced cost/higher performance 3-D Stereo circuit design.
Much of our intellectual property consists of trade secrets. We possess
copyright protection for its principal software applications and has U.S. and
foreign trademark protection for its key product names and logo marks.

The MDT transaction brought a 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 USPTO to bring the total to fifty-two patent applications filed. However,
due to the absence of working capital and suspension of all operating
activities of MDT, MDT cannot pursue 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. MDT has 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 our 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, operations, including all research and
development activities were suspended and we have accounted for MDT as a
discontinued operation.

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Employees

We began 2001 with six full-time and twelve part-time employees and sales
representatives and decreased our staff to five full time and nine part-time
employees, consultants and sales representatives by December 31, 2001. At
year-end, there were three full-time employees and three consultants engaged in
research and development. We employ the services of outside professional
consultants, particularly in the engineering area, due to the tight labor
market for such professionals in Silicon Valley as well as the need for
specialized expertise in the course of our business. None of our employees are
represented by a labor union or are subject to a collective bargaining
agreement. We consider our relations with our employees and consultants to be
satisfactory.

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PART II




Item 2.Properties

Our executive office is located in Westlake Village, California where we
occupy approximately 300 square feet with an annual rent of approximately
$9,600. The lease term on this space expires in April 2002 and is month to
month thereafter. This space in the Los Angeles area is used to facilitate
business and contacts with the entertainment community as well as with our
accountants, lawyers and directors.

Our corporate office in Santa Clara, CA, is the primary location for our
audio technology division, (DPI). We occupy approximately 2,700 square feet
with an annual rent on a full service basis of approximately $79,000. The lease
expires on November 30, 2002.

We lease an apartment in Santa Clara, CA for use by the chief executive
officer when away from the executive office. The annual rent on this apartment
is approximately $18,000. The lease expires on July 31, 2002.

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 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, MDT, alleging breach of contract and fraud,
and claiming $499,954 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 has been settled. The settlement
specifies that I.N. will be entitled to a cashless exercise of warrants for the
125,000 shares originally issued to them in 1997 and 1998, or a cash payment of
$50,000 if the warrants remained unexercised. In January 2001, the cash payment
was made and no further liabilities or contingencies exist.

In connection with the downsizing of the Company, a number of employees
were terminated and have filed, on various dates since the downsizing in 1998,
various employment and compensation related claims with the various California
State labor authorities, all but two of which claims have either been settled
or have been paid as of the date of this report. Two former officers and employees of MDT initiated
proceedings before the Labor Commissioner in 2000 seeking amounts allegedly due
under their employment agreements, which claims, if resolved in favor of the
claimants, could be material to the financial statements of the Company. The
Labor Commissioner has postponed those proceedings. In that action, the
claimants filed a motion to strike the MDT complaint under the California
anti-Slapp legislation. The Court rejected that motion and the litigation is
in the discovery stages. Separately, MDT has initiated litigation in the
Superior Court, Orange County seeking declaratory relief to bar the labor
claims, as well as return of intellectual property and unspecified damages for
breaches of the former officers and employees employment agreements. Both
employees have filed for personal bankruptcy and as a result, the claims are
inactive. At year end, bankruptcy for one such employee had been dismissed. That proceeding could be reactivated.

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




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, 2001.

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Item 5.Market for Registrants Common Equity and Related Stockholder Matters

Our Common Stock trades on the OTC Bulletin Board under the symbol SPAZ.
The following table sets forth the high and low sales price of our Common Stock
on its principal market for fiscal years 2001 and 2000:

|        |                |               |   |              |  |  |   |      | 
|------- | -------------- | ------------- | - | ------------ |  |  | - | ---- | 
|Period: |                | High (U.S. $) |   | Low (U.S. $)
|        |                |               |   |             
|2000    |                |               |   |              |  |  |   |     
|        | First Quarter  |               | $ | 2.56         |  |  | $ | 0.94 | 
|        | Second Quarter |               | $ | 1.56         |  |  | $ | 0.44 | 
|        | Third Quarter  |               | $ | 1.06         |  |  | $ | 0.50 | 
|        | Fourth Quarter |               | $ | 0.69         |  |  | $ | 0.56 | 
|2001    |                |               |   |              |  |  |   |     
|        | First Quarter  |               | $ | 0.56         |  |  | $ | 0.25 | 
|        | Second Quarter |               | $ | 0.38         |  |  | $ | 0.23 | 
|        | Third Quarter  |               | $ | 0.31         |  |  | $ | 0.15 | 
|        | Fourth Quarter |               | $ | 0.21         |  |  | $ | 0.11 | 

On March 20, 2002, the closing price reported by the OTC Bulletin Board
was U.S. $0.20. Stockholders are urged to obtain current market prices for our
Common Stock. Since April 1, 1997, Computershare Investor Services, successor
to Harris Trust Company of California, has been our transfer agent.

Record Holders

To our knowledge there were approximately 200 holders of record of the
stock of the Company as of March 20, 2002. However, our transfer agent has
indicated that beneficial ownership is in excess of 6,000 shareholders.

Dividends

We have not paid any cash dividends on its Common Stock and have 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.

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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 year ended December 31,
1997 is 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, 2001,
2000, 1999 and 1998 are derived from the Companys consolidated financial
statements that have been audited by Farber & Hass LLP, independent certified
public accountants. The consolidated statements of operation and cash flows for
the year ended December 31, 2001 and the report thereon are included elsewhere
in this Report.

|                                           |  |                   |            |              |  |              |            |              |  |              |            |   |  |   |            |   |  |   |            |  
|------------------------------------------ |  | ----------------- | ---------- | ------------ |  | ------------ | ---------- | ------------ |  | ------------ | ---------- | - |  | - | ---------- | - |  | - | ---------- | -
|                                           |  | Fiscal Year Ended
|                                           |  |                  
|                                           |  | December 31,      |            | December 31, |  | December 31, |            | December 31, |  | December 31,
|                                           |  | 1997              |            | 1998         |  | 1999         |            | 2000         |  | 2001        
|                                           |  |                   |            |              |  |              |            |              |  |             
|Consolidated Statement of
Operations Data: |  |                   |            |              |  |              |            |              |  |              |            |   |  |   |            |   |  |   |            |  
|Revenues                                   |  | $                 | 2,781      |              |  | $            | 1,680      |              |  | $            | 1,660      |   |  | $ | 2,202      |   |  | $ | 1,604      |  
|Cost Of Revenues                           |  |                   | (230       | )            |  |              | (134       | )            |  |              | (49        | ) |  |   | (248       | ) |  |   | (97        | )
|                                           |  |                   |            |              |  |              |            |              |  |              |            |   |  |   |            |   |  |   |            |  
|Gross Profit                               |  |                   | 2,551      |              |  |              | 1,546      |              |  |              | 1,611      |   |  |   | 1,954      |   |  |   | 1,507      |  
|Total Operating Expenses                   |  |                   | (7,238     | )            |  |              | (3,490     | )            |  |              | (1,156     | ) |  |   | (1,596     | ) |  |   | (1,823     | )
|Other Income (Expense),
Net                |  |                   | 27         |              |  |              | (108       | )            |  |              | (94        | ) |  |   | 34         |   |  |   | 73         |  
|Loss from Discontinued
Operations          |  |                   |            |              |  |              | (3,702     | )            |  |              |            |   |  |   |            |   |  |   |            |  
|Income taxes                               |  |                   | (60        | )            |  |              | (38        | )            |  |              | (6         | ) |  |   | (10        | ) |  |   | 3          |  
|                                           |  |                   |            |              |  |              |            |              |  |              |            |   |  |   |            |   |  |   |            |  
|Net Income (Loss)                          |  | $                 | (4,720     | )            |  | $            | (5,792     | )            |  | $            | 355        |   |  | $ | 382        |   |  | $ | (240       | )
|                                           |  |                   |            |              |  |              |            |              |  |              |            |   |  |   |            |   |  |   |            |  
|Basic Income (Loss) Per
Share(5)           |  | $                 | (0.23      | )            |  | $            | (0.29      | )            |  | $            | 0.01       |   |  | $ | 0.01       |   |  | $ | (0.01      | )
|                                           |  |                   |            |              |  |              |            |              |  |              |            |   |  |   |            |   |  |   |            |  
|Diluted Income (Loss) Per
Share(5)         |  | $                 | (0.23      | )            |  | $            | (0.29      | )            |  | $            | 0.01       |   |  | $ | 0.01       |   |  | $ | (0.01      | )
|                                           |  |                   |            |              |  |              |            |              |  |              |            |   |  |   |            |   |  |   |            |  
|Weighted Average Common
Shares             |  |                   | 20,604,095 |              |  |              | 22,180,180 |              |  |              | 33,805,512 |   |  |   | 46,736,224 |   |  |   | 47,388,235 |  
|                                           |  |                   |            |              |  |              |            |              |  |              |            |   |  |   |            |   |  |   |            |  
|Consolidated Balance
Sheet Data:           |  |                   |            |              |  |              |            |              |  |              |            |   |  |   |            |   |  |   |            |  
|Cash and Cash Equivalents                  |  | $                 | 577        |              |  | $            | 264        |              |  | $            | 1,022      |   |  | $ | 1,468      |   |  | $ | 869        |  
|Working Capital (Deficit)                  |  |                   | 83         |              |  |              | (1,975     | )            |  |              | 395        |   |  |   | 1,195      |   |  |   | 1,124      |  
|Total Assets                               |  |                   | 3,165      |              |  |              | 893        |              |  |              | 2,118      |   |  |   | 2,457      |   |  |   | 1,753      |  
|Advances From Related
Parties              |  |                   | 113        |              |  |              | 857        |              |  |              | 337        |   |  |   | 337        |   |  |   | 113        |  
|Total Shareholders Equity
(Deficit)       |  | $                 | 1,525      |              |  | $            | (1,553     | )            |  | $            | 768        |   |  | $ | 1,651      |   |  | $ | 1,411      |  

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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 the Company and our subsidiaries for the year
ended December 31, 2001 compared to the year ended December 31, 2000, and the
year ended December 31, 2000 compared with the year ended December 31, 1999.

Results of Operations

For the Year Ended December 31, 2001, Compared to the Year Ended December 31, 2000

Revenues

Revenues decreased to $1,604,000 for the year ended December 31, 2001
compared to $2,202,000 for the year ended December 31, 2000, a decrease of
27%. Revenues include license issuance fees and royalties pertaining to the
licensing of Spatializer® audio signal processing designs and non-recurring
engineering fees.

The decrease in revenues is attributed primarily to (i) decreased
royalties from one account resulting from lower unit sales compared to the
prior year, (ii) lower royalties from another account due to a timing
difference between 2000 and 2001 created when royalty reporting shifted from
the DSP foundry (on shipment of DSP) to OEM customer (shipment of DVD player),
(iii) loss of an account in mid 2001 which had comprised less than 10% of sales
in the prior year and (iv) decreases in per unit Spatializer N-2-2 royalties
due to a volume-based sliding scale pricing structure with DSP foundries which
did not stabilize until the beginning of the third quarter of 2000.

Gross profit decreased to $1,507,000 for the year ended December 31, 2001
compared to $1,954,000 in the comparable period last year. Gross margin
increased to 95% of revenue in the year ended December 31, 2001 compared with
89% of revenue for the comparable period last year. The decrease in gross
profit results from lower revenues in the current year, partially offset by
higher gross margin. This increase in the gross margin percentage reflects the
realignment of our Asian sales rep network which included the implementation of
lower commission rates. The Company maintains a high margin since revenues are
from licensing and royalty activities, which have little or no associated
direct manufacturing or selling costs.

Operating Expenses

Operating expenses for the year ended December 31, 2001 increased to
$1,823,000 (114% of sales) from $1,595,000 (72% of sales) for the year ended
December 31, 2000, a increase of 11%. The increase in operating expenses
results from expansion of the Companys research and development efforts and
higher general and administrative expenses relating to legal and public company
expenses. The Company undertook an expansion of headcount in early 2001. When
it became clear in mid 2001 that anticipated revenue growth was not occurring,
the Company began to curtail the scope of its initiatives in order to bring
spending levels back in line with reported revenue streams.

General and Administrative

General and administrative costs increased to $707,000 for the year ended
December 31, 2001 from $599,000 for the year ended December 31, 2000, an
increase of 18%. The increase is primarily due to increased legal expenses
related to public filings and increased travel by the CEO. General operating
costs include rent, telephone, legal, public filing, office supplies and
stationery, postage, depreciation and similar costs.

Research and Development

Research and Development costs increased to $640,000 for the year ended
December 31, 2001, compared to $540,000 for the year ended December 31,2000, an
increase of 19%. The increase in research and development expense was due to
the additions to headcount early in the year, search fees paid for certain
engineers hired by the Company and expanded use of engineering consultants for
specialized projects.

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In addition, the Company continued efforts to identify, validate, and
develop new product ideas at DPI. Specific engineering efforts were directed
toward the launch of Spatializer N-2-2 Ultra , development of Spatializer
PCE, refinement of Spatializer Natural Headphone and applications engineering
to port the Companys technology to leading processor platforms.

Sales and Marketing

Sales and Marketing costs increased to $476,000 for the year ended
December 31, 2001, compared to $456,000 for the year ended December 31, 2000,
an increase of less than one percent. Spending was maintained at the prior
years level in order to continue the development of markets for
existing products.

Net Income (Loss)

Net loss was $240,000 for the year ended December 31, 2001, compared to
net income of $382,000 for the year ended December 31, 2000. The net loss for
the current period is primarily the result of lower revenues and higher
overhead, partially offset by improved gross margin.

For the Year Ended December 31, 2000, Compared to the Year Ended December 31, 1999

Revenues

Revenues increased to $2,202,000 for the year ended December 31, 2000
compared to $1,660,000 for the year ended December 31, 1999, an increase of
33%. Revenues include license issuance fees and royalties pertaining to the
licensing of Spatializer® audio signal processing designs and non-recurring
engineering fees.

The increase in revenues is attributed primarily to the inclusion of four
quarters of royalties from a major account for which there was only one quarter
of royalty and a non-recurring engineering fee in the prior year and increases
in Spatializer N-2-2 running royalties from OEM DVD player sales. This increase
in revenues was partially offset by decreases in per unit Spatializer N-2-2
royalties due to a volume-based sliding scale pricing structure with DSP
foundries agreed to in prior years when the original agreements were made. By
the beginning of the third quarter of 2000, pricing levels at the maximum
volume levels were substantially achieved, resulting in a stabilization of the
per unit royalty rate.

Gross profit increased to $1,954,000 for the year ended December 3, 2000
compared to $1,612,000 in the comparable period last year. Gross margin
decreased to 89% of revenue in the year ended December 31, 2000 compared with
97% of revenue for the comparable period last year. The increase in gross
profit results from higher revenues in the current year, partially offset by
lower gross margin. This decrease in the gross margin percentage reflects the
restoration of Japan sales support which were reduced significantly in 1999
during the period of constrained liquidity. 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, 2000 increased to
$1,595,000 (72% of sales) from $1,156,000 (70% of sales) for the year ended
December 31, 1999, an increase of 38%. The increase in operating expenses
result from expansion of the Companys research and development and sales and
marketing efforts, which were curtailed in most of 1999 to minimal levels as a
result of the period of constrained liquidity. With liquidity restored as a
result of the December 1999 financing, the Company expanded its staff to more
normalized levels and the increase was limited to 200 basis points of sales.

General and Administrative

General and administrative costs increased to $599,000 for the year ended
December 31, 2000 from $516,000 for the year ended December 31, 1999, an
increase of 16%. The increase is primarily due to the retention of an investor
relations firm and a local business tax settlement. General operating costs
include rent, telephone, office supplies and stationery, postage, depreciation
and similar costs.

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Research and Development

Research and Development costs increased to $540,000 for the year ended
December 31, 2000, compared to $383,000 for the year ended December 31,1999, an
increase of 41%. The increase in research and development expense was due
additions to headcount throughout the year, search fees paid for certain
engineers hired and expanded use of engineering consultants for specialized
projects.
In addition, the Company continued efforts to identify, validate, and
develop new product ideas at DPI. Specific engineering efforts were directed
toward a new version of Spatializer N-2-2 , optimization of technologies for
the DigitalFX series and development of a new series of headphone algorithms.

Sales and Marketing

Sales and marketing costs increased to $456,000 for the year ended
December 31, 2000, compared to $257,000 for the year ended December 31, 1999,
an increase of 77%. The increase results from the appointment of a public
relations firm, formal trade show participation, increased customer visits and
prospecting, support staff expansion and revision of marketing collateral
materials.

Net Income

Net Income increased to $382,000 for the year ended December 31, 2000,
compared to net income of $355,000 for the year ended December 31, 1999, an
increase of 8%. The improvement for the period is primarily the result of
higher interest income and lower interest expense, partially offset by lower
operating profit driven by lower gross margin and slightly higher overhead
expenses as a percentage of sales.

Liquidity and Capital Resources

At December 31, 2001, we had $869,000 in cash and cash equivalents as
compared to $1,468,000 at December 31, 2000. The decrease in cash and cash
equivalents is attributed to elimination of all non-Desper Trust related party
notes payable, reduction in liabilities and cash components of the net loss. We
had working capital of $1,124,000 at December 31, 2001 as compared with working
capital of $1,195,000 at December 31, 2000. Our future cash flow will come
primarily from the audio signal processing licensing, Original Equipment
Manufacturers (OEM) royalties and from possible common stock issuances
including warrants and options. We are actively engaged in negotiations for
additional audio signal processing licensing arrangements which should generate
additional cash flow without imposing any substantial costs on the Company.

Like other operating enterprises, the events of September 11, 2001 in the
United States brought a degree of uncertainty to our operations and hindered
our ability to plan and meet with our contractual partners outside the United
States in this dynamic environment. The operations of our business, and those
of our competitors, may also be impacted by the continued trend in the
semiconductor industry to offer free, but minimal audio solutions to certain
product classes to maintain and attract market share. This challenges our
ability to convert business opportunities to licensing agreements in those
segments that allow us to maintain or rapidly increase revenue. As a result,
the Company must develop and license its products and software solutions in a
market that treats some audio products, including those of our competitors, on
a commodity basis in those cases where the OEM product is considered a
commodity product. While our software applications deliver what we and most
manufacturers who listen to it believe is a significantly superior audio
experience, the competitive market forces that pressure manufacturers to
reduce their costs may create some resistance to new technology adoption or
use. In addition, certain of our competitors appear to be pursuing a business
plan that disregards commercially reasonable pricing to achieve a larger market
penetration even if the penetration will not provide for viable margins or
returns. The Company has responded by offering additional products targeted to
each price/quality segment of the market and continues to aggressively pursue
new opportunities in emerging product categories and complements to our
existing core business. In addition, our products have been positioned as a
means for manufacturers to save money while delivering an enhanced audio
experience. Nevertheless, these market conditions and competitive forces make
it more challenging for the Company, and its rational commercial competitors,
to enhance their operating results.

We have a related party obligation of $112,500, which is due upon demand.
We repaid related party obligations of $225,000 plus accrued interest of
approximately $30,000, which were convertible into Common Stock at our or the
Lenders option in June 2001. The Company owed a total of $337,500 to related
parties on December 31, 2000 and December 31, 1999.

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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 $0.56 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 there
from 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 our existing operations and customer base is expected to be sufficient for
us to meet our operating obligations and the anticipated additional research
and development for our audio technology business.

Net Operating Loss Carry forwards

At December 31, 2001, the Company had net operating loss carry forwards
for Federal income tax purposes of approximately $26,000,000 which are
available to offset future Federal taxable income, if any, through 2013.
Approximately $21,700,000 of these net operating loss carry forwards are
subject to an annual limitation of approximately $1,000,000.

Inflation

We believe that the moderate inflation rate of the last several years has
not impacted our operations.

The Asian Economic Crisis

Approximately 59% of our revenues for the year ended December 31, 2001
were derived from foundries or OEMs based in Japan and other Asian countries.
While the level of the Companys Asian business is material, the concentration
of this Asian business with large, well-capitalized entities such as Matsushita
Electronics Corporation, Toshiba Corporation and Samsung may tend to minimize
any real or potential risk of concentration in this market.

16



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##### Table of Contents



INDEPENDENT AUDITORS REPORT

To the Board of Directors
Of Spatializer Audio Laboratories, Inc.:

We have audited the accompanying consolidated balance sheets of
Spatializer Audio Laboratories, Inc. and subsidiaries (The Company) as of
December 31, 2001 and 2000 and the related consolidated statements of
operations, shareholders equity, and cash flows for the years ended
December 31, 2001, 2000 and 1999. 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, 2001 and 2000, and
the results of its operations and its cash flows for the years ended December
31, 2001, 2000 and 1999 in conformity with generally accepted accounting
principles.

/s/ FARBER & HASS LLP

Oxnard, California
March 15, 2002

17



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##### Table of Contents






Item 8.Financial Statements

SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES




CONSOLIDATED BALANCE SHEETS

ASSETS

|                                     |                                                                                                                                                                                       |                            |           |             |              |   |              |             |           |  | 
|------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | --------- | ----------- | ------------ | - | ------------ | ----------- | --------- |  | 
|                                     |                                                                                                                                                                                       |                            |           |             | December 31, |   | December 31,
|                                     |                                                                                                                                                                                       |                            |           |             | 2001         |   | 2000        
|                                     |                                                                                                                                                                                       |                            |           |             |              |   |             
|Current Assets:                      |                                                                                                                                                                                       |                            |           |             |              |   |              |            
|                                     | Cash and Cash Equivalents                                                                                                                                                             |                            | $         | 869,478     |              |   | $            | 1,467,988   |          
|                                     | Accounts Receivable                                                                                                                                                                   |                            |           | 442,555     |              |   |              | 506,558     |          
|                                     | Prepaid Expenses and Deposits                                                                                                                                                         |                            |           | 133,251     |              |   |              | 26,458      |          
|                                     |                                                                                                                                                                                       |                            |           |             |              |   |              |            
|                                     |                                                                                                                                                                                       | Total Current Assets       |           |             | 1,465,284    |   |              |             | 2,001,004 | 
|Property and Equipment, Net          |                                                                                                                                                                                       |                            | 50,586    |             |              |   | 108,061      |            
|Intangible Assets, Net               |                                                                                                                                                                                       |                            | 255,726   |             |              |   | 302,789      |            
|Other Assets                         |                                                                                                                                                                                       |                            | 1,510     |             |              |   | 45,170       |            
|                                     |                                                                                                                                                                                       |                            |           |             |              |   |              |            
|                                     |                                                                                                                                                                                       | $                          | 1,753,106 |             |              | $ | 2,457,024    |            
|                                     |                                                                                                                                                                                       |                            |           |             |              |   |              |            
|LIABILITIES AND STOCKHOLDERS EQUITY
|Current Liabilities:                 |                                                                                                                                                                                       |                            |           |             |              |   |              |            
|                                     | Notes Payable to Related Party                                                                                                                                                        |                            |           | 112,500     |              |   |              | 337,742     |          
|                                     | Accounts Payable                                                                                                                                                                      |                            |           | 14,872      |              |   |              | 51,782      |          
|                                     | Accrued Wages and Benefits                                                                                                                                                            |                            |           | 72,969      |              |   |              | 61,390      |          
|                                     | Accrued Expenses                                                                                                                                                                      |                            |           | 41,197      |              |   |              | 99,595      |          
|                                     | Net Liabilities of Discontinued Operation                                                                                                                                             |                            |           | 100,000     |              |   |              | 255,840     |          
|                                     |                                                                                                                                                                                       |                            |           |             |              |   |              |            
|                                     |                                                                                                                                                                                       | Total Current Liabilities  |           |             | 341,538      |   |              |             | 806,349   | 
|                                     |                                                                                                                                                                                       |                            |           |             |              |   |              |            
|                                     | Commitments and Contingencies                                                                                                                                                         |                            |           |             |              |   |              |             |          
|Stockholders Equity (Deficit):      |                                                                                                                                                                                       |                            |           |             |              |   |              |            
|                                     | 10% Series B Convertible Preferred shares,
$0.01 par value; 1,000,000 shares authorized; 87,967 and 102,967
shares issued and outstanding at December
31, 2001 and 2000, respectively |                            |           | 880         |              |   |              | 1,030       |          
|                                     | Common shares, $0.01 par value; 65,000,000 shares
authorized;47,406,939 and 47,087,971 shares issued and
outstanding at December 31, 2001 and 2000,
respectively                      |                            |           | 474,070     |              |   |              | 470,880     |          
|                                     | Additional Paid-In Capital                                                                                                                                                            |                            |           | 46,402,852  |              |   |              | 46,404,892  |          
|                                     | Accumulated Deficit                                                                                                                                                                   |                            |           | (45,466,234 | )            |   |              | (45,226,127 | )        
|                                     |                                                                                                                                                                                       |                            |           |             |              |   |              |            
|                                     |                                                                                                                                                                                       | Total Shareholders Equity |           |             | 1,411,568    |   |              |             | 1,650,675 | 
|                                     |                                                                                                                                                                                       |                            |           |             |              |   |              |            
|                                     |                                                                                                                                                                                       | $                          | 1,753,106 |             |              | $ | 2,457,024    |            
|                                     |                                                                                                                                                                                       |                            |           |             |              |   |              |            

See accompanying notes to consolidated financial statements

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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES




CONSOLIDATED STATEMENTS OF OPERATIONS

|                            |                            |                                            |                                     |           |                         |            |           |           |         |            |           |           |         |            | 
|--------------------------- | -------------------------- | ------------------------------------------ | ----------------------------------- | --------- | ----------------------- | ---------- | --------- | --------- | ------- | ---------- | --------- | --------- | ------- | ---------- | 
|                            |                            |                                            |                                     |           | Year Ended December 31,
|                            |                            |                                            |                                     |           |                        
|                            |                            |                                            |                                     |           | 2001                    |            | 2000      |           | 1999   
|                            |                            |                                            |                                     |           |                         |            |           |           |        
|Revenues:                   |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          
|                            | Product Revenues, Net      |                                            |                                     |           |                         |            |           |           |         |            |           |           |        
|                            | Licensing Revenues         |                                            |                                     |           |                         |            |           |           |         |            |           |           |        
|                            | Royalty Revenues           |                                            | $                                   | 1,603,782 |                         |            | $         | 2,201,812 |         |            | $         | 1,660,371 |        
|                            |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          
|                            |                            |                                            | 1,603,782                           |           |                         |            | 2,201,812 |           |         |            | 1,660,371 |          
|                            |                            | Cost of Revenues                           |                                     |           | 96,783                  |            |           |           | 248,217 |            |           |           | 48,780  |           
|                            |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          
|                            |                            |                                            | 1,506,999                           |           |                         |            | 1,953,595 |           |         |            | 1,611,591 |          
|                            |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          
|Operating Expenses:         |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          
|                            | General and Administrative |                                            |                                     | 707,115   |                         |            |           | 599,291   |         |            |           | 515,843   |        
|                            | Research and Development   |                                            |                                     | 639,223   |                         |            |           | 540,269   |         |            |           | 383,176   |        
|                            | Sales and Marketing        |                                            |                                     | 476,432   |                         |            |           | 455,901   |         |            |           | 257,017   |        
|                            |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          
|                            |                            |                                            | 1,822,770                           |           |                         |            | 1,595,461 |           |         |            | 1,156,036 |          
|                            |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          
|                            |                            | Operating Income (Loss)                    |                                     |           | (315,771                | )          |           |           | 358,134 |            |           |           | 455,555 |           
|                            |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          
|Interest Income             |                            |                                            | 41,358                              |           |                         |            | 64,857    |           |         |            | 3,401     |          
|Interest Expense            |                            |                                            | (11,250                             | )         |                         |            | (34,112   | )         |         |            | (102,468  | )        
|Other Income (Expense), Net |                            |                                            | 42,691                              |           |                         |            | 3,140     |           |         |            | 4,804     |          
|                            |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          
|                            |                            |                                            | 72,799                              |           |                         |            | 33,885    |           |         |            | (94,263   | )        
|                            |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          
|                            |                            | Income (Loss) Before Income Taxes          |                                     |           | (242,972                | )          |           |           | 392,019 |            |           |           | 361,292 |           
|                            |                            | Income Taxes                               |                                     |           | 2,865                   |            |           |           | (10,000 | )          |           |           | (6,500  | )         
|                            |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          
|                            |                            | Net Income (Loss)                          |                                     | $         | (240,107                | )          |           | $         | 382,019 |            |           | $         | 354,792 |           
|                            |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          
|                            |                            | Basic and Diluted Income (Loss) per Share: |                                     | $         | (.01                    | )          |           | $         | .01     |            |           | $         | .01     |           
|                            |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          
|                            |                            |                                            | Weighted-Average Shares Outstanding |           |                         | 47,247,455 |           |           |         | 46,736,224 |           |           |         | 33,805,512 | 
|                            |                            |                                            |                                     |           |                         |            |           |           |         |            |           |          

See accompanying notes to consolidated financial statements

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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES




CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                  |                                                                                                 |                                        |           |                         |          |      |           |         |          |   |           |           |          |  
|------------------------------------------------- | ----------------------------------------------------------------------------------------------- | -------------------------------------- | --------- | ----------------------- | -------- | ---- | --------- | ------- | -------- | - | --------- | --------- | -------- | -
|                                                  |                                                                                                 |                                        |           | Year Ended December 31,
|                                                  |                                                                                                 |                                        |           |                        
|                                                  |                                                                                                 |                                        |           | 2001                    |          | 2000 |           | 1999   
|                                                  |                                                                                                 |                                        |           |                         |          |      |           |        
|Cash Flows from Operating Activities:             |                                                                                                 |                                        |           |                         |          |      |           |         |          |   |           |          
|                                                  | Net Income (Loss)                                                                               |                                        | $         | (240,107                | )        |      | $         | 382,019 |          |   | $         | 354,792   |         
|                                                  | Adjustments to Reconcile Net Income (Loss) to Net
Cash Provided (Used) by Operating Activities: |                                        |           |                         |          |      |           |         |          |   |           |           |         
|                                                  |                                                                                                 | Depreciation                           |           |                         | 77,785   |      |           |         | 64,730   |   |           |           | 58,855   |  
|                                                  |                                                                                                 | Amortization                           |           |                         | 61,345   |      |           |         | 21,239   |   |           |           | 44,709   |  
|                                                  |                                                                                                 | Stock and Options Issued for Services  |           |                         |          |      |           |         | 30,000   |   |           |           |          |  
|                                                  | Net Change in Assets and Liabilities:                                                           |                                        |           |                         |          |      |           |         |          |   |           |           |         
|                                                  |                                                                                                 | Accounts Receivable                    |           |                         | 64,003   |      |           |         | 181,037  |   |           |           | (558,583 | )
|                                                  |                                                                                                 | Inventory                              |           |                         |          |      |           |         |          |   |           |           | 7,993    |  
|                                                  |                                                                                                 | Prepaid Expenses and Deposits          |           |                         | (63,132  | )    |           |         | (3,818   | ) |           |           | 16,521   |  
|                                                  |                                                                                                 | Accounts Payable                       |           |                         | (36,910  | )    |           |         | (182,335 | ) |           |           | (101,667 | )
|                                                  |                                                                                                 | Accrued Expenses and Other Liabilities |           |                         | (46,819  | )    |           |         | (183,268 | ) |           |           | (360,718 | )
|                                                  |                                                                                                 | Discontinued Operations                |           |                         | (155,840 | )    |           |         | (163,760 | ) |           |           | (114,291 | )
|                                                  |                                                                                                 |                                        |           |                         |          |      |           |         |          |   |           |          
|Net Cash Provided (Used) by Operating Activities  |                                                                                                 |                                        | (339,675  | )                       |          |      | 145,844   |         |          |   | (665,382  | )        
|                                                  |                                                                                                 |                                        |           |                         |          |      |           |         |          |   |           |          
|Cash Flows from Investing Activities:             |                                                                                                 |                                        |           |                         |          |      |           |         |          |   |           |          
|                                                  |                                                                                                 | Purchase of Property and Equipment     |           |                         | (20,311  | )    |           |         | (40,489  | ) |           |           | (16,365  | )
|                                                  |                                                                                                 | Proceeds from Disposal                 |           |                         |          |      |           |         | 500      |   |           |           |          |  
|                                                  |                                                                                                 | Intangible Assets                      |           |                         | (14,282  | )    |           |         | (116,235 | ) |           |           | (6,740   | )
|                                                  |                                                                                                 |                                        |           |                         |          |      |           |         |          |   |           |          
|Net Cash Used by Investing Activities             |                                                                                                 |                                        | (34,593   | )                       |          |      | (156,224  | )       |          |   | (23,105   | )        
|                                                  |                                                                                                 |                                        |           |                         |          |      |           |         |          |   |           |          
|Cash Flows from Financing Activities:             |                                                                                                 |                                        |           |                         |          |      |           |         |          |   |           |          
|                                                  | Issuance of Common and Preferred Shares, Net                                                    |                                        |           |                         |          |      |           |         |          |   |           | 1,959,627 |         
|                                                  | Exercise of Options and Warrants                                                                |                                        |           | 1,000                   |          |      |           | 470,519 |          |   |           | 7,208     |         
|                                                  | Notes and Amounts Due to (from) Related Parties                                                 |                                        |           | (225,242                | )        |      |           |         |          |   |           | (519,757  | )       
|                                                  | Repayments/Termination of Notes Payable                                                         |                                        |           |                         |          |      |           | (14,149 | )        |   |           | (647      | )       
|                                                  |                                                                                                 |                                        |           |                         |          |      |           |         |          |   |           |          
|Net Cash Provided by Financing Activities         |                                                                                                 |                                        | (224,242  | )                       |          |      | 456,370   |         |          |   | 1,446,431 |          
|                                                  |                                                                                                 |                                        |           |                         |          |      |           |         |          |   |           |          
|Increase (Decrease) in Cash and Cash Equivalents  |                                                                                                 |                                        | (598,510  | )                       |          |      | 445,990   |         |          |   | 757,944   |          
|Cash and Cash Equivalents, Beginning of Year      |                                                                                                 |                                        | 1,467,988 |                         |          |      | 1,021,998 |         |          |   | 264,054   |          
|                                                  |                                                                                                 |                                        |           |                         |          |      |           |         |          |   |           |          
|Cash and Cash Equivalents, End of Year            |                                                                                                 | $                                      | 869,478   |                         |          | $    | 1,467,988 |         |          | $ | 1,021,998 |          
|                                                  |                                                                                                 |                                        |           |                         |          |      |           |         |          |   |           |          
|Supplemental Disclosure of Cash Flow Information: |                                                                                                 |                                        |           |                         |          |      |           |         |          |   |           |          
|                                                  | Cash Paid During the Year for:                                                                  |                                        |           |                         |          |      |           |         |          |   |           |           |         
|                                                  |                                                                                                 | Interest                               |           | $                       | 11,250   |      |           | $       | 11,250   |   |           | $         | 11,250   |  
|                                                  |                                                                                                 | Income Taxes                           |           | $                       | 3,237    |      |           | $       | 2,569    |   |           | $         | 6,500    |  

See accompanying notes to consolidated financial statements

20



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SPATIALIZER AUDIO LABORATORIES, INC.
AND SUBSIDIARIES




CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)



|                                  |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  |            | 
|--------------------------------- |  | ------------------------ | ------- | ------------------------- |  | ------------- | ---- | --------- |  | ------ | ------- | - |  | --------- | ----- | - |  |  | ---------- | 
|                                  |  | Series A, 7% Convertible |         | Series B, 10% Convertible |  |               |      |          
|                                  |  | Preferred Shares         |         | Preferred Shares          |  | Common Shares
|                                  |  |                          |         |                           |  |              
|                                  |  | Number of                |         |                           |  |               |      | Number of |  |        |         |   |  | Number of
|                                  |  | Shares                   |         | Par Value                 |  | Shares        |      | Par Value |  | Shares
|                                  |  |                          |         |                           |  |               |      |           |  |       
|Balance, December 31,
1998        |  |                          | 52,900  |                           |  | $             | 529  |           |  |        |         |   |  |           |       |   |  |  | 25,841,867 | 
|Issuance of Preferred
Shares, Net |  |                          |         |                           |  |               |      |           |  |        | 102,967 |   |  | $         | 1,030 |   |  |  |            | 
|Issuance of Common
Shares, Net    |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  | 1,884,254  | 
|Options Exercised                 |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  | 59,998     | 
|Conversion of
Preferred Shares    |  |                          | (52,900 | )                         |  |               | (529 | )         |  |        |         |   |  |           |       |   |  |  | 18,388,851 | 
|Net Income                        |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  |           | 
|                                  |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  |            | 
|Balance, December 31,
1999        |  |                          | 0       |                           |  |               | 0    |           |  |        | 102,967 |   |  | $         | 1,030 |   |  |  | 46,174,970 | 
|Options Exercised                 |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  | 648,001    | 
|Warrants Exercised                |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  | 210,000    | 
|Stock Issued for Services         |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  | 55,000     | 
|Net Income                        |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  |            | 
|Balance, December 31,
2000        |  |                          | 0       |                           |  |               | 0    |           |  |        | 102,967 |   |  | $         | 1,030 |   |  |  | 47,087,971 | 
|                                  |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  |            | 
|Conv. of Pfd. Shares, net         |  |                          |         |                           |  |               |      |           |  |        | (15,000 | ) |  |           | (150  | ) |  |  | 313,968    | 
|Options Exercised                 |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  |            | 
|Warrants Exercised                |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  | 5,000      | 
|Stock Issued for Services         |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  |            | 
|Net Loss                          |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  |            | 
|Balance, December 31,
2001        |  |                          | 0       |                           |  |               | 0    |           |  |        | 87,967  |   |  | $         | 880   |   |  |  | 47,406,939 | 
|                                  |  |                          |         |                           |  |               |      |           |  |        |         |   |  |           |       |   |  |  |            | 

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                  |  |               |         |                 |  |            |            |             |  |               |             |   |  |   |            |  
|--------------------------------- |  | ------------- | ------- | --------------- |  | ---------- | ---------- | ----------- |  | ------------- | ----------- | - |  | - | ---------- | -
|                                  |  | Common Shares |         |                 |  |            |            |            
|                                  |  |               |         |                 |  |            |            | Total      
|                                  |  |               |         |                 |  | Additional |            | Accumulated |  | Shareholders'
|                                  |  | Par Value     |         | Paid-In-Capital |  | Deficit    |            | Equity     
|                                  |  |               |         |                 |  |            |            |            
|Balance, December 31,
1998        |  | $             | 258,418 |                 |  |            | 44,150,501 |             |  |               | (45,962,938 | ) |  |   | (1,553,490 | )
|Issuance of Preferred
Shares, Net |  |               |         |                 |  |            | 1,028,617  |             |  |               |             |   |  |   | 1,029,647  |  
|Issuance of Common
Shares, Net    |  |               | 18,843  |                 |  |            | 911,137    |             |  |               |             |   |  |   | 929,980    |  
|Options Exercised                 |  |               | 600     |                 |  |            | 6,608      |             |  |               |             |   |  |   | 7,208      |  
|Conversion of
Preferred Shares    |  |               | 183,889 |                 |  |            | (183,360   | )           |  |               |             |   |  |   |            |  
|Net Income                        |  |               |        |                 |  |            |           |             |  |               | 354,792     |   |  |   | 354,792    |  
|                                  |  |               |         |                 |  |            |            |             |  |               |             |   |  |   |            |  
|Balance, December 31,
1999        |  | $             | 461,750 |                 |  | $          | 45,913,503 |             |  | $             | (45,608,146 | ) |  | $ | 768,137    |  
|Options Exercised                 |  |               | 6,480   |                 |  |            | 438,839    |             |  |               |             |   |  |   | 445,319    |  
|Warrants Exercised                |  |               | 2,100   |                 |  |            | 23,100     |             |  |               |             |   |  |   | 25,200     |  
|Stock Issued for Services         |  |               | 550     |                 |  |            | 29,450     |             |  |               |             |   |  |   | 30,000     |  
|Net Income                        |  |               |         |                 |  |            |            |             |  |               | 382,019     |   |  |   | 382,019    |  
|Balance, December 31,
2000        |  | $             | 470,880 |                 |  | $          | 46,404,892 |             |  | $             | (45,226,127 | ) |  | $ | 1,650,675  |  
|                                  |  |               |         |                 |  |            |            |             |  |               |             |   |  |   |            |  
|Conv. of Pfd. Shares, net         |  |               | 3,140   |                 |  |            | (2,990     | )           |  |               |             |   |  |   |            |  
|Options Exercised                 |  |               |         |                 |  |            |            |             |  |               |             |   |  |   |            |  
|Warrants Exercised                |  |               | 50      |                 |  |            | 950        |             |  |               |             |   |  |   | 1,000      |  
|Stock Issued for Services         |  |               |         |                 |  |            |            |             |  |               |             |   |  |   |            |  
|Net Loss                          |  |               |         |                 |  |            |            |             |  |               | (240,107    | ) |  |   | (240,107   | )
|Balance, December 31,
2001        |  | $             | 474,070 |                 |  | $          | 46,402,852 |             |  | $             | (45,466,234 | ) |  | $ | 1,411,568  |  
|                                  |  |               |         |                 |  |            |            |             |  |               |             |   |  |   |            |  



See accompanying notes to consolidated financial statements

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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 sales,
research and subsidiary administration are conducted out of facilities in Santa
Clara, California.

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

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 have been marketed for sale (see Note 11).

(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 11). All significant
intercompany balances and transactions have been eliminated in consolidation.
Corporate administration is not allocated to subsidiaries.

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, cash equivalents and trade accounts receivable. The Company places its
temporary cash investments in certificates of deposit in excess of FDIC
insurance limits, principally at CitiBank FSB. At December 31, 2001
substantially all cash and cash equivalents were on deposit at two financial
institutions.

At December 31, 2001, three customers accounted for 34%, 27% and 27%,
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. Due to the contractual nature of sales agreements
and historical trends, no allowance for doubtful accounts has been provided.

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

Customers Outside of the U.S.Sales to foreign customers were 59% and 60%
of total sales in the years ended December 31, 2001 and 2000, respectively.

Major Customers During the year ended December 31, 2001, four customers
accounted for 40%, 23%, 15% and 14%, respectively, of the Companys net sales.

Research and Development Costs The Company expenses research and
development costs as incurred.

Advertising Costs Costs incurred for producing and communicating
advertising are expensed when incurred and included in selling, general and
administrative expenses. Consolidated advertising expense amounted to $20,568,
$2,968 and $7,304 in 2001, 2000 and 1999, respectively.

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Property and
Equipment Property and equipment are stated at cost. Property and equipment are depreciated over the useful lives of the asset under
the straight line method. 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 and
trademarks which are amortized on a straight-line basis over the estimated
useful lives of the patents which range from five to twenty years.

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.

Since the Company generated a net loss in 2001, outstanding stock options
and warrants would have been anti-dilutive and are not applicable to this
calculation.

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

|                                                                                                                |  |                         |            |      |  |   |            | 
|--------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ---------- | ---- |  | - | ---------- | 
|                                                                                                                |  | Year Ended December 31,
|                                                                                                                |  |                        
|                                                                                                                |  | 2000                    |            | 1999
|                                                                                                                |  |                         |            |     
|BASIC:                                                                                                          |  |                         |            |      |  |   |            | 
|Net Income (Loss) Available to Common
Shareholders                                                              |  | $                       | 382,019    |      |  | $ | 354,792    | 
|Weighted Average Shares Outstanding                                                                             |  |                         | 46,736,224 |      |  |   | 33,805,512 | 
|Basic Earnings(Loss)per Share                                                                                   |  | $                       | 0.01       |      |  | $ | 0.01       | 
|DILUTED:                                                                                                        |  |                         |            |      |  |   |            | 
|Net Income (Loss) Available to Common
Shareholders                                                              |  | $                       | 382,019    |      |  | $ | 354,792    | 
|Weighted Average Shares Outstanding                                                                             |  |                         | 46,736,224 |      |  |   | 33,805,512 | 
|Net Effect of Dilutive Stock Options and Warrants
Based on the Treasury Stock Method Using Average
Market Price |  |                         | 544,586    |      |  |   | 1,859,519  | 
|Total Shares                                                                                                    |  |                         | 47,280,810 |      |  |   | 35,665,031 | 
|Diluted Earnings per Share                                                                                      |  | $                       | 0.0100     |      |  | $ | 0.0100     | 
|Average Market Price of Common Stock                                                                            |  | $                       | 0.9418     |      |  | $ | 0.4700     | 
|Ending Market Price of Common Stock                                                                             |  | $                       | 0.2344     |      |  | $ | 0.9375     | 

The following table presents contingently issuable shares, options and
warrants to purchase shares of common stock at 2000 and 1999 and those that
were outstanding during 2001 which were not included in the computation of
diluted loss per share because the impact would have been anti-dilutive:

|         |  |      |           |      |  |      |           |  |  |  |           | 
|-------- |  | ---- | --------- | ---- |  | ---- | --------- |  |  |  | --------- | 
|         |  | 2001 |           | 2000 |  | 1999
|         |  |      |           |      |  |     
|Options  |  |      | 1,872,299 |      |  |      | 2,212,299 |  |  |  | 2,859,467 | 
|Warrants |  |      | 2,100,000 |      |  |      | 2,520,000 |  |  |  | 2,730,000 | 
|         |  |      |           |      |  |      |           |  |  |  |           | 
|Total    |  |      | 3,972,299 |      |  |      | 4,732,299 |  |  |  | 5,589,467 | 
|         |  |      |           |      |  |      |           |  |  |  |           | 

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

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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 8).

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, 2001, the Company has only
one operating segment, DPI, the Companys 3-D Audio Signal Processing business.

Income Taxes Income taxes are accounted for under the asset and
liability method. Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carry forwards. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.

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

Fair Value of Financial Instruments The fair and carrying values of cash
equivalents, accounts receivable, accounts payable, short-term debt to a
related party and accrued liabilities and those potentially subject to
valuation risk at December 31, 2001 and 2000 approximated fair value due to
their short maturity or nature.

The fair values of notes payable to a related party at December 31, 2001
and 2000 are materially consistent with the related carrying values based on
current rates offered to the Company for instruments with similar maturities.

Discontinued Operation In September 1998, the Board of Directors
approved a plan to refocus corporate activities on the Companys core audio
business, Desper Products, Inc. In conjunction to this strategic refocusing,
the Company permanently suspended operations of MDT and placed the business and
its related patent portfolio up for sale. The Company is accounting for the
on-going operating and termination expenses of MDT as a discontinued operation
(see Note 11).

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(3) Property and Equipment

Property and equipment, as of December 31, 2001 and 2000, consists of the
following, net of a reserve for impairment loss in 1998 in accordance with
application of SFAS 121:

|                                                    |  |      |         |      |  |   |         | 
|--------------------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | 
|                                                    |  | 2001 |         | 2000
|                                                    |  |      |         |     
|Office Computers, Software, Equipment and Furniture |  | $    | 304,127 |      |  | $ | 268,799 | 
|Test Equipment                                      |  |      | 73,300  |      |  |   | 61,737  | 
|Tooling Equipment                                   |  |      | 45,539  |      |  |   | 49,514  | 
|Trade Show Booth and Demonstration Equipment        |  |      | 100,155 |      |  |   | 122,761 | 
|Automobiles                                         |  |      | 7,000   |      |  |   | 7,000   | 
|Leasehold Improvements                              |  |      | 22,122  |      |  |   | 22,122  | 
|                                                    |  |      |         |      |  |   |         | 
|Total Property and Equipment                        |  |      | 552,243 |      |  |   | 531,933 | 
|Less Accumulated Depreciation and Amortization      |  |      | 501,657 |      |  |   | 423,872 | 
|                                                    |  |      |         |      |  |   |         | 
|Property and Equipment, Net                         |  | $    | 50,586  |      |  | $ | 108,061 | 
|                                                    |  |      |         |      |  |   |         | 

(4) Intangible Assets

Intangible assets, as of December 31, 2001 and 2000 consist of the
following:

|                                                    |  |      |         |      |  |   |         | 
|--------------------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | 
|                                                    |  | 2001 |         | 2000
|                                                    |  |      |         |     
|Capitalized Patent, Trademarks and Technology Costs |  | $    | 465,650 |      |  | $ | 489,911 | 
|Less Accumulated Amortization                       |  |      | 209,924 |      |  |   | 187,122 | 
|                                                    |  |      |         |      |  |   |         | 
|Intangible Assets, Net                              |  | $    | 255,726 |      |  | $ | 302,789 | 
|                                                    |  |      |         |      |  |   |         | 

(5) Notes Payable to Related Parties

The Company was indebted to the Desper Family Trust, a related party, in
the amount of $112,500 at December 31, 2001. This amount bears interest at a
fixed rate of 10% annually and is due on demand.

(6) Shareholders Equity

During the year ended December 31, 2001, shares were issued or converted
as follows:

In 2001, the Company converted 15,000 shares of Series B Convertible
Preferred Shares into 313,968 shares of common stock as per the terms of the
December Transactions. In addition, warrants to purchase 5,000 shares of common
stock were exercised in 2001, increasing shareholders equity by $1,000.

During the year ended December 31, 2000, shares were issued or converted
as follows:

In the third quarter of 2000, the Company issued 55,000 shares of common
stock to its law firm for services rendered. No other issuances or conversions
occurred during the year ended December 31, 2000.

(7) 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.

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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, 2001, 2000 and 1999. 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.

(8) 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, 4,740,694 as of December 31, 2001. 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, 2001, there were 2,868,395 additional shares available for
grant under the Plan. The per share weighted-average fair value of stock
options granted during 2001, 2000 and 1999 was $0.29, $0.19, and $0.32,
respectively, on the date of grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions: 2001 expected dividend yield
0%, risk-free interest rate of 9.0%, expected volatility of 332% and an
expected life of 5 years; 2000 expected dividend yield 0%, risk-free interest
rate of 9.0%, expected volatility of 654% and an expected life of 5 years;
1999 expected dividend yield 0%, risk-free interest rate of 9.0%, expected
volatility of 95% and an expected life of 3 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 income (loss) would have
been increased to the pro forma amounts indicated below:

|                        |  |      |          |      |  |      |         |  |  |   |         |  
|----------------------- |  | ---- | -------- | ---- |  | ---- | ------- |  |  | - | ------- | -
|                        |  | 2001 |          | 2000 |  | 1999
|                        |  |      |          |      |  |     
|NET INCOME (LOSS):      |  |      |          |      |  |      |         |  |  |   |         |  
|As Reported             |  | $    | (240,107 | )    |  | $    | 382,019 |  |  | $ | 354,792 |  
|Pro Forma               |  | $    | 344,853  |      |  | $    | 292,169 |  |  | $ | (49,978 | )
|BASIC AND DILUTED LOSS: |  |      |          |      |  |      |         |  |  |   |         |  
|As Reported             |  | $    | (0.01    | )    |  | $    | 0.01    |  |  | $ | 0.01    |  
|Pro Forma               |  | $    | (0.01    | )    |  | $    | 0.01    |  |  | $ | (0.01   | )

Pro forma net income (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:

|                                         |  |        |           |                |  |                  |       | 
|---------------------------------------- |  | ------ | --------- | -------------- |  | ---------------- | ----- | 
|                                         |  |        |           |                |  | Weighted-Average
|                                         |  | Number |           | Exercise Price
|                                         |  |        |           |               
|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 | 
|                                         |  |        |           |                |  |                  |       | 
|Options granted                          |  |        | 400,000   |                |  | $                | 0.19  | 
|Options exercised                        |  |        | (648,001  | )              |  | $                | 0.69  | 
|Options forfeited                        |  |        | (399,167  | )              |  | $                | 1.92  | 
|                                         |  |        |           |                |  |                  |       | 
|Options outstanding at December 31, 2000 |  |        | 2,212,299 |                |  | $                | 1.13  | 
|                                         |  |        |           |                |  |                  |       | 
|Options granted                          |  |        | 410,000   |                |  | $                | 0.29  | 
|Options exercised                        |  |        | (0        | )              |  | $                | 0.00  | 
|Options forfeited                        |  |        | (750,000  | )              |  | $                | 0.83  | 
|                                         |  |        |           |                |  |                  |       | 
|Options outstanding at December 31, 2001 |  |        | 1,872,299 |                |  | $                | 0.45  | 
|                                         |  |        |           |                |  |                  |       | 

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##### Table of Contents



At December 31, 2001, the number of options exercisable was 1,529,132 and
the weighted-average exercise price of those options was $0.51.

(9) Warrants

Warrant activity for the periods indicated below is as follows:

|                                          |  |          |           |               |  |   |      | 
|----------------------------------------- |  | -------- | --------- | ------------- |  | - | ---- | 
|                                          |  | Warrants |           | Warrant Price
|                                          |  |          |           |              
|Warrants outstanding at December 31, 1998 |  |          | 732,000   |               |  | $ | 1.11 | 
|Warrants issued                           |  |          | 2,410,000 |               |  | $ | 0.60 | 
|Warrants exercised                        |  |          | 0         |               |  | $ | 0.00 | 
|Warrants expired                          |  |          | (412,000  | )             |  | $ | 1.26 | 
|                                          |  |          |           |               |  |   |      | 
|Warrants outstanding at December 31, 1999 |  |          | 2,730,000 |               |  | $ | 0.67 | 
|Warrants issued                           |  |          | 0         |               |  | $ | 0.00 | 
|Warrants exercised                        |  |          | (210,000  | )             |  | $ | 0.12 | 
|Warrants expired                          |  |          | 0         |               |  | $ | 0.00 | 
|                                          |  |          |           |               |  |   |      | 
|Warrants outstanding at December 31, 2000 |  |          | 2,520,000 |               |  | $ | 0.72 | 
|                                          |  |          |           |               |  |   |      | 
|Warrants issued                           |  |          | 0         |               |  | $ | 0.00 | 
|Warrants exercised                        |  |          | (5,000    | )             |  | $ | 0.20 | 
|Warrants expired                          |  |          | (415,000  | )             |  | $ | 1.16 | 
|                                          |  |          |           |               |  |   |      | 
|Warrants outstanding at December 31, 2001 |  |          | 2,100,000 |               |  | $ | 0.65 | 
|                                          |  |          |           |               |  |   |      | 

All of the warrants granted in 1999 were issued in connection with private
placements. At December 31, 2001, the number of warrants exercisable was
2,100,000 and were effective through 2003.

(10) Income Taxes

The Company files a consolidated return for U.S. income tax purposes.
Income tax expense for the years ended December 31, 2001, 2000 and 1999
consisted of the following:

|                    |  |      |       |      |  |      |        |  |  |   |       | 
|------------------- |  | ---- | ----- | ---- |  | ---- | ------ |  |  | - | ----- | 
|                    |  | 2001 |       | 2000 |  | 1999
|                    |  |      |       |      |  |     
|State franchise tax |  | $    | 2,864 |      |  | $    | 800    |  |  | $ | 800   | 
|Federal taxes       |  |      | (0    | )    |  |      | 9,200  |  |  |   | 5,700 | 
|                    |  |      |       |      |  |      |        |  |  |   |       | 
|Total               |  | $    | 2,864 |      |  | $    | 10,000 |  |  | $ | 6,500 | 
|                    |  |      |       |      |  |      |        |  |  |   |       | 

Certain revenues received from customers in foreign countries are subject
to withholding taxes that are deducted from outgoing funds at the time of
payment. These taxes range from approximately 10% to 16.5% and are recorded as
net foreign revenue.

Income tax expense for the years ended December 31, 2001, 2000 and 1999
differed from the amounts computed by applying the U.S. federal income tax rate
of 34 percent to loss before income taxes primarily due to the generation of
additional net operating loss carryforwards for which no tax benefit has been
provided.

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets at December 31, 2001 is composed primarily
of the net loss carryforwards. The net change in the total valuation allowance
for the year ended December 31, 2001 was insignificant. In assessing the
realizability of deferred tax assets, management considers whether it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income during the periods in which those temporary
differences become deductible. Management considers projected future taxable
income and tax planning strategies in making this assessment. Based upon the
level of historical taxable losses, management believes it is more likely than
not the Company will not realize the benefits of these deductible differences
and has established a valuation allowance to fully reserve the deferred tax
assets at December 31, 2001. 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, 2001, 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. Approximately
$21,700,000 of these net operating loss carryforwards are subject to an annual
limitation of approximately $1,000,000. .

(11) Discontinued Operation

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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, 2001 are
comprised of the following:

|                                           |  |   |          |  
|------------------------------------------ |  | - | -------- | -
|Accounts payable                           |  | $ | (100,000 | )
|Net liabilities of discontinued operations |  | $ | (100,000 | )
|                                           |  |   |          |  

(12) 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 $499,954 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 has
been settled. The settlement specifies that I.N. will be entitled to a cashless
exercise of warrants for the 125,000 shares originally issued to them in 1997
and 1998, or a cash payment of $50,000 if the warrants remained unexercised. In
January 2001, the cash payment was made and no further liabilities or
contingencies exist.

In connection with the downsizing of the Company, a number of employees
were terminated and have filed, on various dates since the downsizing in 1998,
various employment and compensation related claims with the various State labor
authorities, all but two of which claims have either been settled or have been
paid as of the date of this report. 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, which was not
material to the financial statements for the period ended March 31, 2000. In
July 2000, the Labor Commission of the State of California awarded $122,000 to
a claimant arising from a claim for commissions over a three-year period. We
appealed the order to the Superior Court of California, Santa Clara County,
since, under California law, the Labor Commission order will have no effect on
the courts consideration of the matter. On October 27, 2000, the matter was
settled by mutual release and payment in an amount which was not material to
the financial statements of the Company for the period ended September 30,
2000. Two former officers and employees of MDT initiated proceedings before the
Labor Commissioner in 2000 seeking amounts allegedly due under their employment
agreements, which claims, if resolved in favor of the claimants, could be
material to the financial statements of the Company. The Labor Commissioner
has postponed those proceedings. In that action, the claimants filed a motion
to strike the MDT complaint under the California anti-Slapp legislation. The
Court rejected that motion and the litigation is in the discovery stages.
Separately, MDT has initiated litigation in the Superior Court, Orange County
seeking declaratory relief to bar the labor claims, as well as return of
intellectual property and unspecified damages for breaches of the former
officers and employees employment agreements. The two employees have filed
for personal bankruptcy and as a result, the claims are inactive.

Operating Lease Commitments

The Company is
obligated under several non-cancelable operating leases. Future minimum rental payments for all
operating leases of approximately $77,000 through November 2002. Rent expense
amounted to approximately $ 78,000, $115,000 and $140,000 for the years ended
December 31, 2001, 2000 and 1999, respectively.

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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 to be filed on or before April 30,2002.




Item 11.Executive Compensation

Information required for this item incorporated by reference to the
Definitive Proxy to be filed on or before April 30,2002.




Item 12.Security Ownership of Certain Beneficial Owners and Management

Information required for this item incorporated by reference to the
Definitive Proxy to be filed on or before April 30,2002.




Item 13.Certain Relationships and Related Transactions

Information required for this item incorporated by reference to the
Definitive Proxy to be filed on or before April 30,2002.




PART IV




Item 14.Exhibits

|        |  |                                                                                                                                                                                                                                                                                                                                                           |  |  |  | 
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | 
|Exhibit |  |                                                                                                                                                                                                                                                                                                                                                           |  |  |  | 
|Number  |  | Description                                                                                                                                                                                                                                                                                                                                               |  |  |  | 
|        |  |                                                                                                                                                                                                                                                                                                                                                           |  |  |  | 
|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.)

29



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|        |  |                                                                                                                                                                                                                                                                  |  |  |  | 
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | 
|Exhibit |  |                                                                                                                                                                                                                                                                  |  |  |  | 
|Number  |  | Description                                                                                                                                                                                                                                                      |  |  |  | 
|        |  |                                                                                                                                                                                                                                                                  |  |  |  | 
|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.                                                                                                            
|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.)                                                               

30



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|        |  |                                                                                                                                                                                                          |  |  |  | 
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | 
|Exhibit |  |                                                                                                                                                                                                          |  |  |  | 
|Number  |  | Description                                                                                                                                                                                              |  |  |  | 
|        |  |                                                                                                                                                                                                          |  |  |  | 
|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.                                                                                                                                                                



---

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

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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 28, 2002 |  | SPATIALIZER AUDIO LABORATORIES, INC.
(Registrant)                                     
|                     
|                      |  | /s/ Henry R. Mandell
Henry R. MandellChief 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.

|                                         |  |          |  |               
|---------------------------------------- |  | -------- |  | --------------
|Signature                                |  | Title    |  | Date          
|                                         |  |          |  |               
|/s/ Carlo Civelli

Carlo Civelli         |  | Director |  | March 28, 2002
|                                        
|/s/ Stephen W. Desper

Stephen W. Desper |  | Director |  | March 28, 2002
|                                        
|/s/ James D. Pace

James D. Pace         |  | Director |  | March 28, 2002
|                                        
|/s/ Gilbert N. Segel

Gilbert N. Segel   |  | Director |  | March 28, 2002

32