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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 0-21123
SRS LABS, INC.
(Exact name of registrant as specified in its charter)
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Delaware 36-0714264
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
2909 Daimler Street, Santa Ana, California 92705
(Address of principal executive offices) (Zip Code)
(949) 442-1070
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $.001 Per Share
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. [_]
The aggregate market value of the registrant's voting Common Stock held by
non-affiliates of the registrant was approximately $22,918,017 (computed using
the closing price of $3.00 per share of Common Stock on March 15, 2001, as
reported by the Nasdaq Stock Market).
There were 12,581,744 shares of the registrant's Common Stock, par value
$.001 per share, outstanding on March 15, 2001. Of that amount, 71,100 shares
were held as treasury shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement prepared in connection with
the Annual Meeting of Stockholders to be held in 2001 are incorporated by
reference in Part III of this Form 10-K.
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SRS LABS, INC.
TABLE OF CONTENTS
Page
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PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 15
Item 3. Legal Proceedings........................................... 16
Item 4. Submission of Matters to a Vote of Security Holders......... 16
PART II
Market for Registrant's Common Equity and Related
Item 5. Stockholder Matters......................................... 17
Item 6. Selected Financial Data..................................... 19
Management's Discussion and Analysis of Financial Condition
Item 7. and Results of Operations................................... 20
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.. 32
Item 8. Financial Statements and Supplementary Data................. 33
Changes in and Disagreements With Accountants on Accounting
Item 9. and Financial Disclosure.................................... 57
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 57
Item 11. Executive Compensation...................................... 57
Security Ownership of Certain Beneficial Owners and
Item 12. Management.................................................. 57
Item 13. Certain Relationships and Related Transactions.............. 57
PART IV
Exhibits, Financial Statement Schedules, and Reports on Form
Item 14. 8-K......................................................... 58
Signatures ............................................................ 63
This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended,
and Section 27A of the Securities Act of 1933, as amended, reflecting
management's current expectations. Examples of such forward-looking statements
include the expectations of the Company with respect to its strategy. Although
the Company believes that its expectations are based upon reasonable
assumptions, there can be no assurances that the Company's financial goals
will be realized. Such forward-looking statements involve known and unknown
risks, uncertainties and other factors that may cause the actual results,
performance or achievements of the Company, or industry results, to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Numerous factors may
affect the Company's actual results and may cause results to differ materially
from those expressed in forward-looking statements made by or on behalf of the
Company. For this purpose, any statements contained herein that are not
statements of historical fact may be deemed to be forward-looking statements.
Without limiting the foregoing, the words, "believes," "anticipates," "plans,"
"expects" and similar expressions are intended to identify forward-looking
statements. The important factors discussed under the caption "Factors That
May Affect Future Results" in Item 7. Management's Discussions and Analysis of
Financial Condition and Results of Operations, herein, among others, would
cause actual results to differ materially from those indicated by forward-
looking statements made herein and represent management's current expectations
and are inherently uncertain. Investors are warned that actual results may
differ from management's expectations. The Company assumes no obligation to
update the forward-looking information to reflect actual results or changes in
the factors affecting such forward-looking information.
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PART I
Item 1. Business
Overview
SRS Labs, Inc. ("SRS Labs") was incorporated in the State of California on
June 23, 1993 and reincorporated in the State of Delaware on June 28, 1996.
The Company's telephone number is (949) 442-1070, and its executive offices
are located at 2909 Daimler Street, Santa Ana, California 92705.
SRS Labs is a developer and provider of audio and voice technology
solutions for the consumer electronics, home theater, computer, game, Internet
and telecommunications markets. For the fiscal year ended December 31, 2000
("Fiscal 2000"), principal business activities in these markets included:
. Developing and licensing audio and voice technologies to original
equipment manufacturers ("OEMs") and semiconductor manufacturers around
the world;
. Through its majority-owned subsidiary, SRSWOWcast.com, Inc.
("SRSWOWcast"), licensing of audio and voice enhancement technology
solutions for the internet and telecommunications markets; and
. Through its wholly-owned subsidiary, ValenceTech Limited and its foreign
subsidiaries (collectively, "Valence"), designing and selling technology
solutions through custom application specific integrated circuits
("ASICs") to OEMs; and designing, distributing and manufacturing
components, sub-assemblies and finished goods for targeted markets within
selected OEM and retail communities.
SRS Labs and its majority-owned and wholly-owned subsidiaries together are
hereby collectively referred to as the "Company".
The Company was formed in 1993 by purchasing all rights and assets of
various audio and speaker technologies from the Hughes Aircraft Company
("Hughes"). The Company successfully completed its initial public offering in
August 1996, raising approximately $22 million. From the Company's inception
in 1993 until February 1998, the Company derived substantially all of its
revenues from audio technology licensing activities for the consumer
electronics, computer and game markets. The primary technologies that
contributed to revenue during that period were SRS(R) (Sound Retrieval
System(R)) ("SRS"), which produces a 3D sound-enhanced stereo image from any
mono or stereo source, and TruSurround, a "virtual" audio technology which
processes multi-channel surround sound through any standard pair of stereo
speakers.
On March 2, 1998, the Company acquired 100% of the outstanding stock of
Valence Technology Inc. (a British Virgin Islands holding company ultimately
succeeded by Valence), which had its principal business operations and office
locations in Hong Kong and the Peoples Republic of China (the "PRC"). This
acquisition significantly expanded the Company's business activities from the
original licensing model to include the design, manufacture and marketing of
chips, components and products.
In addition to the acquisition of Valence, during the fiscal year ended
December 31, 1998 ("Fiscal 1998"), the Company acquired two additional
technologies. In the first quarter of Fiscal 1998, the Company acquired
certain rights to Voice Intelligibility Processor ("VIP"), a patented voice
processing technology that improves the intelligibility of the spoken voice,
especially in high ambient noise environments. In the following quarter of
Fiscal 1998, the Company acquired certain rights to Circle Surround, a
patented audio delivery system that allows multi-channel surround sound to be
encoded into a two-channel stereo format and allows an encoded two-channel
audio source to be decoded into a multi-channel surround format.
During Fiscal 2000, the Company developed its SRSWOWcast website thereby
launching its internet-based business. Initially, SRSWOWcast's business plan
was focused on developing and acquiring audio based content to generate and
retain visitor traffic to its website in order to sell advertising and e-
commerce products. Recently, the Company changed its Internet strategy to
focus on the licensing of the Company's audio and voice
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enhancement technology solutions for Internet streaming, 3G wireless, Voice
over Internet Protocol ("VoIP") and telephony applications.
Key Business Developments in Fiscal 2000
In March 2000, Microsoft Corporation ("Microsoft") and the Company entered
into a strategic alliance relating to the Company's WOW TM Technology. In
connection with this alliance, Microsoft purchased 290,529 shares of the
Company's common stock for $17.21 per share or $5,000,000, received warrants
to purchase additional shares of the Company's common stock, warrants to
purchase common stock of SRSWOWcast and received licensing rights to include
WOW in any of their products for a three year term. As a result of this
alliance, Microsoft embedded the Company's WOW technology into their newest
generation Windows Media Player 7 and placed the SRS Logo and WOW controls
directly on the Media Player interface. The technology was prominently
featured with a Media Player 7 Interface in the form of the SRS Labs logo that
hyperlinks to the Company's technology page in the SRSWOWcast website.
Placement of the SRS Logo on the Media Player 7 marks an unprecedented move by
Microsoft to feature third party logos on the Media Player 7.
While Microsoft was incorporating the Company's WOW technology in the
Windows Media Player 7, the Company's Internet technology subsidiary began to
develop its SRSWOWcast website and the technology page that is directly linked
from the SRS logo on the Media Player. Both Media Player and the SRSWOWcast
website launched simultaneously on July 18, 2000. The Company's technology
receives significant exposure to current and prospective licensing customers
due to the alliance with Microsoft and the SRSWOWcast website continues to
receive over 750,000 unique visitors per month to the technology page as a
result of the Media Player link. In addition, the Microsoft Media Player 7
with WOW is included in the Windows ME operating system and the WOW technology
is currently in the Beta version of the Microsoft Windows Media Player 8.
Valence continued to execute on the previous year's strategy to de-
emphasize lower-margin distribution activities in favor of higher-margin,
award-winning ASIC chip design business and general purpose branded chip
products.
Valence also began work on developing its own digital signal processor
("DSP") during Fiscal 2000 that will support the Company's audio and voice
technologies. This DSP is expected be available in the second half of 2001.
Valence continues to incorporate the Company's audio and voice-related
technologies into its product offerings thereby leveraging on the strengths
offered by the SRS Labs' patented technology portfolio.
On March 3, 2000, Valence (the successor entity to Valence Technology Inc.
for purposes of listing common shares on the Growth Enterprise Market of the
Hong Kong Stock Exchange (the "GEM") filed an application to list its common
shares on the GEM in connection with an initial public offering (the "GEM
Offering"). In June 2000, the Company decided not to proceed with the GEM
Offering based upon the weaker than expected response by institutional
investors and market conditions in Hong Kong and to continue to expand
Valences' core business utilizing available working capital. The Company does
not anticipate a significant adverse financial impact from its decision to
postpone the GEM Offering. The Company will continue to evaluate its future
financing options in both domestic and foreign capital markets.
During Fiscal 2000, the Company continued to develop consumer products
incorporating SRS Labs' patented technology portfolio. In addition, licensing
partners also continued to produce consumer products incorporating SRS Labs'
technologies. Some of the better known consumer products incorporating SRS
technologies in consumer products to date include the Kenwood receiver, the
Sony Walkman, Philips and Sony digital video disc ("DVD") players, as well as
Hitachi TVs. In addition to these consumer products, the Company continues to
develop relationships with key licensees including industry manufacturers
Loewe, ST Microelectronics and TCE in Europe; Yamaha and Marantz in Japan;
Konka and TCL in the PRC; Samsung Electronics Co., Ltd. ("Samsung") and LG in
Korea and Cirrus Logic, Lucent and Peavey in the United States.
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Description of the Company's Business
The Company operates in three business segments: (a) the development and
marketing of technology either in the form of ASICs through Valence or the
licensing of technologies developed by the Company to original equipment
manufacturers and semiconductor manufacturers; (b) the sale of consumer
electronic products and components; and (c) the SRSWOWcast internet-based
business. A summary of the Company's operations and activities by business
segment and geographic area is set forth below. The financial information for
business segments and geographic areas is included in this Report under "Item
8. Financial Statements and Supplementary Data" in Note 10 to the Notes to
Consolidated Financial Statements. Reference also is made to "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Factors That May Affect Future Results" for a discussion
relating to certain business risks relating to the business of the Company and
its subsidiaries.
In Fiscal 2000, in the fiscal year ended December 31, 1999 ("Fiscal 1999")
and in Fiscal 1998, chip and licensing revenue accounted for 46.8%, 52.0% and
35.2%, respectively, of consolidated revenue and product and component sales
revenues accounted for 53.2%, 48.0% and 64.8% of consolidated revenue,
respectively. The Company's internet-based business generated insignificant
revenues in Fiscal 2000. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations," for additional discussion
relating to the Company's revenues for the periods indicated. For Fiscal 2000,
a single customer, STD Manufacturing, accounted for 13.6% of the Company's
consolidated revenues and 29.0% of its chip and licensing revenues.
Technology Solutions and Licensing
Design and Sale of Integrated Circuits
The Company, through Valence, designs and sells custom analog, digital and
mixed signal ASICs for OEM customers worldwide. Applications for these ASICs
include consumer audio and video electronic products, Internet appliances,
electronic educational toys, video game players, car audio systems, set-top
boxes, video compact disc ("VCD") and DVD players, smart-cards, cordless
telephone sets, speakers, digital power amplifiers, and pagers. Based in the
PRC and Hong Kong, over 20 engineers, with state-of-the-art equipment and
software, support Valence's custom chip design capabilities. Valence sells
these custom designed chips to its contracted customers, outsourcing the
manufacturing to a network of fabrication partners throughout Asia Pacific,
including Chartered Semiconductor, Samsung and Tower Semiconductor Limited in
Israel. As of December 2000 and 1999, the backlog of orders for ASIC design
work to non-affiliated parties was $738,841 and $828,052, respectively. The
Company expects that all or substantially all of the current backlog orders
for Fiscal 2000 will be completed in Fiscal 2001.
Valence's ASIC customers include industry leading consumer electronics,
telecommunications, game and personal computer manufacturers in North America
and Europe, as well as in Asia Pacific. Due to nondisclosure agreements,
specific current customers cannot be disclosed, but previous design projects
have been performed for such international companies as Creative Technology
Limited, Innovision Research and Technology Limited, National Semiconductor
Corporation, Raytron Inc., Toshiba Corporation, System LSI Division and Utron
Technology Inc. Under many of the design contracts, Valence negotiates to
retain ownership of the specific designs. These designs form a significant
library of intellectual property that can be used in future projects.
In addition to performing contract design work, Valence designs, produces
and sells integrated circuits ("ICs") to OEMs of consumer electronics, games,
telecommunication and personal computer equipment in Asia Pacific under the
brand name ASP. The general purpose integrated circuits offered include micro-
controllers with EPROM and ROMs for DVD Players, set-top box receivers and
audio/video equipment; ICs for telecommunication and game equipment; small
signal transistors and ICs used mainly in the manufacture of consumer products
such as television sets, radios, telephones, computer mother boards, add-on
boards and audio hi-fi systems. The products created are based upon
management's analysis of trends in the market, knowledge gained from long
standing relationships with customers and overall business experience. Many of
these products are developed by capitalizing upon Valence's custom design
libraries.
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Currently, a DSP is under development by Valence to be sold under their own
brand name which will be compatible with SRS Labs' audio and voice
technologies -- thus providing a total audio or voice solution to both Valence
and SRS Labs customers. This DSP is expected to be available in the second
half of 2001.
Technologies and Licensing
The Company's technology portfolio covers a wide range of audio, voice and
speaker technologies. The Company licenses these technologies to product and
semiconductor manufacturers, as well as develops and markets implementation
options and finished goods that feature these proprietary and patented
technologies.
The Company's technology strategy continues to be the development,
acquisition and licensing of audio and voice technologies to product and
semiconductor manufacturers in the consumer electronics, home theater,
computer, game, Internet, voice, wireless and telecommunications markets
around the world. By providing a continuous stream of patented audio and voice
technologies, enhancing relationships with existing licensees and creating a
strong brand awareness in order to attract new licensees, the Company believes
that it will strengthen its market position as a world leader in audio and
voice technology.
The Company's technologies may be implemented in a variety of methods,
including discrete analog components, chip modules, analog semiconductors,
DSP's and software. These various implementation options offer customers
significant flexibility when incorporating the Company's technologies into
products. The markets which the Company's technologies address include a wide
variety of audio and voice-related consumer products such as TVs, computers,
stereo receivers, DVD, MP3 and CD players, VCRs, video games, musical
instruments, cellular phones, cordless phones, voice portals, public address
equipment and car audio equipment. The markets for these consumer electronics
products are highly competitive and generally dominated by large
manufacturers. The Company provides technology to these manufacturers who need
to differentiate their products by continually adding new features and
increasing product performance.
License agreements for the Company's technologies have terms that typically
range from one to ten years and require per unit royalty payments for all
products implementing the Company's technologies. Certain agreements provide
for a fixed annual or quarterly royalty payment instead of a per-unit payment.
License agreements also specify the use of the Company's trademarks and logos
on the front of the product, within the packaging and in the user's manual.
Agreements also require product review and approval by the Company to
guarantee the quality of the technology implementation and the display of
Company logos and trademark verbiage. This ensures that quality and the
Company's brand awareness is elevated in the marketplace. The agreements do
not have volume requirements and may be terminated by the licensees or the
Company without substantial financial penalty.
The Company's licensing model most often employs a two-tiered system
whereby semiconductor manufacturers are licensed to build and sell
semiconductor implementations of the Company's technology solutions. These
semiconductor technology solutions are then sold by the semiconductor
licensees to consumer product manufacturers. The consumer product
manufacturers also enter into licensing arrangements with the Company for the
use of its technology solutions and display of the Company's trademarks. Under
this two-tiered licensing method, consumer product licensees are free to
choose a semiconductor solution from a number of choices that best suit their
requirements and matches their price expectations. The Company receives
royalties from the use of its technologies by a consumer product manufacturer
either directly by the consumer product manufacturer or by the semiconductor
licensee. Many major consumer product manufacturers having licenses for the
use of one or more of the Company's technologies pay royalties directly to the
Company. However, this methodology is not well established in the computer
multimedia industry or the PRC consumer electronics marketplace. To address
these market conditions, the Company implements an alternate royalty
collection method, whereby the royalty is "bundled" into the cost of the
semiconductor product and remitted to the Company when the semiconductor
product is sold to the consumer product manufacturer. This methodology
simplifies the business process for the consumer product manufacturer, the
semiconductor manufacturer and the Company. Under this model, the royalty is
remitted directly to the Company by the semiconductor manufacturer
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after the chip has been delivered to the product manufacturer. The Company
determines which licensing model to follow based on factors involving mutual
discussions with the semiconductor and consumer product manufacturing
licensees, the particular market segment involved, the particular region where
the products are manufactured and sold and/or other factors.
Portfolio of Audio and Voice Technologies
The portfolio of audio, voice and speaker technologies developed or
acquired by the Company includes SRS(R), TruSurround, FOCUS(R), Baser(R),
ORB(R), AVT TM, VIP TM, Circle Surround(R) ("CS"), SRS Headphone TM,
TruBass TM, WOW TM, WOWVoice TM and NuVoice TM. These technologies are
described below. SRS, TruSurround and FOCUS are currently the subject of
numerous license agreements and are actively marketed by the Company. Baser
and ORB, speaker technologies that were included in the original technology
acquisition from Hughes, and AVT have not been actively promoted. VIP and CS,
acquired during the first and second quarters of Fiscal 1998, respectively,
saw marketing efforts begin to generate license agreements starting in Fiscal
1999 leading to revenue contributions for Fiscal 2000. SRS Headphone, WOW, and
TruBass were developed internally and were introduced to the marketplace in
Fiscal 1998 but have not yet contributed significantly to revenues. Licensing
royalties associated with SRS, TruSurround, FOCUS, VIP, CS and technology
transfer fees for new technologies have accounted for virtually all of the
Company's licensing revenues to date. More background information concerning
the Company's technology portfolio follows.
. SRS 3D Sound
SRS 3D Sound is one of the world's leading 3D audio enhancement
technologies. The patented technology broadens any mono or stereo audio signal
and creates a realistic 3D sound image from just two standard stereo speakers.
SRS is based on the fundamentals of the human hearing system and recreates the
multitude of spatial cues that are present in a live listening environment but
are lost in recording and playback. SRS dramatically widens the "sweet spot"
associated with traditional stereo; therefore does not require the listener to
be positioned in a specific location to experience the immersive 3D sound
image. It is commonly used in television sets providing each member of the
family sitting in different parts of a room with a virtual surround sound
listening experience.
The technology can also be encoded onto CDs, cassettes or videotapes during
the recording process and reproduced through a conventional stereo system,
multimedia computer, radio and television broadcast, or the Internet. SRS was
originally developed by Hughes, which spent significant resources to develop
and patent SRS and related audio technologies. Since acquiring the SRS
technology from Hughes in June 1993, the Company has improved the performance
of SRS, reduced the cost for OEMs to implement the technology, secured
licensing relationships with various semiconductor manufacturers who offer the
technology in various analog and digital chip options, and introduced the
technology to a wider variety of consumer applications.
To date, products have been shipped with SRS technology from more than 180
manufacturers including Acer Peripherals, Ltd., Daewoo Telecom Ltd., Hitachi
Ltd., IBM, Kawai Musical Instruments Mfg. Co., Ltd., Kenwood Corporation,
Young Chang America, Inc. (Kurzweil), LG Electronics, Inc., Packard Bell/NEC,
Pioneer Electronic Corporation, Thomson Consumer Electronics, Inc. (RCA),
Thompson Multimedia, SA, Samsung, Sharp Electronics Corporation, Smart
Devices, Inc., Sony Corporation and Toshiba Corporation. Semiconductor
manufacturers who have included SRS technology in their chip offerings include
Cirrus Logic (Crystal Semiconductor), Fujitsu Semiconductor Corporation,
Mitsubishi Electric Corporation, New Japan Radio Co. Ltd., Philips
Semiconductors, ST Microelectronics, Toshiba Semiconductor Corporation and
Zoran Corporation.
. TruSurround
TruSurround is a Dolby-certified virtual audio technology, which takes
audio from a multi-channel audio source, such as Dolby Digital or Dolby Pro
Logic and creates an immersive surround sound listening experience from just
two standard speakers. It was originally designed to take advantage of the 5.1
channel audio standard
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for DVD, Dolby Digital, without requiring the use of six speakers. TruSurround
processes the six discrete channels of digital audio into just two channels,
retaining all of the original audio information and giving listeners the
perception that they are surrounded by additional "phantom" speakers. This
technology is useful in televisions and set top boxes because much of the
satellite and cable programming is being broadcast in multi-channel formats.
TruSurround takes advantage of that encoded information and creates a much
more immersive, home theater-like experience without the need for additional
speakers.
TruSurround has been successfully introduced to the consumer electronics
marketplace and is featured in a wide variety of products, including
televisions from Sony Corporation and DVD players from Pioneer Electronic
Corporation and Philips Consumer Electronics B.V. Semiconductor companies who
have offered TruSurround in analog or digital implementation options for
various applications in consumer electronics have included AKM Semiconductor,
Broadcom Corporation, New Japan Radio Co., Ltd., ST Microelectronics,
Mitsubishi Electric Corporation and Zoran Corporation.
. FOCUS
In many audio environments, speakers are not placed in an ideal location
directly in front of a listener. This makes it difficult to achieve a
realistic sound experience from speakers that are below the plane of the
listener's ear. The Company developed FOCUS as a technology solution for this
problem. Originally designed for use in automobiles where front speakers are
often placed under the dashboard or facing each other in the door panels, the
patented FOCUS technology electronically repositions the sound image to create
the appropriate perception of image height. In addition to automobiles, FOCUS
is ideally suited for any product application where speakers cannot be placed
in optimal locations for either space or aesthetic reasons, such as big screen
or projection TVs, home in-wall speakers and commercial applications such as
drive-through restaurant communications. The first analog and digital chip
options of FOCUS became available for sampling to OEMs beginning in the last
half of Fiscal 1998 from Mitsubishi Electric Corporation, New Japan Radio Co.,
Ltd. and ST Microelectronics. To date, Focus has been successfully
incorporated into consumer electronics products marketed by Hitachi Limited
and Marantz Japan, Inc.
. Speaker Technologies
The Company holds patents for speaker technologies originally developed at
Hughes. One such technology, ORB, provides a unique approach to the physical
design of speakers by incorporating a baffle that creates a 180 degrees
dispersion of sound. A second speaker technology developed by Hughes, BASER,
is a high-efficiency design for a subwoofer product. Another speaker
technology, referred to as AVT, projects the listening material so that the
human ear can more easily identify the direction of ambient sounds. To date,
no significant commercial applications involving these speaker technologies
have been developed.
. VIP -- Voice Intelligibility Processor Technology
VIP is a patented audio processing technology that improves the
intelligibility of the spoken voice especially in noisy environments or in
text-to-speech applications. VIP selectively processes only those spectral
portions of the speech signal that the brain uses for cognition, without
requiring increase in gain or volume. SRS inventor Arnold Klayman, who is now
the principal audio scientist at the Company, originally developed the VIP
technology at Hughes. During a divestiture in 1994, Hughes sold this non-core
business division to VIP Labs. From 1994 until the acquisition by the Company,
VIP Labs further developed the technology as well as selectively marketed a
stand-alone signal processor for use in the professional sound reinforcement
industry.
The Company believes that the market opportunities for VIP are significant
and include cellular phones, wireless products, text-to-speech applications,
hearing aids, public address and emergency warning systems, talking toys,
hands-free devices, VoIP, traditional and Internet broadcasting and other
voice-related applications. The Company directly offers both software and
hardware implementation options for VIP. VIP technology is available as
digital code that may be ported to DSP chips used by manufacturers of cellular
phones, paging
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systems, digital televisions, sound reinforcement equipment and hearing aids.
The Company announced the porting of this technology to a popular DSP platform
in February and March 2001, the TI TMS320C54x and 55x generations which
provide a simple solution to add VIP into products already on that platform.
VIP is also available in software and can run on client or server-side
applications.
To date the Company has licensed VIP for use by Samsung and Lucent
Technologies. Samsung has also successfully implemented VIP in a semiconductor
chip targeted at the cellular and traditional telephone applications. In
Fiscal 2000, the Samsung cellular phone shipped into the Korean marketplace
and the Company also discovered capabilities for VIP in the text-to-speech
marketplace. The Company began to expand the marketing of VIP in the fourth
quarter of Fiscal 2000 and expects to see additional opportunities for this
technology in future periods.
. Circle Surround
CS is a patented, multi-channel encoding and decoding audio technology
designed to encode five discrete channels into two channels (the same space
required for stereo) and then decode the two channels back into five for
playback over a stereo or home theater system equipped for multi-channel
playback. CS is significantly unique to the market because it enables new
audio applications allowing the delivery of surround sound audio into new
products and formats in an effective and efficient manner that has not been
done before.
The versatility of CS is demonstrated by the fact that it is backward
compatible and can produce up to 6.1 channels from any mono or stereo
material. As a result, consumers who own home theater speaker systems can
enjoy listening to all of the speakers in a multi-channel mode while watching
television or VHS movies or listening to music CDs. CS also is compatible with
Dolby encoded material. One of the most interesting applications is that CS
can stream multi-channel audio for movies, trailers, music videos, games and
other content over the Internet without increasing the bandwidth. It requires
about 56kbs and sends the information in stereo format allowing end users the
option to listen through a multi-channel speaker system using a CS decoding
device or software.
CS can be used in the recording process for music or movies or in the
development of games for computers or video game consoles and then implemented
in a decoding playback device, such as a home audio receiver, multi-media
speakers, DVD player or car audio product. When used as an encoding/decoding
technology, CS encodes five discrete channels of sound through only two
channels (the same space required for stereo). In the playback device, CS then
takes the two channels of encoded material and decodes them back into the
original five recorded channels for playback through a multi-channel (surround
sound) home theater or cinema system equipped with four or five speakers plus
subwoofer. In addition, CS creates multiple channel surround sound from the
wealth of legacy stereo and surround encoded material available on traditional
music CDs, VHS tapes, television or AM/FM broadcasts.
In Fiscal 2000, the Company demonstrated CS's game encoding capabilities
and is pursuing game encoding relationships to further the technologies use in
the game market.
CS technology is available for product manufacturers worldwide in the
following formats: analog ICs through a relationship with Analog Devices; DSP
implementations from Cirrus Logic and AKM; digital software code from the
Company; and reference boards, sub-systems and finished products for the home
and car audio market from Valence. Current manufacturers who have announced
products using CS to date include Haitai Electronics Co., Ltd. (Sherwood),
Theta Digital, Kenwood Corporation, Loewe Optic GmbH and Amiosonic Electronics
Co. Smart Devices, Inc. has included CS in a line of movie theater audio
processors that are being marketed to cinemas around the world. Hundreds of
music CDs have been encoded with CS by audiophile record labels such as
Telarc, DMP and Northsound, which market the CDs through traditional retail
channels and online music sites.
9
. SRS Headphone
Introduced in early 1998, SRS Headphone is based on the core SRS 3D sound
technology and provides optimal 3D sound enhancement to a mono, stereo or
surround sound signal working with any pair of headphones. In January 1999,
Mitsubishi Semiconductor announced the availability of the M62458FP, the first
analog IC implementation of this technology. To date, SRS Headphone technology
has been licensed to and incorporated into products by manufacturers that
include Sony Corporation, Yamaha Corporation and Sennheiser Electronic GmbH &
Co. KG.
. TruBass
In November 1998, at COMDEX in Las Vegas, Nevada (the computer industry's
leading tradeshow) the Company introduced TruBass TM, a psycho-acoustic
process that creates the perception of dramatically increased bass performance
in smaller speaker systems and headphones far beyond the physical capabilities
of the speakers themselves. TruBass is an important part of the feature-set
for the Company's WOW technology (described below) and is well-suited to
improve the low-frequency range of products with small speakers such as those
found in television, radios, boom boxes, games and smaller hand-held devices.
TruBass has been implemented into semiconductors by AKM and NJRC.
.WOW
Also in November 1998, at COMDEX, the Company introduced its WOW technology
and began to market it to the MP3 and computer audio markets. WOW is the
Company's next generation audio enhancement for speakers and headphones. It
significantly improves the spatial imaging (width and height of the sound
image field) and bass response from traditional multimedia speakers and
headphones. The result is a much "bigger" sound, a reduction in the "tinny"
sound from digitally compressed media files such as MP3 and Windows Media
Audio ("WMA"), more dynamics and more bass.
Discussions with Microsoft resulted in a technology alliance between SRS
Labs and Microsoft in March 2000. As a result of this alliance, Microsoft
embedded the Company's WOW technology into their newest generation Windows
Media Player 7 and placed the SRS Logo and WOW controls directly on the Media
Player interface.
WOW's applications include MP3 and DVD players, televisions, multimedia
speakers, powered home audio speakers, mini stereo systems, video game
consoles, portable "boom boxes", car radios, portable headset audio systems
and other products in the consumer audio, gaming, car audio and professional
sound markets.
In September 1999, the Company commenced the manufacture and sale of the
WOW Thing family of software and hardware products that have been listed on
the Company's Internet website www.wowthing.com. The Company packaged the
hardware and began to market two additional models: "WOW Thing for Computers"
and "WOW Thing for Game Consoles" to consumers and resellers in the third
quarter of 2000. Although the revenue from this activity was not significant
in the third and fourth quarters of Fiscal 2000, it has elevated the
technology's brand awareness with the Company's customers and with consumers.
.WOWVoice and NuVoice
In Fiscal 2000, the Company introduced two new technologies, WOWVoice TM
and NuVoice TM. These technologies are part of the technology offering based
on the Company's VIP technology and is specifically designed for telephone
voice quality and intelligibility and text-to-speech enhancement applications.
VIP alone increases the intelligibility of voice, particularly in noisy
listening environments and dramatically improves the quality and clarity of
synthesized speech in text-to-speech applications (see VIP description above
for more details). NuVoice adds warmth to voice and speech restoring the lower
bass-frequencies oftentimes cut-off or lost in the transmission or compression
of the telephony bandwidth. It overcomes the physical limitations of
10
small transducers found in cellular and traditional telephones by producing
lower bass tones using psycho-acoustics and harmonic principles to make the
speech sound more realistic, closer to the original human speech before it was
sent over the telephony equipment. NuVoice also improves the quality of text-
to-speech engines making synthesized voices sound more natural. When NuVoice
is added to VIP, the resulting suite of voice technology is called "WOW
Voice". The Company began actively marketing these technologies in the third
and fourth quarter of 2000 and continue to refine the technology based on
needs found in the marketplace.
Product and Component Sales
The Company, through Valence, is an authorized, non-exclusive distributor
in Hong Kong and/or the PRC for semiconductor products from Philips Hong Kong
Ltd., Molex Hong Kong/China, Tripath Technology Inc., Silicon Wave and
Portalplayer Inc. as well as its own ASP brand. Access to multiple suppliers
of similar ICs provides value to customers by insuring an adequate supply of
components and "just in time delivery" of goods to meet their production
schedules.
In the normal course of business, Valence carries in its inventory selected
products that it distributes to meet rapid delivery requirements of customers.
Valence significantly improved the profit margins during Fiscal 2000 and
Fiscal 1999 by discontinuing lower margin component products in favor of
higher margin product lines. The Company provides normal and customary
merchandise return policy and generally does not provide payment terms. As of
December 2000 and 1999, the backlog orders of components were $5,777,740 and
$3,180,021, respectively. The Company expects that all or substantially all of
the backlog orders for Fiscal 2000 will be filled during the fiscal year ended
December 31, 2001 ("Fiscal 2001").
In September 1999, the Company commenced the manufacture and sale of the
WOW Thing family of software and hardware products that have been listed on
the Company's Internet website www.wowthing.com. The WOW Thing family of
software and hardware products enhances the sound quality of music downloaded
over the Internet as well as the audio performance of computer and home
entertainment products and speakers. The Company packaged the hardware and
began to market two additional models: "WOW Thing for Computers" and "WOW
Thing for Game Consoles" to consumers and resellers in the third quarter of
2000. The revenue from this activity was not significant in the third and
fourth quarters of Fiscal 2000, however, it has elevated the technology's
brand awareness with the Company's customers and with consumers.
Sales and Marketing
Integrated Circuits and Licensing
The Company's existing sales and marketing strategies relating to the
integrated circuit and licensing segment target the consumer electronics, home
theater, computer, gaming and telecommunications industries. To implement its
strategy, the Company has established a direct sales force and a worldwide
network of independent sales agents and distributors. In Fiscal 2000, the
Company added two small technology support offices in India and in the Czech
Republic to support its multi-national OEM customers. The Company already has
a licensing sales presence in the United States, Japan, Hong Kong and Korea.
The Company has previously established distributors in Korea, Taiwan, Japan,
Singapore, Hong Kong and the PRC. The Company actively promotes the use of its
trademarks and logos and directs customers to prominently display the
appropriate SRS technology logo on products, packaging and in advertising.
Product and Component Sales
Through a dedicated sales team, the Company is an authorized non-exclusive
distributor in Hong Kong and/or the PRC for semiconductor products as well as
its own ASP-brand line of products.
DVD and VCD have become and will continue to be the standard video format
and have received mass-market adoption in the PRC. Through its distribution
agreements and close relationships with leading digital video chip suppliers,
such as Philips Hong Kong Ltd., the Company designs, develops and markets
complete
11
DVD and VCD players, as well as assembly kits and reference boards for use in
audio products, DVD players and telecommunication and wireless infrastructure
equipment.
In addition to distributing semiconductor products, the Company's team of
software, hardware and application engineers offers value-added engineering
services, such as the design of application software in field programmable
gate arrays, ASICs and system design. Local support is very valuable to many
manufacturers who have limited experience in the design and manufacturing of
products, especially handling surface mount technology equipment. The
technology solutions can be readily incorporated into OEM products, thus
enabling a Company's customer to shorten their own design, development and
manufacturing cycle and, with competitive pricing of these technology
solutions, reduce the overall cost of the end product.
Owing to the competitive pricing in the component market, the Company will
continue with its strategy to de-emphasize lower margin component sales in
favor of higher margin ASIC design and licensing revenue. This will likely
result in a continued reduction in component sales for future periods.
Internet-Based Business
Recently, the Company changed its Internet strategy in order to focus on
the licensing of the Company's audio and voice enhancement technology
solutions for Internet streaming, 3G wireless, VoIP and telephony
applications. To implement this strategy, the Company has established a direct
sales force to market the technology solutions to web portals, encoding
companies, service providers, wireless technology providers and broadcasting
companies. Consistent with the hardware licensing trademark policy, the
Company will actively promote the use of its trademarks and logos and will
direct its customers to display the appropriate SRS technology logo. The
communications program of SRSWOWcast includes press releases and informational
mailings to existing and potential customers around the world, as well as
press tours, presentations and demonstrations to various media outlets. The
Company regularly participates in tradeshows and conferences to increase
awareness of its technologies and to market its solutions to the industry.
Overall Sales Support
The Company's corporate communications program includes press releases and
corporate newsletter dissemination to its customers around the world,
primarily through e-mail. The Company began to use the Intranet to provide
easy-to-use audio technology demonstrations for those technologies that can be
appropriately demonstrated on the World Wide Web. The Company conducts
technology demonstrations or presentations for the press and other companies
to promote the Company's technologies and products.
The Company regularly participates in tradeshows and conferences to
increase awareness of its technologies and to market its technologies and
products. The Company also works closely with its licensees and semiconductor
partners to actively explore other opportunities to utilize the Company's
technologies in new products and/or markets.
Research and Development
The Company has spent approximately 17.3%, 25.5% and 17.1% and of total
operating expenses on research and development in Fiscal 2000, 1999 and 1998,
respectively. The percentage calculation for 1998 excludes expense related to
acquired in-process research and development ("Acquired R&D").
The Company's research and development group includes 35 software, hardware
and application engineers who focus on developing intellectual property,
technology solutions and consumer products. Seven engineers are based in the
U.S. with the remainder based in Hong Kong and the PRC.
The U.S.-based engineering group is focused upon developing new audio and
voice technologies, improving the performance of existing technologies and
reducing the implementation cost of the Company's technologies.
12
These engineers also are focused on assisting customers to implement the
Company's technologies and supporting the Company's sales and marketing
efforts on a worldwide basis.
The U.S.-based engineering group has also found new applications for VIP,
NuVoice and WOWVoice in wireless, hands-free, text-to-speech, unified
messaging and VoIP. The Company and sales team will continue developing
solutions for delivering the technology and on February 8 and March 15, 2001,
the Company announced that they were eXpressDSP compliant and had successfully
ported VIP and WOW to the Texas Instrument ("TI") DSP TMS320C54x platform for
quick implementation by manufacturers. The company also became a TI third
party program member working with TI to market the technologies on the TI
platform through the third party marketing programs that TI offers.
Through Valence, the Company operates one of the largest independent IC
design houses in Hong Kong, whose activities are primarily engaged in working
on custom design ASIC projects for clients in the consumer electronics, game
and telecommunications industries. These clients range from local producers to
large, multi-national manufacturers around the world. In 1998, ASP
Microelectronics, one of Valence's subsidiaries, was awarded the Hong Kong
Industry Award's HKITCC Technological Achievement Award. In 1999 and 2000, VSD
Electronics Ltd., another Valence subsidiary, was awarded the Hong Kong
Industry Award's HKITCC Certificate of Merit in Technology Achievement.
The market for the Company's technologies and products is subject to rapid
and significant changes and frequent new technology and product introductions.
The Company believes that its future success will depend on its ability to
continue to enhance its existing technologies and to introduce or acquire new
technologies on a competitive basis. There can be no assurance, however, that
the Company will be able to successfully enhance existing technologies and
products or introduce or acquire new technologies and products.
Competition
The Company competes in each of its business segments with a number of
companies that produce a variety of audio and voice enhancement technologies,
processes and products. These technologies, processes and products include:
THX(R), a certification program that indicates if a movie theater or
particular piece of audio equipment meets certain specifications; Dolby(R) A-
type, B-type and C-type noise reduction; Dolby SR(R), which provides noise
reduction and encodes analog sound using four sound channels; ProLogich TM and
ProLogicII, surround sound systems incorporating an active center channel;
DolbySRD(R), which encodes a six channel digital sound track on a movie print;
DTS(R), which uses CDs to reproduce six channels of digital sound synchronized
with a movie print; and SDDS(R), which encodes six or eight channels of
digital sound on both sides of a movie print. Because SRS works with any
existing recorded material whether mono, stereo, surround sound or other
encoding process, SRS can be used either as an alternative or as a complement
and enhancement to almost any competing audio technology. As a multi-channel
encode/decode technology, Circle Surround competes more directly with the
various surround sound technologies listed above.
The Company also directly competes in the field of 3D audio enhancement
with other 3D audio providers, including Qsound Labs, Inc. and Spatializer.
The Company is not aware of any direct competing technologies to its voice
intelligibility technology, VIP. The Company believes that TruBass might
directly compete with several technologies that are included on a variety of
electronics products, including televisions, audio systems and speaker
products.
In addition, the Company's technologies may, in the future, compete with
audio technologies developed by other companies, some of whom may be current
licensees of the Company.
Certain of these companies referenced above have, or may have,
substantially greater resources than the Company to devote to further
technologies and new product developments. The Company believes that it will
compete based primarily on the quality and performance of its proprietary
technologies, brand name awareness, the ease and cost of implementing its
technologies, the ability to meet OEMs' needs to differentiate their products,
and the strength of its licensee relationships including the relationship with
Microsoft. There can be no
13
assurance that based on these factors the Company will continue to be
competitive with existing or future products or technologies of its
competitors.
The Company's competitors to its semiconductor IC business are primarily
fabless semiconductor design houses and manufacturers located in Taiwan, Japan
and Korea. Given that Taiwan is focusing on the development of the personal
computer industry, most of the fabless semiconductor design houses in Taiwan
also focus on the design of dynamic random access memory, static random access
memory and semiconductors for personal computer applications. These fabless
semiconductor design houses focus less on semiconductors for consumer
electronics such as home audio and video products, communications equipment
and electronic games players.
Although the Chinese semiconductor industry is dominated by several major
chip suppliers, such as Motorola, National Semiconductor and Texas
Instruments, within every major market there is need for local, niche
participants, such as the Company. Generally speaking, established
semiconductor companies do not offer semiconductor design services to
manufacturers and will only do so if the number of semiconductors required by
such manufacturers is very large. Instead, they supply standard semiconductors
to such manufacturers. These standard semiconductors may not be the most
suitable components for the manufacturers as they may require additional
semiconductor components to perform the designed functions required in their
products. In such cases, these semiconductors will be bulkier, heavier and
more expensive compared to one custom-designed system-on-chip ASIC. The
Company's ASIC team is more flexible in its strategy of designing new
products, as well as more responsive and flexible in the service provided to
clients. With fifteen years of background in the Chinese semiconductor market,
the Company's personnel has expertise in local business practices and a strong
franchise of relationships with clients that the Company believes gives it a
competitive advantage over newcomers to the industry or the large multi-
national firms.
The Company's (through Valence and its subsidiaries) chip and component
distribution contracts to distribute products for third party semiconductor
manufacturers in the domestic Chinese market are not exclusive, and the
Company competes with other distributors, such as Arrow Electronics, Future
Electronics and Avnet Inc. In addition, the semiconductor companies who
manufacture the components and chips also sell directly to manufacturers
within the PRC.
DVD and VCD have become and will continue to be the standard video format
and have received mass-market adoption in the PRC. Through its distribution
agreements and close relationships with leading digital video chip suppliers,
such as Philips Hong Kong Ltd., the Company designs, develops and markets
complete DVD and VCD players, as well as assembly kits and reference boards
for use in audio products, DVD players and telecommunication and wireless
infrastructure equipment. Although the overall consumer electronics market in
the PRC is vast, it is highly competitive with many large manufacturers
competing in the retail channel with established brand names.
The markets in which the Company sells its products are subject to extreme
price competition, thus the Company expects to continue to experience declines
in the selling prices of its products over the life cycle of each product. In
order to offset declines in the selling prices of its products, the Company
must continue to reduce the costs of products through product design changes,
manufacturing process changes, volume discounts and other savings negotiated
with its manufacturing subcontractors. Since the Company does not operate its
own manufacturing facilities with respect to ASICs or product or component
sales, it may not be able to reduce its costs as rapidly as its competitors
who perform their own manufacturing. The failure of the Company to design and
introduce, in a timely manner, lower cost versions of existing products or
higher gross margin new products, or to successfully manage its manufacturing
subcontractor relationships could have a material adverse effect on the
Company's gross margins.
Intellectual Property Rights and Proprietary Information
The Company operates in industries where innovation, investment in new
ideas and protection of its resulting intellectual property rights are
important for success. The Company relies on a variety of intellectual
14
property protections for its products and services, including patent,
copyright, trademark and trade secret laws, and contractual obligations, and
pursues a policy of enforcing such rights. There can be no assurance, however,
that the Company's intellectual property rights will be adequate to ensure the
Company's competitive position, or that competitors will not be able to
produce a non-infringing competitive product or service. There can be no
assurance that third parties will not assert infringement claims against the
Company, or that if required to obtain any third party licenses as a result of
an infringement dispute the Company will be able to obtain such licenses.
Although the Company believes that its patents and trademarks are important to
each of its business segments, such patents and trademarks are especially
important to the chip and licensing business segment.
In order to protect the underlying technology concepts, the Company has
filed and/or obtained patents for all of its marketed technologies including
technologies marketed under the trademarks SRS, TruSurround, FOCUS, Circle
Surround, WOW, VIP and TruBass. In addition, the Company has numerous issued
patents and patents pending for speaker and other acoustic reproduction
technologies. The Company pursues a general practice of filing patent
applications for its technologies in the United States and various foreign
countries where its licensees manufacture, distribute or sell licensed
products. The Company continually updates and adds new applications to its
patent portfolio to address changing worldwide market conditions and new
technological innovations of the Company. The range of expiration dates for
the Company's patents extend between the year 2005 to 2017. The Company has
multiple patents covering unique aspects and improvements for many of its
technologies. Accordingly, the expiration of any single patent is not likely
to affect the Company's intellectual property position or the ability to
generate licensing revenue.
The Company's strategy for protection of its trademarks identifying the
various Company technology solutions is commensurate with its strategy for
obtaining patent protection. Specifically, the Company routinely files U.S.
federal and foreign trademark applications for the various word names and
logos used to market its technology solutions to licensees and the general
public. The duration of the U.S. and foreign registered trademarks can
typically be maintained indefinitely, provided proper maintenance fees are
paid and trademarks are continually used or licensed by the Company.
Seasonality
Due to the Company's dependence on the consumer electronics market, the
substantial seasonality of sales in the market could impact the Company's
revenues and net income. In particular, the Company believes that there is
seasonality relating to the Christmas season as well as the Chinese New Year
in the Asia Pacific region, which fall into the fourth and first quarters,
respectively.
Employees
The Company employed 73 persons and 47 persons, respectively, in its Chip
and Licensing and its Product and Component Sales business segments as of
December 31, 2000. Of the aggregate number of employees, 78 are employed by
Valence and its subsidiaries and are located overseas. None of the Company's
employees are covered by a collective bargaining agreement or are presently
represented by a labor union. The Company has not experienced any work
stoppages and considers its employee relations to be good.
Item 2. Properties
The Company's corporate headquarters are located in Santa Ana, California,
in a 23,400 square foot facility consisting of office and warehouse space. The
Company leases the facility from Daimler Commerce Partners, L.P. (the
"Partnership"), an affiliated partnership. The general partner of the
Partnership is Conifer Investments, Inc. ("Conifer"). The sole shareholders of
Conifer are Thomas C.K. Yuen and Misako Yuen, as co-trustees of the Thomas
Yuen Family Trust (the "Trust"), and the executive officers of Conifer include
Mr. and Mrs. Yuen. Mr. and Mrs. Yuen, as co-trustees of the Trust, also
beneficially own a significant amount of the Company's outstanding shares of
common stock. Mr. Yuen is the Chairman of the Board and Chief Executive
Officer of the Company.
15
Pursuant to the Company's lease agreement with the Partnership, the Company
leases all 23,400 square feet of space at the above-referenced facility. The
lease is for a term of two years which commenced June 1, 2000 and is scheduled
to expire on May 31, 2002. At the time of expiration, the Company will have an
option to renew the lease, under similar terms and conditions, for two
additional years commencing on June 1, 2002 and terminating on May 31, 2004.
The Company paid the Partnership rent of $175,500 during Fiscal 2000, $165,672
during Fiscal 1999 and $165,672 during Fiscal 1998.
The Company, through Valence and its subsidiaries, leases several offices
and warehouses in Hong Kong and the PRC. Valence's principal operations are
conducted at two leased facilities located in Hong Kong. The principal
executive offices of Valence are located in Kowloon Tong, Hong Kong, in a
5,887 square foot office facility under a lease, which expires in August 2003.
Valence's other principal office is located in Kwun Tong, Kowloon, Hong Kong,
in a 7,453 square foot office facility under a lease, which expires in
December 2003. Pursuant to these leases, the Company paid rent of $413,569
during Fiscal 2000, $429,672 during Fiscal 1999 and $461,044 during Fiscal
1998.
The Company's corporate headquarters house personnel responsible for the
development of the Company's technologies, including SRSWOWcast, as well as
the administration of the Company's license program, while the Valence
facilities are used in connection with the design and marketing of ASICs and
the sale of consumer electronic products and components.
The Company believes that the current facilities of the Company will be
adequate to meet the Company's needs for the foreseeable future. Should the
Company need further additional space, management believes that the Company
will be able to secure additional space at reasonable rates.
Item 3. Legal Proceedings
The Company is a party to ordinary disputes and litigation matters arising
in the normal course of business. The Company does not believe that the
outcome of any current legal proceedings will have a material adverse effect
on the Company's consolidated financial position, results of operations or
cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the Company's stockholders during
the fourth quarter of 2000.
16
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Market for Common Stock
The common stock of the Company, par value $.001 per share (the "Common
Stock"), trades on the Nasdaq Stock Market as a National Market System
Security under the symbol SRSL. The table below reflects the high and low
sales prices of the Common Stock as reported by The Nasdaq Stock Market, Inc.
for the periods indicated.
High Low
---- ---
FISCAL 2000
First Quarter........................................... 47 5 3/4
Second Quarter.......................................... 24 15/16 8 3/8
Third Quarter........................................... 11 5/8 7 1/16
Fourth Quarter.......................................... 8 1/2 1 3/4
FISCAL 1999
First Quarter........................................... 5 5/8 3 1/16
Second Quarter.......................................... 4 1/4 2 5/8
Third Quarter........................................... 4 5/8 2 7/8
Fourth Quarter.......................................... 7 5/8 2 15/16
At March 15, 2001, the last sale price of the Common Stock was $3.00 per
share.
Holders
At March 15, 2001, there were 407 stockholders of record.
Dividend Policy
The Company has never paid cash dividends on the Common Stock. The Company
currently intends to retain its available funds for future growth and,
therefore, does not anticipate paying any dividends in the foreseeable future.
See "Item 7. Management's Discussion and Analysis and Results of Operations --
Liquidity and Capital Resources" for a discussion regarding certain
restrictions which relate to the Company's ability to pay cash dividends.
Use of Proceeds
The effective date of the Company's initial public offering of shares of
Common Stock was August 8, 1996 (SEC Registration No. 333-4974-LA). During the
fourth quarter of Fiscal 2000, the Company utilized approximately $862,000 of
the $22,052,955 net offering proceeds for working capital. The table below
sets forth at December 31, 2000, the amount of the net offering proceeds used
for the purposes noted in the table.
17
Direct or indirect payments to
directors, officers, general
partners of the issuer or their
associates to persons owning ten
percent or more of any class of
equity securities of the issuer, and Direct or indirect
to affiliates of the issuer payments to others
------------------------------------ ------------------
Construction of plant,
building and
facilities............. -- --
Purchase and
installation of
machinery and
equipment.............. -- --
Purchase of real
estate................. -- --
Acquisition of other
business(es) / assets.. -- $9,714,222(1)
Repayment of
indebtedness........... -- --
Working capital......... -- $9,347,480
Temporary investment
(cash and municipal
bonds)................. -- $2,991,253
- ----------
(1) During the second quarter of Fiscal 1998, the Company utilized $500,000 of
the net offering proceeds as part of the consideration to acquire assets
related to the Circle Surround technology. During the first quarter of
Fiscal 1998, the Company utilized an aggregate of $7,894,222 in connection
with two other acquisitions (see Note 2 to the Notes to the Consolidated
Financial Statements included under Item 8 of this Report).
18
Item 6. Selected Consolidated Financial Data
The following table sets forth selected financial data of the Company for
the fiscal years ended December 31, 2000, 1999, 1998, 1997 and 1996 which has
been derived from the Company's consolidated audited financial statements. The
following information should be read in conjunction with the Consolidated
Financial Statements and Notes thereto included elsewhere in this Report.
Fiscal Year Ended December 31,
-------------------------------------------
2000 1999 1998 1997 1996
-------- ------- -------- ------- ------
(in thousands except per share data)
Revenues:
Chip and licensing revenues...... $ 13,098 $18,624 $ 15,762 $10,081 $5,392
Product and component sales...... 14,874 17,172 28,963 -- --
-------- ------- -------- ------- ------
Total revenues................ 27,972 35,796 44,725 10,081 5,392
Cost of sales..................... 16,611 22,003 29,819 210 95
-------- ------- -------- ------- ------
Gross margin..................... 11,361 13,793 14,906 9,871 5,297
Operating costs and expenses
Sales and marketing.............. 6,355 5,148 6,846 2,112 1,163
Research and development......... 4,151 4,142 2,555 596 522
General and administrative....... 10,357 6,932 5,531 2,615 1,616
Non-cash stock issuance cost..... 3,112 -- -- -- --
Acquired in-process research and
development..................... -- -- 18,510 -- --
-------- ------- -------- ------- ------
Total operating costs and
expenses..................... 23,975 16,222 33,442 5,323 3,301
-------- ------- -------- ------- ------
(Loss) income from operations..... (12,614) (2,429) (18,536) 4,548 1,996
Other income, net................ 1,180 735 705 1,088 366
Minority interest................ 250 -- -- -- --
-------- ------- -------- ------- ------
(Loss) income before income tax
expense (benefit)................ (11,184) (1,694) (17,831) 5,636 2,362
Income tax expense (benefit)...... 325 50 (273) 1,863 501
-------- ------- -------- ------- ------
Net (loss) income................. $(11,509) $(1,744) $(17,558) $ 3,773 $1,861
======== ======= ======== ======= ======
Net (loss) income per common
share:
Basic........................... $ (0.93) $ (0.15) $ (1.54) $ 0.39 $ 0.24
======== ======= ======== ======= ======
Diluted......................... $ (0.93) $ (0.15) $ (1.54) $ 0.35 $ 0.21
======== ======= ======== ======= ======
Weighted average number of shares
used in the calculation of net
(loss) income per common share:
Basic........................... 12,379 11,696 11,410 9,556 7,625
Diluted......................... 12,379 11,696 11,410 10,852 8,686
Balance sheet data:
Working capital.................. $ 21,914 $10,953 $ 7,644 $ 9,075 $3,375
Total assets..................... 41,569 39,101 45,535 31,542 26,674
Short-term debt and current
portion of long-term
obligations..................... 8,000 8,000 8,000 82 180
Long-term obligations, net of
current portion................. -- -- -- -- 69
Stockholders' equity............. 28,303 25,040 26,072 29,420 25,151
19
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
The Company is a developer and provider of audio and voice technology
solutions for the consumer electronics, home theater, computer, game, Internet
and telecommunications markets. As of the end of Fiscal 2000, the Company's
principal business activities in these markets included:
. Developing and licensing audio and voice technologies to OEMs and
semiconductor manufacturers around the world;
. Through its majority-owned subsidiary, SRSWOWcast, developing audio and
voice enhancement technology solutions dedicated to the Internet and
telecommunications markets; and
. Through its wholly-owned subsidiary, Valence, designing and selling
technology solutions through custom ASICs to OEMs; and designing,
distributing and manufacturing components, sub-assemblies and finished
goods for targeted markets within selected OEM and retail communities.
From the Company's inception in 1993 until February 1998, the Company
derived substantially all of its revenue from royalties received from
technology licenses. On March 2, 1998, the Company acquired all of the
outstanding capital stock of Valence, a British Virgin Islands holding company
with its principal business operations in Hong Kong and the PRC for an
aggregate purchase price, excluding non-compete agreements and acquisition
costs, of $19,500,000 consisting of approximately $7,400,000 in cash and
approximately 1,680,611 shares of the Company's common stock, $.001 par value
per share (the "Common Stock"). The acquisition was accounted for as a
purchase with an effective date of February 1, 1998. The acquisition of
Valence had a material impact on the Company's financial statements subsequent
to February 1998. Accordingly, current and future financial statements may not
be directly comparable to the Company's historical financial statements.
During the first quarter of Fiscal 1998, the Company acquired certain
rights to VIP, which is a patented voice processing technology that improves
the intelligibility of the spoken voice, especially in high ambient noise
environments. Aggregate consideration, including acquisition costs, was
$1,138,710 and was comprised of $620,178 in cash, 25,000 shares of Common
Stock and warrants to purchase 100,000 shares of Common Stock at $9.47 per
share.
During the second quarter of Fiscal 1998, the Company acquired certain
rights to Circle Surround, a patented audio delivery system that allows multi-
channel surround sound to be encoded into a two-channel stereo format and
allows an encoded two-channel audio source or a traditional stereo audio
source to be decoded into a multi-channel surround format. The aggregate
purchase price, including acquisition costs, was $834,985 and was comprised of
$534,985 in cash and 35,294 shares of Common Stock.
The Company operates in three business segments: (a) the development and
marketing of technology either in the form of integrated circuits through
Valence (ASICs) or the licensing of technologies developed by the Company to
OEMs and semiconductor manufacturers; (b) the sale of consumer electronic
products and components; and (c) the SRSWOWcast internet-based business.
20
Results of Operations
The following table sets forth certain consolidated operating data as a
percentage of total revenues for the years ended December 31, 2000, 1999 and
1998:
Percentage of Total
Revenue Years Ended
December 31,
------------------------
2000 1999 1998
------ ------ ------
Chip and licensing revenue......................... 47% 52% 35%
Product and component sales........................ 53 48 65
------ ------ ------
Total revenue..................................... 100 100 100
Cost of sales...................................... 59 61 67
------ ------ ------
Gross margin....................................... 41 39 33
Sales and marketing................................ 23 14 15
Research and development........................... 15 12 6
General and administrative......................... 37 20 12
Non-cash stock issuance cost....................... 11 0 0
Acquired in-process research and development....... 0 0 41
------ ------ ------
Total operating expense........................... 86 46 74
------ ------ ------
Operating loss..................................... (45) (7) (41)
Other income, net.................................. 4 2 2
Minority interest.................................. 1 0 0
------ ------ ------
Loss before income taxes........................... (40) (5) (39)
Income tax expense (benefit)....................... 1 0 0
------ ------ ------
Net loss.......................................... (41)% (5)% (39)%
====== ====== ======
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Revenues
Chip and licensing revenue consists of design fees and sales of ASICs by
Valence to OEM manufacturers and sales of general purpose ICs designed by the
Company under the brand name ASP Microelectronics. Licensing revenues are
royalties generated primarily from the license of the Company's audio and voice
technologies. License and royalty agreements generally provide for the license
of technologies for a specified period of time for either a single fee or a fee
based on the number of units distributed by the licensee. Product and component
sales represent (a) the manufacture and sale of Valence's own branded product
line of VCD players, amplifiers and game products and (b) the distribution of
semiconductor products, manufacturing components and sub-assemblies to OEMs for
the Hong Kong and the PRC markets.
Total revenues for Fiscal 2000 were $27,972,694, consisting of chip and
licensing revenue of $13,098,242 and product and component revenue of
$14,874,452. This contrasts with Fiscal 1999, where chip and licensing revenues
were $18,624,221, and product and component revenues were $17,171,362. Both
categories of chip and licensing revenue decreased from the same period last
year with licensing revenue decreasing by 13.3% and revenue from custom ASIC
chip design and chip sales related to Valence's activities decreasing by 33.3%.
These decreases were due to a continued general weakness in the Asian markets
leading to reduced demand for consumer electronics products in the region which
negatively impacted the sales of semiconductor ICs that include the Company's
audio technologies and the trend by consumer electronic manufacturers to
initially adopt the Company's new technologies into higher end models resulting
in limited volume potential for the short term. Product and component revenues
decreased by 13.4% from the same prior year period which is consistent with the
Company's decision to focus on higher margin chip and licensing revenues and
de-emphasize certain lower margin distribution activities. Revenues generated
by the Company's internet-based business were not significant during Fiscal
2000.
21
Gross Margin
Cost of sales consists primarily of component cost, fabrication costs,
assembly and test costs, and the cost of materials and overhead from
operations. Gross margin for Fiscal 2000 increased to 40.6% as a percentage of
total revenue from 38.5% for the same period in 1999. The increase resulted
primarily from the Company's decision to focus the revenue base towards higher
margin chip and licensing sales and away from lower margin component
distribution.
Sales and Marketing
Sales and marketing expenses consist primarily of employee-related
expenses, sales commissions and product promotion costs. Sales and marketing
expenses were $6,355,742 in Fiscal 2000 compared to $5,148,458 in Fiscal 1999,
an increase of $1,207,284 or 23.5%. This increase is attributable primarily to
spending associated with the development and promotion of the SRSWOWcast
website and creation of program content for the website. Effective February
21, 2001, SRSWOWcast discontinued efforts to develop program content to focus
on utilizing the website to promote the licensing of the Company's audio and
voice technology solutions. Although this should reduce sales and marketing
expenditures related to the SRSWOWcast business, management believes sales and
marketing expenditures will continue to be a significant component of
operating costs in the future to promote the adoption of the Company's
technology in new and existing markets. As a percentage of total revenues,
sales and marketing expenses increased to 22.7% in Fiscal 2000 from 14.4% in
Fiscal 1999.
Research and Development
Research and development expenses consist of salaries and related costs of
employees engaged in ongoing research, design and development activities and
costs for engineering materials and supplies. Research and development
expenses were $4,151,064 in Fiscal 2000 compared to $4,141,571 in Fiscal 1999,
an increase of $9,493 or 0.2%. This increase is primarily attributable to
expenses related to SRSWOWcast, offset partially by a reduction in staffing
levels at Valence. As a percentage of total revenues, research and development
expenses increased to 14.8% in Fiscal 2000 from 11.6% in Fiscal 1999.
Management believes that research and development expenses will increase in
the future as a result of the Company's ongoing product development efforts
including activity related to the expansion of consumer products incorporating
the Company's audio and voice technologies.
General and Administrative
General and administrative expenses consist primarily of employee-related
expenses, legal costs associated with the administration of intellectual
property, professional fees and various other administrative costs. General
and administrative expenses were $10,357,001 in Fiscal 2000 compared to
$6,932,397 in Fiscal 1999, an increase of $3,424,604 or 49.4%. The increase is
primarily due to compensation costs incurred as a result of the resignation of
an employee of Valence, accelerated amortization of intellectual property
incorporating obsolete or unpursued technologies, higher legal and employee
related expenses associated with the launch of SRSWOWcast, expenses related to
the postponed Valence IPO, plus higher salaries and benefits, legal, and other
administrative expenses in the Company's core licensing business. As a
percentage of total revenues, general and administrative expenses increased to
37.0% in Fiscal 2000 from 19.4% in Fiscal 1999.
On March 3, 2000, the Company filed an application to list the common
shares of Valence on the GEM, in order to sell a minority interest in Valence
to the public. The initial public offering was targeted for completion in the
second quarter of 2000. However, due to negative market conditions affecting
equity markets worldwide, including the GEM, the Company elected not to
proceed with the offering. Offering costs incurred by the Company, comprised
primarily of legal, accounting and underwriting fees, totaled $1,142,175 as of
December 31, 2000. These costs are included in general and administrative
expense in the accompanying financial statements.
22
Non-cash Stock Issuance Cost
In March 2000, the Company entered into a technology and marketing alliance
with Microsoft. In conjunction with this transaction, Microsoft purchased
shares of common stock of the Company and was issued warrants to purchase
additional shares of common stock of the Company and of its subsidiary,
SRSWOWcast (together referred to as the "Microsoft transaction"). As a result
of the Microsoft transaction, the Company recognized a one-time, non-cash
charge totaling $3,111,859. See Note 9 of the Notes to Consolidated Financial
Statements for more information concerning the Microsoft transaction.
Other Income, Net
Other income, net consists primarily of interest income, interest expense,
realized gains and losses on the sale of investments and foreign currency
transaction gains and losses at Valence. Net interest income was $1,059,009 in
Fiscal 2000 compared to $448,117 in Fiscal 1999, an increase of 236.3%. The
increase is primarily attributable to higher average cash and investment
balances during the current year as compared to the prior year due partly to
the $5,000,000 received in the Microsoft investment.
Minority Interest
Minority interest represents the minority shareholders' proportionate share
of losses in SRSWOWcast. Losses in SRSWOWcast are expected to continue as a
result of expenditures exceeding revenues in an effort to support the
expansion and growth of SRSWOWcast business operations. Should losses continue
in SRSWOWcast, the minority interest adjustment in the consolidated statement
of operations will continue to reduce the Company's net losses by the minority
shareholders' proportionate share of SRSWOWcast's net losses to the extent of
their investment.
Provision for Income Taxes
The income tax provision for Fiscal 2000 was $324,981 compared to $49,662
for Fiscal 1999. The higher tax expense in Fiscal 2000 was primarily a result
of Valence fully utilizing tax loss carry forwards during Fiscal 2000
resulting in higher income tax expense and the Company recognizing a tax
benefit in Fiscal 1999 primarily due to a taxable loss recognized for U.S.
federal income tax purposes related to domestic operations. In addition, the
Company benefited from certain tax credits and statutory tax rates in the
Asian countries where Valence has its principal business operations which are
lower than United States statutory rates. The Company had federal and state
net operating loss carry forwards at December 31, 2000, of approximately
$15,400,000 and $9,400,000, respectively. These net operating loss carry
forwards will begin to expire in 2019 and 2003, respectively. In addition, the
Company has federal tax credit carry forwards of approximately $683,000 which
will begin to expire in 2003. As of December 31, 2000, a valuation allowance
of approximately $6,062,000 has been provided based on the Company's
assessment of the future realizability of certain deferred tax assets.
Approximately $1,287,000 of the valuation allowance is attributable to the
potential tax benefit of stock option transactions that will be credited
directly to additional paid in capital, if realized.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Impact of Valence Acquisition
The Company's consolidated financial results for Fiscal 1998 include the
results of the Valence operations beginning as of February 1, 1998.
Accordingly, results for the year ended December 31, 1999 may not be directly
comparable to results for the year ended December 31, 1998.
Revenues
Total revenues for Fiscal 1999 were $35,795,583, consisting of chip and
licensing revenue of $18,624,221 and product and component revenue of
$17,171,362. This contrasts with Fiscal 1998, where chip and licensing
23
revenues were $15,762,369, and product and component revenues were
$28,962,671. Excluding chip design revenue, licensing revenue decreased 38.2%
from the same period last year due to the following factors: (a) the shift in
the PC market to lower cost models which cannot bear the cost of performance
enhancement technologies such as those offered by SRS Labs; (b) the reduced
growth rate of the PRC economy which reduced demand for consumer electronics
products in the region and negatively impacted the sales of semiconductor ICs
that include the Company's audio technologies; and (c) the trend by consumer
electronic manufacturers to initially adopt the Company's new technologies
into their higher end models with limited volume potential for the short term.
Revenue from custom ASIC chip design and chip sales related to Valence's
activities increased 48.0% from the same period last year primarily due to the
Company's decision to focus on higher margin chip and licensing revenues and
de-emphasize certain lower margin distribution activities. The 40.7% decrease
in product and component revenues in Fiscal 1999 also is due to the Company's
decision to de-emphasize certain lower margin distribution activities.
Gross Margin
Gross margin for Fiscal 1999 increased to 38.5% as a percentage of total
revenue from 33.3% for the same period in 1998. The increase resulted
primarily from the shift in the Company's revenue base towards higher margin
chip and licensing sales and away from lower margin component distribution.
Sales and Marketing
Sales and marketing expenses were $5,148,458 in Fiscal 1999 compared to
$6,845,674 in Fiscal 1998, a decrease of 24.8%. This decrease is attributable
primarily to lower advertising, promotional, trade show and travel costs,
resulting from the Company's efforts during 1999 to reduce costs in these
areas. As a percentage of total revenues, sales and marketing expenses
decreased to 14.4% in Fiscal 1999 from 15.3% in Fiscal 1998.
Research and Development
Research and development expenses were $4,141,571 in Fiscal 1999 compared
to $2,554,883 in Fiscal 1998, an increase of 62.1%. This increase is primarily
attributable to ASIC related research and development, and design and
development of ASP branded products based on SRS technologies. As a percentage
of total revenues, research and development expenses increased to 11.6% in
Fiscal 1999 from 5.7% in Fiscal 1998.
General and Administrative
General and administrative expenses were $6,932,397 in Fiscal 1999 compared
to $5,530,957 in Fiscal 1998, an increase of 25.3%. The increase was primarily
attributable to headcount added to support new business development, costs
incurred for due diligence activities related to potential acquisitions, and
costs incurred to reserve for certain non-collectible accounts receivable. As
a percentage of total revenues, general and administrative expenses increased
to 19.4% in Fiscal 1999 from 12.4% in Fiscal 1998.
As part of the Valence acquisition, the Company allocated a portion of the
purchase price to various intangible assets totaling approximately $5,910,400.
This amount was capitalized and is being amortized on a straight line basis
over periods ranging from three to eleven years with the related amortization
expense of $1,205,988 and $1,180,489 included in general and administrative
expenses for Fiscal 1999 and 1998, respectively. See Note 2 of the Notes to
the Consolidated Financial Statements for more information concerning the
purchase price allocation associated with the Valence acquisition.
Acquired In-Process Research and Development
The Company's Consolidated Statement of Operations for the year ended
December 31, 1998 includes the one-time charge of $18,510,378 for the write-
off of Acquired R&D expenses associated with the Valence acquisition and the
acquisition of certain assets associated with the VIP technology. The Acquired
R&D expenses
24
arose from new product projects that were under development at the date of the
acquisition and expected to eventually lead to new products but had not yet
established technological feasibility and for which no future alternative use
was identified. The valuation of the Acquired R&D projects was based upon the
discounted expected future net cash flows of the products over the products'
expected lives, reflecting the estimated stages of completion of the projects
and the estimated costs to complete the projects.
New product development projects underway at Valence at the time of the
Valence acquisition included, among others, ASICs for consumer electronics,
computing and voice and audio applications, home entertainment systems,
digital multimedia players and digital power amplifiers. The Company estimated
that these projects were approximately 63% complete at the date of acquisition
and estimated that the cost to complete these projects will aggregate
approximately $7 million and will be incurred over a three-year period.
New product development projects utilizing the VIP technology at the time
of the VIP acquisition included, among others, digital and analog sound
reinforcement, wireless and non-wireless telecommunications applications,
hearing aid applications and headphone and microphone applications. The
Company estimated that these projects were approximately 62% complete at the
date of acquisition and estimated that the cost to complete these projects
will aggregate approximately $525,000 and will be incurred over a two-year
period.
Uncertainties that could impede the progress of converting a development
project to a developed technology include the availability of financial
resources to complete the project, failure of the technology to function
properly, continued economic feasibility of developed technologies, customer
acceptance, customer demand and customer qualification of such new technology
and general competitive conditions in the industry. There can be no assurance
that the Acquired R&D projects will be successfully completed and commercially
introduced.
Other Income, Net
Net interest income was $448,117 in Fiscal 1999 compared to $694,760 in
Fiscal 1998, a decrease of 35.5%. The decrease is primarily attributable to
lower average cash and investment balances during Fiscal 1999 as compared to
the prior year due to the $7,894,222 paid in conjunction with the acquisitions
of Valence and VIP and interest expense on the outstanding borrowings under
the Company's line of credit obtained during Fiscal 1998.
Provision for Income Taxes
The income tax provision for Fiscal 1999 was $49,662 compared to a benefit
of $273,156 for Fiscal 1998. The Company recognized a tax benefit in Fiscal
1998 primarily due to a taxable loss recognized for U.S. federal income tax
purposes related to domestic operations. In addition, the Company benefited
from certain tax credits and statutory tax where Valence has its principal
business operations which are lower than United States statutory rates. The
Company had federal and state net operating loss carry forwards at December
31, 1999, of approximately $3,400,000 and $3,100,000, respectively. These net
operating loss carry forwards will begin to expire in 2019 and 2003,
respectively. In addition, the Company has federal tax credit carry forwards
of approximately $541,000 which will begin to expire in 2003. As of December
31, 1999, a valuation allowance of approximately $1,154,000 has been provided
based on the Company's assessment of the future realizeability of certain
deferred tax assets. Approximately $125,000 of the valuation allowance is
attributable to the potential tax benefit of stock option transactions that
will be credited directly to additional paid in capital, if realized.
Selected Quarterly Operating Results (Unaudited)
The following table sets forth certain quarterly financial data for the
eight quarters in the period ended December 31, 2000. The quarterly
information is based upon unaudited financial statements prepared by the
Company on a basis consistent with the Company's audited consolidated
financial statements and, in management's opinion, includes all adjustments,
consisting only of normal recurring adjustments necessary for a fair
presentation of the information for the periods presented. This information
should be read in conjunction with the Company's audited Consolidated
Financial Statements and Notes thereto appearing elsewhere in this
25
Report. The acquisition of Valence in the first quarter of fiscal 1998 will
continue to have a material impact on the Company's financial statements. The
Company's quarterly operating results have varied significantly in the past
and are expected to vary significantly in the future.
Three Months Ended
----------------------------------------------------------------------------
March 31, June 30, Sep. 30, Dec. 31, March 31, June 30, Sep. 30, Dec. 31,
2000 2000 2000 2000 1999 1999 1999 1999
--------- -------- -------- -------- --------- -------- -------- --------
(In thousands except per share amounts)
Revenues:
Chip and licensing..... $ 2,879 $ 2,860 $ 3,872 $ 3,487 $ 3,581 $3,978 $ 4,849 $6,216
Product and component.. 4,312 3,733 4,136 2,694 4,074 4,214 5,168 3,716
------- ------- ------- ------- ------- ------ ------- ------
Total revenues...... 7,191 6,593 8,008 6,181 7,655 8,192 10,017 9,932
Gross margin............ 2,342 2,326 3,391 3,302 2,561 3,239 3,724 4,269
Operating expenses...... 6,755 6,603 4,723 5,895 4,496 3,238 3,467 5,021
------- ------- ------- ------- ------- ------ ------- ------
Operating income
(loss)................. (4,413) (4,277) (1,332) (2,593) (1,935) 1 257 (752)
Net income (loss)..... $(4,341) $(4,107) $(1,222) $(1,839) $(1,497) $ 6 $ 310 $ (563)
Net income (loss) per
Common share:
Basic and diluted..... $ (0.36) $ (0.33) $ (0.10) $ (0.14) $ (0.13) $ -- $ 0.03 $(0.05)
- --------
(a) Operating expenses for the three month period ended March 31, 2000
included $3,111,859 related to non-cash stock issuance cost.
(b) Operating expenses for the three month period ended June 30, 2000 included
$1,142,175 related to offering costs incurred on the postponed Valence
IPO.
Liquidity and Capital Resources
In August 1996, the Company completed an initial public offering of
3,107,452 shares of Common Stock at $8.00 per share. Net proceeds to the
Company were approximately $22 million.
As of December 31, 2000, cash, cash equivalents, and investments were
$30,425,210 compared to $25,312,411 as of December 31, 1999. The Company's
principal source of liquidity to fund ongoing operations for the year ended
December 31, 2000 was cash, cash equivalents and investments. The Company has
adopted an investment guideline restricting the types and minimum quality of
investments the Company is authorized to purchase. At December 31, 2000, the
Company had cash and cash equivalents of $24,128,480 and investments of
$6,296,730. Investments consist of municipal bonds rated a minimum of A1. Net
cash used in operating activities during Fiscal 2000 was $4,848,803 and was
generated primarily from the net loss during the year and a net decrease in
accounts payable, offset somewhat by a decrease in accounts receivable as well
as certain adjustments to reconcile net loss to cash used in operating
activities including depreciation and amortization and non-cash stock issuance
costs. Net cash provided by investing activities of $525,630 resulted from
sales of the Company's investments offset by purchases of furniture, fixtures
and equipment and intangible assets. Net cash provided by financing activities
of $12,481,975 resulted from proceeds from the Microsoft investment, proceeds
from sale of stock of a subsidiary and sale of common stock pursuant to
exercise of the Company's stock options. Net cash provided by operating
activities during Fiscal 1999 was $1,633,177 and was generated primarily from
decreases in accounts receivable, inventory, and other assets, plus non-cash
depreciation and amortization, offset by a net decrease in accounts payable.
Net cash provided by investing activities of $1,667,744 resulted primarily
from sales of the Company's investments. Net cash provided by financing
activities of $327,515 resulted primarily from sale of common stock pursuant
to exercise of the Company's stock options.
Inventories in Fiscal 2000 increased from $2,726,193 at December 31, 1999
to $3,068,478 at December 31, 2000. This increase was primarily a result of a
build-up of inventory in anticipation of orders which were deferred into the
following year. Accounts payable decreased from $2,882,686 at December 31,
1999 to $1,603,401 at December 31, 2000 primarily due to reduced activity
during the later stages of Fiscal 2000
26
compared to Fiscal 1999. Accrued liabilities increased from $1,658,964 at
December 31, 1999 to $1,974,357 at December 31, 2000 primarily due to the
inclusion of SRSWOWcast accruals and certain compensation related expenses by
Valence.
On March 2, 1998, the Company acquired all of the outstanding shares of
capital stock of Valence for an aggregate purchase price of $19,500,000,
excluding acquisition costs and non-compete agreements, consisting of
approximately $7,400,000 in cash and approximately 1,680,611 shares of the
Company's common stock.
On March 4, 1998, the Company obtained a revolving line of credit and
letter of credit facility with a bank which expires on April 1, 2001 and is
secured by certain of the Company's investments. The total availability under
the line of credit is the lesser of $10 million or a percentage of the fair
market value of the collateral. The line of credit bears interest at the
bank's prime rate (9.5% as of December 31, 2000) or LIBOR plus 0.75% (6.75% as
of December 31, 2000). As of December 31, 2000, the Company had $8.0 million
outstanding under the line of credit. The collateral requirements under the
above-referenced credit facility may have the effect of restricting the amount
available to pay cash dividends.
In November 1999, Valence and its subsidiaries obtained a credit facility
with a bank that provides for borrowings aggregating approximately $5,000,000.
The facility has no fixed expiration date and is collateralized by certain of
the Valence's assets on deposit with the bank. The facility provides for a
variety of import/export trade instruments which bear interest at rates
ranging from 1% over the Hong Kong Dollar prime rate to 1.75% over LIBOR. The
facility also provides for a revolving line of credit of up to $3,500,000
which bears interest at 1.25% over the related collateral deposit interest
rate. At December 31, 2000, there were no obligations outstanding under this
credit facility.
Based on current plans and business conditions, the Company expects that
its cash, cash equivalents, investments and/or available borrowings under its
line of credit together with any amounts generated from operations will be
sufficient to meet the Company's cash requirements for at least the next 12
months. However, there can be no assurance that the Company will not be
required to seek other financing sooner or that such financing, if required,
will be available on terms satisfactory to the Company.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities". In June 2000, the FASB issued
SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities--an amendment of FASB Statement No. 133" which amends
certain provisions of SFAS No. 133 to clarify four areas causing difficulties
in implementation. The amendment included expanding the normal purchase and
sale exemption for supply contracts, permitting the offsetting of certain
intercompany foreign currency derivatives and thus reducing the number of
third party derivatives, permitting hedge accounting for foreign-currency
denominated assets and liabilities and redefining interest rate risk to reduce
sources of ineffectiveness. The adoption of SFAS No. 133 on January 1, 2001,
as amended by SFAS No. 138, did not have a material impact on the Company's
consolidated results of operations, financial position or cash flows.
In December 1999, the Securities and Exchange Commission ("SEC") staff
issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in
Financial Statements". SAB No. 101 summarizes the SEC staff's views in
applying generally accepted accounting principles to revenue recognition in
financial statements. The implementation of SAB No. 101 in the fourth quarter
of 2000 did not have a material effect on the Company's consolidated results
of operations, financial position or cash flows.
In March 2000, FASB issued Interpretation No. ("FIN") 44 of Accounting
Principles Board Opinion No. 25 "Accounting for Certain Transactions Involving
Stock Compensation", which, among other things, addresses accounting
consequences of a modification that reduces the exercise price of a fixed
stock option award (otherwise known as repricing). FIN 44 did not have a
material impact on the Company's consolidated results of operations, financial
position or cash flows.
27
Factors That May Affect Future Results
Quarterly Fluctuations
The Company's operating results may fluctuate from those in prior quarters
and will continue to be subject to quarterly and other fluctuations due to a
variety of factors, including the extent to which the Company's licensees
incorporate the Company's technologies into their products; the timing of
orders from, and the shipments to, major customers; the timing of new product
introductions by the Company; the gain or loss of significant customers;
competitive pressures on selling prices; the market acceptance of new or
enhanced versions of the Company's technologies; the rate that the Company's
semiconductor licensees manufacture and distribute chips to product
manufacturers; and fluctuations in general economic conditions, particularly
those affecting the consumer electronics market. Due to the Company's
dependence on the consumer electronics market, the substantial seasonality of
sales in the market could impact the Company's revenues and net income. As a
result, the Company believes that period-to-period comparisons of its results
of operations are not necessarily meaningful and should not be relied upon as
indications of future performance. The Company believes that there is
seasonality relating to the Christmas season as well as the Chinese New Year
within the Asia region, which fall into the fourth and first quarters,
respectively.
Valence's Business
The Company derives a significant amount of its revenue from Valence's ASIC
and component distribution business. Valence's engineering team focuses on the
design of custom ASICs to meet specific customers' requirements and outsources
the production of the design to mask houses, foundries and packaging houses
located primarily in Asia. The operations of Valence could be affected by a
variety of factors, including the timing of customer orders, the timing of
development revenue, changes in the mix of products distributed and the mix of
distribution channels employed, the emergence of a new industry standard,
product obsolescence and changes in pricing policies by the Company, its
competitors or its suppliers.
Business revenue from ASICs is concentrated in a limited number of
customers in the areas of consumer electronics, communications products,
computers and computer peripherals. As such, the loss of any such customers or
any bad debt arising from them may have a material adverse impact on the
Company's financial condition and results of operation. Beginning in Fiscal
1999, Valence began to exit from certain lower margin product offerings in the
distribution side of the business and has focused upon developing and
distributing products that are related to or incorporate the Company's
proprietary technologies. As a result, the immediate loss in revenue of the
low margin distribution business will not be entirely offset by the new
proprietary technology based products, which will take time to develop and be
introduced into the marketplace. There can be no assurance that the Company
will be able to quickly introduce new products to offset the loss in revenue
or that the new products developed will receive a favorable market acceptance.
The public offering of common shares of Valence in Hong Kong was intended
to bring new capital to grow Valence's core business while, at the same time,
adding significant value to the Company's shareholders. The Company's decision
not to proceed with the offering is not expected to adversely affect Valence's
core business operations, and the Company will continue to evaluate its
financing options domestically and in foreign capital markets.
The acquisition of Valence has added significant diversity to the Company's
overall business structure and the Company's opportunities. The Company
recognizes that in the presence of such corporate diversity, and in particular
with regard to the semiconductor industry, there will always exist a potential
for a conflict among sales channels between the Company and certain of the
Company's technology licensees. Although the operations of the Company's
licensing business and those of Valence are generally complementary, there can
be no assurances that sales channel conflicts will not arise. If such
potential conflicts do materialize, the Company may or may not be able to
mitigate the effect of such perceived conflicts, which, if not resolved, may
impact the results of operations.
28
Internet Business
In Fiscal 1999, the Company launched its Internet business with the
formation of SRSWOWcast. In Fiscal 2000 SRSWOWcast commenced operations with a
business plan which focused on developing and acquiring audio based content to
attract visitor traffic to its website in order to sell advertising and e-
commerce products. In 2001, the Company changed its Internet strategy to focus
on licensing of the Company's audio and voice enhancement technology solutions
for Internet streaming, 3G wireless, VoIP and telephony applications. There
can be no assurance that this new business model will develop a sufficient
customer base to be able to generate meaningful revenue from their targeted
markets.
Product Business
In Fiscal 1999, the Company developed and marketed on its e-commerce site,
www.wowthing.com, its first consumer audio product, the WOW Thing Processor
Box. The WOW Thing Processor Box enhances the sound quality of music
downloaded over the Internet as well as audio performance of computer and home
entertainment products and speakers. This was the Company's first entry into
the consumer market in the United States which is both competitive and demands
products with short life cycles.
In Fiscal 2000, the Company packaged the hardware and began to market two
models: "WOW Thing for Computers" and "WOW Thing for Game Consoles" to
consumers and resellers. Although the revenues from these product launches
during Fiscal 2000 were not significant, the product introductions did help to
elevate the technology's brand awareness with the Company's customers and with
consumers.
The Company intends to continue to expand its offerings of high-end audio
enhancement products in the year 2001 and beyond. There can be no assurance
that the Company will be able to develop an effective distribution channel and
build acceptable brand recognition as a product manufacturer. As the business
increases, it is anticipated that significant capital will be required to
finance product inventory and accounts receivable. As a result, the Company is
subject to risks of product obsolescence, bad debt and insufficient finance to
grow the business.
The Company also recognizes that as new consumer audio products are
developed and marketed by the Company, there will always exist a potential for
conflict and competition between the Company and certain of the Company's
technology licensees. Although the intended products of the Company and those
of its licenses do not generally overlap, there can be no assurances that the
Company's products will not compete with those of their licensees. If such
conflicts do materialize, it is uncertain whether the Company will be able to
mitigate the effect of such conflicts, which, if not resolved, may adversely
impact its business and results of operations.
Economic Risks Associated with Doing Business in Asia
The Company's significant operations in Hong Kong, the PRC and other parts
of Asia have required, and will continue to require, refinement to adapt to
the changing market conditions in the region. The Company's operations in
Asia, and international operations in general, are subject to risks of
unexpected changes in, or impositions of legislative or regulatory
requirements.
The Asian consumer electronics markets accounted for approximately 94%, 94%
and 92% of total Company sales in 2000, 1999 and 1998, respectively and are
expected to continue to account for a substantial percentage of sales in the
future. The recent economic crisis in Asia has been characterized by declines
in consumer spending, currency devaluation, unemployment and bank failures.
Any of these factors, should they continue, could significantly reduce the
demand for the end user goods in which the Company's products are used.
The PRC economy has experienced significant growth in the past decade, but
such growth has been uneven across geographic and economic sectors and has
recently been slowing. There can be no assurance that such growth will not
continue to decrease or that any slow down will not have a negative effect on
the Company's
29
business, including Valence. The PRC economy has also experienced deflation in
the past which may continue in the future. The current economic situation may
adversely affect the Company's profitability over time as expenditures for
consumer electronics products and information technology may decrease due to
the results of slowing domestic demand and deflation.
Hong Kong is a Special Administrative Region of the PRC with its own
government and legislature. Hong Kong enjoys a high degree of autonomy from
the PRC under the principle of "one country, two systems". The Company can
give no assurance that Hong Kong will continue to enjoy autonomy from the PRC.
The Hong Kong dollar has remained relative constant due to the US dollar
peg and currency board system that has been in effect in Hong Kong since 1983.
Since mid-1997, interest rates in Hong Kong have fluctuated significantly and
real estate and retail sales have declined. The Company can give no assurance
that the Hong Kong economy will not worsen or that the historical currency peg
of the Hong Kong dollar to the U.S. dollar will be maintained. Continued
declining consumer spending in Hong Kong, deflation or the discontinuation of
the currency peg could adversely affect the Company's business.
Currency Risk/Stability of Asian Markets
The Company expects that international sales will continue to represent a
significant portion of total revenues. To date, all of the Company's licensing
revenues have been denominated in U.S. dollars and most costs have been
incurred in U.S. dollars. It is the Company's expectation that licensing
revenues will continue to be denominated in U.S. dollars for the foreseeable
future. Because Valence and its subsidiaries' business is primarily focused in
Asia and because of the Company's anticipated expansion of its business in
China and other parts of Asia, the Company's consolidated operations and
financial results could be significantly affected by risks associated with
international activities, including economic and labor conditions, political
instability, tax laws (including U.S. taxes on foreign subsidiaries) and
changes in the value of the U.S. dollar versus the local currency in which the
products are sold. In addition, the Company's valuation of assets recorded as
a result of the Valence acquisition may also be adversely impacted by the
currency fluctuations relative to the U.S. dollar. The Company intends to
actively monitor its foreign exchange exposure and to implement strategies to
reduce its foreign exchange risk at such time that the Company determines the
benefits of such strategies outweigh the associated costs. However, there is
no guarantee that the Company will take steps to insure against such risks,
and should such risks occur, there is no guarantee that the Company will not
be significantly impacted. Countries in the Asia Pacific region have
experienced weakness in their currency, banking and equity markets. These
weaknesses could adversely affect consumer demand for Valence's products, the
U.S. dollar value of the Company's and its subsidiaries' foreign currency
denominated sales, the availability and supply of product components to
Valence and ultimately, the Company's consolidated results of operations.
Competitive Pressures
The Company's existing and potential competitors include both large and
emerging domestic and international companies that have substantially greater
financial, manufacturing, technical, marketing, distribution and other
resources. The Company's present or future competitors may be able to develop
products and technologies comparable or superior to those offered by the
Company, and to adapt more quickly than the Company to new technologies or
evolving market needs. The Company believes that the competitive factors
affecting the market for the Company's products and technologies include
product performance, price and quality; product functionality and features;
the ease of integration; and implementation of the products and technologies
with other hardware and software components in the OEM's products. In
addition, the markets in which the Company competes are intensely competitive
and are characterized by rapid technological changes, declining average sales
prices and rapid product obsolescence. Accordingly, there can be no assurance
that the Company will be able to continue to compete effectively in its
respective markets, that competition will not intensify or that future
competition will not have a material adverse effect on the Company's business,
operating results, cash flows and financial condition.
30
Importance of Intellectual Property
The Company's ability to compete may be affected by its ability to protect
its proprietary information. The Company has filed several U.S. and foreign
patent applications and to date has a number of issued U.S. and foreign
patents covering various aspects of its technologies. There can be no
assurance that the steps taken by the Company to protect its intellectual
property will be adequate to prevent misappropriation of its technology or
that the Company's competitors will not independently develop technologies
that are substantially equivalent or superior to the Company's technology. In
addition, the laws of certain foreign countries may not protect the Company's
intellectual property rights to the same extent, as do the laws of the U.S.
The semiconductor industry is characterized by frequent claims and litigation
regarding patent and other property rights. The Company is not currently a
party to any claims of this nature. There can be no assurances that third
parties will not assert additional claims or initiate litigation against the
Company or its customers with respect to existing or future products. In
addition, the Company may initiate claims or litigation against third parties
for infringement of the Company's proprietary rights or to determine the scope
and validity of the proprietary rights of the Company or others.
Management of Growth; Dependence on Key Personnel
The growth of the Company and its subsidiaries has placed, and will
continue to place, a significant strain on its administrative, operational and
financial resources, and has increased, and will continue to increase, the
level of responsibility for both existing and new management personnel. The
Company's future success depends in part on the continued service of its key
engineering, sales, marketing and executive personnel, including highly
skilled semiconductor design personnel. The Company anticipates that any
future growth will require it to recruit and hire a number of new personnel in
engineering, operations, finance, sales and marketing. Competition for such
personnel is intense, and there can be no assurance that the Company can
recruit and retain necessary personnel to operate its business and support
future growth. The Company's ability to manage its growth successfully also
will require the Company to continue to expand and improve its administrative,
operational, management and financial systems and controls.
Volatility of Stock Price
The trading price of the Common Stock has been, and will likely continue to
be, subject to wide fluctuations in response to quarterly variations in the
Company's operating results, announcements of new products or technological
innovations by the Company or its competitors, strategic alliances between the
Company and third parties, general market fluctuations and other events and
factors. Changes in earnings estimates made by brokerage firms and industry
analysts relating to the markets in which the Company does business, or
relating to the Company specifically, have in the past resulted in, and could
in the future result in, an immediate and adverse effect on the market price
of the Common Stock.
Acquisitions
From time-to-time, the Company expects to make acquisitions of businesses
or technologies that are complementary to its business strategy. Such future
acquisitions would expose the Company to risks commonly encountered in
acquisitions of businesses. Such risks include, among others, difficulty of
assimilating the operations, information systems and personnel of the acquired
business(es), the potential disruption of the Company's ongoing business; and
the inability of management to maximize the financial and strategic position
of the Company through successful incorporation of the acquired technologies,
employees and customers. There can be no assurance that any potential
acquisition will be consummated or, if consummated, that it will not have a
material adverse effect on the Company's business, financial condition and
results of operations.
Acquired In-Process Research And Development
Uncertainties that could impede the progress of converting a development
project to a developed technology include the availability of financial
resources to complete the project, the technology not functioning properly,
31
continued economic feasibility of developed technologies, customer acceptance,
customer demand and customer qualification of such new technology and general
competitive conditions in the industry. There can be no assurance that the
Acquired R&D projects associated with the acquisitions of Valence and VIP will
be successfully completed and commercially introduced.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to a variety of risks, including foreign currency
fluctuations and changes in interest rates affecting the cost of its debt.
Foreign Currency
The Company has subsidiary operations in Hong Kong and the PRC, and,
accordingly, the Company is exposed to transaction gains and losses that could
result from changes in foreign currency exchange rates. The Company uses the
local currency (Hong Kong dollars) as the functional currency for its
subsidiaries. Translation adjustments resulting from the process of
translating foreign currency financial statements into U.S. dollars were not
significant in Fiscal 2000, 1999 and 1998 due to the fact that the value of
the Hong Kong dollar is currently pegged to the U.S. dollar, and the exchange
rate remained relatively constant throughout such fiscal years. Under the
current circumstances, the Company believes that the foreign currency market
risk is not material. The Company actively monitors its foreign exchange
exposure and, should circumstances change, intends to implement strategies to
reduce its risk at such time that it determines that the benefits of such
strategies outweigh the associated costs. There can be no assurance that
management's efforts to reduce foreign exchange exposure will be successful.
Interest Rates
The Company's line of credit bears interest based on the lending bank's
prime rate or LIBOR. The interest rate on the balance of $8 million
outstanding at December 31, 2000 was 7.5%. If interest rates were to increase
by 10%, the impact on the Company's consolidated financial statements would be
additional interest expense of approximately $60,000.
32
Item 8. Financial Statements and Supplementary Data
Page
----
CONSOLIDATED FINANCIAL STATEMENTS:
Independent Auditors' Report............................................. 34
Consolidated Balance Sheets as of December 31, 2000 and 1999............. 35
Consolidated Statements of Operations for the years ended December 31,
2000, 1999 and 1998..................................................... 36
Consolidated Statements of Comprehensive Loss for the years ended
December 31, 2000, 1999 and 1998........................................ 36
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2000, 1999 and 1998........................................ 37
Consolidated Statements of Cash Flows for the years ended December 31,
2000, 1999 and 1998..................................................... 38
Notes to Consolidated Financial Statements............................... 40
FINANCIAL STATEMENT SCHEDULE:
Schedule II -- Valuation and Qualifying Accounts and Reserves
for the years ended December 31, 2000, 1999 and 1998.................... 56
The Quarterly Financial Information required by this Item 8 is set forth in
Item 7 of the Annual Report on Form 10-K and is hereby incorporated into this
Item 8.
33
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
and Stockholders of
SRS Labs, Inc.:
We have audited the accompanying consolidated balance sheets of SRS Labs,
Inc. and subsidiaries (the "Company") as of December 31, 2000 and 1999, and
the related consolidated statements of operations, comprehensive loss,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2000. Our audits also included the financial statement
schedule listed in the Index at Item 14(a)(2). These financial statements and
financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of SRS Labs, Inc. and
subsidiaries as of December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 2000, in conformity with accounting principles generally
accepted in the United States of America. Also, in our opinion, such financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ DELOITTE & TOUCHE LLP
Costa Mesa, California
February 12, 2001
34
SRS LABS, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31, December 31,
2000 1999
------------ ------------
Current Assets
Cash and cash equivalents......................... $ 24,128,480 $ 15,969,678
Investments available for sale.................... 5,713,881 3,011,250
Accounts receivable, net of allowance for doubtful
accounts of $995,599 in 2000 and $1,083,961 in
1999............................................. 787,908 2,495,157
Inventories, net of reserve of $757,185 in 2000
and $624,844 in 1999............................. 3,068,478 2,726,193
Prepaid expenses and other current assets,
including other receivables of $150,856 in 2000
and $161,258 in 1999............................. 847,953 729,881
Deferred income taxes............................. 38,116 81,467
------------ ------------
Total Current Assets........................... 34,584,816 25,013,626
Investments available for sale.................... 582,849 6,331,483
Furniture, fixtures and equipment, net............ 1,808,624 1,166,757
Intangible assets, net............................ 3,692,218 5,425,273
Deferred income taxes............................. 900,839 740,889
Other assets...................................... -- 422,493
------------ ------------
Total Assets................................... $ 41,569,346 $ 39,100,521
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable.................................. $ 1,603,401 $ 2,882,686
Accrued liabilities............................... 1,974,357 1,658,964
Line of credit.................................... 8,000,000 8,000,000
Income taxes payable.............................. 1,093,107 1,518,548
------------ ------------
Total Current Liabilities...................... 12,670,865 14,060,198
Minority interest.................................. 595,428 --
Commitments and contingencies (Note 7)
Stockholders' Equity
Preferred stock -- $.001 par value; 2,000,000
shares authorized; no shares issued and
outstanding...................................... -- --
Common stock -- $.001 par value; 56,000,000 shares
authorized;
12,652,844 and 11,890,691 shares issued; and
12,581,744 and
11,819,591 outstanding for 2000 and 1999,
respectively..................................... 12,653 11,891
Additional paid-in capital........................ 55,060,403 40,312,336
Deferred stock option compensation................ 376,052 264,557
Cumulative other comprehensive (loss) income...... (64,950) 23,330
Accumulated deficit............................... (26,817,824) (15,308,510)
Treasury stock at cost, 71,100 shares at December
31, 2000 and 1999, respectively.................. (263,281) (263,281)
------------ ------------
Total Stockholders' Equity..................... 28,303,053 25,040,323
------------ ------------
Total Liabilities And Stockholders' Equity..... $ 41,569,346 $ 39,100,521
============ ============
See accompanying notes to consolidated financial statements
35
SRS LABS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
---------------------------------------
2000 1999 1998
------------ ----------- ------------
REVENUES
Chip and licensing revenue........... $ 13,098,242 $18,624,221 $ 15,762,369
Product and component sales.......... 14,874,452 17,171,362 28,962,671
------------ ----------- ------------
TOTAL REVENUES................... 27,972,694 35,795,583 44,725,040
COST OF SALES........................ 16,611,290 22,002,817 29,819,071
------------ ----------- ------------
GROSS MARGIN......................... 11,361,404 13,792,766 14,905,969
EXPENSES
Sales and marketing.................. 6,355,742 5,148,458 6,845,674
Research and development............. 4,151,064 4,141,571 2,554,883
General and administrative........... 10,357,001 6,932,397 5,530,957
Non-cash stock issuance cost......... 3,111,859 -- --
Acquired in-process research and
development......................... -- -- 18,510,378
------------ ----------- ------------
TOTAL EXPENSES................... 23,975,666 16,222,426 33,441,892
LOSS FROM OPERATIONS............. (12,614,262) (2,429,660) (18,535,923)
OTHER INCOME, NET.................... 1,180,352 735,122 704,992
MINORITY INTEREST.................... 249,577 -- --
------------ ----------- ------------
LOSS BEFORE INCOME TAX EXPENSE
(BENEFIT)........................... (11,184,333) (1,694,538) (17,830,931)
INCOME TAX EXPENSE (BENEFIT)......... 324,981 49,662 (273,156)
------------ ----------- ------------
NET LOSS............................. $(11,509,314) $(1,744,200) $(17,557,775)
============ =========== ============
Net loss per common share:
Basic and diluted................... $ (0.93) $ (0.15) $ (1.54)
============ =========== ============
Weighted average shares used in the
calculation of net loss per common
share:
Basic and diluted................... 12,379,281 11,696,272 11,410,346
============ =========== ============
SRS LABS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
Years Ended December 31,
---------------------------------------
2000 1999 1998
------------ ----------- ------------
Net loss............................. $(11,509,314) $(1,744,200) $(17,557,775)
Other comprehensive loss
Foreign currency translation........ (81,219) (4,827) --
Unrealized loss on investments
available for sale, net of tax..... (7,061) (113,232) (22,211)
------------ ----------- ------------
Comprehensive loss................... $(11,597,594) $(1,862,259) $(17,579,986)
============ =========== ============
See accompanying notes to consolidated financial statements
36
SRS LABS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Cumulative
Other Retained
Common Stock Deferred Comprehensive Earnings
------------------- Additional Stock Option Income (Accumulated Treasury
Shares Amount Paid-In Capital Compensation (Loss) Deficit) Stock Total
---------- ------- --------------- ------------ ------------- ------------ --------- ------------
BALANCE, January 1,
1998............... 9,609,867 $ 9,610 $25,022,437 $ 231,087 $163,600 $ 3,993,465 $ -- $ 29,420,199
Proceeds from
exercise of stock
options........... 213,121 213 311,199 -- -- -- -- 311,412
Tax benefit
associated with
exercise of stock
options........... -- -- 13,623 -- -- -- -- 13,623
Deferred stock
option
compensation...... -- -- -- 82,215 -- -- -- 82,215
Unrealized loss on
investments
available for
sale, net of tax.. -- -- -- -- (22,211) -- -- (22,211)
Issuance of common
stock to acquire
Valence........... 1,680,611 1,681 12,104,097 -- -- -- -- 12,105,778
Issuance of common
stock for
noncompetition
agreements........ 125,000 125 900,275 -- -- -- -- 900,400
Issuance of common
stock and warrants
to acquire VIP.... 25,000 25 518,507 -- -- -- -- 518,532
Issuance of common
stock to acquire
Circle Surround... 35,294 35 299,965 -- -- -- -- 300,000
Net loss........... -- -- -- -- -- (17,557,775) -- (17,557,775)
---------- ------- ----------- --------- -------- ------------ --------- ------------
BALANCE,
December 31, 1998.. 11,688,893 11,689 39,170,103 313,302 141,389 (13,564,310) -- 26,072,173
Proceeds from
exercise of stock
options........... 201,798 202 760,857 (170,263) -- -- -- 590,796
Tax benefit
associated with
exercise of stock
options........... -- -- 381,376 -- -- -- -- 381,376
Deferred stock
option
compensation...... -- -- -- 121,518 -- -- -- 121,518
Treasury stock..... (71,100) -- -- -- -- -- (263,281) (263,281)
Unrealized loss on
investments
available for
sale, net of tax.. -- -- -- -- (113,232) -- -- (113,232)
Currency
translation
adjustment........ -- -- -- -- (4,827) -- -- (4,827)
Net loss........... -- -- -- -- -- (1,744,200) -- (1,744,200)
---------- ------- ----------- --------- -------- ------------ --------- ------------
BALANCE,
December 31, 1999.. 11,819,591 11,891 40,312,336 264,557 23,330 (15,308,510) (263,281) 25,040,323
Proceeds from
exercise of stock
options........... 471,624 471 1,481,213 -- -- -- -- 1,481,684
Deferred stock
option
compensation...... -- -- -- 111,495 -- -- -- 111,495
Issuance of common
stock and
warrants.......... 290,529 291 8,111,859 -- -- -- -- 8,112,150
Increase in
additional paid-in
capital from sale
of stock by
subsidiary........ -- -- 5,154,995 -- -- -- -- 5,154,995
Unrealized loss on
investments
available for
sale, net of tax.. -- -- -- -- (7,061) -- -- (7,061)
Currency
translation
adjustment........ -- -- -- -- (81,219) -- -- (81,219)
Net loss........... -- -- -- -- -- (11,509,314) -- (11,509,314)
---------- ------- ----------- --------- -------- ------------ --------- ------------
BALANCE,
December 31, 2000.. 12,581,744 $12,653 $55,060,403 $ 376,052 $(64,950) $(26,817,824) $(263,281) $ 28,303,053
========== ======= =========== ========= ======== ============ ========= ============
See accompanying notes to consolidated financial statements
37
SRS LABS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
---------------------------------------
2000 1999 1998
------------ ----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................. $(11,509,314) $(1,744,200) $(17,557,775)
Adjustments to reconcile net loss to
net cash (used in) provided by
operating activities:
Non-cash stock issuance cost........ 3,111,859 -- --
Minority interest................... (249,577) -- --
Provision for doubtful accounts..... 116,560 1,040,271 (82,785)
Provision for obsolete inventory.... 132,341 628,006 353,814
Depreciation and amortization....... 3,549,075 2,127,736 1,888,635
Deferred income taxes............... (116,599) (836,140) (298,205)
Write-off of acquired in-process
research and development........... -- -- 18,510,378
Realized gain on sales of
investments available for sale..... -- -- (86,337)
Amortization of premium on
investments available for sale..... 34,035 54,964 62,534
Accretion of consideration due on
asset purchase..................... -- -- 8,196
Stock option compensation expense... 111,495 121,518 82,215
Currency translation adjustment..... (81,219) (4,827) --
Loss on disposition of furniture,
fixtures and equipment............. 16,483 1,594 --
Changes in operating assets and
liabilities, net of the effect of
acquisitions:
Accounts receivable................ 1,590,689 1,785,258 2,024,562
Inventories........................ (474,626) 1,278,769 1,645,004
Prepaid expenses and other assets.. 304,421 2,091,859 (2,212,510)
Accounts payable................... (1,279,285) (7,749,819) 1,878,303
Accrued liabilities................ 315,393 1,236,121 (403,399)
Income taxes payable............... (420,534) 1,602,067 (790,542)
------------ ----------- ------------
Net cash (used in) provided by
operating activities............... (4,848,803) 1,633,177 5,022,088
------------ ----------- ------------
Cash Flows From Investing Activities:
Purchase of furniture, fixtures and
equipment........................... (1,154,370) (464,037) (466,368)
Proceeds from sales of investments
available for sale.................. 3,000,000 2,500,000 9,467,572
Cash paid for acquisitions, less cash
acquired............................ -- -- (6,911,216)
Expenditures related to intangible
assets.............................. (1,320,000) (368,219) (590,555)
------------ ----------- ------------
Net cash provided by investing
activities......................... 525,630 1,667,744 1,499,433
------------ ----------- ------------
Cash Flows From Financing Activities:
Proceeds from sale of common stock... 5,000,291 -- --
Proceeds from sale of stock by
subsidiary.......................... 6,000,000 -- --
Proceeds from line of credit......... -- -- 8,000,000
Payments on subsidiary debt.......... -- -- (6,846,737)
Payment of consideration due on asset
purchase............................ -- -- (91,707)
Exercise of stock options............ 1,481,684 590,796 311,412
Purchase of treasury stock........... -- (263,281) --
------------ ----------- ------------
Net cash provided by financing
activities......................... 12,481,975 327,515 1,372,968
------------ ----------- ------------
Net increase in cash and cash
equivalents......................... 8,158,802 3,628,436 7,894,489
Cash and cash equivalents, beginning
of period........................... 15,969,678 12,341,242 4,446,753
------------ ----------- ------------
Cash and cash equivalents, end of
period.............................. $ 24,128,480 $15,969,678 $ 12,341,242
============ =========== ============
Supplemental Disclosures Of Cash Flow
Information:
Cash paid during the period for:
Interest............................ $ 586,722 $ 179,194 $ 488,732
Income taxes........................ $ 963,794 $ -- $ 640,079
SUPPLEMENTAL DISCLOSURE OF NON-CASH
INVESTING AND FINANCING ACTIVITIES:
Additional consideration accrued for
asset purchase..................... $ -- $ -- $ 8,196
Unrealized loss on investments,
net................................ $ (7,061) $ (113,232) $ (22,211)
Tax benefit associated with exercise
of stock options................... $ -- $ 381,376 $ 13,623
See accompanying notes to consolidated financial statements
38
The Company acquired the stock of Valence Technology Inc. on March 2, 1998
(Notes 2 and 9) and issued 1,680,611 shares of common stock in payment of
$12,105,778 of the acquisition price. The acquisition was accounted for as a
purchase having an effective date of February 1, 1998.
In conjunction with the acquisition, certain liabilities were assumed as
follows:
Fair value of assets acquired................................ $ 14,076,279
Acquired in-process research and development costs........... 17,471,668
Acquired intangible assets................................... 5,910,400
Total consideration, including acquisition costs............. (21,879,033)
------------
Liabilities assumed.......................................... $ 15,579,314
============
The Company issued 125,000 shares of common stock in consideration for
certain non-competition agreements with the key employees of Valence
Technology Inc. The shares have an ascribed fair value of $900,400 (Notes 2
and 9).
The Company issued 25,000 shares of common stock and warrants to purchase
100,000 shares of common stock in conjunction with the acquisition of Voice
Intelligibility Processor ("VIP"). The shares and warrants have an ascribed
fair value of $176,575 and $341,957, respectively (Notes 2 and 9).
The Company issued 35,294 shares of common stock in conjunction with the
acquisition of certain rights associated with the Circle Surround technology.
The shares have an ascribed fair value of $300,000 (Notes 2 and 9).
39
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2000, 1999 and 1998
1. Organization and Significant Accounting Policies
Organization
SRS Labs, Inc. ("SRS Labs") was incorporated under the laws of the State of
California on June 23, 1993 and reincorporated under the laws of the State of
Delaware on June 28, 1996.
The Company is a developer and provider of technology solutions for the
consumer electronics, computer, game, Internet and telecommunications markets.
For the fiscal year ended December 31, 2000 ("Fiscal 2000"), the Company's
principal business activities in these markets included:
. Developing and licensing audio and voice technologies to original
equipment manufacturers ("OEMs") and semiconductor manufacturers around
the world;
. Through its majority-owned subsidiary, SRSWOWcast.com, Inc.
("SRSWOWcast"), developing audio and voice enhancement technology
solutions dedicated to the Internet and telecommunications markets; and
. Through its wholly-owned subsidiary, ValenceTech Limited and its foreign
subsidiaries (collectively, "Valence"), designing and selling technology
solutions through custom application specific integrated circuits
("ASICs") to OEMs; and designing, distributing and manufacturing
components, sub-assemblies and finished goods for the OEM and retail
communities within the Company's targeted markets.
SRS Labs and its majority-owned and wholly-owned subsidiaries together are
hereby collectively referred to as the "Company".
Basis of Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
include the Company and its wholly and majority owned subsidiaries, Valence
and SRSWOWcast, after elimination of all intercompany accounts and
transactions. The equity and net loss attributable to minority shareholders
are shown separately in the consolidated balance sheet and statement of
operations, respectively.
Cash Equivalents
Cash and cash equivalents generally consist of cash, money market funds and
other money market instruments with original or remaining maturities of three
months or less at the date of purchase. The Company maintains cash and cash
equivalents, investments, and certain other financial instruments with various
major financial institutions. The Company performs periodic evaluations of the
relative credit standing of these financial institutions and limits the amount
of credit exposure with any one institution.
Investments
The Company accounts for investments in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" issued by the Financial Accounting
Standards Board ("FASB"). Investments, consisting primarily of municipal
bonds, have been classified as available for sale and are reported at fair
value, based on quoted market prices, in the accompanying consolidated balance
sheets. Unrealized gains and losses, net of applicable income taxes, are
reported as a separate component of stockholders' equity.
40
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
Inventories
Inventories, which consist of finished goods, are stated at the lower of
cost or net realizable value. Cost is calculated using the weighted average
method and is comprised of material costs and, where applicable,
subcontracting and overhead costs that have been incurred in bringing the
inventories to their present location and condition. Net realizable value
represents the estimated selling price less estimated costs to completion and
costs to be incurred in selling and distribution.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are stated at cost, net of accumulated
depreciation and amortization. Depreciation and amortization are provided for
using the straight-line method, which amortizes cost over the lesser of the
estimated useful lives of the respective assets or the term of the related
lease. Useful lives range from two to five years.
Patents and Intangible Assets
Costs paid by the Company related to the establishment and transfer of
patents, primarily legal costs, are capitalized and amortized over periods
ranging from five to ten years, depending on the estimated life of the
technology patented.
Consideration for the purchase of assets in excess of the fair market value
of specifically identified tangible assets has been capitalized as intangible
assets in the accompanying consolidated balance sheets. These assets are being
amortized over periods ranging from three to eleven years depending on the
useful life of the asset.
The Company annually evaluates the recoverability of its patents and
intangible assets based on the estimated future undiscounted cash flows.
Should the carrying value of patents or intangible assets exceed the estimated
operating income for the expected periods of benefit, impairment for the
excess is recorded at that time.
Long-Lived Assets
The Company accounts for the impairment and disposition of long-lived
assets in accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of". In accordance
with SFAS No. 121, long-lived assets are reviewed for events or changes in
circumstances that indicate that their carrying value may not be recoverable.
The Company periodically reviews the carrying value of long-lived assets to
determine whether or not an impairment to such value has occurred and, based
on its most recent assessment, has determined that there was no impairment at
December 31, 2000.
Other Assets
Other assets consist primarily of notes receivable. Collection of these
notes receivable occurred in July, 2000.
Minority Interest in Consolidated Subsidiary
Minority interest in consolidated subsidiary represents the minority
stockholders' proportionate share of the equity of SRSWOWcast. At December 31,
2000, the Company owned approximately 87% of the capital stock of SRSWOWcast.
41
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles necessarily requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported revenues and expenses during the
reporting periods. Actual results could differ from these estimates.
Revenue Recognition
Royalty revenues associated with ongoing royalty license agreements are
recognized when license payments are due upon receipt of reports from
licensees stating the number of products implementing SRS patented
technologies on which royalties are due. Licensing revenues for one-time
technology transfer fees are recognized in the period in which the license
agreement is consummated and the related technology and passage of title is
transferred.
Revenue from product sales is generally recognized upon shipment. Design
revenue under design contracts is recognized on the percentage-of-completion
method. Estimates are reviewed and revised periodically throughout the lives
of the contracts. Any revisions are recorded in the accounting period in which
the revisions are made.
Commission income derived from the Company's distribution activities is
recognized on an accrual basis in the period when earned.
Research and Development
Research and development expenses include costs and expenses associated
with the development of the Company's design methodology and the design and
development of new products, including initial nonrecurring engineering and
product verification charges from foundries. Research and development is
expensed as incurred.
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." Deferred taxes on income result from temporary
differences between the reporting of income for financial statement and tax
reporting purposes.
Foreign Currency Translation
The Company's reporting currency is the U.S. dollar, while the functional
currency of Valence is the Hong Kong dollar. Assets and liabilities of Valence
are translated at the rate of exchange on the balance sheet date. Revenues and
expenses are translated using the average exchange rate for the period.
Translation adjustments resulting from the process of translating foreign
currency financial statements into U.S. dollars are included as a separate
component of stockholders' equity (other comprehensive (loss) income). Foreign
currency translation losses were $81,219, $4,827 and $0 during the years ended
December 31, 2000, 1999 and 1998, respectively. Transaction gains (losses)
arising on exchange of foreign currency are recognized as incurred in the
statements of operations and aggregated $51,855, $26,775 and ($76,000) during
the years ended December 31, 2000, 1999 and 1998, respectively.
42
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
Net Loss Per Common Share
The Company applies SFAS No. 128, "Earnings per Share," which requires the
disclosure of basic and diluted net income or loss per share for all current
and prior periods. Basic net income or loss per common share is computed by
dividing net income or loss available to common stockholders by the weighted-
average number of common shares outstanding during each year. Diluted net
income or loss per common share reflects the maximum dilution, based on the
average price of the Company's common stock each period and is computed
similar to basic income or loss per share except that the denominator is
increased to include the number of additional shares that would have been
outstanding if potentially dilutive stock options and warrants had been
exercised. Common stock equivalents have not been included in calculating
diluted net loss per share for the years ended December 31, 2000, 1999 and
1998, respectively as their inclusion would be anti-dilutive.
Stock-Based Compensation
The Company accounts for stock-based awards to employees using the
intrinsic value method in accordance with Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees."
Fair Value of Financial Instruments
Management believes the carrying amounts of cash and cash equivalents,
accounts receivable and accounts payable approximate fair value due to the
short period of time between origination of the instruments and their expected
realization. The carrying amounts of investments available for sale are
reported at fair value based on quoted market prices (Note 3). Management
believes the carrying amount of balances outstanding under the line of credit
approximate fair value as the underlying interest rates reflect market rates.
Customer Concentration
During Fiscal 2000 and the fiscal year ended December 31, 1999 ("Fiscal
1999"), one customer accounted for approximately 14% and 21% of revenues,
respectively. For the fiscal year ended December 31, 1998 ("Fiscal 1998"), two
customers accounted for approximately 40% of revenues. Given the significant
amount of revenues derived from these customers, the loss of any such customer
or the uncollectibility of related receivables could have a material adverse
effect on the Company's financial condition and results of operations.
Concentrations of Credit Risk
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist primarily of cash equivalents,
investments, trade accounts receivable and the bank credit line. The Company
places its cash in banks and its cash equivalents in commercial paper.
Investments consist primarily of short-term and long-term municipal bonds. The
Company has not experienced any significant losses on its cash equivalents or
investments. Market risk on the bank credit line relates to changes in the
bank's lending rates, including the bank's reference rate and LIBOR, on which
interest charges on the Company's borrowings under the line are based.
The Company's trade receivables are derived from sales to OEMs and
distributors in the consumer electronics, computer, game, Internet and
telecommunications markets primarily in Asia, North America and Europe. The
Company makes periodic evaluations of the creditworthiness of its customers
and manages its exposure to losses from bad debts by limiting the amount of
credit extended whenever deemed necessary and generally does not require
collateral. The Company maintains an allowance for estimated credit losses and
such losses have historically been within management's expectations.
43
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
Geographic Risk
The Company's significant operations in Hong Kong, the PRC and other parts
of Asia have required, and will continue to require, refinement to adapt to
the changing market conditions in the region. The Company's operations in
Asia, and international operations in general, are subject to risks of
unexpected changes in, or impositions of legislative or regulatory
requirements.
The Asian consumer electronics markets accounted for approximately 94%, 94%
and 93% of total Company sales in 2000, 1999 and 1998, respectively and are
expected to continue to account for a substantial percentage of sales in the
future. The recent economic crises in Asia have been characterized by declines
in consumer spending, currency devaluation, unemployment and bank failures.
Any of these factors, should they continue, could significantly reduce the
demand for the end user goods in which the Company's products are used.
Recent Accounting Pronouncements
On January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities" as amended by SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging
Activities -- an amendment of FASB Statement No. 133" which requires
derivatives to be reported as assets or liabilities in the balance sheet at
fair value. The amendment included expanding the normal purchase and sale
exemption for supply contracts, permitting the offsetting of certain
intercompany foreign currency derivatives and thus reducing the number of
third party derivatives, permitting hedge accounting for foreign-currency
denominated assets and liabilities and redefining interest rate risk to reduce
sources of ineffectiveness. The adoption of SFAS No. 133, as amended by SFAS
No. 138, did not have a material impact on the Company's consolidated results
of operations, financial position or cash flows.
In December 1999, the Securities and Exchange Commission ("SEC") staff
issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in
Financial Statements". SAB No. 101 summarizes the SEC staff's views in
applying generally accepted accounting principles to revenue recognition in
financial statements. The implementation of SAB No. 101 in the fourth quarter
of 2000 did not have a material effect on the Company's consolidated results
of operations, financial position or cash flows.
In March 2000, FASB issued Interpretation No. ("FIN") 44 of Accounting
Principles Board Opinion No. 25 "Accounting for Certain Transactions Involving
Stock Compensation", which, among other things, addresses accounting
consequences of a modification that reduces the exercise price of a fixed
stock option award (otherwise known as repricing). FIN 44 did not have a
material impact on the Company's consolidated results of operations, financial
position or cash flows.
Reclassifications
Certain amounts as previously reported have been reclassified to conform to
the current year presentation.
2. Acquisitions
On March 2, 1998, the Company acquired (the "Acquisition") all of the
outstanding shares of capital stock of Valence, a British Virgin Islands
holding company. Valence, which conducts its operations through its
subsidiaries based in Hong Kong and the Peoples Republic of China ("PRC"), is
engaged in the following business activities: (i) the development and
marketing of technology in the form of integrated circuits (ASICs) to original
equipment manufacturers and (ii) the sale of consumer electronic and
telecommunications products and components.
44
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
The Acquisition included certain assets and liabilities and all
intellectual property rights to the products as well as acquired in-process
research and development ("Acquired R&D") activities. The aggregate purchase
price of $19,500,000, excluding acquisition costs and non-compete agreements,
consisted of approximately $7,400,000 in cash, of which the Company utilized
its existing cash balances and 1,680,611 shares of the Company's common stock
with a fair value of $12,105,778. The Acquisition was accounted for as a
purchase having an effective date of February 1, 1998, and accordingly, the
total purchase price was allocated to the assets acquired and liabilities
assumed at their estimated fair values in accordance with APB Opinion No. 16.
The Company's consolidated statement of operations for the year ended December
31, 1998 includes a charge of approximately $17,500,000 million for the write-
off of Acquired R&D expense associated with the Acquisition. In connection
with the Acquisition, three of the four management shareholders and their
respective sole shareholders, each of whom was a key employee of Valence or
one of its subsidiaries, entered into non-competition agreements with the
Company. In consideration for these agreements and for a nominal cash payment
equal to the par value of the shares, the Company issued 125,000 additional
shares of its common stock, with a fair value of $900,400 in aggregate, to
such three shareholders. The following summarizes the consideration granted
for the Acquisition and the non-compete agreements, the allocation of the
purchase price and other purchase accounting adjustments:
Cash......................................................... $ 7,394,222
Common stock................................................. 13,006,178
-----------
Total purchase price......................................... 20,400,400
Deficiency in net assets acquired............................ 1,503,035
Acquisition costs............................................ 1,478,633
-----------
Excess of purchase price over net assets acquired............ $23,382,068
===========
Allocation to:
In-process research and development......................... $17,471,668
Developed technology........................................ 1,200,000
Cell library................................................ 1,150,000
Customer list............................................... 1,000,000
Workforce................................................... 1,000,000
Non-compete agreement....................................... 900,400
Brand name.................................................. 660,000
-----------
$23,382,068
===========
The Acquired R&D expenses arose from new product projects that were under
development at the date of the acquisition and expected to eventually lead to
new products, but had not yet established technological feasibility and for
which no future alternative use was identified. The valuation of the Acquired
R&D projects was based upon the discounted expected future net cash flows of
the products over the products' expected life, reflecting the estimated stages
of completion of the projects and the estimated costs to complete the
projects.
New product development projects underway at Valence at the time of the
Acquisition included, among others, ASICs for consumer electronics, computing
and voice and audio applications, home entertainment systems, digital
multimedia players and digital power amplifiers. The Company estimated that
these projects were approximately 63% complete at the date of the Acquisition
and estimated that the cost to complete these projects will aggregate
approximately $7 million and will be incurred over a three-year period.
Uncertainties that could impede the progress of converting a development
project to a developed technology include the availability of financial
resources to complete the project, failure of the technology to function
45
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
properly, continued economic feasibility of developed technologies, customer
acceptance, customer demand and customer qualification of such new technology
and general competitive conditions in the industry. There can be no assurance
that the Acquired R&D projects will be successfully completed and commercially
introduced.
On February 28, 1998, the Company acquired certain rights to a proprietary
technology, Voice Intelligibility Processor ("VIP"), from a third party. The
aggregate consideration, including acquisition costs, was $1,138,710 and was
comprised of $620,178 in cash, 25,000 shares of the Company's common stock
with a fair value of $176,575 and warrants to purchase 100,000 shares of the
Company's common stock at $9.47 per share with a fair value of $341,957. The
portion of the purchase price allocated to Acquired R&D, $1,038,710, was
charged to the Company's operations. The remainder of the purchase price was
allocated to an intangible asset and is being amortized over eight years.
The following summarizes the consideration granted for the acquisition of
VIP, the allocation of the purchase price and other purchase accounting
adjustments:
Cash.......................................................... $ 500,000
Common stock and warrants..................................... 518,532
Acquisition costs............................................. 120,178
----------
Total purchase price...................................... $1,138,710
==========
Allocation to:
In-process research and development.......................... $1,038,710
Intangible assets............................................ 100,000
----------
$1,138,710
==========
The Acquired R&D expenses arose from new product projects that were under
development at the date of the acquisition and expected to eventually lead to
new products, but had not yet established technological feasibility and for
which no future alternative use was identified. The valuation of the Acquired
R&D projects was based upon the discounted expected future net cash flows of
the products over the products' expected life, reflecting the estimated stages
of completion of the projects and the costs to complete the projects.
New product development projects utilizing the VIP technology at the time
of the acquisition included, among others, digital and analog sound
reinforcement, wireless and non-wireless telecommunications applications,
hearing aid applications, and headphone and microphone applications. The
Company estimated that these projects were approximately 62% complete at the
date of acquisition and estimated that the cost to complete these projects
will aggregate approximately $525,000 and will be incurred over a two-year
period.
Uncertainties that could impede the progress of converting a development
project to a developed technology include the availability of financial
resources to complete the project, failure of the technology to function
properly, continued economic feasibility of developed technologies, customer
acceptance, customer demand and customer qualification of such new technology
and general competitive conditions in the industry. There can be no assurance
that the Acquired R&D projects will be successfully completed and commercially
introduced.
The Company's financial statements for Fiscal 1998 reflect one-time charges
related to Acquired R&D expenses of $17,471,668 associated with the Valence
acquisition and $1,038,710 associated with the VIP acquisition.
46
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
On May 21, 1998, the Company acquired certain rights to a proprietary
technology, Circle Surround, from a third party. The aggregate consideration,
including acquisition costs, was $834,985 and was comprised of $534,985 in
cash and 35,294 shares of the Company's common stock with a fair value of
$300,000. The purchase price was allocated to intangible assets and is being
amortized over ten years.
3. Investment Securities Available for Sale
The following table summarizes the Company's investment securities
available for sale:
December 31,
---------------------
2000 1999
---------- ----------
Municipal bonds available for sale:
Cost.............................................. $6,260,975 $9,295,010
Unrealized gains.................................. 35,755 47,723
---------- ----------
Estimated fair value.............................. $6,296,730 $9,342,733
========== ==========
The contractual maturities of investments are shown below. Actual
maturities may differ from contractual maturities.
2000 1999
--------------------- ---------------------
Estimated Estimated
Cost Fair Value Cost Fair Value
---------- ---------- ---------- ----------
Municipal bonds:
Due in one year or less..... $5,684,486 $5,713,881 $2,993,206 $3,011,250
Due in one to five years.... 576,489 582,849 6,301,804 6,331,483
---------- ---------- ---------- ----------
$6,260,975 $6,296,730 $9,295,010 $9,342,733
========== ========== ========== ==========
4. Furniture, Fixtures and Equipment
Furniture, fixtures and equipment, net, consist of the following:
December 31,
------------------------
2000 1999
----------- -----------
Furniture, fixtures and equipment............. $ 1,207,731 $ 847,117
Computer equipment............................ 2,508,403 1,366,595
Leasehold improvements........................ 290,164 145,408
----------- -----------
4,006,298 2,359,120
Less accumulated depreciation and
amortization................................. (2,197,674) (1,192,363)
----------- -----------
$ 1,808,624 $ 1,166,757
=========== ===========
47
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
5. Intangible Assets
Intangible assets consist of the following:
December 31,
------------------------
2000 1999
----------- -----------
Goodwill......................................... $ 711,886 $ 711,886
Patents.......................................... 1,142,654 2,154,716
Developed technology............................. 1,200,000 1,200,000
Cell library..................................... 1,150,000 1,150,000
Customer list.................................... 1,000,000 1,000,000
Workforce........................................ 1,000,000 1,000,000
Non-compete agreement............................ 900,400 900,400
Brand name....................................... 660,000 660,000
Other purchased technology....................... 120,000 --
----------- -----------
7,884,940 8,777,002
Less accumulated amortization.................... (4,192,722) (3,351,729)
----------- -----------
$ 3,692,218 $ 5,425,273
=========== ===========
Amortization periods range from three to eleven years depending on the
estimated useful life of the asset. A review for impairment during Fiscal 2000
resulted in a write down of intangible assets with a cost of $1,693,740 and a
net book value of $1,116,000.
6. Financing Arrangements
The Company has a revolving line of credit (and letter of credit facility)
with a bank which expires on April 1, 2001 and is secured by certain of the
Company's investments. The total availability under the line of credit is the
lesser of $10 million or a percentage of the fair market value of the
collateral. The line of credit bears interest at the bank's prime rate (9.5%
as of December 31, 2000) or LIBOR (6.75% as of December 31, 2000) plus 0.75%.
As of December 31, 2000, the Company had $8.0 million outstanding under the
line of credit.
Valence has a credit facility with a bank that provides for borrowings
aggregating approximately $5,000,000. The facility has no fixed expiration
date and is collateralized by certain of Valence's assets on deposit with the
bank. The facility provides for a variety of import/export trade instruments
which bear interest rates ranging from 1% over the Hong Kong Dollar prime rate
to 1.75% over LIBOR. The facility also provides for a revolving line of credit
of up to $3,500,000 which bears interest at 1.25% over the related collateral
deposit interest rate. At December 31, 2000, there were no obligations
outstanding under this credit facility.
7. Commitments and Contingencies
The Company leases office space and certain equipment under noncancelable
operating leases expiring through 2003.
The Company leases its corporate office and storage facilities located in
Santa Ana, California, under a lease agreement with a partnership which is
affiliated with a principal stockholder and executive officer of the Company.
The lease is for a term of two years, commencing June 1, 2000, with an option
to extend the term for an additional two years thereafter. Additionally, the
Company leases several offices and warehouses in Hong Kong and China from
unrelated parties. Total rent expense was $615,847, $604,198 and $646,498 for
the years ended December 31, 2000, 1999, and 1998, respectively, of which
$175,500, $165,672 and $165,672 was
48
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
paid to related parties, respectively. Future annual minimum lease payments
under noncancelable operating leases at December 31, 2000, are as follows:
Year Ending Office
December 31, Facility Equipment Total
------------ ---------- --------- ----------
2001...................................... $ 569,304 $12,112 $ 581,416
2002...................................... 365,188 5,112 370,300
2003...................................... 243,154 2,130 245,284
---------- ------- ----------
$1,177,646 $19,354 $1,197,000
========== ======= ==========
Litigation -- The Company is involved from time to time in litigation or
claims arising in the ordinary course of its business. While the ultimate
liability, if any, arising from these claims cannot be predicted with
certainty, the Company believes that the resolution of these matters will not
likely have a material adverse effect on the Company's financial statements.
8. Income Taxes
The provision (benefit) for income taxes consists of the following:
December 31,
-----------------------------------
2000 1999 1998
----------- ----------- ---------
Current:
Federal............................. $ (82,801) $ 35,553 $(679,205)
State............................... (10,828) 88,282 35,963
Foreign............................. 535,210 761,967 668,291
----------- ----------- ---------
441,581 885,802 25,049
----------- ----------- ---------
Deferred:
Federal............................. (4,352,139) (1,583,931) (161,286)
State............................... (626,850) (281,414) (136,919)
Foreign............................. (44,812) (125,196) --
Change in valuation allowance....... 4,907,201 1,154,401 --
----------- ----------- ---------
(116,600) (836,140) (298,205)
----------- ----------- ---------
$ 324,981 $ 49,662 $(273,156)
=========== =========== =========
The reconciliation of the provision (benefit) for income taxes computed at
U.S. federal statutory rates to the provision for income taxes is as follows:
December 31,
------------------------------------
2000 1999 1998
----------- ---------- -----------
Tax at U.S. federal statutory
rates............................. $(4,001,868) $ (593,088) $(6,240,826)
State income taxes................. (420,868) (127,467) (75,645)
Tax exempt interest................ 70,179 (35,862) (150,766)
Change in valuation allowance...... 4,907,201 1,154,401 --
Intangibles........................ -- -- 5,940,367
Other.............................. (229,663) (348,322) 253,714
----------- ---------- -----------
Total income tax expense
(benefit)..................... $ 324,981 $ 49,662 $ (273,156)
=========== ========== ===========
49
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets and liabilities are as follows:
December 31,
------------------------
2000 1999
----------- -----------
Deferred tax assets (liabilities):
State income taxes............................. $ (362,895) $ (149,765)
Depreciation and amortization.................. 566,727 78,191
Accruals not currently deductible.............. (20,205) 74,223
Net operating losses........................... 6,085,899 1,433,151
Tax credits.................................... 683,224 540,957
Other.......................................... 47,807 --
Valuation allowance............................ (6,061,602) (1,154,401)
----------- -----------
Total net deferred tax assets............... $ 938,955 $ 822,356
=========== ===========
The Company has federal and state net operating loss carry forwards at
December 31, 2000, of approximately $15,400,000 and $9,400,000, respectively.
These net operating loss carry forwards will begin to expire in 2019 and 2003,
respectively. In addition, the Company has federal tax credit carry forwards
of approximately $683,000 which will begin to expire in 2003.
As of December 31, 2000, a valuation allowance of approximately $6,062,000
has been provided based on the Company's assessment of the future
realizability of certain deferred tax assets. Approximately $1,287,000 of the
valuation allowance is attributable to the potential tax benefit of stock
option transactions that will be credited directly to additional paid in
capital, if realized.
9. Stockholders' Equity
Issuance of Common Stock
Stock Repurchases
During Fiscal 1998, the Company's Board of Directors authorized the
repurchase of up to 500,000 of the outstanding shares of the Company's common
stock for a period from December 23, 1998 to December 31, 1999. As of December
31, 2000 and 1999, 71,100 shares had been repurchased at a cost of $263,281.
Such repurchased shares are reflected as treasury stock in the accompanying
consolidated balance sheets.
Common Stock Issuances
On March 2, 1998, the Company issued 1,680,611 shares of common stock in
conjunction with the acquisition of Valence (Note 2). On February 28, 1998,
the Company issued 25,000 shares of common stock in conjunction with the
acquisition of the VIP technology (Note 2). On May 29, 1998, the Company
issued 35,294 shares of common stock in conjunction with the acquisition of
the Circle Surround technology (Note 2).
On March 8, 2000, the Company entered into a technology and marketing
alliance with Microsoft Corporation ("Microsoft"). On March 9, 2000, in
connection with this transaction, Microsoft purchased 290,529 shares of the
Company's common stock for $17.21 per share or $5,000,000 in the aggregate
(together referred to as the "Microsoft Transaction"). The difference between
the purchase price received and the fair value of the common stock on the date
of purchase, totaling $556,076, was recorded as non-cash stock issuance cost
by the Company during the quarter ended March 31, 2000.
50
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
Stock Award/Option Plans/Warrants
On December 10, 1993, the Company's Board of Directors and shareholders
adopted an Incentive Stock Option, Nonqualified Stock Option and Restricted
Stock Purchase Plan (the "1993 Plan"). Under the 1993 Plan, 801,971 shares of
the Company's common stock are reserved for issuance to executives, employees
and non-employee directors of the Company at the discretion of the Board of
Directors or the committee administering the 1993 Plan. The Compensation
Committee of the Board or, in the absence of a Compensation Committee, the
Board has been appointed to administer the 1993 Plan. Options issued under the
1993 Plan vest in the manner prescribed by the Compensation Committee or the
Board, as applicable. As of December 31, 2000, options to purchase 801,971
shares of the Company's common stock were granted under the 1993 Plan.
In June 1997, the Company's Board of Directors adopted and the Company's
stockholders approved the Amended and Restated 1996 Long-Term Incentive Plan
(the "1996 Plan"), for which 2,000,000 shares of the Company's common stock
were reserved for issuance to officers, employees and consultants of the
Company. If any award granted under the 1996 Plan expires, terminates or is
forfeited before the exercise thereof or the payment in full thereof, the
shares covered by the unexercised or unpaid portion will become available for
new grants under the 1996 Plan. In June 1998, the Company's Board of Directors
adopted and the Company's stockholders approved an amendment to the 1996 Plan
to increase the number of shares in the plan by 2,500,000. Also in June 1998,
in a separate amendment, the Company's Board of Directors and the Company's
stockholders approved an amendment to allow all directors of the Company and
any subsidiary of the Company to participate in the 1996 Plan. The
Compensation Committee or, in the absence of a Compensation Committee, the
Board of Directors has been appointed to administer the 1996 Plan. Options
issued under the 1996 Plan vest in the manner prescribed by the Compensation
Committee or the Board, as applicable. As of December 31, 2000, options to
purchase 5,568,259 shares of the Company's common stock were granted under the
1996 Plan.
In July 1996, the Company's Board of Directors adopted and the Company's
stockholders approved the 1996 Non-employee Directors Stock Option Plan (the
"Non-employee Directors Plan"), a non-discretionary formula plan for which
120,000 shares of the Company's common stock are reserved for issuance to the
Company's non-employee directors. A committee consisting of all directors who
are not eligible to participate in the Non-employee Directors Plan administers
the Non-employee Directors Plan. With the exception of the initial option
granted to a non-employee director, which vests immediately, options granted
under the Non-employee Directors Plan vest over a three-year period, the first
installment vesting on the date of grant. In June 1999, the shareholders
approved the Amended and Restated 1996 Nonemployee Directors' Stock Option
Plan. Among the changes set forth in the Amended and Restated Plan was to
increase by 130,000 the number of shares of common stock that may be issued.
As of December 31, 2000, options to purchase 160,000 shares of common stock
were granted under the Non-employee Directors Plan.
On February 28, 1998, warrants were granted for the purchase of up to
100,000 common shares of the Company at a price per share of $9.47 to certain
parties in connection with the acquisition of VIP ("VIP Warrants") (Note 2).
In connection with the Microsoft Transaction, as of December 31, 2000,
Microsoft has a three year warrant to purchase 100,000 shares of common stock
of the Company at an exercise price per share of $17.21. The number of
eligible shares to purchase under this warrant is subject to adjustment based
upon the occurrence of certain conditions as set forth in the SRS Labs, Inc.
Common Stock Purchase Warrant Agreement dated March 8, 2000 (the "SRS
Warrant"). The Company's majority-owned subsidiary, SRSWOWcast, also issued to
Microsoft a three-year warrant to purchase up to 2,500,000 shares of its
common stock at an price per share of $2.00 as specified in the
SRSWOWcast.com, Inc. Common Stock Purchase Warrant Agreement dated March 8,
2000 (the "SRSWOWcast Warrant"), subject to certain conditions and adjustment
as set forth in the SRSWOWcast
51
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
Warrant. The fair value of these warrants, totaling $2,555,783, was recorded
as non-cash stock issuance cost by the Company during the quarter ended March
31, 2000. Fair value was calculated using the Black-Scholes option-pricing
model with the following weighted average assumptions: expected life --
36 months; stock volatility -- 96%; and risk-free interest rate -- 6.54%.
The following table summarizes stock option activity under the Company's
stock option plans, the VIP Warrants (Note 2) and the SRS Warrants for the
periods indicated:
Weighted
Options Average
Outstanding Exercise Price
----------- --------------
Outstanding at January 1, 1998.................. 2,384,496 $ 3.69
Granted........................................ 2,898,500 $ 5.06
Stock options exercised........................ (213,121) $ 1.44
Forfeited...................................... (150,667) $ 4.88
---------
Outstanding at December 31, 1998................ 4,919,208 $ 4.54
Granted........................................ 1,255,875 $ 3.39
Stock options exercised........................ (201,798) $ 2.93
Forfeited...................................... (888,742) $ 5.17
---------
Outstanding at December 31, 1999................ 5,084,543 $ 4.23
Granted........................................ 578,814 $11.20
Stock options exercised........................ (471,624) $ 3.03
Forfeited...................................... (194,319) $ 7.88
---------
Outstanding at December 31, 2000................ 4,997,414 $ 5.01
=========
The following table summarizes information concerning currently outstanding
and exercisable options and warrants:
Weighted-
Number of Average Weighted Exercisable Weighted-
Range of Options Remaining Average As of Average
Exercise Prices Outstanding Contractual Life Exercise Price 12/31/2000 Exercise Price
--------------- ----------- ---------------- -------------- ----------- --------------
Range of exercise prices:
$ 0.00 - $ 1.90 172,807 3.2 $ 0.2724 172,807 $ 0.2724
$ 1.91 - $ 3.80 1,638,472 7.1 $ 3.1648 666,692 $ 2.9861
$ 3.81 - $ 5.70 2,366,580 4.6 $ 5.0433 1,709,372 $ 4.9155
$ 5.71 - $ 7.60 299,814 7.9 $ 6.2083 195,814 $ 6.1457
$ 7.61 - $ 9.50 307,500 5.6 $ 8.8511 130,000 $ 9.1285
$ 9.51 - $11.40 42,241 7.6 $10.5056 22,241 $10.4544
$11.41 - $13.30 30,000 9.5 $11.7500 10,000 $11.7500
$17.10 - $19.00 140,000 2.9 $17.7200 100,000 $17.2100
--------- --- -------- --------- --------
4,997,414 5.6 $ 5.0082 3,006,926 $ 4.9557
On December 1, 1995, options were granted for the purchase of up to 300,875
common shares at prices of $4.14 to $4.56 per share, which the Company's Board
of Directors deemed the fair market value of the common stock at the date of
grant. The Company recorded compensation expense resulting from the difference
between the option price per share and the estimated fair market value of the
common stock ($4.99) determined by a third-party appraisal completed in May
1996, totaling $236,456. This amount is recorded ratably over the vesting
52
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
period of the respective options. During the years ended December 31, 1999 and
1998, the Company recorded $7,306 and $26,828, respectively, of deferred
compensation expense associated with these stock option grants. In addition,
during the years ended December 31, 2000, 1999 and 1998, the Company recorded
$111,495, $114,212 and $55,387, respectively, of deferred compensation expense
related to stock options granted to non-employee contractors.
On March 5, 1999, pursuant to a technology license agreement entered into
by the Company and a customer, options were granted to the customer to
purchase up to 50,000 shares of common stock at an exercise price of $3.94 per
share. The fair value of the grant is being recognized as compensation expense
ratably over the vesting period of the options. The Company recognized $27,636
and $30,857 of compensation expense relating to these options in Fiscal 2000
and 1999, respectively. In addition to the 50,000 options granted in 1999, the
Company has an obligation to grant up to 200,000 additional options if the
customer meets specified performance criteria as defined by the agreement. The
exercise price of additional option grants will be the fair market value of
the common stock at the date of grant.
SFAS No. 123, Accounting for Stock-Based Compensation, requires the
disclosure of pro forma net income and earnings per share had the Company
adopted the fair value method as of the beginning of fiscal 1995. Under SFAS
No. 123, the fair value of stock-based awards to employees is calculated
through the use of option pricing models, even though such models were
developed to estimate the fair value of freely tradable, fully transferable
options without vesting restrictions, which significantly differ from the
Company's stock option awards. These models also require subjective
assumptions, including future stock price volatility and expected time to
exercise, which greatly affect the calculated values. The Company's
calculations were made using the Black-Scholes option-pricing model with the
following weighted average assumptions:
December 31,
-------------------------------
2000 1999 1998
--------- --------- ---------
Expected life............................. 60 months 60 months 60 months
Stock volatility.......................... 105% 65% 57%
Risk-free interest rate................... 6.2% 5.9% 5.5%
The Company's calculations are based on a single option valuation approach
and forfeitures are recognized as they occur. If the computed fair values of
the 2000, 1999 and 1998 awards had been amortized to expense over the vesting
period of the awards, pro forma net loss would have been $13,699,489 or $1.17
per share in 2000; $3,392,244 or $.35 per share in 1999; and $18,684,945, or
$1.77 per share in 1998. However, the impact of outstanding nonvested stock
options granted prior to 1995 has been excluded from the pro forma
calculation; accordingly, the 1998 and 1999 pro forma adjustments are not
indicative of future period pro forma adjustments, when the calculation will
apply to all applicable stock options.
Sale of Stock by Subsidiary
On September 29, 2000, the Company's wholly-owned subsidiary SRSWOWcast and
certain investors, which included shareholders, directors and an executive
officer of the Company, entered into a Series A Preferred Stock and Warrant
Purchase Agreement (the "Private Placement Agreement") relating to the
purchase and sale of 3,000,000 shares of SRSWOWcast Series A Convertible
Preferred Stock ("Preferred Stock") for a purchase price of $2.00 per share or
$6,000,000 in the aggregate (the "Private Placement"). Pursuant to the Private
Placement Agreement, investors received an immediately exercisable, three year
warrant evidencing a right to purchase one-tenth of a share of SRSWOWcast's
common stock for each share of Preferred Stock purchased by such investor,
exercisable at $2.50 per whole share. The fair value of the warrants was zero
at the date of issuance. In accordance with SAB No. 51, "Accounting for Sales
of Stock by a Subsidiary" the Company recorded $5,154,995 of additional paid-
in capital associated with the Private Placement.
53
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
10. Segment Information
The Company operates in three business segments: (i) the development and
marketing of technology either in the form of ASICs through Valence or the
licensing of technologies developed by the Company to original equipment
manufacturers and semiconductor manufacturers; (ii) the sale of consumer
electronic products and components; and (iii) the SRSWOWcast internet-based
business. The Company's internet-based business generated insignificant
revenues and incurred a net loss of $3,982,461 for Fiscal 2000. The Company
does not allocate corporate operating expenses or specific assets to these
segments. Therefore, the following segment information includes only net
revenues, cost of sales and gross margin of the segments described in clauses
(a) and (b) above:
Business Segments
-----------------------------------
Product and
Chips and Component
Licensing Sales Total
----------- ----------- -----------
Fiscal 2000
Net revenues.......................... $13,098,242 $14,874,452 $27,972,694
Cost of sales......................... 3,713,112 12,898,178 16,611,290
----------- ----------- -----------
Gross margin.......................... $ 9,385,130 $ 1,976,274 $11,361,404
=========== =========== ===========
Fiscal 1999
Net revenues.......................... $18,624,221 $17,171,362 $35,795,583
Cost of sales......................... 6,095,197 15,907,620 22,002,817
----------- ----------- -----------
Gross margin.......................... $12,529,024 $ 1,263,742 $13,792,766
=========== =========== ===========
Fiscal 1998
Net revenues.......................... $15,762,369 $28,962,671 $44,725,040
Cost of sales......................... 4,084,805 25,734,266 29,819,071
----------- ----------- -----------
Gross margin.......................... $11,677,564 $ 3,228,405 $14,905,969
=========== =========== ===========
The following schedule presents the Company's revenue by geographic area.
For product sales, revenue is allocated based on the country to which product
was shipped. For licensing-related revenue, the allocation is based on the
location of the licensee's corporate headquarters. The Americas region
includes North, Central and South America.
December 31,
-----------------------------------
Region Revenue: 2000 1999 1998
--------------- ----------- ----------- -----------
Asia Pacific.......................... $26,316,233 $33,536,423 $41,502,348
Americas.............................. 1,104,210 1,268,918 3,017,596
Europe................................ 552,251 990,242 205,096
----------- ----------- -----------
Total............................... $27,972,694 $35,795,583 $44,725,040
=========== =========== ===========
11. Related-Party Transactions
The Company leases its corporate office and storage facilities located in
Santa Ana, California, under a lease agreement with a partnership which is
affiliated with a stockholder and officer of the Company. The original lease
term commenced on June 1, 1994 and expired on May 31, 1997. Upon expiration of
the lease on May 31, 1997, the Company entered into a new lease agreement for
additional space at the same facility with the same
54
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
lessor for a term of three years which expired on May 31, 2000. Upon
expiration of the lease on May 31, 2000, the lease was extended for a term of
two years, with an option to extend the term for an additional two years
thereafter.
During the years ended December 31, 2000, 1999 and 1998, total revenue from
an affiliated company which is 100% owned by a Company officer/stockholder,
amounted to $0, $1,326 and $6,834, respectively. As of December 31, 2000 and
1999, there were no amounts owing from or to this affiliated company.
As described in Note 9, certain shareholders, directors and an executive
officer of the Company purchased preferred shares issued by a subsidiary of
the Company.
12. Employee Benefit Plan
The Company's employees based in the United States may participate in a
salary deferral plan (the "401(k) Plan") in which eligible employees can
contribute up to 15% of their eligible compensation. The Company also may
contribute on a discretionary basis. During the years ended December 31, 2000,
1999 and 1998, the Company contributed $48,543, $0 and $0, respectively to the
401(k) Plan.
55
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Additions
Additions (reductions)
Balance at Due to Charged to Balance
Beginning Business Costs and at End
of Period Acquisitions Expense Deductions of Period
---------- ------------ ------------ ---------- ----------
For the year ended
December 31, 2000:
Allowance for doubtful
accounts.............. $1,083,961 $ -- $ 116,560 $(204,922) $ 995,599
========== ========== ========== ========= ==========
Inventory reserve...... $ 624,844 $ -- $ 357,244 $(224,903) $ 757,185
========== ========== ========== ========= ==========
For the year ended
December 31, 1999:
Allowance for doubtful
accounts.............. $ 422,138 $ -- $1,040,271 $(378,448) $1,083,961
========== ========== ========== ========= ==========
Inventory reserve...... $ 653,370 $ -- $ 628,006 $(656,532) $ 624,844
========== ========== ========== ========= ==========
For the year ended
December 31, 1998:
Allowance for doubtful
accounts.............. $ -- $ 647,600 $ (82,785) $(142,677) $ 422,138
========== ========== ========== ========= ==========
Inventory reserve...... $ -- $1,275,097 $ 353,814 $(975,541) $ 653,370
========== ========== ========== ========= ==========
56
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not Applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information set forth under the captions "ELECTION OF DIRECTORS" and
"TRANSACTIONS WITH MANAGEMENT AND OTHERS -- Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's definitive proxy statement (the "Proxy
Statement") for the Annual Meeting of Stockholders scheduled to be held in
June 2001, is incorporated herein by reference. The Proxy Statement will be
filed with the U.S. Securities and Exchange Commission (the "Commission") not
later than 120 days after the close of Fiscal 2000.
Item 11. Executive Compensation
Except as specifically provided, the information set forth under the
captions "COMPENSATION OF EXECUTIVE OFFICERS" and "INFORMATION ABOUT THE BOARD
OF DIRECTORS AND COMMITTEES OF THE BOARD -- Compensation of Directors" in the
Proxy Statement is incorporated herein by reference. The Proxy Statement will
be filed with the Commission not later than 120 days after the close of Fiscal
2000. The Report on Executive Compensation and the Performance Graph set forth
under the caption "COMPENSATION OF EXECUTIVE OFFICERS" in the Proxy Statement
shall not be deemed incorporated by reference herein and shall not otherwise
be deemed "filed" as part of this Annual Report on Form 10-K.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information set forth under the caption "SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT" in the Proxy Statement is incorporated
herein by reference. The Proxy Statement will be filed with the Commission not
later than 120 days after the close of Fiscal 2000.
Item 13. Certain Relationships and Related Transactions
The information set forth under the caption "TRANSACTIONS WITH MANAGEMENT
AND OTHERS" in the Proxy Statement is incorporated herein by reference. The
Proxy Statement will be filed with the Commission not later than 120 days
after the close of Fiscal 2000.
57
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Documents Filed as Part of This Report:
(1) Financial Statements
INDEX TO FINANCIAL STATEMENTS:
Page
----
Independent Auditors' Report....................................... 34
Consolidated Balance Sheets as of December 31, 2000 and 1999....... 35
Consolidated Statements of Operations for the years ended December
31, 2000, 1999 and 1998........................................... 36
Consolidated Statements of Comprehensive Loss for the years ended
December 31, 2000, 1999 and 1998.................................. 36
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2000, 1999 and 1998.................................. 37
Consolidated Statements of Cash Flows for the years ended December
31, 2000, 1999 and 1998........................................... 38
Notes to Consolidated Financial Statements......................... 40
(2) Financial Statement Schedules
Page
----
Schedule II -- Valuation and Qualifying Accounts and Reserves for
the years ended December 31, 2000, 1999 and 1998................... 56
The financial statement schedule included in Part II, Item 8 herein is filed
as part of this Annual Report on Form 10-K. All other schedules are omitted as
the required information is inapplicable or the information is presented in the
consolidated financial statements or related notes.
(3) Exhibits
The exhibits listed below are hereby filed with the Commission as part of
this Annual Report on Form 10-K. The Company will furnish a copy of any exhibit
upon request, but a reasonable fee will be charged to cover the Company's
expenses in furnishing such exhibit.
Exhibit
Number Description
------- -----------
2.1 Purchase Agreement dated as of February 24, 1998, by and among the
Company, Valence Technology Inc., Thomrose Holdings (BVI) Limited,
Rayfa (BVI) Limited, Cape Spencer International Limited, and Anki
(BVI) Limited, previously filed with the Commission as Exhibit 2.1
to the Company's Current Report on Form 8-K filed with the
Commission on March 13, 1998 (the "Form 8-K"), which is incorporated
herein by reference.
2.2 Stock Purchase Agreement dated as of February 24, 1998, by between
the Company and North 22 Capital Partners 2, Inc., previously filed
with the Commission as Exhibit 2.2 to the Form 8-K, which is
incorporated herein by reference.
2.3 Purchase Agreement dated as of January 28, 1998, between the Company
and R.G.A. & Associates, Ltd. d/b/a ToteVision and VIP Labs
previously filed with the Commission as Exhibit 2.3 to the Company's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1997 filed with the Commission on March 31, 1998 (the "1997 Annual
Report"), which is incorporated herein by reference.
58
Exhibit
Number Description
------- -----------
2.4 Asset Purchase Agreement dated as of May 21, 1998 by and between
Rocktron Corporation and the Company, previously filed with the
Commission as Exhibit 2.1 to the Company's Quarterly Report on Form
10-Q for the period ended June 30, 1998 (the "June 1998 10-Q"),
which is incorporated herein by reference.
3.1 Certificate of Incorporation of the Company, previously filed with
the Commission as Exhibit 3.1 to the Company's Registration
Statement on Form SB-2, specifically included in Amendment No. 1 to
such Registration Statement filed with the Commission on July 3,
1996 (File No. 333-4974-LA) (the "Registration Statement Amendment
No. 1"), which is incorporated herein by reference.
3.2 Bylaws of the Company, previously filed with the Commission as
Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1999, filed with the Commission on
November 12, 1999, which is incorporated herein by reference.
Material Contracts Relating to Management
Compensation Plans or Arrangements
10.1 Employment Agreement dated July 1, 1996, between the Company and
Thomas C.K. Yuen, previously filed with the Commission as Exhibit
10.8 to the Registration Statement Amendment No. 1, which is
incorporated herein by reference.
10.2 Amendment to Employment Agreement dated as of March 14, 1997,
between the Company and Thomas C.K. Yuen, previously filed with the
Commission as Exhibit 10.2 to the Company's Annual Report on Form
10-KSB for the fiscal year ended December 31, 1996, filed with the
Commission on March 31, 1997 (the "1996 Annual Report"), which is
incorporated herein by reference.
10.3 Employment Agreement dated July 1, 1996, between the Company and
Arnold I. Klayman, previously filed with the Commission as Exhibit
10.10 to the Registration Statement Amendment No. 1, which is
incorporated herein by reference.
10.4 Amendment to Employment Agreement dated as of March 14, 1997,
between the Company and Arnold I. Klayman, previously filed as
Exhibit 10.5 to the 1996 Annual Report, which is incorporated herein
by reference.
10.5 Employment Agreement dated July 1, 1996, between the Company and
Alan D. Kraemer, previously filed with the Commission as Exhibit
10.11 to the Registration Statement Amendment No. 1, which is
incorporated herein by reference.
10.6 SRS Labs, Inc. Incentive Stock Option, Nonqualified Stock Option and
Restricted Purchase Plan-- 1993, as amended and restated, previously
filed with the Commission as Exhibit 10.12 to the Company's
Registration Statement on Form SB-2 filed with the Commission on
June 3, 1996 (File No. 333-4974-LA) (the "Registration Statement"),
which is incorporated herein by reference.
10.7 Stock Option Agreement dated January 19, 1994, between the Company
and Stephen V. Sedmak, as amended, previously filed with the
Commission as Exhibit 10.13 to the Registration Statement, which is
incorporated herein by reference.
10.8 SRS Labs, Inc. Amended and Restated 1996 Long-Term Incentive Plan,
previously filed with the Commission as Appendix A to the Company's
Definitive Proxy Statement dated April 30, 1998, filed with the
Commission on April 30, 1998, which is incorporated herein by
reference.
10.9 SRS Labs, Inc. Amended and Restated 1996 Long-Term Incentive Plan,
as amended, previously filed with the Commission as Appendix A to
the Company's Definitive Proxy Statement dated and filed with the
Commission on April 26, 2000, which is incorporated herein by
reference.
10.10 SRS Labs, Inc. 1996 Amended and Restated Nonemployee Directors Stock
Option Plan, previously filed with the Commission as Appendix A to
the Company's Definitive Proxy Statement dated and filed with the
Commission on April 29, 1999, which is incorporated herein by
reference.
59
Exhibit
Number Description
------- -----------
10.11 Annual Incentive Bonus Plan, previously filed with the Commission as
Exhibit 10.18 to the Registration Statement Amendment No. 1, which
is incorporated herein by reference.
10.12 SRS Labs, Inc. Supplemental Executive Incentive Bonus Plan,
previously filed with the Commission as Exhibit 10.14 to the 1996
Annual Report, which is incorporated herein by reference.
10.13 Form of Indemnification Agreement, previously filed with the
Commission as Exhibit 10.20 to the Registration Statement Amendment
No. 1, which is incorporated herein by reference.
10.14 Employment Agreement dated as of March 2, 1998, by and among the
Company, Valence Technology Inc., and Thomas Wah Tong Wan,
previously filed with the Commission as Exhibit 10.16 to the 1997
Annual Report, which is incorporated herein by reference.
10.15 Employment Agreement dated as of March 2, 1998, by and among the
Company, Valence Semiconductor Design Limited, and Choi Yat Ming,
previously filed with the Commission as Exhibit 10.17 to the 1997
Annual Report, which is incorporated herein by reference.
10.16 Employment Agreement dated as of March 2, 1998, by and among the
Company, LEC Electronic Components Limited, and Wong Yin Bun,
previously filed with the Commission as Exhibit 10.18 to the 1997
Annual Report, which is incorporated herein by reference.
10.17 Noncompetition Agreement dated as of March 2, 1998, by and among the
Company, Thomrose Holdings (BVI) Limited, and Thomas Wah Tong Wan,
previously filed with the Commission as Exhibit 2.5 to the Company's
Current Report on Form 8-K filed with the Commission on March 13,
1998 (the "Form 8-K"), which is incorporated herein by reference.
10.18 Noncompetition Agreement dated as of March 2, 1998, by and among the
Company, Cape Spencer International Limited and Wong Yin Bun,
previously filed with the Commission as Exhibit 2.6 to the Form 8-K,
which is incorporated herein by reference.
10.19 Noncompetition Agreement dated as of March 2, 1998, by and among the
Company, Rayfa (BVI) Limited and Choi Yat Ming, previously filed
with the Commission as Exhibit 2.7 to the Form 8-K, which is
incorporated herein by reference.
10.20 Employment Agreement dated as of July 1, 1998 by and between the
Company and John AuYeung, previously filed with the Commission as
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1998, which is incorporated herein by
reference.
10.21 Severance Agreement, dated February 23, 1999, by and between the
Company and Thomas P. Parkinson, previously filed as Exhibit 10.1 to
the Company's Quarterly Report on Form 10-Q for the period ended
March 31, 1999, filed with the Commission on May 17, 1999, which is
incorporated herein by reference.
10.22 Employment Agreement dated August 27, 1999 by and between the
Company and James F. Gardner.
10.23 Settlement and Release Agreement by and among Thomas Wah Tong Wan,
the Company and ValenceTech Limited dated July 27, 2000, previously
filed with the Commission as Exhibit 10.1 to the September 2000 10-
Q, which is incorporated herein by reference.
Other Material Contracts
10.24 Shareholders Agreement dated as of January 27, 1994, between the
Company and the Shareholders of the Company named therein,
previously filed with the Commission as Exhibit 9.3 to the Company's
Registration Statement on Form SB-2, specifically included in
Amendment No. 2 to such Registration Statement filed with the
Commission on August 2, 1996 (File No. 333-4974-LA) (the
"Registration Statement Amendment No. 2"), which is incorporated
herein by reference.
60
Exhibit
Number Description
------- -----------
10.25 Shareholders Agreement II dated as of January 9, 1995, between the
Company and the Shareholders of the Company named therein,
previously filed with the Commission as Exhibit 9.1 to the
Registration Statement, which is incorporated herein by reference.
10.26 Shareholders Agreement III dated as of April 21, 1995, between the
Company and the Shareholders of the Company named therein,
previously filed with the Commission as Exhibit 9.2 to the
Registration Statement, which is incorporated herein by reference.
10.27 Asset Purchase Agreement dated as of June 30, 1993, between the
Company and Hughes Aircraft, previously filed with the Commission as
Exhibit 10.1 to the Registration Statement, which is incorporated
herein by reference.
10.28 Stock Purchase Agreement dated as of January 9, 1995, between the
Company and Packard Bell Electronics, Inc. d/b/a Packard Bell
Corporation, previously filed with the Commission as Exhibit 10.3 to
the Registration Statement Amendment No. 2, which is incorporated
herein by reference.
10.29 Amended and Restated Stock Option Agreement dated as of January 9,
1995, between the Company and Packard Bell Electronics, Inc. d/b/a
Packard Bell Corporation, previously filed with the Commission as
Exhibit 10.4 to the Registration Statement, which is incorporated
herein by reference.
10.30 License Agreement dated as of January 9, 1995, between the Company
and Packard Bell Electronics, Inc. d/b/a Packard Bell Corporation,
previously filed with the Commission as Exhibit 10.5 to the
Company's Registration Statement on Form SB-2, specifically included
in Amendment No. 3 to such Registration Statement filed with the
Commission on August 7, 1996 (File No. 333-4974-LA) (the
"Registration Statement Amendment No. 3"), which is incorporated
herein by reference.
10.31 License Agreement dated as of June 27, 1988, between Hughes Aircraft
and Sony Corporation, as amended and assigned to the Company,
previously filed with the Commission as Exhibit 10.6 to the
Registration Statement Amendment No. 3, which is incorporated herein
by reference.
10.32 Industrial Real Estate Lease dated May 30, 1997, between the Company
and Daimler Commerce Partners, L.P., previously filed with the
Commission as Exhibit 10.1 to the Company's Form 10-QSB for the
quarterly period ended June 30, 1997, filed with the Commission on
August 13, 1997, which is incorporated herein by reference.
10.33 Tenancy Agreement dated September 7, 1998, by and between Hong Kong
Industrial Technology Centre Corporation and Valence Semiconductor
Design Limited relating to the premises located at Unit 413 on the
Fourth Floor of the Hong Kong Industrial Technology Centre.
10.34 Tenancy Agreement commencing January 1, 1998, by and between Jugada
Company Limited and Valence Semiconductor Design Limited relating to
the premises located at Workshops Nos. 1, 2, 3, 4, 5, 6, 7 and 8 on
the 19th Floor of APEC Plaza, No. 49 Hoi Yuen Road, Kwun Tong, Hong
Kong, previously filed with the Commission as Exhibit 10.34 to the
1997 Annual Report, which is incorporated herein by reference.
10.35 Stock Divestment Agreement dated July 1, 1996, between the Company,
Thomas C.K. Yuen, Stephen V. Sedmak and Walter W. Cruttenden III,
previously filed with the Commission as Exhibit 10.17 to the
Registration Statement Amendment No. 2, which is incorporated herein
by reference.
10.36 Services Agreement dated July 1, 1996, between the Company and
Sierra Digital Productions, Inc., previously filed with the
Commission as Exhibit 10.19 to the Registration Statement Amendment
No. 1, which is incorporated herein by reference.
10.37 Registration Rights Agreement dated as of January 28, 1998, by and
between the Company and R.G.A. & Associates, Ltd., d/b/a ToteVision
and VIP Labs and William S. Taraday, previously filed with the
Commission as Exhibit 10.37 to the 1997 Annual Report, filed with
the Commission on March 31, 1998, which is incorporated herein by
reference.
61
Exhibit
Number Description
------- -----------
10.38 Warrant to Purchase 94,000 Shares of Common Stock of the Company
dated February 26, 1998, held by R.G.A. & Associates, Ltd., d/b/a
ToteVision and VIP Labs, previously filed with the Commission as
Exhibit 10.38 to the 1997 Annual Report, which is incorporated
herein by reference.
10.39 Warrant to Purchase 2,500 Shares of Common Stock of the Company
dated February 26, 1998, held by Herbert H. Wax, previously filed
with the Commission as Exhibit 10.39 to the 1997 Annual Report,
which is incorporated herein by reference.
10.40 Warrant to Purchase 2,500 Shares of Common Stock of the Company
dated February 26, 1998, held by Steven E. Loyd, previously filed
with the Commission as Exhibit 10.40 to the 1997 Annual Report,
which is incorporated herein by reference.
10.41 Warrant to Purchase 1,000 Shares of Common Stock of the Company
dated February 26, 1998, held by the Van Valkenberg Furber Law
Group, P.L.L.C., previously filed with the Commission as Exhibit
10.41 to the 1997 Annual Report, which is incorporated herein by
reference.
10.42 Registration Rights Agreement dated as of May 21, 1998, previously
filed with the Commission as Exhibit 10.1 to the June 1998 Form 10-
Q, which is incorporated herein by reference.
10.43 Credit and Security Agreement dated as of July 6, 1999, by and
between the Company and City National Bank.
10.44 Securities Account Control Agreement dated as of July 6, 1999, by
and among the Company, Investors Bank & Trust Company, Salomon
Brothers Asset Management Inc. and City National Bank.
10.45 Revolving Credit Note dated July 6, 1999, by the Company in favor of
City National Bank.
10.46 Common Stock Purchase Agreement dated as of March 8, 2000 by and
among SRS Labs, Inc., SRSWOWcast.com, Inc. and Microsoft
Corporation, previously filed with the Commission as Exhibit 10.1 to
the March 2000 10-Q, which is incorporated herein by reference.
10.47 Common Stock Purchase Warrant dated March 8, 2000 granted to
Microsoft Corporation by SRS Labs, Inc., previously filed with the
Commission as Exhibit 10.2 to the March 2000 10-Q, which is
incorporated herein by reference.
10.48 Common Stock Purchase Warrant dated March 8, 2000 granted to
Microsoft Corporation by SRSWOWcast.com, Inc., previously filed with
the Commission as Exhibit 10.3 to the March 2000
10-Q, which is incorporated herein by reference.
10.49 Series A Preferred Stock and Warrant Purchase Agreement dated
September 29, 2000 between SRSWOWcast.com, Inc. and the Investors
named on Schedule A to the Series A Preferred Stock and Warrant
Purchase Agreement, previously filed with the Commission as Exhibit
10.2 to the September 2000 10-Q, which is incorporated herein by
reference.
10.50 Investor Rights Agreement dated as of September 29, 2000 between
SRSWOWcast.com, Inc. and the persons whose names appear on the
Signature Page to the Investor Rights Agreement, previously filed
with the Commission as Exhibit 10.3 to the September 2000 10-Q,
which is incorporated herein by reference.
21 Subsidiaries.
23 Consent of Deloitte & Touche LLP dated March 28, 2001.
24 Power of attorney (included on page 55 of the Form 10-K).
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the fourth quarter of the fiscal
year covered by this Report.
62
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.
SRS LABS, INC., a Delaware
corporation
Date: March 28, 2001 /s/ Thomas C.K. Yuen
By: __________________________________
Thomas C.K. Yuen
Chairman of the Board and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that such person whose signature appears
below constitutes and appoints Thomas C.K. Yuen and Darrell E. Baker, and each
of them his true and lawful attorneys-in-fact and agents, with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign any and all amendments to this Form 10-K and to
file the same, with all exhibits thereto, and other documents in connection
therewith, with the U.S. Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said attorneys-in-
fact and agents, or any of them, or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
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.
Name Capacity Date
---- -------- ----
/s/ Thomas C.K. Yuen Director, Chairman of the Board March 28, 2001
_________________________________ and Chief Executive Officer
Thomas C.K. Yuen (Principal Executive Officer)
/s/ Darrell E. Baker Vice President -- Finance, March 28, 2001
_________________________________ Secretary and acting Treasurer
Darrell E. Baker (Principal Financial and
Accounting Officer)
/s/ Gareth C.C. Chang Director March 28, 2001
_________________________________
Gareth C.C. Chang
/s/ Roger W. Johnson Director March 28, 2001
_________________________________
Roger W. Johnson
/s/ Robert Pfannkuch Director March 28, 2001
_________________________________
Robert Pfannkuch
/s/ Stephen V. Sedmak Director March 28, 2001
_________________________________
Stephen V. Sedmak
/s/ Jeffrey I. Scheinrock Director March 28, 2001
_________________________________
Jeffrey I. Scheinrock
/s/ John Tu Director March 28, 2001
_________________________________
John Tu
/s/ Sam Yau Director March 28, 2001
_________________________________
Sam Yau
63
EXHIBIT INDEX
Exhibit
Number Description
------- -----------
2.1 Purchase Agreement dated as of February 24, 1998, by and among the
Company, Valence Technology Inc., Thomrose Holdings (BVI) Limited,
Rayfa (BVI) Limited, Cape Spencer International Limited, and Anki
(BVI) Limited, previously filed with the Commission as Exhibit 2.1 to
the Company's Current Report on Form 8-K filed with the Commission on
March 13, 1998 (the "Form 8-K"), which is incorporated herein by
reference.
2.2 Stock Purchase Agreement dated as of February 24, 1998, by between the
Company and North 22 Capital Partners 2, Inc., previously filed with
the Commission as Exhibit 2.2 to the Form 8-K, which is incorporated
herein by reference.
2.3 Purchase Agreement dated as of January 28, 1998, between the Company
and R.G.A. & Associates, Ltd. d/b/a ToteVision and VIP(R) Labs
previously filed with the Commission as Exhibit 2.3 to the Company's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1997 filed with the Commission on March 31, 1998 (the "1997 Annual
Report"), which is incorporated herein by reference.
2.4 Asset Purchase Agreement dated as of May 21, 1998 by and between
Rocktron Corporation and the Company, previously filed with the
Commission as Exhibit 2.1 to the Company's Quarterly Report on Form
10-Q for the period ended June 30, 1998 (the "June 1998 10-Q"), which
is incorporated herein by reference.
3.1 Certificate of Incorporation of the Company, previously filed with the
Commission as Exhibit 3.1 to the Company's Registration Statement on
Form SB-2, specifically included in Amendment No. 1 to such
Registration Statement filed with the Commission on July 3, 1996 (File
No. 333-4974-LA) (the "Registration Statement Amendment No. 1"), which
is incorporated herein by reference.
3.2 Bylaws of the Company, previously filed with the Commission as Exhibit
3.1 to the Company's Quarterly Report on Form 10-Q for the period
ended September 30, 1999, filed with the Commission on November 12,
1999, which is incorporated herein by reference.
Material Contracts Relating to Management
Compensation Plans or Arrangements
10.1 Employment Agreement dated July 1, 1996, between the Company and
Thomas C.K. Yuen, previously filed with the Commission as Exhibit 10.8
to the Registration Statement Amendment No. 1, which is incorporated
herein by reference.
10.2 Amendment to Employment Agreement dated as of March 14, 1997, between
the Company and Thomas C.K. Yuen, previously filed with the Commission
as Exhibit 10.2 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1996, filed with the Commission on
March 31, 1997 (the "1996 Annual Report"), which is incorporated
herein by reference.
10.3 Employment Agreement dated July 1, 1996, between the Company and
Arnold I. Klayman, previously filed with the Commission as Exhibit
10.10 to the Registration Statement Amendment No. 1, which is
incorporated herein by reference.
10.4 Amendment to Employment Agreement dated as of March 14, 1997, between
the Company and Arnold I. Klayman, previously filed as Exhibit 10.5 to
the 1996 Annual Report, which is incorporated herein by reference.
10.5 Employment Agreement dated July 1, 1996, between the Company and Alan
D. Kraemer, previously filed with the Commission as Exhibit 10.11 to
the Registration Statement Amendment No. 1, which is incorporated
herein by reference.
10.6 SRS Labs, Inc. Incentive Stock Option, Nonqualified Stock Option and
Restricted Purchase Plan--1993, as amended and restated, previously
filed with the Commission as Exhibit 10.12 to the Company's
Registration Statement on Form SB-2 filed with the Commission on June
3, 1996 (File No. 333-4974-LA) (the "Registration Statement"), which
is incorporated herein by reference.
64
Exhibit
Number Description
------- -----------
10.7 Stock Option Agreement dated January 19, 1994, between the Company and
Stephen V. Sedmak, as amended, previously filed with the Commission as
Exhibit 10.13 to the Registration Statement, which is incorporated
herein by reference.
10.8 SRS Labs, Inc. Amended and Restated 1996 Long-Term Incentive Plan,
previously filed with the Commission as Appendix A to the Company's
Definitive Proxy Statement dated April 30, 1998, filed with the
Commission on April 30, 1998, which is incorporated herein by
reference.
10.9 SRS Labs, Inc. Amended and Restated 1996 Long-Term Incentive Plan, as
amended, previously filed with the Commission as Appendix A to the
Company's Definitive Proxy Statement dated and filed with the
Commission on April 26, 2000, which is incorporated herein by
reference.
10.10 SRS Labs, Inc. 1996 Amended and Restated Nonemployee Directors Stock
Option Plan, previously filed with the Commission as Appendix A to the
Company's Definitive Proxy Statement dated and filed with the
Commission on April 29, 1999, which is incorporated herein by
reference.
10.11 Annual Incentive Bonus Plan, previously filed with the Commission as
Exhibit 10.18 to the Registration Statement Amendment No. 1, which is
incorporated herein by reference.
10.12 SRS Labs, Inc. Supplemental Executive Incentive Bonus Plan, previously
filed with the Commission as Exhibit 10.14 to the 1996 Annual Report,
which is incorporated herein by reference.
10.13 Form of Indemnification Agreement, previously filed with the
Commission as Exhibit 10.20 to the Registration Statement Amendment
No. 1, which is incorporated herein by reference.
10.14 Employment Agreement dated as of March 2, 1998, by and among the
Company, Valence Technology Inc., and Thomas Wah Tong Wan, previously
filed with the Commission as Exhibit 10.16 to the 1997 Annual Report,
which is incorporated herein by reference.
10.15 Employment Agreement dated as of March 2, 1998, by and among the
Company, Valence Semiconductor Design Limited, and Choi Yat Ming,
previously filed with the Commission as Exhibit 10.17 to the 1997
Annual Report, which is incorporated herein by reference.
10.16 Employment Agreement dated as of March 2, 1998, by and among the
Company, LEC Electronic Components Limited, and Wong Yin Bun,
previously filed with the Commission as Exhibit 10.18 to the 1997
Annual Report, which is incorporated herein by reference.
10.17 Noncompetition Agreement dated as of March 2, 1998, by and among the
Company, Thomrose Holdings (BVI) Limited, and Thomas Wah Tong Wan,
previously filed with the Commission as Exhibit 2.5 to the Company's
Current Report on Form 8-K filed with the Commission on March 13, 1998
(the "Form 8-K"), which is incorporated herein by reference.
10.18 Noncompetition Agreement dated as of March 2, 1998, by and among the
Company, Cape Spencer International Limited and Wong Yin Bun,
previously filed with the Commission as Exhibit 2.6 to the Form 8-K,
which is incorporated herein by reference.
10.19 Noncompetition Agreement dated as of March 2, 1998, by and among the
Company, Rayfa (BVI) Limited and Choi Yat Ming, previously filed with
the Commission as Exhibit 2.7 to the Form 8-K, which is incorporated
herein by reference.
10.20 Employment Agreement dated as of July 1, 1998 by and between the
Company and John AuYeung, previously filed with the Commission as
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1998, which is incorporated herein by
reference.
10.22 Employment Agreement dated August 27, 1999 by and between the Company
and James F. Gardner.
10.23 Settlement and Release Agreement by and among Thomas Wah Tong Wan, the
Company and ValenceTech Limited dated July 27, 2000, previously filed
with the Commission as Exhibit 10.1 to the September 2000 10-Q, which
is incorporated herein by reference.
65
Exhibit
Number Description
------- -----------
Other Material Contracts
10.24 Shareholders Agreement dated as of January 27, 1994, between the
Company and the Shareholders of the Company named therein, previously
filed with the Commission as Exhibit 9.3 to the Company's Registration
Statement on Form SB-2, specifically included in Amendment No. 2 to
such Registration Statement filed with the Commission on August 2,
1996 (File No. 333-4974-LA) (the "Registration Statement Amendment No.
2"), which is incorporated herein by reference.
10.25 Shareholders Agreement II dated as of January 9, 1995, between the
Company and the Shareholders of the Company named therein, previously
filed with the Commission as Exhibit 9.1 to the Registration
Statement, which is incorporated herein by reference.
10.26 Shareholders Agreement III dated as of April 21, 1995, between the
Company and the Shareholders of the Company named therein, previously
filed with the Commission as Exhibit 9.2 to the Registration
Statement, which is incorporated herein by reference.
10.27 Asset Purchase Agreement dated as of June 30, 1993, between the
Company and Hughes Aircraft, previously filed with the Commission as
Exhibit 10.1 to the Registration Statement, which is incorporated
herein by reference.
10.28 Stock Purchase Agreement dated as of January 9, 1995, between the
Company and Packard Bell Electronics, Inc. d/b/a Packard Bell
Corporation, previously filed with the Commission as Exhibit 10.3 to
the Registration Statement Amendment No. 2, which is incorporated
herein by reference.
10.29 Amended and Restated Stock Option Agreement dated as of January 9,
1995, between the Company and Packard Bell Electronics, Inc. d/b/a
Packard Bell Corporation, previously filed with the Commission as
Exhibit 10.4 to the Registration Statement, which is incorporated
herein by reference.
10.30 License Agreement dated as of January 9, 1995, between the Company and
Packard Bell Electronics, Inc. d/b/a Packard Bell Corporation,
previously filed with the Commission as Exhibit 10.5 to the Company's
Registration Statement on Form SB-2, specifically included in
Amendment No. 3 to such Registration Statement filed with the
Commission on August 7, 1996 (File No. 333-4974-LA) (the "Registration
Statement Amendment No. 3"), which is incorporated herein by
reference.
10.31 License Agreement dated as of June 27, 1988, between Hughes Aircraft
and Sony Corporation, as amended and assigned to the Company,
previously filed with the Commission as Exhibit 10.6 to the
Registration Statement Amendment No. 3, which is incorporated herein
by reference.
10.32 Industrial Real Estate Lease dated May 30, 1997, between the Company
and Daimler Commerce Partners, L.P., previously filed with the
Commission as Exhibit 10.1 to the Company's Form 10-QSB for the
quarterly period ended June 30, 1997, filed with the Commission on
August 13, 1997, which is incorporated herein by reference.
10.33 Tenancy Agreement dated September 7, 1998, by and between Hong Kong
Industrial Technology Centre Corporation and Valence Semiconductor
Design Limited relating to the premises located at Unit 413 on the
Fourth Floor of the Hong Kong Industrial Technology Centre.
10.34 Tenancy Agreement commencing January 1, 1998, by and between Jugada
Company Limited and Valence Semiconductor Design Limited relating to
the premises located at Workshops Nos. 1, 2, 3, 4, 5, 6, 7 and 8 on
the 19th Floor of APEC Plaza, No. 49 Hoi Yuen Road, Kwun Tong, Hong
Kong, previously filed with the Commission as Exhibit 10.34 to the
1997 Annual Report, which is incorporated herein by reference.
10.35 Stock Divestment Agreement dated July 1, 1996, between the Company,
Thomas C.K. Yuen, Stephen V. Sedmak and Walter W. Cruttenden III,
previously filed with the Commission as Exhibit 10.17 to the
Registration Statement Amendment No. 2, which is incorporated herein
by reference.
66
Exhibit
Number Description
------- -----------
10.36 Services Agreement dated July 1, 1996, between the Company and Sierra
Digital Productions, Inc., previously filed with the Commission as
Exhibit 10.19 to the Registration Statement Amendment No. 1, which is
incorporated herein by reference.
10.37 Registration Rights Agreement dated as of January 28, 1998, by and
between the Company and R.G.A. & Associates, Ltd., d/b/a ToteVision
and VIP Labs(R) and William S. Taraday, previously filed with the
Commission as Exhibit 10.37 to the 1997 Annual Report, filed with the
Commission on March 31, 1998, which is incorporated herein by
reference.
10.38 Warrant to Purchase 94,000 Shares of Common Stock of the Company dated
February 26, 1998, held by R.G.A. & Associates, Ltd., d/b/a ToteVision
and VIP Labs(R), previously filed with the Commission as Exhibit 10.38
to the 1997 Annual Report, which is incorporated herein by reference.
10.39 Warrant to Purchase 2,500 Shares of Common Stock of the Company dated
February 26, 1998, held by Herbert H. Wax, previously filed with the
Commission as Exhibit 10.39 to the 1997 Annual Report, which is
incorporated herein by reference.
10.40 Warrant to Purchase 2,500 Shares of Common Stock of the Company dated
February 26, 1998, held by Steven E. Loyd, previously filed with the
Commission as Exhibit 10.40 to the 1997 Annual Report, which is
incorporated herein by reference.
10.41 Warrant to Purchase 1,000 Shares of Common Stock of the Company dated
February 26, 1998, held by the Van Valkenberg Furber Law Group,
P.L.L.C., previously filed with the Commission as Exhibit 10.41 to the
1997 Annual Report, which is incorporated herein by reference.
10.42 Registration Rights Agreement dated as of May 21, 1998, previously
filed with the Commission as Exhibit 10.1 to the June 1998 Form 10-Q,
which is incorporated herein by reference.
10.43 Credit and Security Agreement dated as of July 6, 1999, by and between
the Company and City National Bank.
10.44 Securities Account Control Agreement dated as of July 6, 1999, by and
among the Company, Investors Bank & Trust Company, Salomon Brothers
Asset Management Inc. and City National Bank.
10.45 Revolving Credit Note dated July 6, 1999, by the Company in favor of
City National Bank.
10.46 Common Stock Purchase Agreement dated as of March 8, 2000 by and among
SRS Labs, Inc., SRSWOWcast.com, Inc. and Microsoft Corporation,
previously filed with the Commission as Exhibit 10.1 to the March 2000
10-Q, which is incorporated herein by reference.
10.47 Common Stock Purchase Warrant dated March 8, 2000 granted to Microsoft
Corporation by SRS Labs, Inc., previously filed with the Commission as
Exhibit 10.2 to the March 2000 10-Q, which is incorporated herein by
reference.
10.48 Common Stock Purchase Warrant dated March 8, 2000 granted to Microsoft
Corporation by SRSWOWcast.com, Inc., previously filed with the
Commission as Exhibit 10.3 to the March 2000 10-Q, which is
incorporated herein by reference.
10.49 Series A Preferred Stock and Warrant Purchase Agreement dated
September 29, 2000 between SRSWOWcast.com, Inc. and the Investors
named on Schedule A to the Series A Preferred Stock and Warrant
Purchase Agreement, previously filed with the Commission as Exhibit
10.2 to the September 2000 10-Q, which is incorporated herein by
reference.
10.50 Investor Rights Agreement dated as of September 29, 2000 between
SRSWOWcast.com, Inc. and the persons whose names appear on the
Signature Page to the Investor Rights Agreement, previously filed with
the Commission as Exhibit 10.3 to the September 2000 10-Q, which is
incorporated herein by reference.
67
Exhibit
Number Description
------- -----------
21 Subsidiaries.
23 Consent of Deloitte & Touche LLP dated March 28, 2001.
24 Power of attorney (included on page 55 of the Form 10-K).
68