UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

 

 

 

SRS LABS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

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 ý No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o   No ý

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: as of May 9, 2003, 13,213,498 of the issuer’s common stock, par value $.001 per share, were outstanding. In addition, as of May 9, 2003, 225,300 shares of the issuer’s common stock were held as treasury shares.

 

 

SRS LABS, INC.

 

Form 10-Q

For the Period Ended March 31, 2003

 

Index

 

PART I—FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of March 31, 2003 (Unaudited) and December 31, 2002 (Audited)
	Condensed Consolidated Statements of Operations for the three months ended March 31, 2003 and 2002 (Unaudited)
	Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss) for the three months ended March 31, 2003 (Unaudited)
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and 2002 (Unaudited)
	Notes to the Condensed Interim Consolidated Financial Statements (Unaudited)
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II—OTHER INFORMATION
Item 2.	Changes in Securities and Use of Proceeds
Item 6.	Exhibits and Reports on Form 8-K
SIGNATURES
CERTIFICATIONS

 

 

FORWARD-LOOKING INFORMATION

 

This Quarterly Report on Form 10-Q 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 in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors That May Affect Future Results”, herein, among others, could cause actual results to differ materially from those indicated by forward-looking statements made herein and presented elsewhere by management. Such forward-looking statements 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.

 

1

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

SRS LABS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		March 31, 2003			December 31, 2002
		(Unaudited)
ASSETS
Current Assets
Cash and cash equivalents		$	13,225,769		$	15,720,860
Accounts receivable, net		920,282			1,074,421
Inventories, net		855,092			807,382
Prepaid expenses and other current assets		407,870			462,442
Deferred income taxes		36,147			36,147
Total Current Assets		15,445,160			18,101,252
Investments available for sale		8,540,024			6,630,771
Furniture, fixtures & equipment, net		1,870,616			1,935,424
Goodwill, net		1,173,102			533,031
Intangible assets, net		1,908,903			1,957,359
Deferred income taxes		147,190			149,498
Total Assets		$	29,084,995		$	29,307,335
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts payable		$	815,604		$	1,011,032
Accrued liabilities		1,715,192			2,347,702
Income taxes payable		323,448			341,172
Total Current Liabilities		2,854,244			3,699,906
Minority interest		—			325,371
Commitments and contingencies
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; 13,213,498 and 12,876,314 shares issued; and 12,988,198 and 12,651,014 shares outstanding at March 31, 2003 and December 31, 2002, respectively		13,214			12,877
Additional paid in capital		56,957,625			55,966,589
Cumulative other comprehensive loss		(173,778		)	(88,564		)
Accumulated deficit		(29,847,709		)	(29,890,243		)
Less treasury stock at cost, 225,300 shares at March 31, 2003 and at December 31, 2002		(718,601		)	(718,601		)
Total Stockholders’ Equity		26,230,751			25,282,058
Total Liabilities and Stockholders’ Equity		$	29,084,995		$	29,307,335

 

See accompanying notes to the condensed interim consolidated financial statements

 

2

 

SRS LABS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Three Months Ended March 31,
		2003			2002
Revenues:
Licensing		$	2,628,311		$	1,795,722
Semiconductor		1,711,819			1,471,142
Other		130,244			288,516
Total revenues		4,470,374			3,555,380
Cost of sales		669,568			793,345
Gross margin		3,800,806			2,762,035
Operating expenses:
Sales and marketing		1,352,490			1,260,440
Research and development		1,081,215			965,076
General and administrative		1,314,610			1,233,525
Total operating expenses		3,748,315			3,459,041
Income (loss) from operations		52,491			(697,006		)
Other income, net		164,126			87,963
Minority interest		5,430			19,748
Income (loss) before income tax expense		222,047			(589,295		)
Income tax expense		179,513			101,438
Net income (loss)		$	42,534		$	(690,733	)
Net income (loss) per common share:
Basic		$	0.00		$	(0.05	)
Diluted		$	0.00		$	(0.05	)
Weighted average shares used in the calculation of net income (loss) per common share:
Basic		12,798,238			12,669,407
Diluted		12,983,526			12,669,407

 

 See accompanying notes to the condensed interim consolidated financial statements

 

3

 

SRS LABS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME (LOSS) (Unaudited)

 

							Additional Paid-In Capital				Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Treasury Stock			Total			Comprehensive Income (Loss) for the Periods Ended
		Common Stock
		Shares		Amount
BALANCE, Dec 31, 2002		12,651,014		$	12,877		$	55,966,589			$	(88,564	)	$	(29,890,243	)	$	(718,601	)	$	25,282,058		$	791,843
Proceeds from exercise of stock options		5,000		5			13,120				—			—			—			13,125
Deferred stock option compensation		—		—			18,236				—			—			—			18,236
Issuance of Common Stock		332,184		332			959,680				—			—			—			960,012
Unrealized loss on investments available for sale, net of tax		—		—			—				(85,214		)	—			—			(85,214		)	$	(85,214	)
Net income		—		—			—				—			42,534						42,534			42,534
BALANCE, March 31, 2003		12,988,198		$	13,214		$		56,957,625		$	(173,778	)	$	(29,847,709	)	$	(718,601	)	$	26,230,751		$	749,163

 

See accompanying notes to the condensed interim consolidated financial statements

 

4

 

SRS LABS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Three Months Ended March 31,
		2003			2002
Cash Flows From Operating Activities:
Net income (loss)		$	42,534		$	(690,733	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization		286,115			352,407
Minority interest		(5,430		)	(19,748		)
Provision for doubtful accounts		8,804			38,319
Provision for obsolete inventory		(27,108		)	93,714
Deferred Taxes		2,308			—
Amortization of premium on investments available for sale		—			263
Increase in deferred stock option compensation		18,236			13,703
Changes in operating assets and liabilities:
Accounts receivable		145,335			(356,106		)
Inventories		(20,602		)	2,092
Prepaid expenses and other current assets		54,572			242,633
Accounts payable		(195,428		)	(20,354		)
Accrued liabilities		(632,510		)	336,041
Income taxes payable		(17,724		)	9,148
Net cash (used in) provided by operating activities		(340,898		)	1,379
Cash Flows From Investing Activities:
Purchase of furniture, fixtures and equipment		(120,843		)	(93,747		)
Purchase of investments available for sale		(1,994,467		)	—
Expenditures related to patents and intangible assets		(52,008		)	—
Net cash used in investing activities		(2,167,318		)	(93,747		)
Cash Flows From Financing Activities:
Proceeds from exercise of stock options		13,125			28,381
Net cash provided by financing activities		13,125			28,381
Net Decrease in Cash and Cash Equivalents		(2,495,091		)	(63,987		)
Cash and Cash Equivalents, Beginning of Period		15,720,860			19,011,167
Cash and Cash Equivalents, End of Period		$	13,225,769		$	18,947,180
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Income taxes		$	209,491		$	92,290
Supplemental Disclosure of Non-Cash Investing and Financing Activities:
Unrealized (loss) on investments, net		$	(85,214	)	$	(2,407	)
Issuance of Common stock for minority interest		$	960,012		—

 

See accompanying notes to the condensed interim consolidated financial statements

 

5

 

1.                                      General/Basis of Presentation

 

SRS Labs is a leading developer and provider of application specific integrated circuits (“ASICs”), standard integrated circuits (“ICs”) and audio and voice technology solutions for the home theater, portable audio, wireless, computer, game, automotive, broadcast, Internet and telecommunications markets. The Company operates its business through three operating units: SRS Labs, the parent company; its wholly-owned subsidiary, SRSWOWcast.com, Inc., doing business as SRSWOWcast Technologies (“SRSWOWcast”); and its wholly-owned subsidiary, ValenceTech Limited, and ValenceTech Limited’s wholly-owned subsidiaries (collectively “Valence”). SRS Labs and its wholly-owned subsidiaries together are hereby collectively referred to as the “Company”.

 

The Company operates in three business units in the following five business segments:

 

SRS Labs

 

Licensing:  The Company’s licensing segment develops and licenses audio and voice technologies to many of the world’s leading original equipment manufacturers (“OEMs”), software providers and semiconductor manufacturers.

 

Products:  The product segment develops and sells consumer products that incorporate proprietary audio and speaker technologies.

 

Valence

 

Semiconductor:  The semiconductor segment develops and sells technology solutions in the form of analog and digital signal processor (“DSP”) ASIC semiconductors or other imbedded custom semiconductor designs to OEMs around the world.

 

Component Distribution:  The component distribution segment is an authorized, non-exclusive distributor of semiconductor components, subassemblies and finished goods for selected OEM customers. The Company is no longer emphasizing this business due to its decision to focus on higher margin revenue. Although the Company expects revenues for this segment to decline further in the current year, it will continue to operate in this segment.

 

SRSWOWcast

 

Internet and Broadcast:  The Company’s Internet and broadcast segment develops and licenses software and hardware audio enhancement technology solutions for the Internet and broadcast markets.

 

The accompanying condensed interim consolidated financial statements have been prepared by the Company without audit in conformity with accounting principles generally accepted in the United States of America (“generally accepted accounting principles”) for interim financial information and with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). In the opinion of management, all adjustments (which include only normal recurring adjustments) considered necessary for a fair presentation have been included. Certain accounts have been reclassified from that previously reported to conform to the current period presentation.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to SEC rules and regulations for presentation of interim financial information. Therefore, the condensed interim consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002. Current and future financial statements may not be directly comparable to the Company’s historical financial statements. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

 

6

 

2.                                      Goodwill and Intangible Assets

 

On January 1, 2002 the Company adopted SFAS No. 142 “Goodwill and Other Intangible Assets”, which, among other things, establishes new standards for goodwill acquired in a business combination, eliminates the amortization of goodwill and requires the carrying value of goodwill and identifiable intangibles to be evaluated for impairment on an annual basis. Identifiable intangible assets with a determinable useful life are amortized over that period.

 

In accordance with SFAS No. 142, all of our intangible assets that have definite lives are being amortized on a straight-line basis over their estimated useful lives and goodwill is evaluated to determine if fair value of the asset has decreased below its carrying value. At December 31, 2002, we evaluated goodwill and determined that no adjustment to impair goodwill was necessary.

 

Goodwill and intangible assets consist of the following:

 

		March 31, 2003			December 31, 2002
Goodwill & assembled workforce		$	1,173,102		$	533,031
Patents		1,399,134			1,398,565
Accumulated amortization		(573,939		)	(590,365		)
Patents, net		825,195			808,200
Other intangibles		5,030,400			5,030,400
Accumulated amortization		(3,946,692		)	(3,881,241		)
Other intangibles, net		1,083,708			1,149,159
Goodwill and intangible assets, net		$	3,082,005		$	2,490,390

 

In February 2003, SRS Labs completed an exchange offer with the minority shareholders of SRSWOWcast, pursuant to which SRS Labs acquired all 3,000,000 outstanding shares of Series A Convertible Preferred Stock in exchange for the issuance of 332,184 shares of SRS Labs common stock. As a result of the exchange offer, goodwill in the amount of $640,071 was recorded.

 

Amortization periods range from three to eleven years depending on the estimated useful life of the asset. Amortization expense consists of the following:

 

		Three months ended March 31,
		2003				2002
Patents		$		35,013		$		32,751
Other intangibles		65,451				146,497
Total amortization expense		$	100,464			$	179,248

 

7

 

Our weighted average amortization period for patents and other intangibles is approximately 10 years. The following table shows the estimated amortization expense for those assets for the current year and each of the four succeeding fiscal years.

 

 

3.                                      Investments Available for Sale

 

The Company has classified its investments as available-for-sale in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.”

 

The following table summarizes the Company’s investment securities available for sale:

 

		March 31, 2003			December 31, 2002
U.S. Government securities available for sale:
Cost		$	8,632,500		$	6,638,033
Unrealized (losses)		(92,476		)	(7,262		)
Estimated fair value		$	8,540,024		$	6,630,771

 

The contractual maturities of investments are shown below. Actual maturities may differ from contractual maturities.

 

		March 31, 2003						December 31, 2002
		Cost			Estimated Fair Value			Cost			Estimated Fair Value
U.S. Government securities available for sale:
Due in one to five years		$	8,632,500		$	8,540,024		$	6,638,033		$	6,630,771

 

4.                                      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 costs to be incurred in selling and distribution.

 

8

 

5.                                      Minority Interest

 

Minority interest represents the minority stockholders’ proportionate share of the equity in the consolidated subsidiary SRSWOWcast. At March 31, 2002 and December 31, 2002, the Company owned approximately 87% of the outstanding capital stock of SRSWOWcast. In February 2003, SRS Labs completed an exchange offer with the minority shareholders of SRSWOWcast, pursuant to which SRS Labs acquired all 3,000,000 outstanding shares of Series A Convertible Preferred Stock in exchange for the issuance of 332,184 shares of SRS Labs common stock. As a result of the exchange offer, SRSWOWcast became a wholly-owned subsidiary of SRS Labs.  The proforma effect as if this transaction had occurred at the beginning of this quarter and the beginning of last year would have been immaterial.

 

6.                                      Stock-Based Compensation

 

The Company accounts for stock-based awards to employees under the recognition and measurement principles of APB No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The Company has adopted the disclosure-only provisions of FAS No. 123. Accordingly, no stock-based employee compensation cost is reflected in net income (loss), as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. Had compensation cost for the Company’s stock option plan been determined based on the fair value at the grant date for awards for the three months ended March 31, 2003 and 2002, consistent with the provisions of FAS No. 123, the Company’s net income (loss) and earnings (loss) per share would have been increased to the pro forma amounts indicated below:

 

		For the Quarter ended March 31,
		2003			2002
Net income (loss) (attributable to common shareholder) — as reported		$	42,534		$	(690,733	)
Add: deferred compensation expense already recognized		18,236			13,703
Less fair value of stock-based employee compensation expense, net of related tax effects		(514,866		)	(456,549		)
Net (loss) (attributable to common shareholder)—pro forma		(454,096		)	(1,133,579		)
Net (loss) per share (basic and diluted)—as reported		$	0.00		$	(0.05	)
Net income (loss) per share (basic and diluted)—pro forma		$	(0.04	)	$	(0.09	)

 

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 2002.  There have been no grants during the quarter ended March 31, 2003.

 

 

Because FAS No. 123 has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in the future years.

 

9

 

7.                                      Net Income (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 our 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.

 

Basic and diluted net income (loss) per share computed in accordance with SFAS 128 for the three months ended March 31 are as follows:

 

 

There were 4,237,038 and 5,479,921 potentially dilutive options outstanding at March 31, 2003 and 2002, respectively, that were not included above because they would be anti-dilutive.

 

8.                                      Commitments and Contingencies

 

The Company is subject to legal proceedings and claims that arise in the normal course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, management does not believe that the outcome of any of these matters will have a material adverse effect on the Company’s consolidated financial position or results of operations.

 

The Company has contractual obligations and commitments with regards to operating lease arrangements. The following table quantifies the expected contractual obligations and commitments subsequent to December 31, 2002:

 

		Payments due in fiscal
		2003			2004			2005
Operating lease commitments		$	421,894		$	340,297		$	114,770

 

10

 

9.                                      Stockholders’ Equity

 

On May 9, 2002, 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 May 10, 2002 to November 10, 2002 (the “2002 Repurchase Program”). As of March 31, 2003, 225,300 shares had been repurchased at a cost of $718,601 under the 2002 Repurchase Program. All repurchased shares under all the Repurchase Programs are reflected as treasury stock in the accompanying consolidated balance sheets.

 

10.                               Segment Information

 

The Company operates its three operating units in the following five business segments: (i) SRS Labs:  (a) the licensing of technologies developed by the Company to OEMs and semiconductor manufacturers, and (b) the sale of consumer products incorporating SRS proprietary technologies; (ii) Valence:  (a) the development and marketing of technology either in the form of ASICs or other imbedded custom semiconductor designs, and (b) the component distribution business; and (iii) SRSWOWcast:  the sale of hardware and software solutions to the Internet and broadcast audio markets. The Company does not allocate corporate operating expenses or specific assets to these segments. Therefore, the segment information that follows includes only net revenues, cost of sales and gross margins of the identified segments:

 

		Business Segments
		SRS Labs						Valence						SRS WOWcast
		Licensing			Products			ASIC			Components			Product and Internet Sales			Total
Three Months Ended March 31, 2003
Net revenues		$	2,628,311		$	1,248		$	1,711,819		$	52,261		$	76,735		$	4,470,374
Cost of sales		11,782			852			567,748			74,839			14,347			669,568
Gross margin		$	2,616,529		$	396		$	1,144,071		$	(22,578	)	$	62,388		$	3,800,806
Three Months Ended March 31, 2002
Net revenues		$	1,795,722		24,919			$	1,471,142		$	234,931		28,666			$	3,555,380
Cost of sales		26,272			17,967			514,821			234,217			68			793,345
Gross margin		$	1,769,450		$	6,952		$	956,321		$	714		$	28,598		$	2,762,035

 

The following schedule presents the Company’s revenue by geographic area. For product sales, revenue is allocated based on the country to which the 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.

 

 

11

 

11.                               Recent Accounting Pronouncements

 

In July 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addressed financial accounting and reporting for costs associated with exit or disposal activities and supercedes Emerging Issues Task Force (EITF) Issue 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).” SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized at the date of an entity’s commitment to an exit plan. SFAS 146 also establishes that the liability should initially be measured and recorded at fair value. The Company has adopted the provisions of the SFAS 146 for exit or disposal activities effective January 1, 2003. The adoption of SFAS No. 146 did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an Amendment to SFAS No. 123.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method on accounting for stock-based employee compensation. The Comany has not currently adopted SFAS No. 123 and accordingly the implementation of SFAS No. 148 has not had a material effect on the Company's consolidated financial position or results of operations.

 

In November 2002, the FASB issued interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees. Including indirect Guarantees of Indebtedness of Others,” which disclosures are effective for financial statements for periods ending after December 15, 2002. While the Company has various guarantees included in contracts in the normal course of business, primarily in the form of indemnities, these guarantees would only result in immaterial increases in future costs, but do not represent significant commitments or contingent liabilities of the indebtedness of others.

 

In January 2003, the FASB issued interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46) which requires the consolidation of variable interest entities, as defined. FIN 46 is applicable to financial statements to be issued by the Company after 2002; however, disclosures are required currently if the Company expects to consolidate any variable interest entities. No material entities were consolidated as a result of FIN 46.

 

12

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

This information should be read in conjunction with the unaudited condensed interim consolidated financial statements and the notes thereto included in this Quarterly Report, and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

 

Overview

 

SRS Labs is a leading developer and provider of application specific integrated circuits, (“ASICs”), standard integrated circuits (“ICs”) and audio and voice technology solutions for the home theater, portable audio, wireless, computer, game, automotive, broadcast, Internet and telecommunications markets. The Company operates its business through three operating units: SRS Labs, the parent company; its wholly-owned subsidiary, SRSWOWcast.com, Inc., doing business as SRSWOWcast Technologies (“SRSWOWcast”); and its wholly-owned subsidiary, ValenceTech Limited, and ValenceTech Limited’s wholly-owned subsidiaries (collectively “Valence”).

 

The Company operates in three business units in the following five business segments:

 

SRS Labs

 

Licensing:  The Company’s licensing segment develops and licenses audio and voice technologies to many of the world’s leading original equipment manufacturers (“OEMs”), software providers and semiconductor manufacturers.

 

Products:  The product segment develops and sells consumer products that incorporate proprietary audio and speaker technologies.

 

Valence

 

Semiconductor:  The semiconductor segment develops and sells technology solutions in the form of analog and digital signal processor (“DSP”) ASIC semiconductors or other imbedded custom semiconductor designs to OEMs around the world.

 

Component Distribution:  The component distribution segment is an authorized, non-exclusive distributor of semiconductor components, subassemblies and finished goods for selected OEM customers. The Company is no longer emphasizing this business due to its decision to focus on higher margin revenue. Although the Company expects revenues for this segment to decline further in the current year, it will continue to operate in this segment.

 

SRSWOWcast

 

Internet and Broadcast:  The Company’s Internet and broadcast segment develops and licenses software and hardware audio enhancement technology solutions for the Internet and broadcast markets.

 

13

 

Critical Accounting Policies

 

The Company has prepared the accompanying condensed interim consolidated financial statements without audit in conformity with accounting principles generally accepted in the United States for interim financial information.

 

The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. We base our estimates on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from our estimates.

 

The following represents a summary of our critical accounting policies, defined as those policies that we believe are: (a) the most important to the portrayal of our financial condition and results of operations, and (b) that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the matters that are inherently uncertain.

 

Allowance for Doubtful Accounts

 

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We evaluate the ability to collect upon our accounts receivable based on specific customer circumstances, current economic trends, historical experience and the age of past due receivables. Unanticipated changes in the liquidity or financial position of our customers may require additional provisions for doubtful accounts.

 

Inventory Obsolescence Reserves

 

Our inventories are stated at the lower of cost or net realizable value. We make provisions for estimated excess and obsolete inventory based on our regular reviews of inventory quantities on hand and the latest forecasts of product demand and production requirements from our customers. If actual market conditions or our customer’s product demands are less favorable than those projected, additional provisions may be required.

 

Valuation of Intangible Assets

 

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, we assess potential impairments to intangible assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. Our judgments regarding the existence of impairment indicators and future cash flows related to intangible assets are based on operational performance of our acquired businesses, market conditions, and other factors. If the carrying value of a reporting unit exceeds its fair value, goodwill is considered impaired and a second test is performed to measure the amount of impairment loss, if any. For fiscal 2002, an independent valuation of goodwill and other intangibles was performed. To date, we have not recognized any impairment of our goodwill and other intangible assets in connection with our adoption of SFAS 142. However, no assurances can be given that future evaluation of goodwill will not result in charges as a result of future impairment.

 

Income Taxes

 

In preparing our consolidated financial statements, we go through a process to estimate our income taxes in each of the countries in which we operate. The process includes an assessment of the current tax expense, the results from tax examinations and the effects of temporary differences resulting from the different treatment of transactions for tax and financial accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Consolidated Balance Sheet. The realization of deferred tax assets as a result of future taxable income must be assessed and to the extent that the realization is doubtful, we establish a valuation allowance. Our income tax provision is based on calculations and assumptions that will be subject to examination by the taxing authorities in the jurisdictions in which we operate. Should the actual results differ from our estimates, we would have to adjust the income tax provision in the period in which the facts and circumstances that give rise to the revision become known. Tax law and rate changes are reflected in the income tax provision in the period in which such changes are enacted.

 

14

 

Results of Operations

 

Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002

 

Revenues

 

The Company generates revenues in three operating business units in five business segments. Semiconductor revenues consists of (a) design fees relating to, and sales of, application specific integrated circuits (“ASICs”) for third parties by Valence to original equipment manufacturers (“OEMs”); and (b) sales of general purpose integrated circuits (“ICs”) designed by Valence under the brand name ASP. Licensing revenues are royalties generated primarily from the license of SRS Labs’ 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. Component distribution revenue consists of (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 People’s Republic of China (“PRC”) markets. Product sales represent sales of consumer products incorporating one or more of SRS Labs’ proprietary technologies. Internet and broadcast revenues consist of the sale of hardware and software applications involving the Internet and broadcast audio markets.

 

Total revenues for the three months ended March 31, 2003 were $4,470,374 compared to $3,555,380 for the three months ended March 31, 2002, an increase of $914,994 or 25.7%. Semiconductor revenues were $1,711,819 for the three months ended March 31, 2003 compared to $1,471,142 for the three months ended March 31, 2002, an increase of $240,677 or 16.4%. This increase was attributable to expansion of Valence’s ASIC customer base, increased design wins and new chip offerings.  Licensing revenues were $2,628,311 for the three months ended March 31, 2003, compared to $1,795,722 for the three months ended March 31, 2002, an increase of $832,589 or 46.4%. This increase was attributable to the continuation of the sales growth of home entertainment products such as DVD players, TV’s and set top boxes, which incorporate SRS Labs’ technologies. Other revenues were $130,244 for the three months ended March 31, 2003 compared to $288,516 for the three months ended March 31, 2002 a decrease of $158,272 or 54.9%.  Other revenues are comprised of the following components for the quarters ended March 31, 2003 and 2002 respectively:  component distribution — 40% and 81%; product revenues — 1% and 9% ; internet and broadcast business — 59% and 10%.  Component distribution revenues were $52,261 for the three months ended March 31, 2003 compared to $234,931 for the three months ended March 31, 2002 a decrease of $182,670 or 77.8%. This decrease was due to the Company’s decision to focus on higher margin ASIC and licensing revenues and de-emphasize certain lower margin distribution activities. Product revenues were $1,248 for the three months ended March 31, 2003 compared to $24,919 for the comparable period in 2002, a decrease of $23,671 or 95%. This decrease was due to the decrease of the on-line merchandising of the WOW Thing processor box.  Revenues generated by the Company’s Internet and broadcast based business were $76,735 for the three months ended March 31, 2003 compared to $28,666 for the three months ended March 31, 2002 an increase of $48,069 or 167.7%. This increase was attributable to the sales of professional hardware equipment to the broadcast market.

 

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Gross Margin

 

Cost of sales consists primarily of fabrication costs, assembly and test costs, and the cost of materials and overhead from operations. The gross margin percentage for the three months ended March 31, 2003 increased to 85.0% as a percentage of total revenue as compared to 77.7% for the three months ended March 31, 2002. The increase is attributable to continued efforts by the Company to focus the revenue base towards higher margin semiconductor and licensing revenues and away from lower margin component distribution.  Gross margins may fluctuate in future quarters depending on the mix of products sold and services provided, royalties earned, competitive pricing, new product introduction costs and other factors.

 

Sales and Marketing

 

Sales and marketing expenses consist primarily of employee salaries, sales consultants’ fees and related expenses, sales commissions and product promotion costs. Sales and marketing expenses were $1,352,490 for the three months ended March 31, 2003 compared to $1,260,440 for the same prior year period, an increase of $92,050 or 7.3%. The net increase in sales and marketing expenses for the three months ended March 31, 2003 is primarily attributable to increased promotion costs associated with higher licensing revenue and costs associated with the promotion of our technologies in new markets. As a percentage of total revenues, sales and marketing expenses decreased from 35.5% for the quarter ended March 31, 2002, to 30.3% for the same period this year.

 

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 $1,081,215 for the three months ended March 31, 2003 compared to $965,076 for the same prior year period, an increase of $116,139, or 12.0%. The increase in research and development costs is primarily due to the addition of research and development personnel and increased costs associated with the increased semiconductor business activity.  As a percentage of total revenues, research and development expenses decreased from 27.1% for the quarter ended March 31, 2002, to 24.2% for the same period this year.

 

General and Administrative

 

General and administrative (“G&A”) expenses consist primarily of employee-related expenses, legal costs associated with the administration of intellectual property and other professional fees. G&A expenses were $1,314,610 for the three months ended March 31, 2003 compared to $1,233,525 for the same prior year period, an increase of $81,085 or 6.6%. The increase was primarily attributable to increased professional fees and public company expenses.  As a percentage of total revenues, G&A expenses decreased from 34.7% for the quarter ended March 31, 2002, to 29.4% for the same period this year.

 

Income (Loss) From Operations

 

Income from operations increased by $749,497 to $52,491 for the quarter ended March 31, 2003, as compared to a loss from operations of $697,006 for the quarter ended March 31, 2002.  The increase in income from operations is due to an increase in gross profit of $1,038,771, partially offset by an increase in sales and marketing, research and development and general and administrative expenses of $289,274.

 

Other Income, Net

 

Other income, net, consists primarily of interest income, gain or (loss) on sale of securities, interest expense and foreign currency transaction gains and losses. Other income, net, was $164,126 for the three months ended March 31, 2003, compared to $87,963 for the same prior year period, an increase of $76,163 or 87.4%. The increase is primarily attributable to higher interest rates earned on investment balances.

 

16

 

Minority Interest

 

Minority interest represents the minority shareholders’ proportionate share of losses in SRSWOWcast. Minority interest was $5,430 for the three months ended March 31, 2003, compared to $19,748 for the three months ended March 31, 2002, a decrease of $14,318 or 72.5%. The decrease is primarily attributable to decreased losses and the difference in the reporting period of 30 days. In February 2003, SRS Labs completed an exchange offer with the minority shareholders of SRSWOWcast, pursuant to which SRS Labs acquired all of the outstanding shares of Series A Convertible Preferred Stock in exchange for the issuance of shares of SRS Labs common stock. As a result of the exchange offer, SRSWOWcast became a wholly-owned subsidiary of SRS Labs.

 

Provision for Income Taxes

 

The income tax expense for the three months ended March 31, 2003 was $179,513, compared to tax expense of $101,438 for the same prior year period, an increase of $78,075 or 77.0%. The increase results from the increase in the Hong Kong tax rate from 16.5% to 17.5%, effective January 1, 2003, and the higher levels of foreign tax on higher licensing revenues sourced from countries requiring foreign tax withholdings.

 

Liquidity and Capital Resources

 

The Company’s principal source of liquidity to fund ongoing operations at March 31, 2003 consisted of cash, cash equivalents and long-term investments aggregating $21,765,793. At March 31, 2003, the Company had cash and cash equivalents of $13,225,769 and long-term investments of $8,540,024. Cash and cash equivalents generally consist of cash, money market funds and other money market instruments with original maturities of three months or less. Investments consist of U.S. government securities rated AAA.

 

The Company’s operating activities used $340,898 in cash for the three months ended March 31, 2003.  The use of cash by operations resulted from a net decrease in accounts receivable and prepaid expenses and other current assets, a net decrease in accounts payable, accrued liabilities and income taxes payable and increases in inventories, as well as certain adjustments to reconcile net income to cash used in operating activities including depreciation and amortization.  The primary use of cash for the three months ended March 31, 2003 resulted from the Company’s payment of accounts payable and accrued liabilities associated with commissions and product promotion costs as well as professional fees. Net cash used in investing activities for the three months ended March 31, 2003 was $2,167,318, resulting primarily from the purchase of U.S. government securities, purchases of furniture, fixtures and equipment and expenditures related to intangible assets. Net cash provided by financing activities for the three months ended March 31, 2003 was $13,125, reflecting the proceeds from sale of common stock pursuant to exercise of employee stock options.

 

Based on current plans and business conditions, the Company expects that its cash, cash equivalents and investments together with any amounts generated from operations will be sufficient to meet the Company’s cash requirements for the foreseeable future. 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.

 

Newly Adopted and Recent Accounting Pronouncements

 

In July 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addressed financial accounting and reporting for costs associated with exit or disposal activities and supercedes Emerging Issues Task Force (EITF) Issue 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).” SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized at the date of an entity’s commitment to an exit plan. SFAS 146 also establishes that the liability should initially be measured and recorded at fair value. The Company has adopted the provisions of the SFAS 146 for exit or disposal activities effective January 1, 2003. The adoption of SFAS No. 146 did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an Amendment to SFAS No. 123.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method on accounting for stock-based employee compensation. The Company

 

17

 

has not currently adopted SFAS No. 123 and accordingly the implementation of SFAS No. 148 has not had a material effect on the Company’s consolidated financial position or results of operations.

 

In November 2002, the FASB issued interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees. Including indirect Guarantees of Indebtedness of Others,” which disclosures are effective for financial statements for periods ending after December 15, 2002. While the Company has various guarantees included in contracts in the normal course of business, primarily in the form of indemnities, these guarantees would only result in immaterial increases in future costs, but do not represent significant commitments or contingent liabilities of the indebtedness of others.

 

In January 2003, the FASB issued interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46) which requires the consolidation of variable interest entities, as defined. FIN 46 is applicable to financial statements to be issued by the Company after 2002; however, disclosures are required currently if the Company expects to consolidate any variable interest entities. No material entities were consolidated as a result of FIN 46.

 

Factors That May Affect Future Results

 

Our quarterly results may fluctuate

 

Our 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 our licensees incorporate our technologies into their products; the timing of orders from, and the shipments to, major customers; the timing of new product introductions; the gain or loss of significant customers; competitive pressures on selling prices; the market acceptance of new or enhanced versions of our technologies; the rate that our semiconductor licensees manufacture and distribute chips to product manufacturers; and fluctuations in general economic conditions, particularly those affecting the consumer electronics market. Due to our dependence on the consumer electronics market, the substantial seasonality of sales in the market could impact our revenues and net income. In particular, we believe that there is seasonality relating to the Christmas season generally and the Chinese New Year within the Asia region, which fall into the fourth and first quarters respectively. As a result, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied on as indications of future performance.

 

We rely on revenue contribution from our ASIC and standard IC business

 

We derive a significant amount of our revenue from Valence’s ASIC business. Valence’s engineering team focuses on the design of custom ASICs to meet specific customers’ requirements and out sources 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. The business generated from any one customer may be for a fixed length or quantity. As such, it is customary in our ASIC business to have a certain amount of customer turnover as new ASIC projects are obtained for different customers. However, it is possible that the loss of any particular customer or any bad debt arising from such customer may have a material adverse impact on our 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 placed more emphasis on developing and distributing products that are related to or incorporate our 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 we 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.

 

Valence adds significant diversity to our overall business structure and opportunities. We recognize 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 our technology licensees. Although the operations of

 

18

 

our 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, we may or may not be able to mitigate the effect of such perceived conflicts, which, if not resolved, may impact the results of operations.

 

We are exposed to risks in our licensing business related to product concentration

 

Currently, our licensing revenue is concentrated in the home theater market with the majority of revenue generated from the inclusion of SRS technology inside televisions, DVD players and set-top boxes. We expect that the consumer home entertainment market will continue to account for a significant portion of our licensing revenues for the foreseeable future. While consumer spending in general on consumer electronic products has increased, retail prices for certain consumer electronics products that include our audio technology, such as DVD players have decreased significantly and indications are that this trend will continue for the foreseeable future. Declining prices of consumer electronic products could put pressure on our licensing fees that are charged to the manufacturers.  In addition, consumer electronics products manufacturers could decide to exclude our audio enhancement technology from their home theater products altogether in an effort to reduce cost.  Also, given the current economic environment, consumer spending on DVD players and other home electronic products may not increase as expected.  Such declines in consumer spending, should they occur, and continued decreases in consumer product pricing for electronic goods may have a significant negative impact on our financial results.

 

We are exposed to certain risks in producing professional and consumer products

 

We intend to continue to develop and offer high-end audio enhancement products, including professional and consumer hardware and software products. We have also developed a line of speakers that incorporate proprietary flat panel designs, which have been marketed to OEMs and industry retail buyers. There can be no assurance that our products will be accepted in the market or that we 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, we are subject to risks of product obsolescence, bad debt and insufficient finance to grow the business.

 

We also recognize that as we develop and market new consumer audio products, there will always exist a potential for conflict and competition between SRS Labs and our technology licensees. Although our intended products and those of our licensees do not generally overlap, there can be no assurances that our products will not compete with those of our licensees. If such conflicts do materialize, it is uncertain whether we will be able to mitigate the effect of such conflicts, which, if not resolved, may adversely impact our business and results of operations.

 

We conduct operations in a number of countries and are subject to risks of international operations, particularly in Asia and the PRC

 

We have significant operations in Hong Kong, the PRC and other parts of Asia that require refinement to adapt to the changing market conditions in that region. Our customers geographically located in the Asia Pacific markets accounted for approximately 90%, and 76% of total Company sales in the quarters ended March 31, 2003 and 2002, respectively and are expected to continue to account for a substantial percentage of sales in the future. Because we rely on sales to customers in Asia for a substantial portion of our revenue, our business is very likely to be adversely impacted by economic downturns and instability in that region. In addition, international sales are subject to risks, including, but not limited to:

 

•                           fluctuations in foreign exchange rates;

•                           changes in legal and regulatory requirements;

•                           political and economic instability and acts of terrorism;

•                           any public health crisis such as SARS;

•                           difficulties in staffing and managing international operations;

•                           foreign trade disputes; and

•                           potentially adverse tax consequences.

 

19

 

The PRC economy has experienced significant growth in the past decade; but such growth has been uneven across geographic and economic sectors. There can be no assurance that such growth will continue or that any potential currency devaluation in the region will not have a negative effect on our business, including Valence.

 

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.” We can give no assurance that Hong Kong will continue to enjoy autonomy from the PRC.

 

The Hong Kong dollar has remained relatively constant due to the U.S. 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. We 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 our business.

 

Our results of operations may be adversely affected by the ongoing slowdown in the global economy

 

Over the past year, the global economy has been experiencing a slowdown due to many factors, including decreased consumer confidence, unemployment, the ongoing threat and cost of terrorism and reduced corporate profits and capital spending. Recent political events, including the U.S. military action in the Middle East, have put further pressure on economic conditions. The potential turmoil that may result from such events contributes to the uncertainty of the economic climate, further reducing predictability and our ability to develop and implement long-term strategic plans. The impact of these or future similar events may have a material adverse impact on our operating results and financial position.

 

We are subject to competitive pressures

 

Our 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. Present or future competitors may be able to develop products and technologies comparable or superior to ours, and to adapt more quickly than us to new technologies or evolving market needs. We believe that the competitive factors affecting the market for our 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 we compete 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 we 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 our business, operating results, cash flows and financial condition.

 

We strongly rely on our intellectual property

 

Our ability to compete may be affected by our ability to protect our proprietary information. We have filed numerous U.S. and foreign patent applications and to date have a number of issued U.S. and foreign patents covering various aspects of our technologies. There can be no assurance that the steps taken by SRS Labs to protect our intellectual property will be adequate to prevent misappropriation of our technology or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology. In addition, the laws of certain foreign countries may not protect our 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. We are not currently a party to any claims of this nature. There can be no assurances that third parties will not assert claims or initiate litigation against the Company or our customers with respect to existing or future products. In addition, we may initiate claims or litigation against third parties for infringement of our proprietary rights or to determine the scope and validity of our proprietary rights.

 

20

 

We depend on our executive officers and other key personnel

 

Our future success depends to a large extent upon the continued service of our executives, as well as key engineering, sales, and marketing staff, including highly skilled semiconductor design personnel. We anticipate that any future growth will require us to recruit and hire a number of new personnel in engineering, operations, finance, sales and marketing. Competition for such personnel during times of economic growth is intense, and there can be no assurance that we can recruit and retain necessary personnel to operate its business and support future growth.

 

The market price of our common stock is volatile

 

The trading price of our Common Stock has been, and will likely continue to be, subject to wide fluctuations in response to quarterly variations in our operating results, announcements of new products or technological innovations by the Company or our competitors, strategic alliances between SRS Labs 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 we do 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. Even though our stock is quoted on the NASDAQ Stock Market, our stock has had and may continue to have low trading volume and high volatility. The historically low trading volume of our stock makes it more likely that a severe fluctuation in volume, either up or down, will significantly impact the stock price. Since our shares are thinly traded, our shareholders may have difficulty selling our common stock.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk.

 

There have been no material changes to information called for by this Item 3 from the disclosures set forth in Part II, Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

 

Item 4.  Controls and Procedures.

 

Within the 90 days prior to the date of this Report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s President and Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Exchange Act Rule 15d-14(c). Based upon that evaluation, the Company’s President and Chief Executive Officer and the Company’s Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in enabling the Company to record, process, summarize and report information required to be included in the Company’s periodic filings with the U.S. Securities and Exchange Commission (the “Commission”) within the required time period. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the date the Company carried out its evaluation.

 

21

 

PART II—OTHER INFORMATION

 

Item 2.  Changes in Securities and Use of Proceeds.

 

On January 10, 2003, the Company offered each holder of shares of Series A Preferred Stock (“Series A Preferred”) of SRSWOWcast.com, Inc. (“SRSWOWcast”) the right to exchange their shares of Series A Preferred for shares of SRS Labs common stock (the “SRS Common Stock”) at the following exchange ratio: each share of Series A Preferred would be converted into that number of whole shares of SRS Labs Common Stock determined by dividing $0.32 by the greater of $2.50 or the closing sale price of a shares of SRS Labs Common Stock on February 14, 2003, or such later date to which the exchange offer was extended (the “Expiration Date”), as such closing sale price is reported by the Nasdaq Stock Market.  The exchange offer expired on February 14, 2003.  At the time of the exchange offer, there were a total of eight holders of shares of Series A Preferred.  All of the holders of Series A Preferred Stock accepted the exchange offer and exchanged an aggregate of 3,000,000 shares of Series A Preferred Stock for 332,184  shares of SRS Common Stock. The Company received no remuneration for this exchange.

 

There was no general solicitation in connection with the exchange offer.  The exchange offer was limited to the eight holders of the Series A Preferred.  All of the holders of the Series A Preferred were sophisticated investors with pre-existing relationships with the Company and its management and were accredited investors as defined under Regulation D under the Securities Act of 1933, as amended (the "Securities Act").  Based on these facts, the Issuer believes that the issuance of the SRS Labs Common Stock was exempt from registration under the Securities Act pursuant to Section 4(2) of the Securities Act, as a transaction by an issuer not involving a public offering.

 

Item 6.  Exhibits and Reports on Form 8-K.

 

(a)                                  Exhibits.

 

The exhibit listed below is hereby filed with the Commission as part of this Report.

 

Exhibit Number		Description
99.1*		Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2*		Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

*                                 Pursuant to Commission Release No. 33-8212, this certification will be treated as “accompanying” this Annual Report on Form 10-K and not “filed” as part of such report for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of Section 18 of the Exchange Act and this certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

 

(b)                         Reports on Form 8-K.

 

No report on Form 8-K was filed with the SEC during the three-month period ended March 31, 2003.

 

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SIGNATURES

 

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

 

 

	SRS LABS, INC., a Delaware corporation
Date: May 15, 2003	By:	/s/ THOMAS C.K. YUEN
		Thomas C.K. Yuen
		Chairman of the Board and Chief Executive Officer

 

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CERTIFICATIONS

 

I, Thomas C.K. Yuen, certify that:

 

1.                                       I have reviewed this quarterly report on Form 10-Q of SRS Labs, Inc.;

 

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

 

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

 

4.                                       I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and I have:

 

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

 

b)                                     evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)                                      presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.                                       I have disclosed, based on my most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a)                                      all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b)                                     any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6.                                       I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Date: May 15, 2003	/s/ THOMAS C.K. YUEN
	Thomas C.K. Yuen
	Chairman of the Board and Chief Executive Officer (Principal Executive Officer)

 

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I, Janet M. Biski, certify that:

 

1.                                       I have reviewed this quarterly report on Form 10-Q of SRS Labs, Inc.;

 

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

 

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

 

4.                                       The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

 

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

 

b)                                     evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the ‘‘Evaluation Date’’); and

 

c)                                      presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

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

 

a)                                      all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b)                                     any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6.                                       The registrant’s other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Date: May 15, 2003	By:	/s/ JANET M. BISKI
		Janet M. Biski
		Chief Financial Officer (Principal Financial Officer)

 

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