<PAGE> 1
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
--------------
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
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)
--------------
DELAWARE 33-0714264
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
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)
NOT APPLICABLE
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGES
SINCE LAST REPORT)
--------------
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. [X] Yes [ ] No
APPLICABLE ONLY TO CORPORATE ISSUERS
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 7, 1999,
11,697,944 shares of the issuer's common stock, par value $.001 per share, were
outstanding.
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<PAGE> 2
SRS LABS, INC.
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 1999
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Consolidated Balance Sheets as of March 31, 1999 (Unaudited)
and December 31, 1998 3
Consolidated Statements of Operations for the three months
ended March 31, 1999 and 1998 (Unaudited) 4
Consolidated Statements of Comprehensive Loss for the three
months ended March 31, 1999 and 1998 (Unaudited) 5
Consolidated Statements of Cash Flows for the three months ended
March 31, 1999 and 1998 (Unaudited) 6
Notes to the Interim Consolidated Financial Statements (Unaudited) 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations. 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 18
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds. 19
Item 6. Exhibits and Reports on Form 8-K. 19
SIGNATURES 20
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
SRS LABS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------ -------------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 11,159,639 $ 12,341,242
Investments available for sale 3,039,915 1,519,425
Accounts receivable, net 2,715,337 5,320,686
Inventories, net 5,621,161 4,632,968
Prepaid expenses and other current assets 3,634,707 3,244,233
Deferred income taxes 17,456 17,456
------------ ------------
TOTAL CURRENT ASSETS 26,188,215 27,076,010
Investments available for sale 9,022,113 10,570,192
Furniture, fixtures & equipment, net 911,304 1,219,433
Intangible assets, net 6,586,865 6,669,671
------------ ------------
TOTAL ASSETS $ 42,708,497 $ 45,535,306
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 7,917,636 $ 10,632,505
Accrued liabilities 1,829,070 422,843
Line of credit 8,000,000 8,000,000
Income taxes payable 287,872 376,545
------------ ------------
TOTAL CURRENT LIABILITIES 18,034,578 19,431,893
Deferred income taxes 31,240 31,240
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;
11,697,944 (at March 31, 1999) and 11,688,893
(at December 31, 1998) shares issued and outstanding 11,698 11,689
Additional paid-in capital 39,207,565 39,170,103
Deferred stock option compensation 403,863 313,302
Cumulative other comprehensive income 133,473 141,389
Retained deficit (15,061,420) (13,564,310)
Less treasury stock at cost, 12,000 (at March 31, 1999)
and zero (at December 31, 1998) shares (52,500) --
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 24,642,679 26,072,173
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 42,708,497 $ 45,535,306
============ ============
</TABLE>
See accompanying notes to consolidated financial statements
3
<PAGE> 4
SRS LABS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------------------
1999 1998
------------ -------------
<S> <C> <C>
REVENUES
Chip and licensing revenue $ 4,104,067 $ 2,881,961
Product and component sales 3,612,774 4,175,435
------------ ------------
TOTAL REVENUES 7,716,841 7,057,396
COST OF SALES 5,275,642 4,398,416
------------ ------------
GROSS MARGIN 2,441,199 2,658,980
Sales and marketing 1,571,999 1,188,894
Research and development 640,018 399,079
General and administrative 2,139,545 1,252,823
Acquired in-process research and development -- 18,510,378
------------ ------------
LOSS FROM OPERATIONS (1,910,363) (18,692,194)
OTHER INCOME, NET 103,347 197,492
------------ ------------
LOSS BEFORE INCOME TAX BENEFIT (1,807,016) (18,494,702)
INCOME TAX BENEFIT (309,906) (283,768)
------------ ------------
NET LOSS $ (1,497,110) $(18,210,934)
============ ============
NET LOSS PER COMMON SHARE
Basic $ (0.13) $ (1.68)
============ ============
Diluted $ (0.13) $ (1.68)
============ ============
WEIGHTED AVERAGE SHARES USED IN THE
CALCULATION OF NET LOSS PER
COMMON SHARE
Basic 11,681,419 10,852,052
============ ============
Diluted 11,681,419 10,852,052
============ ============
</TABLE>
See accompanying notes to consolidated financial statements
4
<PAGE> 5
SRS LABS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Net loss $ (1,497,110) $(18,210,934)
Other comprehensive income (loss)
Unrealized gain (loss) on investments available
for sale, net of tax (7,916) 40,414
------------ ------------
Comprehensive loss $ (1,505,026) $(18,170,520)
============ ============
</TABLE>
See accompanying notes to consolidated financial statements
5
<PAGE> 6
SRS LABS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------------
1999 1998
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,497,110) $(18,210,934)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization 499,913 359,399
Deferred income taxes -- (335,000)
Write-off of acquired in-process research and development -- 18,510,378
Amortization of premium on investments available for sale 14,171 56,197
Accretion of consideration due on asset purchase -- 4,098
Increase in deferred stock option compensation 90,561 26,670
Changes in operating assets and liabilities, net of the
effect of acquisitions:
Accounts receivable 2,305,349 1,448,496
Inventories (988,193) 2,262,754
Prepaid expenses and other current assets (219,882) 398,660
Accounts payable (2,714,869) (2,123,534)
Accrued liabilities 1,463,578 153,648
Income taxes payable (83,171) (446,163)
------------ ------------
Net cash provided by (used in) operations (1,129,653) 2,104,669
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture, fixtures and equipment (28,425) (72,640)
Proceeds from sales of investments available for sale -- 7,467,571
Cash paid for acquisitions, less cash acquired -- (6,911,216)
Expenditures related to patents (8,496) --
------------ ------------
Net cash provided by (used in) investing activities (36,921) 483,715
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from line of credit -- 7,000,000
Payments on subsidiary debt -- (6,755,382)
Payment of consideration due on asset purchase -- (55,918)
Repurchase of stock (52,500) --
Exercise of stock options 37,471 147,865
------------ ------------
Net cash provided by (used in) financing activities (15,029) 336,565
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,181,603) 2,924,949
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 12,341,242 4,446,753
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 11,159,639 $ 7,371,702
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 112,307 $ --
Income taxes $ -- $ 330,000
</TABLE>
See accompanying notes to consolidated financial statements
6
<PAGE> 7
SRS LABS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
1999 1998
-------- -------
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
Unrealized gain (loss) on investments, net $(7,916) $40,414
</TABLE>
The Company acquired the stock of Valence Technology Inc. ("Valence") during
March 1998 (Note 2) and issued 1,680,611 shares of common stock in payment of
$12,105,778 of the acquisition price.
In conjunction with the acquisition, certain liabilities were assumed as
follows:
<TABLE>
<S> <C>
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
============
</TABLE>
The Company issued 125,000 shares of common stock in consideration for certain
non-competition agreements with the key employees of Valence. The shares have an
ascribed fair value of $900,400 (Note 2).
In February 1998, 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 (Note 2).
In May 1998, 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 (Note 2).
In January 1999, the Company received certain computer equipment and a fully
paid-up license for MPEG-1 Technology Core from DVS Inc. in payment for $300,000
of license fees due to the Company for the use of its technologies.
See accompanying notes to consolidated financial statements
7
<PAGE> 8
SRS LABS, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL/BASIS OF PRESENTATION
SRS Labs, Inc. is a developer and provider of technology solutions for the
consumer electronics, computer, game and telecommunications markets. The
Company's principal business activities in these markets include:
- Developing and licensing audio and voice technologies to original
equipment manufacturers ("OEMs") and semiconductor manufacturers
around the world; and
- Through its subsidiary, Valence Technology Inc. and its foreign
subsidiaries, designing and selling technology solutions through custom
application specific integrated circuits ("ASICs") to OEMs; and
designing, distributing and manufacturing components, sub-assemblies
and electronics products for the OEM and retail communities within
the Company's targeted markets.
The accompanying interim consolidated financial statements have been
prepared by the Company without audit (except for the balance sheet information
as of December 31, 1998) in conformity with generally accepted accounting
principles for interim financial information and with the rules and regulations
of the U.S. Securities and Exchange Commission. In the opinion of management,
all adjustments (which include only normal recurring adjustments) considered
necessary for a fair presentation have been included.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. Therefore, the interim financial statements
should be read in conjunction with the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1998. 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.
2. ACQUISITIONS
On March 2, 1998, the Company acquired (the "Acquisition") all of the
outstanding shares of capital stock of Valence Technology Inc., a British Virgin
Islands holding company with its principal business operations in Hong Kong and
China ("Valence"). Valence, which conducts its business through its subsidiaries
based in Hong Kong and China, is engaged in the following business activities:
(i) the development and marketing of technology in the form of integrated
circuits (ASICs) to original equipment manfacturers and (ii) the sale of
consumer electronic and telecommunications products and components. The
aggregate purchase price of $19,500,000 consisted of approximately $7,400,000 in
cash and 1,680,611 shares of the Company's common stock with a fair value of
$12,105,778. The Company's consolidated statement of operations for the three
months ended March 31, 1998 includes a charge of $17.5 million for the write-off
of acquired in-process research and development expense associated with the
Valence acquisition. The acquisition was accounted for as a purchase having an
effective date of February 1, 1998. In connection with such 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 in aggregate to
such three shareholders.
8
<PAGE> 9
SRS LABS, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The following summarizes the consideration granted for the acquisition of
Valence and non-compete agreements, the allocation of the purchase price and
other purchase accounting adjustments:
<TABLE>
<CAPTION>
<S> <C>
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
Intangible assets 5,910,400
-----------
$23,382,068
===========
</TABLE>
The resulting intangible assets are being amortized on a straight-line
basis over periods ranging from three to eleven years.
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
purchase price allocated to in-process research and development was charged to
the Company's operations, resulting in a charge of $1,038,710. The remainder of
the purchase price was allocated to an intangible asset and is being amortized
over eight years.
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 an intangible asset and is being amortized
over ten years.
3. INVESTMENTS AVAILABLE FOR SALE
The Company has classified its investments as available-for-sale in
accordance with SFAS No. 115. As of March 31, 1999, the Company's
available-for-sale investments had a cost of $11,835,803 and an estimated fair
value of $12,062,028, based on quoted market prices. The unrealized gains on
these investments of $226,225, net of income taxes of $92,752, are reported as a
separate component of stockholders' equity.
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 estimated costs to completion and costs to be incurred in
selling and distribution.
9
<PAGE> 10
SRS LABS, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
5. NET LOSS PER COMMON SHARE
The Company computes earnings per share (EPS) in accordance with Statement
of Financial Accounting Standards No. 128, "Earnings per Share" (FAS 128). FAS
128 requires the Company to disclose basic and diluted earnings per share.
6. 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.
7. STOCKHOLDERS' EQUITY
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. As of March 31, 1999, 12,000 shares had been repurchased at a cost of
$52,500. Such repurchased shares are reflected as treasury stock in the
accompanying consolidated balance sheets.
8. SEGMENT INFORMATION
The Company operates in two business segments: (i) 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
original equipment manufacturers and semiconductor manufacturers and (ii) the
sale of consumer electronic products and components. The Company does not
allocate operating expenses or specific assets to these segments. Therefore,
segment information includes only net revenues, cost of sales and gross margin.
Prior to the acquisition of Valence, the Company operated in the single business
segment of licensing audio technologies.
<TABLE>
<CAPTION>
Three Months Ended March 31, 1999
---------------------------------------------------------
Chips and Product and
Licensing Component Sales Total
------------- --------------- -------------
<S> <C> <C> <C>
Net revenues $ 4,104,067 $ 3,612,774 $ 7,716,841
Cost of sales 1,737,578 3,538,064 5,275,642
------------- ------------- -------------
Gross margin $ 2,366,489 $ 74,710 $ 2,441,199
============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended March 31, 1998
---------------------------------------------------------
Chips and Product and
Licensing Component Sales Total
------------- --------------- -------------
<S> <C> <C> <C>
Net revenues $ 2,881,961 $ 4,175,435 $ 7,057,396
Cost of sales 671,932 3,726,484 4,398,416
------------- ------------- -------------
Gross margin $ 2,210,029 $ 448,951 $ 2,658,980
============= ============= =============
</TABLE>
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
SRS Labs, Inc. is a developer and provider of technology solutions for the
consumer electronics, computer, game and telecommunications markets. The
Company's principal business activities in these markets include:
- Developing and licensing audio and voice technologies to original
equipment manufacturers ("OEMs") and semiconductor manufacturers around
the world; and
- Through its subsidiary, Valence Technology Inc. and its foreign
subsidiaries, designing and selling technology solutions through custom
application specific integrated circuits ("ASICs") to OEMs; and
designing, distributing and manufacturing components, sub-assemblies
and electronics products for the OEM and retail communities within
the Company's targeted markets.
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 Technology, Inc., a British Virgin Islands holding company with
its principal business operations in Hong Kong and China ("Valence") 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 for the fiscal year ended
December 31, 1998 ("Fiscal 1998") and will continue to have a material impact
for the reporting periods thereafter; 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 Voice Intelligibility Processor ("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, which is 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.
SRS currently operates in two business segments: (a) the development and
marketing of technology in the forms of integrated circuits designed and
distributed through Valence and the licensing of technologies developed by the
Company to OEMs and semiconductor manufacturers and (b) the sale of consumer
electronic products and components. A summary of the Company's operations and
activities by business segment is included in the notes to the interim
consolidated financial statements.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31, 1998
Impact of Valence acquisition
The Company's consolidated financial results for the three month period
ended March 31, 1998 include the results of the Valence operations beginning as
of February 1, 1998. Accordingly, results for the three months ended March 31,
1999 may not be directly comparable to the results for the three months ended
March 31, 1998.
11
<PAGE> 12
Revenues
Chip and licensing revenue consists of design fees and sales of custom
application specific integrated circuits (ASICs) by Valence to OEM manufacturers
and sales of general purpose integrated circuits ("IC"s) designed by the Company
under the brand name ASP Microelectronics. Licensing revenues are royalties
generated primarily from the license of the Company's audio 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
primarily represent the distribution of semiconductor products, manufacturing
components and sub-assemblies to OEMs for the Hong Kong and China markets.
Total revenues for the three months ended March 31, 1999 were $7,716,841
compared to $7,057,396 for the three months ended March 31, 1998. Excluding chip
design revenue, licensing revenue decreased 50.3% 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 Asian financial crisis 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. The licensing revenue decrease was offset by an
increase of 134.8% in the custom ASIC chip design and chip sales related to
Valence's activities. Revenue from product and component sales decreased to
$3,612,774 for the quarter ended March 31, 1999 from $4,175,435 for the same
prior year quarter primarily due to the Company's decision to focus on higher
margin revenue and deemphasize certain lower margin distribution activities. The
Company expects that the revenue mix in future quarters will continue to be
weighted more towards chip and electronic component sales and less to licensing.
Gross Margin
Cost of sales consists primarily of fabrication costs, assembly and test
costs, and the cost of materials and overhead from operations. Gross margin for
the three months ended March 31, 1999 decreased to 31.6% from 37.7% for the same
period in 1998. The decrease resulted from the shift in the Company's revenue
base towards ASIC and general purpose IC chip sales, which have significantly
lower margins than the Company's historic licensing revenue base. The Company
expects that, consistent with trends in the revenue mix, gross margins in future
quarters will continue to be impacted by the cost of procuring and manufacturing
products for sale as opposed to licensing transactions which typically have
higher gross margins.
Sales and Marketing
Sales and marketing expenses consist primarily of employee salaries and
sales consultants' fees and related expenses, sales commissions and product
promotion. Sales and marketing expenses were $1,571,999 for the three months
ended March 31, 1999 compared to $1,188,894 for the same prior year period, an
increase of 32.2%. The increase was primarily due to additional sales and
marketing headcount needed to promote the Company's new technologies, increased
promotional activities related to product sales in the PRC and increased selling
expenses related to higher chip sales. As a percentage of total revenues, sales
and marketing expenses increased to 20.4% for the quarter ended March 31, 1999
from 16.8% for the same prior year quarter.
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 $640,018 for the three months ended March 31, 1999 compared to $399,079 for
the same prior year period, an increase of 60.4%. The increase is primarily
attributable to headcount added to support the increased ASIC design activity,
to develop, enhance and implement new audio and voice technologies and to
develop software and Internet applications for the Company's technologies. As a
percentage of total revenues, research and development expenses increased to
8.3% for the quarter ended March 31, 1999 from 5.7% for the same prior year
quarter. Management believes research and development expenses will increase in
the future as a result of the Company's product development efforts.
12
<PAGE> 13
General and Administrative
General and administrative expenses consist primarily of employee-related
expenses, legal costs associated with the administration of intellectual
property and other professional fees. General and administrative expenses were
$2,139,545 for the three months ended March 31, 1999 compared to $1,252,823 for
the same prior year period, an increase of 70.8%. The increase was primarily
attributable to increased corporate headcount added to manage the acquired
operations and to support new business development, costs incurred for due
diligence activities related to potential acquisitions that did not occur and
higher costs associated with year end reporting activities required of a public
company due to the expanded scope of the Company's operations. As a percentage
of total revenues, general and administrative expenses increased to 27.7% for
the quarter ended March 31, 1999 from 17.8% for the same prior year quarter.
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 $332,796 and $200,998 for the quarters ended March 31, 1999 and March 31,
1998, respectively, included in general and administrative expenses. See Note 2
of the notes to the interim 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 three months
ended March 31, 1998 includes the one-time charge of $18,510,378 for the
write-off of acquired in-process research and development expenses associated
with the Valence acquisition and the acquisition of certain assets associated
with the VIP technology. The in-process research and development 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 in-process research and development
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, (a) ASICs for consumer electronics,
computing and voice and audio applications, (b) home entertainment systems, (c)
digital multimedia players and (d) 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, 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 in-process research and development projects will be pursued
or successfully completed and commercially introduced.
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<PAGE> 14
Other Income, Net
Net other income consists primarily of interest income, interest expense,
realized gains and losses on the sale of investments and foreign currency
transaction gains and losses. Net other income was $103,347 for the three
months ended March 31, 1999 compared to $197,492 for the same prior year period,
a decrease of 47.7%. The decrease is primarily attributable to lower average
cash and investment balances during the current year quarter as compared to the
prior year quarter due to the cash 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 the first quarter of Fiscal 1998.
Provision for Income Taxes
The income tax benefit for the three months ended March 31, 1999 was
$309,906 compared to $283,768 for the same prior year period. Related to
domestic operations, the Company recognized tax benefits in connection with
federal refundable taxes which could be recovered through a net operating loss
carryback. In addition, the Company recorded a tax provision at statutory tax
rates in the Asian countries where Valence has its principal business operations
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal source of liquidity at March 31, 1999 consisted of
cash, cash equivalents and investments aggregating $23.2 million, as well as
borrowings available under its credit facility. At December 31, 1998, the
Company had cash, cash equivalents and long term investments of approximately
$24.4 million.
The Company has primarily financed its operations through the cash provided
by its operations and proceeds from its initial public offering of Common Stock
in August 1996. The Company's operating activities utilized $1,129,653 in cash
for the three months ended March 31, 1999 and provided $2,104,669 for the three
months ended March 31, 1998. The use of cash in operations for the quarter ended
March 31, 1999 was primarily due to the Company's loss from operations. In
addition, cash increased due to a reduction in accounts receivable of $2.3
million which was primarily due to the collection of certain large balances due
from SRS and Valence customers that were outstanding at December 31, 1998. This
increase was partially offset by a decrease in cash due to a net decrease in
accounts payable and accrued liabilities of $1.3 million due to payments made
to certain major component suppliers. In addition, cash was used to increase
inventory by approximately $988,000 in anticipation of customer demand.
As described above, the Company acquired Valence and additional
technologies during the first quarter of Fiscal 1998. (See Note 2 to the interim
consolidated financial statements.)
On March 4, 1998, the Company obtained a revolving line of credit with a
bank which expires on June 1, 2000 and is secured by certain of the Company's
cash, cash equivalents and investments. As of March 31, 1999, approximately
$817,000 in cash and cash equivalents and $11.1 million in investments were
pledged as collateral for the line of credit. 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 or LIBOR plus 0.75%. The Company had $8.0 million outstanding under the
line of credit as of March 31, 1999. As a result of the acquisition of Valence,
the Company provided Valence $8.0 million to pay off its short-term debt and
other obligations. These funds were provided by borrowings on the
above-referenced line of credit.
The Company anticipates that its primary uses of working capital in future
periods will be to acquire new technologies, to provide Valence with additional
working capital and to fund increased costs for additional sales and engineering
headcount and marketing activities associated with the introduction of new
technologies and products into the market.
Based on current plans and business conditions, the Company believes that
its cash, cash equivalents, investments and/or available borrowings under its
line of credit, together with any amounts generated from
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<PAGE> 15
operations, will be sufficient to meet the Company's operating and capital
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.
YEAR 2000 READINESS DISCLOSURE
The Company is currently in the process of addressing a problem that is
facing all users of automated information systems. The "Year 2000 issue" arises
out of the fact that many of the world's computer systems currently record years
in a two-digit format. Such computer systems will be unable to properly
interpret dates beyond the year 1999, which could lead to business disruptions
in the U.S. and internationally.
The Company and its subsidiaries have identified the following areas which
could be impacted by the Year 2000 issue: Company products; internally used
systems and software; products or services provided by key third parties; and
the ability of chip partners, licensees or customers to process business
transactions relating to chip design and licensing revenue and product and
component sales.
During Fiscal 1998, the Company and its subsidiaries reviewed its internal
systems including those which support manufacturing process control and
financial and general business operations. The review consisted of an evaluation
of significant internal hardware systems and major software application programs
for their ability to accurately recognize and process dates properly in the Year
2000 and beyond. As a result of this evaluation, the Company identified certain
systems which require upgrades to be Year 2000 ready, including certain business
software applications. The Company is in the process of installing a new
computer system in its overseas operation and has been assured by the software
and hardware providers that these systems will be fully compliant with the Year
2000. The Company's products do not have any material Year 2000 problems.
In addition, the Company and its subsidiaries are in the process of
assessing the compliance of their major customers, suppliers and vendors.
Management believes that third-party relationships upon which the Company relies
represent the greatest risk with respect to the Year 2000 issue, because the
Company cannot guarantee that third parties will be able to adequately assess
and address their Year 2000 compliance issues in a timely manner. As a
consequence, the Company can give no assurances that issues related to Year 2000
would not have a material adverse effect on future results of operations or
financial condition.
Total costs relating to the Company's compliance efforts, based on
management's best estimates, are estimated to be as high as $350,000.
Should the Company not be completely successful in mitigating internal and
external Year 2000 risks, the likely worst case scenario could be a system
failure causing disruptions of operations, including, among other things, a
temporary inability to process transactions, manufacture products, send invoices
or engage in similar normal business activities at the Company or its vendors
and suppliers. The Company currently does not have a contingency plan with
respect to potential Year 2000 failures of its suppliers or customers and, at
the present time, does not intend to develop one. If these failures would occur,
depending upon their duration and severity, they could have a material adverse
effect on the Company's business, results of operations and financial condition.
The information set forth above under this caption "Year 2000 Readiness
Disclosure" relates to the Company's efforts to address the Year 2000 concerns
regarding the Company's (a) operations, (b) products and technologies licensed
or sold to third parties and (c) major suppliers and customers. Such statements
are intended as Year 2000 Statements and Year 2000 Readiness Disclosures and are
subject to the Year 2000 Information Readiness Act."
FORWARD-LOOKING INFORMATION AND CERTAIN FACTORS
Included in this Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations are certain forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995,
reflecting management's current expectations. Examples of such forward-looking
statements include the expectations of the Company with respect to its strategy
and the shift in revenue mix which is expected to be weighted more toward chip
and electronic component sales and less to licensing. Although the Company
believes
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<PAGE> 16
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. Such factors
include, among others, those set forth below. 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.
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 original equipment
manufacturers ("OEMs"), and fluctuations in general economic conditions,
particularly those affecting the consumer electronics market. In addition, due
to the Company's dependence on the consumer electronics market, the substantial
seasonality of sales in the market has impacted the Company's revenues and net
income. In particular, the Company believes 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, 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.
Changes to the Business Model/Integration of Valence/Refinement of Asian
Strategy
From the Company's inception in 1993 through 1997, the Company derived
substantially all of its revenues from licensing activities. As a result of the
acquisition of Valence, the Company has added business operations engaged in the
design and sale of ASICs and other semiconductor products; the design,
manufacture and sale of consumer electronics components and products; and the
distribution of components and products within mainland China and throughout
Asia. These operations differ substantially from the Company's previous business
model, and future operating results 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 new industry standards, product obsolescence and
changes in pricing policies by the Company, its competitors or its suppliers.
The integration of certain operations following the Valence acquisition has
required, and will continue to require, the dedication of management and other
personnel resources which may temporarily distract them from the day-to-day
business of the combined company. The geographic separation of these operations
is likely to place additional strain on the Company's resources. In addition,
the Company's significant operations in China and Asia have required refinement
to adapt to the changing market conditions in that region. This refinement may
impact certain of the Company's current business directions, including Valence,
as the Company attempts to position itself to maximize penetration of selected
growth segments in that region. The Company's operations in Asia, and
internationally in general, also are subject to risks of unexpected changes in,
or impositions of, legislative or regulatory requirements.
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.
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<PAGE> 17
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. With its
acquisition of Valence and 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 recently 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; and 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.
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. 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 Company has experienced rapid growth and expansion with the acquisition
of Valence. This acquisition 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
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<PAGE> 18
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 retain
and recruit 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, 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 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
businesses; 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.
ITEM 3. 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 China, 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 nil in Fiscal 1998
and in the three month period ended March 31, 1999 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 constant throughout the period. 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 March 31, 1999 was 5.72%. The Company believes that if interest rates were to
increase by as much as 10%, the impact on the Company's consolidated financial
statements would not be material.
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PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
SECURITIES SOLD
On December 31, 1998, the Company and Samsung Electronics Co., Ltd.
("Samsung") entered into a License Agreement (the "License Agreement") relating
to the Company's Voice Intelligibility Processor (VIP(TM)) technology. In
connection with the License Agreement and as consideration for the marketing
efforts to be provided by Samsung, the Company on March 5, 1999 granted to
Samsung an option (the "Option") to purchase an aggregate of 50,000 shares (the
"Shares") of common stock, par value $.001 per share, of the Company ("Common
Stock"), at a purchase price of $3.94 per Share. The Option vests pro rata in
three annual installments commencing on the first anniversary of the date of
grant. In addition, under the License Agreement, the Company has agreed to grant
to Samsung additional options to purchase up to an aggregate of 200,000 shares
of Common Stock if certain goals are met by Samsung. Each such additional option
shall be granted in 50,000 share increments and shall vest in the same manner as
the option described above. The date of grant for each such option shall be the
date during the two week period commencing on the date specified in the License
Agreement that the closing price of a share of Common Stock is the lowest. Such
last sale price on such date shall then become the exercise price for that
option. The shares of Common Stock to be issued to Samsung upon exercise of all
such options shall be issued in reliance on the private offering exemption set
forth in Section 4(2) of the Securities Act of 1933, as amended, on the basis
that they were issued under circumstances not involving a public offering.
USE OF PROCEEDS
The effective date of the Company's initial public offering of its Common
Stock was August 8, 1996 (SEC Registration No. 333-4974-LA). There has been no
change in the Company's use of its aggregate net offering proceeds of
$22,052,955 since the disclosure set forth in the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended June 30, 1998. As noted in such prior
Quarterly Report, the Company utilized an aggregate of $8,394,222 in connection
with three acquisitions (see Note 2 to the interim consolidated financial
statements herein) with the remaining funds being temporarily invested in cash
and municipal bonds pending application.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits. The exhibits listed below are hereby filed with the U.S.
Securities and Exchange Commission (the "Commission") as part of this Report.
Exhibit
No. Description
------- -----------
10.1 Severance Agreement, dated February 23, 1999, by and
between the Company and Thomas R. Parkinson.
27 Financial Data Schedule.
(b) Reports on Form 8-K
No reports on Form 8-K were filed with the Commission during the three
month period ended March 31, 1999.
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<PAGE> 20
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 14, 1999 By: /s/ JOHN AUYEUNG
-------------------------------
John AuYueng
Executive Vice President,
Chief Operating Officer,
Secretary, Acting Chief
Financial Officer and
Acting Treasurer (Principal
Financial and Accounting
Officer)
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<PAGE> 21
EXHIBIT INDEX
Exhibit
No. Description
- ------- -----------
10.1 Severance Agreement, dated February 23, 1999, by and between the
Company and Thomas R. Parkinson.
27 Financial Data Schedule.
<PAGE> 1
SEVERANCE AGREEMENT
Thomas R. Parkinson ("Parkinson") and SRS Labs, Inc. ("SRS Labs"), hereby
agree to terminate their employment relationship on the following basis:
1. Parkinson has resigned his employment as President and Chief Operating
Officer of SRS Labs voluntarily effective February 5, 1999. His personnel
records will be marked accordingly. Should any employer or prospective employer
inquire of the Chief Executive Officer of SRS Labs or his designated
representative regarding Parkinson's reason for leaving the employment of SRS
Labs, then "voluntary resignation" will be given as the reason.
2. Parkinson represents to SRS Labs that he is signing this Agreement
voluntarily and with a full understanding of its terms, for the purpose of being
allowed to resign his employment with SRS Labs and receiving severance benefits
as described in this Agreement. Based on that representation and in addition to
regular pay through February 15th, 1999, and pay for accrued vacation, Parkinson
will be provided the following benefits:
(a) Expenses in the amount of $7,000 to cover (i) January 1999 living
expenses, (ii) lease-cancelling expenses, and (iii) moving expenses. SRS
Labs will also reimburse Parkinson for any outstanding business expenses
submitted to and approved by SRS Labs;
(b) Notwithstanding his voluntary resignation, Parkinson will be paid
three months' severance benefits, in the gross amount of $75,000, less
required legal deductions, as severance pay. Such severance amounts will
sent by mail to Parkinson in three equal monthly installments of $25,000,
less required legal deductions, commencing on March 1, 1999, and continuing
on the first day of each month thereafter through May 1, 1999, unless
Parkinson revokes this Agreement as described in Paragraph 8 below;
(c) Medical coverage through May 15th, 1999; and
(d) SRS Labs will vest 52,500 SRS Labs stock options, previously
issued to Parkinson on July 7, 1998, immediately upon action by the Board
of Directors of SRS Labs, in addition to the already-vested option to
purchase 8,750 shares granted to Parkinson on December 23, 1998. All such
options shall expire if not exercised on or before December 31st, 1999.
In addition, Parkinson agrees that he has been paid all other sums owed to
him at the time of his termination, which sums include all salary, all bonuses,
all personal days, and all accrued, unused vacation pay. By signing this
Agreement, Parkinson acknowledges receipt of all sums owed to him at
termination. Parkinson further agrees that he will be entitled to no other
payments from SRS Labs and/or any parent, related, or subsidiary companies,
and/or the officers, directors, or employees of any of them, other than those
set forth in this Paragraph.
<PAGE> 2
3. In exchange for such severance pay and grant of stock options, Parkinson
agrees to, and by signing this document does, acknowledge that he resigned his
employment with SRS Labs voluntarily effective February 5, 1999. In addition,
Parkinson agrees to, and hereby does, waive and release all claims (known or
unknown), including but not limited to claims under the California Fair
Employment and Housing Act, the Civil Rights of 1964, the Age Discrimination in
Employment Act, and/or the Americans with Disabilities Act, which he has or
might have had against SRS Labs and any parent, related, or subsidiary
companies, and the officers, directors, employees, former employees,
representatives, and agents of any of them (collectively, the "Releasees"),
regarding any aspect of his employment with SRS Labs or the termination of that
employment. Furthermore, Parkinson hereby represents that he will not hereafter
file any claims, charges or complaints against the Releasees, or any of them,
regarding any aspect of his employment with SRS Labs or the termination of that
employment with any state or federal administrative agency or court.
4. Parkinson waives all rights and benefits afforded by Section 1542 of the
Civil Code of the State of California, and does so understanding the
significance of that waiver. Section 1542 provides:
"A general release does not extend to claims which the creditor does not
know or suspect to exist in his favor at the time of executing the release,
which if known by him must have materially affected his settlement with the
debtor."
In order to achieve a full and complete release of the Releasees, Parkinson
acknowledges that this Agreement is intended to include in its effect all claims
that Parkinson does not know or suspect to exist in his favor at the time that
he signs this Agreement.
5. Parkinson represents and agrees that he has kept and will keep the fact,
amount and terms of this Agreement completely confidential, and that he will not
hereafter disclose any information concerning this Agreement to any person,
including but not limited to any past or present employee of SRS Labs or any
parent, related, or subsidiary companies, other than members of his immediate
family. Before Parkinson tells his immediate family anything about this
Agreement, he will inform them of this confidentiality clause and have them
agree to follow it.
6. Parkinson represents and agrees that he will not criticize, denigrate,
or otherwise disparage or cause disparagement to SRS Labs or any other Releasee.
Parkinson further represents and agrees that he will not engage in any conduct
or take any action to encourage any person or entity to initiate litigation or
assert any other kind of claim against SRS Labs or any other Releasee.
7. Parkinson represents and agrees that any disclosure of information or
other action contrary to the terms of Paragraphs 5 and/or 6 by him would cause
SRS Labs and/or other Releasees injury and damage, the actual amount of which
would be impractical or extremely difficult to determine. Accordingly, Parkinson
agrees that SRS Labs shall be entitled to recover from him liquidated damages in
the amount of Five
-2-
<PAGE> 3
Thousand Dollars ($5,000) for each instance in which Parkinson discloses any
information or takes any other action in violation of the terms of Paragraphs 5
and/or 6.
8. Parkinson is hereby advised (a) to consult with an attorney prior to
signing this Agreement and (b) that he has 21 days in which to consider and
accept this Agreement by signing and returning this Agreement to SRS Labs c/o
Tom Yuen. In addition, Parkinson has a period of seven (7) days following his
execution of this Agreement in which he may revoke this Agreement. If Parkinson
does not advise SRS Labs (by a writing received by Tom Yuen within such seven
(7) day period) of his intent to revoke the Agreement, the Agreement will become
effective and enforceable. If Parkinson revokes the Agreement, then no amounts
will be paid or options granted to him under Paragraph 2 above, or otherwise.
9. Parkinson understands and agrees that, in the course of his employment
with SRS Labs, Parkinson has acquired privileged and/or confidential,
proprietary information and trade secrets concerning the operations, future
plans, and methods of doing business of SRS Labs (Trade Secrets), which
information Parkinson understands and agrees would be extremely damaging to SRS
Labs if disclosed to a competitor or made available to any other person or
corporation. Parkinson understands and agrees that such Trade Secrets have been
divulged to Parkinson in confidence and Parkinson understands and agrees that
Parkinson will keep such Trade Secrets secret and confidential, and will not,
directly or indirectly, use or disclose for his own benefit or the benefit of
another, any of such Trade Secrets.
10. Parkinson further agrees that he will not, for a period of eighteen
(18) months from the date he signs this Agreement, solicit or participate in or
assist in any way in the solicitation of any other employees of SRS Labs, or of
any of its parent, related, or subsidiary companies, for the purpose of inducing
them to sever their employment relationship with SRS Labs or any of its parent,
related, or subsidiary companies.
11. In view of the nature of Parkinson's employment and the information and
Trade Secrets which Parkinson has received during the course of his employment,
Parkinson likewise agrees that SRS Labs would be irreparably harmed by any
violation or threatened violation of Paragraphs 10 and/or 11, and that,
therefore, SRS Labs shall be entitled to damages and an injunction prohibiting
Parkinson from any violation or threatened violation of those Paragraphs. The
undertakings set forth in Paragraphs 10 and/or 11 shall survive the termination
of other arrangements contained in this Agreement.
12. This Agreement contains all of the terms, promises, representations and
understandings made between the parties. Parkinson agrees that no promises,
representations or inducements have been made to him which caused him to sign
this Agreement other than those which are expressly set forth above.
13. This Agreement is the sole and entire agreement between the parties,
and supersedes all prior agreements and understandings, oral or written, express
or implied, between the parties. It is expressly understood and agreed that this
Agreement constitutes a novation and accord and satisfaction of the letters of
May 15, 1998, and June 4, 1998, from Tom Yuen to Parkinson, that any contract
created by such
-3-
<PAGE> 4
letters is hereby extinguished, and that he will not claim monies and/or stock
options, and no monies or stock options will be paid or granted to him, under
those letters.
14. Any dispute regarding any aspect of the formation, interpretation or
application this Agreement or any act which allegedly has or would violate this
Agreement will be submitted to arbitration in Orange County, California, before
a retired judicial officer employed by, and such arbitration shall be conducted
in accordance with, the rules of the Judicial Arbitration and Mediation Service
("JAMS/ENDISPUTE"). Such arbitration shall be the exclusive remedy for any such
claim or dispute. The party losing the arbitration shall reimburse the party who
prevailed for all expenses of the prevailing party, including but not limited to
attorneys' fees and costs as determined by the arbitrator, in such arbitration.
Should Parkinson or SRS Labs hereinafter institute any legal action or
administrative proceeding against the other with respect to any claim waived by
this Agreement or pursue any dispute or matter covered by this Paragraph by any
method other than said arbitration, the responding party shall be entitled to
recover from the other party all damages, costs, expenses and attorneys' fees
incurred as a result of such action or proceeding.
SRS LABS, INC.
By: /s/ THOMAS C.K. YUEN /s/ THOMAS R. PARKINSON
------------------------- -------------------------
Thomas C.K. Yuen Tom Parkinson
Title: Chief Executive Officer
Dated: 2/23/99 Dated: 2/20/99
-4-
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM BALANCE
SHEET AND STATEMENT OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
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<SECURITIES> 12,062,028
<RECEIVABLES> 2,715,337
<ALLOWANCES> 0
<INVENTORY> 5,621,161
<CURRENT-ASSETS> 26,188,215
<PP&E> 911,304
<DEPRECIATION> 0
<TOTAL-ASSETS> 42,708,497
<CURRENT-LIABILITIES> 18,034,578
<BONDS> 0
0
0
<COMMON> 11,698
<OTHER-SE> 24,630,981
<TOTAL-LIABILITY-AND-EQUITY> 42,708,497
<SALES> 3,612,774
<TOTAL-REVENUES> 7,716,841
<CGS> 5,275,642
<TOTAL-COSTS> 4,351,562
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 129,798
<INTEREST-EXPENSE> (103,347)
<INCOME-PRETAX> (1,807,016)
<INCOME-TAX> (309,906)
<INCOME-CONTINUING> (1,497,110)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,497,110)
<EPS-PRIMARY> (0.13)
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