<PAGE> 1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
------------------------
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 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)
------------------------
<TABLE>
<S> <C>
DELAWARE 33-0714264
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
2909 DAIMLER STREET, SANTA ANA, CALIFORNIA 92705
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(949) 442-1070
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.001 PER SHARE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the registrant's voting Common Stock held by
non-affiliates of the registrant was approximately $183,303,194 (computed using
the closing price of $26.625 per share of Common Stock on March 17, 2000, as
reported by The Nasdaq Stock Market, Inc.).
There were 12,181,220 shares of the registrant's Common Stock, par value
$.001 per share, outstanding on March 17, 2000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement prepared in connection with
the Annual Meeting of Stockholders to be held in 2000 are incorporated by
reference in Part III of this Form 10-K.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
SRS LABS, INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 13
Item 3. Legal Proceedings........................................... 14
Item 4. Submission of Matters to a Vote of Security Holders......... 14
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 15
Item 6. Selected Consolidated Financial Data........................ 17
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 18
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 29
Item 8. Financial Statements and Supplementary Data................. 31
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................. 54
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 54
Item 11. Executive Compensation...................................... 54
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 54
Item 13. Certain Relationships and Related Transactions.............. 54
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K....................................................... 55
Signatures............................................................ 60
</TABLE>
This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended,
and Section 27A of the Securities Act of 1933, as amended, reflecting
management's current expectations. Examples of such forward-looking statements
include the expectations of the Company with respect to its strategy. Although
the Company believes that its expectations are based upon reasonable
assumptions, there can be no assurances that the Company's financial goals will
be realized. Such forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of the Company, or industry results, to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements. Numerous factors may affect the Company's
actual results and may cause results to differ materially from those expressed
in forward-looking statements made by or on behalf of the Company. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words, "believes," "anticipates," "plans," "expects" and similar
expressions are intended to identify forward-looking statements. The important
factors discussed under the caption "Factors That May Affect Future Results" in
Item 7. Management's Discussions and Analysis of Financial Condition and Results
of Operations, herein, among others, 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.
2
<PAGE> 3
PART I
ITEM 1. BUSINESS
OVERVIEW
SRS Labs, Inc. (the "Company" or "SRS Labs") was incorporated in the State
of California on June 23, 1993 and reincorporated in the State of Delaware on
June 28, 1996. The Company's executive offices are located at 2909 Daimler
Street, Santa Ana, California 92705. Its telephone number is (949) 442-1070, and
its address on the World Wide Web is http://www.srslabs.com.
SRS Labs, Inc. is a developer and provider of technology solutions for the
consumer electronics, computer, game and telecommunications markets. For the
fiscal year ended December 31, 1999 ("Fiscal 1999"), the Company's principal
business activities in these markets included:
- Developing and licensing audio and voice technologies to original
equipment manufacturers ("OEMs") and semiconductor manufacturers around
the world; and
- Through its subsidiary, Valence Technology Inc. and its foreign
subsidiaries (collectively, "Valence"), designing and selling technology
solutions through custom application specific integrated circuits
("ASICs") to OEMs; and designing, distributing and manufacturing
components, sub-assemblies and finished goods for the OEM and retail
communities within the Company's targeted markets.
The Company was formed in 1993 by purchasing all rights and assets of
various audio and speaker technologies from the Hughes Aircraft Company. The
Company successfully completed its initial public offering in August 1996,
raising approximately $22 million. From the Company's inception in 1993 until
February 1998, the Company derived substantially all of its revenues from audio
technology licensing activities for the consumer electronics, computer and game
markets. The primary technologies that contributed to revenue were SRS(R) (Sound
Retrieval System(R)) ("SRS"), which produces a 3D sound-enhanced stereo image
from any mono or stereo source, and TruSurround(TM), a "virtual" audio
technology which processes multi-channel surround sound through any standard
pair of stereo speakers.
On March 2, 1998, the Company acquired 100% of the outstanding stock of
Valence Technology Inc., a British Virgin Islands holding company with its
principal business operations in Hong Kong and China. This acquisition
significantly expanded the Company's business activities from the original
licensing model to include the design, manufacture and marketing of chips,
components and products. Valence and its subsidiaries operate offices that are
located in Hong Kong and China.
In addition to the acquisition of Valence, during the fiscal year ended
December 31, 1998 ("Fiscal 1998"), the Company acquired two additional
technologies. In the first quarter of Fiscal 1998, the Company acquired certain
rights to Voice Intelligibility Processor ("VIP"), a patented voice processing
technology that improves the intelligibility of the spoken voice, especially in
high ambient noise environments and, in the following quarter, acquired certain
rights to Circle Surround, a patented audio delivery system that allows
multi-channel surround sound to be encoded into a two-channel stereo format and
allows an encoded two-channel audio source to be decoded into a multi-channel
surround format.
KEY BUSINESS DEVELOPMENTS IN FISCAL 1999
In Fiscal 1999, the Company re-engineered its business model and
operational structure. Valence, while continuing to expand its ASICs business,
exited certain of the lower margin distribution product lines and directed more
of its resources to develop and market solutions that integrate the SRS
technologies. In addition, the Company began to explore the feasibility of
selling a minority interest in Valence Technology Inc. to the public by listing
such shares on a foreign exchange. This strategy materialized when ValenceTech
Limited, the ultimate successor corporation to Valence Technology Inc., filed an
application to list on the Growth Enterprise Market of the Hong Kong Stock
Exchange on March 3, 2000. The Company anticipates retaining 75% ownership of
Valence Tech Limited upon completion of an initial public offering in Asia
targeted for the second quarter of the fiscal year ended December 31, 2000.
3
<PAGE> 4
With respect to the licensing business, the Company changed its focus from
entering into technology licenses with PC chip manufacturers to developing a new
business model which focuses on Internet audio. This new focus resulted in the
Company launching the WOWThing product family and establishing a new Delaware
wholly-owned subsidiary, SRSWOWcast.com, Inc., to be the platform to launch this
business. In March 2000, Microsoft Corporation ("Microsoft") and the Company
entered into a strategic alliance whereby Microsoft and the Company entered into
a License Agreement relating to the Company's WOW Technology. In addition,
Microsoft made an equity investment into the Company and was granted a warrant
to purchase additional shares of the Company's common stock as well as a warrant
to purchase shares of common stock in SRSWOWcast.com, Inc.
The Company's technologies were also implemented in new consumer products
in Fiscal 1999. Some of the most notable implementations included the Kenwood
receiver (Circle Surround), the Sony Walkman (SRS Headphones), Philips and Sony
DVD players (TruSurround), as well as Hitachi TVs (Focus). In addition to these
new implementations, the Company entered into new licenses with key industry
manufacturers including Loewe, ST Microelectronics and TCE in Europe; Yamaha and
Marantz in Japan; Konka and TCL in China; Samsung and LG in Korea and Cirrus
Logic, Lucent and Peavey in the United States.
DESCRIPTION OF THE COMPANY'S BUSINESS
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 and geographic area is set forth below. The
financial information for business segments and geographic areas is included in
Note 10 to the Notes to Consolidated Financial Statements, included herein under
Item 8 of this Report. Reference also is made to "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Factors That May Affect Future Results" for a discussion relating
to certain business risks relating to the business of the Company and its
subsidiaries.
During the year ended December 31, 1997 ("Fiscal 1997"), licensing revenue
accounted for all of the Company's revenue while in Fiscal 1998 and Fiscal 1999,
chip and licensing revenue accounted for 35% and 52%, respectively, of
consolidated revenue and product and component sales revenues accounted for 65%
and 48% of consolidated revenue, respectively. See Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
herein. For Fiscal 1999, a single customer, STD Manufacturing, accounted for 21%
of the Company's consolidated revenues and approximately 40% of its chip and
licensing revenues.
TECHNOLOGY SOLUTIONS AND LICENSING
Design and Sale of Integrated Circuits
The Company, through Valence, designs and sells custom analog, digital and
mixed signal application specific integrated circuits (ASICs) for OEM
manufacturers worldwide. Applications for these ASICs include consumer audio and
video electronic products, internet appliances and electronic educational toys,
video game players, car audio systems, set-top boxes, VCD and DVD players,
smart-cards, cordless telephone sets, speakers, digital power amphifers, and
pagers. Based in China and Hong Kong, over 20 engineers, with state-of-the-art
equipment and software, support Valence's custom chip design capabilities.
Valence sells these custom designed chips to its contracted customers,
outsourcing the manufacturing to a network of fabrication partners throughout
Asia Pacific, including Chartered Semiconductor, Samsung Electronics Co., LTD
and Tower Semiconductor Limited in Israel. As of December 1999 and 1998, the
backlog orders of ASIC design work to non-affiliated parties was $828,052 and
$721,661, respectively. The Company expects that all or substantially all of the
current backlog orders for Fiscal 1999 will be completed in Fiscal 2000.
Valence's ASIC customers are industry leading consumer electronics,
telecommunications, game and personal computer manufacturers in North America
and Europe, as well as in Asia Pacific. Due to nondisclosure agreements,
specific current customers cannot be disclosed, but previous design projects
have
4
<PAGE> 5
been performed for such international companies as Creative Technology Limited,
Innovision Research and Technology Limited, National Semiconductor Corporation,
Raytron Inc., Toshiba Corporation, System LSI Division and Utron Technology Inc.
Under many of the design contracts, Valence negotiates to retain ownership of
the specific designs. These designs form a significant library of intellectual
property that can be used in future projects.
In addition to performing contract design work, Valence designs, produces
and sells ICs to OEMs of consumer electronics, games, telecommunication and
personal computer equipment in Asia Pacific under the brand name ASP
Microelectronics. The general purpose integrated circuits offered include
micro-controllers, PROM and ROMs for DVD Players, set-top box receivers and
audio/video equipment; ICs for telecommunication and game equipment; small
signal transistors and ICs used mainly in the manufacture of consumer products
such as television sets, radios, telephones, computer mother boards, add-on
boards and audio hi-fi systems. The products created are based upon management's
analysis of trends in the market, knowledge gained from long standing
relationships with customers and overall business experience. Many of these
products are developed by capitalizing upon the Valence's custom design
libraries.
Technologies and Licensing
The Company's technology portfolio covers a wide range of audio, voice and
speaker technologies. The Company licenses these technologies to product and
semiconductor manufacturers, as well as develops and markets implementation
options and finished goods that feature these proprietary and patented
technologies.
The Company's technology strategy continues to be the development,
acquisition and license of audio and voice technologies to product and
semiconductor manufacturers in the consumer electronics, computer, game and
telecommunications markets around the world. By providing a continuous stream of
patented audio and voice technologies, enhancing relationships with existing
licensees and attracting new licensees, the Company believes that it will
strengthen its market position as a world leader in audio and voice technology.
The Company's technologies may be implemented in a variety of methods,
including discrete analog components, chip modules, analog semiconductors,
digital signal processors and software. These various implementation options
offer customers significant flexibility when incorporating the Company's
technologies into products. The markets which the Company's technologies address
include a wide variety of audio and voice-related consumer products such as TVs,
computers, stereo receivers, VCRs, video games, musical instruments, cellular
phones, cordless phones, public address equipment and car audio equipment. The
markets for these consumer electronics products are highly competitive and
generally dominated by large manufacturers. The Company provides technology to
these manufacturers who need to differentiate their products by continually
adding new features and increasing product performance.
License agreements with product manufacturers have terms which typically
range from one to ten years and require per unit royalty payments for all
products implementing the Company's technologies. Certain agreements provide for
a fixed annual or quarterly royalty payment. License agreements also specify the
use of the Company's trademarks and logos and provide for product review and
approval by the Company. The agreements do not have volume requirements and may
be terminated by the licensees or the Company without substantial financial
penalty.
The Company has primarily followed a licensing model whereby licensees are
free to choose a semiconductor solution from a number of choices and, regardless
of the semiconductor selection, the licensee pays a royalty directly to the
Company after the licensee's product has been shipped. However, this methodology
is not well established in the computer multimedia industry or the Chinese
consumer electronics marketplace. To address these market conditions, the
Company has implemented an alternate royalty collection method, whereby the
royalty is "bundled" into the cost of the semiconductor product when it is sold
to the product manufacturer. This methodology simplifies the business process
for the product manufacturer, the semiconductor manufacturer and the Company.
Under this model, the royalty is remitted directly to the Company by the
semiconductor manufacturer after the chip has been delivered to the product
manufacturer.
5
<PAGE> 6
Portfolio of Audio and Voice Technologies
The portfolio of audio, voice and speaker technologies offered by the
Company includes SRS(R), TruSurround(TM), FOCUS(R), Baser(R), ORB(R), AVT(TM),
VIP(TM), Circle Surround(R), SRS Headphone(TM), WOW(TM), TruBass(TM),
WOWVoice(TM) and NuVoice(TM). SRS, FOCUS and TruSurround are currently the
subject of numerous license agreements and are actively marketed by the Company.
Baser and ORB are speaker technologies that were included in the original
technology acquisition from Hughes Aircraft and have not been actively promoted.
VIP and Circle Surround were acquired during the first and second quarters of
Fiscal 1998, respectively, and did not contribute significantly to revenue in
Fiscal 1998 or 1999. SRS Headphone, WOW, AVT and TruBass were developed
internally and were introduced to the marketplace in Fiscal 1998 and also did
not contribute significantly to revenues in Fiscal 1998 or 1999. Licensing
royalties associated with SRS, TruSurround, FOCUS, and technology transfer fees
for new technologies have accounted for virtually all of the Company's licensing
revenues to date.
- SRS 3D SOUND
SRS 3D Sound is one of the world's leading 3D audio enhancement
technologies. The patented technology broadens any mono or stereo audio signal
and creates a realistic 3D sound image from just two standard stereo speakers.
SRS is based on the fundamentals of the human hearing system and recreates the
multitude of spatial cues that are present in a live listening environment but
are lost in recording and playback. SRS eliminates the "sweet spot" associated
with traditional stereo; accordingly, it does not require the listener to be
positioned in a specific location to experience the immersive 3D sound image.
The technology can also be encoded onto CDs, cassettes or videotapes during
the recording process and reproduced through a conventional stereo system,
multimedia computer, radio and television broadcast, or the Internet. SRS was
originally developed by Hughes Aircraft, which spent significant resources to
develop and patent SRS and related audio technologies. Since acquiring the SRS
technology from Hughes Aircraft in June 1993, the Company has improved the
performance of SRS, reduced the cost for OEMs to implement the technology,
secured licensing relationships with various semiconductor manufacturers who
offer the technology in various analog and digital chip options, and introduced
the technology to a wider variety of consumer applications.
To date, products have been shipped with SRS technology from more than 180
manufacturers including Acer Peripherals, Ltd., Daewoo Telecom Ltd., Hitachi
Ltd., IBM, Kawai Musical Instruments Mfg. Co., Ltd., Kenwood Corporation, Young
Chang America, Inc. (Kurzweil), LG Electronics, Inc., Packard Bell/ NEC, Pioneer
Electronic Corporation, Thomson Consumer Electronics, Inc. (RCA), Thompson
Multimedia, SA, Samsung Electronics Co., Ltd., Sharp Electronics Corporation,
Smart Devices, Inc., Sony Corporation and Toshiba Corporation. Semiconductor
manufacturers who offer SRS technology in their chip offerings include Cirrus
Logic (Crystal Semiconductor), Fujitsu Semiconductor Corporation, Mitsubishi
Electric Corporation, New Japan Radio Co. Ltd., Philips Semiconductors,
STMicroelectronics, Toshiba Semiconductor Corporation and Zoran Corporation.
- TRUSURROUND
TruSurround is a Dolby-certified virtual audio technology, which creates an
immersive surround sound experience from just two standard speakers from a
multi-channel audio source, such as Dolby Digital or Dolby Pro Logic. It was
originally designed to take advantage of the 5.1 channel audio standard for DVD,
Dolby Digital, without requiring the use of six speakers. TruSurround processes
the six discrete channels of digital audio into just two channels, retaining all
of the original audio information and giving the listener the perception that
they are surrounded by additional "phantom" speakers.
TruSurround has been successfully introduced to the consumer electronics
marketplace and is featured in a wide variety of products, including televisions
from Sony Corporation, and DVD players from Pioneer Electronic Corporation and
Philips Consumer Electronics B.V. Semiconductor companies who offer TruSurround
in analog or digital implementation options for various applications in consumer
electronics currently include AKM Semiconductor, New Japan Radio Co., Ltd.,
STMicroelectronics, Mitsubishi Electric
6
<PAGE> 7
Corporation and Zoran Corporation. The Company believes that the eventual
worldwide use of the DVD format will offer further opportunities for revenue
growth.
- FOCUS
In many audio environments, speakers are not placed directly in front of a
listener making it difficult to achieve a realistic sound experience from
speakers that are below the plane of the listener's ear. The Company developed
FOCUS as a technology solution for this problem. Originally designed for use in
automobiles where front speakers are often placed under the dashboard or facing
each other in the door panels, the patented FOCUS technology electronically
repositions the sound image to create the appropriate perception of image
height. In addition to automobiles, FOCUS is ideally suited for any product
application where speakers cannot be placed in optimal locations for either
space or aesthetic reasons, such as big screen TVs, home in-wall speakers and
commercial applications such as drive-through restaurant communications. The
first analog and digital chip options of FOCUS became available for sampling to
OEMs from Mitsubishi Electric Corporation, New Japan Radio Co., Ltd. and
STMicroelectronics during the last half of Fiscal 1998. Focus has been
successfully incorporated into consumer electronics products marketed by Hitachi
Limited and Marantz Japan, Inc.
- SPEAKER TECHNOLOGIES
The Company holds patents for speaker technologies originally developed at
Hughes Aircraft. One such technology, ORB, provides a unique approach to the
physical design of speakers by incorporating a baffle that creates a 180 degrees
dispersion of sound. Another speaker technology, referred to as AVT, projects
the listening material so that the human ear can more easily identify the
direction of ambient sounds. A third speaker technology, BASER, is a
high-efficiency design for a subwoofer product.
- VIP -- VOICE INTELLIGIBILITY PROCESSOR TECHNOLOGY
VIP is a patented audio processing technology that improves the
intelligibility of the spoken voice in a variety of challenging listening
situations. VIP selectively processes only those spectral portions of the speech
signal that the brain uses for cognition, without requiring increase in gain or
volume. SRS inventor Arnold Klayman, who is now the principal audio scientist at
the Company, originally developed the VIP technology at Hughes Aircraft. During
a divestiture in 1994, Hughes sold this non-core business division to VIP Labs.
From 1994 until the acquisition by the Company, VIP Labs further developed the
technology as well as selectively marketed a stand-alone signal processor for
use in the professional sound reinforcement industry.
The Company believes that the market opportunities for VIP are significant
and include cellular phones, wireless products, hearing aids, public address and
emergency warning systems, talking toys, voice recognition products, Voice Over
IP (Internet protocol) and other Internet applications. The Company directly
offers both software and hardware implementation options for VIP. VIP software
is available as digital code that may be ported to DSP chips used by
manufacturers of cellular phones, paging systems, digital televisions, sound
reinforcement equipment and hearing aids. VIP is also available as software that
may be executed on computer platforms to improve a variety of voice-related
processes. Hardware options are marketed by the Company as a DSP chip and
subassembly board for sale to OEMs of sound reinforcement equipment.
During the first quarter of Fiscal 1999, the Company announced the first
licensing contracts for VIP. On January 26, 1999, the Company announced that
Samsung Electronics Co., Ltd. ("Samsung") has licensed VIP for use in cellular
and wireless products. On February 2, 1999, the Company announced the license of
VIP by Lucent Technologies. VIP has also been successfully implemented by
Samsung in a semiconductor chip targeted at the cellular and traditional
telephone applications.
- CIRCLE SURROUND
Circle Surround ("CS") is a patented audio delivery system that allows
multi-channel surround sound to be encoded into a two-channel stereo format and
then allows an encoded two-channel audio source or traditional audio source to
be decoded into a multi-channel surround format.
7
<PAGE> 8
Circle Surround can be used in the recording process of music or movies and
then implemented in a decoding playback device, such as a home audio receiver,
DVD player or car audio product. When used as an encoding/decoding technology,
CS encodes five discrete channels of sound through only two channels (the same
space required for stereo). In the playback device, CS then takes the two
channels of encoded material and decodes them back into the original five
recorded channels for playback through a multi-channel (surround sound) home
theater or cinema system equipped with four or five speakers plus a subwoofer.
In addition, CS creates multiple channel surround sound from the wealth of
legacy stereo and surround encoded material available on traditional music CDs,
VHS tapes, television or AM/FM broadcast.
Circle Surround technology is available for product manufacturers worldwide
in the following formats: analog ICs through a relationship with Analog Devices;
DSP implementations from Cirrus Logic and AKM, digital software code from the
Company; and reference boards, sub-systems and finished products for the home
and car audio market from Valence. Current manufacturers who have announced
products with Circle Surround include Haitai Electronics Co., Ltd. (Sherwood),
Theta Digital, Kenwood Corporation, Loewe Optic GmbH and Amiosonic Electronics
Co. Smart Devices, Inc. has included Circle Surround in a line of movie theater
audio processors that are marketed to cinemas around the world. Hundreds of
music CDs have been encoded with CS by audiophile record labels such as Telarc,
DMP and Northsound, which market the CDs through traditional retail channels and
online music sites.
- SRS HEADPHONE, WOW AND TRUBASS
In Fiscal 1998, the Company developed and began marketing three additional
audio technologies to the consumer electronics, computer and game markets.
Introduced in early 1998, SRS Headphone is based on the core SRS 3D sound
technology and provides 3D sound enhancement to a mono, stereo or surround sound
signal, but is optimized to work with any pair of headphones. In January 1999,
Mitsubishi Semiconductor announced the availability of the M62458FP, the first
analog IC implementation of this technology. In November 1998, at COMDEX in Las
Vegas, the computer industry's leading tradeshow, the Company introduced two
additional technologies, WOW(TM) and TruBass(TM). WOW is the Company's next
generation audio enhancement for speakers and headphones. It significantly
improves the spatial imaging and bass response from traditional loudspeakers and
headphone products. The TruBass(TM) technology is a psycho-acoustic process that
creates the perception of dramatically increased bass performance in smaller
speaker systems and headphones without requiring additional physical components.
Product applications for these technologies include multimedia speakers,
powered home audio speakers, mini stereo systems, portable "boom boxes", car
radios, portable headset audio systems, televisions and other products in the
consumer audio, car audio and professional sound markets.
In addition to licensing these technologies, the Company anticipates using
its chip design expertise and network of manufacturing partners to market chip
modules of these technologies to product manufacturers around the world. SRS
Headphone and TruBass have been licensed to and incorporated into products by
manufacturers that include Sony Corporation, Yamaha Corporation and Sennheiser
Electronic GmbH & Co. KG. The Company announced in September 1999 the WOW Thing
family of software and hardware products which have been marketed on the
Internet web site www.wowthing.com. The first product in the family is the WOW
Thing Processor Box, a hardware product which provides a combination of audio
enhancement technologies using the WOW technology. The second product in the
family consists of WOW Thing software plug-ins designed for use with the Winamp
Media Player to improve significantly the sound quality of compressed Internet
music such as MP3 music files.
- WOWVOICE AND NUVOICE
In Fiscal 2000, the Company introduced two new technologies, WOWVoice(TM)
and NuVoice(TM). These technologies are specifically designed for telephone
voice quality and intelligibility enhancement applications. The Company is now
actively marketing these new technologies to potential customers.
8
<PAGE> 9
PRODUCT AND COMPONENT SALES
The Company, through Valence, is an authorized non-exclusive distributor in
Hong Kong and/or China for semiconductor products from Lucent Technologies
Microelectronics Asia/Pacific, National Semiconductor Hong Kong Ltd., Philips
Hong Kong Ltd., Utron Technology Co. Ltd., Analog Devices, Incorporated, as well
as its own ASP-brand. Access to multiple suppliers of similar ICs provides value
to customers by insuring an adequate supply of components and "just in time
delivery" of goods to meet their production schedules.
In the normal course of business, Valence carries in its inventory selected
products that it distributes to meet rapid delivery requirements of customers.
Valence significantly improved the inventory turns towards the end of Fiscal
1999. The Company provides normal and customary merchandise return policy and
generally does not provide payment terms. As of December 1999 and 1998, the
backlog orders of components were $3,180,021 and $2,985,305, respectively. The
Company expects that all or substantially all of the backlog orders for Fiscal
1999 will be filled in Fiscal 2000.
In addition to distributing semiconductor products, Valence and its
subsidiaries incorporate these components in assembly kits and reference boards
for use in audio products, video compact disc ("VCD") players and
telecommunication and wireless infrastructure equipment. Asia Pacific customers
include Acer, Daeyoung, Huawei Technologies Co., Ltd., Idall, Konka and SAST.
Consumer electronic home entertainment products offered under the Valence brand
name that include state-of-the-art technology with unique features are VCD and
karaoke players, audio/video receivers, game products and home entertainment
amplifiers. The Company introduced new products to the China market during
Fiscal 1999 with Circle Surround, TruSurround and TruBass.
The Company's team of software, hardware and application engineers offers
value-added engineering services, such as the design of application software in
FPGAs (field programmable gate arrays), ASICs and system design. Local support
is very valuable to many manufacturers who have limited experience in the design
and manufacturing of products, especially handling surface mount technology
equipment. The Company's qualified engineers can solve its customers'
manufacturing and design problems locally and on a timely basis.
The Company introduced in September 1999 its first e-commerce product on
www.wowthing.com, the WOW Thing Processor Box which enhances the sound quality
of music downloaded over the Internet as well as audio performance of computer
and home entertainment products and speakers. Other audio enhancement products
for computer, home entertainment and game applications are in development for
future introduction into the market place.
SALES AND MARKETING
Integrated Circuits and Licensing
The Company's sales and marketing strategies target the consumer
electronics, computer, game and telecommunications industries. To implement its
strategy, the Company has established a direct sales force and a worldwide
network of independent sales agents and distributors. The Company has
established distributors in Korea, Taiwan, Japan, Singapore, Hong Kong and
China. The Company actively promotes the use of its trademarks and logos and
directs customers to prominently display the appropriate SRS technology logo on
products, packaging and in advertising.
The Company's corporate communications program includes press releases and
sales informational mailings to its customers around the world. The Company also
distributes audio CD/CD ROMs that demonstrate SRS technology and provides
technical assistance and general consumer-related information on the World Wide
Web. The Company conducts tours and presentations for the press and other media
outlets to promote the Company's technologies and products.
The Company regularly participates in tradeshows and conferences to
increase awareness of its technologies and to market its technologies and
products. The Company also works closely with its licensees
9
<PAGE> 10
and semiconductor partners to actively explore other opportunities to utilize
the Company's technologies in new products and/or markets.
Product and Component Sales
The consumer electronics market in China is an important market for the
Company. One way the Company participates in this market is through the design
and distribution of components and assembly kits to DVD and VCD manufacturers.
DVD and VCD players, which allow the playing of digital video on a compact disc
format, are well suited for a broad range of applications, including music,
video, education, training, movies and Karaoke. In a few short years, DVD and
VCD have become and will continue to be the standard video format and have
received mass-market adoption in China.
Through its distribution agreements and close relationships with leading
digital video chip suppliers in China, such as National Semiconductor and
Philips Hong Kong Ltd., the Company designs, develops and markets complete DVD
and VCD players, as well as assembly kits and reference boards, at very
competitive prices.
During Fiscal 1998, through a network of manufacturing partners in China,
the Company also produced and began offering home entertainment products under
the brand name "Valence." The consumer electronics market in China is highly
competitive with many leading companies marketing to consumers in the larger
cities in China; therefore, the Company focuses its sales efforts on secondary
markets. The Company has established a network of eight to ten regional
distributors in various cities in China, who then sell the Valence-branded
products to smaller distributors, dealers and retail establishments.
In Fiscal 1999, the Company focused on the design and development of
product and technology solutions either on a customer's request or under its own
marketing and R&D initiatives. Product and technology solutions developed and
sold were for applications in DVD players, VCD players, digital power
amplifiers, set-top boxes, and surround sound decoders. The technology solutions
can be readily incorporated into end products, thus enabling a Company's
customer to shorten its time-to-market by reducing its own design and
development cycle time.
RESEARCH AND DEVELOPMENT
The Company has spent approximately 11.2%, 17.1% and 25.5% of total
operating expenses on research and development in Fiscal 1997, 1998 and 1999,
respectively. The percentage calculation for 1998 excludes expense related to
acquired in-process research and development.
The Company's research and development group includes 32 software, hardware
and application engineers who focus on developing intellectual property,
technology solutions and consumer products. Seven engineers are based in the
U.S. with the remainder based in Hong Kong and China.
The U.S.-based engineering group is focused upon developing new audio and
voice technologies, improving the performance of existing technologies and
reducing the implementation cost of the Company's technologies. These engineers
also are focused on assisting customers to implement the Company's technologies
and supporting the Company's sales and marketing efforts on a worldwide basis.
Through Valence, the Company operates one of the largest independent IC
design houses in Hong Kong, whose activities are primarily engaged in working on
custom design ASIC projects for clients in the consumer electronics, game and
telecommunications industries. These clients range from local producers to
large, multi-national manufacturers around the world. In 1998, ASP
Microelectronics, one of Valence's subsidiaries, was awarded the Hong Kong
Industry Award's HKITCC Technological Achievement Award. In 1999, VSD
Electronics Ltd., another Valence subsidiary, was awarded the Hong Kong Industry
Award's HKITCC Certificate of Merit in Technology Achievement.
The market for the Company's technologies and products is subject to rapid
and significant changes and frequent new technology and product introductions.
The Company believes that its future success will depend on its ability to
continue to enhance its existing technologies and to introduce or acquire new
technologies on a
10
<PAGE> 11
competitive basis. There can be no assurance, however, that the Company will be
able to successfully enhance existing technologies and products or introduce or
acquire new technologies and products.
COMPETITION
The Company competes in each of its business segments with a number of
companies which produce a variety of audio and voice enhancement technologies,
processes and products. These technologies, processes and products include:
THX(R), a certification program that indicates if a movie theater or particular
piece of audio equipment meets certain specifications; Dolby(R) A-type, B-type
and C-type noise reduction; Dolby SR(R), which provides noise reduction and
encodes analog sound using four sound channels; ProLogic(TM), a surround sound
system incorporating an active center channel; DolbySRD(R), which encodes a six
channel digital sound track on a movie print; DTS(R), which uses CDs to
reproduce six channels of digital sound synchronized with a movie print; and
SDDS(R), which encodes six or eight channels of digital sound on both sides of a
movie print. Because SRS works with any existing recorded material whether mono,
stereo, surround sound or other encoding process, SRS can be used either as an
alternative or as a complement and enhancement to almost any competing audio
technology. As a multi-channel encode/decode technology, Circle Surround
competes more directly with the various surround sound technologies listed
above.
The Company also directly competes in the field of 3D audio enhancement
with other 3D audio providers, including Aureal, Qsound Labs, Inc., Sensaura and
Spatializer. The Company is not aware of any direct competing technologies to
its voice intelligibility technology, VIP. The Company believes that TruBass
might directly compete with several technologies, including MaxxBass from Waves,
Ltd. and non-proprietary bass enhancement circuits, such as Bass Boost, that are
included on a variety of electronics products, including televisions, audio
systems and speaker products.
In addition, the Company's technologies may, in the future, compete with
audio technologies developed by other companies, some of whom may be current
licensees of the Company.
Certain of these companies referenced above have, or may have,
substantially greater resources than the Company to devote to further
technologies and new product developments. The Company believes that it will
compete based primarily on the quality and performance of its proprietary
technologies, brand name awareness, the ease and cost of implementing its
technologies, the ability to meet OEMs' needs to differentiate their products,
and the strength of its licensee relationships. There can be no assurance that
based on these factors the Company will continue to be competitive with existing
or future products or technologies of its competitors.
The Company's competitors to its semiconductor IC business are primarily
fabless semiconductor design houses and manufacturers located in Taiwan, Japan
and Korea. Given that Taiwan is focusing on the development of the personal
computer industry, most of the fabless semiconductor design houses in Taiwan
also focus on the design of dynamic random access memory, static random access
memory and semiconductors for personal computer applications. These fabless
semiconductor design houses focus less on semiconductors for consumer
electronics such as home audio and video products, communications equipment and
electronic games players.
Although the Chinese semiconductor industry is dominated by several major
chip suppliers, such as Motorola, National Semiconductor and Texas Instruments,
within every major market there is need for local, niche participants, such as
the Company. Generally speaking, established semiconductor companies do not
offer semiconductor design services to manufacturers and will only do so if the
volume of semiconductors required by such manufacturers is of a very large
quantity. Instead, they supply standard semiconductors to such manufacturers.
These standard semiconductors may not be the most suitable components for the
manufacturers as they may require additional semiconductor components to perform
the designed functions required in their products. In such cases, these
semiconductors will be bulkier, heavier and more expensive compared to using
just one custom-designed system-on-chip ASIC. The Company's ASIC team is more
flexible in its strategy of designing new products, as well as more responsive
and flexible in the service provided to clients. With fourteen years of
background in the Chinese semiconductor market, the Company's personnel
11
<PAGE> 12
has expertise in local business practices and a strong franchise of
relationships with clients that the Company believes gives it a competitive
advantage over newcomers to the industry or the large multi-national firms.
The Company's (through Valence and its subsidiaries) chip and component
distribution contracts to distribute products for third party semiconductor
manufacturers in the domestic Chinese market are not exclusive, and the Company
competes with other distributors, such as Arrow Electronics, Future Electronics
and Avnet Inc. In addition, the semiconductor companies who manufacture the
components and chips also sell directly to manufacturers within China.
Through a network of manufacturing partners in China, the Company during
Fiscal 1998 produced and offered home entertainment products for wholesale and
distribution through retailers, under the brand name "Valence." In Fiscal 1999,
the Company focused on the development and marketing of product and technology
solutions targeted at applications in DVD players, VCD players, digital power
amplifiers, set-top boxes, and surround sound decoders. The technology solutions
can be readily incorporated into end products, thus enabling a Company's
customer to shorten its time-to-market by reducing its own design and
development cycle time. Although the overall consumer electronics market in
China is vast, it is highly competitive with many large manufacturers competing
in the retail channel with established brand names.
The markets in which the Company sells its products are subject to extreme
price competition, thus the Company expects to continue to experience declines
in the selling prices of its products over the life cycle of each product. In
order to offset declines in the selling prices of its products, the Company must
continue to reduce the costs of products through product design changes,
manufacturing process changes, volume discounts and other savings negotiated
with its manufacturing subcontractors. Since the Company does not operate its
own manufacturing facilities with respect to ASICs or product or component
sales, it may not be able to reduce its costs as rapidly as its competitors who
perform their own manufacturing. The failure of the Company to design and
introduce, in a timely manner, lower cost versions of existing products or
higher gross margin new products, or to successfully manage its manufacturing
subcontractor relationships could have a material adverse effect on the
Company's gross margins.
INTELLECTUAL PROPERTY RIGHTS AND PROPRIETARY INFORMATION
The Company operates in industries where innovation, investment in new
ideas and protection of its resulting intellectual property rights are important
for success. The Company relies on a variety of intellectual property
protections for its products and services, including patent, copyright,
trademark and trade secret laws, and contractual obligations, and pursues a
policy of enforcing such rights. There can be no assurance, however, that the
Company's intellectual property rights will be adequate to ensure the Company's
competitive position, or that competitors will not be able to produce a
non-infringing competitive product or service. There can be no assurance that
third parties will not assert infringement claims against the Company, or that
if required to obtain any third party licenses as a result of an infringement
dispute the Company will be able to obtain such licenses. Although the Company
believes that its patents and trademarks are important to each of its business
segments, such patents and trademarks are especially important to the chip and
licensing business segment.
SRS is the subject of five U.S. patents containing a combined total of 276
claims. The expiration dates for these U.S. patents are May 31, 2005, June 20,
2006, September 12, 2006, October 5, 2010 and April 27, 2015, respectively. In
addition, the Company has 49 issued foreign patents relating to SRS and over 59
additional foreign patents pending. The expiration dates for these foreign
patents varies depending on the particular patent and the particular country,
but in most cases the duration of such foreign patents will extend into the year
2006.
The Company also owns four U.S. patents for speaker technologies and has 30
issued foreign patents for these technologies with several other foreign patents
pending. The expiration dates for these U.S. patents are April 4, 2006, June 6,
2006, January 10, 2010 and October 7, 2016, respectively. The expiration dates
for these foreign patents varies depending on the particular patent and the
particular country, but in most cases the duration of such foreign patents will
extend into the year 2006.
12
<PAGE> 13
The Company owns U.S. patents for VIP, FOCUS, TruSurround and Circle
Surround with numerous foreign patents pending for each of these technologies.
In addition, the Company has multiple new audio technology patents pending in
the U.S. and worldwide for improvements to SRS and for its FOCUS, TruSurround
and TruBass technologies.
The Company is the owner of the following federally registered trademarks:
SRS(R), the SRS symbol "(o)(R)", Sound Retrieval System(R), ORB(R), BASER(R),
"everything else is only stereo", 3D Stereo(R), 3D Stereo II(R), 3D Cinema
Stereo(R), F( -- )CUS(R), Dr. 3D(R), TruSurround(R) and Circle Surround(R).
Trademark applications are pending for AVT(TM), VIP(TM), TruBass(TM), WOW
Thing(TM), NuVoice(TM), Power 3D Audio(TM), XTREME BASS(TM), Best Sounding Site
on the World Wide Web(TM) and WOW(TM). The duration of the federally registered
trademarks can be maintained indefinitely, provided proper maintenance fees are
paid and the trademarks are continually used or licensed by the Company. The
Company also has foreign trademarks either registered or pending for many of the
aforementioned trademarks.
SEASONALITY
Due to the Company's dependence on the consumer electronics market, the
substantial seasonality of sales in the market could impact the Company's
revenues and net income. In particular, the Company believes that there is
seasonality relating to the Christmas season as well as the Chinese New Year in
the Asia Pacific region, which fall into the fourth and first quarters,
respectively.
EMPLOYEES
The Company and its subsidiaries employed 73 persons and 43 persons,
respectively, in its IC Chip and Licensing and Product and Component Sales
business segments as of December 31, 1999. Of the aggregate number of employees,
86 are employed by Valence and its subsidiaries and are located overseas. None
of the Company's employees are covered by a collective bargaining agreement or
are presently represented by a labor union. The Company has not experienced any
work stoppages and considers its employee relations to be good.
ITEM 2. PROPERTIES
The Company's corporate headquarters are located in Santa Ana, California,
in a 23,400 square foot facility consisting of office and warehouse space. The
Company leases the facility from Daimler Commerce Partners, L.P. (the
"Partnership"), an affiliated partnership. The general partner of the
Partnership is Conifer Investments, Inc. ("Conifer"). The sole shareholders of
Conifer are Thomas C.K. Yuen and Misako Yuen, as co-trustees of the Thomas Yuen
Family Trust (the "Trust"), and the executive officers of Conifer include Mr.
and Mrs. Yuen. Mr. and Mrs. Yuen, as co-trustees of the Trust, also beneficially
own a significant amount of the Company's outstanding shares of common stock.
Mr. Yuen is the Chairman of the Board and Chief Executive Officer of the
Company.
Pursuant to the Company's lease agreement with the Partnership, the Company
leases all 23,400 square feet of space at the above-referenced facility. The
lease is for a term of three years which commenced June 1, 1997 and is scheduled
to expire on May 31, 2000. At the time of expiration, the Company will have an
option to renew the lease, under similar terms and conditions, for two
additional years commencing on June 1, 2000 and terminating on May 31, 2002. The
Company intends to exercise such renewal rights. The Company paid the
Partnership rent of $129,369 during Fiscal 1997, $165,672 during Fiscal 1998 and
$165,672 during Fiscal 1999.
The Company, through Valence and its subsidiaries, leases several offices
and warehouses in Hong Kong and China. Valence's principal operations are
conducted at two leased facilities located in Hong Kong. The principal executive
offices of Valence are located in Kowloon Tong, Hong Kong, in a 3,726 square
foot office facility under a lease which expires in August 2000. Valence's other
principal office is located in Kwun Tong, Kowloon, Hong Kong, in a 7,453 square
foot office facility under a lease which expires in December 2000. Pursuant to
these leases, the Company paid rent of $461,044 during Fiscal 1998, and $429,672
during Fiscal 1999. Management of Valence expects to reach renewal agreements
with respect to each of the above-
13
<PAGE> 14
referenced facilities. To the extent that management is unable to reach such
agreements, it believes that it will be able to secure comparable space at
reasonable rates.
The Company's corporate headquarters house personnel responsible for the
development of the Company's technologies, as well as the administration of the
Company's license program, while the Valence facilities are used in connection
with the design and marketing of ASICs and the sale of consumer electronic
products and components.
The Company believes that the current facilities of the Company and its
subsidiaries will be adequate to meet the Company's needs for the foreseeable
future. Should the Company need further additional space, management believes
that the Company will be able to secure additional space at reasonable rates.
ITEM 3. LEGAL PROCEEDINGS
On April 23, 1999, Dolby Laboratories, Inc. ("Dolby") filed a civil lawsuit
in the United States District Court for the Central District of California (the
"Court") against the Company and Smart Devices, Inc. ("Smart Devices"). Smart
Devices is a licensee of the Company under the SRS(R) and CIRCLE SURROUND(R)
technologies. The complaint sought both preliminary and permanent injunctions,
monetary damages in an unspecified amount and further equitable relief, based
upon allegations of false advertising, unfair competition, trademark
infringement and false labeling relating to the CIRCLE SURROUND EX trademark. On
May 17, 1999, the Company filed an answer to such complaint generally denying
the allegations made by the plaintiff under each claim for relief and denying
that the plaintiff is entitled to any relief under each stated claim for relief.
In addition, the Company also responded by alleging affirmative defenses to each
claim for relief. The Company did not provide a defense for Smart Devices.
On November 23, 1999, a Stipulation of Dismissal (the "Stipulation") was
entered by the Court. Pursuant to the Stipulation, the parties, Dolby and the
Company, agreed to dismiss the above-referenced action as between themselves
with prejudice based upon a Settlement Agreement and Mutual Release (the
"Settlement Agreement"). The Stipulation did not affect the claims that Dolby
has asserted against Smart Devices. Pursuant to the Settlement Agreement, (a)
the Company agreed (i) to pay Dolby $50,000, (ii) to abandon the Intent-To-Use
application it had filed for the mark "Circle Surround EX"; (iii) not to
register or use as a trademark the term "Circle Surround EX" (iv) not to oppose
Dolby's application for registration of marks "Surround EX" and "Dolby Digital
Surround EX" and to consent to Dolby's use of such marks; and (v) that it will
not attempt to register or use as a trademark the phrase "Surround EX" alone;
and (b) Dolby agreed to pay to the Company $45,000 to assist in the deferment of
the costs to be incurred by the Company in changing its trademark. The
Stipulation expressly stated that it will not be construed as an admission of
liability or infringement by either Dolby or the Company.
From time to time, the Company is a party to ordinary disputes arising in
the normal course of business. The Company does not believe that the outcome of
any current legal proceedings will have a material adverse effect on the
Company's business, financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
14
<PAGE> 15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET FOR COMMON STOCK
The common stock of the Company, par value $.001 per share (the "Common
Stock"), trades on the Nasdaq Stock Market as a National Market System Security
under the symbol SRSL. The table below reflects the high and low sales prices of
the Common Stock as reported by The Nasdaq Stock Market, Inc. for the periods
indicated.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
FISCAL 1998
First Quarter............................................ $10 1/4 $6 1/4
Second Quarter........................................... 9 5/8 4 7/8
Third Quarter............................................ 7 5/8 3 3/8
Fourth Quarter........................................... 5 3/8 2 3/8
FISCAL 1999
First Quarter............................................ $ 5 5/8 $3 1/16
Second Quarter........................................... 4 1/4 2 5/8
Third Quarter............................................ 4 5/8 2 7/8
Fourth Quarter........................................... 7 5/8 2 15/16
</TABLE>
At March 17, 2000, the last sale price of the Common Stock was $26.625 per
share.
HOLDERS
At March 17, 2000, there were 407 stockholders of record.
DIVIDEND POLICY
The Company has never paid cash dividends on the Common Stock. The Company
currently intends to retain its available funds from earnings for future growth
and, therefore, does not anticipate paying any dividends in the foreseeable
future. See Item 7. "Management's Discussion and Analysis and Results of
Operations -- Liquidity and Capital Resources" for a discussion regarding
certain restrictions which relate to the Company's ability to pay cash
dividends.
USE OF PROCEEDS
The effective date of the Company's initial public offering of shares of
Common Stock was August 8, 1996 (SEC Registration No. 333-4974-LA). During the
fourth quarter of Fiscal 1999, the Company utilized approximately $1,552,999 of
the $22,052,955 net offering proceeds for working capital. The table below sets
forth at December 31, 1999, the amount of the net offering proceeds used for the
purposes noted in the table.
15
<PAGE> 16
<TABLE>
<CAPTION>
DIRECT OR INDIRECT PAYMENTS TO
DIRECTORS, OFFICERS, GENERAL
PARTNERS OF THE ISSUER OR THEIR
ASSOCIATES, TO PERSONS OWNING TEN
PERCENT OR MORE OF ANY CLASS OF DIRECT OR INDIRECT
EQUITY SECURITIES OF THE ISSUER, AND PAYMENTS TO
TO AFFILIATES OF THE ISSUER OTHERS
------------------------------------ ------------------
<S> <C> <C>
Construction of plant, building and
facilities................................ -- --
Purchase and installation of machinery and
equipment................................. -- --
Purchase of real estate..................... -- --
Acquisition of other business(es)/assets.... -- $8,394,222(1)
Repayment of indebtedness................... -- --
Working capital............................. -- $4,316,000
Temporary investment (cash and municipal
bonds).................................... -- $9,342,733
</TABLE>
- ---------------
(1) During the second quarter of Fiscal 1998, the Company utilized $500,000 of
the net offering proceeds as part of the consideration to acquire assets
related to the Circle Surround technology. During the first quarter of
Fiscal 1998, the Company utilized an aggregate of $7,894,222 in connection
with two other acquisitions (see Note 2 to the Notes to the Consolidated
Financial Statements included under Item 8 of this Report).
16
<PAGE> 17
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected financial data of the Company for
the fiscal years ended December 31, 1995, 1996, 1997, 1998 and 1999 which has
been derived from the Company's consolidated audited financial statements. The
following information should be read in conjunction with the Consolidated
Financial Statements and Notes thereto included elsewhere in this Report.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED DECEMBER 31,
----------------------------------------------------
1995 1996 1997 1998 1999
------- ------- ------- -------- -------
(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Revenues:
Chip and licensing revenues........... $ 844 $ 5,392 $10,081 $ 15,762 $18,624
Product and component sales........... -- -- -- 28,963 17,172
------- ------- ------- -------- -------
Total revenues................ 844 5,392 10,081 44,725 35,796
Cost of sales........................... 15 95 210 29,819 22,003
------- ------- ------- -------- -------
Gross margin.......................... 829 5,297 9,871 14,906 13,793
Operating costs and expenses:
Sales and marketing................... 937 1,163 2,112 6,846 5,148
Research and development.............. 384 522 596 2,555 4,142
General and administrative............ 1,107 1,616 2,615 5,531 6,932
Acquired in-process research and
development........................ -- -- -- 18,510 --
------- ------- ------- -------- -------
Total operating costs and
expenses.................... 2,428 3,301 5,323 33,442 16,222
------- ------- ------- -------- -------
Income (loss) from operations........... (1,599) 1,996 4,548 (18,536) (2,429)
Other income (expense), net........... (41) 366 1,088 705 735
------- ------- ------- -------- -------
Income (loss) from operations before
income tax expense (benefit).......... (1,640) 2,362 5,636 (17,831) (1,695)
Income tax expense (benefit)............ 1 501 1,863 (273) (49)
------- ------- ------- -------- -------
Net income (loss)....................... $(1,641) $ 1,861 $ 3,773 $(17,558) $(1,744)
======= ======= ======= ======== =======
Net income (loss) per common share:
Basic.............................. $ (0.28) $ 0.24 $ 0.39 $ (1.54) $ (0.15)
======= ======= ======= ======== =======
Diluted............................ $ (0.28) $ 0.21 $ 0.35 $ (1.54) $ (0.15)
======= ======= ======= ======== =======
Weighted average number of shares used
in the calculation of net income per
common share:
Basic.............................. 5,928 7,625 9,556 11,410 11,696
Diluted............................ 5,928 8,686 10,852 11,410 11,696
Balance sheet data:
Working capital....................... $ 431 $ 3,375 $ 9,075 $ 7,644 $10,953
Total assets.......................... 1,698 26,674 31,542 45,535 39,101
Short-term debt and current portion of
long-term obligations.............. 180 180 82 8,000 8,000
Long-term obligations, net of current
portion............................ 211 69 -- -- --
Stockholders' equity.................. 888 25,151 29,420 26,072 25,040
</TABLE>
17
<PAGE> 18
ITEM 7. 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. As of the
end of Fiscal 1999, the Company's principal business activities in these markets
included:
- Developing and licensing audio and voice technologies to original
equipment manufacturers ("OEMs") and semiconductor manufacturers around
the world; and
- Through its subsidiary, Valence Technology Inc. and its foreign
subsidiaries (collectively, "Valence"), designing and selling technology
solutions through custom application specific integrated circuits
("ASICs") to OEMs; and designing, distributing and manufacturing
components, sub-assemblies and finished goods for the OEM and retail
communities within the Company's targeted markets.
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 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 Fiscal 1998 and 1999 financial statements. 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, 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 product and semiconductor manufacturers and (b) the sale of consumer
electronic products and components.
18
<PAGE> 19
RESULTS OF OPERATIONS
The following table sets forth certain consolidated operating data as a
percentage of total revenues for the years ended December 31, 1997, 1998 and
1999:
<TABLE>
<CAPTION>
PERCENTAGE OF TOTAL
REVENUE YEARS ENDED
DECEMBER 31,
--------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Chip and licensing revenue.............................. 100% 35% 52%
Product and component sales............................. -- 65 48%
--- --- ---
Total revenue......................................... 100 100 100
Cost of sales........................................... 2 67 61
--- --- ---
Gross margin............................................ 98 33 39
Sales and marketing..................................... 21 15 14
Research and development................................ 6 6 12
General and administrative.............................. 26 12 20
Acquired in-process research and development............ 0 41 0
--- --- ---
Total operating expense............................... 53 74 46
Operating income (loss)................................. 45 (41) (7)
Other income, net....................................... 11 2 2
--- --- ---
Income (loss) before income taxes....................... 56 (39) (5)
Income tax expense (benefit)............................ 18 -- --
--- --- ---
Net income (loss)..................................... 38% (39)% (5)%
=== === ===
</TABLE>
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Impact of Valence Acquisition
The Company's consolidated financial results for Fiscal 1998 include the
results of the Valence operations beginning as of February 1, 1998. Accordingly,
results for the year ended December 31, 1999 may not be directly comparable to
results for the year ended December 31, 1998.
Revenues
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 ICs designed by the Company under the brand name
ASP Microelectronics. Licensing revenues are royalties generated primarily from
the license of the Company's audio technologies. License and royalty agreements
generally provide for the license of technologies for a specified period of time
for either a single fee or a fee based on the number of units distributed by the
licensee. Product and component sales represent (a) the manufacture and sale of
Valence's own branded product line of VCD players, amplifiers and game products
and (b) the distribution of semiconductor products, manufacturing components and
sub-assemblies to OEMs for the Hong Kong and China markets.
Total revenues for Fiscal 1999 were $35,795,583, consisting of chip and
licensing revenue of $18,624,221 and product and component revenue of
$17,171,362. This contrasts with Fiscal 1998, where chip and licensing revenues
were $15,762,370, and product and component revenues were $28,962,671. Excluding
chip design revenue, licensing revenue decreased 38.2% from the same period last
year due to the following factors: (a) the shift in the PC market to lower cost
models which cannot bear the cost of performance enhancement technologies such
as those offered by SRS Labs; (b) the reduced growth rate of the Chinese economy
which reduced demand for consumer electronics products in the region and
negatively impacted the sales of semiconductor ICs that include the Company's
audio technologies; and (c) the trend by consumer electronic manufacturers to
initially adopt the Company's new technologies into their higher end models with
limited volume potential for the short term. Revenue from custom ASIC chip
design and chip sales related to
19
<PAGE> 20
Valence's activities increased 48% from the same prior year period primarily due
to the Company's decision to focus on higher margin chip and licensing revenues
and de-emphasize certain lower margin distribution activities. The 41% decrease
in product revenues in Fiscal 1999 also is due to the Company's decision to
de-emphasize certain lower margin distribution activities.
Gross Margin
Cost of sales for Fiscal 1999 consists primarily of component cost,
fabrication costs, assembly and test costs, and the cost of materials and
overhead from operations. Gross margin for the twelve months ended December 31,
1999 increased to 38.5% from 33.3% for the same period in 1998. The increase
resulted primarily from the shift in the Company's revenue base towards higher
margin chip and licensing sales and away from lower margin component
distribution.
Sales and Marketing
Sales and marketing expenses consist primarily of employee-related
expenses, sales commissions and product promotion costs. Sales and marketing
expenses were $5,148,458 in Fiscal 1999 compared to $6,845,674 in Fiscal 1998, a
decrease of 24.8%. This decrease is attributable primarily to lower advertising,
promotional, trade show and travel costs, resulting from the Company's efforts
during 1999 to reduce costs in these areas. As a percentage of total revenues,
sales and marketing expenses decreased to 14.4% in Fiscal 1999 from 15.3% in
Fiscal 1998.
Research and Development
Research and development expenses consist of salaries and related costs of
employees engaged in ongoing research, design and development activities and
costs for engineering materials and supplies. Research and development expenses
were $4,141,571 in Fiscal 1999 compared to $2,554,883 in Fiscal 1998, an
increase of 62.1%. This increase is primarily attributable to ASIC related
research and development, and design and development of ASP branded products
based on SRS technologies. As a percentage of total revenues, research and
development expenses increased to 11.6% in Fiscal 1999 from 5.7% in Fiscal 1998.
Management believes that research and development expenses will increase in the
future as a result of the Company's continual product development efforts.
General and Administrative
General and administrative expenses consist primarily of employee-related
expenses, legal costs associated with the administration of intellectual
property, professional fees and various other administrative costs. General and
administrative expenses were $6,932,397 in Fiscal 1999 compared to $5,530,957 in
Fiscal 1998, an increase of 25.3%. The increase was primarily attributable to
headcount added to support new business development, costs incurred for due
diligence activities related to potential acquisitions, and costs incurred to
reserve for certain non-collectible accounts receivable. As a percentage of
total revenues, general and administrative expenses increased to 19.4% in Fiscal
1999 from 12.4% in Fiscal 1998.
As part of the Valence acquisition, the Company allocated a portion of the
purchase price to various intangible assets totaling approximately $5,910,400.
This amount was capitalized and is being amortized on a straight line basis over
periods ranging from three to eleven years with the related amortization expense
of $1,205,988 and $1,180,489 included in general and administrative expenses for
the years ended December 31, 1999 and 1998 respectively. See Note 2 of the Notes
to the Consolidated Financial Statements for more information concerning the
purchase price allocation associated with the Valence acquisition.
Acquired In-Process Research and Development
The Company's Consolidated Statement of Operations for the year ended
December 31, 1998 includes the one-time charge of $18,510,378 for the write-off
of acquired 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
20
<PAGE> 21
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, ASICs for consumer electronics,
computing and voice and audio applications, home entertainment systems, digital
multimedia players and digital power amplifiers. The Company estimated that
these projects were approximately 63% complete at the date of acquisition and
estimated that the cost to complete these projects will aggregate approximately
$7 million and will be incurred over a three-year period.
New product development projects utilizing the VIP technology at the time
of the VIP acquisition included, among others, digital and analog sound
reinforcement, wireless and non-wireless telecommunications applications,
hearing aid applications and headphone and microphone applications. The Company
estimated that these projects were approximately 62% complete at the date of
acquisition and estimated that the cost to complete these projects will
aggregate approximately $525,000 and will be incurred over a two-year period.
Uncertainties that could impede the progress of converting a development
project to a developed technology include the availability of financial
resources to complete the project, failure of the technology to function
properly, continued economic feasibility of developed technologies, customer
acceptance, customer demand and customer qualification of such new technology
and general competitive conditions in the industry. There can be no assurance
that the acquired in-process research and development projects will be
successfully completed and commercially introduced.
Other Income, Net
Other income, net consists primarily of interest income, interest expense,
realized gains and losses on the sale of investments and foreign currency
transaction gains and losses at Valence. Net interest income was $448,117 in
Fiscal 1999 compared to $694,760 in Fiscal 1998, a decrease of 35.5%. The
decrease is primarily attributable to lower average cash and investment balances
during the current year as compared to the prior year due to the $7,894,222 paid
in conjunction with the acquisitions of Valence and VIP and interest expense on
the outstanding borrowings under the Company's line of credit obtained during
Fiscal 1998.
Provision for Income Taxes
The income tax provision for Fiscal 1999 was $49,662 compared to a benefit
of $273,156 for Fiscal 1998. The Company recognized a tax benefit in Fiscal 1998
primarily due to a taxable loss recognized for U.S. federal income tax purposes
related to domestic operations. In addition, the Company benefited from certain
tax credits and statutory tax rates in the Asian countries where Valence has its
principal business operations which are lower than United States statutory
rates. The Company had federal and state net operating loss carry forwards at
December 31, 1999, of approximately $3.4 million and $3.1 million, respectively.
These net operating loss carry forwards will begin to expire in 2019 and 2003,
respectively. In addition, the Company has federal tax credit carry forwards of
approximately $541,000 which will begin to expire in 2003. As of December 31,
1999, a valuation allowance of $1,154,401 has been provided based on the
Company's assessment of the future realizeability of certain deferred tax
assets. Approximately $125,000 of the valuation allowance is attributable to the
potential tax benefit of stock option transactions that will be credited
directly to additional paid in capital, if realized.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Revenues
Total revenues for Fiscal 1998 were $44,725,040, which includes revenues
generated by Valence since February 1, 1998. This contrasts with Fiscal 1997
where revenues were $10,081,283 and were generated solely
21
<PAGE> 22
from licensing activities. Excluding chip design revenue, licensing revenue
decreased 45.8% 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 adopt the Company's technologies into their higher end models
which has limited volume growth of models using the Company's licensed audio
technologies. The licensing revenue decrease was offset by the custom ASIC chip
design and chip sales of $10,294,851 related to Valence's activities. Revenue
generated from product and component sales in Fiscal 1998 is attributable to
Valence and therefore is not comparable to Fiscal 1997. Revenues in future
quarters are expected to consist primarily of ASIC design and product and
electronic component sales.
Cost of sales for Fiscal 1998 consisted primarily of fabrication costs,
assembly and test costs, and the cost of materials and overhead from operations.
Cost of sales for Fiscal 1997 consisted primarily of fees paid to third party
representatives for sales administration and support. Gross margin for the
twelve months ended December 31, 1998 decreased to 33.3% from 97.9% for the same
period in Fiscal 1997. The decrease resulted from the shift in the Company's
revenue base towards product and electronic component sales, which have
significantly lower margins than the Company's historic licensing revenue base.
Gross margins in future quarters will primarily reflect the cost of
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-related
expenses, sales commissions and product promotion. Sales and marketing expenses
were $6,845,674 in Fiscal 1998 compared to $2,111,839 in Fiscal 1997, an
increase of 224.2% which was attributable to the Valence acquisition and an
increase in domestic staffing to promote new technologies. As a percentage of
total revenues, sales and marketing expenses decreased to 15.3% in Fiscal 1998
from 20.9% in Fiscal 1997, as a result of the higher revenue base.
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 $2,554,883 in Fiscal 1998 compared to $595,689 in Fiscal 1997, an increase
of 328.9%, primarily attributable to the Valence acquisition. As a percentage of
total revenues, research and development expenses decreased to 5.7% in Fiscal
1998 from 5.9% in Fiscal 1997, as a result of the higher revenue base.
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
$5,530,957 in Fiscal 1998 compared to $2,615,706 in Fiscal 1997, an increase of
111.5%, primarily attributable to the Valence acquisition and increased staffing
at corporate headquarters to support new business development. As a percentage
of total revenues, general and administrative expenses decreased to 12.4% in
Fiscal 1998 from 25.9% in Fiscal 1997 as a result of the higher revenue base.
As part of the Valence acquisition, the Company allocated a portion of the
purchase price to various intangible assets totaling approximately $5,910,400.
See the discussion above and in Note 2 of the Notes to the Consolidated
Financial Statements for more information concerning the purchase price
allocation associated with the Valence acquisition.
Acquired In-Process Research and Development
See the discussion above relating to the acquired in-process research and
development expenses related to the Valence acquisition.
22
<PAGE> 23
Other Income, Net
Other income, net consists primarily of interest income, interest expense,
realized gains and losses on the sale of investments and foreign currency
transaction gains and losses at Valence. Net interest income was $694,760 in
Fiscal 1998 compared to $1,088,718 in Fiscal 1997, a decrease of 36.2%. The
decrease is primarily attributable to lower average cash and investment balances
during the current year as compared to the prior year due to the $7,894,222 paid
in conjunction with the acquisitions of Valence and VIP and interest expense on
the outstanding borrowings under the Company's line of credit obtained during
Fiscal 1998. The Company also recognized $86,337 of realized gains on the sale
of investments available for sale and a foreign exchange transaction loss
related to the Valence operations of $76,105 in Fiscal 1998.
Provision for Income Taxes
The income tax benefit for Fiscal 1998 was $273,156 compared to income tax
expense of $1,863,200 for Fiscal 1997. The Company recognized a tax benefit in
Fiscal 1998 primarily due to a taxable loss recognized for U.S. federal income
tax purposes related to domestic operations. In addition, the Company benefited
from certain tax credits and statutory tax rates in the Asian countries where
Valence has its principal business operations which are lower than United States
statutory rates.
SELECTED QUARTERLY OPERATING RESULTS (UNAUDITED)
The following table sets forth certain quarterly financial data for the
eight quarters in the period ended December 31, 1999. The quarterly information
is based upon unaudited financial statements prepared by the Company on a basis
consistent with the Company's audited consolidated financial statements and, in
management's opinion, includes all adjustments, consisting only of normal
recurring adjustments necessary for a fair presentation of the information for
the periods presented. This information should be read in conjunction with the
Company's audited Consolidated Financial Statements and Notes thereto appearing
elsewhere in this Report. The acquisition of Valence in the first quarter of
Fiscal 1998 has had and will continue to have a material impact on the Company's
Fiscal 1998 and 1999 financial statements and for the reporting periods
thereafter; accordingly, the operating results for any quarter are not
necessarily indicative of results for any future period. The Company's quarterly
operating results have varied significantly in the past and are expected to vary
significantly in the future.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEP. 30, DEC. 31, MARCH 31, JUNE 30, SEP. 30, DEC. 31,
1998 1998 1998 1998 1999 1999 1999 1999
--------- -------- -------- -------- --------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Chip and licensing...... $ 2,882 $ 4,524 $ 3,936 $ 4,420 $ 4,104 $3,990 $ 4,830 $5,700
Product and component... 4,175 7,101 7,382 10,305 3,613 4,214 5,175 4,170
-------- ------- ------- ------- ------- ------ ------- ------
Total
revenues...... 7,057 11,625 11,318 14,725 7,717 8,204 10,005 9,870
Gross margin.............. 2,659 4,238 3,507 4,502 2,441 3,301 3,940 4,110
Operating expenses........ 21,351(a) 3,480 3,291 5,320 4,352 3,301 3,713 4,857
-------- ------- ------- ------- ------- ------ ------- ------
Operating income (loss)... (18,692) 758 216 (818) (1,911) -- 227 (747)
Net income (loss).... (18,211) 720 192 (259) (1,497) 6 310 (563)
Net income (loss) per
Common share:
Basic................ $ (1.68) $ .06 $ .02 $ (.02) $ (.13) $ -- $ .03 $ (.05)
Diluted.............. $ (1.68) $ .06 $ .02 $ (.02) $ (.13) $ -- $ .03 $ (.05)
</TABLE>
- ---------------
(a) Operating expenses for the three month period ended March 31, 1998 included
$18,510,378 related to the write-off of acquired in-process research and
development
23
<PAGE> 24
LIQUIDITY AND CAPITAL RESOURCES
In August 1996, the Company completed an initial public offering of
3,107,452 shares of Common Stock at $8.00 per share. Net proceeds to the Company
were approximately $22 million.
As of December 31, 1999 and 1998, cash, cash equivalents, and investments
totaled $25,312,411 and $24,430,859, respectively. Net cash provided by
operating activities during Fiscal 1999 was $1,633,177 and was generated
primarily from decreases in accounts receivable, inventory, and other assets,
plus non-cash depreciation and amortization, offset by a net decrease in
accounts payable and accrued liabilities. Net cash provided by investing
activities of $1,667,744 resulted primarily from sales of the Company's
investments. Net cash provided by financing activities of $327,515 resulted
primarily from sale of common stock pursuant to exercise of the Company's stock
options. Net cash provided by operating activities during Fiscal 1998 was
$5,022,088 and was generated primarily from decreases in accounts receivable and
inventory and increases in accounts payable, offset by increases in prepaid
expense and other assets. During Fiscal 1998, net cash provided by investing
activities of $1,499,433 resulted primarily from the sale of the Company's
investments, offset by cash used in the acquisition of Valence and the
acquisition of new technologies. Net cash provided by financing activities of
$1,372,968 resulted primarily from borrowings under the Company's credit line
offset by payments on Valence's current debt.
Inventories in Fiscal 1999 decreased from $4,632,968 at December 31, 1998
to $2,726,193 at December 31, 1999. This decrease was primarily a result of
disposing of slow-moving and obsolete inventory of Valence's distribution
business. Valence also exited from certain of the lower margin distribution
business which enabled it to carry less inventories to support customer demands.
Prepaid expenses and other current assets decreased from $3,244,233 at December
31, 1998 to $729,881 at December 31, 1999, primarily due to the collection of
other receivables of $2,131,352 during Fiscal 1999. Accounts payable decreased
from $10,632,505 at December 31, 1998 to $2,882,686 at December 31, 1999
primarily due to the decrease in component sales volume at Valence, which
resulted in reduced inventory levels and purchasing activity, as well as payment
of various other trade payables by Valence. Accrued liabilities increased from
$422,843 at December 31, 1998 to $1,658,964 at December 31, 1999 primarily due
to the timing of the payment of certain recurring compensation related expenses
plus the recording of a customer deposit.
The Company's principal source of liquidity at December 31, 1999 consisted
of cash, cash equivalents and investments. The Company has adopted investment
guidelines restricting the types and minimum quality of investments the Company
is authorized to purchase. At December 31, 1999, the Company had cash and cash
equivalents of $15,969,678 and investments of $9,342,733. Investments consist of
municipal bonds rated a minimum of A1.
On March 2, 1998, the Company acquired all of the outstanding shares of
capital stock of Valence for an aggregate purchase price of $19,500,000,
excluding acquisition costs and non-compete agreements, consisting of
approximately $7,400,000 in cash and approximately 1,680,611 shares of the
Company's common stock.
On March 4, 1998, the Company obtained a revolving line of credit (and
letter of credit facility) with a bank which expires on April 1, 2001 and is
secured by certain of the Company's investments. The total availability under
the line of credit is the lesser of $10 million or a percentage of the fair
market value of the collateral. The line of credit bears interest at the bank's
prime rate (8.5% as of December 31, 1999) or LIBOR plus 0.75% (6.875% as of
December 31, 1999). As of December 31, 1999, the Company had $8.0 million
outstanding under the line of credit and was contingently liable for $1,000,000
under an irrevocable letter of credit which expires July 31, 2000. The
collateral requirements under the above-referenced credit facility may have the
effect of restricting the amount available to pay cash dividends.
In November 1999, Valence and its subsidiaries obtained a credit facility
with a bank that provides for borrowings aggregating approximately $5,000,000.
The facility has no fixed expiration date and is collateralized by certain of
the Valence's assets on deposit with the bank. The facility provides for a
variety of import/ export trade instruments which bear interest rates ranging
from 1% over the Hong Kong Dollar prime rate to 1.75% over LIBOR. The facility
also provides for a revolving line of credit of up to $3,500,000 which bears
24
<PAGE> 25
interest at 1.25% over the related collateral deposit interest rate. At December
31, 1999, there were no obligations outstanding under this credit facility.
Based on current plans and business conditions, the Company expects that
its cash, cash equivalents, investments and/or available borrowings under its
line of credit together with any amounts generated from operations will be
sufficient to meet the Company's cash requirements for at least the next 12
months. However, there can be no assurance that the Company will not be required
to seek other financing sooner or that such financing, if required, will be
available on terms satisfactory to the Company.
SUBSEQUENT EVENTS
As noted in Item 1, Business, of this Report, on March 3, 2000 ValenceTech
Limited (the ultimate successor entity to Valence Technology Inc. for purposes
of listing common shares on the Growth Emerging Market of the Stock Exchange of
Hong Kong Limited (the "GEM")) filed an application to list its common shares on
the GEM in connection with an initial public offering. The Company estimates
that the completion of the offering will occur during the second quarter of
Fiscal 2000. As contemplated in the offering documents, approximately one-third
of the net proceeds of the offering is earmarked to be repatriated to the
Company. The amount of such repatriation is currently not determinable.
For a discussion relating to the strategic alliance between the Company and
Microsoft Corporation consummated in March 2000, see Item 1, Business in this
Report. Also see Note 13 to the Notes to Consolidated Financial Statements,
included herein under Item 8 of this Report.
YEAR 2000 ISSUE UPDATE
The Company did not experience any significant malfunctions or errors in
its operating or business systems when the date changed from 1999 to 2000. Based
on operations since January 1, 2000, the Company does not expect any significant
impact to its ongoing business as a result of the "Year 2000 issue." However, it
is possible that the full impact of the date change, which was of concern due to
computer programs that use two digits instead of four digits to define years,
has not been fully recognized. For example, it is possible that Year 2000 or
similar issues such as leap year-related problems may occur with billing,
payroll, or financial closings at month, quarterly, or year end. The Company
believes that any such problems are likely to be minor and correctable. In
addition, the Company could still be negatively affected if its customers or
suppliers are adversely affected by the year 2000 or similar issues. The Company
currently is not aware of any significant Year 2000 or similar problems that
have arisen for its customers and suppliers.
The Company expended less than $200,000 on Year 2000 readiness efforts from
Fiscal 1997 to Fiscal 1999. These efforts included replacing some outdated,
noncompliant hardware and noncompliant software as well as identifying and
remediating Year 2000 problems.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which is effective for fiscal years
beginning after June 15, 2000. This standard establishes accounting and
reporting standards for derivative instruments and for hedging activities and
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The Company does not believe that its adoption of this new
standard will have a material impact on its financial position or results of
operations.
FACTORS THAT MAY AFFECT FUTURE RESULTS
QUARTERLY FLUCTUATIONS
The Company's operating results may fluctuate from those in prior quarters
and will continue to be subject to quarterly and other fluctuations due to a
variety of factors, including the extent to which the Company's licensees
incorporate the Company's technologies into their products; the timing of orders
from, and the shipments, to major customers; the timing of new product
introductions by the Company; the gain or
25
<PAGE> 26
loss of significant customers; competitive pressures on selling prices; the
market acceptance of new or enhanced versions of the Company's technologies; the
rate that the Company's semiconductor licensees manufacture and distribute chips
to product manufacturers; and fluctuations in general economic conditions,
particularly those affecting the consumer electronics market. Due to the
Company's dependence on the consumer electronics market, the substantial
seasonality of sales in the market could impact the Company's revenues and net
income. As a result, the Company believes that period-to-period comparisons of
its results of operations are not necessarily meaningful and should not be
relied upon as indications of future performance. The Company believes that
there is seasonality relating to the Christmas season as well as the Chinese New
Year within the Asia region, which fall into the fourth and first quarters,
respectively.
VALENCE'S BUSINESS
The Company derived a significant amount of its revenue from Valence's ASIC
and component distribution business. Valence's engineering team focuses on the
design of custom ASIC to meet specific customers' requirements and outsources
the production of the design to mask houses, foundries and packaging houses
located primarily in Asia. The operations of Valence could be affected by a
variety of factors, including the timing of customer orders, the timing of
development revenue, changes in the mix of products distributed and the mix of
distribution channels employed, the emergence of a new industry standards,
product obsolescence and changes in pricing policies by the Company, its
competitors or its suppliers.
The ASIC business' revenue is concentrated in a limited number of customers
in the areas of consumer electronics, communications products, computers and
computer peripherals. As such, the loss of any such customers or any bad debt
arising from them may have a material adverse impact on the Company's financial
condition and results of operation. Beginning in Fiscal 1999, Valence began to
exit from certain lower margin product offerings in the distribution side of the
business and has begun developing and distributing products that are related to
or incorporate the Company's proprietary technologies. As a result, the
immediate loss in revenue of the low margin distribution business will not be
entirely offset by the new proprietary technology based products, which will
take time to develop and be introduced into the marketplace. There can be no
assurance that the Company will be able to quickly introduce new products to
offset the loss in revenue or that the new products developed will receive a
favorable market acceptance.
The public offering of common shares of ValenceTech Limited in Hong Kong is
intended to bring new capital to grow Valence's core business while, at the same
time, adding significant value to the Company's shareholders. Although the
Company expects that such offering will be completed during the second quarter
of Fiscal 2000, there is no assurance that the offering will be completed during
that time period or at all. Changes in the economic environment of Hong Kong
and/or the PRC may adversely affect the offering or, if the offering is
completed, may adversely affect the market price of the common shares.
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.
INTERNET BUSINESS
In Fiscal 1999, the Company launched its Internet business with the
formation of SRSWOWcast.com, Inc. SRSWOWcast.com plans to develop and acquire
engaging and audio based content to generate and retain visitor traffic to its
web site. The revenue of SRSWOWcast.com will, in turn, depend on fees charged to
third party businesses for advertising on the site as well as e-commerce
products sold to visitors to the site. The Company has planned for other
Internet subsidiaries in different geographical regions to be launched at a
later date by duplicating the business model of SRSWOWcast.com and with content
that is adapted for local
26
<PAGE> 27
culture and taste. However, there can be no assurance that SRSWOWcast.com and
other planned subsidiaries or business ventures will be able to develop or
acquire the content necessary to attract significant Internet traffic or able to
generate substantial revenue from advertising and e-commerce.
PRODUCT BUSINESS
In Fiscal 1999, the Company developed and marketed on its e-commerce site,
www.wowthing.com, its first consumer audio product, the WOW Thing Processor Box.
The WOW Thing Processor Box enhances the sound quality of music downloaded over
the Internet as well as audio performance of computer and home entertainment
products and speakers. This was the Company's first entry into the consumer
market in the United States which is both competitive and demands products with
short life cycles.
The Company intends to expand its offerings of high-end audio enhancement
products in the year 2000 and beyond. There can be no assurance that the Company
will be able to develop an effective distribution channel and build a brand
recognition as a product manufacturer. And as the business increases, it is
anticipated that significant capital will be required to finance product
inventory and account receivables. As a result, the Company is subject to risks
of product obsolescence, bad debt and insufficient finance to grow the business.
The Company also recognizes that as new consumer audio products are
developed and marketed by the Company, there will always exist a potential for a
conflict and competition between the Company and certain of the Company's
technology licensees. Although the intended products of the Company and those of
its licenses do not generally overlap, there can be no assurances that the
Company's products will not compete with those of their licensees. If such
conflicts do materialize, it is uncertain whether the Company will be able to
mitigate the effect of such conflicts, which, if not resolved, may impact the
results of operations.
ECONOMIC RISKS ASSOCIATED WITH DOING BUSINESS IN ASIA, PARTICULARLY IN HONG
KONG AND THE PRC
The Company's significant operations in China and Asia have required, and
will continue to require, refinement to adapt to the changing market conditions
in the region. The Company's operations in Asia, and internationally in general,
are subject to risks of unexpected changes in, or impositions of legislative or
regulatory requirements.
The PRC economy has experienced significant growth in the past decade, but
such growth has been uneven across geographic and economic sectors and has
recently been slowing. There can be no assurance that such growth will not
continue to decrease or that any slow down will not have a negative effect on
the Company's business, including Valence. The PRC economy is also experiencing
deflation which may continue in the future. The current economic situation may
adversely affect the Company's profitability over time as expenditures for
consumer electronics products and information technology may decrease due to the
results of slowing domestic demand and deflation.
Hong Kong is a Special Administrative Region of the PRC with its own
government and legislature. Hong Kong enjoys a high degree of autonomy from the
PRC under the principle of "one country, two systems". The Company can give no
assurance that Hong Kong will continue to enjoy autonomy from the PRC.
The Hong Kong dollar has remained relative constant due to the US dollar
peg and currency board system that has been in effect in Hong Kong since 1983.
Since mid-1997, interest rates in Hong Kong have fluctuated significantly and
real estate and retail sales have declined. The Company can give no assurance
that the Hong Kong economy will not worsen or that the historical currency peg
of the Hong Kong dollar to the U.S. dollar will be maintained. Continued
recession in Hong Kong, deflation or the discontinuation of the currency peg
could adversely affect the Company's business.
CURRENCY RISK/STABILITY OF ASIAN MARKETS
The Company expects that international sales will continue to represent a
significant portion of total revenues. To date, all of the Company's licensing
revenues have been denominated in U.S. dollars and most
27
<PAGE> 28
costs have been incurred in U.S. dollars. It is the Company's expectation that
licensing revenues will continue to be denominated in U.S. dollars for the
foreseeable future. Because Valence and its subsidiaries' business is primarily
focused in Asia and because of the Company's anticipated expansion of its
business in China and other parts of Asia, the Company's consolidated operations
and financial results could be significantly affected by risks associated with
international activities, including economic and labor conditions, political
instability, tax laws (including U.S. taxes on foreign subsidiaries) and changes
in the value of the U.S. dollar versus the local currency in which the products
are sold. In addition, the Company's valuation of assets recorded as a result of
the Valence acquisition may also be adversely impacted by the currency
fluctuations relative to the U.S. dollar. The Company intends to actively
monitor its foreign exchange exposure and to implement strategies to reduce its
foreign exchange risk at such time that the Company determines the benefits of
such strategies outweigh the associated costs. However, there is no guarantee
that the Company will take steps to insure against such risks, and should such
risks occur, there is no guarantee that the Company will not be significantly
impacted. Countries in the Asia Pacific region have experienced weakness in
their currency, banking and equity markets. These weaknesses could adversely
affect consumer demand for Valence's products, the U.S. dollar value of the
Company's and its subsidiaries' foreign currency denominated sales, the
availability and supply of product components to Valence and ultimately, the
Company's consolidated results of operations.
COMPETITIVE PRESSURES
The Company's existing and potential competitors include both large and
emerging domestic and international companies that have substantially greater
financial, manufacturing, technical, marketing, distribution and other
resources. The Company's present or future competitors may be able to develop
products and technologies comparable or superior to those offered by the
Company, and to adapt more quickly than the Company to new technologies or
evolving market needs. The Company believes that the competitive factors
affecting the market for the Company's products and technologies include product
performance, price and quality; product functionality and features; the ease of
integration; and implementation of the products and technologies with other
hardware and software components in the OEM's products. In addition, the markets
in which the Company competes are intensely competitive and are characterized by
rapid technological changes, declining average sales prices and rapid product
obsolescence. Accordingly, there can be no assurance that the Company will be
able to continue to compete effectively in its respective markets, that
competition will not intensify or that future competition will not have a
material adverse effect on the Company's business, operating results, cash flows
and financial condition.
IMPORTANCE OF INTELLECTUAL PROPERTY
The Company's ability to compete may be affected by its ability to protect
its proprietary information. The Company has filed several U.S. and foreign
patent applications and to date has a number of issued U.S. and foreign patents
covering various aspects of its technologies. There can be no assurance that the
steps taken by the Company to protect its intellectual property will be adequate
to prevent misappropriation of its technology or that the Company's competitors
will not independently develop technologies that are substantially equivalent or
superior to the Company's technology. In addition, the laws of certain foreign
countries may not protect the Company's intellectual property rights to the same
extent, as do the laws of the U.S. The semiconductor industry is characterized
by frequent claims and litigation regarding patent and other property rights.
The Company is not currently a party to any claims of this nature. There can be
no assurances that third parties will not assert additional claims or initiate
litigation against the Company or its customers with respect to existing or
future products. In addition, the Company may initiate claims or litigation
against third parties for infringement of the Company's proprietary rights or to
determine the scope and validity of the proprietary rights of the Company or
others.
MANAGEMENT OF GROWTH; DEPENDENCE ON KEY PERSONNEL
The continued growth of the Company and its subsidiaries has placed, and
will continue to place, a significant strain on its administrative, operational
and financial resources, and has increased, and will continue
28
<PAGE> 29
to increase, the level of responsibility for both existing and new management
personnel. The Company's future success depends in part on the continued service
of its key engineering, sales, marketing and executive personnel, including
highly skilled semiconductor design personnel. The Company anticipates that any
future growth will require it to recruit and hire a number of new personnel in
engineering, operations, finance, sales and marketing. Competition for such
personnel is intense, and there can be no assurance that the Company can 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, strategic alliances between the
Company and third parties, general market fluctuations and other events and
factors. Changes in earnings estimates made by brokerage firms and industry
analysts relating to the markets in which the Company does business, or relating
to the Company specifically, have in the past resulted in, and could in the
future result in, an immediate and adverse effect on the market price of the
Common Stock.
ACQUISITIONS
From time-to-time, the Company expects to make acquisitions of businesses
or technologies that are complementary to its business strategy. Such future
acquisitions would expose the Company to risks commonly encountered in
acquisitions of businesses. Such risks include, among others, difficulty of
assimilating the operations, information systems and personnel of the acquired
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.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
Uncertainties that could impede the progress of converting a development
project to a developed technology include the availability of financial
resources to complete the project, 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 associated with
the acquisitions of Valence and VIP will be successfully completed and
commercially introduced.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to a variety of risks, including foreign currency
fluctuations and changes in interest rates affecting the cost of its debt.
FOREIGN CURRENCY
The Company has subsidiary operations in Hong Kong and 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 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
such fiscal years. Under the current circumstances, the Company believes that
the foreign currency market risk is not material. The Company actively monitors
its foreign exchange exposure and, should circumstances change, intends to
29
<PAGE> 30
implement strategies to reduce its risk at such time that it determines that the
benefits of such strategies outweigh the associated costs. There can be no
assurance that management's efforts to reduce foreign exchange exposure will be
successful.
INTEREST RATES
The Company's line of credit bears interest based on the lending bank's
prime rate or LIBOR. The interest rate on the balance of $8 million outstanding
at December 31, 1999 was 6.875%. If interest rates were to increase by 10%, the
impact on the Company's consolidated financial statements would be additional
interest expense of approximately $55,000.
30
<PAGE> 31
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS:
Independent Auditors' Report.............................. 32
Consolidated Balance Sheets as of December 31, 1998 and
1999................................................... 33
Consolidated Statements of Operations for the years ended
December 31, 1997, 1998 and 1999....................... 34
Consolidated Statements of Comprehensive Income (Loss) for
the years ended December 31, 1997, 1998 and 1999....... 34
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1997, 1998 and 1999........... 35
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1998 and 1999....................... 36
Notes to Consolidated Financial Statements................ 38
FINANCIAL STATEMENT SCHEDULE:
Schedule II -- Valuation and Qualifying Accounts and
Reserves for the years ended December 31, 1998 and
1999................................................... 53
</TABLE>
31
<PAGE> 32
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
and Stockholders of
SRS Labs, Inc.:
We have audited the accompanying consolidated balance sheets of SRS Labs,
Inc. (the "Company") as of December 31, 1998 and 1999, and the related
consolidated statements of operations, comprehensive income (loss),
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1999. Our audits also included the financial statement
schedule listed in the Index at Item 14(a)(2). These financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of SRS Labs, Inc. as of December
31, 1998 and 1999, and the results of its operations and its cash flows for each
of the three years in the period ended December 31, 1999, in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, such financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
/s/ DELOITTE & TOUCHE LLP
Costa Mesa, California
March 3, 2000
(March 9, 2000 as to Note 13)
32
<PAGE> 33
SRS LABS, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1999
------------ ------------
<S> <C> <C>
Current Assets
Cash and cash equivalents................................. $ 12,341,242 $ 15,969,678
Investments available for sale............................ 1,519,425 3,011,250
Accounts receivable, net of allowance for doubtful
accounts of $422,138 in 1998 and $1,083,961 in 1999.... 5,320,686 2,495,157
Inventories, net of reserve of $653,370 in 1998 and
$624,844 in 1999....................................... 4,632,968 2,726,193
Prepaid expenses and other current assets, including other
receivables of $2,131,352 in 1998 and $161,258 in
1999................................................... 3,244,233 729,881
Deferred income taxes..................................... 17,456 81,467
------------ ------------
Total Current Assets.............................. 27,076,010 25,013,626
Investments available for sale............................ 10,570,192 6,331,483
Furniture, fixtures and equipment, net.................... 1,219,433 1,166,757
Intangible assets, net.................................... 6,669,671 5,425,273
Deferred income taxes..................................... -- 740,889
Other assets.............................................. -- 422,493
------------ ------------
Total Assets...................................... $ 45,535,306 $ 39,100,521
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable.......................................... $ 10,632,505 $ 2,882,686
Accrued liabilities....................................... 422,843 1,658,964
Line of credit............................................ 8,000,000 8,000,000
Income taxes payable...................................... 376,545 1,518,548
------------ ------------
Total Current Liabilities......................... 19,431,893 14,060,198
Deferred income taxes....................................... 31,240 --
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; 11,688,893 and 11,890,691 shares issued;
and 11,688,893 and 11,819,591 outstanding for 1998 and
1999, respectively..................................... 11,689 11,891
Additional paid-in capital................................ 39,170,103 40,312,336
Deferred stock option compensation........................ 313,302 264,557
Cumulative other comprehensive income..................... 141,389 23,330
Retained deficit.......................................... (13,564,310) (15,308,510)
Treasury stock at cost, -0- and 71,100 shares at December
31, 1998 and 1999...................................... -- (263,281)
------------ ------------
Total Stockholders' Equity........................ 26,072,173 25,040,323
------------ ------------
Total Liabilities And Stockholders' Equity........ $ 45,535,306 $ 39,100,521
============ ============
</TABLE>
See accompanying notes to consolidated financial statements
33
<PAGE> 34
SRS LABS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1997 1998 1999
----------- ------------ -----------
<S> <C> <C> <C>
REVENUES
Chip and licensing revenue......................... $10,081,283 $ 15,762,369 $18,624,221
Product and component sales........................ -- 28,962,671 17,171,362
----------- ------------ -----------
TOTAL REVENUES........................... 10,081,283 44,725,040 35,795,583
COST OF SALES...................................... 210,348 29,819,071 22,002,817
----------- ------------ -----------
GROSS MARGIN....................................... 9,870,935 14,905,969 13,792,766
EXPENSES
Sales and marketing................................ 2,111,839 6,845,674 5,148,458
Research and development........................... 595,689 2,554,883 4,141,571
General and administrative......................... 2,615,706 5,530,957 6,932,397
Acquired in-process research and development....... -- 18,510,378 --
----------- ------------ -----------
TOTAL EXPENSES........................... 5,323,234 33,441,892 16,222,426
INCOME (LOSS) FROM OPERATIONS............ 4,547,701 (18,535,923) (2,429,660)
OTHER INCOME, NET.................................. 1,088,718 704,992 735,122
----------- ------------ -----------
INCOME (LOSS) BEFORE INCOME TAX EXPENSE
(BENEFIT)........................................ 5,636,419 (17,830,931) (1,694,538)
INCOME TAX EXPENSE (BENEFIT)....................... 1,863,200 (273,156) 49,662
----------- ------------ -----------
NET INCOME (LOSS).................................. $ 3,773,219 $(17,557,775) $(1,744,200)
=========== ============ ===========
Net income (loss) per common share:
Basic............................................ $ 0.39 $ (1.54) $ (0.15)
=========== ============ ===========
Diluted.......................................... $ 0.35 $ (1.54) $ (0.15)
=========== ============ ===========
Weighted average shares used in the calculation of
net income (loss) per common share:
Basic............................................ 9,556,015 11,410,346 11,696,272
=========== ============ ===========
Diluted.......................................... 10,852,281 11,410,346 11,696,272
=========== ============ ===========
</TABLE>
SRS LABS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1997 1998 1999
---------- ------------ -----------
<S> <C> <C> <C>
Net income (loss)................................... $3,773,219 $(17,557,775) $(1,744,200)
Other comprehensive income (loss)
Foreign currency translation...................... -- -- (4,827)
Unrealized gain (loss) on investments available
for sale, net of tax........................... 75,912 (22,211) (113,232)
---------- ------------ -----------
Comprehensive income (loss)......................... $3,849,131 $(17,579,986) $(1,862,259)
========== ============ ===========
</TABLE>
See accompanying notes to consolidated financial statements
34
<PAGE> 35
SRS LABS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CUMULATIVE
OTHER
COMMON STOCK DEFERRED RETAINED COMPREHENSIVE
-------------------- ADDITIONAL TREASURY STOCK OPTION EARNINGS INCOME
SHARES AMOUNT PAID-IN CAPITAL STOCK COMPENSATION (DEFICIT) (LOSS)
---------- ------- --------------- --------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, January 1, 1997....... 9,468,548 $ 9,469 $24,678,961 $ -- $ 154,386 $ 220,246 $ 87,688
Proceeds from exercise of
stock options.............. 141,319 141 144,461 -- -- -- --
Tax benefit associated with
exercise of stock
options.................... -- -- 199,015 -- -- -- --
Deferred stock option
compensation............... -- -- -- -- 76,701 -- --
Unrealized gain on
investments available for
sale, net of tax........... -- -- -- -- -- -- 75,912
Net income................... -- -- -- -- -- 3,773,219 --
---------- ------- ----------- --------- --------- ------------ ---------
BALANCE, December 31, 1997..... 9,609,867 9,610 25,022,437 -- 231,087 3,993,465 163,600
Proceeds from exercise of
stock options.............. 213,121 213 311,199 -- -- -- --
Tax benefit associated with
exercise of stock
options.................... -- -- 13,623 -- -- -- --
Deferred stock option
compensation............... -- -- -- -- 82,215 -- --
Unrealized loss on
investments available for
sale, net of tax........... -- -- -- -- -- -- (22,211)
Issuance of common stock to
acquire Valence............ 1,680,611 1,681 12,104,097 -- -- -- --
Issuance of common stock for
noncompetition
agreements................. 125,000 125 900,275 -- -- -- --
Issuance of common stock and
warrants to acquire VIP.... 25,000 25 518,507 -- -- -- --
Issuance of common stock to
acquire Circle Surround.... 35,294 35 299,965 -- -- -- --
Net loss..................... -- -- -- -- -- (17,557,775) --
---------- ------- ----------- --------- --------- ------------ ---------
BALANCE, December 31, 1998..... 11,688,893 11,689 39,170,103 -- 313,302 (13,564,310) 141,389
Proceeds from exercise of
stock options.............. 201,798 202 760,857 -- (170,263) -- --
Tax benefit associated with
exercise of stock
options.................... -- -- 381,376 -- -- -- --
Deferred stock option
compensation............... -- -- -- 121,518 -- --
Treasury stock............... (71,100) -- -- (263,281) -- -- --
Unrealized gain on
investments available for
sale, net of tax........... -- -- -- -- -- -- (113,232)
Currency translation
adjustment................. -- -- -- -- -- -- (4,827)
Net loss..................... -- -- -- -- -- (1,744,200) --
---------- ------- ----------- --------- --------- ------------ ---------
BALANCE, December 31, 1999..... 11,819,591 $11,891 $40,312,336 $(263,281) $ 264,557 $(15,308,510) $ 23,330
========== ======= =========== ========= ========= ============ =========
<CAPTION>
TOTAL
------------
<S> <C>
BALANCE, January 1, 1997....... $ 25,150,750
Proceeds from exercise of
stock options.............. 144,602
Tax benefit associated with
exercise of stock
options.................... 199,015
Deferred stock option
compensation............... 76,701
Unrealized gain on
investments available for
sale, net of tax........... 75,912
Net income................... 3,773,219
------------
BALANCE, December 31, 1997..... 29,420,199
Proceeds from exercise of
stock options.............. 311,412
Tax benefit associated with
exercise of stock
options.................... 13,623
Deferred stock option
compensation............... 82,215
Unrealized loss on
investments available for
sale, net of tax........... (22,211)
Issuance of common stock to
acquire Valence............ 12,105,778
Issuance of common stock for
noncompetition
agreements................. 900,400
Issuance of common stock and
warrants to acquire VIP.... 518,532
Issuance of common stock to
acquire Circle Surround.... 300,000
Net loss..................... (17,557,775)
------------
BALANCE, December 31, 1998..... 26,072,173
Proceeds from exercise of
stock options.............. 590,796
Tax benefit associated with
exercise of stock
options.................... 381,376
Deferred stock option
compensation............... 121,518
Treasury stock............... (263,281)
Unrealized gain on
investments available for
sale, net of tax........... (113,232)
Currency translation
adjustment................. (4,827)
Net loss..................... (1,744,200)
------------
BALANCE, December 31, 1999..... $ 25,040,323
============
</TABLE>
See accompanying notes to consolidated financial statements
35
<PAGE> 36
SRS LABS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1997 1998 1999
----------- ------------ -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................... $ 3,773,219 $(17,557,775) $(1,744,200)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Provision for doubtful accounts......................... -- (82,785) $ 1,040,271
Provision for obsolete inventory........................ -- 353,814 628,006
Depreciation and amortization........................... 341,152 1,888,635 2,127,736
Deferred income taxes................................... 5,615 (298,205) (836,140)
Write-off of acquired in-process research and
development........................................... -- 18,510,378 --
Realized gain on sales of investments available for
sale.................................................. -- (86,337) --
Amortization of premium on investments available for
sale.................................................. 109,817 62,534 54,964
Accretion of consideration due on asset purchase........ 23,844 8,196 --
Increase in deferred stock option compensation.......... 76,701 82,215 121,518
Currency translation adjustment......................... -- -- (4,827)
Loss on disposition of furniture, fixtures and
equipment............................................. -- -- 1,594
Changes in operating assets and liabilities, net of the
effect of acquisitions:
Accounts receivable................................... (3,286,961) 2,024,562 1,785,258
Inventories........................................... -- 1,645,004 1,278,769
Prepaid expenses and other assets..................... (127,186) (2,212,510) 2,091,859
Accounts payable...................................... (73,202) 1,878,303 (7,749,819)
Accrued liabilities................................... 260,103 (403,399) 1,236,121
Income taxes payable.................................. 726,519 (790,542) 1,602,067
----------- ------------ -----------
Net cash provided by operating activities............... 1,829,621 5,022,088 1,633,177
----------- ------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture, fixtures and equipment............... (64,582) (466,368) (464,037)
Proceeds from sales of investments available for sale....... -- 9,467,572 2,500,000
Purchases of investments available for sale................. (580,256) -- --
Cash paid for acquisitions, less cash acquired.............. -- (6,911,216) --
Expenditures related to patents............................. (103,877) (590,555) (368,219)
----------- ------------ -----------
Net cash (used in) provided by investing activities..... (748,715) 1,499,433 1,667,744
----------- ------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from line of credit................................ -- 8,000,000 --
Payments on subsidiary debt................................. -- (6,846,737) --
Payment of consideration due on asset purchase.............. (234,752) (91,707) --
Exercise of stock options................................... 144,602 311,412 590,796
Purchase of treasury stock.................................. -- -- (263,281)
----------- ------------ -----------
Net cash (used in) provided by financing activities..... (90,150) 1,372,968 327,515
----------- ------------ -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS................... 990,756 7,894,489 3,628,436
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............. 3,455,997 4,446,753 12,341,242
----------- ------------ -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................... $ 4,446,753 $ 12,341,242 $15,969,678
=========== ============ ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest................................................ $ -- $ 488,732 $ 179,194
Income taxes............................................ $ 811,700 $ 640,079 $ --
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
Additional consideration accrued for asset purchase..... $ 44,077 $ 8,196 $ --
Unrealized gain (loss) on investments, net.............. $ 75,912 $ (22,211) $ 113,232
Tax benefit associated with exercise of stock options... $ 199,015 $ 13,623 $ 381,376
</TABLE>
See accompanying notes to consolidated financial statements
36
<PAGE> 37
The Company acquired the stock of Valence Technology Inc. ("Valence") on
March 2, 1998 (Notes 2 and 9) and issued 1,680,611 shares of common stock in
payment of $12,105,778 of the acquisition price. The acquisition was accounted
for as a purchase having an effective date of February 1, 1998.
In conjunction with the acquisition, certain liabilities were assumed as
follows:
<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 (Notes 2 and 9).
The Company issued 25,000 shares of common stock and warrants to purchase
100,000 shares of common stock in conjunction with the acquisition of Voice
Intelligibility Processor ("VIP"). The shares and warrants have an ascribed fair
value of $176,575 and $341,957, respectively (Notes 2 and 9).
The Company issued 35,294 shares of common stock in conjunction with the
acquisition of certain rights associated with the Circle Surround technology.
The shares have an ascribed fair value of $300,000 (Notes 2 and 9).
37
<PAGE> 38
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization
SRS Labs, Inc. (the "Company" or "SRS") was incorporated under the laws of
the State of California on June 23, 1993 and reincorporated under the laws of
the State of Delaware on June 28, 1996.
The Company is a developer and provider of technology solutions for the
consumer electronics, computer, game and telecommunications markets. For the
fiscal year ended December 31, 1999, the Company's principal business activities
in these markets included:
- Developing and licensing audio and voice technologies to original
equipment manufacturers ("OEMs") and semiconductor manufacturers around
the world; 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
finished goods for the OEM and retail communities within the Company's
targeted markets.
Basis of Presentation
The consolidated financial statements include the Company and its wholly
owned subsidiaries, Valence Technology Inc. ("Valence") and SRSWOWcast.com,
Inc., after elimination of all intercompany accounts and transactions.
Cash Equivalents
Cash and cash equivalents generally consist of cash, money market funds and
other money market instruments with original or remaining maturities of three
months or less at the date of purchase.
Investments
The Company accounts for investments in accordance with Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities". Investments, consisting primarily of
municipal bonds, have been classified as available for sale and are reported at
fair value, based on quoted market prices, in the accompanying consolidated
balance sheets. Unrealized gains and losses, net of applicable income taxes, are
reported as a separate component of stockholders' equity.
Inventories
Inventories, which consist of finished goods, are stated at the lower of
cost or net realizable value. Cost is calculated using the weighted average
method and is comprised of material costs and, where applicable, subcontracting
and overhead costs that have been incurred in bringing the inventories to their
present location and condition. Net realizable value represents the estimated
selling price less estimated costs to completion and costs to be incurred in
selling and distribution.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are stated at cost, net of accumulated
depreciation and amortization. Depreciation and amortization are provided for
using the straight-line method, which amortizes cost over the lesser of the
estimated useful lives of the respective assets or the term of the related
lease. Useful lives range from three to five years.
38
<PAGE> 39
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
Patents and Other Intangible Assets
Costs paid by the Company related to the establishment and transfer of
patents, primarily legal costs, are capitalized and amortized over periods
ranging from five to ten years, depending on the estimated life of the
technology patented.
Consideration for the purchase of assets in excess of the fair market value
of specifically identified tangible assets has been capitalized as other
intangible assets in the accompanying consolidated balance sheets. These assets
are being amortized over periods ranging from three to eleven years depending on
the useful life of the asset. The Company annually evaluates the recoverability
of its intangible assets based on the estimated future undiscounted cash flows.
Should the carrying value of intangible assets exceed the estimated operating
incomes for the expected periods of benefit, impairment for the excess is
recorded at that time.
Other Assets
Other assets consist primarily of notes receivable with expected collection
dates beyond December 31, 2000.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles necessarily requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported revenues and expenses during the reporting periods.
Actual results could differ from these estimates.
Revenue Recognition
Royalty revenues associated with ongoing royalty license agreements are
recognized when license payments are due upon receipt of reports from licensees
stating the number of products implementing SRS patented technologies on which
royalties are due. Licensing revenues for one-time technology transfer fees are
recognized in the period in which the license agreement is consummated and the
related technology is transferred.
Revenue from product sales is generally recognized upon shipment. Design
revenue under design contracts is recognized on the percentage-of-completion
method. Estimates are reviewed and revised periodically throughout the lives of
the contracts. Any revisions are recorded in the accounting period in which the
revisions are made.
Commission income derived from the Company's distribution activities is
recognized on an accrual basis in the period when earned.
Research and Development
Research and development expenses include costs and expenses associated
with the development of the Company's design methodology and the design and
development of new products, including initial nonrecurring engineering and
product verification charges from foundries. Research and development is
expensed as incurred.
39
<PAGE> 40
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." Deferred taxes on income result from temporary
differences between the reporting of income for financial statement and tax
reporting purposes.
Foreign Currency Translation
The Company's reporting currency is the U.S. dollar, while the functional
currency of Valence is the Hong Kong dollar. Assets and liabilities of Valence
are translated at the rate of exchange on the balance sheet date. Revenues and
expenses are translated using the average exchange rate for the period.
Translation adjustments resulting from the process of translating foreign
currency financial statements into U.S. dollars are included as a separate
component of stockholders' equity (other comprehensive income). Translation
adjustments were $0 and $4,827 during the years ended December 31, 1998 and
1999. Transaction gains and losses arising on exchange are recognized as
incurred in the statements of operations and aggregated $76,000 (gain) and
$26,775 (loss) during the years ended December 31, 1998 and 1999.
Net Income (Loss) Per Common Share
Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings
per Share," which requires the disclosure of basic and diluted earnings per
share for all current and prior periods. Basic net income (loss) per common
share is computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding during each year. Diluted
net income per common share reflects the maximum dilution, based on the average
price of the Company's common stock each period and is computed similar to basic
income (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 had been exercised. Common stock equivalents have not
been included in calculating diluted net income (loss) per share where inclusion
would be anti-dilutive.
The following is an illustration of the reconciliation of the numerators
and the denominators of the basic and diluted net income (loss) per common share
computations:
<TABLE>
<CAPTION>
FOR YEAR ENDED DECEMBER 31, 1997 FOR YEAR ENDED DECEMBER 31, 1998
--------------------------------------- ----------------------------------------
INCOME SHARES PER SHARE INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- --------- ------------ ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Basic:
Income (loss) available to
common stockholders........... $3,773,219 9,556,015 $0.39 $(17,557,775) 11,410,346 $(1.54)
===== ======
Diluted Effect of dilutive
securities.................... -- 1,296,266 -- --
---------- ---------- ------------ ----------
Stock options
Income available to common
stockholders plus assumed
conversion.................... $3,773,219 10,852,281 $0.35 $(17,557,775) 11,410,346 $(1.54)
========== ========== ===== ============ ========== ======
<CAPTION>
FOR YEAR ENDED DECEMBER 31, 1999
---------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Basic:
Income (loss) available to
common stockholders........... $(1,744,200) 11,696,272 $(0.15)
======
Diluted Effect of dilutive
securities.................... -- --
----------- ----------
Stock options
Income available to common
stockholders plus assumed
conversion.................... $(1,744,200) 11,696,272 $(0.15)
=========== ========== ======
</TABLE>
Stock-Based Compensation
The Company accounts for stock-based awards to employees using the
intrinsic value method in accordance with Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees."
Fair Value of Financial Instruments
Management believes the carrying amounts of cash and cash equivalents,
accounts receivable and accounts payable approximate fair value due to the short
period of time between origination of the instruments
40
<PAGE> 41
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
and their expected realization. Management also believes the carrying amounts of
investments available for sale approximate fair value as the investments are
recorded at fair value based on quoted market prices (Note 3). Management
believes the carrying amount of balances outstanding under the line of credit
approximate fair value as the underlying interest rates reflect market rates.
Customer Concentration
During the years ended December 31, 1997 and 1998, two customers (not
necessarily the same customers each year) accounted for 39% and 40%,
respectively, of revenues. For Fiscal 1999, one customer accounted for 21% of
revenues. Given the significant amount of revenues derived from these customers,
the loss of any such customer or the uncollectibility of related receivables
could have a material adverse effect on the Company's financial condition and
results of operations.
Concentrations of Credit Risk
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist primarily of cash equivalents,
investments, trade accounts receivable and the bank credit line. The Company
places its cash in banks and its cash equivalents in commercial paper.
Investments consist primarily of short-term and long-term municipal bonds. The
Company has not experienced any significant losses on its cash equivalents or
investments. Market risk on the bank credit line relates to changes in the
bank's lending rates, including the bank's reference rate and LIBOR, on which
interest charges on the Company's borrowings under the line are based.
The Company's trade receivables are derived from sales to manufacturers and
distributors in the consumer electronics, computer and communications markets
primarily in Asia, North America and Europe. The Company makes periodic
evaluations of the creditworthiness of its customers and manages its exposure to
losses from bad debts by limiting the amount of credit extended whenever deemed
necessary and generally does not require collateral. The Company maintains a
provision for potential credit losses and such losses have historically been
within management's expectations.
Geographic Risk
The Asian consumer electronics markets accounted for approximately 94% and
92% of total Company sales in 1999 and 1998 and are expected to continue to
account for a substantial percentage of sales in the future. The recent economic
crisis in Asia has been characterized by declines in consumer spending, currency
devaluation, unemployment and bank failures. Any of these factors, should they
continue, could significantly reduce the demand for the end user goods in which
the Company's products are used.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, which is effective
for fiscal years beginning after June 15, 2000. This standard establishes
accounting and reporting standards for derivative instruments and for hedging
activities and requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. The Company does not believe that the adoption of
this new standard will have a material impact on its financial position or
results of operations.
Reclassifications
Certain amounts as previously reported have been reclassified to conform to
the current year presentation.
41
<PAGE> 42
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
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 operations 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 manufacturers and (ii) the
sale of consumer electronic and telecommunications products and components.
The Valence acquisition included certain assets and liabilities and all
intellectual property rights to the products as well as in-process research and
development activities. The aggregate purchase price of $19,500,000, excluding
acquisition costs and non-compete agreements, consisted of approximately
$7,400,000 in cash, of which the Company utilized its existing cash balances and
1,680,611 shares of the Company's common stock with a fair value of $12,105,778.
The acquisition was accounted for as a purchase having an effective date of
February 1, 1998, and accordingly, the total purchase price was allocated to the
assets acquired and liabilities assumed at their estimated fair values in
accordance with APB Opinion No. 16. The Company's consolidated statement of
operations for the year ended December 31, 1998 includes a charge of $17.5
million for the write-off of acquired in-process research and development
expense associated with the Valence acquisition. In connection with the
acquisition, three of the four management shareholders and their respective sole
shareholders, each of whom was a key employee of Valence or one of its
subsidiaries, entered into non-competition agreements with the Company. In
consideration for these agreements and for a nominal cash payment equal to the
par value of the shares, the Company issued 125,000 additional shares of its
common stock, with a fair value of $900,400 in aggregate, to such three
shareholders. The following summarizes the consideration granted for the
acquisition of Valence and the non-compete agreements, the allocation of the
purchase price and other purchase accounting adjustments:
<TABLE>
<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
Developed technology...................................... 1,200,000
Cell library.............................................. 1,150,000
Customer list............................................. 1,000,000
Workforce................................................. 1,000,000
Non-compete agreement..................................... 900,400
Brand name................................................ 660,000
-----------
$23,382,068
===========
</TABLE>
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 life, reflecting the estimated stages of completion of the projects and
the estimated costs to complete the projects.
42
<PAGE> 43
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
New product development projects underway at Valence at the time of the
acquisition included, among others, ASICs for consumer electronics, computing
and voice and audio applications, home entertainment systems, digital multimedia
players and digital power amplifiers. The Company estimated that these projects
were approximately 63% complete at the date of acquisition and estimated that
the cost to complete these projects will aggregate approximately $7 million and
will be incurred over a three-year period.
Uncertainties that could impede the progress of converting a development
project to a developed technology include the availability of financial
resources to complete the project, failure of the technology to function
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 in-process research and development projects will be successfully
completed and commercially introduced.
The following unaudited pro forma consolidated condensed statement of
operations for the year ended December 31, 1997 has been prepared by combining
the statement of operations of SRS for the year ended December 31, 1997 with the
consolidated statement of operations of Valence for the year ended March 31,
1998. Pro forma results for the year ended December 31, 1998 do not differ
materially from the results of operations set forth in the accompanying
statement of operations. The pro forma information is presented for information
purposes only and is not necessarily indicative of what actually would have
occurred if the acquisition had been in effect for the entire period presented,
or of future operations of the combined companies.
<TABLE>
<CAPTION>
PRO FORMA
YEAR ENDED
DECEMBER 31, 1997
-----------------
<S> <C>
Revenues.................................................... $47,377,020
Costs and expense........................................... 45,369,225
-----------
Net income.................................................. $ 2,007,795
===========
Net income per share........................................ $ 0.16
===========
</TABLE>
On February 28, 1998, the Company acquired certain rights to a proprietary
technology, Voice Intelligibility Processor ("VIP"), from a third party. The
aggregate consideration, including acquisition costs, was $1,138,710 and was
comprised of $620,178 in cash, 25,000 shares of the Company's common stock with
a fair value of $176,575 and warrants to purchase 100,000 shares of the
Company's common stock at $9.47 per share with a fair value of $341,957. The
portion of the purchase price allocated to acquired in-process research and
development, $1,038,710, was charged to the Company's operations. The remainder
of the purchase price was allocated to an intangible asset and is being
amortized over eight years.
The following summarizes the consideration granted for the acquisition of
VIP, the allocation of the purchase price and other purchase accounting
adjustments:
<TABLE>
<S> <C>
Cash........................................................ $ 500,000
Common stock and warrants................................... 518,532
Acquisition costs........................................... 120,178
----------
Total purchase price.............................. $1,138,710
==========
Allocation to:
In-process research and development....................... $1,038,710
Intangible assets......................................... 100,000
----------
$1,138,710
==========
</TABLE>
43
<PAGE> 44
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
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 life, reflecting the estimated stages of completion of the projects and
the costs to complete the projects.
New product development projects utilizing the VIP technology at the time
of the acquisition included, among others, digital and analog sound
reinforcement, wireless and non-wireless telecommunications applications,
hearing aid applications, and headphone and microphone applications. The Company
estimated that these projects were approximately 62% complete at the date of
acquisition and estimated that the cost to complete these projects will
aggregate approximately $525,000 and will be incurred over a two-year period.
Uncertainties that could impede the progress of converting a development
project to a developed technology include the availability of financial
resources to complete the project, failure of the technology to function
properly, continued economic feasibility of developed technologies, customer
acceptance, customer demand and customer qualification of such new technology
and general competitive conditions in the industry. There can be no assurance
that the in-process research and development projects will be successfully
completed and commercially introduced.
The Company's financial statements for the year ended December 31, 1998,
reflect one-time charges related to in-process research and development expenses
of $17,471,668 associated with the Valence acquisition and $1,038,710 associated
with the VIP acquisition.
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. INVESTMENT SECURITIES AVAILABLE FOR SALE
The following table summarizes the Company's investment securities
available for sale as of December 31, 1998 and 1999:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1998 1999
----------- ----------
<S> <C> <C>
Municipal bonds available for sale:
Cost............................................. $11,849,972 $9,295,010
Unrealized gains................................. 239,645 47,723
----------- ----------
Estimated fair value............................. $12,089,617 $9,342,733
=========== ==========
</TABLE>
44
<PAGE> 45
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
The contractual maturities of investments at December 31, 1998 and 1999,
are shown below. Actual maturities may differ from contractual maturities.
<TABLE>
<CAPTION>
1998 1999
-------------------------- ------------------------
ESTIMATED ESTIMATED
COST FAIR VALUE COST FAIR VALUE
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Municipal bonds:
Due in one year or
less.................. $ 1,505,168 $ 1,519,425 $2,993,206 $3,011,250
Due in one to five
years................. 9,344,804 9,570,192 6,301,804 6,331,483
Due in five to ten
years................. -- -- -- --
Due after ten years...... 1,000,000 1,000,000 -- --
----------- ----------- ---------- ----------
$11,849,972 $12,089,617 $9,295,010 $9,342,733
=========== =========== ========== ==========
</TABLE>
4. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment, net, consist of the following at
December 31, 1998 and 1999:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1998 1999
---------- -----------
<S> <C> <C>
Furniture, fixtures and equipment.................. $ 753,446 $ 847,117
Computer equipment................................. 1,008,751 1,366,595
Leasehold improvements............................. 138,900 145,408
---------- -----------
1,901,097 2,359,120
Less accumulated depreciation and amortization..... (681,664) (1,192,363)
---------- -----------
$1,219,433 $ 1,166,757
========== ===========
</TABLE>
5. INTANGIBLE ASSETS
Intangible assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1999
----------- -----------
<S> <C> <C>
Goodwill.......................................... $ 711,886 $ 711,886
Patents........................................... 1,786,497 2,154,716
Developed technology.............................. 1,200,000 1,200,000
Cell library...................................... 1,150,000 1,150,000
Customer list..................................... 1,000,000 1,000,000
Workforce......................................... 1,000,000 1,000,000
Non-compete agreement............................. 900,400 900,400
Brand name........................................ 660,000 660,000
----------- -----------
8,408,783 8,777,002
Less accumulated amortization..................... (1,739,112) (3,351,729)
----------- -----------
$ 6,669,671 $ 5,425,273
=========== ===========
</TABLE>
Amortization periods range from three to eleven years depending on the
estimated useful life of the asset.
6. FINANCING ARRANGEMENTS
On March 4, 1998, the Company obtained a revolving line of credit (and
letter of credit facility) with a bank which expires on April 1, 2001 and is
secured by certain of the Company's investments. The total
45
<PAGE> 46
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
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 (8.5% as of December 31, 1999) or LIBOR plus
0.75% (6.875% as of December 31, 1999). As of December 31, 1999, the Company had
$8.0 million outstanding under the line of credit and was contingently liable
for $1,000,000 under an irrevocable letter of credit which expires July 31,
2000.
In November 1999, Valence and its subsidiaries obtained a credit facility
with a bank that provides for borrowings aggregating approximately $5,000,000.
The facility has no fixed expiration date and is collateralized by certain of
Valence's assets on deposit with the bank. The facility provides for a variety
of import/ export trade instruments which bear interest rates ranging from 1%
over the Hong Kong Dollar prime rate to 1.75% over LIBOR. The facility also
provides for a revolving line of credit of up to $3,500,000 which bears interest
at 1.25% over the related collateral deposit interest rate. At December 31,
1999, there were no obligations outstanding under this credit facility.
7. COMMITMENTS AND CONTINGENCIES
The Company leases office space and certain equipment under noncancelable
operating leases expiring through 2001.
The Company leases its corporate office and storage facilities located in
Santa Ana, California, under a lease agreement with a partnership which is
affiliated with a stockholder and officer of the Company. The lease is for a
term of three years, commencing June 1, 1997, with an option to extend the term
for an additional two years thereafter. Additionally, the Company leases several
offices and warehouses in Hong Kong and China from unrelated parties. Total rent
expense incurred on office facilities and equipment was $129,369, $646,498 and
$604,198 for the years ended December 31, 1997, 1998, and 1999, respectively, of
which $129,369, $165,672 and $165,672 was paid to related parties, respectively.
Future annual minimum lease payments under noncancelable operating leases at
December 31, 1999, are as follows:
<TABLE>
<CAPTION>
YEAR ENDING OFFICE
DECEMBER 31, FACILITY EQUIPMENT TOTAL
------------ -------- --------- --------
<S> <C> <C> <C>
2000..................................... $317,562 $ 9,306 $326,868
2001..................................... -- 7,000 7,000
-------- ------- --------
$317,562 $16,306 $338,868
======== ======= ========
</TABLE>
Litigation -- The Company is involved from time to time in litigation or
claims arising in the ordinary course of its business. While the ultimate
liability, if any, arising from these claims cannot be predicted with certainty,
the Company believes that the resolution of these matters will not likely have a
material adverse effect on the Company's financial statements.
46
<PAGE> 47
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
8. INCOME TAXES
For the years ended December 31, 1997, 1998 and 1999, the provision
(benefit) for income taxes consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------
1997 1998 1999
---------- --------- -----------
<S> <C> <C> <C>
Current:
Federal............................. $1,078,637 $(679,205) $ 35,553
State............................... 482,791 35,963 88,282
Foreign............................. 296,157 668,291 761,967
---------- --------- -----------
1,857,585 25,049 885,802
Deferred:
Federal............................. (15,724) (161,286) (1,583,931)
State............................... 21,339 (136,919) (281,414)
Foreign............................. -- -- (125,196)
Valuation allowance................. -- -- 1,154,401
---------- --------- -----------
5,615 (298,205) (836,140)
---------- --------- -----------
$1,863,200 $(273,156) $ 49,662
========== ========= ===========
</TABLE>
The reconciliation of the provision (benefit) for income taxes computed at
U.S. federal statutory rates to the provision for income taxes for the years
ended December 31, 1996, 1997 and 1998 is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------
1997 1998 1999
---------- ----------- -----------
<S> <C> <C> <C>
Tax at U.S. federal statutory
rates.............................. $1,916,382 $(6,240,826) $ (593,088)
State income taxes................... 334,079 (75,645) (127,467)
Tax exempt interest.................. (365,194) (150,766) (35,862)
Change in valuation allowance........ -- -- 1,028,398
Intangibles.......................... -- 5,940,367 --
Other................................ (22,067) 253,714 (222,319)
---------- ----------- -----------
Total income tax expense
(benefit)................ $1,863,200 $ (273,156) $ 49,662
========== =========== ===========
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1997 1998 1999
-------- -------- -----------
<S> <C> <C> <C>
Deferred tax assets (liabilities):
State income taxes..................... $121,952 $(54,085) $ (149,765)
Depreciation and amortization.......... 247,038 (13,810) 78,191
Accruals not currently deductible...... 30,907 5,383 74,223
Net operating losses................... -- 26,712 1,433,151
Tax credits............................ -- 22,016 540,957
Valuation allowance.................... -- -- (1,154,401)
-------- -------- -----------
Total net deferred tax assets
(liability).................. $399,897 $(13,784) $ 822,356
======== ======== ===========
</TABLE>
47
<PAGE> 48
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
The Company has federal and state net operating loss carry forwards at
December 31, 1999, of approximately $3.4 million and $3.1 million, respectively.
These net operating loss carry forwards will begin to expire in 2019 and 2003,
respectively. In addition, the Company has federal tax credit carry forwards of
approximately $541,000 which will begin to expire in 2003.
As of December 31, 1999, a valuation allowance of $1,154,401 has been
provided based on the Company's assessment of the future realizability of
certain deferred tax assets. Approximately $126,000 of the valuation allowance
is attributable to the potential tax benefit of stock option transactions that
will be credited directly to additional paid in capital, if realized.
9. STOCKHOLDERS' EQUITY
ISSUANCE OF COMMON STOCK
Stock Repurchases
During the fiscal year ended December 31, 1998 ("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 December 31, 1999,
71,100 shares had been repurchased at a cost of $263,281. Such repurchased
shares are reflected as treasury stock in the accompanying consolidated balance
sheets.
On March 2, 1998, the Company issued 1,680,611 shares of common stock in
conjunction with the acquisition of Valence (Note 2). On February 28, 1998, the
Company issued 25,000 shares of common stock in conjunction with the acquisition
of the VIP technology (Note 2). On May 29, 1998, the Company issued 35,294
shares of common stock in conjunction with the acquisition of the Circle
Surround technology (Note 2).
Stock Award/Option Plans
On December 10, 1993, the Company's Board of Directors and shareholders
adopted an Incentive Stock Option, Nonqualified Stock Option and Restricted
Stock Purchase Plan (the "1993 Plan"). Under the 1993 Plan, 801,971 shares of
the Company's common stock are reserved for issuance to executives, employees
and non-employee directors of the Company at the discretion of the Board of
Directors or the committee administering the 1993 Plan. The Compensation
Committee of the Board or, in the absence of a Compensation Committee, the Board
has been appointed to administer the 1993 Plan. Options issued under the 1993
Plan vest in the manner prescribed by the Compensation Committee or the Board,
as applicable. As of December 31, 1999, options to purchase 801,971 shares of
the Company's common stock were granted under the 1993 Plan.
In June 1997, the Company's Board of Directors adopted and the Company's
stockholders approved the Amended and Restated 1996 Long-Term Incentive Plan
(the "1996 Plan"), for which 2,000,000 shares of the Company's common stock were
reserved for issuance to officers, employees and consultants of the Company. If
any award granted under the 1996 Plan expires, terminates or is forfeited before
the exercise thereof or the payment in full thereof, the shares covered by the
unexercised or unpaid portion will become available for new grants under the
1996 Plan. In June 1998, the Company's Board of Directors adopted and the
Company's stockholders approved an amendment to the 1996 Plan to increase the
number of shares in the plan by 2,500,000. Also in June 1998, in a separate
amendment, the Company's Board of Directors and the Company's stockholders
approved an amendment to allow all directors of the Company and any subsidiary
of the Company to participate in the 1996 Plan. The Compensation Committee or,
in the absence of a Compensation Committee, the Board of Directors has been
appointed to administer the 1996 Plan. Options issued under the 1996 Plan vest
in the manner prescribed by the Compensation Committee or the Board, as
48
<PAGE> 49
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
applicable. As of December 31, 1999, options to purchase 5,149,445 shares of the
Company's common stock were granted under the 1996 Plan.
In July 1996, the Company's Board of Directors adopted and the Company's
stockholders approved the 1996 Non-employee Directors Stock Option Plan (the
"Non-employee Directors Plan"), a non-discretionary formula plan for which
120,000 shares of the Company's common stock are reserved for issuance to the
Company's non-employee directors. The Non-employee Directors Plan is
administered by a committee consisting of all directors who are not eligible to
participate in the Non-employee Directors Plan. With the exception of the
initial option granted to a non-employee director, which vests immediately,
options granted under the Non-employee Directors Plan vest over a three-year
period, the first installment vesting on the date of grant. In June 1999, the
shareholders approved the Amended and Restated 1996 Nonemployee Directors' Stock
Option Plan. Among the changes set forth in the Amended and Restated Plan was to
increase by 130,000 the number of shares of common stock that may be issued. As
of December 31, 1999, options to purchase 100,000 shares of common stock were
granted under the Non-employee Directors Plan.
On February 28, 1998, warrants were granted for the purchase of up to
100,000 common shares of the Company at a price per share of $9.47 to certain
parties in connection with the acquisition of VIP ("VIP Warrants") (Note 2).
The following table summarizes stock option activity under all of the
Company's stock option plans and the VIP Warrants (Note 2) for the periods
indicated:
<TABLE>
<CAPTION>
WEIGHTED
OPTIONS AVERAGE
OUTSTANDING EXERCISE PRICE
----------- --------------
<S> <C> <C>
Outstanding at January 1, 1997..................... 2,176,596 $4.16
Granted.......................................... 1,366,801 $5.70
Stock options exercised.......................... (141,319) $1.02
Forfeited........................................ (1,017,582) $7.68
----------
Outstanding at December 31, 1997................... 2,384,496 $3.69
Granted.......................................... 2,898,500 $5.06
Stock options exercised.......................... (213,121) $1.44
Forfeited........................................ (150,667) $4.88
----------
Outstanding at December 31, 1998................... 4,919,208 $4.54
Granted.......................................... 1,255,875 $3.39
Stock options exercised.......................... (201,798) $2.93
Forfeited........................................ (888,742) $5.17
----------
Outstanding at December 31, 1999................... 5,084,543 $4.23
==========
</TABLE>
49
<PAGE> 50
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
The following table summarizes information concerning currently outstanding
and exercisable options:
<TABLE>
<CAPTION>
WEIGHTED EXERCISABLE
NUMBER OF AVERAGE WEIGHTED AS OF WEIGHTED
RANGE OF OPTIONS REMAINING AVERAGE DECEMBER 31, AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE 1999 EXERCISE PRICE
- --------------- ----------- ---------------- -------------- ------------ --------------
<S> <C> <C> <C> <C> <C>
$0.00 - $ 1.05 252,807 4.2 $0.2634 252,807 $0.2634
$2.10 - $ 3.15 850,177 6.8 $2.7064 500,834 $2.7023
$3.15 - $ 4.20 1,680,331 7.4 $3.6602 513,481 $4.1390
$4.20 - $ 5.25 756,237 6.7 $4.9789 560,135 $4.9716
$5.25 - $ 6.30 1,263,250 8.4 $5.5019 364,875 $5.5090
$6.30 - $ 7.35 129,500 8.1 $6.6578 41,750 $6.6504
$7.35 - $ 8.40 30,000 6.6 $8.0000 30,000 $8.0000
$9.45 - $10.50 122,241 2.9 $9.6467 120,430 $9.6359
--------- --- ------- --------- -------
5,084,543 7.2 $4.2314 2,384,312 $4.2017
</TABLE>
On December 1, 1995, options were granted for the purchase of up to 300,875
common shares at prices of $4.14 to $4.56 per share, which the Company's Board
of Directors deemed the fair market value of the common stock at the date of
grant. The Company recorded compensation expense resulting from the difference
between the option price per share and the estimated fair market value of the
common stock ($4.99) determined by a third-party appraisal completed in May
1996, totaling $236,456. This amount is recorded ratably over the vesting period
of the respective options. During the years ended December 31, 1997, 1998 and
1999, the Company recorded $56,397, $26,828 and $7,306, respectively, of
deferred compensation expense associated with these stock option grants. In
addition, during the years ended December 31, 1997, 1998 and 1999, the Company
recorded $20,304, $55,387 and $114,212, respectively, of deferred compensation
expense related to stock options granted to non-employee contractors.
On March 5, 1999, pursuant to a technology license agreement entered into
by the Company and a customer, options were granted to the customer to purchase
up to 50,000 shares of common stock at an exercise price of $3.94 per share. The
fair value of the grant is being recognized as compensation expense ratably over
the vesting period of the options. The Company recognized $30,857 of
compensation expense relating to these options in Fiscal 1999. In addition to
the 50,000 options granted in 1999, the Company has an obligation to grant up to
200,000 additional options if the customer meets specified performance criteria
as defined by the agreement. The exercise price of additional option grants will
be the fair market value of the common stock at the date of grant.
SFAS No. 123, Accounting for Stock-Based Compensation, requires the
disclosure of pro forma net income and earnings per share had the Company
adopted the fair value method as of the beginning of fiscal 1995. Under SFAS No.
123, the fair value of stock-based awards to employees is calculated through the
use of option pricing models, even though such models were developed to estimate
the fair value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option awards.
These models also require subjective assumptions, including future stock price
volatility and expected time to exercise, which greatly affect the calculated
values. The Company's calculations were made using the Black-Scholes
option-pricing model with the following weighted average assumptions:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Expected life.......................... 60 months 60 months 60 months
Stock volatility....................... 69% 57% 65%
Risk-free interest rate................ 5.45% 5.50% 5.9%
</TABLE>
50
<PAGE> 51
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
The Company's calculations are based on a single option valuation approach
and forfeitures are recognized as they occur. If the computed fair values of the
1997, 1998 and 1999 awards had been amortized to expense over the vesting period
of the awards, pro forma net income (loss) would have been $3,429,526, or $.32
per share in 1997; ($18,684,945), or ($1.77) per share in 1998; and ($3,392,244)
or ($.35) per share in 1999. However, the impact of outstanding nonvested stock
options granted prior to 1995 has been excluded from the pro forma calculation;
accordingly, the 1997, 1998 and 1999 pro forma adjustments are not indicative of
future period pro forma adjustments, when the calculation will apply to all
applicable stock options.
10. 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. Therefore, segment information is
presented for 1999 and 1998 only.
<TABLE>
<CAPTION>
BUSINESS SEGMENTS
-----------------------------------------------
CHIPS AND PRODUCT AND
LICENSING COMPONENT SALES TOTAL
----------- ----------------- -----------
<S> <C> <C> <C>
Year ended December 31, 1998
Net revenues..................... $15,762,369 $28,962,671 $44,725,040
Cost of sales.................... 4,084,805 25,734,266 29,819,071
----------- ----------- -----------
Gross margin..................... $11,677,564 $ 3,228,405 $14,905,969
=========== =========== ===========
Year ended December 31, 1999
Net revenues..................... $18,624,221 $17,171,362 $35,795,583
Cost of sales.................... 6,095,197 15,907,620 22,002,817
----------- ----------- -----------
Gross margin..................... $12,529,024 $ 1,263,742 $13,792,766
=========== =========== ===========
</TABLE>
The following schedule presents the Company's revenue by geographic area.
For product sales, revenue is allocated based on the country to which product
was shipped. For licensing-related revenue, the allocation is based on the
location of the licensee's corporate headquarters. The Americas region includes
North, Central and South America.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
REGION REVENUE 1998 1999
-------------- ----------- -----------
<S> <C> <C>
Asia Pacific...................................... $41,502,348 $33,536,423
Americas.......................................... 3,017,596 1,268,918
Europe............................................ 205,096 990,242
----------- -----------
Total................................... $44,725,040 $35,795,583
=========== ===========
</TABLE>
11. RELATED-PARTY TRANSACTIONS
The Company shares certain general and administrative expenses with an
affiliated company which is 100% owned by a Company officer/stockholder.
Pursuant to a written agreement which was terminated on December 31, 1997,
one-half of these expenses were allocated to the Company during 1997.
The Company leases its corporate office and storage facilities located in
Santa Ana, California, under a lease agreement with a partnership which is
affiliated with a stockholder and officer of the Company. The
51
<PAGE> 52
SRS LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
original lease term commenced on June 1, 1994 and expired on May 31, 1997. Upon
expiration, the Company entered into a new lease agreement for additional space
at the same facility with the same lessor. The new lease is for a term of three
years, commencing June 1, 1997, with an option to extend the term for an
additional two years thereafter.
During the years ended December 31, 1997, 1998 and 1999, total revenue from
an affiliated company which is 100% owned by a Company officer/stockholder,
amounted to $17,779, $6,834 and $1,326, respectively. As of December 31, 1998
and 1999, accounts receivable from this affiliated company were $9,646 and $0,
respectively. Amounts due to this affiliated company were $1,747 and $0 as of
December 31, 1998 and 1999, respectively.
A stockholder of the Company paid $2,500,000 in license royalties to the
Company during the year ended December 31, 1997. There were no license royalties
from this stockholder during the years ended December 31, 1998 or 1999.
12. EMPLOYEE BENEFIT PLAN
The Company's employees based in the United States may participate in a
salary deferral plan (the "401(k) Plan") in which eligible employees can
contribute up to 15% of their eligible compensation. The Company also may
contribute on a discretionary basis. During the years ended December 31, 1997,
1998 and 1999, the Company did not contribute to the 401(k) Plan.
13. SUBSEQUENT EVENTS
On March 3, 2000, ValenceTech Limited (a newly formed holding company of
Valence Technology Inc.) filed an application to list its shares on the Growth
Enterprise Market (GEM) of the Hong Kong Stock Exchange.
On March 9, 2000, the Company entered into a technology and marketing
alliance with a third party. In conjunction with this transaction, the third
party purchased 290,529 shares of the Company's common stock for $17.21 per
share or $5 million in the aggregate. The difference between the purchase price
and the fair value of the common stock on the date of purchase, totalling
approximately $555,000, will be recorded as an expense by the Company during the
quarter ended March 31, 2000. Additionally, the Company granted to the third
party a warrant to purchase up to 200,000 shares of the common stock of SRS
Labs, Inc. and the Company's wholly-owned subsidiary, SRSWOWcast.com,Inc.,
granted a warrant to purchase up to 1,250,000 shares of its common stock. The
fair value of these warrants, aggregating approximately $2,550,000, also will be
recorded as an expense by the Company during the quarter ended March 31, 2000.
52
<PAGE> 53
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
<TABLE>
<CAPTION>
ADDITIONS
ADDITIONS (REDUCTIONS)
BALANCE AT DUE TO CHARGED TO BALANCE
BEGINNING BUSINESS COSTS AND AT END
OF PERIOD ACQUISITIONS EXPENSE DEDUCTIONS OF PERIOD
---------- ------------ ------------ ---------- ----------
<S> <C> <C> <C> <C> <C>
For the year ended December 31, 1998:
Allowance for doubtful accounts...... $ -- $ 647,600 $ (82,785) $(142,677) $ 422,138
======== ========== ========== ========= ==========
Inventory reserve.................... $ -- $1,275,097 $ 353,814 $(975,541) $ 653,370
======== ========== ========== ========= ==========
For the year ended December 31, 1999:
Allowance for doubtful accounts...... $422,138 $ -- $1,040,271 $(378,448) $1,083,961
======== ========== ========== ========= ==========
Inventory reserve.................... $653,370 $ -- $ 628,006 $(656,532) $ 624,844
======== ========== ========== ========= ==========
</TABLE>
53
<PAGE> 54
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under the captions "ELECTION OF DIRECTORS" and
"TRANSACTIONS WITH MANAGEMENT AND OTHERS -- Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's definitive proxy statement (the "Proxy
Statement") for the Annual Meeting of Stockholders scheduled to be held in June
2000, is incorporated herein by reference. The Proxy Statement will be filed
with the U.S. Securities and Exchange Commission (the "Commission") not later
than 120 days after the close of Fiscal 1999.
ITEM 11. EXECUTIVE COMPENSATION
Except as specifically provided, the information set forth under the
captions "COMPENSATION OF EXECUTIVE OFFICERS" and "INFORMATION ABOUT THE BOARD
OF DIRECTORS AND COMMITTEES OF THE BOARD -- Compensation of Directors" in the
Proxy Statement is incorporated herein by reference. The Proxy Statement will be
filed with the Commission not later than 120 days after the close of Fiscal
1999. The Report on Executive Compensation and the Performance Graph set forth
under the caption "COMPENSATION OF EXECUTIVE OFFICERS" in the Proxy Statement
shall not be deemed incorporated by reference herein and shall not otherwise be
deemed "filed" as part of this Annual Report on Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under the caption "SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT" in the Proxy Statement is incorporated herein
by reference. The Proxy Statement will be filed with the Commission not later
than 120 days after the close of Fiscal 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the caption "TRANSACTIONS WITH MANAGEMENT
AND OTHERS" in the Proxy Statement is incorporated herein by reference. The
Proxy Statement will be filed with the Commission not later than 120 days after
the close of Fiscal 1999.
54
<PAGE> 55
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents Filed as Part of This Report:
(1) Financial Statements
The financial statements included in Part II, Item 8 herein are filed as
part of this Annual Report on Form 10-K.
(2) Financial Statement Schedules
The financial statement schedule included in Part II, Item 8 herein is
filed as part of this Annual Report on Form 10-K. All other schedules are
omitted as the required information is inapplicable or the information is
presented in the consolidated financial statements or related notes.
(3) Exhibits
The exhibits listed below are hereby filed with the Commission as part of
this Annual Report on Form 10-K.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
2.1 Stock Purchase Agreement dated as of February 24, 1998, by
and among the Company, Valence Technology Inc., Thomrose
Holdings (BVI) Limited, Rayfa (BVI) Limited, Cape Spencer
International Limited, and Anki (BVI) Limited, previously
filed with the Commission as Exhibit 2.1 to the Company's
Current Report on Form 8-K filed with the Commission on
March 13, 1998 (the "Form 8-K"), which is incorporated
herein by reference.
2.2 Stock Purchase Agreement dated as of February 24, 1998, by
and between the Company and North 22 Capital Partners 2,
Inc., previously filed with the Commission as Exhibit 2.2 to
the Form 8-K, which is incorporated herein by reference.
2.3 Asset Purchase Agreement dated as of January 28, 1998,
between the Company and R.G.A. & Associates, Ltd. d/b/a
ToteVision and VIP Labs(R) previously filed with the
Commission as Exhibit 2.3 to the Company's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1997
filed with the Commission on March 31, 1998 (the "1997
Annual Report"), which is incorporated herein by reference.
2.4 Asset Purchase Agreement dated as of May 21, 1998 by and
between Rocktron Corporation and the Company, previously
filed with the Commission as Exhibit 2.1 to the Company's
Quarterly Report on Form 10-Q for the period ended June 30,
1998 (the "June 1998 10-Q"), which is incorporated herein by
reference.
3.1 Certificate of Incorporation of the Company, previously
filed with the Commission as Exhibit 3.1 to the Company's
Registration Statement on Form SB-2, specifically included
in Amendment No. 1 to such Registration Statement filed with
the Commission on July 3, 1996 (File No. 333-4974-LA) (the
"Registration Statement Amendment No. 1"), which is
incorporated herein by reference.
3.2 Bylaws of the Company, previously filed with the Commission
as Exhibit 3.1 to the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1999, filed with the
Commission on November 12, 1999, which is incorporated
herein by reference.
MATERIAL CONTRACTS RELATING TO MANAGEMENT
COMPENSATION PLANS OR ARRANGEMENTS
10.1 Employment Agreement dated July 1, 1996, between the Company
and Thomas C.K. Yuen, previously filed with the Commission
as Exhibit 10.8 to the Registration Statement Amendment No.
1, which is incorporated herein by reference.
</TABLE>
55
<PAGE> 56
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.2 Amendment to Employment Agreement dated as of March 14,
1997, between the Company and Thomas C.K. Yuen, previously
filed with the Commission as Exhibit 10.2 to the Company's
Annual Report on Form 10-KSB for the fiscal year ended
December 31, 1996, filed with the Commission on March 31,
1997 (the "1996 Annual Report"), which is incorporated
herein by reference.
10.3 Employment Agreement dated July 1, 1996, between the Company
and Arnold I. Klayman, previously filed with the Commission
as Exhibit 10.10 to the Registration Statement Amendment No.
1, which is incorporated herein by reference.
10.4 Amendment to Employment Agreement dated as of March 14,
1997, between the Company and Arnold I. Klayman, previously
filed as Exhibit 10.5 to the 1996 Annual Report, which is
incorporated herein by reference.
10.5 Employment Agreement dated July 1, 1996, between the Company
and Alan D. Kraemer, previously filed with the Commission as
Exhibit 10.11 to the Registration Statement Amendment No. 1,
which is incorporated herein by reference.
10.6 SRS Labs, Inc. Incentive Stock Option, Nonqualified Stock
Option and Restricted Purchase Plan -- 1993, as amended and
restated, previously filed with the Commission as Exhibit
10.12 to the Company's Registration Statement on Form SB-2
filed with the Commission on June 3, 1996 (File No.
333-4974-LA) (the "Registration Statement"), which is
incorporated herein by reference.
10.7 Stock Option Agreement dated January 19, 1994, between the
Company and Stephen V. Sedmak, as amended, previously filed
with the Commission as Exhibit 10.13 to the Registration
Statement, which is incorporated herein by reference.
10.8 SRS Labs, Inc. Amended and Restated 1996 Long-Term Incentive
Plan, previously filed with the Commission as Appendix A to
the Company's Definitive Proxy Statement dated April 30,
1998, filed with the Commission on April 30, 1998, which is
incorporated herein by reference.
10.9 SRS Labs, Inc. 1996 Amended and Restated Nonemployee
Directors Stock Option Plan, previously filed with the
Commission as Appendix A to the Company's Definitive Proxy
Statement dated and filed with the Commission on April 29,
1999, which is incorporated herein by reference.
10.10 Annual Incentive Bonus Plan, previously filed with the
Commission as Exhibit 10.18 to the Registration Statement
Amendment No. 1, which is incorporated herein by reference.
10.11 SRS Labs, Inc. Supplemental Executive Incentive Bonus Plan,
previously filed with the Commission as Exhibit 10.14 to the
1996 Annual Report, which is incorporated herein by
reference.
10.12 Form of Indemnification Agreement, previously filed with the
Commission as Exhibit 10.20 to the Registration Statement
Amendment No. 1, which is incorporated herein by reference.
10.13 Employment Agreement dated as of March 2, 1998, by and among
the Company, Valence Technology Inc., and Thomas Wah Tong
Wan, previously filed with the Commission as Exhibit 10.16
to the 1997 Annual Report, which is incorporated herein by
reference.
10.14 Employment Agreement dated as of March 2, 1998, by and among
the Company, Valence Semiconductor Design Limited, and Choi
Yat Ming, previously filed with the Commission as Exhibit
10.17 to the 1997 Annual Report, which is incorporated
herein by reference.
10.15 Employment Agreement dated as of March 2, 1998, by and among
the Company, LEC Electronic Components Limited, and Wong Yin
Bun, previously filed with the Commission as Exhibit 10.18
to the 1997 Annual Report, which is incorporated herein by
reference.
</TABLE>
56
<PAGE> 57
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.16 Noncompetition Agreement dated as of March 2, 1998, by and
among the Company, Thomrose Holdings (BVI) Limited, and
Thomas Wah Tong Wan, previously filed with the Commission as
Exhibit 2.5 to the Company's Current Report on Form 8-K
filed with the Commission on March 13, 1998 (the "Form
8-K"), which is incorporated herein by reference.
10.17 Noncompetition Agreement dated as of March 2, 1998, by and
among the Company, Cape Spencer International Limited and
Wong Yin Bun, previously filed with the Commission as
Exhibit 2.6 to the Form 8-K, which is incorporated herein by
reference.
10.18 Noncompetition Agreement dated as of March 2, 1998, by and
among the Company, Rayfa (BVI) Limited and Choi Yat Ming,
previously filed with the Commission as Exhibit 2.7 to the
Form 8-K, which is incorporated herein by reference.
10.19 Employment Agreement dated as of July 1, 1998 by and between
the Company and John AuYeung, previously filed with the
Commission as Exhibit 10.1 to the Company's Quarterly Report
on Form 10-Q for the period ended September 30, 1998, which
is incorporated herein by reference.
10.20 Severance Agreement, dated February 23, 1999, by and between
the Company and Thomas P. Parkinson, previously filed as
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the period ended March 31, 1999, filed with the
Commission on May 17, 1999, which is incorporated herein by
reference.
10.21 Employment Agreement dated August 27, 1999 by and between
the Company and James F. Gardner.
OTHER MATERIAL CONTRACTS
10.22 Shareholders Agreement dated as of January 27, 1994, between
the Company and the Shareholders of the Company named
therein, previously filed with the Commission as Exhibit 9.3
to the Company's Registration Statement on Form SB-2,
specifically included in Amendment No. 2 to such
Registration Statement filed with the Commission on August
2, 1996 (File No. 333-4974-LA) (the "Registration Statement
Amendment No. 2"), which is incorporated herein by
reference.
10.23 Shareholders Agreement II dated as of January 9, 1995,
between the Company and the Shareholders of the Company
named therein, previously filed with the Commission as
Exhibit 9.1 to the Registration Statement, which is
incorporated herein by reference.
10.24 Shareholders Agreement III dated as of April 21, 1995,
between the Company and the Shareholders of the Company
named therein, previously filed with the Commission as
Exhibit 9.2 to the Registration Statement, which is
incorporated herein by reference.
10.25 Asset Purchase Agreement dated as of June 30, 1993, between
the Company and Hughes Aircraft, previously filed with the
Commission as Exhibit 10.1 to the Registration Statement,
which is incorporated herein by reference.
10.26 Stock Purchase Agreement dated as of January 9, 1995,
between the Company and Packard Bell Electronics, Inc. d/b/a
Packard Bell Corporation, previously filed with the
Commission as Exhibit 10.3 to the Registration Statement
Amendment No. 2, which is incorporated herein by reference.
10.27 Amended and Restated Stock Option Agreement dated as of
January 9, 1995, between the Company and Packard Bell
Electronics, Inc. d/b/a Packard Bell Corporation, previously
filed with the Commission as Exhibit 10.4 to the
Registration Statement, which is incorporated herein by
reference.
</TABLE>
57
<PAGE> 58
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.28 License Agreement dated as of January 9, 1995, between the
Company and Packard Bell Electronics, Inc. d/b/a Packard
Bell Corporation, previously filed with the Commission as
Exhibit 10.5 to the Company's Registration Statement on Form
SB-2, specifically included in Amendment No. 3 to such
Registration Statement filed with the Commission on August
7, 1996 (File No. 333-4974-LA) (the "Registration Statement
Amendment No. 3"), which is incorporated herein by
reference.
10.29 License Agreement dated as of June 27, 1988, between Hughes
Aircraft and Sony Corporation, as amended and assigned to
the Company, previously filed with the Commission as Exhibit
10.6 to the Registration Statement Amendment No. 3, which is
incorporated herein by reference.
10.30 Industrial Real Estate Lease dated May 30, 1997, between the
Company and Daimler Commerce Partners, L.P., previously
filed with the Commission as Exhibit 10.1 to the Company's
Form 10-QSB for the quarterly period ended June 30, 1997,
filed with the Commission on August 13, 1997, which is
incorporated herein by reference.
10.31 Tenancy Agreement dated September 7, 1998, by and between
Hong Kong Industrial Technology Centre Corporation and
Valence Semiconductor Design Limited relating to the
premises located at Unit 413 on the Fourth Floor of the Hong
Kong Industrial Technology Centre.
10.32 Tenancy Agreement commencing January 1, 1998, by and between
Jugada Company Limited and Valence Semiconductor Design
Limited relating to the premises located at Workshops Nos.
1, 2, 3, 4, 5, 6, 7 and 8 on the 19th Floor of APEC Plaza,
No. 49 Hoi Yuen Road, Kwun Tong, Hong Kong, previously filed
with the Commission as Exhibit 10.34 to the 1997 Annual
Report, which is incorporated herein by reference.
10.33 Stock Divestment Agreement dated July 1, 1996, between the
Company, Thomas C.K. Yuen, Stephen V. Sedmak and Walter W.
Cruttenden III, previously filed with the Commission as
Exhibit 10.17 to the Registration Statement Amendment No. 2,
which is incorporated herein by reference.
10.34 Services Agreement dated July 1, 1996, between the Company
and Sierra Digital Productions, Inc., previously filed with
the Commission as Exhibit 10.19 to the Registration
Statement Amendment No. 1, which is incorporated herein by
reference.
10.35 Registration Rights Agreement dated as of January 28, 1998,
by and between the Company and R.G.A. & Associates, Ltd.,
d/b/a ToteVision and VIP Labs(R) and William S. Taraday,
previously filed with the Commission as Exhibit 10.37 to the
1997 Annual Report, filed with the Commission on March 31,
1998, which is incorporated herein by reference.
10.36 Warrant to Purchase 94,000 Shares of Common Stock of the
Company dated February 26, 1998, held by R.G.A. &
Associates, Ltd., d/b/a ToteVision and VIP Labs(R),
previously filed with the Commission as Exhibit 10.38 to the
1997 Annual Report, which is incorporated herein by
reference.
10.37 Warrant to Purchase 2,500 Shares of Common Stock of the
Company dated February 26, 1998, held by Herbert H. Wax,
previously filed with the Commission as Exhibit 10.39 to the
1997 Annual Report, which is incorporated herein by
reference.
10.38 Warrant to Purchase 2,500 Shares of Common Stock of the
Company dated February 26, 1998, held by Steven E. Loyd,
previously filed with the Commission as Exhibit 10.40 to the
1997 Annual Report, which is incorporated herein by
reference.
10.39 Warrant to Purchase 1,000 Shares of Common Stock of the
Company dated February 26, 1998, held by the Van Valkenberg
Furber Law Group, P.L.L.C., previously filed with the
Commission as Exhibit 10.41 to the 1997 Annual Report, which
is incorporated herein by reference.
</TABLE>
58
<PAGE> 59
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.40 Registration Rights Agreement dated as of May 21, 1998,
previously filed with the Commission as Exhibit 10.1 to the
June 1998 Form 10-Q, which is incorporated herein by
reference.
10.41 Credit and Security Agreement dated as of July 6, 1999, by
and between the Company and City National Bank.
10.42 Securities Account Control Agreement dated as of July 6,
1999, by and among the Company, Investors Bank & Trust
Company, Salomon Brothers Asset Management Inc. and City
National Bank.
10.43 Revolving Credit Note dated July 6, 1999, by the Company in
favor of City National Bank.
21 Subsidiaries.
23 Consent of Deloitte & Touche LLP dated March 24, 2000
24 Power of attorney (included on page 60 of the Form 10-K).
27 Financial Data Schedule.
</TABLE>
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the fourth quarter of the fiscal
year covered by this Report.
59
<PAGE> 60
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SRS LABS, INC., a
Delaware corporation
Date: March 28, 2000 By: /s/ THOMAS C.K. YUEN
------------------------------------
Thomas C.K. Yuen
Chairman of the Board and Chief
Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that such person whose signature appears
below constitutes and appoints Thomas C.K. Yuen and John AuYeung, and each of
them his true and lawful attorneys-in-fact and agents, with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign any and all amendments to this Form 10-K and to
file the same, with all exhibits thereto, and other documents in connection
therewith, with the U.S. Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
NAME CAPACITY DATE
---- -------- ----
<C> <C> <S>
/s/ THOMAS C.K. YUEN Director, Chairman of the Board March 28, 2000
- ----------------------------------------------------- and Chief Executive Officer
Thomas C.K. Yuen (Principal Executive Officer)
/s/ JOHN AUYEUNG Director and Executive Vice March 28, 2000
- ----------------------------------------------------- President, Chief Operating
John AuYeung Officer, Chief Financial
Officer, Secretary and
Treasurer (Principal Financial
and Accounting Officer)
/s/ THOMAS W.T. WAN Director and Vice President March 28, 2000
- -----------------------------------------------------
Thomas W.T. Wan
/s/ ROBERT PFANNKUCH Director March 28, 2000
- -----------------------------------------------------
Robert Pfannkuch
/s/ STEPHEN V. SEDMAK Director March 28, 2000
- -----------------------------------------------------
Stephen V. Sedmak
/s/ JEFFREY I. SCHEINROCK Director March 28, 2000
- -----------------------------------------------------
Jeffrey I. Scheinrock
/s/ JOHN TU Director March 28, 1999
- -----------------------------------------------------
John Tu
</TABLE>
60
<PAGE> 61
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
2.1 Stock Purchase Agreement dated as of February 24, 1998, by
and among the Company, Valence Technology Inc., Thomrose
Holdings (BVI) Limited, Rayfa (BVI) Limited, Cape Spencer
International Limited, and Anki (BVI) Limited, previously
filed with the Commission as Exhibit 2.1 to the Company's
Current Report on Form 8-K filed with the Commission on
March 13, 1998 (the "Form 8-K"), which is incorporated
herein by reference.
2.2 Stock Purchase Agreement dated as of February 24, 1998, by
and between the Company and North 22 Capital Partners 2,
Inc., previously filed with the Commission as Exhibit 2.2 to
the Form 8-K, which is incorporated herein by reference.
2.3 Asset Purchase Agreement dated as of January 28, 1998,
between the Company and R.G.A. & Associates, Ltd. d/b/a
ToteVision and VIP Labs(R) previously filed with the
Commission as Exhibit 2.3 to the Company's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1997
filed with the Commission on March 31, 1998 (the "1997
Annual Report"), which is incorporated herein by reference.
2.4 Asset Purchase Agreement dated as of May 21, 1998 by and
between Rocktron Corporation and the Company, previously
filed with the Commission as Exhibit 2.1 to the Company's
Quarterly Report on Form 10-Q for the period ended June 30,
1998 (the "June 1998 10-Q"), which is incorporated herein by
reference.
3.1 Certificate of Incorporation of the Company, previously
filed with the Commission as Exhibit 3.1 to the Company's
Registration Statement on Form SB-2, specifically included
in Amendment No. 1 to such Registration Statement filed with
the Commission on July 3, 1996 (File No. 333-4974-LA) (the
"Registration Statement Amendment No. 1"), which is
incorporated herein by reference.
3.2 Bylaws of the Company, previously filed with the Commission
as Exhibit 3.1 to the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1999, filed with the
Commission on November 12, 1999, which is incorporated
herein by reference.
MATERIAL CONTRACTS RELATING TO MANAGEMENT
COMPENSATION PLANS OR ARRANGEMENTS
10.1 Employment Agreement dated July 1, 1996, between the Company
and Thomas C.K. Yuen, previously filed with the Commission
as Exhibit 10.8 to the Registration Statement Amendment No.
1, which is incorporated herein by reference.
10.2 Amendment to Employment Agreement dated as of March 14,
1997, between the Company and Thomas C.K. Yuen, previously
filed with the Commission as Exhibit 10.2 to the Company's
Annual Report on Form 10-KSB for the fiscal year ended
December 31, 1996, filed with the Commission on March 31,
1997 (the "1996 Annual Report"), which is incorporated
herein by reference.
10.3 Employment Agreement dated July 1, 1996, between the Company
and Arnold I. Klayman, previously filed with the Commission
as Exhibit 10.10 to the Registration Statement Amendment No.
1, which is incorporated herein by reference.
10.4 Amendment to Employment Agreement dated as of March 14,
1997, between the Company and Arnold I. Klayman, previously
filed as Exhibit 10.5 to the 1996 Annual Report, which is
incorporated herein by reference.
10.5 Employment Agreement dated July 1, 1996, between the Company
and Alan D. Kraemer, previously filed with the Commission as
Exhibit 10.11 to the Registration Statement Amendment No. 1,
which is incorporated herein by reference.
</TABLE>
<PAGE> 62
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.6 SRS Labs, Inc. Incentive Stock Option, Nonqualified Stock
Option and Restricted Purchase Plan -- 1993, as amended and
restated, previously filed with the Commission as Exhibit
10.12 to the Company's Registration Statement on Form SB-2
filed with the Commission on June 3, 1996 (File No.
333-4974-LA) (the "Registration Statement"), which is
incorporated herein by reference.
10.7 Stock Option Agreement dated January 19, 1994, between the
Company and Stephen V. Sedmak, as amended, previously filed
with the Commission as Exhibit 10.13 to the Registration
Statement, which is incorporated herein by reference.
10.8 SRS Labs, Inc. Amended and Restated 1996 Long-Term Incentive
Plan, previously filed with the Commission as Appendix A to
the Company's Definitive Proxy Statement dated April 30,
1998, filed with the Commission on April 30, 1998, which is
incorporated herein by reference.
10.9 SRS Labs, Inc. 1996 Amended and Restated Nonemployee
Directors Stock Option Plan, previously filed with the
Commission as Appendix A to the Company's Definitive Proxy
Statement dated and filed with the Commission on April 29,
1999, which is incorporated herein by reference.
10.10 Annual Incentive Bonus Plan, previously filed with the
Commission as Exhibit 10.18 to the Registration Statement
Amendment No. 1, which is incorporated herein by reference.
10.11 SRS Labs, Inc. Supplemental Executive Incentive Bonus Plan,
previously filed with the Commission as Exhibit 10.14 to the
1996 Annual Report, which is incorporated herein by
reference.
10.12 Form of Indemnification Agreement, previously filed with the
Commission as Exhibit 10.20 to the Registration Statement
Amendment No. 1, which is incorporated herein by reference.
10.13 Employment Agreement dated as of March 2, 1998, by and among
the Company, Valence Technology Inc., and Thomas Wah Tong
Wan, previously filed with the Commission as Exhibit 10.16
to the 1997 Annual Report, which is incorporated herein by
reference.
10.14 Employment Agreement dated as of March 2, 1998, by and among
the Company, Valence Semiconductor Design Limited, and Choi
Yat Ming, previously filed with the Commission as Exhibit
10.17 to the 1997 Annual Report, which is incorporated
herein by reference.
10.15 Employment Agreement dated as of March 2, 1998, by and among
the Company, LEC Electronic Components Limited, and Wong Yin
Bun, previously filed with the Commission as Exhibit 10.18
to the 1997 Annual Report, which is incorporated herein by
reference.
10.16 Noncompetition Agreement dated as of March 2, 1998, by and
among the Company, Thomrose Holdings (BVI) Limited, and
Thomas Wah Tong Wan, previously filed with the Commission as
Exhibit 2.5 to the Company's Current Report on Form 8-K
filed with the Commission on March 13, 1998 (the "Form
8-K"), which is incorporated herein by reference.
10.17 Noncompetition Agreement dated as of March 2, 1998, by and
among the Company, Cape Spencer International Limited and
Wong Yin Bun, previously filed with the Commission as
Exhibit 2.6 to the Form 8-K, which is incorporated herein by
reference.
10.18 Noncompetition Agreement dated as of March 2, 1998, by and
among the Company, Rayfa (BVI) Limited and Choi Yat Ming,
previously filed with the Commission as Exhibit 2.7 to the
Form 8-K, which is incorporated herein by reference.
10.19 Employment Agreement dated as of July 1, 1998 by and between
the Company and John AuYeung, previously filed with the
Commission as Exhibit 10.1 to the Company's Quarterly Report
on Form 10-Q for the period ended September 30, 1998, which
is incorporated herein by reference.
</TABLE>
<PAGE> 63
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.20 Severance Agreement, dated February 23, 1999, by and between
the Company and Thomas P. Parkinson, previously filed as
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the period ended March 31, 1999, filed with the
Commission on May 17, 1999, which is incorporated herein by
reference.
10.21 Employment Agreement dated August 27, 1999 by and between
the Company and James F. Gardner.
OTHER MATERIAL CONTRACTS
10.22 Shareholders Agreement dated as of January 27, 1994, between
the Company and the Shareholders of the Company named
therein, previously filed with the Commission as Exhibit 9.3
to the Company's Registration Statement on Form SB-2,
specifically included in Amendment No. 2 to such
Registration Statement filed with the Commission on August
2, 1996 (File No. 333-4974-LA) (the "Registration Statement
Amendment No. 2"), which is incorporated herein by
reference.
10.23 Shareholders Agreement II dated as of January 9, 1995,
between the Company and the Shareholders of the Company
named therein, previously filed with the Commission as
Exhibit 9.1 to the Registration Statement, which is
incorporated herein by reference.
10.24 Shareholders Agreement III dated as of April 21, 1995,
between the Company and the Shareholders of the Company
named therein, previously filed with the Commission as
Exhibit 9.2 to the Registration Statement, which is
incorporated herein by reference.
10.25 Asset Purchase Agreement dated as of June 30, 1993, between
the Company and Hughes Aircraft, previously filed with the
Commission as Exhibit 10.1 to the Registration Statement,
which is incorporated herein by reference.
10.26 Stock Purchase Agreement dated as of January 9, 1995,
between the Company and Packard Bell Electronics, Inc. d/b/a
Packard Bell Corporation, previously filed with the
Commission as Exhibit 10.3 to the Registration Statement
Amendment No. 2, which is incorporated herein by reference.
10.27 Amended and Restated Stock Option Agreement dated as of
January 9, 1995, between the Company and Packard Bell
Electronics, Inc. d/b/a Packard Bell Corporation, previously
filed with the Commission as Exhibit 10.4 to the
Registration Statement, which is incorporated herein by
reference.
10.28 License Agreement dated as of January 9, 1995, between the
Company and Packard Bell Electronics, Inc. d/b/a Packard
Bell Corporation, previously filed with the Commission as
Exhibit 10.5 to the Company's Registration Statement on Form
SB-2, specifically included in Amendment No. 3 to such
Registration Statement filed with the Commission on August
7, 1996 (File No. 333-4974-LA) (the "Registration Statement
Amendment No. 3"), which is incorporated herein by
reference.
10.29 License Agreement dated as of June 27, 1988, between Hughes
Aircraft and Sony Corporation, as amended and assigned to
the Company, previously filed with the Commission as Exhibit
10.6 to the Registration Statement Amendment No. 3, which is
incorporated herein by reference.
10.30 Industrial Real Estate Lease dated May 30, 1997, between the
Company and Daimler Commerce Partners, L.P., previously
filed with the Commission as Exhibit 10.1 to the Company's
Form 10-QSB for the quarterly period ended June 30, 1997,
filed with the Commission on August 13, 1997, which is
incorporated herein by reference.
10.31 Tenancy Agreement dated September 7, 1998, by and between
Hong Kong Industrial Technology Centre Corporation and
Valence Semiconductor Design Limited relating to the
premises located at Unit 413 on the Fourth Floor of the Hong
Kong Industrial Technology Centre.
</TABLE>
<PAGE> 64
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.32 Tenancy Agreement commencing January 1, 1998, by and between
Jugada Company Limited and Valence Semiconductor Design
Limited relating to the premises located at Workshops Nos.
1, 2, 3, 4, 5, 6, 7 and 8 on the 19th Floor of APEC Plaza,
No. 49 Hoi Yuen Road, Kwun Tong, Hong Kong, previously filed
with the Commission as Exhibit 10.34 to the 1997 Annual
Report, which is incorporated herein by reference.
10.33 Stock Divestment Agreement dated July 1, 1996, between the
Company, Thomas C.K. Yuen, Stephen V. Sedmak and Walter W.
Cruttenden III, previously filed with the Commission as
Exhibit 10.17 to the Registration Statement Amendment No. 2,
which is incorporated herein by reference.
10.34 Services Agreement dated July 1, 1996, between the Company
and Sierra Digital Productions, Inc., previously filed with
the Commission as Exhibit 10.19 to the Registration
Statement Amendment No. 1, which is incorporated herein by
reference.
10.35 Registration Rights Agreement dated as of January 28, 1998,
by and between the Company and R.G.A. & Associates, Ltd.,
d/b/a ToteVision and VIP Labs(R) and William S. Taraday,
previously filed with the Commission as Exhibit 10.37 to the
1997 Annual Report, filed with the Commission on March 31,
1998, which is incorporated herein by reference.
10.36 Warrant to Purchase 94,000 Shares of Common Stock of the
Company dated February 26, 1998, held by R.G.A. &
Associates, Ltd., d/b/a ToteVision and VIP Labs(R),
previously filed with the Commission as Exhibit 10.38 to the
1997 Annual Report, which is incorporated herein by
reference.
10.37 Warrant to Purchase 2,500 Shares of Common Stock of the
Company dated February 26, 1998, held by Herbert H. Wax,
previously filed with the Commission as Exhibit 10.39 to the
1997 Annual Report, which is incorporated herein by
reference.
10.38 Warrant to Purchase 2,500 Shares of Common Stock of the
Company dated February 26, 1998, held by Steven E. Loyd,
previously filed with the Commission as Exhibit 10.40 to the
1997 Annual Report, which is incorporated herein by
reference.
10.39 Warrant to Purchase 1,000 Shares of Common Stock of the
Company dated February 26, 1998, held by the Van Valkenberg
Furber Law Group, P.L.L.C., previously filed with the
Commission as Exhibit 10.41 to the 1997 Annual Report, which
is incorporated herein by reference.
10.40 Registration Rights Agreement dated as of May 21, 1998,
previously filed with the Commission as Exhibit 10.1 to the
June 1998 Form 10-Q, which is incorporated herein by
reference.
10.41 Credit and Security Agreement dated as of July 6, 1999, by
and between the Company and City National Bank.
10.42 Securities Account Control Agreement dated as of July 6,
1999, by and among the Company, Investors Bank & Trust
Company, Salomon Brothers Asset Management Inc. and City
National Bank.
10.43 Revolving Credit Note dated July 6, 1999, by the Company in
favor of City National Bank.
21 Subsidiaries.
23 Consent of Deloitte & Touche LLP dated March 24, 2000
24 Power of attorney (included on page 60 of the Form 10-K).
27 Financial Data Schedule.
</TABLE>
<PAGE> 1
EXHIBIT 10.21
[SRS LETTERHEAD]
August 27, 1999
Mr. James Gardner
4 Christamon East
Irvine, CA 92620
Dear Jim:
It is with great pleasure that I invite you to join SRS (o) Labs, Inc. as Vice
President and Chief Financial Officer. This is an extremely important position
as you will be responsible for managing and controlling all aspects of the
company's financial and corporate administrative activities.
Your position will have a monthly salary of $9,583.33. You will also be eligible
to participate in the executive bonus plan. A copy of the plan will be provided
to you.
You will be eligible on your first day to enroll in our benefits plan, which
includes medical, dental and vision insurance, for you and your family, as well
as life insurance for yourself in the amount of $50,000. Coverage will begin on
the first day of the month following your employment. A copy of the plan will be
provided to you during your first week of employment.
As an added incentive, we are pleased to grant you 75,000 stock options for SRS
Labs, Inc. The Compensation Committee of the Board of Directors will set the
grant date. The Company Stock Option program will govern these stock options and
a copy of the plan will be provided to you.
You will be eligible to take two weeks vacation each year. Your vacation
eligibility will begin after the completion of your introductory period, at
which time, you may take what you have earned.
SRS also offers employees the option to participate in an Employee-only
Contributory 401(k) plan. You are eligible to participate in this Plan after
completing a 90-day introductory period. The entry dates of the plan fall on the
first day of each month. A copy of the plan will be provided to you during your
first week of employment.
Your official starting date will be August 31, 1999, and you will be reporting
to Tom Yuen, Chief Executive Officer.
<PAGE> 2
Mr. James Gardner
August 27, 1999
Any offer of employment will be contingent on the submission of proof of your
eligibility to work in the United States and the signing of the SRS Labs, Inc.
At-Will Employment Agreement and the Confidentiality, Non-Competition, and
Compliance Agreement, copies of which are attached for your reference.
Jim, if this offer meets with your approval, please indicate your acceptance in
the space provided below. We look forward to having you as part of our team as
we establish SRS (o) as the industry standard in contemporary audio and voice
processing.
Sincerely,
SRS Labs, Inc.
/s/ THOMAS C.K. YUEN
Thomas C.K. Yuen
Chairman and Chief Executive Officer
Enc.
I Accept: /S/ JAMES F. GARDNER 8/31/99
------------------------- --------------
Name Date
<PAGE> 1
EXHIBIT 10.31
Dated this 7th day of September 1998
HONG KONG INDUSTRIAL TECHNOLOGY
CENTRE CORPORATION
and
VALENCE SEMICONDUCTOR DESIGN LIMITED
----------------------------------------------
TENANCY AGREEMENT
of
Unit 413 on the 4th Floor of
Hong Kong Industrial Technology Centre
----------------------------------------------
DENTON HALL
10/F HUTCHISON HOUSE
10 HARCOURT ROAD
CENTRAL
HONG KONG
Ref.: RMSK/MWYT/jm/84410.00159
0124656.01
<PAGE> 2
THIS TENANCY AGREEMENT is made the day of One
thousand nine hundred and ninety-eight
Parties
BETWEEN HONG KONG INDUSTRIAL TECHNOLOGY CENTRE CORPORATION whose registered
office is situate at 1st Floor, Hong Kong Industrial Technology Centre, 72 Tat
Chee Avenue, Kowloon, Hong Kong (hereinafter called "the Landlord" which
expression shall include its successors in title and assigns) of the one part
and the party whose particulars are set out in the First Schedule (hereinafter
called "the Tenant") of the other part.
NOW IT IS HEREBY AGREED as follows
Premises
1. The Landlord shall let and the Tenant shall take ALL THOSE PREMISES more
particularly described in Part I of the Second Schedule and for
identification purposes only shown and coloured pink on the plan annexed
hereto ("the Premises") forming part of HONG KONG INDUSTRIAL TECHNOLOGY
CENTRE ("the Building"), situate at the junction of Tat Chee Avenue and
Fa Po Street, Kowloon, Hong Kong and erected on All That piece or parcel
of ground registered in the Land Registry as New Kowloon Inland Lot No.
6128.
Term
2. The Tenant shall hold the Premises for the term set out in Part II of
the Second Schedule ("the Term") Together with the right to use in
common with the Landlord and all others having the like right the
entrance(s) passages staircases landings accessways and lifts (if any
and whenever the same shall be operating) of the Building without
causing any obstruction thereto and so far as the same is necessary for
the proper enjoyment of the Premises Subject To all casements and
similar rights and privileges which the Premises are or may be subject
to.
Tenant's Obligations
3. The Tenant hereby covenants and agrees with the Landlord as follows:-
-1-
<PAGE> 3
Rent and Management Fees
3.01 To pay to the Landlord or such person(s) as the Landlord may
direct the rent set out in Part I of the Third Schedule ("the
Rent") and the management fees set out in Part II of the Third
Schedule ("the Management Fees") in advance without any
deduction on the first day of each and every calendar month
throughout the Term. When the term of tenancy hereby created
does not commence on the first day of the month, the Landlord
may at any time during the said term require the Tenant to pay
the Rent for a particular month on a pro-rata basis, namely,
from the commencement day to the end of the month, and
thereafter the Tenant shall pay the Rent for each calendar month
(including the last month of the said term also on a pro-rata
basis) on the first day of each such calendar month.
Cost of Additional Air-Conditioning Services
3.02 To pay to the Landlord or such person(s) as the Landlord may
direct the costs of additional air-conditioning services (if
any) and the costs of chilled water supply for the purpose of
cooling the Tenant's equipment (if any) at such time and in such
manner as provided in Clause 5.10 hereof
Rates, etc.
3.03 To pay and discharge all rates taxes assessments duties
impositions charges and outgoings whatsoever now or hereafter
to be imposed or levied on the Premises or upon the owner or
occupier in respect thereof by the Government of the Hong Kong
Special Administrative Region or other lawful authority
(Government Rent and Property Tax alone excepted). Without
prejudice to the generality of this sub-clause the Tenant shall
pay all rates imposed on the Premises in the first place to the
Landlord who shall settle the same with the Government of the
Hong Kong Special Administrative Region and in the event of the
Premises not yet having been separately assessed to rates the
Tenant shall until such time as the Premises are assessed to
rates pay to the Landlord quarterly and in advance a sum equal
to the rates which would have been charged by the Government of
the Hong Kong Special Administrative Region for each quarter on
the basis of a rateable value equal to twelve months' rent
-2-
<PAGE> 4
payable by the Tenant hereunder, any overpayment or underpayment
by the Tenant shall be adjusted and credited to the account of
the Tenant or (as the case may be) paid by the Tenant to the
Landlord immediately upon the separate assessment in respect of
the Premises having been made in accordance with the Rating
Ordinance (Cap. 116).
Utility Charges and Deposits
3.04 To pay and discharge all utility deposits and charges including
without limitation deposits and charges in respect of gas water
electricity facsimile and telephone as may be shown by or
operated from the Tenant's own metered supplies or by accounts
rendered to the Tenant by the appropriate utility companies or
otherwise in respect of all such utilities consumed on or in the
Premises.
House rules and Regulations
3.05 To obey and comply with and to indemnify the Landlord against
any breach of such house rules and regulations as may from time
to time be adopted by the Landlord or such person as may from
time to time be appointed by the Landlord as the manager of the
Building ("the Manager") in accordance with Clause 5.17 hereof.
No Breach of Government Grant or Deed of Mutual Covenants
3.06 Not to do or permit or suffer to be done any act, deed, matter
or thing whatsoever which may amount to a breach of the
covenants terms and conditions respectively contained in
Agreement and Conditions of Grant No. 12221 (including any
modification or variation thereto) and the Deed of Mutual
Covenants (if any) and Sub-Deed of Mutual Covenants (if any
affecting the Building and to fully indemnify the Landlord
against the consequences of any such breach.
Compliance with Ordinances
3.07 To obey and comply with all ordinances, regulations, bye-laws,
rules and requirements of any Governmental or other competent
authority relating to the use and occupation of the Premises by
the Tenant or to any other act deed matter or thing done
permitted suffered or omitted therein or thereon by the Tenant
or any employee, agent or licensee of the Tenant, and without
prejudice to the foregoing to obtain any licence approval or
permit
-3-
<PAGE> 5
required by any Governmental or other competent authority in
connection with the Tenant's use and occupation of the Premises
and to maintain in force and observe and comply with the terms
of the same during the continuance of this tenancy and to
indemnify the Landlord against the consequences of any breach of
this provision.
Fitting Out Decoration Refurbishing Renovation and Repairs
3.08 (i) To fit out the Premises at its own costs and expenses
and before the commencement of any fitting-out works or
other decoration refurbishing or renovation works or
repairs which are the responsibility of the Tenant
hereunder, at its own costs and expenses to prepare and
submit to the Landlord for approval ten full sets of
suitable drawings plans and specifications of the works
to be carried out by the Tenant together with schematic
sketches showing the Tenant's design and layout proposal
(hereinafter collectively called "the Tenant's Plans").
The Tenant's Plans shall, without limitation:-
(a) include detailed drawings, plans and
specifications of all partition and floor
coverings;
(b) include detailed drawings, plans and
specifications of all electrical installations
or (as the case may be) any changes thereof,
(c) include detailed drawings, plans and
specifications of any proposed amendments,
additions or alterations,
(d) include details of all lighting fixtures;
(e) show in complete details the decorative
architectural mechanical and electrical
components; and
-4-
<PAGE> 6
(f) comply with all relevant ordinances, regulations
and bye-laws from time to time issued by the
Government of the Hong Kong Special
Administrative Region.
The Landlord will consider the Tenant's Plans and may in
its absolute discretion accept reject or require the
Tenant to modify the Tenant's Plans or any part of them
as it thinks fit. The Landlord will notify the Tenant of
its decision within 30 days of receiving the Tenant's
Plans.
(ii) To modify amend and re-submit those plans as requested
by the Landlord within 30 days of receiving the
Landlord's request.
(iii) Upon submission of the Tenant's Plans to pay to the
Landlord a vetting fee at the rate as specified in Part
V of the Third Schedule and if the Tenant's Plans are
subsequently amended or modified whether pursuant to the
Landlord's request or otherwise, to pay to the Landlord
such further vetting fees as may be demanded by the
Landlord.
(iv) To be solely responsible for compliance with all
applicable codes ordinances and other regulations for
all works performed by or on behalf of the Tenant on the
Premises, and the Landlord's or the Landlord's agent's
or representative's approval of plans drawings
specifications or calculations contained in the Tenant's
Plans shall not constitute any implication
representation or certification by the Landlord that the
Tenant's Plans are in compliance with the said codes
ordinances and other regulations and the Landlord's
approval thereof shall be without prejudice to the right
of the Landlord to require the Tenant to stop, remove,
or dismantle at the cost of the Tenant any Tenant's
works which, in the opinion of the Landlord, may
prejudice the safety or security of the Building or any
part thereof, or may contravene any ordinance,
regulation, rule
-5-
<PAGE> 7
or requirement of any governmental or competent
authority. In instances where more than one standard may
be applicable in approving the Tenant's Plans, the
strictest standard shall apply.
(v) Not to commence any fitting-out decoration refurbishing
renovation or repair works before receiving notice in
writing from the Landlord that such works may be
commenced and thereafter to commence such works as soon
as practicable and carry such works to completion
expeditiously.
(vi) Not to make any subsequent variation or modification to
the Tenant's Plans as approved by the Landlord without
the previous approval in writing of the Landlord.
(vii) To employ only such contractor(s) as may from time to
time be nominated by the Landlord to carry out any
fitting-out decoration refurbishing renovation or repair
works on the Premises. In the absence of such nominated
contractor(s), the Tenant shall, upon the Landlord's
approval of the Tenant's Plans and prior to the
commencement of any of the proposed works by the Tenant,
submit to the Landlord a list of contractors to be
appointed for such proposed works. The Landlord after
receiving such list may in its absolute discretion
approve or reject the same or nominate such
contractor(s) in place of any of those listed in the
said list as the Landlord shall think fit. All such
nominated or approved contractors shall be employed
directly by the Tenant and shall for the purpose of this
Agreement be treated as the servants employees agents or
contractors of the Tenant and the Landlord shall not in
any way be held responsible for any loss or damage of
whatsoever nature directly or indirectly caused by or
arising from such employments.
-6-
<PAGE> 8
(viii) To ensure that all works are carried out strictly in
accordance with the Tenant's Plans as approved by the
Landlord and in a good and proper workmanlike fashion
using good quality materials and without causing any
damage to any part of the Building or any disturbance or
annoyance to the Landlord or the tenants or occupiers of
adjacent or neighbouring premises and observe all house
rules and regulations and fitting-out guides as may from
time to time be made imposed adopted or amended by the
Landlord or the Manager and to ensure that all
contractors and workmen employed by him shall co-operate
fully with the Landlord, the Manager or their respective
authorised representatives.
Installation of Wires Cables and Services
3.09 Further to and without prejudice to sub-clause 3.08 of this
Clause:-
(i) To install all wires pipes and cables and other services
serving the Premises in and through the ducts trunkings
and conduits in the Building provided by the Landlord
for such purposes and at all times in accordance with
the Landlord's directions and not to install any such
wires pipes cables or other services without first
providing the Landlord with full particulars and fully
detailed plans and drawings of such intended
installation and obtaining the Landlord's prior written
consent as provided in sub-clause 3.08.
(ii) To provide to the Landlord full coloured drawings of all
electrical wiring to be installed by the Tenant within
or serving or connected to the Premises and/or within
the ducts, trunkings or conduits provided by the
Landlord within the Building for the installation of
electrical and/or fibre-optical or other wires or cables
or means of passing receiving or transmitting
information and all telephone and other service wires
conduits and cables installed by or at the order of the
Tenant and to clearly label and in accordance with any
directions given by the Landlord colour-code all such
wires
-7-
<PAGE> 9
conduits and cables to the same as being the Tenant's
and if required by the Landlord at the expiration or
sooner determination of the Term at the Tenant's expense
to remove the same from all ducts conduits or trunkings
within the Building taking care not to disturb damage or
interfere with any wires cables or other means of
communication belonging to the Landlord or to other
tenants or occupiers of any part or parts of the
Building that may have been installed within any such
ducts conduits or trunkings and making good any damage
caused by the Tenant in so doing and the Tenant will
indemnify and hold the Landlord harmless against any
claim action or demand that may be brought by any person
suffering any loss or damage or interference with
business or inconvenience directly or indirectly caused
by or arising from the Tenant's actions in complying
with its obligations under this sub-clause 3.09.
Installation of Telephone Cables
3.10 Subject to sub-clauses 3.08 and 3.09 of this Clause to make its
own arrangements with regard to the installation of telephones
or other communication systems in the Premises, but the
installation of telephone and communication lines outside the
Premises must be in the common ducting provided in the Building
for that purpose and in all respects in accordance with the
Landlord's directions.
Good Repair of Interior
3.11 At its own expenses to well and sufficiently paint maintain and
keep in good clean tenantable substantial and proper repair and
condition (fair wear and tear excepted) to the satisfaction of
the Landlord the non-structural interior of the Premises
including without limitation the flooring and interior plaster
or other finishing material or rendering to walls floors and
ceilings and all the Landlord's fixtures fittings and additions
therein or thereto including without limitation all doors,
windows, light fittings, fire fighting apparatus, ducts,
air-conditioning
-8-
<PAGE> 10
units and fan coils and all waste drain, water and other pipes
and sanitary apparatus and fittings therein and all painting
papering and decoration thereof.
Repair of Electrical Wiring and Installations
3.12 To repair or replace such electrical wiring, piping
installations and fittings in the Premises and such wiring from
the Tenant's meter(s) to the Premises as the same may become
dangerous or be required to be repaired or replaced by any
appropriate utility company or any governmental or other
competent authority.
Permitting Landlord to Enter and View
3.13 To permit the Landlord its agents and all persons authorised by
the Landlord with or without workmen or others and with or
without appliances at all reasonable times and upon prior notice
(save in the case of an emergency) to enter into the Premises to
view the condition thereof and to test the Tenant's electrical
wiring piping and/or other installations and to take inventories
of the Landlord's fixtures and fittings therein and to give or
leave notice in writing to the Tenant or upon the Premises of
all defects and want of repair there found if such repair is the
responsibility of the Tenant hereunder or to carry out any work
or repair required to be done provided that in the event of an
emergency the Landlord its servants or agents may enter without
notice and forcibly if need be.
Execution of Repair on Receipt of Notice
3.14 At its own expenses, to make good all defects and wants of
repair to the Premises for which the Tenant may be liable upon
receipt of written notice from the Landlord to repair and make
good the same and within such period as may be stipulated in the
said written notice, and to pay all reasonable costs (including
fees of professional consultants) incurred by the Landlord in
the preparation and service of such notice, and if the Tenant
shall fall to execute such works or repairs as aforementioned to
permit the Landlord to enter upon the Premises and execute the
same and the expenses thereof shall be a debt due from the
Tenant to the Landlord and be recoverable forthwith by action.
-9-
<PAGE> 11
Paying Cost of Replacing Broken Windows
3.15 To pay to or reimburse the Landlord the cost of replacing all
broken or damaged windows of the Premises (or elsewhere if used
exclusively by the Tenant) whether the same be broken or damaged
by the negligence of the Tenant or otherwise.
To Reimburse Landlord for Making Good Damage to Building
3.16 To pay or reimburse the Landlord immediately on demand the costs
of repairing or making good any part of the Building or any of
the lifts or other services and facilities installed therein or
any property of the Landlord that may be damaged by reason of
any act default or neglect on the part of the Tenant its agents
servants invitees licensees employees contractors guests or
visitors.
Giving Notice to the Landlord on Damage
3.17 To give notice in writing to the Landlord or the Manager of any
damage that the Premises may suffer and of any accident to or
defects in the structure of the Premises, the water pipes, gas
pipes, electrical wiring or installations, fixtures, fittings or
other utility supply equipment provided by the Landlord directly
once the Tenant becomes aware of any such damage accident or
defect.
No Structural Alterations
3.18 Not to make any structural alterations to the Premises or the
Building or to erect install or alter any fixtures partitioning
or make or carry out any works to the Premises or the Building
or make any alterations installations in or additions to the
air-conditioning system and/or electrical wiring and/or gas
piping and/or fire fighting system and/or apparatus or any
security system or install any equipment apparatus or machinery
which requires any additional electrical wiring gas mains piping
without the prior written consent of the Landlord which consent
the Landlord may grant or withhold at its absolute discretion
and if granted the Landlord may impose such conditions as it
shall think fit.
Not to Maim or Injure
3.19 Not without the prior written consent of the Landlord to cut,
maim, injure, drill into, mark or deface or permit or suffer to
be cut, maimed, injured, drilled into, marked or defaced any
doors, windows, walls, beams,
-10-
<PAGE> 12
air-conditioner ducts, structural members or any part of the
fabric of the Premises nor any of the plumbing or sanitary
apparatus or installation included therein.
Not to Erect Gates or Grilles
3.20 Not without the prior written consent of the Landlord to erect
or install doors, gates, grilles, shutters or other similar
installation whatsoever whether temporary or permanent at the
door-way or entrance to the Premises or at any of the fire exits
therefrom or erect any such door or grille or shutter or gate
that might in any way contravene the regulations from time to
time in force of the Fire Services Department or other competent
authority concerned, nor in any other respect to contravene the
said regulations.
No Additional Locks
3.21 Not to alter the existing locks, bolts and fittings on the
entrance of the Premises or install any additional locks, bolts
or fittings thereon without obtaining the prior written approval
of the Landlord.
Installation of Machinery
3.22 During the continuance of the Term, before installing any
machinery in the Premises to submit to a consultant appointed by
the Landlord for approval full particulars and information
regarding such machinery as intended to be installed in the
Premises including but without limitation the type and weight
thereof, together with a general layout plan of such machinery
showing the actual position at which each article of machinery
is intended to be placed and to install such machinery in
accordance with the layout plans after written approval by the
Landlord's consultant has been obtained. The Tenant shall not
without the prior written approval of the Landlord's consultant
alter the position of any of the machinery installed as
previously approved by the Landlord's consultant or replace any
of such installed machinery with another, unless the new
machinery is in all respects to the one to be substituted. The
Tenant shall bear and pay the vetting or approval fees of the
Landlord's consultant.
-11-
<PAGE> 13
Anti-Vibration or Anti-Dumping, Absorbers for Machinery
3.23 (i) At its own expenses to mount and equip any machinery
liable to produce vibration with anti-vibration
absorbers and anti-dumping absorbers of such types and
designs as first approved of in writing by the
Landlord's consultant and shall at its own expenses
comply with all directions and orders of the Landlord
for eliminating and reducing vibrations and dumping
produced by the operation and running of any of the
machinery installed at the Premises.
Operation of Machinery
(ii) In operating and running any machinery installed in the
Premises to do all acts and things required by and
conform with all ordinances, bye-laws and regulations
applicable thereto and also all orders and directions
(if any) from time to time given by the Urban Council
and any other competent authority.
Not to Exceed Maximum Floor Loading Capacity
3.24 Not without the prior written consent of the Landlord to install
or permit or suffer to be installed upon the Premises or any
part thereof any equipment, apparatus or machinery which imposes
a weight on any part of the flooring in excess of that for which
it is designed and the Landlord shall be entitled to prescribe
the maximum weight and permitted location within the Premises of
safes and other heavy equipment, apparatus or machinery and to
require the same to stand on supports of such dimensions and
material to distribute the weight as the Landlord may deem
necessary.
Not to Cause Electro-Magnetic
3.25 To duly observe and comply with all laws, rules and regulations
in relation to electromagnetic interference from time to time in
force including but without limitation to those laws, rules and
regulations prescribed by the Office Of Telecommunication
Authority and not to carry out or suffer or permit to be carried
out any work process or operation of whatsoever nature in the
Premises which may cause any electro-magnetic interference to
the Landlord or other tenants or occupiers of any adjoining or
-12-
<PAGE> 14
neighbouring premises and the Tenant shall indemnify the
Landlord and such other tenants or occupiers for any damage or
loss suffered as a result of the Tenant's breach of this
sub-clause.
Anti-Nuisance
3.26 The Tenant shall not do or permit or suffer anything to be done
at any time in or upon the Premises or any part thereof which
may be or become a nuisance or annoyance or which may cause
damage or inconvenience to the Government of the Hong Kong
Special Administrative Region or to the owners or occupiers of
any adjoining or neighbouring lot or lots or premises. In
particular, the Tenant shall not cause or produce or suffer or
permit to be produced on or in the Premises any sound or noise
(including sound produced by broadcasting from television, radio
and any apparatus or instrument capable of producing or
reproducing music and sound) or any vibration or resonance or
other form of disturbance or other acts or things in or on the
Premises which is or are or may be or become a nuisance or
annoyance to the Landlord or the tenants or occupiers of
adjacent or neighbouring premises and the Tenant shall take all
such necessary measures as may be required by and to the
satisfaction of the Director of Environmental Protection to
ensure that the operation of all plant and equipment installed
or used on the Premises will not make any noise which causes
disturbance or annoyance to the residents or occupiers of any
adjourning premises or lot or lots or to the general public. The
decision of the Director of Environmental Protection as to
whether any such plant and equipment are causing disturbance or
annoyance as aforesaid shall be final and binding on the Tenant.
No Discharge of Pollutant or Noxious, Harmful or Corrosive Matter
3.27 Except with the prior written consent of the Director of
Environmental Protection, not to, in or upon the Premises,
install any machinery, furnace or boiler or any other equipment
or use any fuel or any method or process of manufacture or
treatment that might in any circumstances result in the
discharge or emission of any pollutant or any noxious, harmful
or corrosive matter, whether it be in the form of gas, smoke,
liquid, solid or otherwise.
-13-
<PAGE> 15
Compliance with Legislation Regarding Pollution
3.28 To comply with and observe all Ordinances, Bye-laws, Regulations
and rules for the time being in force in Hong Kong governing the
control of any form of pollution, air, noise, water and waste
pollution and the protection of the environment and to comply
with EPD Advice Note 2/89 "Application of the environmental
impact assessment process to major private sector projects"
issued by the Environmental Protection Department and any
subsequent amendment thereto.
Discharge into Sewers, etc.
3.29 (i) Not to discharge directly or indirectly or cause or
permit or suffer to be discharged into any public sewer,
storm water drain, channel, streamcourse or sea any
trade effluent or foul or contaminated water or cooling
or hot water without the prior written consent of the
Director of Environmental Protection, who may as a
condition of granting his consent require the Tenant to
provide, operate and maintain at the Tenant's own
expense, within the Premises or otherwise and to the
satisfaction of the Director of Environmental Protection
suitable works for the treatment and disposal of such
trade effluent or foul or contaminated or cooling or hot
water.
To Reimburse Landlord for Cleaning Drains
(ii) Not to pass or allow to pass into the drains pipes
gutters ducts or watercourses channels of the Premises
or the Building ("the conduits") any noxious or
deleterious effluent or other substance which may cause
any obstruction or deposit in or injury to the conduits
and to pay on demand to the Landlord the cost incurred
by the Landlord in repairing cleansing and clearing any
of the conduits damaged choked or stopped up owing to
the improper or careless use of any toilet or water or
sanitary or drainage equipment by the Tenant or its
employees invitees contractors or licensees.
Removal of Waste Matters
3.30 Not to permit any sewage, waste water or effluent containing
sand, cement, silt or any other Suspended or dissolved material
to flow from the Premises onto any adjoining land or allow any
waste matter which is not
-14-
<PAGE> 16
part of the final product from waste processing plants to be
deposited anywhere within the Building and/or the land on which
the Building stands and to have all such matter removed from the
Building and/or the land on which the Building stands in a
proper manner to the satisfaction of the Director of
Environmental Protection.
Disposal of Garbage
3.31 To be responsible for the removal of refuse and garbage from the
Premises to such location as shall be specified by the Landlord
from time to time and to use only such type of refuse container
as shall be specified by the Landlord from time to time. In the
event of the Landlord providing a collection service for refuse
and garbage the same shall be used by the Tenant to the
exclusion of any other similar service and the Tenant shall bear
an appropriate proportion of the cost of such service.
Cleaning and Cleaning Contractors
3.32 To keep the Premises including without limitation all windows at
all times in a clean and sanitary state and condition and for
the better observance hereof the Tenant shall only employ as
cleaners of the Premises such persons or firms as may be
nominated or approved by the Landlord. Such cleaners shall be
employed by and at the expense of the Tenant.
Not to Misuse Lavatories
3.33 Not to use or permit or suffer to be used any lavatory
facilities whether shared with other tenants or occupiers of the
Building or reserved exclusively for the use of the Tenant for
any purpose other than that for which they are intended and not
to throw or permit or suffer to be thrown into any W.C. pan,
urinal, basin sink or other lavatory fitting any foreign or
deleterious substance of any kind and to keep such lavatory
facilities clean tidy and in a hygienic condition at all times
during the Term and in the Landlord's absolute discretion either
to make good any breakage, blockage or damage of any such
lavatory facilities resulting from the breach by the Tenant of
this sub-clause or to pay to the Landlord on demand the cost of
making good such breakage, blockage or damage.
-15-
<PAGE> 17
Infestation
3.34 At the Tenant's expenses to take all such steps and precautions
to the satisfaction of the Landlord as shall be necessary to
prevent the Premises or any part thereof from becoming infested
by termites rats mice roaches or any other pests or vermin and
for the better observance hereof the Landlord may require the
Tenant to employ at the Tenant's cost such pest extermination
contractors as the Landlord may nominate at such intervals as
the Landlord may direct.
Fuel
3.35 The Tenant shall not use any fuel on the Premises other than
town gas, liquefied petroleum gas, natural gas, kerosene or
other conventional liquid fuel with a sulphur content not
exceeding 0.5% by weight and a viscosity of not more than 6
centistokes at 40 degree Celsius, or a conventional solid fuel
with a sulphur content not exceeding 1% by weight.
Storage of Merchandise and Hazardous Goods
3.36 Not to use the Premises for the manufacture of goods or
merchandise or for the storage of goods or merchandise other
than in small quantities consistent with the nature of the
Tenant's trade or business by way of samples and exhibits and
not to keep or store or cause permit or suffer to be kept or
stored any arms ammunitions gunpowder saltpetre petrol kerosene
liquified petroleum gas butane gas or other explosive or
combustible substances or dangerous hazardous or prohibited
goods, within the meaning of the Dangerous Goods Ordinance
(Cap.295) and the regulations made thereunder or any statutory
modification or re-enactment thereof from time to time in force
(save those which are solely and exclusively for the business of
the Tenant and approved by the Landlord and duly authorized by
the Police Department and any other government department as may
be necessary) or unlawful goods and shall not at any time during
the Term use or allow the Premises or any part thereof to be
used in any way entailing a fine forfeiture or penalty against
the Landlord under any law in force in Hong Kong
-16-
<PAGE> 18
Restriction on Use of Water Supply
3.37 Except with the prior written consent of the Water Authority, no
water from Government mains and/or the mains maintained by the
Landlord shall be used for any heating, cooling or
humidification purpose.
User
3.38 Not to use the Premises for any purpose other than for such
purposes and to conduct its business in the manner as stated in
the Fourth Schedule and unless with the prior written consent of
the Landlord not to change the use thereof or to carry on any
other trade or business therein, and in particular but without
prejudice to the generality of the foregoing, not to use or
allow the Premises or any part thereof to be used as domestic
premises within the meaning of any ordinance for the time being
in force or as sleeping quarters or for any religious purpose or
the performance of any religious ceremony.
No Illegal or Immoral Use
3.39 Not to use or cause suffer or permit to be used the Premises or
any part thereof for any illegal immoral or improper purposes.
Security System
3.40 To ensure that its own security system within and at the
entrance of the Premises (if any) is at all times compatible
with the security system for the Building (if any) provided and
operated by the Landlord.
Protection from Typhoon
3.41 To take all necessary and appropriate precautions to protect the
interior of the Premises from heavy rainfall storm or typhoon
damage.
No Auction
3.42 Not to conduct or allow any auction to be held on the Premises
without the Landlord's prior written approval.
No Pets or Animals
3.43 Not to keep or permit or suffer to be kept any pets, livestock
or animals in the Premises without the prior written approval of
the Landlord.
-17-
<PAGE> 19
No Preparation of Food and Prevention of Odours
3.44 Not to prepare or permit or suffer to be prepared any food in
the Premises or cause or permit any offensive or unusual odours
to be produced upon, permeate through or emanate from the
Premises.
Signs
3.45 Not to paint affix display or exhibit any writing sign signboard
or other device whether illuminated or not upon or outside the
windows or external walls of the Premises or inside the Premises
which may be visible from outside or in at or above any common
area landings or corridors of the Building except the display of
a name plate of the Tenant in such form and size as may be
previously approved by the Landlord at the entrance of the
Premises.
Directory Boards
3.46 To pay the Landlord immediately upon demand the cost of affixing
repairing or replacing as necessary the name of the Tenant in
lettering to the directory board (if any) at the entrance(s) to
the Building and to the directory board (if any) on the floor on
which the Premises are situated.
Obstructions to Outside Windows
3.47 Not to block up, darken or obstruct or obscure any of the
windows or lights belonging to the Premises.
Obstructions in Passages
3.48 Not to place or leave or suffer or permit to be placed or left
by any contractor employee invitee licensee or agent of the
Tenant any boxes furniture articles or rubbish in any passage
ways lift staircases landings entrances exits of the Building
used in common with other tenants and occupiers and/or the
Landlord or otherwise obstruct or encumber the same, and if any
such obstruction or encumbrance shall happen and the Tenant
shall fail to remove the same immediately upon request by the
Landlord either to the Tenant or to the person then in charge of
the Premises on the Tenant's behalf the Landlord his employee
servant or
-18-
<PAGE> 20
agents may remove or dispose of the same at the Tenant's
expenses without incurring any liability whether contractual or
tortious to the Tenant or any other person whomsoever.
Fire-Prevention
3.49 To install all necessary fire fighting equipments at the
Tenant's expenses and take all necessary fire precautions and in
general to comply with all directives from time to time given by
the Fire Services Department.
Access for Fire Service Appliances and Personnel
3.50 (i) At his own expense and to the satisfaction of the
Director of Fire Services to provide in the Premises
suitable means of access for the passage of fire service
appliances and fire service personnel to any part of the
Building and at all times permit such fire service
personnel and fire service appliances the free and
uninterrupted use of such means of access and shall
maintain such means of access and keep the same free
from obstruction.
(ii) To permit the Director of Fire Services, his officers,
servants or agents at all reasonable times with or
without notice to enter upon the Premises or any part
thereof for the purpose of inspecting the same so as to
ensure that the relevant requirements referred to in
sub-clause (i) of this Clause have been complied with.
Parking
3.51 Not to park any vehicle or otherwise use or permit any vehicle
to be parked or otherwise used by any employee agent licensee or
contractor of the Tenant at any place other than in accordance
with the house rules and regulations from time to time made by
the Landlord or the Manager.
Loading and Unloading of Goods
3.52 To load and unload furniture, machinery, goods, merchandise, raw
materials or other large objects only at such places and at such
times and through such entrances and by such cargo/service lifts
as shall be designated by the Landlord for the purpose of
loading and unloading and to use the loading and unloading areas
designated by the Landlord only for the purpose of loading and
unloading. The Tenant shall not use the
-19-
<PAGE> 21
passenger lifts for the conveyance of furniture, machinery,
goods, merchandise, raw materials or other large objects or load
or permit or suffer to be loaded into any cargo/service lift or
passenger lift in the Building a weight greater than such lift
is designed or permitted to carry.
Not to Assign or Underlet
3.53 Not to assign underlet or otherwise part with the possession of
the Premises or any part thereof in any way whether by way of
sub-letting lending sharing or other means whereby any person or
persons not a party to this Tenancy Agreement obtains the use or
possession of the Premises or any part thereof irrespective of
whether any rental or other consideration is given for such use
or possession and in the event of any such transfer sub-letting
sharing assignment or parting with the possession of the
Premises (whether for monetary consideration or not) this
Tenancy Agreement shall at the Landlord's discretion absolutely
determine and the Tenant shall forthwith vacate the Premises on
notice to that effect from the Landlord. The tenancy hereby
created shall be personal to the Tenant named in the First
Schedule of this Tenancy Agreement and without in any way
limiting the generality of the foregoing each of the following
acts and events shall unless approved in writing by the Landlord
be deemed to be a breach of this Clause:-
(i) In the case of a tenant which is a partnership the
taking in of one or more new partners whether on the
death or retirement of an existing partner or otherwise;
(ii) In the case of a tenant who is an individual (including
a sole surviving partner of a partnership tenant) the
death insanity or disability of that individual to the
intent that no right to use possess occupy or enjoy the
Premises or any part thereof shall vest in the executors
administrators personal representatives next of kin
trustee or committee of any such individual;
-20-
<PAGE> 22
(iii) In the case of a tenant which is a corporation any
take-over reconstruction amalgamation merger voluntary
liquidation or change in the person or persons who owns
or own a majority of its voting shares or who otherwise
has or have effective control thereof;
(iv) The giving by the Tenant of a Power of Attorney or
similar authority whereby the donee of the Power of
Attorney obtains the right to use possess occupy or
enjoy the Premises or any part thereof or does in fact
use possess occupy or enjoy the same; and
(v) The change of the Tenant's business name.
Yielding Up
3.54 To yield up the Premises with all the Landlord's fixtures
fittings and additions therein and thereto at the expiration or
sooner determination of this Tenancy Agreement in good clean
tenantable substantial and proper repair and condition (fair
wear and tear excepted) together with all keys giving access to
all parts of the Premises Provided That where the Tenant has
made any alterations or installed any fixtures fittings or
additions in or to the Premises and notwithstanding that the
Landlord's consent for so doing may have been obtained or have
been given or be deemed to have been given at the Tenant's sole
cost and expense to reinstate or remove or do away with all or
any such alterations fixtures fittings or additions or any part
or portion thereof as shall be directed by the Landlord and to
make good and repair in a proper and workmanlike manner any
damage to the Premises and the Landlord's fixtures fittings and
additions therein and thereto as a result of such reinstatement
or removal before delivering up the Premises to the Landlord.
Injury or Damage to Person and Property and Insurance
3.55 To be wholly responsible for any loss damage or injury or death
caused to any person whomsoever or to any property whatsoever
directly or indirectly through the defective or damaged
condition or operation of any
-21-
<PAGE> 23
part of the interior of the Premises or any machinery plant
fixtures or fittings or wiring or piping therein for the repair
of which the Tenant is responsible hereunder or in any way
caused by or owing to the spread of fire fumes or smoke or the
leakage or overflow of water of whatsoever origin from the
Premises or any part thereof as a result of the act default or
neglect of the Tenant its servants agents licensees contractors
employees guests Invitees visitors or customers and to make good
the same by payment or otherwise and to indemnify the Landlord
against all losses damages costs claims demands actions and
legal proceedings whatsoever made upon or against the Landlord
by any person in respect of any such loss damage or injury or
death and all costs and expenses incidental thereto AND for the
better observance of the Tenant's obligations in regard to the
foregoing TO INSURE or at the discretion of the Landlord to
permit the Landlord at the Tenant's expense and in the name of
the Tenant to effect and maintain insurance cover to the
satisfaction of the Landlord with such reputable insurance
company as shall be nominated or approved by the Landlord in
respect of all such risks as aforesaid including without
limitation adequate fire, water and third party insurance in
respect of the Premises (including without limitation the full
replacement value of all furniture fixtures fittings goods
chattels samples personal effects contents and stock therein)
and the Policy of Insurance so effected to be endorsed to show
the interest of the Landlord therein and to be in such amount as
may be determined by the Landlord and to contain a provision
that the insurance cover thereby effected and the terms and
conditions thereof may not be altered modified restricted or
cancelled without the express prior written consent of the
Landlord and in the event of such insurance being effected by
the Tenant itself in pursuance of its obligations hereunder
whenever required so to do by the Landlord to produce to the
Landlord as and when required by the Landlord such policy of
insurance together with a receipt for the last payment of
premium.
-22-
<PAGE> 24
Tenant Liable for its Employees, etc.
3.56 To be liable for any act default negligence or omission of the
Tenant's agents, contractors, employees, invitees, guests,
visitors, servants or licensees as if it were the act default
negligence or omission of the Tenant and to indemnify the
Landlord against all losses damages costs claims demands
expense, or liability arising directly or indirectly from the
aforesaid act default negligence or omission. For the purpose of
this Tenancy Agreement any act default neglect or omission of
any guest visitor servant contractor employee agent invitee or
licensee of the Tenant shall be deemed to be the act default
neglect or omission of the Tenant.
Not to Render Insurance Policy Void
3.57 Not to cause or suffer or permit to be done any act or thing
whereby the policy or policies of insurance on the Premises or
the Building against damage by fire or any other insured risks
or liability to third parties for the time being substituting
may become void or voidable or whereby the rate of premium or
premia thereon may be increased, and to repay to the Landlord on
demand all sums paid by the Landlord by way of increased premium
or premia thereon and all expenses incurred by the Landlord in
and about any renewal of such policy or policies arising from or
rendered necessary by a breach of this sub-clause by the Tenant.
4. The Landlord hereby agrees with the Tenant as follows:-
Quiet Enjoyment
4.01 That the Tenant duly paying the rent rates management fees and
other payments hereby stipulated on the days and in the manner
herein provided for payment of the same and performing and
observing the Tenant's agreements, Covenants, stipulations,
terms, conditions and obligations herein contained may peaceably
hold and enjoy the Premises without any interruption by the
Landlord or any person lawfully claiming through under or in
trust for the Landlord.
Pay Government Rent
4.02 To pay all Government rent and property tax payable in respect
of the Premises.
-23-
<PAGE> 25
Roof and Main Structure
4.03 To maintain and keep the main structure roofs main electricity
supply cables main drains water pipes main walls and exterior
window frames of the Building therein and all concealed
electrical installations and wirings and pipings of the Landlord
in the Premises in a proper and substantial state of repair and
condition Provided that the Landlord shall not be liable for
breach of this sub-clause unless and until written notice of any
defect or want of repair thereof shall have been given to the
Landlord by the Tenant and the Landlord shall have failed to
take reasonable steps to repair or remedy the same within a
reasonable period after the service on it of such notice.
5. Provided Always that and it is hereby expressly agreed as follows:-
Default
5.01 If the Rent and/or the rates and/or the Management Fees and/or
any other moneys payable hereunder or any part thereof shall be
in arrear for fifteen (15) days after the same shall have become
payable (whether formally demanded or not) or if there shall be
any breach or nonperformance or non-observance of any of the
stipulations conditions terms and agreements herein contained
and on the part of the Tenant to be observed or performed or if
the Tenant shall stop or suspend payment of its debts or be
unable to or admit inability to pay its debts as they fall due
or enter into any scheme of arrangement with its creditors or
have an encumbrancer taking possession of any of its assets in
circumstances in which the Landlord shall have reasonable
grounds for believing that the ability of the Tenant to pay the
rentals and other charges hereby reserved and to observe and
perform its obligations under this Tenancy Agreement shall have
been prejudiced or put at risk or have a receiving order made
against it or in such circumstance as aforesaid fail to satisfy
any judgement that may be given in any action against it after
final appeal or go into liquidation (save for the purposes of
amalgamation or reconstruction) or become bankrupt or if the
Tenant shall suffer execution to be levied upon the Premises or
otherwise on the Tenant's goods or if in
-24-
<PAGE> 26
such circumstances as aforesaid the Tenant shall suspend or
cease or threaten to suspend or cease to carry on its business
or should any event occur or proceeding be taken with respect to
the Tenant in any jurisdiction to which the Tenant is subject
which has an effect equivalent or similar to any of the events
or circumstances described above then and in any such case it
shall be lawful for the Landlord at any time thereafter to
re-enter on and upon the Premises or any part thereof in the
name of the whole and thereupon this Tenancy Agreement shall
absolutely determine but without prejudice to any right of
action or other remedy of the Landlord against any breach,
non-observance or non-performance by the Tenant of any of the
terms of this Tenancy Agreement. A written notice served by the
Landlord on the Tenant in manner hereinafter provided to the
effect that the Landlord thereby exercises the power of
determination and/or re-entry herein before contained shall be a
full and sufficient exercise of such power without physical
entry on the part of the Landlord notwithstanding any statutory
or common law provision to the contrary. All costs and expenses
incurred by the Landlord in demanding payment of the Rent,
rates, Management Fees and other charges payable hereunder (if
the Landlord elects to demand) and in exercising its rights
and/or remedies or in attempting to do so shall be paid by the
Tenant and shall be recoverable from the Tenant as a debt.
Interest
5.02 Notwithstanding anything herein contained in the event of
default in payment of the Rent and/or rates and/or the
Management Fees and/or other monies payable by the Tenant
hereunder or any part thereof for a period of fifteen (15) days
from the date when such payment is due (whether formally
demanded or not) the Tenant shall pay to the Landlord on demand
daily interest on all such sums outstanding at the monthly rate
of two percent (2%) calculated from the date on which the same
shall be due for payment (in accordance with the provisions
contained in that behalf herein) until the date of payment as
liquidated damages and not as penalty provided that the demand
and/or receipt by the Landlord of interest pursuant to this
sub-clause shall be without prejudice to and shall
-25-
<PAGE> 27
not affect the right of the Landlord to exercise any other right
or remedy hereof or otherwise (including but without prejudice
to the generality of the foregoing the right of re-entry
exercisable under the terms of this Tenancy Agreement).
Condonation Not a Waiver
5.03 No condoning, excusing or overlooking by the Landlord of any
default, breach or non-observance or nonperformance by the
Tenant at any time or times of any of the agreements
stipulations terms and conditions herein contained shall operate
as a waiver of the Landlord's rights hereunder in respect of any
continuing or subsequent default, breach or non-observance or
non-performance or so as to defeat or affect in any way the
rights and remedies of the Landlord hereunder in respect of any
such continuing or subsequent default or breach and no waiver by
the Landlord shall be inferred from or implied by anything done
or omitted by the Landlord, unless expressed in writing and
signed by the Landlord. Any consent given by the Landlord shall
operate as a consent only for the particular matter to which it
relates and shall in no way be considered as a waiver or release
of any of the provisions hereof nor shall it be construed as
dispensing with the necessity of obtaining the specific written
consent of the Landlord in the future, unless expressly so
provided.
Acceptance of Rent
5.04 The acceptance of any of the Rent by the Landlord shall not be
deemed to operate as a waiver by the Landlord of any right to
proceed against the Tenant in respect of any breach
non-observance or non-performance by the Tenant of any of the
agreements stipulations terms and conditions herein contained
and on the part of the Tenant to be observed and performed.
Distraint
5.05 For the purposes of Part III of the Landlord and Tenant
(Consolidation) Ordinance (Cap.7) and of these presents, the
Rent payable in respect of the Premises shall be and be deemed
to be in arrear if not paid in advance at the times and in the
manner herein provided for payment thereof.
-26-
<PAGE> 28
Deposit
5.06 (i) The Tenant shall on the signing hereof deposit with the
Landlord the sum or sums specified in Part III of the
Third Schedule hereto being the aggregate of THREE (3)
months' Rent and THREE (3) months' Management Fees to
secure the due observance and performance by the Tenant
of the agreements stipulations obligations terms and
conditions herein contained and on the part of the
Tenant to be observed and performed which said deposit
shall be held by the Landlord throughout the currency of
this Tenancy Agreement free of any interest to the
Tenant with the right for the Landlord (without
prejudice to any other right or remedy hereunder or
otherwise) to deduct therefrom the amount of any Rent
rates Management Fees and other charges payable
hereunder in case of default on the part of the Tenant
in making any of such payments and any costs expenses
loss or damage sustained by the Landlord as the result
of any non-observance or non-performance by the Tenant
of any of the said agreements, stipulations obligations
terms and conditions. In the event of any deduction
being made by the Landlord from the said deposit in
accordance herewith during the currency of this Tenancy
Agreement the Tenant shall forthwith on demand by the
Landlord make a further deposit with the Landlord equal
to the amount so deducted and failure by the Tenant so
to do shall entitle the Landlord forthwith to re-enter
upon the Premises and to determine this Tenancy
Agreement as hereinbefore provided.
(ii) Notwithstanding any provision to the contrary contained
herein, it is hereby expressly agreed by the parties
hereto that:-
(a) Upon the signing of this Agreement the sum of
HK$319,131.90 being the deposit ("the previous
deposit") held by the Landlord under the Tenancy
Agreement dated 1st September 1995 made between
the Landlord and the Tenant in respect of
Premises ("the previous Tenancy Agreement")
shall be transferred and carried over to this
Agreement as payment of the said deposit and the
sum of
-27-
<PAGE> 29
HK$68,862.50 shall be refunded by the Landlord
to the Tenant.
(b) In the event that the Tenant shall (either
before or after the date hereof) have breached
any of the terms and conditions contained in the
previous Tenancy Agreement which on the part of
the Tenant is to be observed and performed up to
and inclusive of the date of the expiration of
the contractual term or sooner determination of
the previous Tenancy Agreement, then the
Landlord shall be entitled to deduct from the
said deposit such amount as may be required
towards remedying the same insofar as it may be
possible (without prejudice to any other rights
or remedies available to the Landlord for breach
of the previous Tenancy Agreement) and in such
circumstances and as a condition precedent to
the commencement of this Agreement the Tenant
shall forthwith on demand by the Landlord pay a
further sum to the Landlord (to be held as part
of the said deposit) equal to the amount so
deducted and failure by the Tenant so to do
shall entitle the Landlord to forfeit the
tenancy hereby created or maintained and to
re-enter upon the Premises and to determine this
Agreement (and/or the previous Tenancy Agreement
(as appropriate)) without prejudice to any other
right which the Landlord may have against the
Tenant and the balance of the said deposit (if
any) shall be absolutely forfeited as and for
liquidated damages (and not as penalty).
(c) For the avoidance of doubt this Agreement shall
take effect subject to and with the benefit of
the previous Tenancy Agreement until expiry of
the contractual term or sooner determination of
the previous Tenancy Agreement and so that any
breach in the obligations and restrictions on
the
-28-
<PAGE> 30
part of the Tenant in the previous Tenancy
Agreement shall be a breach of this Agreement
and vice versa.
Increase of Management Fees
5.07 By reasons of any increase in the costs of providing the
necessary services to the Premises and/or managing the Building,
the Landlord and/or the Manager shall be entitled at any time
and from time to time to increase the Management Fees after
giving the Tenant one month's notice of such increase. The
Landlord's and/or the Manager's assessment of any increase in
the said costs shall be conclusive.
Increase in Deposit
5.08 If and whenever the Management Fees shall be increased pursuant
to sub-clause 5.07 of this Clause, the amount of the said
deposit shall be increased accordingly following such increase
in the Management Fees so as to bring at all times the amount of
the said deposit equal to the aggregate of THREE (3) months'
Rent and THREE (3) months' Management Fees for the time being
payable by the Tenant hereunder and the Tenant shall make
payment to the Landlord of such additional sum as shall be
required to bring the said deposit up to the appropriate amount
within fifteen (15) days from the date of the Tenant's receipt
of the Landlord's or the Manager's notice of increase of the
Management Fees as aforesaid.
Refund of Deposit
5.09 Subject as aforesaid the said deposit and any further deposits
paid shall be refunded to the Tenant by the Landlord without
interest within thirty (30) days after the expiration or sooner
determination of this Tenancy Agreement and delivery of vacant
possession of the Premises to the Landlord or after settlement
of the last outstanding claim by the Landlord against the Tenant
for any arrears of Rent rates Management Fees and other charges
and for any breach non-observance or non-performance of any of
the agreements stipulations terms and conditions herein
contained and on the part of the Tenant to be observed or
performed, whichever shall be the later.
-29-
<PAGE> 31
Air-conditioning
5.10 (i) The Landlord shall provide and maintain air-conditioning
for the Premises during the hours referred to in Part IV
of the Third Schedule hereto ("the Normal
Air-Conditioning Hours") whenever the air-conditioning
system shall be operating. The costs of such
air-conditioning shall be included in the management
fees payable by the Tenant as set out in Part II of the
Third Schedule hereto. If the Tenant shall require a
supply of air-conditioning outside the Normal
Air-Conditioning Hours, the same will be supplied by the
Landlord on reasonable advance notice to the Landlord
and at such costs per hour and per square feet of gross
floor area of the Premises as the Landlord may in
absolute discretion from time to time charge.
(ii) If the Tenant shall require a supply of chilled water
for the purpose of cooling its equipment, the same will
be supplied by the Landlord on reasonable advance notice
to the Landlord and at such costs as the Landlord may in
its absolute discretion from time to time charge based
on the Tenant's actual consumption of such chilled
water.
(iii) The Tenant shall pay the costs of such additional
air-conditioning services and/or such chilled water
supply immediately upon receipt of the demand note
therefor which may be rendered at such intervals as the
Landlord may in its absolute discretion decide.
Exclusion of Landlord's Liability
5.11 The Landlord and/or the Manager shall not in any circumstances
other than those arising from their respective gross negligence
or willful default be under any liability whatsoever to the
Tenant or the Tenant's agents, contractors, servants, visitors,
guests, employees, licensees, invitees or any other person
whomsoever in respect of any loss of profit or of business or
loss of life or loss, injury or damage to person or property or
for any disruption or inconvenience or for the security or
safekeeping of the Premises or any contents therein caused to or
suffered or sustained by
-30-
<PAGE> 32
the Tenant or any other person caused by or through or in any
way owing to or arising out of or connected with anything
whatsoever including (without limitation):-
(i) any failure breakdown malfunction defect interruption of
or in or to the operation of or non-availability of any
common services and facilities fire-fighting equipment
or system or lifts or any other services rendered or to
be rendered to the Tenant or such other person;
(ii) any act neglect or default of the other tenants and
occupiers of the Building and their respective visitors
guests licensees invitees employees contractors servants
and agents;
(iii) any failure breakdown malfunction defect or interruption
of or in the supply of gas electricity water or
air-conditioning to the Premises or any part of the
Building;
(iv) any fire storm tempest flood typhoon heavy rainfall
landslide subsidence of the ground Act of God or other
inevitable accident escape of fire smoke fumes or any
other substance or thing or overflow or leakage of water
or electric current from or through any part of the
Premises or the Building or otherwise or the dropping or
falling of any article or vibrations from any part of
the Building;
(v) any defective or damaged condition of the Premises the
Building or part(s) thereof or the Landlord's fixtures
and fittings and additions therein and thereto;
(vi) any use of the Premises any designated car parking space
or other areas or parts of the Building; and
-31-
<PAGE> 33
(vii) the provision by the Landlord or the Manager of watchmen
and caretakers (if any),
nor shall any of the Rent rates Management Fees and any other
sums reserved to be payable by the Tenant hereunder abate or
cease to be payable on account thereof.
Notice to be Given to Landlord on Failure to Perform Obligations
5.12 The Landlord shall not in any event be liable to the Tenant in
respect of any failure of the Landlord to perform any of its
obligations to the Tenant hereunder unless and until the Tenant
has notified the Landlord such failure and the Landlord has
failed within a reasonable length of time to remedy the same and
then in such case the Landlord shall be liable to compensate the
Tenant only for loss or damage sustained by the Tenant after
such reasonable time shall have lapsed.
No Compensation or Abatement of Rent
5.13 The Tenant shall not be entitled to any compensation or
abatement of the Rent if the light and/or air to the Premises is
in any way obstructed by adjoining buildings or otherwise.
Power to Enter in Emergency
5.14 In the event of fire, typhoon or any other contingencies or
emergencies which in the opinion of the Landlord may cause or
threaten to cause damage or injury to the Premises and/or any
part of the Building, the Landlord shall have power in the
absence of the Tenant to break open any doors or windows of the
Premises and to do such other things as may be necessary to
prevent the Premises and/or any part of the Building from being
damaged or injured or further damaged or injured and in such
event the Landlord shall not be answerable to the Tenant for any
loss or damage which the Tenant may sustain thereby.
Abatement of Rent and Management
5.15 If the Premises or the Building or any part thereof shall at any
time during the Term be destroyed or damaged or become
inaccessible owing to fire, water, storm, typhoon, defective
construction, white ants, earthquake
-32-
<PAGE> 34
subsidence of the ground, act of God, force majeure or any
calamity beyond the control of the Landlord so as to render the
Premises unfit for use or inaccessible and the same is in no way
attributable directly or indirectly to any act neglect or
default of the Tenant, its agents, guests, invitees, visitors,
servants, employees, contractors or licensees or if at any time
during the continuance of this tenancy the Premises or the
Building or any part thereof shall be condemned as a dangerous
structure or a demolition order or closing order shall become
operative in respect of the Premises or the Building or any part
thereof then the Rent and Management Fees hereby reserved or a
fair proportion thereof according to the nature and extent of
the damage sustained or order made shall be suspended until the
Premises shall again be rendered accessible and fit for use
PROVIDED THAT the Landlord shall be under no obligation to
repair or reinstate the Premises or the Building if, in its
opinion, it is not reasonably economical or practicable so to do
and PROVIDED FURTHER THAT in circumstances when the whole or
substantially the whole of the Premises have been rendered
inaccessible or unfit for use and should the Premises not have
been reinstated in the meantime either the Landlord or the
Tenant may at any time after two (2) months from the occurrence
of such damage or destruction or order give to the other of them
notice in writing to determine this Tenancy Agreement and
thereupon the same and everything herein contained shall cease
and be void as from the date of the occurrence of such
destruction or damage or order or of the Premises becoming
inaccessible or unfit for use but without prejudice to the
rights and remedies of either party against the other in respect
of any antecedent claim or breach of the agreements,
stipulations, terms and conditions herein contained or of the
Landlord in respect of the Rent and Management Fees payable
hereunder prior to the coming into effect of the suspension.
-33-
<PAGE> 35
No Warranty as to Fitness
5.16 The Landlord does not in anyway warrant that the Premises are
fit or suitable for the operation of the trade business or
activities of the Tenant and the Tenant shall make his own
investigation and enquiries in this connection. In the event of
any governmental authority in any way prohibiting the use of the
Premises for the trade business or activities for the time being
carried on by the Tenant, the Landlord shall have power to
determine the Term hereby created at any time by giving notice
to the Tenant of a length and effect equivalent to that of the
notice (if any) given by the relevant governmental authority
(and if such governmental notice is subsequently extended the
Landlord's said notice to the Tenant shall be extended pro
tanto). On the expiration of such notice by the Landlord to the
Tenant the Term of this tenancy shall accordingly be determined
and the Landlord shall not be required to pay any compensation
for the loss of profit or goodwill or loss or damage of any kind
to the Tenant for such determination provided that nothing in
this sub-clause shall prejudice the continuation of the Term
granted hereunder if the prohibition aforesaid shall be waived
by the relevant governmental authority during the notice period.
Introduction of House Rules and Regulations
5.17 (i) The Landlord and/or the Manager shall be entitled from
time to time and by notice to the Tenant to make
introduce and subsequently amend adopt or abolish if
necessary such house rules and regulations as it may
reasonably consider necessary for the proper operation
management and maintenance of the Building.
Conflict
(ii) Such rules and regulations shall be supplementary to the
terms and conditions contained in this Tenancy Agreement
and shall not in any way derogate from such terms and
conditions. In the event of conflict between such rules
and regulations and the terms and conditions of this
Tenancy Agreement the terms and conditions of this
Tenancy Agreement shall prevail.
-34-
<PAGE> 36
Name of Building
5.18 The Landlord reserves the right to rename the Building with any
such name or style as it in its sole discretion may determine
and at any time and from time to time to change, alter,
substitute or abandon any such name without thereby becoming
liable to compensate the Tenant for any loss expense or
inconvenience caused to the Tenant as a consequence thereof
provided that the Landlord shall give the Tenant and the Postal
and other relevant governmental authorities not less than three
months' notice of its intention so to do.
Alterations to the Building
5.19 Without prejudice to any provisions herein contained the
Landlord reserves the right from time to time to improve extend
add to or reduce the Building or in any manner whatsoever and to
alter or deal with the Building (other than the Premises)
Provided always that in exercising such right the Landlord will
endeavour to cause as little inconvenience to the Tenant as is
practicable in the circumstances and make good any damage caused
to the Premises within a reasonable period of time.
Letting or Sale Notices and Entry
5.20 During the three (3) months immediately preceding the expiration
or sooner determination of the Term the Landlord shall be at
liberty to affix and place without interference upon any
external part of the Premises a notice or notices stating that
the Premises are to be let and/or sold and such other
information in connection therewith as the Landlord shall
require and the Tenant shall permit persons with written
authority from the Landlord or the Landlord's agents at
reasonable times of the day upon prior appointment to enter and
view the Premises or any part or parts thereof.
Notice
5.21 Any notice required to be served under this Tenancy Agreement
shall be in writing and any notice to be served on the Tenant
shall be sufficiently served if sent by pre-paid registered post
to or left at the Tenant's registered office or principal place
of business in Hong Kong or the Premises and any notice to be
served on the Landlord shall be sufficiently served if sent to
the Landlord by pre-paid registered post to or left at the
-35-
<PAGE> 37
Landlord's registered office in Hong Kong. A notice delivered by
hand is duly served at the time of delivery and a notice sent by
registered post shall be deemed to be duly served forty-eight
(48) hours after the date of posting.
No Fine or Premium or Key Money
5.22 The Tenant hereby expressly declares that for the grant of the
Term no premium key money or consideration money or other
valuable consideration other than the Rent and other payments
herein expressly reserved and expressed to be payable has been
paid or will be payable by the Tenant to the Landlord or any
other person.
Costs and Stamp Duty
5.23 (i) The Tenant shall bear half of Messrs. Denton Hall, the
Landlord's solicitors' scale charge as stipulated by the
Law Society of Hong Kong for the preparation and
completion of this Agreement. Notwithstanding the above,
it is expressly declared by the parties that Messrs.
Denton Hall is acting as solicitors for the Landlord
only and the Tenant is advised to seek independent legal
advice on the approval of this Agreement.
(ii) The stamp duty and registration fees payable on this
Agreement and their counterparts shall be borne by the
Landlord and the Tenant in equal shares.
Special Conditions
5.24 The parties hereto shall respectively be bound by and entitled
to the benefit of the Special Conditions (if any) set forth in
the Fifth Schedule.
Fixtures and Fittings
5.25 The Landlord shall provide those fixtures and fittings details
of which are listed in the Sixth Schedule hereto.
Marginal Notes
5.26 The marginal notes, headings and index (if any) are intended for
guidance only and do not form a part of this Tenancy Agreement
nor shall any of the provisions of this Tenancy Agreement be
construed or interpreted by reference thereto or in any way
affected or limited thereby.
-36-
<PAGE> 38
Interpretation
5.27 In this Tenancy Agreement if the context permits or requires
words importing the singular number shall include the plural
number and vice versa and words importing the masculine feminine
or neuter gender, shall include the others of them.
Entire Agreement
5.28 This Tenancy Agreement sets out the full agreement between the
parties. No warranties or representations express or implied of
any kind other than those set out herein (if any) are or have
been made or given by the Landlord or by anybody on his behalf
and if any such warranties or representations express or have
been made, the same are withdrawn or deemed to have been
withdrawn immediately before the execution of this Tenancy
Agreement.
AS WITNESS the hands of the parties hereto the day and year first above
written.
-37-
<PAGE> 39
FIRST SCHEDULE
The Tenant
Name : VALENCE SEMICONDUCTOR DESIGN LIMITED
[CHINESE CHARACTERS]
Registered Office : Unit 413, 4/F., Hong Kong Industrial Technology
Centre, 72 Tat Chee Avenue, Kowloon Tong, Kowloon,
Hong Kong
Business Registration No. : 18907543
SECOND SCHEDULE
Part I
The Premises : Unit 413 on the 4th Floor of the Hong Kong
Industrial Technology Centre
Part II
The Term : Two (2) years commencing on the 1st day of
September 1998 and expiring on the 31st day of
August 2000 (both days inclusive)
-38-
<PAGE> 40
THIRD SCHEDULE
Part I
The Rent : HONG KONG DOLLARS SIXTY SEVEN THOUSAND AND SIXTY
EIGHT ONLY (HK$67,068.00) per month exclusive of
rates, management fees and other outgoings
Part II
Management Fees : HONG KONG DOLLARS SIXTEEN THOUSAND AND TWENTY ONE
AND CENTS EIGHTY ONLY (HK$16,021.80) per month
Part III
The Deposit : HONG KONG DOLLARS TWO HUNDRED FORTY NINE THOUSAND
TWO HUNDRED AND SIXTY NINE AND CENTS FORTY ONLY
(HK$249,269.40)
Part IV
Normal Air-Conditioning : Monday - Friday 8:00 a.m. - 6:00 p.m.
Hours Saturday 8:00 a.m. - 2:00 p.m.
Sunday and no air-conditioning
Public Holiday will be provided
Part V
Vetting Fee : HK$1.60 per square foot of the total gross floor
area of the Premises or HK$3,000.00 whichever is
the greater
-39-
<PAGE> 41
FOURTH SCHEDULE
User : (1) Subject to Paragraph (2) of this Fourth
Schedule, to use the Premises as an office
only.
(2) The Tenant shall carry out R&D activities on
full-custom chip design especially on
system-on-a-chip solution and to develop
system multimedia solutions based on MPEG 2
standard. The Tenant plans to continue
employing about 30 staff at the Premises, 15
of whom will carry out the aforesaid R&D
activities and the balance carry out
marketing and administration activities.
-40-
<PAGE> 42
FIFTH SCHEDULE
Special Conditions
Restriction of Gross Floor Area by Director-General of Industry:-
(a) The Tenant hereby declares that he is fully aware of the existence and
implications of Special Condition (12)(b) in the Particulars and
Conditions of Grant of New Kowloon Inland Lot No.6128 which provides,
inter alia, that the Director-General of Industry may in his absolute
discretion from time to time during the term thereby granted restrict
the proportion of the gross floor area of the Building which may be
underlet by the Landlord and in that event may stipulate that any
underletting by the Landlord shall be for a term not exceeding three (3)
years. The Director-General of Industry in exercising his discretion
shall not cause any premature termination of any underletting and/or
licensing entered in accordance with the said Special Condition (12)(b).
(b) In the event the Director-General of Industry shall exercise his power
under the said Special Condition (12)(b) to restrict the gross floor
area of the Building as aforesaid the Landlord shall be entitled upon
giving reasonable notice at any time after the date of this Agreement
and/or during the Term to require the Tenant to vacate and surrender:-
(i) a part of the Premises - the Tenant shall then at the direction
of the Landlord vacate such part of the Premises within a
reasonable period and deliver vacant possession of the same to
the Landlord, this Agreement shall remain in full force and
effect with respect to that part of the Premises not required to
be surrendered by the Tenant. In the event of a partial
surrender the rent for the remaining part of the Premises shall
be reduced on a pro-rata basis for the remainder of the Term and
a pro-rata refund of the rental deposit shall be made by the
Landlord to the Tenant; or
(ii) the whole of the Premises - the Tenant shall vacate the whole of
the Premises within a reasonable period and deliver vacant
possession of the same to the Landlord, this Agreement shall
become null and void but without prejudice to either party's
right of action against the other for any breach of the terms
and covenants of this Agreement prior to termination.
Provided Always that in the event of a requirement for the
Tenant to vacate a part of the Premises the Tenant shall at its
absolute discretion be entitled to surrender the whole of the
Premises in which event the provisions of sub-clause (b)(ii) of
this Condition shall apply.
-41-
<PAGE> 43
SIXTH SCHEDULE
Fixtures and Fittings
1. Screed floor finishing
2. Perimeter dry wall, mini-blind on windows (where applicable)
3. Ceiling tile in lay in grid
4. Fluorescence lighting fixture, main circuit control board
5. Air diffuser and fan coil unit(s)
The fixtures and fittings listed above will be in accordance with the standard
laid down by the Landlord for such items.
-42-
<PAGE> 44
SIGNED BY Dr. James Liu, CEO ) For and on behalf of
} HONG KONG INDUSTRIAL TECHNOLOGY
for and on behalf of the Landlord in ) CENTRE CORPORATION
the presence of:- Eddy Chan )
/s/ EDDY CHAN /s/ JAMES LIU
- -------------------------------- -----------------------------------
Authorized Signature
SIGNED BY WAN WAH TONG, THOMAS ) For and on behalf of
DIRECTOR } VALENCE SEMICONDUCTOR DESIGN
for and on behalf of the Landlord in ) LIMITED
the presence of:- Reivlin Cham )
/s/ REIVLIN CHAM /s/ WAN WAH TONG
- -------------------------------- -----------------------------------
Authorized Signature(s)
Received the day and year first ) For and on behalf of
above written of and from the ) HONG KONG INDUSTRIAL TECHNOLOGY
Tenant the sum of HONG KONG DOLLARS ) CENTRE CORPORATION
TWO HUNDRED FORTY NINE THOUSAND TWO )
HUNDRED AND SIXTY NINE AND FORTY ) /s/ JAMES LIU
CENTS ONLY shall be transferred ) -----------------------------------
from the Previous Tenancy Agreement ) Authorized Signature
being the deposit payable herein )HK$249,269.40
-------------------------
the Landlord
-43-
<PAGE> 1
EXHIBIT 10.41
CREDIT AND SECURITY AGREEMENT
This Credit and Security Agreement ("Agreement") is entered into as of
July 6, 1999, by and between SRS LABS, INC., a Delaware corporation
("Borrower"), and CITY NATIONAL BANK, a national banking association ("CNB").
1. DEFINITIONS. As used herein, the following terms have the meanings indicated:
1.1 "ACCOUNT CONTROL AGREEMENT" shall mean that certain agreement
between CNB, Borrower, Investors Bank & Trust Company, and Salomon Brothers
Asset Management, Inc. substantially in the form as attached hereto as Exhibit
A.
1.2 "AFFILIATE," as applied to any Person, shall mean any other
Person directly or indirectly controlling, controlled by, or under common
control with, that Person. For the purposes of this definition, "control"
(including with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as applied to any Person, shall mean the
possession, directly or indirectly, of the power to direct or cause the
direction of the management and policies of that Person, whether through the
ownership of voting securities or by contract or otherwise. The definition of
"Affiliate" hereunder shall also specifically include any employee stock
ownership plan of Borrower or an Affiliate.
1.3 "BORROWING BASE" shall be equal to:
<TABLE>
<CAPTION>
ADVANCE MAINT.
COLLATERAL VALUE VALUE
- ---------- ------- ------
<S> <C> <C>
U.S. Treasury Bills 100% 100%
U.S. Treasury bonds or notes maturing in one year or less, but not 95% 100%
including U.S. Treasury Bills.
U.S. Treasury bonds or notes maturing in more than one year but not 90% 95%
more than 5 years.
U.S. Treasury bonds or notes maturing in more than 5 years. 80% 95%
Obligations of any state, U.S. territory or commonwealth, and any 80% 85%
municipal or other local government subdivision or entity.
Certificates of Deposit held with CNB and pledged as Collateral. 100% 100%
Bonds, notes, debentures and other debt securities of U.S. corporations, 80% 85%
fourth-rated or higher by a nationally recognized agency such as
Moody's or Standard & Poors, not falling within the definition of
"Margin Stock," as defined in Federal Reserve Board Regulation U, as
amended from time to time
</TABLE>
1.4 "BUSINESS DAY" shall mean a day that CNB is open for business.
1
<PAGE> 2
1.5 "CODE" shall mean the CALIFORNIA UNIFORM COMMERCIAL CODE, except where
the UNIFORM COMMERCIAL CODE of another state governs the perfection of a
security interest in Collateral located in that state.
1.6 "COLLATERAL" shall mean all property securing the Obligations and as
described in Section 7 hereof.
1.7 "COMMERCIAL LETTERS OF CREDIT" shall mean letters of credit issued
pursuant to this Agreement and in response to Borrower's submission of an
Irrevocable Letter of Credit Application and Security Agreement for purposes of
purchasing merchandise.
1.8 "DEBT" shall mean, at any date, the aggregate amount of, without
duplication, (a) all obligations of Borrower for borrowed money; (b) all
obligations of Borrower evidenced by bonds, debentures, notes or other similar
instruments; (c) all obligations of Borrower to pay the deferred purchase price
of property or services; (d) all capitalized lease obligations of Borrower; (e)
all obligations or liabilities of others secured by a lien on any asset of
Borrower, whether or not such obligation or liability is assumed; (f) all
obligations guaranteed by Borrower; (g) all obligations of Borrower, direct or
indirect, for letters of credit; and (h) any other obligations or liabilities
which are required by generally accepted accounting principles to be shown as
debt on the balance sheet of Borrower.
1.9 "ERISA" shall mean the Employee Retirement Income Security Act of
1974, as amended from time to time, and the regulations and published
interpretations thereunder.
1.10 "EUROCURRENCY RESERVE REQUIREMENT" means the aggregate (without
duplication) of the rates (expressed as a decimal) of reserves (including,
without limitation, any basic, marginal, supplemental, or emergency reserves)
that are required to be maintained by banks during the Interest Period under
any regulations of the Board of Governors of the Federal Reserve System, or any
other governmental authority having jurisdiction with respect thereto,
applicable to funding based on so-called "Eurocurrency Liabilities", including
Regulation D (12 CFR 224).
1.11 "EVENT OF DEFAULT" shall mean an event described in Section 8.1 of
this Agreement.
1.12 "INTEREST PERIOD" means the period commencing on the date the LIBOR
Loan is made (including the date a Prime Loan is converted to a LIBOR Loan, or
a LIBOR Loan is renewed as a LIBOR Loan, which, in the latter case, will be the
last day of the expiring Interest Period) and ending on the first day of the
month occurring prior to or on the date which is one (1), two (2), three (3),
six (6), or twelve (12) months thereafter, as selected by the Borrower,
provided, however, no Interest Period may extend beyond the Termination Date.
1.13 "LETTER OF CREDIT COMMITMENT" shall mean CNB's commitment, in
accordance with the terms hereof, to issue Letters of Credit in an aggregate
principal amount of TWO MILLION DOLLARS ($2,000,000).
1.14 "LETTERS OF CREDIT" shall mean Commercial Letters of Credit and
Standby Letters of Credit.
1.15 "LIBOR BASE RATE" means the British Banker's Association definition
of the London InterBank Offered Rates as made available by Bloomberg LP, or
such other information service available to CNB, for the applicable monthly
period upon which the Interest Period is based for the
2
<PAGE> 3
LIBOR Loan selected by Borrower and as quoted by CNB on the Business Day
Borrower requests a LIBOR loan or on the last Business Day of an expiring
Interest Period.
1.16 "LIBOR INTEREST RATE" means the rate per year (rounded upward to the
next one-sixteenth (1/16th) of one percent (0.0625%), if necessary) determined
by CNB to be the quotient of (a) the LIBOR Base Rate divided by (b) one minus
the Eurocurrency Reserve Requirement for the Interest Period; which is expressed
by the following formula:
LIBOR BASE RATE
----------------------------------
1-Eurocurrency Reserve Requirement
1.17 "LOAN" or "LOANS" shall mean one or more of the Loans extended by CNB
to Borrower pursuant to Section 2 hereof.
1.18 "LOAN DOCUMENTS" means, individually and collectively, this Agreement,
any note, security or pledge agreement, financing statement and all other
contracts, instruments, addenda and documents executed in connection with or
related to extensions of credit under this Agreement.
1.19 "NOTE" shall mean the Note referenced in Section 2 hereof.
1.20 "OBLIGATIONS" shall mean all present and future liabilities and
obligations of Borrower to CNB hereunder and all other liabilities and
obligations of Borrower to CNB of every kind and description, now existing or
hereafter owing, matured or unmatured, direct or indirect, absolute or
contingent, joint or several, including any extensions and renewals thereof and
substitutions therefor.
1.21 "PERSON" shall mean and include natural persons, corporations, limited
partnerships, general partnerships, joint ventures, associations, joint stock
companies, companies, trusts, banks, trust companies, business trusts or other
organizations, whether or not legal entities, and governments and agencies and
political subdivisions thereof.
1.22 "POTENTIAL EVENT OF DEFAULT" shall mean any condition that with the
giving of notice or passage of time or both would, unless cured or waived,
become an Event of Default.
1.23 "PRIME RATE" shall mean the rate most recently announced by CNB at its
principal office in Beverley Hills as its "Prime Rate." Any change in the
interest rate resulting from a change in such Prime Rate shall become effective
on the Business Day on which each change in Prime Rate is announced by CNB.
1.24 "REVOLVING CREDIT COMMITMENT" shall mean, CNB's commitment, in
accordance with the terms of this Agreement, to make Revolving Credit Loans in
the aggregate principal amount at any one time of up to TEN MILLION DOLLARS
($10,000,000).
1.25 "REVOLVING CREDIT LOANS" shall have the meaning set forth in Section
2.1 hereof.
1.26 "REVOLVING CREDIT NOTE" shall mean the note required by Section 2.1
hereof.
1.27 "STANDBY LETTERS OF CREDIT" shall mean standby letters of credit
issued pursuant to this Agreement and in response to Borrower's submission of an
Irrevocable Standby Letter of Credit Application and Letter of Credit Agreement.
3
<PAGE> 4
1.28 "TERMINATION DATE" shall mean April 1, 2001, unless the Revolving
Credit Commitment shall have been renewed for an additional term by CNB giving
Borrower prior written notice of such renewal, in which event the Termination
Date shall mean such renewed maturity date of the Revolving Credit Commitment,
as set forth in the notice. Notwithstanding the foregoing, CNB may, at its
option, terminate this Agreement pursuant to Section 8.3 hereof; the date of any
termination under Section 8.3 shall thereupon become the Termination Date as
that term is used in this Agreement.
1.29 "YEAR 2000 COMPLIANT" means that dates occurring on and after January
1, 2000 will be recognized correctly by computer software and not misinterpreted
as a date occurring prior to January 1, 2000.
2. LOANS.
2.1 REVOLVING CREDIT LOANS. Subject to the terms and conditions of this
Agreement and the Revolving Credit Note, CNB agrees to make loans ("Revolving
Credit Loans") to Borrower from the date of this Agreement to, but not
including, the Termination Date, at such times as Borrower may request, up to
the amount of the Revolving Credit Commitment, which Revolving Credit Loans may
be repaid and reborrowed at any time up to the Termination Date; provided,
however, that the aggregate unpaid principal amount of such Revolving Credit
Loans shall at no time exceed the Borrowing Base, determined by using the
Advance Value, less the amount of Letters of Credit outstanding at the time of
the request for the Revolving Credit Loan. The aggregate unpaid principal amount
of all Revolving Credit Loans shall be paid by Borrower to CNB on the
Termination Date. The Revolving Credit Loans shall be evidenced by a promissory
note ("Revolving Credit Note") substantially in the form of Exhibit B attached
hereto.
2.1.1 INTEREST ON REVOLVING CREDIT LOANS. The Revolving Credit Loans
will bear interest from disbursement until due (whether at stated maturity, by
acceleration or otherwise) at a rate equal to one percent (1%) per year above
the rate of interest earned on any certificate of deposit pledged to CNB as
collateral for this Note with respect to Revolving Credit Loans in an amount not
exceeding the face amount of such certificate of deposit. The balance of the
Revolving Credit Loans will bear interest from disbursement until due (whether
at stated maturity, by acceleration or otherwise) at a rate equal to, at
Borrower's option, either (a) for a LIBOR Revolving Loan, the LIBOR Interest
Rate plus three quarters of one percent (0.75%) per year, or (b) for a Prime
Revolving Loan, the fluctuating Prime Rate per year. Interest on the Revolving
Credit Loans and other charges incurred under this Agreement will accrue daily
and be payable (a) monthly in arrears, on the first day of the next month
commencing on the first such date following disbursement; (b) if a LIBOR
Revolving Loan, upon any prepayment of any LIBOR Revolving Loan (to the extent
accrued on the amount prepaid); and (c) at the Termination Date. A Revolving
Credit Loan tied to the LIBOR Interest Rate is called a "LIBOR Revolving Loan,"
and a Revolving Credit Loan tied to the Prime Rate is called a "Prime Revolving
Loan." A Revolving Credit Loan will be a Prime Revolving Loan any time it is not
a LIBOR Revolving Loan.
2.1.2 PAYMENT FOR AMOUNTS EXCEEDING BORROWING BASE. Borrower will,
immediately upon demand, repay the amount by which the unpaid principal amount
of Revolving Credit Loans exceeds the amount CNB has agreed to lend under
Section 2.1, using the Maintenance Value to determine the Borrowing Base. The
portion of the Revolving Credit Loans exceeding the amount CNB has agreed to
lend under Section 2.1 will bear additional interest of three percent (3.0%) per
year over the rate set forth in Section 2.1.1 for Prime Loans.
2.1.3 PROCEDURE FOR REVOLVING CREDIT LOANS. Each Revolving Credit Loan
may be made by CNB at the oral or written request of anyone who is authorized in
writing by Borrower to
4
<PAGE> 5
request and direct the disposition of the Revolving Credit Loans until written
notice of the revocation of such authority is received by CNB. Any Revolving
Credit Loan shall be conclusively presumed to have been made to or for the
benefit of Borrower when CNB in its sole discretion believes that such request
and directions have been made by such authorized persons (whether in fact that
is the case), or when the Revolving Credit Loans are deposited to the credit of
Borrower's account with CNB regardless of the fact that persons other then those
authorized hereunder may have authority to draw against such account.
2.2 LETTER OF CREDIT FACILITY. CNB shall, at the request of
Borrower, at any time up to, but not including, the Termination Date, and upon
the terms and conditions set forth herein, issue Letters of Credit for the
account of Borrower. The aggregate face amount of outstanding Letters of Credit
shall not at any time exceed the lesser of (i) the Revolving Credit Commitment
less Revolving Credit Loans outstanding on the date of the request, or (ii) the
Letter of Credit Commitment.
2.2.1 ISSUANCE OF LETTERS OF CREDIT. Commercial Letters of
Credit shall be issued for the purpose of financing the import of merchandise in
accordance with an Irrevocable Letter of Credit Application and Security
Agreement incorporated herein by this reference, as it may exist form time to
time, subject to the terms of this Agreement in the event of any conflict
herewith. Standby Letters of Credit shall be issued in accordance with an
Irrevocable Standby Letter of Credit Application and Letter of Credit Agreement
incorporated herein by this reference, as it may exist from time to time,
subject to the terms of this Agreement in the event of any conflict herewith.
All Letters of Credit shall be issued on the normal documentation used by CNB
from time to time in accordance with the Uniform Customs and Practices for
Documentary Credits (1993 Revision) International Chamber of Commerce
Publication No. 500 or the International Standby Practices 1998, whichever is
applicable. Unless CNB otherwise agrees in writing, no Letters of Credit may
expire after the Termination Date. Published CNB fees and charges shall apply to
the issuance of Letters of Credit.
2.2.2 REIMBURSEMENT FOR FUNDING LETTER OF CREDIT. Any drawing
under a Letter of Credit shall be deemed to be an irrevocable request for a
Revolving Credit Loan under this Agreement. Borrower's obligation to reimburse
CNB may also be satisfied by charging Borrower's demand deposit account if
requested by Borrower. CNB's obligation under this subsection to make a
Revolving Credit Loan shall exist irrespective of the existence of any Potential
Event of Default or Event of Default.
2.3 LIBOR LOAN TERMS AND CONDITIONS
2.3.1 PROCEDURE FOR LIBOR LOANS. Borrower may request that a
Revolving Credit Loan be a LIBOR Loan (including conversion of a Prime Revolving
Loan to a LIBOR Revolving Loan, or continuation of a LIBOR Revolving Loan as a
LIBOR Revolving Loan) upon the expiration of the Interest Period. Borrower's
request will be irrevocable, will be made to CNB no earlier than two (2)
Business Days before and no later than 1:00 p.m. Pacific Time on the day the
LIBOR Loan is to be made. If Borrower fails to select a LIBOR Loan in accordance
herewith, the Loan will be a Prime Loan, and any outstanding LIBOR Loan will be
deemed a Prime Loan upon expiration of the Interest Period.
2.3.2 AVAILABILITY OF LIBOR LOANS. Notwithstanding anything
herein to the contrary, each LIBOR Loan must be in the minimum amount of
$500,000.00 and increments of $100,000.00. Borrower may not have more than five
(5) LIBOR Loans outstanding at any one time under this Agreement. Borrower may
have Prime Loans and LIBOR Loans outstanding simultaneously.
2.3.3 PREPAYMENT OF PRINCIPAL. Borrower may not make a partial
principal prepayment on a LIBOR Loan. Borrower may prepay the full outstanding
principal balance on a LIBOR Loan prior to the end of the Interest Period,
provided, however, that such prepayment is
5
<PAGE> 6
accompanied by a fee ("LIBOR Prepayment Fee") equal to the amount, if any, by
which (a) the additional interest which would have been earned by CNB had the
LIBOR Loan not been prepaid exceeds (b) the interest which would have been
recoverable by CNB by placing the amount of the LIBOR Loan on deposit in the
LIBOR market for a period starting on the date on which it was prepaid and
ending on the last day of the applicable Interest Period. CNB's calculation of
the LIBOR Prepayment Fee will be deemed conclusive absent manifest error.
2.3.4 SUSPENSION OF LIBOR LOANS. If CNB, on any Business Day, is
unable to determine the LIBOR Base Rate applicable for a new, continued, or
converted LIBOR Loan for any reason, or any law, regulation, or governmental
order, rule or determination, makes it unlawful for CNB to make a LIBOR Loan,
Borrower's right to select LIBOR Loans will be suspended until CNB is again able
to determine the LIBOR Base Rate or make LIBOR Loan, as the case may be. During
such suspension, new Loans, outstanding Prime Loans, and LIBOR Loans whose
Interest Periods terminate may only be Prime Loans.
2.4 PAYMENTS. All payments hereunder shall be in United States Dollars and
in immediately available funds. All interest shall be computed on the basis of a
360-day year and actual days elapsed. Any payment which falls on a non-Business
Day shall be rescheduled to the next Business Day and interest shall continue to
accrue to such rescheduled Business Day. All payments of principal, interest,
fees and other charges on the Loans shall be made by charging, and Borrower
hereby authorizes CNB to charge, Borrower's demand deposit account at CNB for
the amount of each such payment. Borrower shall have sufficient collected
balances in its demand deposit account with CNB in order that each such payment
will be available when due hereunder. If Borrower fails at any time and for any
reason to have a demand deposit account with CNB, all such payments shall be
made directly to CNB at CNB's address specified in Section 9.6 of this
Agreement. CNB is hereby authorized to note the date, amount and interest rate
of each Loan and each payment of principal and interest with respect thereto on
CNB's books and records, which notations shall constitute presumptive evidence
of the accuracy of the information noted.
2.5 INTEREST ON OVERDUE PAYMENTS. Overdue payments of principal (and of
interest to the extent permitted by law) on the Loans shall bear additional
interest from and after written notice by CNB to Borrower of the occurrence of a
Potential Event of Default or an Event of Default (and without constituting a
waiver of such Potential Event of Default or Event of Default) at a fluctuating
rate per annum equal to five percent (5.0%) per annum higher than the interest
rate as determined in Sections 2.1.1 and 2.1.2 until such unpaid amount has been
paid in full. All interest provided for in this Section 2.3 shall be payable on
demand. Except as aforestated in this Section 2.3, the Loans shall bear interest
(whether before or after any breach of this Agreement) at the rate of interest
specified in Sections 2.1.1 and 2.1.2.
3. CONDITIONS PRECEDENT.
3.1 EXTENSION OF CREDIT. The obligation of CNB to make the first Loan or
issue the first Letter of Credit, whichever occurs first, hereunder is subject
to the fulfillment to CNB's satisfaction of each of the following conditions:
3.1.1 CNB shall have received the Note duly executed and delivered by
Borrower;
3.1.2 CNB shall have received (a) a copy of Borrower's Articles of
Incorporation as amended to date; (b) a Resolution of Borrower's Board of
Directors approving and authorizing the execution, delivery and performance of
this Agreement and any other documents required pursuant to
6
<PAGE> 7
this Agreement, certified by Borrower's corporate secretary; and (c) a copy of
the last certificate filed on behalf of Borrower containing the information
required by California Corporations Code Section 1502(a);
3.1.3 CNB shall have received the fully executed Account Control
Agreement;
3.1.4 CNB shall have received evidence that the insurance required
by Section 5.6 hereof is in effect;
3.2 CONDITIONS TO EACH EXTENSION OF ALL LOANS. The obligation of CNB to
make any Loan or issue any Letter of Credit hereunder shall be subject to the
fulfillment of each of the following conditions to CNB's satisfaction:
3.2.1 If a Commercial Letter of Credit is to be issued, CNB shall
have received an Irrevocable Letter of Credit Application and Security
Agreement, duly executed and delivered by Borrower, in the form customarily used
by CNB and in form and substance acceptable to CNB;
3.2.2 If a Standby Letter of Credit is to be issued, CNB shall have
received an Irrevocable Standby Letter of Credit Application and Letter of
Credit Agreement, duly executed and delivered by Borrower, in the form
customarily used by CNB and in form and substance acceptable to CNB;
3.2.3 The representations and warranties of Borrower set forth in
Section 4 hereof shall be true and correct on the date of the making of each
Loan or issuance of any Letter of Credit with the same effect as though such
representations and warranties had been made on and as of such date;
3.2.4 There shall be in full force and effect in favor of CNB a
legal, valid and enforceable security interest in, and a valid and binding first
lien on the Collateral and CNB shall have received evidence, in form and
substance acceptable to CNB, that all filings, recordings and other actions that
are necessary or advisable, in the opinion of CNB, in order to establish,
protect, preserve and perfect CNB's security interests and liens as legal, valid
and enforceable security interests and liens in the Collateral have been
effected;
3.2.5 There shall have occurred no Event of Default or Potential
Event of Default; and
3.2.6 All other documents and legal matters in connection with the
transactions contemplated by this Agreement, shall be satisfactory in form and
substance to CNB.
4. REPRESENTATIONS AND WARRANTIES. To induce CNB to enter into this
Agreement, Borrower makes the following representations and warranties which
shall survive the making and repayment of the Loans:
4.1 CORPORATE EXISTENCE. Borrower is duly organized, validly existing and
in good standing under the laws of its state of incorporation, and is duly
qualified to conduct business as a foreign corporation in all jurisdictions
where the failure to do so would have a material adverse effect on its business.
4.2 REQUISITE POWER. Borrower has all requisite corporate power to borrow
the sums provided for in this Agreement, and to execute and deliver this
Agreement and each other document, contract and instrument delivered to CNB in
connection with this Agreement to which Borrower is required hereunder to be a
party. The execution, delivery and performance of this Agreement have been
7
<PAGE> 8
duly authorized by the Board of Directors of Borrower and do not require any
consent or approval of the stockholders of Borrower.
4.3 BINDING AGREEMENT. This Agreement and the Note when delivered pursuant
hereto, will constitute the valid and legally binding obligations of Borrower,
enforceable against Borrower in accordance with their terms, except as the
enforceability thereof may be affected by bankruptcy, insolvency or similar
laws affecting the enforcement of creditors' rights generally.
4.4 OTHER AGREEMENTS. The execution, delivery and performance of this
Agreement and the Note will not violate any provision of law or regulation
(including, without limitation, Regulations X and U of the Federal Reserve
Board) or any order of any governmental authority, court, arbitration board or
tribunal of the Articles of Incorporation or By-laws of Borrower, or result in
the breach of, constitute a default under, contravene any provisions of, or
result in the creation of any security interest, lien, charge or encumbrance
upon any of the property or assets of Borrower pursuant to any indenture or
agreement to which Borrower or any of its properties is bound, except liens and
security interests in favor of CNB.
4.5 LITIGATION. There is no litigation, investigation or proceeding in
any court or before any arbitrator or regulatory commission, agency or other
governmental authority pending, or threatened against or affecting Borrower, or
its properties, which, if adversely determined would have a material adverse
effect on the business, operation or condition, financial or otherwise, of
Borrower.
4.6 FINANCIAL CONDITION. Borrower's most recent financial statements,
copies of which have heretofore been delivered to CNB, are true, complete and
correct and fairly present the financial condition of Borrower and the
Subsidiaries, including operating results, as of the accounting period
referenced therein. The financial statements have been prepared in accordance
with generally accepted accounting principles consistently applied. There has
been no material adverse change in the business, operations or conditions,
financial or otherwise, of Borrower since the date of such financial
statements. Borrower no has any material liabilities for taxes, long-term
leases or long-term commitments, except as disclosed in the aforementioned
financial statements.
4.7 NO VIOLATIONS. Borrower is not in violation of any law, ordinance,
rule or regulation to which it or any of its properties is subject which would
have a material adverse effect on the business, operation or condition,
financial or otherwise, of Borrower.
4.8 COLLATERAL.
4.8.1 Borrower owns and has the right and power to grant a
security interest in the Collateral;
4.8.2 The Collateral is genuine and free from liens, adverse
claims, set-offs, defaults, prepayments, defenses and encumbrances except those
in favor of CNB;
4.9 USE OF PROCEEDS. Borrower shall use the proceeds of the Revolving
Credit Loans to pay off existing Debt, to provide working capital, for general
corporate purposes and for issuance of letters of credit.
4.10 ERISA. Borrower is in compliance in all material respects with all
applicable provisions of ERISA. No Reportable Event (as defined in ERISA and
the regulations issued thereunder [other than a "Reportable Event" not subject
to the provision for thirty (30) day notice to the Pension Benefit
8
<PAGE> 9
Guaranty Corporation ("PBGC") under such regulations]) has occurred with respect
to any benefit plan of Borrower nor are there any unfunded vested liabilities
under any benefit plan of Borrower. Borrower has met its minimum funding
requirements under ERISA with respect to each of its plans and has not incurred
any material liability to the PBGC in connection with any such plan.
4.11 CONSENTS. No consent, license, permit, approval or authorization of,
exemption by, notice to, report to, or registration, filing or declaration
with, any governmental authority or agency is required in connection with the
execution, delivery and performance by Borrower of this Agreement or the Note
or the transactions contemplated hereby or thereby.
4.12 REGULATION U. Borrower is not engaged principally, or as one of its
principal activities, in the business of extending credit for the purpose of
purchasing or carrying margin stock (within the meaning of Regulations U or X
of the Federal Reserve Board). No part of the proceeds of the Loans will be
used by Borrower to purchase or carry any such margin stock or to extend credit
to others for the purpose of purchasing or carrying such margin stock.
4.13 ENVIRONMENTAL MATTERS.
4.13.1 The operations of Borrower comply in all material respects
with all applicable federal, state and local environmental, health and safety
statutes, regulations and ordinances and fully comply with all terms and
conditions of all required permits and licenses;
4.13.2 Borrower has received no notices of any threatened or pending
governmental or private civil, criminal or administrative proceeding regarding
any environmental or health and safety statute, regulation or ordinance and
has not been subject to any federal, state or local investigations,
inspections or orders regarding any environmental or health and safety statute,
regulation or ordinance;
4.13.3 Borrower knows of no facts or conditions which may exist which
may subject Borrower to liability or contingent liability and Borrower is not
presently liable or contingently liable for any removal, remedial, response or
other costs or damages in connection with any release into the environment of
toxic or hazardous substances or waste included on any federal, state or local
hazardous chemical or substances lists under any federal, state or local
statute, regulation or ordinance.
4.14 YEAR 2000 COMPLIANCE. Borrower has adopted a plan, appropriate to its
business or industry, to insure that its computer software is Year 2000
Compliant. Borrower has or intends to develop an action plan to deal with
significant disruption in its business which might be anticipated in the event
of foreseen or unforeseen failures of its computer systems or its production
and manufacturing equipment to be Year 2000 Compliant.
5. AFFIRMATIVE COVENANTS. Borrower agrees that until payment in full of all
Obligations, Borrower shall comply with the following covenants:
5.1 BOOKS AND RECORDS. Borrower shall maintain, in accordance with sound
accounting practices, accurate records and books of account and shall furnish
CNB with all information regarding the business or finances of Borrower
promptly upon CNB's request.
5.2 COLLATERAL. Borrower shall execute and deliver to CNB any instrument,
document, financing statement, assignment or other writing which CNB may deem
necessary or desirable to carry out the terms of this Agreement, to perfect
CNB's security interest in any Collateral for the Obligations, or to enable CNB
to enforce its security interest in any of the foregoing.
9
<PAGE> 10
5.3 FINANCIAL STATEMENTS. Borrower shall furnish to CNB on a
continuing basis:
5.3.1 Within one hundred and twenty (120) days after the close
of each fiscal year, a copy of the annual audit report for such year for
Borrower and the Subsidiaries including therein a balance sheet, income
statement, reconciliation of net worth and statement of cash flows, with notes
thereto, the balance sheet, income statement and statement of cash flows to be
audited by a certified public accountant acceptable to CNB, and certified by
such accountants to have been prepared in accordance with generally accepted
accounting principles consistently applied and accompanied by Borrower's
certification as to whether any event has occurred which constitutes an Event of
Default or Potential Event of Default, and if so, stating the facts with respect
thereto;
5.3.2 As soon as available, any written report pertaining to
material items with respect to matters involving Borrower's internal controls
submitted to Borrower by Borrower's independent public accountants in connection
with each annual or interim special audit of the financial condition of Borrower
and the Subsidiaries made by such accountants;
5.3.3 Such additional information, reports and/or statements
as CNB may, from time to time, reasonably request.
5.4 COLLATERAL REPORTS. Borrower shall provide CNB with the
following reports:
5.4.1 Within ten (10) days of each month-end, a listing and
pricing of each item of Collateral held pursuant to the Account Control
Agreement;
5.4.2 Within twenty (20) days of each month-end, a
certification detailing the amount of the Borrowing Base as of such month-end.
5.5 TAXES AND PREMIUMS. Borrower shall pay and discharge all taxes,
assessments, governmental charges and real and personal property taxes,
including, but not limited to, federal and state income taxes, employee
withholding taxes and payroll taxes, and all premiums for insurance required
hereunder prior to the date upon which penalties are attached thereto which
would have a material adverse effect on the business, operation or condition,
financial or otherwise, of Borrower.
5.6 INSURANCE.
5.6.1 Borrower shall, and shall cause its Subsidiaries to,
maintain and keep in force insurance of the types and in amounts customarily
carried in its lines of business, including, but not limited to, fire, public
liability, property damage, business interruption and worker's compensation,
such insurance to be carried with companies and in amounts reasonably
satisfactory to CNB, and shall deliver to CNB from time to time, as CNB may
request, schedules setting forth all insurance then in effect; and
5.7 NOTICE. Borrower shall promptly advise CNB in writing of (a) the
change of Borrower's name, trade name or other name under which it does business
or of any such new or additional name; (b) the occurrence of any Event of
Default or Potential Event of Default; (c) any litigation pending or threatened
against Borrower, where the amount or amounts in controversy exceed
$1,000,000.00; (d) any unpaid taxes of Borrower which are more than fifteen (15)
days delinquent; and (e) any other matter that might materially or adversely
affect Borrower's financial condition, operations, property or business.
10
<PAGE> 11
5.8 NOTICE OF CHANGE OF ADDRESS. Borrower shall promptly advise CNB in
writing of the opening of any new places of business, the closing of any of its
existing places of business, which are material to the operation of Borrower's
business.
5.9 FAIR LABOR STANDARDS ACT. Borrower shall comply with the requirements
of, and all regulations promulgated under, the Fair Labor Standards Act of 1938
(29 U.S.C. Code Section 201 et seq.).
5.10 CORPORATE EXISTENCE. Borrower shall preserve and maintain its
corporate existence and all of its rights, privileges and franchises necessary
or desirable in the normal course of its business the loss of which would have a
material adverse effect on the business, operation or condition, financial or
otherwise, of Borrower.
5.11 COMPLIANCE WITH LAW. Borrower shall comply with all requirements of
all applicable laws, rules, regulations (including, but not limited to, ERISA
with respect to each of their benefit plans and all environmental or hazardous
materials law), orders of any governmental agency and all material agreements
to which they are a party.
6. NEGATIVE COVENANTS. Borrower agrees that until payment in full of all
Obligations, Borrower shall not do any of the following without CNB's prior
written consent:
6.1 SALE OF ASSETS. Sell, lease or otherwise dispose of any of Borrower's
assets, other than in the ordinary course of business in excess of an aggregate
amount of $1,000,000 during any calendar year.
6.2 INVOLUNTARY LIENS. Permit any involuntary liens to arise with respect
to any property or assets including but not limited to those arising from the
levy of a writ of attachment or execution, or the levy of any state or federal
tax lien which lien shall not be removed within a period of thirty (30) days.
6.3 SALE AND LEASEBACK. Enter into any sale-leaseback transaction.
6.4 MERGERS. Enter into any merger or consolidation with any Person.
6.5 REDEMPTIONS, DIVIDENDS AND DISTRIBUTIONS. Redeem or repurchase stock
or partnership interests, declare or pay any dividends or make any other
distribution, whether of capital, income or otherwise, and whether in cash or
other property in excess of an aggregate amount of $1,000,000 during any
calendar year.
6.6 EVENT OF DEFAULT. Permit a default to occur under any document or
instrument evidencing Debt incurred under any indenture, agreement or other
instrument under which such Debt may be issued, or any event to occur under any
of the foregoing which would permit any holder of the Debt outstanding
thereunder to declare the same due and payable before its stated maturity,
whether or not such acceleration occurs or such default be waived.
7. SECURITY AGREEMENT.
GRANT OF SECURITY INTEREST. To secure all of Borrower's Obligations hereunder
as well as other Obligations to CNB, Borrower hereby grants and transfers to
CNB a continuing security interest in:
7.1 Borrower's securities held in Custodial Account under 3600014 held
with Investors Bank & Trust Company as more full set forth in the Securities
Account Control Agreement;
11
<PAGE> 12
7.2 Any Certificates of Deposit issued by CNB in the name of Borrower
which are held pursuant to a separate security agreement between CNB and
Borrower.
8. EVENTS OF DEFAULT
8.1 Events of Default. The following shall constitute Events of Default
for purposes of this Agreement:
8.1.1 Borrower shall fail to pay when due any installment of
principal or interest or any other payment payable hereunder or under the Note;
8.1.2 Borrower shall fail to perform or observe any of the terms,
provisions, covenants, conditions, agreements or obligations contained in this
Agreement;
8.1.3 There shall occur the entry of an order for relief or the
filing of an involuntary petition with respect to Borrower, under the United
States Bankruptcy Code; there shall occur the appointment of a receiver,
trustee, custodian or liquidator of or for any part of the assets or property
of Borrower, Borrower, shall make a general assignment for the benefit of
creditors;
8.1.4 Any financial statement, representation or warranty made or
furnished by Borrower, in connection with this Agreement should prove to be in
any material respect incorrect;
8.1.5 CNB's security interest in or lien on any portion of the
Collateral shall become impaired or otherwise unenforceable or CNB's rights
under the Securities Account Control Agreement shall become impaired or
unenforceable;
8.1.6 Any person shall obtain an order or decree in any court of
competent jurisdiction enjoining or prohibiting Borrower or CNB or either of
them from performing this Agreement, and such proceedings shall not be
dismissed or such decree shall not be vacated within ten (10) days after the
granting thereof;
8.1.7 Borrower shall neglect, fail or refuse to keep in full force
and effect any governmental permit or approval which is necessary to the
operation of its business;
8.1.8 All or substantially all of the property of Borrower shall be
condemned, seized or otherwise appropriated;
8.1.9 The occurrence of (a) a Reportable Event as defined in ERISA
which CNB determines in good faith constitutes grounds for the institution of
proceedings to terminate any pension plan by the PBGC, (b) an appointment of a
trustee to administer any pension plan of Borrower, or (c) any other event or
condition which might constitute grounds under ERISA for the involuntary
termination of any pension plan of Borrower, where such event set forth in (a),
(b) or (c) results in a significant monetary liability to Borrower;
8.1.10 The Termination Date shall not have been extended.
8.2 NOTICE OF DEFAULT AND CURE OF POTENTIAL EVENTS OF DEFAULT. Except
with respect to the Events of Default specified in Paragraphs 8.1.1, 8.1.3 or
8.1.5 above, and subject to the provisions of Section 8.4, CNB shall give
Borrower at least ten (10) days' written notice of any event which constitutes
or, with the lapse of time would become an Event of Default, during which time
Borrower shall be entitled to cure same.
12
<PAGE> 13
8.3 CNB'S REMEDIES. Upon the occurrence of an Event of Default, at the
sole and exclusive option of CNB, and upon written notice to Borrower, CNB may
(a) declare the principal of and accrued interest on the Loans immediately due
and payable in full, whereupon the same shall immediately become due and
payable; (b) terminate this Agreement as to any future liability or obligation
of CNB, but without affecting CNB's rights and security interest in the
Collateral and without affecting the Obligations owing by Borrower to CNB;
and/or (c) exercise its rights and remedies hereunder and under the Note, or
any security agreement securing the Obligations, and in addition to the rights
and remedies given it by this Agreement, all of the rights and remedies of a
secured party under the Code and other applicable laws with respect to all of
the Collateral.
8.4 ADDITIONAL REMEDIES. Notwithstanding any other provision of this
Agreement, upon the occurrence of any event, action or inaction by Borrower, or
in the event any action or inaction is threatened which CNB reasonably believes
will materially affect the value of the Collateral, CNB may take such legal
actions as it deems reasonably necessary under the circumstances to protect the
Collateral, including but not limited to, seeking injunctive relief and the
appointment of a receiver, irrespective of whether an Event of Default or
Potential Event of Default has occurred under this Agreement.
9. MISCELLANEOUS.
9.1 COSTS, EXPENSES AND ATTORNEYS' FEES. Borrower shall reimburse CNB for
all costs and expenses relating to the administration or documentation connected
with this Agreement, including, but not limited to, reasonable attorneys' fees
and expenses (which counsel may be CNB employees), expended or incurred by CNB
(or allocable to CNB's in-house counsel) in collecting any sum which becomes
due CNB under this Agreement, the Note, or any other agreement delivered
hereunder or in connection herewith, irrespective of whether suit is filed, or
in the protection, perfection, preservation or enforcement of any and all
rights of CNB in connection with this Agreement, the Note, or any other
agreements delivered hereunder or in connection herewith, including, without
limitation, the fees and costs incurred in any out-of-court workout or a
bankruptcy or reorganization proceeding.
9.2 DISPUTE RESOLUTION.
9.2.1 MANDATORY ARBITRATION. At the request of CNB or Borrower, any
dispute, claim or controversy of any kind (whether in contract or tort,
statutory or common law, legal or equitable) now existing or hereafter arising
between CNB and Borrower and in any way arising out of, pertaining to or in
connection with: (1) this Agreement, and/or any renewals, extensions, or
amendments thereto; (2) any of the Loan Documents; (3) any violation of this
Agreement or the Loan Documents; (4) all past, present and future loans; (5)
any incidents, omissions, acts, practices or occurrences arising out of or
related to this agreement or the Loan Documents causing injury to either party
whereby the other party or its agents, employees or representatives may be
liable, in whole or in part, or (6) any aspect of the present or future
relationships of the parties, will be resolved through final and binding
arbitration conducted at a location determined by the arbitrator in Los Angeles
County, California, and administered by the American Arbitration Association
("AAA") in accordance with the California Arbitration Act (Title 9, California
Code of Civil Procedure Section 1280 et. seq.) and the then existing Commercial
Rules of the AAA. Judgment upon any award rendered by the arbitrator(s) may be
entered in any state or federal court having jurisdiction thereof.
9.2.2 JUDICIAL REFERENCE. At the request of any party, a controversy
or claim which is not submitted to arbitration as provided and limited in
Sections 9.2.1 will be determined by a reference in accordance with California
Code of Civil Procedure Sections 638 et. seq. If such election is made,
13
<PAGE> 14
the parties will designate to the court a referee or referees selected under
the auspices of the AAA in the same manner as arbitrators are selected in
AAA-sponsored proceedings. The presiding referee of the panel, or the referee
if there is a single referee, will be an active attorney or retired judge.
Judgment upon the award rendered by such referee or referees will be entered in
the court in which such proceeding was commenced in accordance with California
Code of Civil Procedure Sections 644 and 645.
9.2.3 PROVISIONAL REMEDIES, SELF HELP AND FORECLOSURE. No
provision of this Agreement will limit the right of any party to: (1) exercise
any rights or remedies as a secured party against any personal property
collateral pursuant to the terms of a security agreement or pledge agreement,
or applicable law, (2) exercise self help remedies such as setoff, or (3)
obtain provisional or ancillary remedies such as injunctive relief or the
appointment of a receiver from a court having jurisdiction before, during or
after the pendency of any arbitration or referral. The institution and
maintenance of an action for judicial relief or pursuit of provisional or
ancillary remedies, or exercise of self help remedies will not constitute a
waiver of the right of any party, including the plaintiff, to submit any
dispute to arbitration or judicial reference.
9.2.4 POWERS AND QUALIFICATIONS OF ARBITRATORS. The arbitrator(s)
will give effect to statutes of limitation, waiver and estoppel and other
affirmative defenses in determining any claim. Any controversy concerning
whether an issue is arbitratable will be determined by the arbitrator(s). The
laws of the State of California will govern. The arbitration award may include
equitable and declaratory relief. All arbitrator(s) selected will be required
to be a practicing attorney or retired judge licensed to practice law in the
State of California and will be required to be experienced and knowledgeable in
the substantive laws applicable to the subject matter of the controversy or
claim at issue.
9.2.5 DISCOVERY. The provisions of California Code of Civil
Procedure Section 1283.05 or its successor section(s) are incorporated herein
and made a part of this Agreement. Depositions may be taken and discovery may be
obtained in any arbitration under this Agreement in accordance with said
section(s).
9.2.6 MISCELLANEOUS. The arbitrator(s) will determine which is
the prevailing party and will include in the award that party's reasonable
attorneys' fees and costs (including allocated costs of in-house legal
counsel). Each party agrees to keep all controversies and claims and the
arbitration proceedings strictly confidential, except for disclosures of
information required in the ordinary course of business of the parties or by
applicable law or regulation.
9.3 CUMULATIVE RIGHTS AND NO WAIVER. Each and every right and remedy
granted to CNB hereunder or under any other document delivered hereunder or in
connection herewith, shall be cumulative and no one such right or remedy shall
be exclusive of any other. No failure on the part of CNB to exercise, and no
delay in exercising, any right or remedy shall operate as a waiver thereof, nor
shall any single or partial exercise or waiver by CNB of any right or remedy
preclude any other or future exercise thereof or the exercise of any other right
or remedy.
9.4 APPLICABLE LAW. This Agreement and the rights and obligations of the
parties hereunder shall be governed by and interpreted and construed in
accordance with the laws of the State of California and venue and jurisdiction
with respect hereto shall be with any court of competent jurisdiction located
in Los Angeles County, State of California.
9.5 LIEN AND RIGHT OF SETOFF. Borrower hereby grants to CNB a continuing
lien for all Obligations of Borrower to CNB upon any and all moneys, securities
and other property of Borrower
14
<PAGE> 15
and the proceeds thereof, now or hereafter held or received by or in transit to
CNB from or for Borrower, whether for safekeeping, custody, pledge,
transmission, collection or otherwise, and also upon any and all deposits
(general or special) and credits of Borrower with, and any and all claims of
Borrower against CNB at any time existing. Upon the occurrence of any Event of
Default, CNB is hereby authorized at any time and from time to time, without
notice to Borrower or any other person, to setoff, appropriate and apply any or
all items hereinabove referred to against all Obligations of Borrower whether
under this Agreement or otherwise, and whether now existing or hereafter
arising.
9.6 NOTICES. Any notice required or permitted to be given shall be given
in writing and shall be deemed to have been given when deposited in the United
States mail certified, return receipt requested, with first-class postage
prepaid and properly addressed. For the purposes hereof, the addresses of the
parties hereto shall, until further notice given as herein provided, be as
follows:
CNB City National Bank
Irvine Spectrum Technology Center
100 Pacifica, Suite 100
Irvine, CA 92618
Attention: Erich Bollinger, Vice President
with a copy to: City National Bank
Legal Department
400 North Roxbury Drive
Beverly Hills, California 90210-5021
Attention: General Counsel
Borrower: SRS Labs, Inc.
2909 Daimler Street
Santa Ana, CA 92705
Attention: Thomas C.K. Yuen, Chief Executive Officer
9.7 COUNTERPARTS. This Agreement may be executed in any number of
counterparts, each of which shall be an original with the same effect as if the
signatures thereto and hereto were upon the same instrument.
9.8 INDEMNIFICATION. Borrower shall, at all times, defend and indemnify
and hold CNB (which for purposes of this Section shall include the shareholders,
officers, directors, employees, representatives and agents of CNB) harmless from
and against any and all liabilities, claims, demands, causes of action, losses,
damages, expenses (including, without limitation, reasonable attorneys' fees,
[which attorneys may be employees of CNB, or may be outside counsel]), costs,
settlements, judgments or recoveries arising out of or resulting from (a) any
breach of the representations, warranties, agreements or covenants made by
Borrower herein; (b) any suit or proceeding of any kind or nature whatsoever
against CNB arising from or connected with the transactions contemplated by this
Agreement or any of the documents, instruments or agreements to be executed
pursuant hereto or any of the rights and properties assigned to CNB hereunder;
and/or (c) any suit or proceeding that CNB may deem necessary or advisable to
institute, in the name of CNB, Borrower or both, against any other person,
company or entity, for any reason whatsoever to protect the rights of CNB
hereunder or under any of the documents, instruments or agreements executed or
to be executed pursuant hereto, including attorneys' fees and court costs and
all other costs and expenses incurred by CNB (or allocable to CNB's
15
<PAGE> 16
in-house counsel), all of which shall be charged to and paid by Borrower and
shall be secured by the Collateral. Any obligation or liability of Borrower to
CNB under this Section 9.8 shall survive the expiration or termination of this
Agreement and the repayment of all Loans and the payment or performance of all
other Obligations of Borrower to CNB.
9.9 ASSIGNMENTS. The provisions of this Agreement are hereby made
applicable to and shall inure to the benefit of CNB's successors and assigns and
Borrower's successors and assigns; provided, however, that Borrower may not
assign or transfer its rights or Obligations under this Agreement without the
prior written consent of CNB.
9.10 HEADINGS. Section and subsection headings in this Agreement are
included herein for convenience of reference only and shall not constitute a
part of the Agreement for any purpose or be given any substantive effect.
9.11 DEFINITIONAL PROVISIONS. Any of the terms defined in this Agreement
may, unless the context otherwise requires, be used in the singular or the
plural depending on the reference.
9.12 ACCOUNTING TERMS. All accounting terms not specifically defined in
this Agreement shall be construed in conformity with, and all financial data
required to be submitted by this Agreement shall be prepared in conformity with,
generally accepted accounting principles applied on a consistent basis, as in
effect on the date hereof, except as otherwise specifically prescribed herein.
9.13 SEVERABILITY. Any provision of this Agreement and the Notes which is
prohibited or unenforceable in any jurisdiction, shall be, only as to such
jurisdiction, ineffective to the extent of such prohibition or unenforceability,
but all the remaining provisions of this Agreement and the Notes shall remain
valid.
9.14 COMPLETE AGREEMENT. This written Agreement, together with the
exhibits to this Agreement, is intended by CNB and Borrower as a final
expression of their agreement and is intended as a complete statement of the
terms and conditions of their agreement.
IN WITNESS WHEREOF, CNB and Borrower have caused this Agreement to be
executed on the date and year first written at the head of this Agreement.
"Borrower" SRS LABS, INC.
a Delaware corporation
By: /s/ THOMAS C.K. YUEN
-----------------------------------------
Thomas C.K. Yuen, Chief Executive Officer
"CNB" CITY NATIONAL BANK, a national
banking association
By: /s/ ERICH BOLLINGER
-----------------------------------------
Erich Bollinger, Vice President
16
<PAGE> 17
EXHIBIT A
[CITY NATIONAL BANK LOGO]
SECURITIES ACCOUNT CONTROL AGREEMENT
(THIRD PARTY INTERMEDIARY)
This SECURITIES ACCOUNT CONTROL AGREEMENT (this "Agreement") is entered
into as of July 6, 1999, by and among SRS LABS, INC., a Delaware corporation
("Customer"), INVESTORS BANK & TRUST COMPANY ("Custodian"), SALOMON BROTHERS
ASSET MANAGEMENT INC. ("Adviser") and CITY NATIONAL BANK, a national banking
association ("Secured Party").
RECITALS
A. Adviser entered into a custody agreement dated January 26, 1996 with
Custodian ("Custodial Agreement") whereby Custodian holds the securities and
other assets of certain investment advisory clients of the Adviser in separate
custodial accounts.
B. Pursuant to an investment advisory agreement dated August 13, 1996
between Adviser and Customer ("Investment Advisory Agreement"), the assets of
the Customer subject to the Investment Advisory Agreement are held with
Custodian in Account 3600014 in the name of Customer ("Custodial Account").
C. Customer has granted to the Secured Party a security interest in the
Custodial Account and all financial assets and other property now or at any time
hereafter held in the Custodial Account.
D. Secured Party, Customer, Adviser and Custodian have agreed to enter
into this Agreement to perfect Secured Party's security interests in the
Collateral, as defined below.
NOW, THEREFORE, in consideration of their mutual covenants and promises,
the parties hereto agree as follows:
1. DEFINITIONS. As used herein:
a. The term "Collateral" shall mean (i) the Custodial Account, (ii) all
financial assets credited to the Custodial Account, (iii) all security
entitlements with respect to the financial assets credited to the Custodial
Account, (iv) an and all other investment property or assets maintained or
recorded in the Custodial Account, and (v) all substitutions for, and proceeds
of the sale or other disposition of, any of the foregoing, including without
limitation, cash proceeds. The parties expressly agree that the Custodial
Account is a "securities account" as such term is defined in the Code, as
defined below.
1
<PAGE> 18
b. The terms "investment property," "entitlement order," "financial
asset" and "security entitlement" shall have the respective meanings set forth
in the Code. The parties hereby expressly agree that all property, including
without limitation, cash certificates of deposit and shares of mutual funds, at
any time held in the Custodial Account are to be treated as "financial assets."
c. The term "Code" shall mean the Uniform Commercial Code of the
Commonwealth of Massachusetts.
2. AGREEMENT FOR CONTROL. Custodian is authorized by Customer and Adviser and
agrees to honor and comply with all entitlement orders originated by Secured
Party with respect to the Custodial Account, and all other requests and
instructions from Secured party regarding disposition and/or delivery of the
Collateral, without further consent or direction from Customer, Adviser or any
other party.
3. CUSTOMER'S RIGHTS WITH RESPECT TO THE COLLATERAL.
a. Until Custodian is notified otherwise by Secured Part; (i) Adviser is
authorized to give to Custodian, and Custodian is authorized to honor, any
instructions from Adviser with respect to the selection of the investments in
the Custodial Account and the trading in connection therewith; and (ii)
Custodian may distribute, in accordance with instructions of Adviser, only that
portion of the Collateral which consists of interest and/or cash dividends
earned on financial assets maintained in the Custodial Account.
b. Without Secured Party's prior written consent, except to the extent
permitted in Section 3.a. hereof: (i) neither Customer, Adviser, nor any other
party may withdraw, transfer, trade or otherwise dispose of any Collateral
from the Custodial Account, and (ii) Custodian shall not comply with any
entitlement order or other order or institution given by Customer, Adviser, or
any party (other than Secured Party) with respect to the Collateral in the
Custodial Account.
c. Upon actual receipt of written notice from Secured Party, (i)
Custodian shall promptly cease complying with entitlement orders and other
instructions concerning the Collateral, including the Custodial Account, from
all parties other than Secured Party, (ii) Custodian shall not make any further
distributions of any of the Collateral to Customer, Adviser, or any party
(other than Secured Party), nor permit any further voluntary changes in the
financial assets, and (iii) Customer shall release and discharge Adviser as an
investment adviser under the Investment Advisory Agreement from all
liabilities, claims, causes of action, charges, complaints, obligations, costs,
losses, damages, and other legal responsibilities, with respect to any action
or inaction of Adviser, where such action or inaction is at the direction of
the Secured Party pursuant to the terms of this Agreement.
4. REPRESENTATIONS, WARRANTIES AND COVENANTS OF CUSTODIAN.
a. Custodian represents and warrants to Secured Party that:
i. the Custodial Account is maintained with Custodian as specified
in Recital B above;
2
<PAGE> 19
ii. Custodian has no actual knowledge of any claim to, security
interest in or lien upon any of the Collateral, except (i) the security
interests in favor of Secured Party (ii) liens of Custodian securing overdrafts,
fees and charges, or payment for open trade commitments, as described in Section
4.b. below; and
iii. attached hereto as Exhibit "A" is an accurate and complete
statement of the financial assets in the Custodial Account as of the date set
forth in said statement.
b. Custodian agrees that any claim to, security interest in, lien upon,
or right of offset with respect to, any of the Collateral which Custodian now
has or at any time hereafter acquire shall be junior and subordinate to the
security interests of Secured Party in the Collateral, except for liens of
Adviser or Custodian securing: (i) fees and charges owed by Customer with
respect to the operation and maintenance of the Custodial Account; (ii) any
overdrafts by the Custodian in favor of the Custodial Account; and (iii) payment
owed to Adviser or Custodian for open trade commitments for purchases in and for
the Custodial Account, if such purchases are permitted hereunder.
5. AGREEMENT OF ADVISER CUSTODIAN AND CUSTOMER:
Adviser, Custodian and Customer agree that:
a. Custodian shall flag its books, records and systems to reflect Secured
Party's security interests in the Collateral, and shall provide notice thereof
to any party making inquiry as to Customer's accounts with Custodian to whom or
which Custodian are legally required to provide information.
b. Custodian shall send copies of all statements relating to the Custodial
Account simultaneously to Customer and Secured Party. Such statements shall be
sent to Customer and Secured Party at the address for each set forth in this
Agreement.
c. Custodian shall promptly notify Secured Party if any other party
asserts any claim to, security interest in or lien upon any of the Collateral,
and Custodian shall not enter into any control, custodial or other similar
agreement with any other party that would create or acknowledge the existence of
any such other claim, security interest or lien, upon any of the Collateral.
d. Without Secured Party's prior written consent, Adviser and Custodian
shall not change the name or account number of the Custodial Account.
e. Neither Adviser, nor Customer shall terminate the Investment Advisory
Agreement without giving thirty (30) days' prior written notice to Secured
Party.
f. Neither Adviser, Custodian, nor Customer shall terminate the Custodial
Account without giving thirty (30) days' prior written notice to Secured Party.
6. RESPONSIBILITY OF CUSTODIAN. The Custodian shall have no responsibility or
liability with respect to the validity or perfection of the security interests
of Secured Party in the Custodial Accounts otherwise than to act in accordance
with the terms of this Agreement and the Custodial Agreement. The Custodian
shall have no responsibility or liability to the Secured Party for settling
trades of financial
3
<PAGE> 20
assets carried in any Custodial Account at the direction of Customer, Adviser or
their respective authorized representatives, or complying with Entitlement
Orders concerning the Custodial Account from the Customer, Adviser or their
respective authorized representatives, which are received by Custodian prior to
receipt of a Notice of Exclusive Control. The Custodian shall have no
responsibility or liability to Customer or Adviser for complying with
Entitlement Orders concerning the Custodial Account originated by Secured Party.
The Custodian shall have no duty to investigate or make any determination as to
whether a default exists under any Agreement between Customer and Secured Party
and shall comply with a notice of Exclusive Control notwithstanding that it may
believe no such default exists.
7. MISCELLANEOUS.
a. This Agreement shall not create any obligation or duty of Adviser and
Custodian except as expressly set forth herein and no implied duties,
responsibilities or obligations shall be read into this Agreement.
b. Notwithstanding any provision contained herein or in any other document
or instrument to the contrary, neither Adviser or Custodian, nor any of their
directors, officers, agents or employees shall be liable for (i) any action
taken or omitted to be taken at the instruction of Secured Party, (ii) any
action taken or omitted to be taken under or in connection with this Agreement,
except for the Adviser's or Custodian's own gross negligence or willful
misconduct or that of its directors, officers, agents or employees.
c. As between Secured Party and Custodian, Secured Party shall indemnify
and hold Custodian harmless from and against any losses or liabilities
(including legal fees and claims of Customer) arising from action taken or not
taken pursuant to instructions of Secured Party hereunder, except to the extent
that any such loss or liability results from Custodian's gross neglect or
willful misconduct. As between Adviser and Custodian, Adviser shall indemnify
and hold Custodian harmless from and against any losses or liabilities
(including legal fees and claims of the Customer) arising from action taken or
not taken pursuant to instructions of Adviser or in complying with the notice
by Secured Party referred to in Section 3(c) hereof, except to the extent that
any such loss or liability results from Custodian's gross negligence or willful
misconduct. As between Customer and Custodian, Customer shall indemnify and hold
Custodian harmless from and against any losses or liabilities arising from
action taken or not taken pursuant to instructions of Customer, Advisor or
Secured Party hereunder, except to the extent that any such loss or liability
results from Custodian's gross negligence or willful misconduct.
d. As to the matters specifically the subject of this Agreement, in the
event of any conflict between this Agreement and the Investment Advisory
Agreement or any other agreement between Adviser and Custodian and Customer,
the terms of this Agreement shall control.
e. All notices, requests and demands which any party is required or may
desire to give to any other party under any provisions of this Agreement must
be in writing (unless otherwise specifically provided) and delivered to each
party at the following address or facsimile number:
"Custodian" Investors Bank & Trust
220 Clarendon Street
Boston, MA 02116
Attention: Andrew Josef, Assistant General Counsel
Fax No. 617 351 4314
4
<PAGE> 21
"Adviser" Salomon Brothers Asset Management Inc
Seven World Trade Center
New York, NY 10048
Attention: Carol Epstein, Associate General Counsel
Fax No. (212) 783-3357
"Customer" SRS Labs, Inc.
2909 Daimler Street
Santa Ana, CA 92705
Attention: Thomas C.K. Yuen, Chief Executive Officer
Fax No. (949) 852-1099
"Secured Party" City National Bank
Irvine Spectrum Technology Center
100 Pacifica, Suite 100
Irvine, CA 92618
Attention: Erich Bollinger, Vice President
Fax No. (949) 754-1510
with a copy to: City National Bank
Legal Department
400 North Roxbury Drive
Beverly Hills, California 90210-5021
Attention: General Counsel
or to such other address or facsimile number as any party may designate by
written notice to all other parties. Each such notice, request and demand shall
be deemed given or made as follows: (i) if sent by hand delivery, upon
delivery; (ii) if sent by facsimile, upon receipt; and (iii) if sent by mail,
upon the earlier of the date of receipt or three (3) days after deposit in the
U.S. mail, first class and postage prepaid.
f. This Agreement shall be binding upon and inure to the benefit of the
heirs, executors, administrators, legal representatives, successors and assigns
of the parties; provided however, that Custodian may not assign its obligations
hereunder without Secured Party's prior written consent. This Agreement may be
amended or modified only in writing signed by all parties hereto.
g. This Agreement shall terminate upon: (i) receipt by Adviser and
Custodian of written notice from Secured Party expressly stating that Secured
Party no longer claims any security interest in the Collateral; or (ii)
termination of the Investment Advisory Agreement pursuant to Section 5.e.
hereof and delivery by Custodian of all Collateral to Secured Party or its
designee in accordance with Secured Party's written instructions.
h. This Agreement shall be governed by and construed in accordance with
the laws of the Commonwealth of Massachusetts. This Agreement may be executed
in any number of counterparts which, when taken together, shall constitute but
one agreement.
5
<PAGE> 22
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
date first set forth above.
"CUSTODIAN" INVESTORS BANK & TRUST COMPANY
By:
-----------------------------------------
Its:
----------------------------------------
"ADVISER" SALOMON BROTHERS ASSET MANAGEMENT INC
By:
-----------------------------------------
Its:
----------------------------------------
"CUSTOMER" SRS LABS, INC.
By:
-----------------------------------------
Thomas C.K. Yuen, Chief Executive Officer
"SECURED PARTY" CITY NATIONAL BANK, a national banking
association
By:
-----------------------------------------
Erich Bollinger, Vice President
6
<PAGE> 23
EXHIBIT B
[CITY NATIONAL BANK LETTERHEAD]
REVOLVING CREDIT NOTE
$10,000,000 Irvine, California
July 6, 1999
FOR VALUE RECEIVED, the undersigned, SRS LABS, INC., a Delaware corporation
("Borrower"), promises to pay on the Termination Date to CITY NATIONAL BANK, a
national banking association ("CNB"), at its Office located at Irvine,
California 92618, the principal amount of TEN MILLION DOLLARS ($10,000,000) or
so much thereof as may be advanced and be outstanding, with interest thereon to
be computed on each Revolving Credit Loan from the date of its disbursement at a
rate computed on the basis of a 360-day year, actual days elapsed, as set forth
that certain Credit and Security Agreement dated as of July 6, 1999, between CNB
and Borrower, as it may be amended from time to time (the "Credit Agreement").
Capitalized terms not defined herein shall have the meanings given them in the
Credit Agreement.
All or any portion of the principal of this Revolving Credit Note ("Note")
may be borrowed, repaid and reborrowed from time to time prior to the
Termination Date, provided at the time of any borrowing no default exists under
this Note and no Event of Default or Potential Event of Default exists under the
terms and conditions of the Credit Agreement and provided, further that the
total borrowings outstanding at any one time shall not exceed $10,000,000. Each
borrowing and repayment of a Revolving Credit Loan shall be noted in the books
and records of CNB. The excess of borrowings over repayments as noted on such
books and records shall constitute presumptive evidence of the principal balance
due hereon from time to time and at any time.
Interest is payable monthly on the first day of each and every month
commencing September 1, 1999.
If payment on this Note becomes due and payable on non-Business Day, the
maturity thereof shall be extended to the next Business Day and, with respect to
payments of principal or interest thereon shall be payable during such extension
at the then applicable rate. Upon the occurrence of one or more of the Events of
Default specified in the Credit Agreement, all amounts remaining unpaid on this
Note may become or be declared to be immediately payable as provided in the
Credit Agreement, without presentment, demand or notice of dishonor, all of
which are expressly waived. Borrower agrees to pay all costs of collection of
this Note and reasonable attorneys' fees (including attorneys' fees allocable to
CNB's in-house counsel) in connection therewith, irrespective of whether suit is
brought thereon.
This is the Revolving Credit Note referred to in the Credit Agreement and
is entitled to the benefits thereof and may be prepaid in whole or in part only
as provided therein.
Any change in the Prime Rate shall become effective on the same Business
Day on which the Prime Rate shall change, without prior notice to Borrower. Any
principal or interest not paid when due hereunder shall thereafter bear
additional interest from its due date at the rate of five percent (5%) per
1
<PAGE> 24
annum higher than the interest rate as determined and computed above, and
continuing thereafter until paid.
This Note shall be governed by the laws of the State of California.
"BORROWER" SRS LABS, INC. a
Delaware corporation
By:
-----------------------------------------
Thomas C.K. Yuen, Chief Executive Officer
2
<PAGE> 1
EXHIBIT 10.42
[CITY NATIONAL BANK LOGO]
SECURITIES ACCOUNT CONTROL AGREEMENT
(THIRD PARTY INTERMEDIARY)
This SECURITIES ACCOUNT CONTROL AGREEMENT (this "Agreement") is entered
into as of July 6, 1999, by and among SRS LABS, INC., a Delaware corporation
("Customer"), INVESTORS BANK & TRUST COMPANY ("Custodian"), SALOMON BROTHERS
ASSET MANAGEMENT INC. ("Adviser") and CITY NATIONAL BANK, a national banking
association ("Secured Party").
RECITALS
A. Adviser entered into a custody agreement dated January 26, 1996 with
Custodian ("Custodial Agreement") whereby Custodian holds the securities and
other assets of certain investment advisory clients of the Adviser in separate
custodial accounts.
B. Pursuant to an investment advisory agreement dated August 13, 1996
between Adviser and Customer ("Investment Advisory Agreement"), the assets of
the Customer subject to the Investment Advisory Agreement are held with
Custodian in Account 3600014 in the name of Customer ("Custodial Account").
C. Customer has granted to the Secured Party a security interest in the
Custodial Account and all financial assets and other property now or at any
time hereafter held in the Custodial Account.
D. Secured Party, Customer, Adviser and Custodian have agreed to enter
into this Agreement to perfect Secured Party's security interests in the
Collateral, as defined below.
NOW THEREFORE, in consideration of their mutual covenants and promises, the
parties hereto agree as follows:
1. DEFINITIONS. As used herein:
a. The term "Collateral" shall mean (i) the Custodial Account, (ii) all
financial assets credited to the Custodial Account, (iii) all security
entitlements with respect to the financial assets credited to the Custodial
Account, (iv) any and all other investment property or assets maintained or
recorded in the Custodial Account, and (v) all substitutions for, and proceeds
of the sale or other disposition of, any of the foregoing, including without
limitation, cash proceeds. The parties expressly agree that the Custodial
Account is a "securities account" as such term is defined in the Code, as
defined below.
1
<PAGE> 2
b. The terms "investment property," "entitlement order," "financial asset"
and "security entitlement" shall have the respective meanings set forth in the
Code. The parties hereby expressly agree that all property, including without
limitation, cash, certificates of deposit and shares of mutual funds, at any
time held in the Custodial Account are to be treated as "financial assets."
c. The term "Code" shall mean the Uniform Commercial Code of the
Commonwealth of Massachusetts.
2. AGREEMENT FOR CONTROL. Custodian is authorized by Customer and Adviser and
agrees to honor and comply with all entitlement orders originated by Secured
Party with respect to the Custodial Account, and all other requests and
instructions from Secured Party regarding disposition and/or delivery of the
Collateral, without further consent or direction from Customer, Adviser or any
other party.
3. CUSTOMER'S RIGHTS WITH RESPECT TO THE COLLATERAL.
a. Until Custodian is notified otherwise by Secured Party: (i) Adviser is
authorized to give to Custodian, and Custodian is authorized to honor, any
instructions from Adviser with respect to the selection of the investments in
the Custodial Account and the trading in connection therewith; and (ii)
Custodian may distribute, in accordance with instructions of Adviser, only that
portion of the Collateral which consists of interest and/or cash dividends
earned on financial assets maintained in the Custodial Account.
b. Without Secured Party's prior written consent, except to the extent
permitted in Section 3.a. hereof: (i) neither Customer, Adviser, nor any other
party may withdraw, transfer, trade or otherwise dispose of any Collateral from
the Custodial Account, and (ii) Custodian shall not comply with any entitlement
order or other order or instruction given by Customer, Adviser, or any party
(other than Secured Party) with respect to the Collateral in the Custodial
Account.
c. Upon actual receipt of written notice from Secured Party, (i) Custodian
shall promptly cease complying with entitlement orders and other instructions
concerning the Collateral, including the Custodial Account, from all parties
other than Secured Party, (ii) Custodian shall not make any further
distributions of any of the Collateral to Customer, Adviser, or any party (other
than Secured Party), nor permit any further voluntary changes in the financial
assets, and (iii) Customers shall release and discharge Adviser as an investment
adviser under the Investment Advisory Agreement from all liabilities, claims,
causes of action, complaints, obligations, costs, losses, damages, and other
legal responsibilities, of any form whatsoever, whether known or unknown,
unforeseen or unanticipated, with respect to any action or inaction of Adviser,
where such action or inaction is at the direction of the Secured Party pursuant
to the terms of this Agreement.
4. REPRESENTATIONS, WARRANTIES AND COVENANTS OF CUSTODIAN.
a. Custodian represents and warrants to Secured Party that:
i. the Custodial Account is maintained with Custodian as specified
in Recital B above;
2
<PAGE> 3
ii. Custodian has no actual knowledge of any claim to, security
interest in or lien upon any of the Collateral, except (i) the security
interests in favor of Secured Party and (ii) liens of Custodian securing
overdrafts, fees and charges, or payment for open trade commitments, as
described in Section 4.b. below; and
iii. attached hereto as Exhibit "A" is an accurate and complete
statement of the financial assets in the Custodial Account as of the date set
forth in said statement.
b. Custodian agrees that any claim to, security interest in, lien upon,
or right of offset with respect to, any of the Collateral which Custodian now
has or at any time hereafter acquire shall be junior and subordinate to the
security interests of Secured Party in the Collateral, except for liens of
Adviser or Custodian securing: (i) fees and charges owed by Customer with
respect to the operation and maintenance of the Custodial Account; (ii) any
overdrafts by the Custodian in favor of the Custodial Account; and (iii) payment
owed to Advisor or Custodian for open trade commitments for purchases in and for
the Custodial Account, if such purchases are permitted hereunder.
5. AGREEMENT OF ADVISER CUSTODIAN AND CUSTOMER:
Adviser, Custodian and Customer agree that:
a. Custodian shall flag its books, records and systems to reflect Secured
Party's security interests in the Collateral, and shall provide notice thereof
to any party making inquiry as to Customer's accounts with Custodian to whom or
which Custodian are legally required to provide information.
b. Custodian shall send copies of all statements relating to the Custodial
Account simultaneously to Customer and Secured Party. Such statements shall be
sent to Customer and Secured Party at the address for each set forth in this
Agreement.
c. Custodian shall promptly notify Secured Party if any other party asserts
any claim to, security interest in or lien upon any of the Collateral, and
Custodian shall not enter into any control, custodial or other similar agreement
with any other party that would create or acknowledge the existence of any such
other claim, security interest or lien upon any of the Collateral.
d. Without Secured Party's prior written consent, Advisor and Custodian
shall not change the name or account number of the Custodial Account.
e. Neither Adviser, nor Customer shall terminate the Investment Advisory
Agreement without giving thirty (30) days' prior written notice to Secured
Party.
f. Neither Adviser, Custodian, nor Customer shall terminate the Custodial
Account without giving thirty (30) days' prior written notice to Secured Party.
6. RESPONSIBILITY OF CUSTODIAN. The Custodian shall have no responsibility or
liability with respect to the validity or perfection of the security interests
of Secured Party in the Custodial Accounts otherwise than to act in accordance
with the terms of this Agreement and the Custodial Agreement. The Custodian
shall have no responsibility or liability to the Secured Party for settling
trades of financial
3
<PAGE> 4
assets carried in any Custodial Account at the direction of Customer, Adviser or
their respective authorized representatives, or complying with Entitlement
Orders concerning the Custodial Account from the Customer, Adviser or their
respective authorized representatives, which are received by Custodian prior to
receipt of a Notice of Exclusive Control. The Custodian shall have no
responsibility or liability to Customer or Adviser for complying with
Entitlement Orders concerning the Custodial Account originated by Secured Party.
The Custodian shall have no duty to investigate or make any determination as to
whether a default exists under any Agreement between Customer and Secured Party
and shall comply with a notice of Exclusive Control notwithstanding that it may
believe no such default exists.
7. MISCELLANEOUS.
a. This Agreement shall not create any obligation or duty of Adviser and
Custodian except as expressly set forth herein and no implied duties,
responsibilities or obligations shall be read into this Agreement.
b. Notwithstanding any provision contained herein or in any other document
or instrument to the contrary, neither Adviser or Custodian, nor any of their
directors, officers, agents or employees shall be liable for (i) any action
taken or omitted to be taken at the instruction of Secured Party, (ii) any
action taken or omitted to be taken under or in connection with this Agreement,
except for the Adviser's or Custodian's own gross negligence or willful
misconduct or that of its directors, officers, agents or employees.
c. As between Secured Party and Custodian, Secured Party shall indemnify
and hold Custodian harmless from and against any losses or liabilities
(including legal fees and claims of the Customer) arising from action taken or
not taken pursuant to instructions of Secured Party hereunder, except to the
extent that any such loss or liability results from Custodian's gross neglect or
willful misconduct. As between Adviser and Custodian, Adviser shall indemnify
and hold Custodian harmless from and against any losses or liabilities
(including legal fees and claims of the Customer) arising from action taken or
not taken pursuant to instructions of Adviser or in complying with the notice by
Secured Party referred to in Section 3(c) hereof, except to the extent that any
such loss or liability results from Custodian's gross negligence or willful
misconduct. As between Customer and Custodian, Customer shall indemnify and hold
Custodian harmless from and against any losses or liabilities arising from
action taken or not taken pursuant to instructions of Customer, Adviser or
Secured Party hereunder, except to the extent that any such loss or liability
results from Custodian's gross negligence or willful misconduct.
d. As to the matters specifically the subject of this Agreement, in the
event of any conflict between this Agreement and the Investment Advisory
Agreement or any other agreement between Adviser and Custodian and Customer, the
terms of this Agreement shall control.
e. All notices, requests and demands which any party is required or may
desire to give to any other party under any provision of this Agreement must be
in writing (unless otherwise specifically provided) and delivered to each party
at the following address or facsimile number:
"Custodian" Investors Bank & Trust
220 Clarendon Street
Boston, MA 02116
Attention: Andrew Josef, Assistant General Counsel
Fax No. 617 351 4314
4
<PAGE> 5
"Adviser" Salomon Brothers Asset Management Inc
Seven World Trade Center
New York, NY 10048
Attention: Carol Epstein, Associate General Counsel
Fax No. 212 783 3357
"Customer" SRS Labs, Inc.
2909 Daimler Street
Santa Ana, CA 92705
Attention: Thomas C.K. Yuen, Chief Executive Officer
Fax No. 949 852-1099
"Secured Party" City National Bank
Irvine Spectrum Technology Center
100 Pacifica, Suite 100
Irvine, CA 92618
Attention: Erich Bollinger, Vice President
Fax No. (949) 754-1510
with a copy to: City National Bank
Legal Department
400 North Roxbury Drive
Beverly Hills, California 90210-5021
Attention: General Counsel
or to such other address or facsimile number as any party may designate by
written notice to all other parties. Each such notice, request and demand shall
be deemed given or made as follows: (i) if sent by hand delivery, upon delivery;
(ii) if sent by facsimile, upon receipt; and (iii) if sent by mail, upon the
earlier of the date of receipt or three (3) days after deposit in the U.S. mail,
first class and postage prepaid.
f. This Agreement shall be binding upon and inure to the benefit of the
heirs, executors, administrators, legal representatives, successors and assigns
of the parties; provided however, that Custodian may not assign its obligations
hereunder without Secured Party's prior written consent. This Agreement may be
amended or modified only in writing signed by all parties hereto.
g. This Agreement shall terminate upon: (i) receipt by Adviser and
Custodian of written notice from Secured Party expressly stating that Secured
Party no longer claims any security interest in the Collateral; or (ii)
termination of the Investment Advisory Agreement pursuant to Section 5.e. hereof
and delivery by Custodian of all Collateral to Secured Party or its designee in
accordance with Secured Party's written instructions.
h. This Agreement shall be governed by and construed in accordance with the
laws of the Commonwealth of Massachusetts. This Agreement may be executed in any
number of counterparts which, when taken together, shall constitute but one
agreement.
5
<PAGE> 6
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date
first set forth above.
"CUSTODIAN" INVESTORS BANK & TRUST COMPANY
By: /s/ MARTIN SULLIVAN
-----------------------------------------
Its: Senior Director
-----------------------------------------
"ADVISER" SALOMON BROTHERS ASSET MANAGEMENT INC
By: /s/ ROSS S. MARGOLISS
-----------------------------------------
Its: Managing Director
-----------------------------------------
"CUSTOMER" SRS LABS, INC.
By: /s/ THOMAS C.K. YUEN
-----------------------------------------
Thomas C.K. Yuen, Chief Executive Officer
"SECURED PARTY" CITY NATIONAL BANK, a national banking
association
By: /s/ ERICH BOLLINGER
-----------------------------------------
Erich Bollinger, Vice President
6
<PAGE> 1
EXHIBIT 10.43
[CITY NATIONAL BANK LETTERHEAD]
REVOLVING CREDIT NOTE
$10,000,000 Irvine, California
July 6, 1999
FOR VALUE RECEIVED, the undersigned, SRS LABS, INC., a Delaware corporation
("Borrower"), promises to pay on the Termination Date to CITY NATIONAL BANK, a
national banking association ("CNB"), at its Office located at Irvine,
California 92618, the principal amount of TEN MILLION DOLLARS ($10,000,000) or
so much thereof as may be advanced and be outstanding, with interest thereon to
be computed on each Revolving Credit Loan from the date of its disbursement at a
rate computed on the basis of a 360-day year, actual days elapsed, as set forth
that certain Credit and Security Agreement dated as of July 6, 1999, between CNB
and Borrower, as it may be amended from time to time (the "Credit Agreement").
Capitalized terms not defined herein shall have the meanings given them in the
Credit Agreement.
All or any portion of the principal of this Revolving Credit Note ("Note")
may be borrowed, repaid and reborrowed from time to time prior to the
Termination Date, provided at the time of any borrowing no default exists under
this Note and no Event of Default or Potential Event of Default exists under the
terms and conditions of the Credit Agreement and provided, further that the
total borrowings outstanding at any one time shall not exceed $10,000,000. Each
borrowing and repayment of a Revolving Credit Loan shall be noted in the books
and records of CNB. The excess of borrowings over repayments as noted on such
books and records shall constitute presumptive evidence of the principal balance
due hereon from time to time and at any time.
Interest is payable monthly on the first day of each and every month
commencing September 1, 1999.
If payment on this Note becomes due and payable on non-Business Day, the
maturity thereof shall be extended to the next Business Day and, with respect to
payments of principal or interest thereon shall be payable during such extension
at the then applicable rate. Upon the occurrence of one or more of the Events of
Default specified in the Credit Agreement, all amounts remaining unpaid on this
Note may become or be declared to be immediately payable as provided in the
Credit Agreement, without presentment, demand or notice of dishonor, all of
which are expressly waived. Borrower agrees to pay all costs of collection of
this Note and reasonable attorneys' fees (including attorneys' fees allocable to
CNB's in-house counsel) in connection therewith, irrespective of whether suit is
brought thereon.
This is the Revolving Credit Note referred to in the Credit Agreement and
is entitled to the benefits thereof and may be prepaid in whole or in part only
as provided therein.
Any change in the Prime Rate shall become effective on the same Business
Day on which the Prime Rate shall change, without prior notice to Borrower. Any
principal or interest not paid when due hereunder shall thereafter bear
additional interest from its due date at the rate of five percent (5%) per
1
<PAGE> 2
annum higher than the interest rate as determined and computed above, and
continuing thereafter until paid.
This Note shall be governed by the laws of the State of California.
"BORROWER" SRS LABS, INC., a
Delaware corporation
By: /s/ THOMAS C.K. YUEN
-----------------------------------------
Thomas C.K. Yuen, Chief Executive Officer
2
<PAGE> 1
EXHIBIT 21
SRS LABS, INC.
SUBSIDIARIES
<TABLE>
<CAPTION>
Jurisdiction of
Name Incorporation Ownership
---- --------------- ---------
<S> <C> <C>
SRSWOWcast.com, Inc. Delaware SRS Labs, Inc. - 100% Direct
ValenceTech Limited Bermuda SRS Labs, Inc. - 100%
Direct
Valence Technology, Inc. British Virgin Islands SRS Labs, Inc. - 100%
("Valence BVI") Direct
Valence Technology, Inc. Hong Kong Valence BVI - 100% Direct
("Valence-H.K.")
Valence Semiconductor Hong Kong Valence H.K. - 100% Direct
Design Limited
ASP Microelectronics Limited Hong Kong Valence H.K. - 100% Direct
("ASP")
LEC Electronic Components Hong Kong Valence H.K. - 100% Direct
Limited ("LEC")
VSD Electronics Limited Hong Kong Valence H.K. - 100% Direct
LEC Microelectronics Limited Hong Kong ASP - 100% Direct
LEC Electronics Limited Hong Kong LEC - 100% Direct
VSD Electronics (Hui Yang) Ltd. Peoples Republic of China LEC - 100% Direct
</TABLE>
<PAGE> 1
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements Nos.
333-18981, 333-18983, 333-18985, 333-18987, 333-18989, 333-29153 and 333-63493,
all on Form S-8 of SRS Labs, Inc., of our report dated March 3, 2000 (March 9,
2000 as to Note 13), appearing in SRS Labs, Inc.'s Annual Report on Form 10-K
for the year ended December 31, 1999.
/s/ DELOITTE & TOUCHE LLP
Costa Mesa, California
March 24, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 15,969,678
<SECURITIES> 9,342,733
<RECEIVABLES> 3,579,118
<ALLOWANCES> 1,083,961
<INVENTORY> 2,726,193
<CURRENT-ASSETS> 25,013,626
<PP&E> 2,359,120
<DEPRECIATION> 1,192,363
<TOTAL-ASSETS> 39,100,521
<CURRENT-LIABILITIES> 14,060,198
<BONDS> 0
0
0
<COMMON> 11,891
<OTHER-SE> 25,028,432
<TOTAL-LIABILITY-AND-EQUITY> 39,100,521
<SALES> 32,120,694
<TOTAL-REVENUES> 35,795,583
<CGS> 21,892,871
<TOTAL-COSTS> 16,222,426
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,040,271
<INTEREST-EXPENSE> 532,720
<INCOME-PRETAX> (1,694,538)
<INCOME-TAX> 49,662
<INCOME-CONTINUING> (1,744,200)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,744,200)
<EPS-BASIC> (0.15)
<EPS-DILUTED> (0.15)
</TABLE>
