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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
----------
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO ______________
COMMISSION FILE NUMBER 0-21123
SRS LABS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
----------------
DELAWARE 33-0714264
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2909 DAIMLER STREET, SANTA ANA, CALIFORNIA 92705
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(949) 442-1070
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NOT APPLICABLE
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGES SINCE LAST REPORT)
----------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: as of August 4, 2000,
12,596,935 shares of the issuer's common stock, par value $.001 per share, were
outstanding; of that amount, 71,100 shares were held as treasury shares.
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SRS LABS, INC.
FORM 10-Q
FOR THE PERIOD ENDED JUNE 30, 2000
INDEX
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.............................................. 4
Consolidated Balance Sheets as of June 30, 2000 (Unaudited)
and December 31, 1999................................................. 4
Consolidated Statements of Operations for the three months and
six months ended June 30, 2000 and 1999 (Unaudited)................... 5
Consolidated Statements of Comprehensive Loss for the three month
and six months ended June 30, 2000 and 1999 (Unaudited)............... 6
Consolidated Statements of Cash Flows for the six months ended
June 30, 2000 and 1999 (Unaudited).................................... 7
Notes to the Interim Consolidated Financial Statements
(Unaudited)........................................................... 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 20
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds........................ 21
Item 4. Submission of Matters to a Vote of Security Holders............. 21
Item 6. Exhibits and Reports on Form 8-K................................. 22
SIGNATURES................................................................... 23
2
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FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended, and Section 27A of the Securities Act of 1933, as amended, reflecting
management's current expectations. Examples of such forward-looking statements
include the expectations of the Company with respect to its strategy. Although
the Company believes that its expectations are based upon reasonable
assumptions, there can be no assurances that the Company's financial goals will
be realized. Such forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of the Company, or industry results, to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements. Numerous factors may affect the Company's
actual results and may cause results to differ materially from those expressed
in forward-looking statements made by or on behalf of the Company. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words, "believes," "anticipates," "plans," "expects" and similar
expressions are intended to identify forward-looking statements. The important
factors discussed in Part I, Item 2, Management's Discussion and Analysis of
Financial Condition and Results of Operations - Factors That May Affect Future
Results", herein, among others, could cause actual results to differ materially
from those indicated by forward-looking statements made herein and presented
elsewhere by management. Such forward-looking statements represent management's
current expectations and are inherently uncertain. Investors are warned that
actual results may differ from management's expectations. The Company assumes no
obligation to update the forward-looking information to reflect actual results
or changes in the factors affecting such forward-looking information.
3
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
SRS LABS, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
----------- ------------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents ............................................ $ 19,185,902 $ 15,969,678
Investments available for sale ....................................... 3,210,100 3,011,250
Accounts receivable, net ............................................. 2,053,165 2,495,157
Inventories, net ..................................................... 3,038,295 2,726,193
Prepaid expenses and other current assets ............................ 888,071 729,881
Deferred income taxes ................................................ 81,467 81,467
------------ ------------
TOTAL CURRENT ASSETS ............................................ 28,457,000 25,013,626
Investments available for sale ......................................... 4,593,816 6,331,483
Furniture, fixtures & equipment, net ................................... 1,208,311 1,166,757
Intangible assets, net ................................................. 5,675,640 5,425,273
Deferred income taxes .................................................. 740,889 740,889
Other assets ........................................................... 422,493 422,493
------------ ------------
TOTAL ASSETS .................................................... $ 41,098,149 $ 39,100,521
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable ................................................... $ 2,961,634 $ 2,882,686
Accrued liabilities ................................................ 2,718,039 1,658,964
Line of credit ..................................................... 8,000,000 8,000,000
Income taxes payable ............................................... 1,487,303 1,518,548
------------ ------------
TOTAL CURRENT LIABILITIES ..................................... 15,166,976 14,060,198
STOCKHOLDERS' EQUITY
Preferred stock - $.001 par value;
2,000,000 shares authorized; no shares
issued and outstanding ............................................ -- --
Common stock - $.001 par value;
56,000,000 shares authorized; 12,596,935
and 11,890,691 shares issued; and
12,525,835 and 11,819,591 shares outstanding
at June 30, 2000 (unaudited) and December 31, 1999,
respectively ...................................................... 12,597 11,891
Additional paid-in capital ......................................... 49,604,342 40,312,336
Deferred stock option compensation ................................. 321,899 264,557
Cumulative other comprehensive income .............................. 12,535 23,330
Retained deficit ................................................... (23,756,919) (15,308,510)
Less treasury stock at cost, 71,100 shares
at June 30, 2000 (unaudited) and December 31, 1999 ................ (263,281) (263,281)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY .................................... 25,931,173 25,040,323
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY .................... $ 41,098,149 $ 39,100,521
============ ============
</TABLE>
See accompanying notes to the interim consolidated financial statements
4
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SRS LABS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
--------------------------------- ---------------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
REVENUES
Chip and licensing revenue .............. $ 2,860,253 $ 3,978,390 $ 5,739,332 $ 7,559,548
Product and component sales ............. 3,732,953 4,214,009 8,044,426 8,287,421
------------ ------------ ------------ ------------
TOTAL REVENUES ....................... 6,593,206 8,192,399 13,783,758 15,846,969
COST OF SALES ........................... 4,267,465 4,953,156 9,116,166 10,046,941
------------ ------------ ------------ ------------
GROSS MARGIN ............................ 2,325,741 3,239,243 4,667,592 5,800,028
EXPENSES
Sales and marketing ..................... 1,422,744 865,154 2,707,477 2,149,486
Research and development ................ 984,908 981,018 1,924,097 2,070,924
General and administrative .............. 4,195,373 1,392,262 5,613,960 3,513,821
Non-cash stock issuance cost ............ -- -- 3,111,859 --
------------ ------------ ------------ ------------
INCOME (LOSS) FROM OPERATIONS ........... (4,277,284) 809 (8,689,801) (1,934,203)
OTHER INCOME, NET ....................... 308,413 138,608 517,976 266,586
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAX (EXPENSE) (3,968,871) 139,417 (8,171,825) (1,667,617)
BENEFIT ..............................
INCOME TAX (EXPENSE) BENEFIT ............ (138,491) (133,542) (276,584) 176,382
------------ ------------ ------------ ------------
NET INCOME (LOSS) ....................... $ (4,107,362) $ 5,875 $ (8,448,409) $ (1,491,235)
============ ============ ============ ============
NET INCOME (LOSS) PER COMMON SHARE
Basic ................................ $ (0.33) $ 0.00 $ (0.69) $ (0.13)
============ ============ ============ ============
Diluted .............................. $ (0.33) $ 0.00 $ (0.69) $ (0.13)
============ ============ ============ ============
WEIGHTED AVERAGE SHARES USED IN THE
CALCULATION OF NET INCOME
(LOSS) PER COMMON SHARE
Basic ................................ 12,492,205 11,686,237 12,198,822 11,686,090
============ ============ ============ ============
Diluted .............................. 12,492,205 12,022,691 12,198,822 11,686,090
============ ============ ============ ============
</TABLE>
See accompanying notes to the interim consolidated financial statements
5
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SRS LABS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30,
-------------------------- --------------------------------
2000 1999 2000 1999
------------ -------- ----------- ------------
<S> <C> <C> <C> <C>
Net income (loss) .......................... $(4,107,362) $ 5,875 $(8,448,409) $(1,491,235)
Other comprehensive income (loss)
Foreign currency translation ........... (1,544) -- 1,269 --
Unrealized loss on investments available
for sale, net of tax ................. (920) (62,914) (12,064) (70,830)
----------- -------- ----------- -----------
Comprehensive loss ......................... $(4,109,826) $(57,039) $(8,459,204) $(1,562,065)
=========== ======== =========== ===========
</TABLE>
See accompanying notes to the interim consolidated financial statements
6
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SRS LABS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------------------
2000 1999
------------ -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ...................................................... $ (8,448,409) $ (1,491,235)
Adjustments to reconcile net loss to net cash used in operating
activities:
Non-cash stock issuance cost ............................. 3,111,859 --
Depreciation and amortization ............................ 1,387,323 1,011,670
Other .................................................... 18,497 28,344
Increase in deferred stock option compensation ........... 57,342 119,807
Changes in operating assets and liabilities:
Accounts receivable .................................. 515,191 230,451
Inventories .......................................... (378,578) (14,206)
Prepaid expenses and other current assets ............ (158,190) 2,239,670
Accounts payable ..................................... 78,948 (7,728,921)
Accrued liabilities .................................. 1,059,075 1,012,523
Income taxes payable ................................. (22,862) (53,312)
------------ ------------
Net cash used in operating activities .................... (2,779,804) (4,645,209)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture, fixtures and equipment ................. (338,800) (105,756)
Proceeds from sale of investments available for sale .......... 1,500,000 --
Expenditures related to patents and intangible assets ......... (1,346,025) (48,221)
------------ ------------
Net cash used in investing activities .................... (184,825) (153,977)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of Common Stock ............................ 5,000,291 --
Purchase of treasury stock .................................... -- (52,500)
Proceeds from exercise of stock options ....................... 1,180,562 42,191
------------ ------------
Net cash provided by (used in) financing activities ...... 6,180,853 (10,309)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .......... 3,216,224 (4,809,495)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................ 15,969,678 12,341,242
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ...................... $ 19,185,902 $ 7,531,747
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest ................................................. $ 284,264 $ 234,378
Income taxes ............................................. $ 177,191 $ --
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
Unrealized loss on investments, net ....................... $ (12,064) $ (70,830)
</TABLE>
In January 1999, the Company received certain computer equipment and a fully
paid-up license for MPEG-1 Technology Core from DVS Inc. in payment for $300,000
of license fees due to the Company for the use of its technologies.
See accompanying notes to the interim consolidated financial statements
7
<PAGE> 8
SRS LABS, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL/BASIS OF PRESENTATION
SRS Labs, Inc. is a developer and provider of technology solutions for the
consumer electronics, computer, game and telecommunications markets. The
Company's principal business activities in these markets include:
o Developing and licensing audio and voice technologies to original
equipment manufacturers ("OEMs") and semiconductor manufacturers
around the world and through its subsidiary, SRSWOWcast.com, Inc., an
internet based business organized in 1999, developing website content
employing SRS Labs, Inc. technologies designed to attract website
viewers and advertisers; and
o Through its subsidiary, ValenceTech Limited and its foreign
subsidiaries (collectively "Valence"), designing and selling
technology solutions through custom application specific integrated
circuits ("ASICs") to OEMs; and designing, distributing and
manufacturing components, sub-assemblies and electronics products for
the OEM and retail communities within the Company's targeted markets.
The accompanying interim consolidated financial statements have been
prepared by the Company without audit (except for the balance sheet information
as of December 31, 1999) in conformity with accounting principles generally
accepted in the United States for interim financial information and with the
rules and regulations of the U.S. Securities and Exchange Commission. In the
opinion of management, all adjustments (which include only normal recurring
adjustments) considered necessary for a fair presentation have been included.
Certain accounts as previously reported have been reclassified to conform to the
current period presentation.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. Therefore, the interim financial statements
should be read in conjunction with the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1999. Current and future financial statements
may not be directly comparable to the Company's historical financial statements.
The results of operations for the interim periods are not necessarily indicative
of the results to be expected for the full year.
2. INVESTMENTS AVAILABLE FOR SALE
The Company has classified its investments as available-for-sale in
accordance with Statement of Financial Accounting Standards No. 115 "Accounting
for Certain Investments in Debt and Equity Securities". As of June 30, 2000, the
Company's available-for-sale investments had a cost of $7,776,640 and an
estimated fair value of $7,803,916, based on quoted market prices. The
unrealized gains on these investments of $27,276 net of income taxes of $11,183,
are reported as a separate component of stockholders' equity.
3. INTANGIBLE ASSETS
During the six months ended June 30, 2000, the Company purchased software
and related intellectual property rights for an aggregate purchase price of
approximately $1,320,000. The purchases are included in intangible assets in the
accompanying financial statements and are being amortized over estimated useful
lives of 5 years.
4. NET LOSS PER COMMON SHARE
The Company computes earnings per share (EPS) in accordance with Statement
of Financial Accounting Standards No. 128, "Earnings per Share" (FAS 128). FAS
128 requires the Company to disclose basic and diluted earnings per share.
8
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SRS LABS, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. CONTINGENCIES
The Company is subject to legal proceedings and claims that arise in the
normal course of business. While the outcome of these proceedings and claims
cannot be predicted with certainty, management does not believe that the outcome
of any of these matters will have a material adverse effect on the Company's
consolidated financial position or results of operations.
6. STOCKHOLDERS' EQUITY
During Fiscal 1998, the Company's Board of Directors authorized the
repurchase of up to 500,000 of the outstanding shares of the Company's common
stock. As of June 30, 2000, 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.
In March 2000, the Company entered into a technology and marketing alliance
with Microsoft Corporation ("Microsoft"). In conjunction with this transaction,
Microsoft purchased 290,529 shares of the Company's common stock for $17.21 per
share or $5,000,000 in the aggregate. The difference between the purchase price
and the fair value of the common stock on the date of purchase, totaling
approximately $555,000, was recorded as non-cash stock issuance cost by the
Company during the quarter ended March 31, 2000. The Company also granted
Microsoft warrants to purchase up to 200,000 shares of common stock of the
Company 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 $2,555,000, was recorded as
non-cash stock issuance cost by the Company during the quarter ended March 31,
2000.
7. SEGMENT INFORMATION
The Company operates in three business segments: (a) the development and
marketing of technology either in the form of integrated circuits through
Valence (ASICs) or the licensing of technologies developed by the Company to
original equipment manufacturers and semiconductor manufacturers; (b) the sale
of consumer electronic products and components; and (c) the SRSWOWcast.com, Inc.
internet based business. The Company does not allocate operating expenses or
specific assets to the segments described in clauses (a) and (b) above.
Therefore, segment information includes only net revenues, cost of sales and
gross margin for those segments. The Company's internet-based business generated
no significant revenues and incurred operating losses of $837,605 and $1,259,605
for the three month
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SRS LABS, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
and six month periods ended June 30, 2000. These losses were composed primarily
of sales and marketing expenses and general and administrative expenses
associated with the development of web content, and the promotion and launch of
the Company's website.
THREE MONTHS ENDED JUNE 30, 2000
----------------------------------------------
CHIPS AND PRODUCT AND
LICENSING COMPONENT SALES TOTAL
---------- --------------- ----------
Net revenues ...... $2,860,253 $3,732,953 $6,593,206
Cost of sales ..... 900,663 3,366,802 4,267,465
---------- ---------- ----------
Gross margin ...... $1,959,590 $ 366,151 $2,325,741
========== ========== ==========
THREE MONTHS ENDED JUNE 30,1999
----------------------------------------------
CHIPS AND PRODUCT AND
LICENSING COMPONENT SALES TOTAL
---------- --------------- ----------
Net revenues ...... $3,978,390 $4,214,009 $8,192,399
Cost of sales ..... 940,067 4,013,089 4,953,156
---------- ---------- ----------
Gross margin ...... $3,038,323 $ 200,920 $3,239,243
========== ========== ==========
SIX MONTHS ENDED JUNE 30, 2000
-----------------------------------------------
CHIPS AND PRODUCT AND
LICENSING COMPONENT SALES TOTAL
---------- --------------- -----------
Net revenues ...... $5,739,332 $8,044,426 $13,783,758
Cost of sales ..... 1,783,663 7,332,503 9,116,166
---------- ---------- -----------
Gross margin ...... $3,955,669 $ 711,923 $ 4,667,592
========== ========== ===========
SIX MONTHS ENDED JUNE 30,1999
-----------------------------------------------
CHIPS AND PRODUCT AND
LICENSING COMPONENT SALES TOTAL
---------- --------------- -----------
Net revenues ...... $7,559,548 $8,287,421 $15,846,969
Cost of sales ..... 2,004,783 8,042,158 10,046,941
---------- ---------- -----------
Gross margin ...... $5,554,765 $ 245,263 $ 5,800,028
========== ========== ===========
10
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
SRS Labs, Inc. is a developer and provider of technology solutions for the
consumer electronics, computer, game and telecommunications markets. The
Company's principal business activities in these markets include:
o Developing and licensing audio and voice technologies to original
equipment manufacturers ("OEMs") and semiconductor manufacturers
around the world and through its subsidiary, SRSWOWcast.com, Inc., an
internet based business organized in 1999, developing website content
employing SRS Labs, Inc. technologies designed to attract website
viewers and advertisers; and
o Through its subsidiary, ValenceTech Limited and its foreign
subsidiaries (collectively, "Valence"), designing and selling
technology solutions through custom application specific integrated
circuits ("ASICs") to OEMS; and designing, distributing and
manufacturing components, sub-assemblies and finished goods for the
OEM and retail communities within the Company's targeted markets.
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 TruSurroundTM, 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.
In addition to the acquisition of Valence Technology, Inc. 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.
During the fiscal year ended December 31, 1999 ("Fiscal 1999"), the Company
re-engineered its business model and operational structure. Valence Technology,
Inc., 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. With respect to its
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 radio. This new focus resulted in the Company launching the
WOWThing product family and establishing a new 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. The License Agreement has facilitated
the incorporation of the WOW Technology into the Windows 2000 Media Player and a
click-through hyper-link on the interface of the Windows Media Player to the
SRSWOWcast.com website. 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 also were implemented in new consumer products
in Fiscal 1999. Among the most notable implementations included the Kenwood
receiver (CircleSurround), the Sony Walkman (SRS Headphones), Philips
(TruSurround) and Sony (SRS Headphone) DVD players, as well as Hitachi TVs
(Focus). In addition to these new implementations, the Company entered into new
licenses with key industry manufacturers including
11
<PAGE> 12
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.
SRS currently operates in three 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, (b) the sale of consumer
electronic products and components, and (c) the SRSWOWcast.com, Inc. internet
based business. A summary of the Company's operations and activities by business
segment is included in the accompanying notes to the interim consolidated
financial statements.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE MONTHS ENDED JUNE 30, 1999
Revenues
Chip and licensing revenue consists of design fees and sales of custom
application specific integrated circuits (ASICs) by Valence to OEM manufacturers
and sales of general purpose integrated circuits ("IC"s) designed by the Company
under the brand name ASP Microelectronics. Licensing revenues are royalties
generated primarily from the license of the Company's audio technologies.
License and royalty agreements generally provide for the license of technologies
for a specified period of time for either a single fee or a fee based on the
number of units distributed by the licensee. Product and component sales
primarily represent (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 the three months ended June 30, 2000, were $6,593,206,
compared to $8,192,399 for the same period in the prior year, a decrease of
$1,599,193, or 20%. The decrease was due primarily to lower demand during the
quarter for the Company's ASIC design services and products, which are order
specific and custom in nature, and subject to variability based on timing of
customer orders, and to a comparative decrease in licensing revenue during the
quarter resulting from the Company's recording of a large one-time technology
transfer fee in the second quarter of 1999, and to a decline in licensing fees
generated by computer manufacturer related activity in the second quarter of
2000. Revenues generated by the Company's internet based business were not
significant during the quarter ended June 30, 2000.
Product and component revenues decreased $481,056, or 11%. This decrease is
consistent with the Company's strategy to exit certain of its low margin
distribution product lines in order to focus resources on expansion of its ASIC
business and integration of SRS technologies into its products.
Gross Margin
Cost of sales consists primarily of fabrication costs, assembly and test
costs, and the cost of materials and overhead from operations. For the three
months ended June 30, 2000, the gross margin percentage decreased to 35%,
compared to 40% for the same period in the prior year. The decrease in margin
percentage is attributable to lower licensing revenue and lower ASIC sales, the
two most profitable components of the Company's revenues. In addition, the
Company experienced higher ASIC fabrication costs during the second quarter of
2000, as a result of higher worldwide demand for semiconductors and limited
fabrication capacity. The Company expects that gross margins in future quarters
will continue to be negatively impacted by higher fabrication costs.
Sales and Marketing
Sales and marketing expenses consist primarily of employee salaries and
sales consultants' fees and related expenses, sales commissions, advertising,
and product promotion. Sales and marketing expenses were $1,422,744 for the
three months ended June 30, 2000 compared to $865,154 for the same prior year
period, an increase of $557,590, or 64%. The increase is due primarily to
spending associated with the development and promotion of the SRSWOWcast.com
website, and creation of program content for such website. The website was
launched July 18,
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<PAGE> 13
2000 and it is the Company's expectation that sales and marketing expenses will
continue to increase as a result of the expansion and growth of SRSWOWcast.com
business operations.
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 $984,908 for the three months ended June 30, 2000 compared to $981,018 for
the same prior year period. Research and development expenses may increase in
the future as a result of ongoing product development efforts.
General and Administrative
General and administrative expenses consist primarily of employee-related
expenses, legal costs and patent and intangible asset amortization costs.
General and administrative expenses were $4,195,373 for the three months ended
June 30, 2000 compared to $1,392,262 for the same prior year period, for an
increase of $2,803,111 or 201%. The increase is due primarily to compensation
costs incurred as a result of the resignation of an employee of Valence
($735,000), accelerated amortization of intellectual property incorporating
outdated technologies ($300,000), additional legal and employee related expenses
associated with the launch of SRSWOWcast.com, Inc. ($190,000), postponed
IPO-related expenses ($1,142,000-discussed below) plus higher salaries and
benefits, legal, and other administrative expenses in the Company's core
licensing business. As part of the acquisition of Valence, the Company allocated
a portion of the purchase price to various intangible assets totaling
approximately $5,910,400. This amount was capitalized and is being amortized on
a straight line basis over periods ranging from three to eleven years with the
related amortization expense of $332,796 and $332,796 for the quarters ended
June 30, 2000 and June 30, 1999, respectively, and is included in general and
administrative expenses.
IPO related expenses
On March 3, 2000, the Company filed an application to list the common
shares of Valence on the Growth Enterprise Market of the Hong Kong Stock
Exchange (the "GEM"), in order to sell a minority interest in Valence to the
public. The initial public offering was targeted for completion in the second
quarter of 2000. However, due to negative market conditions affecting equity
markets worldwide, including the GEM, the Company elected to postpone the
offering indefinitely. Offering costs incurred by the Company, comprised
primarily of legal, accounting and underwriting fees, totaled $1,142,175 as of
June 30, 2000. These costs are included in general and administrative expense in
the accompanying financial statements.
Other Income, Net
Net other income consists primarily of interest income, interest expense
and foreign currency transaction gains and losses. Net other income was $308,413
for the three months ended June 30, 2000 compared to $138,608 for the same prior
year period, an increase of 123%. The increase is primarily due to higher
interest income which is attributable to higher average cash and investment
balances during the current year quarter and favorable foreign currency
transaction gains.
Provision for Income Taxes
The income tax expense for the three months ended June 30, 2000 was
$138,491 compared to $133,542 for the same prior year period. Commencing in the
fiscal year ending December 31, 2000, the Company recorded a tax provision at
statutory tax rates in the Asian countries where Valence has its principal
business operations. In Fiscal 1999, the Company recognized tax benefits related
to domestic operations in connection with federal refundable taxes which could
be recovered through a net operating loss carryback.
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<PAGE> 14
SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999
Revenues
Total revenues for the six months ended June 30, 2000, were $13,783,758,
compared to $15,846,969 for the same period in the prior year, a decrease of
$2,063,211, or 13%. The decrease was due primarily to lower demand during the
period for the Company's ASIC design services and products, which are order
specific and custom in nature, and subject to variability based on timing of
customer orders, and to a comparative decrease in licensing revenue during the
period resulting from the Company's recording of a large one-time technology
transfer fee in the second quarter of 1999, and to a decline in licensing fees
generated by computer manufacturer related activity for the period. Revenues
generated by the Company's internet based business were not significant during
the six months ended June 30, 2000.
Product and component revenues decreased $242,995, or 3%. This decrease is
consistent with the Company's strategy to exit certain of its low margin
distribution product lines in order to focus resources on expansion of its ASIC
business and integration of SRS technologies into its products.
Gross Margin
For the six months ended June 30, 2000, the gross margin percentage
decreased to 34%, compared to 37% for the same period in the prior year. The
decrease in margin percentage is attributable to lower licensing revenue and
lower ASIC sales, historically the most profitable components of the Company's
revenues. In addition, the Company experienced higher ASIC fabrication costs
during the six months ended June 30, 2000, as a result of higher worldwide
demand for semiconductors, and limited fabrication capacity. The Company expects
that gross margins will continue to be negatively impacted by higher fabrication
costs.
Sales and Marketing
Sales and marketing expenses were $2,707,477 for the six months ended June
30, 2000, compared to $2,149,486 for the same period in the prior year, an
increase of $557,991 or 26%. The increase is due primarily to spending during
the second quarter of 2000, associated with the development and promotion of the
SRSWOWcast.com website (website), and creation of program content for the
website. The website was launched July 18, 2000, and it is the Company's
expectation that sales and marketing expenses will continue to increase as a
result of the expansion and growth of SRSWOWcast.com business operations.
Research and Development
Research and development costs were $1,924,097 for the six months ended
June 30, 2000, compared to $2,070,924 for the same period in the prior year, a
decrease of $146,827, or 7%. The decrease is due primarily to lower staffing
levels at Valence. Research and development costs may increase in the future as
a result of ongoing product development efforts.
General and Administrative
General and administrative costs were $5,613,960 for the six months ended
June 30, 2000, compared to $3,513,821 for the same period in the prior year, an
increase of $2,100,139, or 60%. First quarter 2000 general and administrative
expenses were $1,418,587 compared to first quarter 1999 expenses of $2,121,559,
a decrease of approximately $703,000. The decrease in first quarter 2000 general
and administrative expenses was offset in the second quarter of 2000 by
compensation costs incurred as a result of the resignation of an employee of
Valence ($735,000), accelerated amortization of intellectual property
incorporating outdated technologies ($300,000), higher legal and employee
related expenses associated with the launch of SRSWOWcast.com, Inc. ($190,000),
postponed IPO related expenses ($1,142,000), plus higher salaries and benefits,
legal, and other administrative expenses in the Company's core licensing
business.
Amortization expense related to intangible assets associated with the
Valence acquisition was $665,592 for both the six month periods ended June, 30,
2000 and 1999, and is included in general and administrative expenses.
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<PAGE> 15
Non-cash Stock Issuance Costs
In March 2000, the Company entered into a technology and marketing alliance
with Microsoft Corporation. In conjunction with this transaction, Microsoft
purchased shares of common stock of the Company and was issued warrants to
purchase additional shares of the Company and its subsidiary. As a result of the
transaction, the Company recognized one-time, non-cash charges totaling
$3,111,859. See Note 6 of the Notes to the Interim Consolidated Financial
Statements for more information concerning the Microsoft transaction.
Other income, Net
Net other income was $517,976 for the six months ended June 30, 2000,
compared to $266,586 for the same period in the prior year, an increase of
$251,390 or 94%. The increase is due primarily to higher interest income
associated with higher cash and investment balances, and favorable foreign
currency transaction gains.
Income Taxes
The income tax expense for the six months ended June 30, 2000 was $276,584
compared to a tax benefit of $176,382 for the same period in the prior year.
Commencing in the fiscal year ended December 31, 2000, the Company recorded a
tax provision at statutory tax rates in the Asian countries where Valence has
its principal business operations. In Fiscal 1999, the Company recognized tax
benefits related to domestic operations in connection with federal refundable
taxes which could be recovered through a net operating loss carry back.
New Accounting Pronouncements
On December 3, 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin #101 (SAB 101) "Revenue Recognition in Financial
Statements." Management of the Company has determined that the application of
SAB 101 will not have any material impact on the Company's consolidated
financial statements.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal source of liquidity at June 30, 2000 consisted of
cash, cash equivalents and investments aggregating $26,989,818, as well as
borrowings available under its credit facilities. At December 31, 1999, the
Company had cash, cash equivalents and long-term investments of $25,312,411. In
March 2000, the Company sold shares of its common stock to Microsoft
Corporation, for aggregate cash proceeds of $5,000,000. See Note 6 to the
Interim Consolidated Financial Statements.
The Company's operating activities utilized $2,779,804 in cash for the six
months ended June 30, 2000, and $4,645,209 for the six months ended June 30,
1999. The use of cash in operations was primarily due to the Company's loss from
operations for the period, after adjustment for non-cash charges related to the
Microsoft transaction and depreciation and amortization. The net increase in
cash and cash equivalents of $3,216,224 for the period is attributable primarily
to proceeds from sale of long-term investments, proceeds from stock option
exercises and proceeds from the sale of common stock to Microsoft.
In March 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 cash, cash equivalents and investments. As of June 30,
2000, approximately $6,479,000 million in cash and cash equivalents and
$7,804,000 million in investments were pledged as collateral for the line of
credit. The total availability under the line of credit is the lesser of $10
million or a percentage of the fair market value of the collateral. The line of
credit bears interest at the bank's prime rate or LIBOR plus 0.75%. As of June
30, 2000, the Company had $8.0 million outstanding under the line of credit and
was contingently liable for $1.0 million 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 amounts of
cash available to pay dividends.
In November 1999, Valence 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
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<PAGE> 16
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 June 30, 2000, there were
no obligations outstanding under this credit facility.
The Company anticipates that its primary uses of working capital in future
periods will be to acquire new technologies and to fund increased costs for
additional sales and engineering headcount and marketing activities associated
with the introduction of new technologies and products into the market. The
Company also expects to fund increased costs associated with the ongoing
expansion and promotion of its SRSWOWcast.com operations.
Based on current plans and business conditions, the Company expects that
its cash, cash equivalents, investments and/or available borrowings under its
credit facilities, together with any amounts generated from operations, will be
sufficient to meet the Company's cash requirements for 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.
On March 3, 2000, ValenceTech Limited (the successor entity to Valence
Technology Inc. for purposes of listing common shares on the Growth Enterprise
Market of the Hong Kong Stock Exchange (the "GEM)) filed an application to list
its common shares on the GEM in connection with an initial public offering.
Approximately one-third of the net proceeds of the offering were earmarked to be
repatriated to the Company. In June 2000, the Company decided to postpone the
offering indefinitely based upon the weaker than expected response by
institutional investors and market conditions in Hong Kong. Irrespective of the
decision to postpone the offering, the Company has sufficient financial
resources to meet its cash requirements for the next 12 months, and will
continue to expand Valences' core business utilizing available working capital.
Neither the Company nor Valence anticipates a significant adverse financial
impact from the decision to postpone the offering. The Company will continue to
evaluate its future financing options in both domestic and foreign capital
markets.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Quarterly Fluctuations
The Company's operating results may fluctuate from those in prior quarters
and will continue to be subject to quarterly and other fluctuations due to a
variety of factors, including the extent to which the Company's licensees
incorporate the Company's technologies into their products; the timing of orders
from and the shipments to major customers; the timing of new product
introductions by the Company; the gain or loss of significant customers;
competitive pressures on selling prices; the market acceptance of new or
enhanced versions of the Company's technologies; the rate that the Company's
semiconductor licensees manufacture and distribute chips to product
manufacturers; results of operations of SRSWOWcast.com, Inc.; 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 has impacted the
Company's revenues and net income. In particular, the Company believes that
there is seasonality relating to the Christmas season, generally, and the
Chinese New Year within the Asia region, which fall into the fourth and first
quarters, respectively. As a result, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance.
Valence's Business
The Company derives a significant amount of its revenue from Valence's ASIC
and component distribution business. Valence's engineering team focuses on the
design of custom 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 new industry standards, product
obsolescence and changes in pricing policies by the Company, its competitors or
its suppliers.
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<PAGE> 17
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
was intended to bring new capital to grow Valence's core business while, at the
same time, adding significant value to the Company's shareholders. Postponement
of the offering is not expected to adversely affect Valence's core business
operations, and the Company will continue to evaluate its financing options
domestically and in foreign capital markets. There is no assurance however, that
the Company will be successful in a future initial public offering or in
securing alternate sources of capital.
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
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
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 WOWThing Processor Box.
The WOWThing 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 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 financial resources 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 assurance that the
Company's products will not compete with those of their
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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 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
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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 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.
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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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to a variety of risks, including foreign currency
fluctuations and changes in interest rates affecting the cost of its debt.
FOREIGN CURRENCY
The Company has subsidiary operations in Hong Kong and China, and
accordingly, the Company is exposed to transaction gains and losses that could
result from changes in foreign currency exchange rates. The Company uses the
local currency (Hong Kong dollars) as the functional currency for its Asian
subsidiaries. Translation adjustments resulting from the process of translating
foreign currency financial statements into U.S. dollars were not significant in
Fiscal 1999 and for the six months ended June 30, 2000, 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 periods. Under the current
circumstances, the Company believes that the foreign currency market risk is not
material. The Company actively monitors its foreign exchange exposure and,
should circumstances change, intends to implement strategies to reduce its risk
at such time that it determines that the benefits of such strategies outweigh
the associated costs. There can be no assurance that management's efforts to
reduce foreign exchange exposure will be successful.
INTEREST RATES
The Company's credit facilities bear interest based on the lending bank's
prime rate or LIBOR plus 0.75%. The interest rate on the balance of $8.0 million
outstanding at June 30, 2000 was 7.3125%. If interest rates were to increase by
10%, the impact on the Company's consolidated financial statements would be
additional interest expense of approximately $14,600 per quarter.
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PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
USE OF PROCEEDS
The effective date of the Company's initial public offering of its Common
Stock was August 8, 1996 (SEC Registration No. 333-4974-LA). During the second
quarter of Fiscal 2000, the Company utilized $2,528,404 of the $22,052,955 net
offering proceeds for working capital. The table below sets forth at June 30,
2000, the amount of the net offering proceeds used for the purposes noted in the
table.
<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 EQUITY SECURITIES
OF THE ISSUER, AND TO DIRECT OR INDIRECT
affiliates of the issuer PAYMENTS TO 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 ............................. -- 9,640,247(1)(2)
Repayment of indebtedness ............ -- --
Working capital ...................... -- $8,372,475
Temporary investment (cash and
municipal bonds) ................... -- $4,040,233
</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.
(2) During the six month period ended June 30, 2000, the Company utilized
approximately $1,250,000 of the net offering proceeds as consideration for
the purchase of software and related intellectual property rights. The
Company expects to pay an additional $100,000 as final payment for the
software in the third quarter of 2000.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Annual Meeting of Stockholders of SRS Labs, Inc. was held on June 15,
2000 for the purpose of (a) electing three Class I Directors to the Board of
Directors and (b) voting on a proposal to approve an amendment to the SRS Labs,
Inc. Amended and Restated 1996 Long-Term Incentive Plan (the "Incentive Plan")
to increase the number of shares of Common Stock available for issuance
thereunder by 2,500,000.
Robert B. Pfannkuch, Jeffrey I. Scheinrock and Thomas W.T. Wan were elected
to serve as Class I Directors of the Company for three-year terms expiring at
the 2003 Annual Meeting of Stockholders. John AuYeung and John Tu continued in
office as Class II Directors and Stephen V. Sedmark and Thomas C.K. Yuen
continued in office as Class III Directors. The tabulation of the votes cast for
the election of Messrs. Pfannkuch, Scheinrock and Wan was as follows:
VOTES FOR VOTES WITHHELD
--------- --------------
Mr. Pfannkuch 11,491,955 255,475
Mr. Scheinrock 11,492,395 255,035
Mr. Wan 11,494,765 252,665
The proposal to amend the Incentive Plan was approved. The tabulation of
votes was as follows:
VOTES FOR VOTES AGAINST ABSTENTIONS BROKER NON-VOTES
--------- ------------- ----------- ----------------
7,191,100 1,039,859 13,681 3,502,790
21
<PAGE> 22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits. The exhibits listed below are hereby filed with the U.S.
Securities and Exchange Commission (the "Commission") as part of this
Report.
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.1 SRS Labs, Inc. Amended and Restated 1996 Long-Term Incentive
Plan, as amended, previously filed with the Commission as
Appendix A to the Company's Definitive Proxy Statement dated
and filed with the Commission on April 26, 2000, which is
incorporated herein by reference.
27 Financial Data Schedule.
(b) Reports on Form 8-K. No reports on Form 8-K were filed with the
Commission during the quarter for which this report is filed.
22
<PAGE> 23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SRS LABS, INC.,
a Delaware corporation
Date: August 11, 2000 By: /s/ JOHN AUYEUNG
-----------------------------------------------
John AuYeung
Executive Vice President,
Chief Operating Officer,
Chief Financial Officer, Treasurer and Secretary
(Authorized Signatory and
Principal Financial Officer)
23
<PAGE> 24
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.1 SRS Labs, Inc. Amended and Restated 1996 Long-Term Incentive
Plan, as amended, previously filed with the Commission as
Appendix A to the Company's Definitive Proxy Statement dated
and filed with the Commission on April 26, 2000, which is
incorporated herein by reference.
27 Financial Data Schedule.
