UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One) | |
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the quarterly period ended June 30, 2005 | |
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OR | |
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period from to | |
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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 |
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 changed 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. Yes ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: as of July 22, 2005, 14,804,138 of the issuer’s common stock, par value $.001 per share, were outstanding. In addition, as of July 22, 2005, 674,098 shares of the issuer’s common stock were held as treasury shares.
SRS LABS, INC.
Form 10-Q
For the Period Ended June 30, 2005
Index
2
FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements 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
PART I — FINANCIAL INFORMATION
SRS LABS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
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| June 30, 2005 |
| December 31, 2004 |
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| (unaudited) |
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ASSETS |
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Current Assets |
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Cash and cash equivalents |
| $ | 6,834,871 |
| $ | 7,011,912 |
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Accounts receivable, net |
| 2,190,918 |
| 1,318,665 |
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Inventories, net |
| 518,355 |
| 571,280 |
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Prepaid expenses and other current assets |
| 1,203,830 |
| 1,337,506 |
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Deferred income taxes |
| 23,406 |
| 23,406 |
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Total Current Assets |
| 10,771,380 |
| 10,262,769 |
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Investments available for sale |
| 17,221,340 |
| 17,261,267 |
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Investment in LLC |
| 2,739,591 |
| 2,596,090 |
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Furniture, fixtures and equipment, net |
| 1,701,367 |
| 1,995,579 |
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Intangible assets, net |
| 2,604,429 |
| 2,660,955 |
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Goodwill |
| 533,031 |
| 533,031 |
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Deferred income taxes |
| 229,160 |
| 192,750 |
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Total Assets |
| $ | 35,800,298 |
| $ | 35,502,441 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY |
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Current Liabilities |
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Accounts payable |
| $ | 1,178,300 |
| $ | 984,805 |
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Accrued liabilities |
| 1,775,849 |
| 1,640,714 |
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Deferred revenue |
| 308,208 |
| 436,910 |
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Income taxes payable |
| 25,356 |
| 8,628 |
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Total Current Liabilities |
| 3,287,713 |
| 3,071,057 |
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Commitments, contingencies and subsequent event (Notes 8 and 12) |
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Stockholders’ Equity |
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Preferred stock—$.001 par value; 2,000,000 shares authorized; no shares issued or outstanding |
| — |
| — |
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Common stock—$.001 par value; 56,000,000 shares authorized;14,799,138 and 14,671,416 shares issued; and 14,125,040 and 14,229,541 shares outstanding at June 30, 2005 and December 31, 2004, respectively |
| 14,800 |
| 14,672 |
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Additional paid-in capital |
| 62,969,873 |
| 62,523,292 |
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Accumulated other comprehensive loss |
| (350,834 | ) | (309,722 | ) | ||
Accumulated deficit |
| (27,117,809 | ) | (27,853,003 | ) | ||
Treasury stock at cost, 674,098 and 441,875 shares at June 30, 2005 and December 31, 2004, respectively |
| (3,003,445 | ) | (1,943,855 | ) | ||
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Total Stockholders’ Equity |
| 32,512,585 |
| 32,431,384 |
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Total Liabilities and Stockholders’ Equity |
| $ | 35,800,298 |
| $ | 35,502,441 |
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See accompanying notes to the condensed consolidated financial statements
4
SRS LABS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
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| Three Months Ended |
| Six Months Ended |
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| June 30, |
| June 30, |
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| 2005 |
| 2004 |
| 2005 |
| 2004 |
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Revenues: |
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Semiconductor |
| $ | 2,521,174 |
| $ | 2,932,495 |
| $ | 4,505,737 |
| $ | 5,348,213 |
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Licensing |
| 3,539,977 |
| 2,485,404 |
| 6,804,072 |
| 5,412,731 |
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Total revenues |
| 6,061,151 |
| 5,417,899 |
| 11,309,809 |
| 10,760,944 |
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Cost of sales: |
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Semiconductor |
| 999,166 |
| 1,066,033 |
| 1,727,406 |
| 1,948,767 |
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Licensing |
| 94,838 |
| 20,407 |
| 151,183 |
| 46,544 |
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Total cost of sales |
| 1,094,004 |
| 1,086,440 |
| 1,878,589 |
| 1,995,311 |
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Gross Margin |
| 4,967,147 |
| 4,331,459 |
| 9,431,220 |
| 8,765,633 |
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Operating expenses: |
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Sales and marketing |
| 1,678,500 |
| 1,260,067 |
| 3,370,878 |
| 2,955,435 |
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Research and development |
| 1,207,871 |
| 1,144,926 |
| 2,389,940 |
| 2,353,613 |
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General and administrative |
| 1,578,029 |
| 1,484,299 |
| 3,047,258 |
| 3,038,496 |
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Total operating expenses |
| 4,464,400 |
| 3,889,292 |
| 8,808,076 |
| 8,347,544 |
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Income from operations |
| 502,747 |
| 442,167 |
| 623,144 |
| 418,089 |
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Equity in income of investee |
| 13,764 |
| — |
| 91,096 |
| — |
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Other income, net |
| 166,293 |
| 98,774 |
| 314,226 |
| 336,224 |
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Income before income tax expense |
| 682,804 |
| 540,941 |
| 1,028,466 |
| 754,313 |
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Income tax expense |
| 169,070 |
| 311,239 |
| 293,272 |
| 549,142 |
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Net income |
| $ | 513,734 |
| $ | 229,702 |
| $ | 735,194 |
| $ | 205,171 |
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Net income per common share: |
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Basic |
| $ | 0.04 |
| $ | 0.02 |
| $ | 0.05 |
| $ | 0.01 |
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Diluted |
| $ | 0.03 |
| $ | 0.01 |
| $ | 0.05 |
| $ | 0.01 |
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Weighted average shares used in the calculation of net income per common share: |
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Basic |
| 14,076,866 |
| 14,175,127 |
| 14,043,269 |
| 13,960,824 |
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Diluted |
| 14,881,495 |
| 15,348,428 |
| 14,950,693 |
| 16,267,317 |
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See accompanying notes to the condensed consolidated financial statements
5
SRS LABS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME (LOSS) (Unaudited)
|
| Common Stock |
| Additional |
| Accumulated |
| Accumulated |
| Treasury |
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| Comprehensive |
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| Shares |
| Amount |
| Capital |
| Loss |
| Deficit |
| Stock |
| Total |
| Ended |
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BALANCE, Dec. 31, 2004 |
| 14,229,541 |
| $ | 14,672 |
| $ | 62,523,292 |
| $ | (309,722 | ) | $ | (27,853,003 | ) | $ | (1,943,855 | ) | $ | 32,431,384 |
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Proceeds from exercise of stock options |
| 17,612 |
| 18 |
| 66,269 |
| — |
| — |
| — |
| 66,287 |
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Deferred stock option compensation |
| — |
| — |
| 14,831 |
| — |
| — |
| — |
| 14,831 |
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Unrealized loss on investments available for sale, net of tax |
| — |
| — |
| — |
| (259,460 | ) | — |
| — |
| (259,460 | ) | (259,460 | ) | |||||||
Net income |
| — |
| — |
| — |
| — |
| 221,460 |
| — |
| 221,460 |
| 221,460 |
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BALANCE, March 31, 2005 |
| 14,247,153 |
| $ | 14,690 |
| $ | 62,604,392 |
| $ | (569,182 | ) | $ | (27,631,543 | ) | $ | (1,943,855 | ) | $ | 32,474,502 |
| $ | (38,000 | ) |
Proceeds from exercise of stock options |
| 110,110 |
| 110 |
| 355,742 |
| — |
| — |
| — |
| 355,852 |
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Deferred stock option compensation |
| — |
| — |
| 9,739 |
| — |
| — |
| — |
| 9,739 |
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Purchase of treasury stock |
| (232,223 | ) | — |
| — |
| — |
| — |
| (1,059,590 | ) | (1,059,590 | ) |
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Unrealized gain on investments available for sale, net of tax |
| — |
| — |
| — |
| 218,348 |
| — |
| — |
| 218,348 |
| 218,348 |
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Net income |
| — |
| — |
| — |
| — |
| 513,734 |
| — |
| 513,734 |
| 513,734 |
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BALANCE, June 30, 2005 |
| 14,125,040 |
| $ | 14,800 |
| $ | 62,969,873 |
| $ | (350,834 | ) | $ | (27,117,809 | ) | $ | (3,003,445 | ) | $ | 32,512,585 |
| $ | 694,082 |
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See accompanying notes to the condensed consolidated financial statements
6
SRS LABS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
|
| Six Months Ended |
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| 2005 |
| 2004 |
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Cash Flows From Operating Activities: |
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Net income |
| $ | 735,194 |
| $ | 205,171 |
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Adjustments to reconcile net income to net cash provided by operating activities: |
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Depreciation and amortization |
| 675,125 |
| 622,288 |
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Provision for doubtful accounts |
| 32,258 |
| 84,564 |
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Benefit for obsolete inventory |
| (16,782 | ) | (57,451 | ) | ||
Deferred taxes |
| (36,410 | ) | (20,128 | ) | ||
(Accretion) amortization of (discount) premium on investments available for sale |
| (1,185 | ) | 6,188 |
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Increase in deferred stock option compensation |
| 24,570 |
| 40,201 |
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Loss on disposition of furniture, fixtures and equipment |
| 2,267 |
| 31 |
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Impairment on intangible assets |
| — |
| 3,431 |
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Equity in income of investee |
| (91,096 | ) | — |
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Changes in operating assets and liabilities: |
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Accounts receivable |
| (904,511 | ) | (156,424 | ) | ||
Inventories |
| 69,707 |
| 26,481 |
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Prepaid expenses and other current assets |
| 133,676 |
| (67,942 | ) | ||
Accounts payable |
| 193,495 |
| (115,922 | ) | ||
Accrued liabilities |
| 135,135 |
| 25,656 |
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Deferred revenue |
| (128,702 | ) | 241,964 |
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Income taxes payable |
| 16,728 |
| 257,181 |
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Net cash provided by operating activities |
| 839,469 |
| 1,095,289 |
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Cash Flows From Investing Activities: |
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Purchase of furniture, fixtures and equipment |
| (81,338 | ) | (569,688 | ) | ||
Proceeds from sale of investments available for sale |
| — |
| 5,235,626 |
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Investment in LLC |
| (52,405 | ) | — |
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Expenditures related to patents and intangible assets |
| (245,316 | ) | (247,850 | ) | ||
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Net cash (used in) provided by investing activities |
| (379,059 | ) | 4,418,088 |
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Cash Flows From Financing Activities: |
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Proceeds from exercise of stock options |
| 422,139 |
| 2,988,171 |
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Purchase of Treasury Stock |
| (1,059,590 | ) | — |
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Net cash (used in) provided by financing activities |
| (637,451 | ) | 2,988,171 |
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Net (Decrease) Increase in Cash and Cash Equivalents |
| (177,041 | ) | 8,501,548 |
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Cash and Cash Equivalents, Beginning of Period |
| 7,011,912 |
| 12,795,620 |
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Cash and Cash Equivalents, End of Period |
| $ | 6,834,871 |
| $ | 21,297,168 |
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Supplemental Disclosure of Cash Flow Information: |
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Cash paid during the period for: |
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Income taxes |
| $ | 377,551 |
| $ | 360,741 |
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Supplemental Disclosure of Non-Cash Investing Activities: |
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Unrealized loss on investments, net |
| $ | 41,112 |
| $ | 100,053 |
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See accompanying notes to the condensed consolidated financial statements
7
SRS LABS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. Basis of Presentation and Summary of Significant Accounting Policies and Estimates
As used herein, the “Company,” “SRS Labs,” “we,” “us,” or “our” means SRS Labs, Inc. and its wholly-owned subsidiaries, Valence Tech Limited (including its wholly-owned subsidiaries) and SRSWOWcast.com, Inc. (“SRSWOWcast”). The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in conformity with accounting principles generally accepted in the United States of America (“generally accepted accounting principles”) for interim financial information and the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for interim reporting. In the opinion of management, all adjustments (which include only normal recurring adjustments) considered necessary for a fair presentation of our financial position and results of operations have been included. Certain amounts included in the accompanying prior periods’ consolidated financial statements have been reclassified to conform to the current period presentation.
The condensed consolidated financial statements include the accounts of SRS Labs, Inc. and its subsidiaries. All inter-company accounts and transactions have been eliminated.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to SEC rules and regulations for presentation of interim financial information. Therefore, the condensed interim consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004. Current and future financial statements may not be directly comparable to the Company’s historical financial statements. The results of operations for the interim period is not necessarily indicative of the results to be expected for any other interim period or for the full year.
Estimates
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make use of certain 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 amounts of revenues and expenses during the reported periods. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ materially from those estimates. See the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2004 for an additional discussion of the significant accounting policies and estimates used in the preparation of our financial statements.
2. Stock-Based Compensation
The Company accounts for stock-based awards to employees under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The Company provides additional pro forma disclosures as required under Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an Amendment of SFAS No. 123.” Accordingly, no stock-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. Had compensation expense been recorded under the provisions of SFAS No. 123, the Company’s net income (loss) and earnings per share would have been the pro forma amounts indicated below:
8
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| For the three months ended |
| For the six months ended |
| ||||||||
|
| June 30, |
| June 30, |
| ||||||||
|
| 2005 |
| 2004 |
| 2005 |
| 2004 |
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Net income (attributable to common shareholder) — as reported |
| $ | 513,734 |
| $ | 229,702 |
| $ | 735,194 |
| $ | 205,171 |
|
Add: stock-based employee compensation expense Included in reported net income, net of tax effect |
| 5,843 |
| 15,715 |
| 14,742 |
| 23,875 |
| ||||
Less fair value of stock-based employee compensation expense |
| (275,174 | ) | (441,215 | ) | (580,277 | ) | (834,883 | ) | ||||
Net income (loss) (attributable to common shareholder) — pro forma |
| $ | 244,403 |
| $ | (195,798 | ) | $ | 169,659 |
| $ | (605,837 | ) |
Net income (loss) per share: |
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Basic, as reported |
| $ | 0.04 |
| $ | 0.02 |
| $ | 0.05 |
| $ | 0.01 |
|
Basic, pro forma |
| $ | 0.02 |
| $ | (0.01 | ) | $ | 0.01 |
| $ | (0.04 | ) |
Diluted, as reported |
| $ | 0.03 |
| $ | 0.01 |
| $ | 0.05 |
| $ | 0.01 |
|
Diluted, pro forma |
| $ | 0.02 |
| $ | (0.01 | ) | $ | 0.01 |
| $ | (0.04 | ) |
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants during the quarter ended June 30, 2005:
Risk-free interest rate |
| 3.8 | % |
Expected life |
| 6.25 years |
|
Expected volatility |
| 59 | % |
3. Capitalization of Software Development Costs
Costs incurred in the research, design and development of software for sale to others as a separate product or embedded in a product and sold as part of the product as a whole are charged to expense until technological feasibility is established. Under SFAS No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,” the Company capitalizes software purchased from third parties if the related software product under development has reached technological feasibility or if there are alternative future uses for the purchased software, provided that capitalized amounts will be realized over a period not exceeding five years. Costs incurred prior to the establishment of technological feasibility are charged to research and development expense.
Capitalized software as of June 30, 2005 and December 31, 2004 is as follows:
|
| June 30, |
| December 31, |
| ||
Capitalized software |
| $ | 546,568 |
| $ | 464,568 |
|
Accumulated amortization |
| (250,126 | ) | (193,003 | ) | ||
Capitalized software, net |
| $ | 296,442 |
| $ | 271,565 |
|
As of June 30, 2005, the weighted average useful life of the Company’s capitalized software is approximately 2.2 years. The following table shows the estimated amortization expense for those assets for the remaining six months of the current fiscal year end and each of the four succeeding fiscal years.
Year ending December 31, |
| Estimated |
| |
2005 |
| $ | 61,856 |
|
2006 |
| $ | 125,300 |
|
2007 |
| $ | 73,023 |
|
2008 |
| $ | 32,105 |
|
2009 |
| $ | 4,158 |
|
9
4. Goodwill and Intangible Assets
On January 1, 2002, the Company adopted SFAS No. 142 “Goodwill and Other Intangible Assets,” which, among other things, establishes new standards for goodwill acquired in a business combination, eliminates the amortization of goodwill and requires the carrying value of goodwill and identifiable intangibles to be evaluated for impairment on an annual basis.
In accordance with SFAS No. 142, all of our intangible assets that have definite lives are being amortized on a straight-line basis over their estimated useful lives and goodwill is evaluated at least annually to determine if fair value of the asset has decreased below its carrying value. We performed our annual assessment of goodwill as of December 31, 2004, and determined that no adjustment to impair goodwill was necessary.
Goodwill and intangible assets consist of the following:
|
| June 30, |
| December 31, |
| ||
Goodwill |
| $ | 533,031 |
| $ | 533,031 |
|
|
|
|
|
|
| ||
Patents |
| $ | 2,201,898 |
| $ | 2,038,582 |
|
Accumulated amortization |
| (992,560 | ) | (891,178 | ) | ||
Patents, net |
| 1,209,338 |
| 1,147,404 |
| ||
Other Intangibles: |
|
|
|
|
| ||
Assets acquired in the purchase of our subsidiary Valence Technology in 1998: Covenant not to compete, Developed Technology, ASP brand name, Cell Library, and Customer List |
| 4,910,400 |
| 4,910,400 |
| ||
License agreements acquired in purchase of our subsidiary SRSWOWcast in February 2003 |
| 640,071 |
| 640,071 |
| ||
Poly Planar purchased technology for speaker products |
| 120,000 |
| 120,000 |
| ||
Capitalized software and hardware for several technologies |
| 476,841 |
| 394,840 |
| ||
Total of Other Intangibles |
| 6,147,312 |
| 6,065,311 |
| ||
Accumulated amortization, other intangibles |
| (4,752,221 | ) | (4,551,760 | ) | ||
Other intangibles, net |
| 1,395,091 |
| 1,513,551 |
| ||
Intangible assets, net |
| $ | 2,604,429 |
| $ | 2,660,955 |
|
Amortization periods range from three to eleven years depending on the estimated useful life of the asset. Amortization expense consists of the following:
|
| Three months ended |
| Six Months ended |
| ||||||||
|
| 2005 |
| 2004 |
| 2005 |
| 2004 |
| ||||
Patents |
| $ | 51,445 |
| $ | 23,929 |
| $ | 101,382 |
| $ | 64,744 |
|
Other intangibles: |
|
|
|
|
|
|
|
|
| ||||
Covenant not to compete, developed technology, ASP brand name, cell library and customer list |
| 51,477 |
| 51,477 |
| 102,955 |
| 102,954 |
| ||||
License agreements acquired in purchase of our subsidiary SRSWOWcast in February 2003 |
| 16,002 |
| 16,002 |
| 32,003 |
| 32,004 |
| ||||
Poly Planar purchased technology |
| — |
| 6,000 |
| 4,000 |
| 12,000 |
| ||||
Capitalized software and hardware |
| 31,784 |
| 21,665 |
| 61,503 |
| 30,645 |
| ||||
Total intangible amortization expense |
| $ | 150,708 |
| $ | 119,073 |
| $ | 301,843 |
| $ | 242,347 |
|
10
As of June 30, 2005, the weighted average useful life of the Company’s patents and intangible assets is approximately 3.3 years. The following table shows the estimated amortization expense for those assets for the remaining six months of the current fiscal year and each of the four succeeding fiscal years:
Year ending |
| Estimated expense |
| |
2005 |
| $ | 315,288 |
|
2006 |
| $ | 628,210 |
|
2007 |
| $ | 546,529 |
|
2008 |
| $ | 326,121 |
|
2009 |
| $ | 176,931 |
|
Thereafter |
| $ | 611,350 |
|
5. Investments Available for Sale
The Company has classified its investments as available for sale in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” The following table summarizes the Company’s investment securities available for sale:
|
| June 30, 2005 |
| December 31, 2004 |
| ||
Cost |
| $ | 17,489,688 |
| $ | 17,489,688 |
|
Accretion of discount |
| 1,185 |
| — |
| ||
Unrealized loss |
| (269,533 | ) | (228,421 | ) | ||
Estimated fair value |
| $ | 17,221,340 |
| $ | 17,261,267 |
|
The contractual maturities of investments are shown below. Actual maturities may differ from contractual maturities.
|
| June 30, 2005 |
| December 31, 2004 |
| ||||||||
|
| Cost |
| Estimated |
| Cost |
| Estimated |
| ||||
U.S. Government securities available for sale: |
|
|
|
|
|
|
|
|
| ||||
Due in one to five years |
| $ | 17,489,688 |
| $ | 17,221,340 |
| $ | 17,489,688 |
| $ | 17,261,267 |
|
The following table summarizes sales of available for sale securities for three months and six months ended June 30, 2005 and 2004. Specific identification was used to determine costs in computing realized gains or losses.
|
| Three Months Ended |
| Six Months Ended |
| ||||||||
|
| June 30, |
| June 30, |
| ||||||||
|
| 2005 |
| 2004 |
| 2005 |
| 2004 |
| ||||
Proceeds from sale |
| $ | — |
| $ | — |
| $ | — |
| $ | 5,235,626 |
|
Realized gains |
| — |
| — |
| — |
| 139,375 |
| ||||
6. Investment in LLC
On September 23, 2004, the Company entered into a strategic alliance with Coming Home Studios LLC (“CHS”) to produce and sell concert DVDs which include the Company’s Circle Surround technology. In connection with the strategic alliance, the Company and CHS entered into four agreements: a Strategic Alliance Agreement, the CHS/SRS LLC Operating Agreement, a Warrant Agreement and a Production Services Agreement.
In the Strategic Alliance Agreement, CHS and the Company agree to work together to identify and implement co-promotional opportunities, including trade shows, movie theatres, video streaming, concert DVDs, artist endorsements, bundling and premium deals, web-based promotional clips and road shows. The initial term of the agreement expires on July 9, 2006 and is automatically renewable for successive one-year terms.
The Operating Agreement governs CHS/SRS, LLC, which is a joint venture between CHS and the Company formed to complete and distribute concert videos featuring Duran Duran, Boz Scaggs, Godsmack and All Access.
11
Pursuant to the Operating Agreement each of CHS and the Company contributed capital with a value of $2,346,621. CHS’ capital contribution to CHS/SRS, LLC consists of the artist agreements and related contracts pursuant to which CHS/SRS, LLC will produce and distribute the above-referenced concert videos.
The Company’s capital contribution is an aggregate of $2,346,621, consisting of a $700,000 bridge loan that the Company extended to CHS on July 9, 2004 in anticipation of the strategic alliance, which converted to equity on September 23, 2004, plus $1,100,621 in new cash and additional advances of $546,000. In addition, the Company capitalized $229,516 consisting of costs associated with the formation of the LLC and co-promotional projects. CHS’ capital contribution consisted of the artist agreements with Duran Duran, Boz Scaggs, Godsmack and All Access, pursuant to which the concert videos are filmed, produced and distributed. CHS/SRS, LLC contracted with CHS to complete production of the concert videos pursuant to the Production Services Agreement.
Profits from the distribution of the concert videos and related assets will be allocated and distributed in the following manner and order: (a) 100% to the Company until such time as the Company has received 130% of the cumulative additional advances that the Company provided to CHS/SRS, LLC; (b) equally until the Company and CHS have each both received 1.75 times their original capital contributions; and thereafter (c) 90% to CHS and 10% to the Company. The joint venture is accounted for using the equity method and profits are recognized following the guidance for equity method accounting. As of June 30, 2005, two of the concert videos, Boz Scaggs and Godsmack have been released. Profits of $13,764 and $91,096 generated from these videos have been recognized and included in “Equity in Income of Investee” in the Consolidated Statements of Operations for the three and six months ended June 30, 2005, respectively.
Under the Warrant Agreement, the Company paid CHS $40,000 to acquire a warrant to purchase up to 122,000 units of Class A membership interests in CHS, which represents approximately 10% of the equity of CHS, for an exercise price of $9.836 per unit, subject to adjustment based on valuation of CHS at the time of an additional funding. The warrant is immediately vested and exercisable for up to two years. It is transferable and contains customary anti-dilution and price protection provisions for warrants of this type.
Under the Production Services Agreement, CHS/SRS, LLC contracted with CHS as an independent contractor to perform all production services and to provide all other services, personnel, materials and elements for the production, completion and delivery of the concert videos. CHS, as the independent contractor, shall receive an aggregate of $365,000 in production fees for all of its services under the Production Services Agreement. CHS is responsible for payment of all costs and expenses in connection with the production and completion of the concert videos.
7. Net Income Per Common Share
The Company applies SFAS No. 128, “Earnings per Share,” which requires the disclosure of basic and diluted net income or loss per share for all current and prior periods. Basic net income or loss per common share is computed by dividing net income or loss available to common stockholders by the weighted average number of common shares outstanding during each year. Diluted net income or loss per common share reflects the maximum dilution, based on the average price of the Company’s common stock each period, and is computed similar to basic income or loss per share except that the denominator is increased to include the number of additional shares that would have been outstanding if potentially dilutive stock options and warrants had been exercised.
Basic and diluted net income per share computed in accordance with SFAS 128 for the three months and six months ended June 30, are as follows:
|
| For the three months |
| For the six months |
| ||||||||
|
| ended June 30, |
| Ended June 30, |
| ||||||||
|
| 2005 |
| 2004 |
| 2005 |
| 2004 |
| ||||
BASIC EPS |
|
|
|
|
|
|
|
|
| ||||
Net income |
| $ | 513,734 |
| $ | 229,702 |
| $ | 735,194 |
| $ | 205,171 |
|
Denominator: weighted average common shares outstanding |
| 14,076,866 |
| 14,175,127 |
| 14,043,269 |
| 13,960,824 |
| ||||
Net income per share—basic |
| $ | 0.04 |
| $ | 0.02 |
| $ | 0.05 |
| $ | 0.01 |
|
DILUTED EPS |
|
|
|
|
|
|
|
|
| ||||
Net income |
| $ | 513,734 |
| $ | 229,702 |
| $ | 735,194 |
| $ | 205,171 |
|
Denominator: weighted average common shares outstanding |
| 14,076,866 |
| 14,175,127 |
| 14,043,269 |
| 13,960,824 |
| ||||
Common equivalent shares outstanding: |
|
|
|
|
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Options |
| 804,629 |
| 1,173,301 |
| 907,424 |
| 2,306,493 |
| ||||
Total diluted shares |
| 14,881,495 |
| 15,348,428 |
| 14,950,693 |
| 16,267,317 |
| ||||
Net income per share—diluted |
| $ | 0.03 |
| $ | 0.01 |
| $ | 0.05 |
| $ | 0.01 |
|
12
There were 1,979,479 and 1,672,625 potentially dilutive options outstanding for the quarters ending June 30, 2005 and 2004, respectively and there were 1,964,479 and 260,000 potentially dilutive options outstanding for the six months ending June 30, 2005 and 2004, respectively, that were not included in the table above because they would be anti-dilutive.
8. Commitments and Contingencies
The Company is subject to legal proceedings and claims that arise in the normal course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, management does not believe that the outcome of any of these matters will have a material adverse effect on the Company’s consolidated financial position or results of operations.
9. Stockholders’ Equity
On June 30, 2004, the Company’s Board of Directors authorized the repurchase of up to $3,000,000 of its outstanding common stock for a period from July 1, 2004 to December 31, 2004 (the “2004 Repurchase Program”). The Company repurchased 216,575 shares at a cost of $1,225,254 under the 2004 Repurchase Program.
On March 24, 2005, the Company’s Board of Directors authorized the repurchase of up to $3,000,000 of the outstanding shares of the Company’s common stock for a period from January 1, 2005 to December 31, 2005 (the “2005 Repurchase Program”). As of June 30, 2005, 232,223 shares had been repurchased under the 2005 Repurchase Program. Purchases may be made from time to time in the open market, block purchases or privately negotiated transactions, depending on market conditions, share price and other factors. All repurchased shares are reflected as treasury stock in the accompanying consolidated balance sheets. The following table shows activity under the 2005 Repurchase Program for the six months ending June 30, 2005:
|
| June 30, |
| |
|
| 2005 |
| |
Shares repurchased |
| 232,223 |
| |
Average price per share |
| $ | 4.56 |
|
Total repurchase authorized |
| $ | 3,000,000 |
|
Repurchases under the plan |
| $ | (1,059,590 | ) |
Authorized repurchase remaining |
| $ | 1,940,410 |
|
13
10. Segment Information
The Company operates two business segments — semiconductors and licensing. The Company does not allocate corporate operating expenses or specific assets to these segments. Therefore, the segment information that follows includes only net revenues, cost of sales and gross margins of the identified segments:
|
| Valence |
| SRS Labs |
| Total |
| |||
Three Months Ended June 30, 2005 |
|
|
|
|
|
|
| |||
Total revenues |
| $ | 2,521,174 |
| $ | 3,539,977 |
| $ | 6,061,151 |
|
Cost of sales |
| 999,166 |
| 94,838 |
| 1,094,004 |
| |||
|
|
|
|
|
|
|
| |||
Gross margin |
| $ | 1,522,008 |
| $ | 3,445,139 |
| $ | 4,967,147 |
|
|
|
|
|
|
|
|
| |||
Three Months Ended June 30, 2004 |
|
|
|
|
|
|
| |||
Total revenues |
| $ | 2,932,495 |
| $ | 2,485,404 |
| $ | 5,417,899 |
|
Cost of sales |
| 1,066,033 |
| 20,407 |
| 1,086,440 |
| |||
|
|
|
|
|
|
|
| |||
Gross margin |
| $ | 1,866,462 |
| $ | 2,464,997 |
| $ | 4,331,459 |
|
|
| Valence |
| SRS Labs |
| Total |
| |||
Six Months Ended June 30, 2005 |
|
|
|
|
|
|
| |||
Total revenues |
| $ | 4,505,737 |
| $ | 6,804,072 |
| $ | 11,309,809 |
|
Cost of sales |
| 1,727,406 |
| 151,183 |
| 1,878,589 |
| |||
|
|
|
|
|
|
|
| |||
Gross margin |
| $ | 2,778,331 |
| $ | 6,652,889 |
| $ | 9,431,220 |
|
|
|
|
|
|
|
|
| |||
Six Months Ended June 30, 2004 |
|
|
|
|
|
|
| |||
Total revenues |
| $ | 5,348,213 |
| $ | 5,412,731 |
| $ | 10,760,944 |
|
Cost of sales |
| 1,948,767 |
| 46,544 |
| 1,995,311 |
| |||
|
|
|
|
|
|
|
| |||
Gross margin |
| $ | 3,399,446 |
| $ | 5,366,187 |
| $ | 8,765,633 |
|
For the three months ending June 30, 2005, one customer accounted for approximately 11% of consolidated revenues, or $669,084, in the semiconductor segment. For the same period in the prior year, two customers accounted for approximately 28% and 13% of consolidated revenues, or $1,523,144 and $687,831, in the semiconductor segment, respectively. There was no significant customer in the licensing segment for the three months ended June 30, 2005 and June 30, 2004.
For the six months ending June 30, 2005, one customer accounted for approximately 11% of consolidated revenues, or $1,231,510, in the semiconductor segment. For the same period in the prior year, two customers accounted for approximately 23% and 10% of consolidated revenues, or $2,492,034 and $1,102,309, in the semiconductor segment, respectively. There was no significant customer in the licensing segment for the six months ended June 30, 2005 and June 30, 2004.
The following schedule presents the Company’s revenue by geographic area. For product sales, revenue is allocated based on the country to which the product was shipped. For licensing-related revenue, the allocation is based on the location of the licensee’s corporate headquarters. The Americas region includes North, Central and South America.
14
|
| Three Months Ended |
|
|
| Six Months Ended |
|
|
| ||||||||||||
|
| 2005 |
| % |
| 2004 |
| % |
| 2005 |
| % |
| 2004 |
| % |
| ||||
Geographic Area Revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Hong Kong |
| $ | 2,321,159 |
| 37 |
| $ | 2,758,528 |
| 51 |
| $ | 4,055,350 |
| 35 |
| $ | 4,981,065 |
| 46 |
|
Japan |
| 1,446,553 |
| 24 |
| 1,299,523 |
| 24 |
| 2,967,042 |
| 27 |
| 2,657,830 |
| 25 |
| ||||
Other Asia Pacific |
| 1,132,837 |
| 19 |
| 266,895 |
| 5 |
| 2,012,715 |
| 18 |
| 601,160 |
| 6 |
| ||||
Americas |
| 456,325 |
| 8 |
| 526,358 |
| 10 |
| 1,179,851 |
| 11 |
| 1,311,970 |
| 12 |
| ||||
China |
| 612,446 |
| 10 |
| 513,660 |
| 9 |
| 962,603 |
| 8 |
| 793,681 |
| 7 |
| ||||
Europe |
| 91,831 |
| 2 |
| 52,935 |
| 1 |
| 132,248 |
| 1 |
| 415,238 |
| 4 |
| ||||
Total |
| $ | 6,061,151 |
| 100 |
| $ | 5,417,899 |
| 100 |
| $ | 11,309,809 |
| 100 |
| $ | 10,760,944 |
| 100 |
|
11. Recent Accounting Pronouncements
In May 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). Opinion 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, this Statement requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings for that period rather than being reported in an income statement. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 31, 2005. The Company does not expect the adoption of SFAS 154 to have an impact on its consolidated financial position, results of operations or cash flows.
In December 2004, the FASB issued a revised Statement 123, which as amended is effective for the Company’s first quarter of 2006. Statement 123(R) requires companies to expense in their consolidated statement of operations the estimated fair value of employee stock options and similar awards. SFAS 123(R) will be effective for quarterly periods beginning after December 31, 2005. The Company will adopt the provisions of Statement 123(R) using a modified prospective application. Under the modified prospective application, Statement 123(R), which provides certain changes to the method for valuing stock-based compensation among other changes, will apply to new awards and to awards that are outstanding on the effective date and are subsequently modified or cancelled. Compensation expense for outstanding awards for which the requisite service had not been rendered as of the effective date will be recognized over the remaining period using the compensation cost calculated for pro forma disclosure purposes under Statement 123. Depending on the model used to calculate stock-based compensation expense in the future, the implementation of certain other requirements of Statement 123(R) and additional option grants expected to be made in the future, the pro forma disclosure may not be indicative of the stock-based compensation expense that will be recognized in the Company’s future financial statements. The Company is in the process of determining how the new method of valuing stock-based compensation as prescribed in Statement 123(R) will be applied to valuing stock-based awards granted after the effective date and the impact the recognition of compensation expense related to such awards will have on its financial statements.
12. Subsequent Event
On July 20, 2005, the Company became the managing member of CHS/SRS, LLC. Under the terms of the Operating Agreement, the Company is entitled to receive a five percent management fee of all net revenues received, after all additional advances have been repaid. Subsequent to becoming the managing member, the Company contributed additional advances totaling $355,000 to CHS/SRS, LLC. Under the terms of the Operating Agreement, all additional advances shall be repaid out of the profits of the CHS/SRS LLC at 130% of the cumulative additional advances contributed. See Note 6 herein.
15
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This information should be read in conjunction with the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 (the “Form 10-K”), the audited consolidated financial statements and the notes thereto included in the Form 10-K and the unaudited condensed interim consolidated financial statements and notes thereto included in this Quarterly Report.
Overview
SRS Labs is a leading developer and provider of application-specific integrated circuits, or (“ASIC”), standard integrated circuits, or ICs, and audio and voice technology solutions for the home entertainment, portable media device, personal telecommunications, personal computer, automotive and broadcast markets. We operate in the following two business segments:
Semiconductors: Through SRS Labs, Inc.’s wholly-owned subsidiary, Valence Tech Limited, and ValenceTech Limited’s wholly-owned subsidiaries (collectively “Valence”), we operate a fabless semiconductor business which develops, designs and markets standard and custom analog ICs, digital signal processors, or DSPs, and mixed signal integrated circuits primarily to original equipment manufacturers, or OEMs, and original design manufacturers, or ODMs, in the Asia Pacific region.
Licensing: Through SRS Labs, the parent company, and its wholly-owned subsidiary, SRSWOWcast.com, Inc., doing business as SRSWOWcast Technologies (“SRSWOWcast”), the licensing segment develops and licenses audio, voice and surround sound technology solutions to many of the world’s leading OEMs/ODMs, software providers and semiconductor companies, and licenses and markets hardware and software products for the Internet and professional audio markets.
As used herein, the “Company,” “SRS Labs,” “we,” “us,” or “our” means SRS Labs, Inc. and its wholly owned subsidiaries, including Valence and SRSWOWcast.com Inc.
Results of Operations
Three Months Ended June 30, 2005 Compared to Three Months Ended June 30, 2004
Revenues
Semiconductor revenues consists of (a) design fees relating to, and sales of, ASIC for third parties by Valence to original equipment manufacturers (“OEMs”); and (b) sales of general purpose integrated circuits (“ICs”) designed by Valence under the brand name ASP. Licensing revenues consist primarily of royalties generated from the license of SRS Labs’ audio and voice technologies. License and royalty agreements generally provide for the license of technologies for a fee based on the number of units distributed by the licensee. However, we have in the past and may again in the future, enter into a license agreement for a one-time fee. Also included in licensing revenue are revenues generated from the sale of hardware and software applications into the broadcast audio markets.
Total revenues for the three months ended June 30, 2005 were $6,061,151 compared to $5,417,899 for the three months ended June 30, 2004, an increase of $643,252 or 11.9%. Semiconductor revenues were $2,521,174 for the three months ended June 30, 2005 compared to $2,932,495 for the three months ended June 30, 2004, a decrease of $411,321 or 14.0%. Within semiconductor revenue, ASIC accounted for $1,744,614 or 69.2% for the three months ended June 30, 2005 compared to $2,012,938 or 68.6% for the same period last year, a decrease of $268,324 or 13.3%. ASP chips accounted for $776,560 or 30.8% for the three months ended June 30, 2005 compared to $919,557 or 31.4% for the same period last year, a decrease of $142,997 or 15.7%. Within ASP revenues, SRS chips accounted for 40.7% for the three months ended June 30, 2005 compared to 32.4% for the same period last year. The decrease in ASIC and ASP sales can be primarily attributed to competitive pressures within ASP standard products and decreased demand from a major ASIC customer due a shift in market trend that resulted in the end of a product life cycle for two ASIC chips, which had contributed $241,000 in revenue in Q2 2004.
16
Licensing revenues were $3,539,977 for the three months ended June 30, 2005, compared to $2,485,404 for the three months ended June 30, 2004, an increase of $1,054,573 or 42.4%. The sales growth in licensing was attributable to our continued diversification strategy, which expanded the use of our technologies into the portable devices, PC, mobile phone and automotive markets. The following table presents the Company’s licensing revenues mix by market segment:
|
| Three Months Ended June 30, |
| ||
|
| 2005 |
| 2004 |
|
Home Entertainment (TV, Set Top Box, A/V Receiver, DVD) |
| 44 | % | 63 | % |
Portable Media Devices (Digital Media Player, Headphone) |
| 24 | % | 9 | % |
PC (Software, Hardware) |
| 12 | % | 8 | % |
Personal Telecommunications (Mobile Phone, PDA) |
| 16 | % | 19 | % |
Automotive |
| 4 | % | 1 | % |
Gross Margin
Cost of sales consists primarily of fabrication costs, assembly and test costs, and the cost of materials and overhead from operations. Gross margins are dependent on the mix of products sold, services provided and royalties earned. The decline in semiconductor gross margins can be attributable to the amortization of masking charges and an aggressive pricing strategy on ASP chips to increase market penetration. The following table presents the Company’s gross margin percentages for the three months ended June 30:
|
| Three Months Ended June 30, |
| ||
|
| 2005 |
| 2004 |
|
Semiconductor |
|
|
|
|
|
ASIC revenue as a percentage of total semiconductor revenue |
| 69.2 | % | 68.6 | % |
ASIC gross margin |
| 63.4 | % | 66.8 | % |
|
|
|
|
|
|
ASP revenue as a percentage of total semiconductor revenue |
| 30.8 | % | 31.4 | % |
ASP gross margin |
| 53.5 | % | 56.7 | % |
|
|
|
|
|
|
Total semiconductor revenue as a percentage of total revenue |
| 41.6 | % | 54.1 | % |
Total semiconductor gross margin |
| 60.4 | % | 63.6 | % |
|
|
|
|
|
|
Licensing |
|
|
|
|
|
Licensing revenue as a percentage of total revenue |
| 58.4 | % | 45.9 | % |
Licensing gross margin |
| 97.3 | % | 99.2 | % |
|
|
|
|
|
|
Total Gross Margin |
| 82.0 | % | 79.9 | % |
Sales and Marketing
Sales and marketing expenses consist primarily of employee salaries, sales consultants’ fees and related expenses, sales commissions and product promotion costs. Sales and marketing expenses were $1,678,500 for the three months ended June 30, 2005 compared to $1,260,067 for the same prior year period, an increase of $418,433 or 33.2%. The increase is primarily attributable to headcount and recruiting expenses related to increased sales and marketing personnel in our semiconductor segment and increased licensing sales personnel in Korea and China to capitalize on the growing licensing opportunities in those geographies. As a percentage of total revenues, sales and marketing expenses increased from 23.3% for the quarter ended June 30, 2004 to 27.7% for the same period this year.
Research and Development
Research and development expenses consist of salaries and related costs of employees engaged in ongoing research, design and development activities. Research and development expenses were $1,207,871 for the three months ended June 30, 2005 compared to $1,144,926 for the same prior year period, an increase of $62,945 or 5.5%. The increase is primarily attributable to increased costs associated with headcount and expenses incurred in customer support. As a percentage of total revenues, research and development expenses were 21.1% for the quarter ended June 30, 2004, and 19.9% for the same period this year.
17
General and Administrative
General and administrative (“G&A”) expenses consist primarily of employee-related expenses, legal costs associated with the administration of intellectual property and other professional fees. G&A expenses were $1,578,029 for the three months ended June 30, 2005 compared to $1,484,299 for the same prior year period, an increase of $93,730 or 6.3%. The increase is primarily attributable to professional fees associated with the restatement of our financial statements in Q2 2005 for fiscal 2004. As a percentage of total revenues, G&A expenses decreased from 27.4% for the quarter ended June 30, 2004, to 26.0% for the same period this year.
Equity in Income of Investee
On September 23, 2004, we entered into a strategic alliance with Coming Home Studios LLC (“CHS”) to produce and sell concert DVDs which incorporate our Circle Surround technology. In connection with that strategic alliance, we entered into a joint venture, CHS/SRS, LLC, formed to complete and distribute concert videos featuring Duran Duran, Boz Scaggs, Godsmack and All Access. Equity in income of investee represents the Company’s proportionate share of profit from the joint venture. The joint venture is accounted for using the equity method and profits are recognized following the guidance for equity method accounting. CHS/SRS, LLC recognizes and accrues profits as it gets sales and/or royalty reports. For the three months ended June 30, 2005, the profit recognized under the joint venture operating agreement was $13,764.
Other Income, Net
Other income, net, consists primarily of interest income, gain on sale of securities and foreign currency transaction gains and losses. Other income, net, was $166,293 for the three months ended June 30, 2005, compared to $98,774 for the same prior year period, an increase of $67,519 or 68.4%. The increase is primarily attributable to improved interest rates on investments.
Provision for Income Taxes
The income tax expense for the three months ended June 30, 2005 was $169,070, compared to tax expense of $311,239 for the same prior year period, a decrease of $142,169 or 45.7%. The provision consists primarily of taxes paid on licensing revenues sourced from countries requiring foreign tax withholdings and taxes paid on profits in Hong Kong at the rate of 17.5%. The lower tax expense in fiscal 2005 resulted from decreased taxable income in our foreign subsidiary. In addition, we benefited from the U.S. Japan tax treaty, which eliminated source-country withholdings on royalties. That treaty became effective on July 1, 2004.
Six Months Ended June 30, 2005 Compared to Six Months Ended June 30, 2004
Total revenues for the six months ended June 30, 2005 were $11,309,809 compared to $10,760,944 for the period ended June 30, 2004, an increase of $548,865 or 5.1%. Semiconductor revenues were $4,505,737 for the six months ended June 30, 2005 compared to $5,348,213 for the period ended June 30, 2004, a decrease of $842,476 or 15.8%. Within semiconductor revenue, ASIC accounted for $3,214,076 or 71.3% for the six months ended June 30, 2005 compared to $3,662,069 or 68.5% for the same period last year, a decrease of $447,993 or 12.2%. ASP chips accounted for $1,291,661 or 28.7% for the six months ended June 30, 2005 compared to $1,686,144 or 31.5% for the same period last year, a decrease of $394,483 or 23.4%. Within ASP revenues, SRS chips accounted for 47.0% for the six months ended June 30, 2005 compared to 34.7% for the same period last year. The decrease in ASIC and ASP sales can be primarily attributed to competitive pressures and the end of product life cycles for certain chips.
Licensing revenues were $6,804,072 for the three months ended June 30, 2005, compared to $5,412,731 for the six months ended June 30, 2004, an increase of $1,391,341 or 25.7%. The sales growth in licensing was attributable to our continued diversification strategy, which expanded the use of our technologies in the portable devices, PC, mobile phone and automotive markets. The following table presents the Company’s licensing revenues mix by market segment:
|
| Six Months Ended June 30, |
| ||
|
| 2005 |
| 2004 |
|
Home Entertainment (TV, Set Top Box, A/V Receiver, DVD) |
| 53 | % | 67 | % |
Portable Media Devices (Digital Media Player, Headphone) |
| 19 | % | 9 | % |
PC (Software, Hardware) |
| 12 | % | 12 | % |
Personal Telecommunications (Mobile Phone, PDA) |
| 13 | % | 11 | % |
Automotive |
| 3 | % | 1 | % |
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Gross Margin
Cost of sales consists primarily of fabrication costs, assembly and test costs, and the cost of materials and overhead from operations. Gross margins are dependent on the mix of products sold, services provided and royalties earned. The decline in semiconductor gross margins can be attributable to the amortization of masking charges and an aggressive pricing strategy on ASP chips to increase market penetration. The following table presents the Company’s gross margin percentages for the six months ended June 30:
|
| Six Months Ended June 30, |
| ||
|
| 2005 |
| 2004 |
|
Semiconductor |
|
|
|
|
|
ASIC revenue as a percentage of total semiconductor revenue |
| 71.3 | % | 68.5 | % |
ASIC gross margin |
| 64.8 | % | 67.1 | % |
|
|
|
|
|
|
ASP revenue as a percentage of total semiconductor revenue |
| 28.7 | % | 31.5 | % |
ASP gross margin |
| 53.8 | % | 55.9 | % |
|
|
|
|
|
|
Total semiconductor revenue as a percentage of total revenue |
| 39.8 | % | 49.7 | % |
Total semiconductor gross margin |
| 61.7 | % | 63.6 | % |
|
|
|
|
|
|
Licensing |
|
|
|
|
|
Licensing revenue as a percentage of total revenue |
| 60.2 | % | 50.3 | % |
Licensing gross margin |
| 97.8 | % | 99.1 | % |
|
|
|
|
|
|
Total Gross Margin |
| 83.4 | % | 81.5 | % |
Sales and Marketing
Sales and marketing expenses consist primarily of employee salaries, sales consultants’ fees and related expenses, sales commissions and product promotion costs. Sales and marketing expenses were $3,370,878 for the six months ended June 30, 2005 compared to $2,955,435 for the same prior year period, an increase of $415,443 or 14.1%. The increase is primarily attributable to headcount and recruiting expenses related to increased sales and marketing personnel in our semiconductor segment and increased licensing sales personnel in Korea and China to capitalize on the growing licensing opportunities in those geographies. As a percentage of total revenues, sales and marketing expenses increased from 27.5% for the six months ended June 30, 2004 to 29.8% for the same period this year.
Research and Development
Research and development expenses consist of salaries and related costs of employees engaged in ongoing research, design and development activities. Research and development expenses were $2,389,940 for June 30, 2005 compared to $2,353,613 for the same prior year period, an increase of $36,327 or 1.5%. As a percentage of total revenues, research and development expenses were 21.9% for the six months ended June 30, 2004, and 21.1% for the same period this year.
General and Administrative
General and administrative (“G&A”) expenses consist primarily of employee-related expenses, legal costs associated with the administration of intellectual property and other professional fees. G&A expenses were $3,047,258 for the six months ended June 30, 2005 compared to $3,038,496 for the same prior year period, an increase of $8,762 or 0.3%. As a percentage of total revenues, G&A expenses decreased from 28.2% for the six-month period ended June 30, 2004, to 26.9% for the same period this year.
Equity in Income of Investee
Equity in income of investee represents the Company’s proportionate share of profit from the CHS/SRS, LLC joint venture that we entered into with CHS. For the six months ended June 30, 2005, the profit recognized under the operating agreement for the joint venture was $91,096.
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Other Income, Net
Other income, net, consists primarily of interest income, gain on sale of securities and foreign currency transaction gains and losses. Other income, net, was $314,226 for the six months ended June 30, 2005, compared to $336,224 for the same prior year period, a decrease of $21,998 or 6.5%. The decrease is primarily attributable to decreased levels of cash due to the repurchase of treasury shares, offset by improved interest rates on investments.
Provision for Income Taxes
The income tax expense for the six months ended June 30, 2005 was $293,272, compared to tax expense of $549,142 for the same prior year period, a decrease of $255,870 or 46.6%. The provision consists primarily of taxes paid on licensing revenues sourced from countries requiring foreign tax withholdings and taxes paid on profits in Hong Kong at the rate of 17.5%. The lower tax expense in fiscal 2005 resulted from decreased taxable income in our foreign subsidiary. In addition, we benefited from the U.S. Japan tax treaty, which eliminated source-country withholdings on royalties. That treaty became effective on July 1, 2004.
Liquidity and Capital Resources
The Company’s principal source of liquidity to fund ongoing operations at June 30, 2005 consisted of cash, cash equivalents and long-term investments of $24,056,211. At June 30, 2005, the Company had cash and cash equivalents of $6,834,871 and long-term investments of $17,221,340. Cash and cash equivalents generally consist of cash, money market funds and other money market instruments with original maturities of three months or less. Investments consist of U.S. government securities rated AAA.
Net cash provided by operating activities was $839,469 and $1,095,289 during the six months ended June 30, 2005 and June 30, 2004, respectively. The decrease in our operating cash flows is primarily the result of an increase in accounts receivable associated with increased licensing activity. Our accounts payable increased $193,495 and decreased $115,922 during the six months ended June 30, 2005 and 2004, respectively. Our accrued liabilities increased $135,135 and $25,656 during the six months ended June 30, 2005 and 2004, respectively. The changes in liability accounts generally relate to increases in professional fees, commissions and bonus and the timing of payments to vendors and employees.
Our net cash used in and provided by investing activities was $379,059 and $4,418,088 during the six months ended June 30, 2005 and June 30, 2004, respectively. The shift from net cash provided by investing activities during the period ended June 30, 2004, as compared to net cash used in investing activities during the period ended June 30, 2005, was attributable primarily to a $5,235,626 decrease in proceeds from sales of investments available for sale, offset by $488,350 decrease in purchases of furniture, fixtures and equipment.
On September 23, 2004, we entered into a strategic alliance with Coming Home Studios LLC (“CHS”) to produce and sell concert DVDs which incorporate our Circle Surround technology. In connection with that strategic alliance, we entered into a joint venture, CHS/SRS, LLC, formed to complete and distribute concert videos featuring Duran Duran, Boz Scaggs, Godamack and All Access.
Profits from the distribution of the concert videos and related assets will be allocated and distributed in the following manner and order: (a) 100% to the Company until such time as we have received 130% of the cumulative additional advances that we provided to CHS/SRS, LLC; (b) equally until we and CHS have each received 1.75 times our respective original capital contributions; and thereafter (c) 90% to CHS and 10% to the Company. The Company’s capital contribution is an aggregate of $2,346,621, consisting of a $700,000 bridge loan that the Company extended to CHS on July 9, 2004 in anticipation of the strategic alliance, which converted to equity on September 23, 2004, plus $1,100,621 in new cash and additional advances of $546,000. CHS’ capital contribution consisted of the artist agreements with Duran Duran, Boz Scaggs, Godsmack and All Access pursuant to which the concert videos are filmed, produced and distributed. Subsequent to June 30, 2005 and as of August 5, 2005, we have contributed $355,000 in additional advances to the joint venture.
Based on current plans and business conditions, the Company expects that its cash, cash equivalents and investments together with any amounts generated from operations will be sufficient to meet the Company’s cash requirements for the foreseeable future. However, there can be no assurance that the Company will not be required to seek other financing sooner or that such financing, if required, will be available on terms satisfactory to the Company.
Factors That May Affect Future Results
The concert DVDs for our joint venture with Coming Home Studios may not be completed.
We have invested a total of $2.7 million in CHS/SRS, LLC, our joint venture with CHS to produce a total of six concert DVDs by Duran Duran, Godsmack, Boz Scaggs and All Access featuring our Circle Surround technology. Although two of the concert DVDs have been completed and are in distribution, the remaining four concert DVDs have been delayed past the originally scheduled completion date. We depend on the services of other parties beyond our control to produce, complete and distribute the concert DVDs, including, without limitation, the services of CHS pursuant to a production services agreement between CHS and CHS/SRS, LLC. On July 20, 2005 the Company replaced Coming Home Studios as the manager of CHS/SRS, LLC. In this capacity, we are responsible for the financial management of CHS/SRS, LLC, and CHS is responsible for completion of the concert DVDs pursuant to the production services agreement.
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The production, completion and distribution of the concert DVDs is subject to a number of uncertainties, including delays and increased expenditures due to creative problems, technical difficulties, talent availability, accidents, natural disasters and other events beyond our control. Because of these uncertainties, the projected cost of the concert DVDs may increase, the completion dates may be substantially delayed or the projects may be abandoned due to the exigencies of production. Delays in production may also result in concert DVDs not being ready for release at the intended time and being postponed to a less favorable time, which could result in lower revenues. In extreme cases, a concert DVD may be abandoned. We cannot predict the success of any of the concert DVDs even if they are completed because their economic success will depend on their acceptance by the public, which cannot be accurately predicted. The economic success of a concert DVD may also depend on the public’s acceptance of competing shows, the availability of alternative forms of entertainment and leisure time activities, general economic conditions, and other tangible and intangible factors, all of which can change and cannot be predicted with certainty. Although we are not required to expend additional funds related to our strategic alliance with CHS, we have elected to make additional capital contributions subsequent to June 30, 2005 in the aggregate amount of $355,000. There can be no assurance that the concert DVDs can be completed, or if completed and distributed, that the concert DVDs will achieve economic success. If the concert DVDs are further delayed, not completed or generate insufficient returns once completed, there is a risk that our investment in CHS/SRS, LLC will be impaired or lost.
We are exposed to risks in our licensing business related to product and customer concentration
Currently, our licensing revenue is concentrated in the home theater market with the majority of revenue generated from the inclusion of SRS technology inside televisions, DVD players and set-top boxes. We expect that the consumer home entertainment market will continue to account for a significant portion of our licensing revenues for the foreseeable future. While consumer spending in general on consumer electronic products has increased, retail prices for certain consumer electronics products that include our audio technology, such as DVD players, have decreased significantly. Indications are that this trend will continue for the foreseeable future. From time to time, certain of our original equipment manufacturer and semiconductor manufacturer customers may account for a significant portion of revenue from a particular product application, such as DVD players, set-top boxes or televisions. Consumer electronics products manufacturers could decide to exclude our audio enhancement technology from their home theater products altogether in an effort to reduce cost. The loss of any such customer could have a material adverse affect on our financial condition and results of operations.
Our business is highly dependent on the consumer electronics market, which is characterized by short product life cycles, fluctuations in demand and seasonality, and subject to risks related to product transitions and supply of other components
The consumer electronics market is characterized by intense competition, rapidly evolving technology, and ever-changing consumer preferences. These factors result in the frequent introduction of new products, short product life cycles and significant price competition. The dynamic nature of this market limits our, as well as our customers’, ability to accurately forecast quarterly and annual sales. If we, or our customers, are unable to manage product transitions, our business and results of operations could be negatively affected.
Pricing pressures on the consumer electronics product manufacturers who incorporate our technologies into their products could limit the licensing fees we charge for our technologies, which could adversely affect our revenues
The markets for the consumer electronics products in which our technologies are incorporated are intensely competitive and price sensitive. Retail prices for consumer electronics products that include our technologies, such as DVD players and home theater systems, have decreased significantly, and we expect prices to continue to decrease for the foreseeable future. In response, manufacturers have sought to reduce their product costs, which can result in downward pressure on the licensing fees we charge our customers who incorporate our technologies. A decline in the licensing fees we charge could materially and adversely affect our operating results.
Our business and prospects depend on the strength of our brand, and if we do not maintain and strengthen our brand, our business will be materially harmed
Maintaining and strengthening the “SRS” brand is critical to maintaining and expanding both our products and services business and our technology licensing business, as well as to our ability to enter new markets for our audio and other technologies. Our continued success is due, in part, to our reputation for providing high quality products, services and technologies across multiple consumer electronics product segments. If we fail to effectively promote and maintain the SRS brand, our business and prospects will suffer.
21
Our quarterly results may fluctuate
Our operating results may fluctuate from those in prior quarters and will continue to be subject to quarterly and other fluctuations due to a variety of factors, including the extent to which our licensees incorporate our technologies into their products; the timing of orders from, and the shipments to, major customers; the timing of new product introductions; the gain or loss of significant customers; competitive pressures on selling prices; the market acceptance of new or enhanced versions of our technologies; the rate that our semiconductor licensees manufacture and distribute chips to product manufacturers; and fluctuations in general economic conditions, particularly those affecting the consumer electronics market. Due to our dependence on the consumer electronics market, the substantial seasonality of sales in the market could impact our revenues and net income. In particular, we believe that there is seasonality relating to the Christmas season generally and the Chinese New Year within the Asia region, which fall into the fourth and first quarters respectively. As a result, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied on as indications of future performance.
We are subject to the highly cyclical nature of the semiconductor industry
The semiconductor industry is highly cyclical. The industry has experienced significant downturns, often in connection with, or in anticipation of, maturing product cycles (of both semiconductor companies’ and their customers’ products) and declines in general economic conditions. These downturns have been characterized by production overcapacity, high inventory levels and accelerated erosion of average selling prices. Any future downturns could significantly harm our sales or reduce our profitability for a prolonged period of time. From time to time, the semiconductor industry also has experienced periods of increased demand and production capacity constraints. We may experience substantial changes in future operating results due to general semiconductor industry conditions, general economic conditions and other factors.
We rely on revenue contribution from our ASIC and standard IC business
We derive a significant amount of our revenue from Valence’s ASIC business. Valence’s engineering team focuses on the design of custom ASICs to meet specific customers’ requirements and out sources the production of the design to mask houses, foundries and packaging houses located primarily in Asia. The operations of Valence could be affected by a variety of factors, including the timing of customer orders, the timing of development revenue, changes in the mix of products distributed and the mix of distribution channels employed, the emergence of a new industry standard, product obsolescence and changes in pricing policies by us, our competitors or our suppliers.
Business revenue from ASICs is concentrated in a limited number of customers in the areas of consumer electronics, communications products, computers and computer peripherals. The business generated from any one customer may be for a fixed length or quantity. As such, it is customary in our ASIC business to have a certain amount of customer turnover as new ASIC projects are obtained for different customers. However, it is possible that the loss of any particular customer or any bad debt arising from such customer may have a materially adverse impact on our financial condition and results of operation.
Valence adds significant diversity to our overall business structure and opportunities. We recognize that in the presence of such corporate diversity, and in particular with regard to the semiconductor industry, there will always exist a potential for conflict among sales channels between us and our technology licensees. Although the operations of our licensing business and those of Valence are generally complementary, there can be no assurances that sales channel conflicts will not arise. If such potential conflicts do materialize, we may or may not be able to mitigate the effect of such perceived conflicts, which, if not resolved, may impact the results of operations.
Potential channel conflict with existing semiconductor partners could cause us to lose future business
As we bring out more and more Valence semiconductors with SRS audio technologies embedded in them, our current semiconductor partners may perceive those new devices as threats to their own products. The semiconductor partners may respond by reducing or eliminating the volumes of business they presently do with us, which would have an adverse effect on our licensing revenue.
We are exposed to risks in our Valence business related to product fabrication outsourcing to third parties
Valence is a “fabless” semiconductor company meaning that Valence designs, develops and markets our selection of custom and standard integrated circuits but we rely on third-party contractors to manufacture, assemble and test our products. From time to time there can be foundry capacity issues due to global demands that affect the semiconductor industry. Although we believe our relationships are generally good, we do not have long-term supply agreements with our third-party
22
vendors and they are not obligated to perform services or supply products to us for any particular period or in any particular quantities, except as provided in each separate purchase order accepted by them. The increased demand for our products coupled with the demand for foundry services, is, and will continue to be for the foreseeable future, a challenge for us. In times of high demand, there are significant risks associated with our reliance on third-party vendors including: reallocation of capacity to other foundry customers, potential price increases, delays and interruptions in order deliveries, reduced control over product quality and increased risk of misappropriation of intellectual property.
We conduct operations in a number of countries and are subject to risks of international operations, particularly in the People’s Republic of China (“PRC”) and other parts of Asia
We have significant operations in the PRC and other parts of Asia that require refinement to adapt to the changing market conditions in those regions. Our operations in Asia, and international operations in general, are subject to risks of unexpected changes in, or impositions of, legislative or regulatory requirements.
Our customers geographically located in the Asia Pacific markets accounted for approximately 86%, 93% and 90% of total Company sales in 2004, 2003 and 2002, respectively and are expected to continue to account for a substantial percentage of sales in the future.
The PRC economy has experienced significant growth in the past decade; but such growth has been uneven across geographic and economic sectors. There can be no assurance that such growth will continue or that any potential currency devaluation in the region will not have a negative effect on our business, including Valence. The PRC economy has also experienced deflation in the past, which may continue in the future. The current economic situation may adversely affect our 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.” We can give no assurance that Hong Kong will continue to enjoy autonomy from the PRC.
The Hong Kong dollar has remained relatively constant due to the U.S. dollar peg and currency board system that has been in effect in Hong Kong since 1983. Since mid-1997, interest rates in Hong Kong have fluctuated significantly and real estate and retail sales have declined. We can give no assurance that the Hong Kong economy will not worsen or that the historical currency peg of the Hong Kong dollar to the U.S. dollar will be maintained. Continued declining consumer spending in Hong Kong, deflation or the discontinuation of the currency peg could adversely affect our business.
We are exposed to currency fluctuations and instability in the Asian markets
We expect that international sales will continue to represent a significant portion of our total revenues. To date, all of our licensing revenues have been denominated in U.S. dollars and most costs have been incurred in U.S. dollars. It is our expectation that licensing revenues will continue to be denominated in U.S. dollars for the foreseeable future. Because Valence’s business is primarily focused in Asia and because of our anticipated expansion of business in the PRC and other parts of Asia, our consolidated results of operations and financial position 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, our 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. We intend to actively monitor our foreign exchange exposure and to implement strategies to reduce our foreign exchange risk at such time that we determine the benefits of such strategies outweigh the associated costs. However, there is no guarantee that we will take steps to insure against such risks, and should such risks occur, there is no guarantee that we will not be significantly impacted.
If the sale of consumer electronics products incorporating our technologies does not grow in emerging markets, our ability to increase our licensing revenue may be limited
We also expect that growth in our licensing revenue will depend, in part, upon the growth of sales of consumer electronics products incorporating our technologies in other countries, including China and India, as consumers in these markets have more disposable income and are increasingly purchasing entertainment products with surround sound capabilities. However, if our licensing revenue from the use of our technologies in these new markets or geographic areas does not expand, our prospects could be adversely affected.
23
We are subject to competitive pressures
Our existing and potential competitors include both large and emerging domestic and international companies that have substantially greater financial, manufacturing, technical, marketing, distribution and other resources. Present or future competitors may be able to develop products and technologies comparable or superior to ours, and to adapt more quickly than us to new technologies or evolving market needs. We believe that the competitive factors affecting the market for our products and technologies include product performance, price and quality; product functionality and features; the ease of integration; and implementation of the products and technologies with other hardware and software components in the OEM’s products. In addition, the markets in which we compete are intensely competitive and are characterized by rapid technological changes, declining average sales prices and rapid product obsolescence. Accordingly, there can be no assurance that we will be able to continue to compete effectively in its respective markets, that competition will not intensify or that future competition will not have a material adverse effect on our business, operating results, cash flows and financial condition.
We have a long and unpredictable sales cycle, which can result in uncertainty and delays in generating additional revenues
Historically, because of the complexity of our technologies, it can take a significant amount of time and effort to explain the benefits and to negotiate a sale. For example, it typically takes six to nine months after our first contact with a prospective customer before we start licensing our technology to that customer. In addition, purchase of our products is usually made in connection with new design starts, the timing of which is outside of our control. Accordingly, we may be unable to predict accurately the timing of any significant future sales of our products. We may also spend substantial time and management attention on potential license agreements that are not consummated, thereby foregoing other opportunities.
We strongly rely on our intellectual property
Our ability to compete may be affected by our ability to protect our proprietary information. We have filed numerous U.S. and foreign patent applications and to date have a number of issued U.S. and foreign patents covering various aspects of our technologies. There can be no assurance that the steps taken by us to protect our intellectual property will be adequate to prevent misappropriation of our technology or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology. In addition, the laws of certain foreign countries may not protect our intellectual property rights to the same extent, as do the laws of the U.S. The semiconductor industry is characterized by frequent claims and litigation regarding patent and other property rights. We are not currently a party to any claims of this nature. There can be no assurances that third parties will not assert claims or initiate litigation against us or our customers with respect to existing or future products. In addition, we may initiate claims or litigation against third parties for infringement of our proprietary rights or to determine the scope and validity of our proprietary rights.
We depend on our key personnel
Our future success depends to a large extent upon the continued service of key personnel, including engineering, sales and marketing staff, and highly skilled semiconductor design staff. We anticipate that any future growth will require us to recruit and hire a number of new personnel in engineering, operations, finance, sales and marketing. Competition for such personnel can be intense, and there can be no assurance that we can recruit and retain necessary personnel to operate our business and support future growth.
The market price of our common stock is volatile
The trading price of our common stock has been, and will likely continue to be, subject to wide fluctuations in response to quarterly variations in our operating results, announcements of new products or technological innovations by us or our competitors, strategic alliances between us and third parties, general market fluctuations and other events and factors. Changes in earnings estimates made by brokerage firms and industry analysts relating to the markets in which we do business, or relating to us specifically, have in the past resulted in, and could in the future result in, an immediate and adverse effect on the market price of the common stock. Even though our stock is quoted on the Nasdaq Stock Market, our stock has had and may continue to have low trading volume and high volatility. The historically low trading volume of our stock makes it more likely that a severe fluctuation in volume, either up or down, will significantly impact the stock price. Since our shares are thinly traded, our shareholders may have difficulty selling our common stock.
Our certificate of incorporation, bylaws, change in control agreements with officers and key employees, as well as Delaware law contain provisions that could discourage transactions resulting in a change in control, which may negatively affect the market price of our common stock
Our certificate of incorporation, bylaws, change in control agreements with officers and key employees and Delaware law contain provisions that might enable our management to discourage, delay or prevent change in control. In addition, these provisions could limit the price that investors would be willing to pay in the future for shares of our common stock.
24
Item 3. Quantitative and Qualitative Disclosures about Market Risk
There have been no material changes to the information called for by this Item 3 from the disclosures set forth in Part II, Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Quarterly Report. The controls evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. Based on their evaluation as of the end of the period covered by this Quarterly Report, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective.
Changes in Internal Controls
On May 10, 2005, management of the Company was advised by BDO Seidman, LLP, its independent registered public accounting firm (“BDO Seidman”), of the conclusion reached by it regarding the Company’s interim accounting for sales and marketing expenses related to trade shows. This conclusion was reached in connection with BDO Seidman’s financial statement review procedures relating to the Company’s Quarterly Report on Form 10-Q for the first quarter of the year ending December 31, 2005 (“fiscal 2005”). Commencing in the first quarter of the fiscal year ended December 31, 2004 (“fiscal 2004”), the Company began to capitalize and amortize trade show expenses incurred in the fiscal year to reflect the future economic benefits received during such fiscal year. Management discussed the issue with the Audit Committee of the Company’s Board of Directors and BDO Seidman and was of the view that capitalization and amortization of trade show expenses was allowable. As part of the first quarter fiscal 2005 review, BDO Seidman noted that trade show costs previously capitalized and amortized should have been treated as period expenses in fiscal 2004. As a result, BDO Seidman expressed its view that (a) trade show costs previously capitalized and amortized during fiscal 2004 should have been treated as period expenses in fiscal 2004; (b) each of the Company’s quarterly reports previously filed in fiscal 2004 should be amended; and (c) no reliance should be placed on the previously issued fiscal 2004 quarterly financial statements. We restated our financial results for the quarters ended March 31, June 30, and September 30, 2004 to reflect adjustments to our previously reported financial information. In addition, the Company’s annual report on Form 10-K for fiscal 2004 has been amended to reflect the restated quarterly results including the quarter ended December 31, 2004.
In the course of BDO Seidman’s financial statement review procedures relating to the Quarterly Report on Form 10-Q for the first quarter of fiscal 2005, BDO Seidman advised the Company that the Company’s improper interpretation of accounting literature with respect to interim accounting for sales and marketing expenses related to trade show expenses described above constituted a deficiency in the Company’s internal controls and advised the Audit Committee that this internal control deficiency constitutes a reportable condition and a material weakness as defined in Statement on Auditing Standards No. 60. As a result of this internal control deficiency, the Company has implemented in the quarterly period covered by this report more formal procedures regarding changes in accounting treatment and related communications with the Company’s Audit Committee and the Company’s independent registered public accounting firm.
The Company believes that these corrective actions, taken as a whole, will remediate the control deficiency identified above, but the Company will continue to monitor the effectiveness of these actions and will make any other changes or take such other actions as management determines to be appropriate.
Except for the controls described above, no change in the Company’s internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the second quarter ended June 30, 2005, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On March 24, 2005, the Company’s Board of Directors authorized the repurchase of up to $3,000,000 of the outstanding shares of the Company’s common stock for a period from January 1, 2005 to December 31, 2005 (the “2005 Repurchase Program”). As of June 30, 2005, 232,223 shares had been repurchased under the 2005 Repurchase Program. Purchases may be made from time to time in the open market, block purchases or privately negotiated transactions, depending on market conditions, share price and other factors. All repurchased shares are reflected as treasury stock in the accompanying consolidated balance sheets. The following table details our common stock repurchases for the three months ended June 30, 2005:
Issuer Purchases of Equity Securities
|
| (a) |
| (b) |
| (c) |
| (d) |
| ||
Period |
| Total Number of |
| Average Price Paid |
| Total Number of |
| Maximum Number |
| ||
April 1-30, 2005 |
| 150,311 |
| $ | 3.97 |
| 150,311 |
| $ | 2,403,281 |
|
May 1-31, 2005 |
| 38,370 |
| $ | 5.57 |
| 188,681 |
| $ | 2,189,739 |
|
June 1-30, 2005 |
| 43,542 |
| $ | 5.73 |
| 232,223 |
| $ | 1,940,410 |
|
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholders of SRS Labs, Inc. was held on June 22, 2005 for the purpose of (a) electing two Class III directors to the Board of Directors and (b) voting on a proposal to ratify the appointment of BDO Seidman LLP as independent auditors for the fiscal year ending December 31, 2005.
Sam Yau and Thomas C.K. Yuen were elected to serve as a Class III Directors of the Company for a three-year term expiring at the 2008 Annual Meeting of Stockholders. Carol Miltner and Winston Hickman continued as Class I Directors and David R. Dukes continued in office as a Class II Director. The tabulation of the votes cast for the election of Messrs. Yau and Yuen was as follows:
Nominee |
| Votes For |
| Votes Withheld |
|
Sam Yau |
| 11,802,570 |
| 660,576 |
|
Thomas C. K. Yuen |
| 12,422,580 |
| 43,566 |
|
The proposal to ratify the appointment of BDO Seidman LLP as independent auditors for the fiscal year ending December 31, 2005 was approved. The tabulation of votes was as follows:
Votes For |
| Votes Against |
| Abstentions |
| Broker Non-Votes |
|
12,139,455 |
| 324,771 |
| 1,920 |
| 0 |
|
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The exhibits listed below are hereby filed with the U.S. Securities and Exchange Commission as part of this Report.
Exhibit |
| Description |
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), 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. |
|
|
|
10.1 |
| SRS Labs, Inc. 2005 Change in Control Protection Plan, previously filed with the Commission as Exhibit 10.1 to the Form 8-K filed with the Commission on May 2, 2005, which is incorporated herein by reference. |
|
|
|
10.2 |
| Form of Participation Agreement under the SRS Labs, Inc. 2005 Change in Control Protection Plan for Select Executive Officers (with schedule of parties attached), previously filed with the Commission as Exhibit 10.2 to the Form 8-K filed with the Commission on May 2, 2005, which is incorporated herein by reference. |
|
|
|
10.3 |
| Form of Participation Agreement under the SRS Labs, Inc. 2005 Change in Control Protection Plan for Select Employees (with schedule of parties attached), previously filed with the Commission as Exhibit 10.3 to the Form 8-K filed with the Commission on May 2, 2005, which is incorporated herein by reference. |
|
|
|
10.4 |
| SRS Labs, Inc. 2005 Profit Sharing and Bonus Plan, previously filed with the Commission as Exhibit 10.4 to the Form 8-K filed with the Commission on May 2, 2005, which is incorporated herein by reference. |
|
|
|
10.5 |
| SRS Labs, Inc. Amended and Restated 1996 Long-Term Incentive Plan, as amended, previously filed with the Commission as Exhibit 10.5 to the Form 8-K filed with the Commission on May 2, 2005, which is incorporated herein by reference. |
|
|
|
10.6 |
| Form of Nonqualified Stock Option Agreement (with schedule of parties attached), previously filed with the Commission as Exhibit 10.1 to the Form 8-K filed with the Commission on April 4, 2005, which is incorporated herein by reference. |
|
|
|
31.1 |
| Certification of Chief Executive Officer of SRS Labs, Inc., pursuant to Rule 13a-14 of the Securities Exchange Act. |
|
|
|
31.2 |
| Certification of Chief Financial Officer of SRS Labs, Inc., pursuant to Rule 13a-14 of the Securities Exchange Act. |
|
|
|
32.1 |
| Certification of Chief Executive Officer of SRS Labs, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|
|
|
32.2 |
| Certification of Chief Financial Officer of SRS Labs, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
27
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, 2005 | By: | /s/ THOMAS C.K. YUEN |
|
|
| Thomas C.K. Yuen | |
|
| Chairman of the Board and Chief Executive Officer | |
|
| (Principal Executive Officer) | |
|
|
| |
|
|
| |
Date: August 11, 2005 | By: | /s/ JANET M. BISKI |
|
|
| Janet M. Biski | |
|
| Chief Financial Officer | |
|
| (Principal Financial and Accounting Officer) |
28