UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One) | |
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
|
|
For the quarterly period ended September 30, 2007 | |
|
|
OR | |
|
|
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
For the transition period to
Commission File Number 0-21123
SRS LABS, INC.
(Exact name of registrant as specified in its charter)
Delaware |
| 33-0714264 |
(State or other jurisdiction of |
| (I.R.S. Employer |
2909 Daimler Street, Santa Ana, California 92705
(Address of principal executive offices) (Zip Code)
(949) 442-1070
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o |
| Accelerated filer o |
| Non-accelerated filer x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of October 23, 2007, 16,946,377 of the issuer’s common stock, par value $.001 per share, were outstanding; of this amount, 674,098 shares of the common stock were held as treasury shares.
SRS LABS, INC.
Quarterly Report on Form 10-Q
For the Three and Nine Months Ended September 30, 2007
Index
2
FORWARD-LOOKING INFORMATION
As used herein, the “Company,” “SRS Labs,” “SRS,” “we,” “us,” or “our” means SRS Labs, Inc., its wholly-owned subsidiary SRSWOWcast.com, Inc. and, for the applicable periods, its former subsidiary ValenceTech Limited (collectively with its direct and indirect wholly-owned subsidiaries, “Valence”) and the former joint venture with Coming Home Studios LLC, CHS/SRS LLC.
Some of the statements in this Quarterly Report on Form 10-Q contain forward-looking statements regarding our assumptions, projections, expectations, targets, intentions or beliefs about future events, which involve risks and uncertainties. All statements other than statements of historical facts included in this Quarterly Report relating to expectation of future financial performance, continued growth, changes in economic conditions or capital markets and changes in customer usage patterns and preferences, are forward-looking statements. In some cases, you can identify forward-looking statements by terms such as may, will, should, expect, plan, intend, forecast, anticipate, believe, estimate, predict, potential, continue or the negative of these terms or other comparable terminology. The forward-looking statements contained in this Quarterly Report involve known and unknown risks, uncertainties and situations that may cause our or our industry’s actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Factors that might cause actual events or results to differ materially from those indicated by these forward-looking statements may include the matters listed in our most recently filed Annual Report on Form 10-K and elsewhere in this Quarterly Report, including, but not limited to, the loss of any one significant customer; the acceptance of new SRS Labs products and technologies; the import of competitive products and pricing; the timely development and release of technologies by the Company; general business and economic conditions, especially in Asia; product and customer concentration in our business; our high dependence on the consumer electronics market, which is characterized by short product life cycles, fluctuations in demand and seasonality; the risk of widespread illness; our dependence on growth in emerging markets; the length and unpredictable nature of our sales cycle; our ability to protect our products through patents and other intellectual property rights; our dependence on key personnel; the volatility of the price of our common stock; provisions that could discourage transactions resulting in a change in control contained in our certificate of incorporation and bylaws as well as Delaware law; competition we face from companies with greater brand recognition and resources; pricing pressures on the consumer electronics product manufacturers; adverse state, federal or foreign legislation or regulation or adverse determinations by regulators; and other factors identified from time to time in our filings with the Securities and Exchange Commission.
Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for management to predict all such factors.
3
PART I — FINANCIAL INFORMATION
SRS LABS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
|
| September 30, 2007 |
| December 31, 2006 |
| ||
|
| (unaudited) |
|
|
| ||
ASSETS |
|
|
|
|
| ||
Current Assets |
|
|
|
|
| ||
Cash and cash equivalents |
| $ | 40,075,552 |
| $ | 35,011,425 |
|
Accounts receivable, net |
| 1,932,893 |
| 1,180,879 |
| ||
Prepaid expenses and other current assets |
| 655,518 |
| 808,940 |
| ||
|
|
|
|
|
| ||
Total Current Assets |
| 42,663,963 |
| 37,001,244 |
| ||
|
|
|
|
|
| ||
Investments available for sale |
| 5,353,920 |
| 5,226,705 |
| ||
Property and equipment, net |
| 325,082 |
| 389,667 |
| ||
Intangible assets, net |
| 2,250,553 |
| 2,045,139 |
| ||
Deferred income taxes, net |
| 1,408,617 |
| 386,412 |
| ||
|
|
|
|
|
| ||
Total Assets |
| $ | 52,002,135 |
| $ | 45,049,167 |
|
|
|
|
|
|
| ||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
|
|
|
| ||
Current Liabilities |
|
|
|
|
| ||
Accounts payable |
| $ | 360,455 |
| $ | 609,899 |
|
Accrued liabilities |
| 806,077 |
| 1,295,236 |
| ||
Deferred revenue |
| 457,006 |
| 399,565 |
| ||
|
|
|
|
|
| ||
Total Current Liabilities |
| 1,623,538 |
| 2,304,700 |
| ||
|
|
|
|
|
| ||
Commitments and contingencies (Note 6) |
|
|
|
|
| ||
|
|
|
|
|
| ||
Stockholders’ Equity |
|
|
|
|
| ||
Preferred stock—$.001 par value; 2,000,000 shares authorized; no shares issued or outstanding |
| — |
| — |
| ||
Common stock—$.001 par value; 56,000,000 shares authorized; 16,946,377 and 16,561,036 shares issued; and 16,272,279 and 15,886,938 shares outstanding at September 30, 2007 and December 31, 2006, respectively |
| 16,947 |
| 16,562 |
| ||
Additional paid-in capital |
| 73,705,815 |
| 70,574,176 |
| ||
Accumulated other comprehensive loss |
| (146,080 | ) | (273,295 | ) | ||
Accumulated deficit |
| (20,194,640 | ) | (24,569,531 | ) | ||
Treasury stock at cost, 674,098 shares at September 30, 2007 and December 31, 2006 |
| (3,003,445 | ) | (3,003,445 | ) | ||
|
|
|
|
|
| ||
Total Stockholders’ Equity |
| 50,378,597 |
| 42,744,467 |
| ||
|
|
|
|
|
| ||
Total Liabilities and Stockholders’ Equity |
| $ | 52,002,135 |
| $ | 45,049,167 |
|
See accompanying notes to the condensed consolidated financial statements
4
SRS LABS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Revenues |
| $ | 4,769,271 |
| $ | 4,910,203 |
| $ | 14,536,526 |
| $ | 13,505,710 |
|
Cost of sales |
| 36,850 |
| 43,998 |
| 115,912 |
| 127,103 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Gross margin |
| 4,732,421 |
| 4,866,205 |
| 14,420,614 |
| 13,378,607 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Operating expenses: |
|
|
|
|
|
|
|
|
| ||||
Sales and marketing |
| 1,460,185 |
| 1,743,660 |
| 5,104,195 |
| 5,494,445 |
| ||||
Research and development |
| 689,901 |
| 628,227 |
| 2,366,121 |
| 1,914,255 |
| ||||
General and administrative |
| 1,436,184 |
| 1,277,601 |
| 4,105,792 |
| 4,272,598 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total operating expenses |
| 3,586,270 |
| 3,649,488 |
| 11,576,108 |
| 11,681,298 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Operating income |
| 1,146,151 |
| 1,216,717 |
| 2,844,506 |
| 1,697,309 |
| ||||
Other income, net |
| 508,825 |
| 291,236 |
| 1,511,585 |
| 694,954 |
| ||||
Income from continuing operations before income taxes |
| 1,654,976 |
| 1,507,953 |
| 4,356,091 |
| 2,392,263 |
| ||||
Income taxes |
| (18,800 | ) | 231,620 |
| (18,800 | ) | 558,788 |
| ||||
Income from continuing operations |
| 1,673,776 |
| 1,276,333 |
| 4,374,891 |
| 1,833,475 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Discontinued operations (Note 7): |
|
|
|
|
|
|
|
|
| ||||
Income from discontinued operations, net of income taxes |
| — |
| 853,523 |
| — |
| 1,017,079 |
| ||||
Gain on disposal |
| — |
| 260,763 |
| — |
| 632,058 |
| ||||
Income from discontinued operations |
| — |
| 1,114,286 |
| — |
| 1,649,137 |
| ||||
Net income |
| $ | 1,673,776 |
| $ | 2,390,619 |
| $ | 4,374,891 |
| $ | 3,482,612 |
|
|
|
|
|
|
|
|
|
|
| ||||
Income from continuing operations per common share: |
|
|
|
|
|
|
|
|
| ||||
Basic |
| $ | 0.10 |
| $ | 0.09 |
| $ | 0.27 |
| $ | 0.13 |
|
Diluted |
| $ | 0.10 |
| $ | 0.08 |
| $ | 0.26 |
| $ | 0.11 |
|
|
|
|
|
|
|
|
|
|
| ||||
Income from discontinued operations per common share: |
|
|
|
|
|
|
|
|
| ||||
Basic |
| $ | 0.00 |
| $ | 0.07 |
| $ | 0.00 |
| $ | 0.11 |
|
Diluted |
| $ | 0.00 |
| $ | 0.07 |
| $ | 0.00 |
| $ | 0.10 |
|
|
|
|
|
|
|
|
|
|
| ||||
Net income per common share: |
|
|
|
|
|
|
|
|
| ||||
Basic |
| $ | 0.10 |
| $ | 0.16 |
| $ | 0.27 |
| $ | 0.24 |
|
Diluted |
| $ | 0.10 |
| $ | 0.15 |
| $ | 0.26 |
| $ | 0.21 |
|
|
|
|
|
|
|
|
|
|
| ||||
Weighted average shares used in the calculation of net income per common share: |
|
|
|
|
|
|
|
|
| ||||
Basic |
| 16,268,524 |
| 14,939,806 |
| 16,160,970 |
| 14,663,767 |
| ||||
Diluted |
| 16,978,841 |
| 16,479,112 |
| 17,100,334 |
| 16,428,894 |
|
See accompanying notes to the condensed consolidated financial statements
5
SRS LABS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME (Unaudited)
|
| Common Stock |
| Additional |
| Accumulated |
| Accumulated |
| Treasury |
|
|
| Comprehensive |
| |||||||||
|
| Shares |
| Amount |
| Capital |
| Loss |
| Deficit |
| Stock |
| Total |
| Ended |
| |||||||
BALANCE, December 31, 2006 |
| 15,886,938 |
| $ | 16,562 |
| $ | 70,574,176 |
| $ | (273,295 | ) | $ | (24,569,531 | ) | $ | (3,003,445 | ) | $ | 42,744,467 |
|
|
| |
Proceeds from exercise of stock options |
| 385,341 |
| 385 |
| 1,842,579 |
| — |
| — |
| — |
| 1,842,964 |
|
|
| |||||||
Stock based compensation |
| — |
| — |
| 1,289,060 |
| — |
| — |
| — |
| 1,289,060 |
|
|
| |||||||
Unrealized gain on investments available for sale, net of tax |
| — |
| — |
| — |
| 127,215 |
| — |
| — |
| 127,215 |
| 127,215 |
| |||||||
Net income |
| — |
| — |
| — |
| — |
| 4,374,891 |
| — |
| 4,374,891 |
| 4,374,891 |
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
BALANCE, September 30, 2007 |
| 16,272,279 |
| $ | 16,947 |
| $ | 73,705,815 |
| $ | (146,080 | ) | $ | (20,194,640 | ) | $ | (3,003,445 | ) | $ | 50,378,597 |
| $ | 4,502,106 |
|
See accompanying notes to the condensed consolidated financial statements
6
SRS LABS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
|
| Nine Months Ended |
| ||||
|
| 2007 |
| 2006 |
| ||
Cash Flows from Operating Activities: |
|
|
|
|
| ||
Net income |
| $ | 4,374,891 |
| $ | 3,482,612 |
|
Adjustments to reconcile income from continuing operations to net cash provided by operating activities: |
|
|
|
|
| ||
Depreciation and amortization |
| 560,777 |
| 549,259 |
| ||
Provision for doubtful accounts |
| 93,993 |
| (1,588 | ) | ||
Deferred taxes |
| (1,022,205 | ) | (6,026 | ) | ||
Accretion of discount on investments available for sale |
| — |
| (1,565 | ) | ||
Stock-based compensation expense |
| 1,289,060 |
| 1,070,804 |
| ||
Loss on disposition of property and equipment |
| — |
| 1,582 |
| ||
Gain on sale of discontinued operations |
| — |
| (632,058 | ) | ||
Changes in operating assets and liabilities: |
|
|
|
|
| ||
Accounts receivable |
| (846,007 | ) | (401,462 | ) | ||
Prepaid expenses and other current assets |
| 153,422 |
| (466,308 | ) | ||
Accounts payable |
| (249,444 | ) | 156,478 |
| ||
Accrued liabilities |
| (489,159 | ) | 312,031 |
| ||
Deferred revenue |
| 57,441 |
| (96,775 | ) | ||
Net cash used in operating activities of discontinued operations |
| — |
| (1,922,668 | ) | ||
Net cash provided by operating activities |
| 3,922,769 |
| 2,044,316 |
| ||
|
|
|
|
|
| ||
Cash Flows from Investing Activities: |
|
|
|
|
| ||
Purchase of property and equipment |
| (99,343 | ) | (204,790 | ) | ||
Expenditures related to intangible assets |
| (602,263 | ) | (443,118 | ) | ||
Proceeds from sale of investments available for sale |
| — |
| 9,993,748 |
| ||
Proceeds from the sale of Valence |
| — |
| 4,300,000 |
| ||
Proceeds from the sale of equity interest in CHS/SRS LLC |
| — |
| 371,295 |
| ||
Net cash used in investing activities of discontinued operations |
| — |
| (180,216 | ) | ||
Net cash (used in) provided by investing activities |
| (701,606 | ) | 13,836,919 |
| ||
|
|
|
|
|
| ||
Cash Flows from Financing Activities: |
|
|
|
|
| ||
Purchase of treasury stock |
| — |
| (2,114,586 | ) | ||
Proceeds from exercise of stock options |
| 1,842,964 |
| 3,607,927 |
| ||
Net cash provided by financing activities |
| 1,842,964 |
| 1,493,341 |
| ||
|
|
|
|
|
| ||
Net Increase in Cash and Cash Equivalents |
| 5,064,127 |
| 17,374,576 |
| ||
Cash and Cash Equivalents, Beginning of Period |
| 35,011,425 |
| 8,752,339 |
| ||
Cash and Cash Equivalents, End of Period |
| $ | 40,075,552 |
| $ | 26,126,915 |
|
|
|
|
|
|
| ||
Supplemental Disclosure of Cash Flow Information: |
|
|
|
|
| ||
Cash paid during the period for: |
|
|
|
|
| ||
Income taxes |
| $ | 839,967 |
| $ | 506,010 |
|
Supplemental Disclosure of Non-Cash Investing Activities: |
|
|
|
|
| ||
Unrealized gain on investments, net |
| $ | 127,215 |
| $ | 33,247 |
|
See accompanying notes to the condensed consolidated financial statements
7
SRS LABS, INC. AND SUBSIDIARY
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,” “SRS,” “we,” “us,” or “our” means SRS Labs, Inc., its wholly-owned subsidiary SRSWOWcast.com, Inc. and, for the applicable periods, its former subsidiary ValenceTech Limited (collectively with its direct and indirect wholly-owned subsidiaries, “Valence”) and the former joint venture with Coming Home Studios LLC, CHS/SRS LLC. 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. 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 year ended December 31, 2006. Amounts related to disclosure of December 31, 2006 balances within these interim consolidated financial statements were derived from the audited 2006 consolidated financial statements and notes thereto included in the 2006 Form 10-K. 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 are not necessarily indicative of the results to be expected for any other interim period or for the full year.
On February 23, 2006, the Board of Directors of the Company (the “Board of Directors” or the “Board”) approved a plan to sell Valence in order to focus increased management attention and financial resources on its licensing business. Additionally, on February 23, 2006, the Board authorized management to take all reasonable steps to divest the Company’s entire equity interest in the CHS/SRS LLC joint venture (the “Joint Venture”). As a result of the Company’s decisions to sell Valence and its entire equity interest in CHS/SRS LLC, the Company has accounted for Valence and CHS/SRS LLC as discontinued operations in the accompanying condensed consolidated financial statements beginning in the first fiscal quarter of 2006. The Company sold Valence in September 2006 and its entire equity interest in CHS/SRS LLC in June 2006. See Note 7.
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, 2006 for an additional discussion of the significant accounting policies and estimates used in the preparation of our financial statements.
Cash and Cash Equivalents
Cash and cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and are so near maturity that they present insignificant risk of changes in value because of interest rates. Cash and cash equivalents generally consist of cash, money market funds and instruments with original maturities of three months or less.
Customer Concentrations
For the three months ended September 30, 2007, three customers, Samsung, LG, and New Japan Radio Co., accounted for approximately 26%, 14% and 11%, respectively, of the licensing revenue. During 2007, the Company entered
8
into a multi-year license agreement with LG for the usage of our existing technology for televisions and monitors for the next four years. Beginning in the third fiscal quarter of 2007, the Company recognized revenue from LG for televisions and monitors under the new multi-year license agreement. During the third fiscal quarter of 2007, the Company also recognized the final trailing revenue reported by LG for televisions and monitors under the previous license agreement. For the same period in the prior year, one customer, Samsung, accounted for approximately 22% of the revenue. For the nine months ended September 30, 2007, one customer, Samsung, accounted for approximately 25% of the licensing revenue. For the same period in the prior year, two customers, Samsung and Sony, accounted for approximately 17% and 12%, respectively, of the licensing revenue.
2. Stock-Based Compensation
We account for stock-based compensation under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment (“SFAS 123R”). SFAS 123R requires measurement of all employee stock-based awards using a fair-value method and recording of related compensation expense in the consolidated financial statements over the requisite service period. Further, as required under SFAS 123R, we estimate forfeitures for share based awards that are not expected to vest. For the three months ended September 30, 2007, we recorded stock-based compensation expense of $438,050 under the fair-value provisions of SFAS 123R, compared to $383,404 in the same period in the prior year. For the nine months ended September 30, 2007, we recorded stock-based compensation expense of $1,289,060 under the fair-value provisions of SFAS 123R, compared to $1,070,804 for the same period in the prior year.
Option awards are granted with an exercise price equal to the market price of the Company’s stock at the date of grant. Option awards generally have a term of 10 years and vest and become exercisable over a four-year service period.
The fair value of each share-based award is estimated on the grant date using the Black-Scholes-Merton (“BSM”) option-pricing formula and straight-line amortization of compensation expense over the requisite service period of the grant. Expected volatilities are based on the historical volatility of the Company’s stock price. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury interest rates in effect at the time of grant. The fair value of options granted was estimated using the following weighted-average assumptions:
|
| Three Months Ended |
| Nine Months Ended |
| ||||
|
| September 30, |
| September 30, |
| ||||
|
| 2007 |
| 2006* |
| 2007 |
| 2006 |
|
Expected term (in years) |
| 6.25 |
| — |
| 6.25 |
| 6.25 |
|
Expected volatility |
| 56 | % | — | % | 56 | % | 57 | % |
Risk-free interest rate |
| 4.4 | % | — | % | 4.8 | % | 4.9 | % |
Dividend yield |
| 0.00 | % | — | % | 0.00 | % | 0.00 | % |
*Note: There were no options granted in the three months ended September 30, 2006
Total compensation cost recognized is as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Continuing Operations: |
|
|
|
|
|
|
|
|
| ||||
Sales and marketing |
| $ | 112,162 |
| $ | 140,228 |
| $ | 382,655 |
| $ | 438,740 |
|
Research and development |
| 108,987 |
| 67,383 |
| 325,173 |
| 269,544 |
| ||||
General and administrative |
| 216,901 |
| 175,793 |
| 581,232 |
| 362,520 |
| ||||
Total compensation cost recognized in continuing operations |
| 438,050 |
| 383,404 |
| 1,289,060 |
| 1,070,804 |
| ||||
Total compensation cost recognized in discontinued operations |
| — |
| — |
| — |
| 101,143 |
| ||||
Total compensation cost recognized |
| $ | 438,050 |
| $ | 383,404 |
| $ | 1,289,060 |
| $ | 1,171,947 |
|
9
3. Intangible Assets
Intangible assets, net consist of the following:
|
| September 30, |
| December 31, |
| ||
Patents |
| $ | 3,195,304 |
| $ | 2,715,250 |
|
Accumulated amortization |
| (1,543,296 | ) | (1,326,836 | ) | ||
Patents, net |
| 1,652,008 |
| 1,388,414 |
| ||
Other intangibles: |
|
|
|
|
| ||
License agreements acquired in purchase of SRSWOWcast |
| 640,071 |
| 640,071 |
| ||
Poly Planar purchased technology for speaker products |
| — |
| 120,000 |
| ||
Capitalized software and hardware for several technologies |
| 781,150 |
| 658,942 |
| ||
Total of other intangibles |
| 1,421,221 |
| 1,419,013 |
| ||
Accumulated amortization, other intangibles |
| (822,676 | ) | (762,288 | ) | ||
Other intangibles, net |
| 598,545 |
| 656,725 |
| ||
Intangible assets, net |
| $ | 2,250,553 |
| $ | 2,045,139 |
|
Amortization periods range from three to ten years depending on the estimated useful life of the asset. Amortization expense consists of the following:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Patents |
| $ | 76,952 |
| $ | 62,655 |
| $ | 216,460 |
| $ | 180,734 |
|
Other intangibles: |
|
|
|
|
|
|
|
|
| ||||
License agreements acquired in purchase of SRSWOWcast |
| 16,002 |
| 16,002 |
| 48,005 |
| 48,005 |
| ||||
Capitalized software and hardware |
| 40,399 |
| 48,269 |
| 132,383 |
| 133,477 |
| ||||
Total intangible amortization expense |
| $ | 133,353 |
| $ | 126,926 |
| $ | 396,848 |
| $ | 362,216 |
|
As of September 30, 2007, the weighted average useful life of the Company’s intangible assets is approximately 6.6 years. The following table shows the estimated amortization expense for those assets for the remaining three months of the current fiscal year and each of the four succeeding fiscal years and thereafter:
Years Ending December 31, |
| Estimated Expense |
| |
2007 |
| $ | 134,868 |
|
2008 |
| 407,022 |
| |
2009 |
| 313,678 |
| |
2010 |
| 287,509 |
| |
2011 |
| 268,276 |
| |
Thereafter |
| 839,200 |
| |
Total |
| $ | 2,250,553 |
|
4. 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:
|
| September 30, 2007 |
| December 31, 2006 |
| ||
Cost |
| $ | 5,500,000 |
| $ | 5,500,000 |
|
Unrealized loss |
| (146,080 | ) | (273,295 | ) | ||
Estimated fair value |
| $ | 5,353,920 |
| $ | 5,226,705 |
|
10
The contractual maturities of investments are shown below. Actual maturities may differ from contractual maturities.
|
| September 30, 2007 |
| December 31, 2006 |
| ||||||||
|
| Cost |
| Estimated |
| Cost |
| Estimated |
| ||||
U.S. Government securities available for sale: |
|
|
|
|
|
|
|
|
| ||||
Due in one year or less |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
|
Due in one to five years |
| 5,500,000 |
| 5,353,920 |
| 5,500,000 |
| 5,226,705 |
| ||||
|
| $ | 5,500,000 |
| $ | 5,353,920 |
| $ | 5,500,000 |
| $ | 5,226,705 |
|
5. Net Income Per Common Share
The Company applies SFAS No. 128, Earnings per Share (“SFAS 128”), which requires the disclosure of basic and diluted net income per share for all current and prior periods. Basic net income per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during each year. Diluted net income per common share reflects the maximum dilution, based on the average price of the Company’s common stock during each period, and is computed similar to basic income per share except that the denominator is increased to include the number of additional shares that would have been outstanding if potentially dilutive stock options had been exercised and were dilutive.
Basic and diluted net income per share computed in accordance with SFAS 128 for the three and nine months ended September 30, are as follows:
|
| For the Three Months |
| For the Nine Months |
| ||||||||
|
| Ended September 30, |
| Ended September 30, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
BASIC EPS |
|
|
|
|
|
|
|
|
| ||||
Income from continuing operations |
| $ | 1,673,776 |
| $ | 1,276,333 |
| $ | 4,374,891 |
| $ | 1,833,475 |
|
Income from discontinued operations |
| — |
| 1,114,286 |
| — |
| 1,649,137 |
| ||||
Net income |
| $ | 1,673,776 |
| $ | 2,390,619 |
| $ | 4,374,891 |
| $ | 3,482,612 |
|
Denominator: weighted average common shares outstanding |
| 16,268,524 |
| 14,939,806 |
| 16,160,970 |
| 14,663,767 |
| ||||
Income per share from continuing operations—basic |
| $ | 0.10 |
| $ | 0.09 |
| $ | 0.27 |
| $ | 0.13 |
|
Income per share from discontinued operations—basic |
| $ | — |
| $ | 0.07 |
| $ | — |
| $ | 0.11 |
|
Net income per share—basic |
| $ | 0.10 |
| $ | 0.16 |
| $ | 0.27 |
| $ | 0.24 |
|
|
|
|
|
|
|
|
|
|
| ||||
DILUTED EPS |
|
|
|
|
|
|
|
|
| ||||
Income from continuing operations |
| $ | 1,673,776 |
| $ | 1,276,333 |
| $ | 4,374,891 |
| $ | 1,833,475 |
|
Income from discontinued operations |
| — |
| 1,114,286 |
| — |
| 1,649,137 |
| ||||
Net income |
| $ | 1,673,776 |
| $ | 2,390,619 |
| $ | 4,374,891 |
| $ | 3,482,612 |
|
Denominator: weighted average common shares outstanding |
| 16,268,524 |
| 14,939,806 |
| 16,160,970 |
| 14,663,767 |
| ||||
Common equivalent shares outstanding: |
|
|
|
|
|
|
|
|
| ||||
Options |
| 710,317 |
| 1,539,306 |
| 939,364 |
| 1,765,127 |
| ||||
Total diluted shares |
| 16,978,841 |
| 16,479,112 |
| 17,100,334 |
| 16,428,894 |
| ||||
Income per share from continuing operations—diluted |
| $ | 0.10 |
| $ | 0.08 |
| $ | 0.26 |
| $ | 0.11 |
|
Income per share from discontinued operations—diluted |
| $ | — |
| $ | 0.07 |
| $ | — |
| $ | 0.10 |
|
Net income per share—diluted |
| $ | 0.10 |
| $ | 0.15 |
| $ | 0.26 |
| $ | 0.21 |
|
There were 557,439 and 1,051,859 potentially dilutive options outstanding for the three months ending September 30, 2007 and 2006, respectively, and there were 542,660 and 677,336 potentially dilutive options outstanding for the nine months ending September 30, 2007 and 2006, respectively, that were not included in the table above because they would be anti-dilutive.
6. 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 presently predicted, management does not believe that the outcome of
11
any of these matters will have a material adverse effect on the Company’s consolidated financial position or results of operations.
7. Discontinued Operations
On February 23, 2006, the Board approved a plan to sell Valence in order to focus increased management attention and financial resources on its licensing business. On July 14, 2006, we entered into a definitive Sale and Purchase Agreement to sell Valence to Noblehigh Enterprises Inc. (“Noblehigh”). Noblehigh is owned by Willas Array Electronics (Holding) Limited as well as certain members of management of Valence. The sale transaction was completed on September 29, 2006.
The sale to Noblehigh was effected through two simultaneous transactions: (1) the repurchase by Valence of approximately 74% of the outstanding shares of Valence from SRS using its existing cash and (2) the purchase by Noblehigh of the remaining outstanding shares of Valence from SRS for $4.3 million. The sale resulted in a gain on the disposal of discontinued operations of $260,763 in the Company’s third fiscal quarter of 2006.
Additionally, on February 23, 2006, the Board authorized management to take all reasonable steps to divest the Company’s entire equity interest in the Joint Venture. On June 30, 2006, we completed the sale of our interest in the Joint Venture to Coming Home Studios LLC in exchange for $200,000, the rights to all cash assets of the Joint Venture, and a promissory note in the amount of $175,000. The sale of our interest in the Joint Venture resulted in a gain on the sale of $371,295 in the Company’s second fiscal quarter of 2006. As of September 30, 2007, the outstanding principal balance due on the note is $159,724 plus accrued interest. Any amounts related to the promissory note and accrued interest thereon will be recorded at the time the cash is received by us.
As a result of our decision to sell Valence and our entire equity interest in the Joint Venture in February 2006, we accounted for Valence and the Joint Venture as discontinued operations beginning in the first fiscal quarter of 2006.
Income from discontinued operations for the three and nine months ended September 30, 2006 consisted of direct revenues and direct expenses of Valence and CHS/SRS LLC. General corporate overhead costs have not been allocated to discontinued operations. A summary of the operating results of Valence and the Joint Venture included in discontinued operations in the accompanying condensed consolidated statements of operations is as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||
|
| September 30, 2006 |
| September 30, 2006 |
| ||
Valence: |
|
|
|
|
| ||
Revenues. |
| $ | 3,312,397 |
| $ | 7,682,931 |
|
Cost of sales |
| 1,493,004 |
| 3,562,750 |
| ||
Gross margin |
| 1,819,393 |
| 4,120,181 |
| ||
Total operating expenses |
| 983,356 |
| 3,193,519 |
| ||
Income from operations |
| 836,037 |
| 926,662 |
| ||
Other income, net |
| 23,806 |
| 31,669 |
| ||
Income before income tax expense |
| 859,843 |
| 958,331 |
| ||
Income tax expense |
| 2,936 |
| 33,632 |
| ||
Net income from Valence |
| 856,907 |
| 924,699 |
| ||
Net (loss) income from CHS/SRS LLC |
| (3,384 | ) | 92,380 |
| ||
Subtotal |
| 853,523 |
| 1,017,079 |
| ||
Gain on sale of Valence |
| 260,763 |
| 260,763 |
| ||
Gain on sale of CHS/SRS LLC |
| — |
| 371,295 |
| ||
Total income from discontinued operations |
| $ | 1,114,286 |
| $ | 1,649,137 |
|
8. Segment Information
The Company previously operated in two business segments — semiconductors and licensing. However, as a result of the Board’s decision on February 23, 2006 to sell Valence, the semiconductor business, the Company now has continuing operations in only one business segment, licensing. Our revenue from continuing operations is solely derived from licensing related revenue.
12
The following schedule presents the Company’s revenue from continuing operations by geographic area. Licensing-related revenue is allocated based on the location of the licensee’s corporate headquarters. The Americas region includes North, Central and South Americas.
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||||||||||
|
| 2007 |
| % |
| 2006 |
| % |
| 2007 |
| % |
| 2006 |
| % |
| ||||
Geographic Area Revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Korea |
| $ | 2,190,563 |
| 46 |
| $ | 1,613,933 |
| 33 |
| $ | 5,748,574 |
| 39 |
| $ | 3,998,542 |
| 28 |
|
Japan |
| 1,631,214 |
| 34 |
| 1,824,612 |
| 37 |
| 5,970,028 |
| 41 |
| 5,735,707 |
| 45 |
| ||||
Americas |
| 425,798 |
| 9 |
| 528,165 |
| 11 |
| 1,422,278 |
| 10 |
| 1,334,685 |
| 9 |
| ||||
China |
| 426,540 |
| 9 |
| 922,229 |
| 19 |
| 1,276,869 |
| 9 |
| 2,348,057 |
| 17 |
| ||||
Europe |
| 95,156 |
| 2 |
| 21,264 |
| 0 |
| 118,777 |
| 1 |
| 88,719 |
| 1 |
| ||||
Total |
| $ | 4,769,271 |
| 100 |
| $ | 4,910,203 |
| 100 |
| $ | 14,536,526 |
| 100 |
| $ | 13,505,710 |
| 100 |
|
9. Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. FIN 48 is an interpretation of FASB Statement No. 109, Accounting for Income Taxes, and it seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position that an entity takes or expects to take in a tax return. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Under FIN 48, an entity may only recognize or continue to recognize tax positions that meet a “more likely than not” threshold. We adopted FIN 48 on January 1, 2007. As a result of adoption of FIN 48, we recognized no liability for unrecognized income tax benefits. Additionally, we recognized no interest and penalties related to uncertain tax positions and as of the three and nine months ended September 30, 2007, we have no accrued interest related to uncertain tax positions. The tax years 2003-2006 remain open to examination by the major taxing jurisdictions.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”). The purpose of SFAS No. 157 is to define fair value, establish a framework for measuring fair value and enhance disclosures about fair value measurements. The measurement and disclosure requirements are effective for periods beginning after November 15, 2007. We do not expect the adoption of SFAS No. 157 will have a material effect on our consolidated financial position or results of operations.
In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 permits entities to choose to measure financial assets and liabilities (except for those that are specifically scoped out of the Statement) at fair value. The election to measure a financial asset or liability at fair value can be made on an instrument-by-instrument basis and is irrevocable. The difference between carrying value and fair value at the election date is recorded as a transition adjustment to opening retained earnings. Subsequent changes in fair value are recognized in earnings. The effective date for this Statement is as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company will adopt SFAS 159, effective January 1, 2008. The Company does not expect the adoption of SFAS 159 to have a material impact on our consolidated financial position or consolidated results of operations.
13
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, 2006, 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 audio and voice technology solutions for the home entertainment, portable media device, personal telecommunications, personal computer, automotive, and broadcast markets. Prior to September 29, 2006, the Company was also a developer and provider of application specific integrated circuits and standard integrated circuits through its formerly wholly-owned subsidiary, Valence Tech Limited.
Licensing
Our operations are conducted through SRS Labs, Inc., the parent company, and its wholly-owned subsidiary, SRSWOWcast.com, Inc. Our business is focused on developing and licensing audio, voice and surround sound technology solutions to many of the world’s leading original equipment manufacturers, or OEMs, software providers and semiconductor companies, and licensing and marketing hardware and software products for the Internet and professional audio markets.
A focus of the Company at this time is protection of its patents and enforcement of its royalty program. We believe that the proactive enforcement and administration of these programs will help us to identify improper or unauthorized usage of our intellectual properties, as well as to ensure the accurate and timely royalty reporting by our licensees. While there could be a short-term negative impact in terms of increased expenses or decreased revenue, we believe that this strategy will have positive long-term results and will lead to even stronger relationships with our customers.
Discontinued Operations
Valence: Through our formerly wholly-owned subsidiary, ValenceTech Limited, we operated a fabless semiconductor business which developed, designed and marketed standard and custom analog integrated circuits, digital signal processors, and mixed signal integrated circuits primarily to OEMs and original design manufacturers in the Asia Pacific region.
On February 23, 2006, our Board approved a plan to sell Valence in order to focus management’s attention and financial resources on our licensing business. On July 14, 2006, we entered into a definitive Sale and Purchase Agreement to sell Valence to Noblehigh Enterprises Inc. Noblehigh is owned by Willas Array Electronics (Holding) Limited as well as certain members of management of Valence. The sale transaction was completed on September 29, 2006 and accordingly the results of the operations of Valence are included as discontinued operations in the accompanying condensed consolidated statement of operations beginning in the first quarter of 2006.
CHS/SRS LLC: In September 2004, we entered into a strategic alliance with Coming Home Studios LLC, or CHS, to use and promote SRS Labs’ technologies, to promote CHS productions and to promote each company’s respective brands. In connection with the strategic alliance, SRS and CHS established a Joint Venture, CHS/SRS LLC, to produce and distribute nine concert videos featuring our Circle Surround technology. On February 23, 2006, our Board authorized management to take all reasonable steps to divest our entire equity interest in the Joint Venture. On June 30, 2006, we completed the sale of our interest in the Joint Venture to CHS. Accordingly, the results of operations of CHS/SRS LLC are included as discontinued operations in the accompanying condensed consolidated statement of operations beginning in the first quarter of 2006.
Critical Accounting Policies
Our discussion and analysis of our results of operations and liquidity and capital resources are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.
The preparation of these financial statements requires us to make estimates and judgments that affect the reported
14
amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. We base our estimates on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may materially differ from our estimates.
Results of Continuing Operations
Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006
Revenues
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 entered into in the past, and may again enter into in the future, a license agreement for a one-time fee or an annual fixed fee amount. Also included in licensing revenue are revenues generated from the sale of hardware and software applications into the personal computer (“PC”) and broadcast audio markets.
Revenues were $4,769,271 for the three months ended September 30, 2007, compared to $4,910,203 for the three months ended September 30, 2006, a decrease of $140,932, or 3%. The decrease in revenues was primarily attributable to the declining use of our technology by two of our customers. As indicated in our Quarterly Report for the quarter ended March 31, 2007, filed with the SEC in May 2007, during April 2007, we were informed by Sony, one of our largest licensees, it has begun to distribute televisions that include internally developed audio technology, rather than technology licensed from us. Additionally, as indicated in our Quarterly Report for the quarter ended March 31, 2007, filed with the SEC in May 2007, during April 2007, we were informed by Toshiba that they had elected not to utilize our technology in their personal computers during 2007. These two events negatively impacted our revenues in the third quarter of 2007, and we anticipate these two events to continue to negatively affect our revenues in future periods. Included in our third quarter 2006 revenues was approximately $250,000 from Samsung received as a result of royalty compliance activities. There were no material revenues from such compliance activities during the third quarter of 2007. Offsetting a portion of these noted decreases, we continued to increase flat panel television revenues from our largest customer, Samsung Electronics.
During 2007, the Company entered into a multi-year, license agreement with LG Electronics for the usage of our existing technology for televisions and monitors through December 2010. Beginning in the third fiscal quarter of 2007, the Company recognized revenues from LG for televisions and monitors under the new multi-year license agreement, as well as recognized the final trailing revenue reported by LG for televisions and monitors under the previous license agreement. The Company also closed all open compliance issues with LG, which did not result in a material impact to our financial results of the third quarter of 2007.
Earlier this year, we elected to modify our sales approach in our Greater China Region, in that we are no longer requiring certain of our customers to obtain our technology through bundled arrangements with our integrated circuit (“IC”) partners, but instead are allowing them to license our technology directly from us. We believe that this change will strengthen our relationship with these customers. During the third quarter of 2007, our largest China based television licensee transitioned to this new approach and signed a new contract with the Company. Accordingly, we noted a decrease in revenues of approximately $140,000 from this customer for the third quarter of 2007 as a result of the customer placing into production ICs that had previously been purchased from the IC partner under the prior method. Additionally, we entered into a new agreement with another large China based television manufacturer under a direct relationship and anticipate that this will begin to generate revenues for us during 2008.
Revenues in our Portable Media Devices decreased $195,233, or 27%, for the three months ended September 30, 2007, compared to the same period in the prior year, primarily due to the loss of two MP3 customers in the third and fourth quarters of 2006. Additionally, during the third quarter of 2007, we recognized no revenue from our largest China based customer in this segment as their contract with us expired the prior quarter. We have entered into a new contact with this customer and will begin to recognize revenues under the terms of the new agreement during the fourth quarter of this year.
We continue to recognize increasing revenues from our automotive segment and anticipate that revenues will continue to grow in future periods. Our technology usage is being expanded, particularly by Japan based automotive suppliers and we are continuing to obtain design wins that will generate revenues for us through 2010.
15
The following table presents our revenues by market:
|
| Three Months Ended |
| ||
|
| 2007 |
| 2006 |
|
Home Entertainment (TV, Set Top Box, A/V Receiver, DVD) |
| 70 | % | 66 | % |
Portable Media Devices (Digital Media Player, Headphone) |
| 11 | % | 15 | % |
Automotive |
| 7 | % | 5 | % |
PC (Software, Hardware) |
| 6 | % | 9 | % |
Personal Telecommunications (Mobile Phone, PDA) |
| 6 | % | 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 $1,460,185 for the three months ended September 30, 2007, compared to $1,743,660 for the same prior year period, a decrease of $283,475, or 16%. This decrease is primarily attributable to decreased marketing management head count and related expenses. Included in sales and marketing expenses is stock based compensation expense of $112,162 and $140,228 for the three months ended September 30, 2007 and 2006, respectively. As a percentage of total revenues, sales and marketing expenses decreased from 36% for the three months ended September 30, 2006 to 31% for the same period this year.
Research and Development
Research and development expenses consist of salaries and related costs of employees engaged in ongoing research, design and development activities and costs for engineering materials and supplies. Research and development expenses were $689,901 for the three months ended September 30, 2007, compared to $628,227 for the same prior year period, an increase of $61,674, or 10%. This increase is attributable to an increase in head count and payroll related costs and an increase in stock based compensation expense due to current year stock option grants. Included in research and development expenses is stock based compensation expense of $108,987 and $67,383 for the three months ended September 30, 2007 and 2006, respectively. As a percentage of total revenues, research and development expenses increased from 13% for the three months ended September 30, 2006 to 14% for the same period this year.
General and Administrative
General and administrative (“G&A”) expenses consist primarily of employee-related expenses, legal costs associated with the administration of intellectual property and other professional fees. G&A expenses were $1,436,184 for the three months ended September 30, 2007, compared to $1,277,601 for the same prior year period, an increase of $158,583, or 12%. The increase is primarily attributable to increased legal and accounting fees associated with the protection of SRS’s patents and enforcement of its royalty compliance program. The increase is also attributed to increased costs associated with Sarbanes-Oxley compliance and increased stock based compensation expense due to 2007 stock option grants. Partially offsetting the increases is lower bonus expense. Included in general and administrative expenses is stock based compensation expense of $216,901 and $175,793 for the three months ended September 30, 2007 and 2006, respectively. As a percentage of total revenues, G&A expenses increased from 26% for the quarter ended September 30, 2006 to 30% for the same period this year.
Other Income, Net
Other income, net, consists principally of interest income. Other income, net, was $508,825 for the three months ended September 30, 2007, compared to $291,236 for the same prior year period, an increase of $217,589, or 75%. This increase is primarily attributable to higher interest rates earned on larger cash balances invested.
Provision for Income Taxes
The income tax benefit for the three months ended September 30, 2007 was $18,800, compared to tax expense of $231,620 for the same prior year period. The prior year provision consists primarily of taxes paid on licensing revenues sourced from countries requiring foreign tax withholdings, principally Korea. We reduced our current quarter tax provision
16
and our valuation allowance on our deferred tax assets by $450,290 based on our assessment of the future realizability of certain deferred tax assets. The current period income tax benefit reflects a tax refund due from the state of California.
Discontinued Operations
As a result of our February 2006 decisions to sell Valence and our entire equity interest in CHS/SRS LLC, we have accounted for the semiconductor business segment and CHS/SRS LLC as discontinued operations in the accompanying condensed consolidated financial statements beginning in the first fiscal quarter of 2006. The Company sold Valence in September 2006 and its entire equity interest in CHS/SRS LLC in June 2006.
Income from discontinued operations consists of direct revenues and direct expenses of Valence and CHS/SRS LLC. General corporate overhead costs have not been allocated to discontinued operations. A summary of the operating results of Valence and the Joint Venture included in discontinued operations in the accompanying condensed consolidated statements of operation for the three months ended September 30, 2006 is as follows:
Valence: |
|
|
| |
Revenues. |
| $ | 3,312,397 |
|
Cost of sales |
| 1,493,004 |
| |
Gross margin |
| 1,819,393 |
| |
Total operating expenses |
| 983,356 |
| |
Income from operations |
| 836,037 |
| |
Other income, net |
| 23,806 |
| |
Income before income benefit |
| 859,843 |
| |
Income tax expense |
| 2,936 |
| |
Net income from Valence |
| 856,907 |
| |
Net loss from CHS/SRS LLC |
| (3,384 | ) | |
Net income from discontinued operations |
| 853,523 |
| |
Gain on sale of Valence |
| 260,763 |
| |
Total income from discontinued operations |
| $ | 1,114,286 |
|
Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006
Revenues
Revenues consist primarily of royalties generated from the license of our 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 entered into in the past, and may again enter into in the future, a license agreement for a one-time fee or an annual fixed fee amount. Also included in licensing revenue are revenues generated from the sale of hardware and software applications into the PC and broadcast audio markets.
Revenues were $14,536,526 for the nine months ended September 30, 2007, compared to $13,505,710 for the nine months ended September 30, 2006, an increase of $1,030,816, or 8%. The increase in revenues was primarily attributable to our strong sales in flat panel televisions and monitors in our Home Entertainment market, which grew by $2,694,834, or 44%. Partially offsetting the increases in Home Entertainment was a decrease in revenue from Sony, which began selling products using its own internally developed technology, as well as decreases in the CRT television business. Additionally, we experienced an increase in royalties in the Automotive market of $235,597, or 31%. Offsetting revenue increases in the Home Entertainment and Automotive market was a decrease in revenue in our Portable Media Devices of $1,053,621, or 44%, due to decreased MP3 sales and the loss of two MP3 customers in the third and fourth quarters of 2006.
17
The following table presents our licensing revenues mix by market:
|
| Nine Months Ended |
| ||
|
| 2007 |
| 2006 |
|
Home Entertainment (TV, Set Top Box, A/V Receiver, DVD) |
| 68 | % | 59 | % |
PC (Software, Hardware) |
| 9 | % | 10 | % |
Portable Media Devices (Digital Media Player, Headphone) |
| 9 | % | 18 | % |
Personal Telecommunications (Mobile Phone, PDA) |
| 7 | % | 8 | % |
Automotive |
| 7 | % | 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 $5,104,195 for the nine months ended September 30, 2007, compared to $5,494,445 for the same prior year period, a decrease of $390,250, or 7%. This decrease is primarily attributable to decreased marketing management head count and related expenses and decreased bonus expense, partially offset by increased headcount in sales. Included in sales and marketing expenses is stock based compensation expense of $382,655 and $438,740 for the nine months ended September 30, 2007 and 2006, respectively. As a percentage of total revenues, sales and marketing expenses decreased from 41% for the nine months ended September 30, 2006 to 35% for the same period this year.
Research and Development
Research and development expenses consist of salaries and related costs of employees engaged in ongoing research, design and development activities and costs for engineering materials and supplies. Research and development expenses were $2,366,121 for the nine months ended September 30, 2007, compared to $1,914,255 for the same prior year period, an increase of $451,866, or 24%. This increase is attributable to an increase in head count and payroll related costs and an increase in stock based compensation expense due to current year stock option grants. Included in research and development expenses is stock based compensation expense of $325,173 and $269,544 for the nine months ended September 30, 2007 and 2006, respectively. As a percentage of total revenues, research and development expenses increased from 14% for the nine months ended September 30, 2006 to 16% 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 $4,105,792 for the nine months ended September 30, 2007, compared to $4,272,598 for the same prior year period, a decrease of $166,806, or 4%. The decrease is primarily attributable a decrease in consultants fees and costs associated with the Company’s separation from its former Chief Financial Officer in the first quarter of 2006, partially offset by an increase in stock based compensation expense. Included in general and administrative expenses is stock based compensation expense of $581,232 and $362,520 for the nine months ended September 30, 2007 and 2006, respectively. As a percentage of total revenues, G&A expenses decreased from 32% for the nine months ended September 30, 2006 to 28% for the same period this year.
Other Income, Net
Other income, net, consists principally of interest income. Other income, net, was $1,511,585 for the nine months ended September 30, 2007, compared to $694,954 for the same prior year period, an increase of $816,631, or 118%. This increase is primarily attributable to higher interest rates earned on larger cash balances invested.
Provision for Income Taxes
The income tax benefit for the nine months ended September 30, 2007 was $18,800, compared to tax expense of $558,788 for the same prior year period. The prior year provision consists primarily of taxes paid on licensing revenues sourced from countries requiring foreign tax withholdings, principally Korea. We reduced our current quarter tax provision and our valuation allowance on our deferred tax assets by $1,022,205 based on our assessment of the future realizability of certain deferred tax assets. The current period income tax benefit reflects a tax refund due from the state of California.
18
Discontinued Operations
As a result of our February 2006 decisions to sell Valence and our entire equity interest in CHS/SRS LLC, we have accounted for the semiconductor business segment and CHS/SRS LLC as discontinued operations in the accompanying condensed consolidated financial statements beginning in the first fiscal quarter of 2006. The Company sold Valence in September 2006 and its entire equity interest in CHS/SRS LLC in June 2006.
Income from discontinued operations consists of direct revenues and direct expenses of Valence and CHS/SRS LLC. General corporate overhead costs have not been allocated to discontinued operations. A summary of the operating results of Valence and the Joint Venture included in discontinued operations in the accompanying condensed consolidated statements of operation for the nine months ended September 30, 2006 is as follows:
Valence: |
|
|
| |
Revenues. |
| $ | 7,682,931 |
|
Cost of sales |
| 3,562,750 |
| |
Gross margin |
| 4,120,181 |
| |
Total operating expenses |
| 3,193,519 |
| |
Income from operations |
| 926,662 |
| |
Other income, net |
| 31,669 |
| |
Income before income tax expense |
| 958,331 |
| |
Income tax expense |
| 33,632 |
| |
Net income from Valence |
| 924,699 |
| |
Net income from CHS/SRS LLC |
| 92,380 |
| |
Net income from discontinued operations |
| 1,017,079 |
| |
Gain on sale of Valence |
| 260,763 |
| |
Gain on sale of CHS/SRS LLC |
| 371,295 |
| |
Total income from discontinued operations |
| $ | 1,649,137 |
|
Liquidity and Capital Resources
Our principal source of liquidity to fund ongoing operations at September 30, 2007 consisted of cash, cash equivalents and long-term investments of $45,429,472. At September 30, 2007, we had cash and cash equivalents of $40,075,552 and long-term investments of $5,353,920. Cash and cash equivalents are short-term highly liquid investments that are readily convertible to known amounts of cash and are so near maturity that they present insignificant risk of changes in value because of interest rates. Cash and cash equivalents generally consist of cash, money market funds and 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 $3,922,769 and $2,044,316 during the nine months ended September 30, 2007 and September 30, 2006, respectively. The $1,878,453 increase in net cash provided by operating activities for the nine months ended September 30, 2007, compared to the same period in the prior year, was primarily a result of the Company not having any cash outflow related to discontinued operations during the nine months ended September 30, 2007 as the discontinued operations were sold in the second and third fiscal quarters of 2006. Partially offsetting the increase, accounts receivable rose by $846,007 during the nine months ended September 30, 2007 compared to $401,462 in the same period in the prior year, primarily due to a significant customer reporting royalties later than in prior periods. Additionally, accounts payable and accrued liabilities decreased $249,444 and $489,159, respectively, during the nine months ended September 30, 2007 as compared to increasing $156,478 and $312,031, respectively, during the same period in the prior year. The changes in liability accounts generally relate to the timing of payments to vendors and changes in accrued commissions and amounts due to employees under the 2007 Bonus and Profit Sharing Plan.
Net cash used in investing activities was $701,606 during the nine months ended September 30, 2007, and net cash provided by investing activities during the same period in the prior year was $13,836,919. The decrease in cash from investing activities is primarily due to the Company selling its available-for-sale investments for $9,993,748 in September 2006 and re-investing the proceeds into cash equivalents. In the prior period, the Company also received $4,300,000 and $371,295 for the sale of Valence and its equity interest in CCH/SRS LLC, respectively. There were no cash inflows or outflows from the discontinued operations in the current period.
19
Our net cash provided by financing activities from continuing operations was $1,842,964 and $1,493,341 during the nine months ended September 30, 2007 and September 30, 2006, respectively. The increase in net cash provided by financing activities was attributable to the Company not repurchasing any of its common stock in 2007 offset by a decrease in stock option exercises.
We expect expenditures related to patents and intangible assets to increase in the future consistent with the growth in our licensing business, as we continue to invest in the development of new technologies.
Based on current plans and business conditions, we expect that our cash, cash equivalents and investments together with any amounts generated from operations will be sufficient to meet our cash requirements for the next twelve months. However, there can be no assurance that we will not be required to seek other financing sooner or that such financing, if required, will be available on terms satisfactory to us.
Our operations and financial results are subject to various risks and uncertainties that could adversely affect our business, financial condition, results of operations and trading price of our common stock. Please refer to Item 1A, “Risk Factors” in our annual report on Form 10-K for fiscal year 2006 for information concerning these and other uncertainties that could negatively impact us.
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, 2006.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. Our Chief Executive Officer and President and our Chief Financial Officer have evaluated the effectiveness 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) as of the end of the period covered by this Quarterly Report on Form
10-Q and, based on this evaluation, have concluded that our disclosure controls and procedures are effective.
Changes in Internal Controls. There have been no changes in our internal controls over financial reporting that occurred during our third quarter ended September 30, 2007 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
20
The exhibits listed below are hereby filed with the U.S. Securities and Exchange Commission (the “SEC”) as part of this Report.
Exhibit |
| Description |
3.1 |
| Certificate of Incorporation of the Company, previously filed with the SEC 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 SEC 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 SEC as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1999, filed with the SEC on November 12, 1999, which is incorporated herein by reference. |
31.1 |
| Certification of Chief Executive Officer of SRS Labs, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2 |
| Certification of Chief Financial Officer of SRS Labs, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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. |
21
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: November 6, 2007 | By: | /S/ THOMAS C.K. YUEN | |
| Thomas C.K. Yuen | ||
| Chairman of the Board and Chief Executive Officer | ||
| (Principal Executive Officer) | ||
|
|
| |
|
|
| |
Date: November 6, 2007 | By: | /S/ ULRICH GOTTSCHLING | |
| Ulrich Gottschling | ||
| Chief Financial Officer | ||
| (Principal Financial and Accounting Officer) | ||
EXHIBIT INDEX
The exhibits listed below are hereby filed with the SEC as part of this Report.
Exhibit |
| Description |
3.1 |
| Certificate of Incorporation of the Company, previously filed with the SEC 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 SEC 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 SEC as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 1999, filed with the SEC on November 12, 1999, which is incorporated herein by reference. |
31.1 |
| Certification of Chief Executive Officer of SRS Labs, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2 |
| Certification of Chief Financial Officer of SRS Labs, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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. |
22