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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-21123
SRS LABS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 33-0714264
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2909 DAIMLER STREET, SANTA ANA, CALIFORNIA 92705
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(949) 442-1070
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NOT APPLICABLE
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGES SINCE
LAST REPORT)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: as of July 31, 1998,
11,612,423 shares of the issuer's common stock, par value $.001 per share, were
outstanding.
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SRS LABS, INC.
FORM 10-Q
FOR THE PERIOD ENDED JUNE 30, 1998
INDEX
Page
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 1998 (Unaudited)
and December 31, 1997 3
Consolidated Statements of Operations for the three months and
six months ended June 30, 1998 and 1997 (Unaudited) 4
Consolidated Statements of Cash Flows for the six months ended
June 30, 1998 and 1997 (Unaudited) 5
Notes to the Interim Consolidated Financial Statements (Unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
SRS LABS, INC.
CONSOLIDATED BALANCE SHEETS
June 30,
1998 December 31,
(Unaudited) 1997
------------ ------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 5,104,965 $ 4,446,753
Investments available for sale 2,003,496 2,010,775
Accounts receivable 6,048,780 3,989,927
Inventories 6,632,774 --
Prepaid expenses and other current assets 2,626,555 578,957
Deferred income taxes 505,674 170,674
------------ ------------
TOTAL CURRENT ASSETS 22,922,244 11,197,086
Investments available for sale 12,045,824 19,556,262
Furniture, fixtures & equipment, net 1,344,685 245,779
Intangible assets, net 6,488,840 313,673
Deferred income taxes 229,223 229,223
------------ ------------
TOTAL ASSETS $ 43,030,816 $ 31,542,023
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts Payable $ 7,917,510 $ 202,352
Accrued liabilities 1,518,977 826,242
Line of credit 7,000,000 --
Income taxes payable 678,966 1,011,426
Current portion of consideration due on asset purchase -- 81,804
------------ ------------
TOTAL CURRENT LIABILITIES 17,115,453 2,121,824
STOCKHOLDERS' EQUITY
Preferred stock - $.001 par value 2,000,000 shares authorized;
no shares issued and outstanding
Common stock - $.001 par value 56,000,000 shares authorized; 11,612,423 (at
June 30, 1998) and 9,609,867 (at December 31, 1997)
shares issued and outstanding 11,613 9,610
Additional paid-in capital 39,012,115 25,022,437
Deferred stock option compensation 282,841 231,087
Unrealized gain on investments available for sale 105,841 163,600
Retained earnings (deficit) (13,497,047) 3,993,465
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 25,915,363 29,420,199
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 43,030,816 $ 31,542,023
============ ============
See accompanying notes to financial statements
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SRS LABS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ -------------------------------
1998 1997 1998 1997
------------- ------------- ------------- --------------
REVENUES
Chip and licensing revenue $ 4,524,467 $ 2,115,799 $ 7,406,428 $ 4,327,899
Product and component sales 7,100,903 -- 11,276,338 --
------------- ------------- ------------- --------------
TOTAL REVENUES 11,625,370 2,115,799 18,682,766 4,327,899
COST OF SALES 7,387,523 75,885 11,785,939 115,079
------------- ------------- ------------- --------------
GROSS MARGIN 4,237,847 2,039,914 6,896,827 4,212,820
Sales and marketing 1,511,633 361,232 2,700,527 789,894
Research and development 599,631 114,787 998,710 298,379
General and administrative 1,368,305 490,373 2,621,128 1,205,533
------------- ------------- ------------- ---------
OPERATING INCOME BEFORE WRITE-OFF OF ACQUIRED
IN-PROCESS RESEARCH AND DEVELOPMENT 758,278 1,073,522 576,462 1,919,014
WRITE-OFF OF ACQUIRED IN-PROCESS RESEARCH
AND DEVELOPMENT -- -- 18,510,378 --
------------- ------------- ------------- --------------
INCOME (LOSS) FROM OPERATIONS 758,278 1,073,522 (17,933,916) 1,919,014
OTHER INCOME -- -- 77,438 --
INTEREST INCOME, NET 184,906 272,597 304,960 530,241
------------- ------------- ------------- --------------
184,906 272,597 382,398 530,241
INCOME (LOSS) BEFORE INCOME TAX
EXPENSE (BENEFIT) 943,184 1,346,119 (17,551,518) 2,449,255
INCOME TAX EXPENSE (BENEFIT) 222,762 498,064 (61,006) 906,225
------------- ------------- ------------- --------------
NET INCOME (LOSS) $ 720,422 $ 848,055 $ (17,490,512) $ 1,543,030
============= ============= ============= ==============
NET INCOME (LOSS) PER COMMON SHARE
Basic $ 0.06 $ 0.09 $ (1.56) $ 0.16
============= ============= ============= ==============
Diluted $ 0.06 $ 0.08 $ N/A $ 0.14
============= ============= ============= ==============
WEIGHTED AVERAGE SHARES USED IN THE
CALCULATION OF NET INCOME (LOSS) PER
COMMON SHARE
Basic 11,545,318 9,560,089 11,199,935 9,547,807
============= ============= ============= ==============
Diluted 12,572,615 10,740,610 N/A 10,744,356
============= ============= ============= ==============
See accompanying notes to financial statements
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SRS LABS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended
June 30,
-----------------------------------
1998 1997
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(17,490,512) $ 1,543,030
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation and amortization 805,683 163,459
Deferred income taxes (335,000) --
Write-off of acquired in-process research and development 18,510,378 --
Realized gain on sales of investments available for sale (76,277) --
Amortization of premium on investments available for sale 32,520 54,602
Accretion of consideration due on asset purchase 8,196 5,961
Increase in deferred compensation 51,754 43,096
Increase (decrease) in cash resulting from changes in operating accounts,
net of acquisitions:
Accounts receivable 1,213,908 (1,287,568)
Inventories (988) --
Prepaid expenses and other current assets (1,595,057) (37,811)
Accounts payable (836,693) (115,268)
Other accrued liabilities 692,735 (224,227)
Income taxes payable (477,042) 545,031
------------ ------------
Net cash provided by operations 503,606 690,305
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture, fixtures and equipment (95,292) (15,373)
Proceeds from sales of investments available for sale 7,467,572
Purchases of investments available for sale (580,256)
Cash paid for acquisitions, less cash acquired (6,911,216) --
Expenditures related to patents (534,985) (51,439)
------------ ------------
Net cash used in investing activities (73,921) (647,068)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from line of credit 7,000,000 --
Payments on subsidiary debt (6,846,737) --
Payment of consideration due on asset purchase (91,707) (112,305)
Exercise of stock options 166,971 140,543
------------ ------------
Net cash provided by financing activities 228,527 28,238
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 658,212 71,475
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 4,446,753 3,455,997
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 5,104,965 $ 3,527,472
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 109,896 $ 0
Income taxes $ 640,000 $ 0
SUPPLEMENTAL DISCLOSURES ON NON-CASH TRANSACTIONS:
Additional consideration accrued for asset purchase $ 8,196 $ 41,794
Unrealized gain (loss) on investments, net $ 57,759 $ (7,665)
See accompanying notes to financial statements
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SRS LABS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITY:
During the six months ended June 30, 1998, the Company issued 1,680,611 shares
of common stock in payment of $12,105,778 of the acquisition price of Valence
Technologies, Inc. (Note 2)
During the six months ended June 30, 1998, the Company issued 125,000 shares of
common stock in consideration for certain non-competition agreements with the
key employees of Valence. The shares have an ascribed fair value of $900,400.
(Note 2)
During the six months ended June 30, 1998, the Company issued 25,000 shares of
common stock in conjunction with the acquisition of VIP. The shares have an
ascribed fair value of $176,575. (Note 2)
During the six months ended June 30, 1998, the Company issued warrants to
purchase 100,000 shares of common stock in conjunction with the acquisition of
VIP. The warrants have an ascribed value of $341,957. (Note 2)
The Company acquired the stock of Valence Technologies, Inc. during the six
months ended June 30, 1998 (Note 2)
In conjunction with the acquisition, certain liabilities were assumed as
follows:
Fair value of assets acquired $ 14,076,279
Acquired in-process research and development costs 17,471,668
Acquired intangible assets 5,910,400
Total consideration (21,879,033)
------------
Liabilities assumed $ 15,579,314
============
During the six months ended June 30, 1998, the Company issued 35,294 shares of
common stock in conjunction with the acquisition of certain rights associated
with the Circle Surround technology. The shares have an ascribed fair value of
$300,000. (Note 2)
See accompanying notes to financial statements
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SRS LABS, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL/BASIS OF PRESENTATION
SRS Labs, Inc. (the "Company") is known as a leading provider of audio and
voice enhancement technology solutions. The Company's business consists of
licensing audio and voice enhancement technologies to manufacturers of consumer
electronics, computer, gaming and telecommunications equipment; the design of
custom ASICs (application-specific integrated circuits) for consumer
electronics, game, telecommunications and personal computer manufacturers; the
distribution of components, chips and assembly systems for the China and Hong
Kong markets; and the manufacturing and marketing of home theater and game
products for the Asian consumer marketplace.
The accompanying interim consolidated financial statements have been
prepared by the Company without audit (except for the balance sheet information
as of December 31, 1997) in conformity with generally accepted accounting
principles for interim financial information and with the rules and regulations
of the U.S. Securities and Exchange Commission. 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 such regulations. In the opinion of management, all adjustments
(which include only normal recurring adjustments) considered necessary for a
fair presentation have been included.
The interim financial statements should be read in conjunction with the
Company's Annual Report on Form 10-KSB for the fiscal year ended December 31,
1997, the Current Report on Form 8-K dated March 12, 1998 and the Current Report
on Form 8-K/A dated May 18, 1998. Current and future financial statements may
not be directly comparable to the Company's historical financial statements. The
results of operations for the interim periods are not necessarily indicative of
the results to be expected for the full year.
2. ACQUISITIONS
On March 2, 1998, the Company acquired (the "Acquisition") all of the
outstanding shares of capital stock of Valence Technology Inc., a British Virgin
Islands holding company with its principal business operations in Hong Kong and
China ("Valence"). Valence, which conducts its business through its subsidiaries
based in Hong Kong and China, is engaged in three primary areas of business,
namely, the design and sale of application-specific integrated circuits (ASICs)
and other semiconductor products; the design, manufacture and sale of consumer
electronics products; and the distribution of components and products within
mainland China and throughout Asia. The aggregate purchase price of $19,500,000
consisted of approximately $7,400,000 in cash and 1,680,611 shares of the
Company's common stock. The acquisition was accounted for as a purchase having
an effective date of February 1, 1998. In connection with such acquisition,
three of the four management shareholders and their respective sole
shareholders, each of whom was a key employee of Valence or one of its
subsidiaries, entered into non-competition agreements with the Company. In
consideration for these agreements and for a nominal cash payment equal to the
par value of the shares, the Company issued 125,000 additional shares of its
common stock in aggregate to such three shareholders.
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SRS LABS, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following summarizes the consideration granted for the acquisition of
Valence and non-compete agreements, the allocation of the purchase price and
other purchase accounting adjustments:
Cash $ 7,394,222
Common stock 13,006,178
-------------
Total purchase price 20,400,400
Deficiency in net assets acquired 1,503,035
Estimated acquisition costs 1,478,633
-------------
Excess of purchase price over net assets $ 23,382,068
=============
Allocation to:
In-process research and development $ 17,471,668
Intangible assets 5,910,400
-------------
$ 23,382,068
=============
The resulting intangible assets are being amortized on a straight-line
basis over periods ranging from three to eleven years.
Unaudited proforma combined results of operations for the six months ended
June 30, 1998 would have been as follows had the Acquisition occurred on January
1, 1998:
Revenues $ 21,020,759
Proforma Net Loss $ (520,064)
Proforma Net Loss Per Share $ (0.05)
Weighted Average Shares Outstanding 11,500,870
On February 28, 1998, the Company acquired certain rights to a proprietary
technology, Voice Intelligibility Processor, ("VIP") from a third party. The
aggregate consideration, including acquisition costs, was $1,138,710 and was
comprised of $620,178 in cash, 25,000 shares of the Company's common stock with
a fair value of $176,575 and warrants to purchase 100,000 shares of the
Company's common stock at $9.47 per share with a fair value of $341,957. The
purchase price allocated to in-process research and development was charged to
the Company's operations, resulting in a charge of $1,038,710. The remainder of
the purchase price was allocated to an intangible asset and is being amortized
over eight years.
On May 21, 1998, the Company acquired certain rights to a proprietary
technology, Circle Surround, from a third party. The aggregate consideration,
including acquisition costs, was $834,985 and was comprised of $534,985 in cash
and 35,294 shares of the Company's common stock with a fair value of $300,000.
The purchase price was allocated to an intangible asset and is being amortized
over ten years.
3. INVESTMENTS AVAILABLE FOR SALE
The Company has classified its investments as available-for-sale in
accordance with SFAS No. 115. As of June 30, 1998, the Company's
available-for-sale investments had a cost of $13,879,987 and an estimated fair
value of $14,049,320, based on quoted market prices. The unrealized gains on
these investments of $179,393, net of income taxes of $73,552, have been
reported in the Company's Consolidated Balance Sheet as an increase in
stockholders' equity.
4. CHANGE IN ACCOUNTING PRINCIPLES
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS 130). FAS
130 requires that all items recognized under accounting standards as components
of comprehensive earnings be reported in an annual financial statement that is
displayed with the same prominence as other annual financial statements. It also
requires that an entity classify items of other comprehensive earnings by their
nature in an annual financial statement. For example, other comprehensive
earnings
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SRS LABS, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
may include foreign currency translation adjustments and unrealized
gains and losses on marketable securities classified as available-for-sale.
Annual financial statements for prior periods will be reclassified, as required.
The Company's total comprehensive income (loss) is as follows:
FOR THREE MONTHS ENDED FOR SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------------- -----------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
Net income (loss) $ 720,422 $ 848,055 $(17,490,512) $ 1,543,030
Unrealized gain (loss) on investments
available for sale, net of tax (17,343) 81,656 (57,759) (4,589)
--------------------------------------------------------------------------------
Total comprehensive income (loss) $ 703,079 $ 929,711 $(17,548,271) $ 1,538,441
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5. NET INCOME (LOSS) PER COMMON SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" (FAS 128) which
is effective for financial statements for both interim and annual periods ending
after December 15, 1997. FAS 128 requires the Company to disclose a basic and
diluted earnings per share (EPS). The Company adopted the provisions of FAS 128
in the fiscal year ended December 31, 1997. The following is an illustration of
the reconciliation of the numerators and the denominators of the basic and
diluted net income (loss) per common share computations:
FOR THREE MONTHS FOR THREE MONTHS
ENDED JUNE 30, 1998 ENDED JUNE 30, 1997
----------------------------------------- -----------------------------------------
INCOME SHARES PER SHARE INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- --------- ----------- ------------- ---------
BASIC:
Income available to
common stockholders $ 720,422 11,545,318 $ 0.06 $ 848,055 9,560,089 $ 0.09
DILUTED:
Effect of Dilutive Securities:
Stock options 1,027,297 1,180,521 (0.01)
---------- ---------- ---------- ---------- ---------- ----------
Income available to common
stockholders $ 720,422 12,572,615 $ 0.06 $ 848,055 10,740,610 $ 0.08
========== ========== ========== ========== ========== ==========
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SRS LABS, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
FOR SIX MONTHS FOR SIX MONTHS
ENDED JUNE 30, 1998 ENDED JUNE 30, 1997
-------------------------------------------- --------------------------------------------
LOSS SHARES PER SHARE INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
------------ ------------ ------------ ------------ ------------ ------------
BASIC:
Income (loss) available to
common stockholders $(17,490,512) 11,199,935 $ (1.56) $ 1,543,030 9,547,807 $ 0.16
DILUTED :
Effect of Dilutive Securities:
Stock options 1,196,549 (0.02)
------------ ------------ ------------ ------------ ------------ ------------
Income available to common
stockholders N/A N/A N/A $ 1,543,030 10,744,356 $ 0.14
============ ============ ============ ============ ============ ============
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
SRS Labs, Inc. (the "Company") is known as a leading provider of audio and
voice enhancement technology solutions. The Company's business consists of
licensing audio and voice enhancement technologies to manufacturers of consumer
electronics, computer, gaming and telecommunications equipment; the design of
custom ASICs (application-specific integrated circuits) for consumer
electronics, game, telecommunications and personal computer manufacturers; the
distribution of components, chips and assembly systems for the China and Hong
Kong markets; and the manufacturing and marketing of home theater and game
products for the Asian consumer marketplace.
From the Company's inception in 1993 through February of 1998, the Company
derived substantially all of its revenue from royalties received from technology
licenses. On March 2, 1998, the Company acquired all of the outstanding capital
stock of Valence Technology Inc., a British Virgin Islands holding company with
its principal business operations in Hong Kong and China ("Valence") for an
aggregate purchase price, excluding non-compete agreements and acquisition
costs, of $19,500,000 consisting of approximately $7,400,000 in cash and
approximately 1,680,611 shares of the Company's common stock, $.001 par value
per share (the "Common Stock"). The acquisition was accounted for as a purchase
with an effective date of February 1, 1998. The acquisition of Valence has had,
and will continue to have, a material impact on the Company's financial
statements for the reporting period ending June 30, 1998 and for the reporting
periods thereafter; accordingly, current and future financial statements may not
be directly comparable to the Company's historical financial statements.
During the first quarter of the fiscal year ending December 31, 1998
("Fiscal 1998"), the Company acquired certain rights to Voice Intelligibility
Processor ("VIP"), which is a patented voice processing technology that improves
the intelligibility of the spoken voice, especially in high ambient noise
environments. Aggregate consideration, including acquisition costs, was
$1,138,710 and was comprised of $620,178 in cash, 25,000 shares of Common Stock
and warrants to purchase 100,000 shares of Common Stock at $9.47 per share.
During the second quarter of Fiscal 1998, the Company acquired certain
rights to Circle Surround, which is a patented audio delivery system that allows
multi-channel surround sound to be encoded into a two-channel stereo format and
allows an encoded two-channel audio source or a traditional stereo audio source
to be decoded into a multi-channel surround format. The aggregate purchase
price, including acquisition costs, was $834,985 and was comprised of $534,985
in cash and 35,294 shares of Common Stock.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997
Revenues
Total revenues for the three months ended June 30, 1998 were $11,625,370
including revenues generated by Valence. This contrasts with the second quarter
of 1997 when the revenues of $2,115,799 were generated entirely from the
Company's licensing activities. Chip and licensing revenue of $4,524,467
increased 113.8% compared to the same period last year. Licensing revenue
decreased from the same period last year, but the decrease was offset by the
custom ASIC chip design and chip sales related to Valence's activities. Revenue
generated from product and component sales is primarily attributable to Valence;
and therefore, is not comparable to last year.
Gross Margin
Gross margin for the three month period ended June 30, 1998 decreased to
36.5% from 96.4% for the same period in 1997. This decrease results from the
shift in the Company's revenue base towards product and electronic component
sales which have significantly lower margins compared with the Company's
historic technology licensing revenue base. The Company's gross margins in the
future will depend on the revenue mix between product and electronic component
sales and revenues from licensing and chip activities. However, the Company
expects product and electronic component sales to contribute a significant
portion of revenues in the near term, resulting in lower anticipated margins
compared to its historical margins.
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Sales and Marketing
Sales and marketing expenses for the second quarter were $1,511,633
compared to $361,232 for the same quarter last year, an increase of 318.5% which
is primarily due to sales and marketing activities attributed to Valence. Sales
and marketing expenses as a percentage of total revenue for the three months
ended June 30, 1998 decreased to 13.0% from 17.1% for the three months ended
June 30, 1997 due to the leveraging of these expenses over a wider revenue
base.
Research and Development
Research and development expenses for the second quarter were $599,631
compared to $114,787 for the same quarter last year, an increase of 422.4% which
is primarily due to research and development activities attributed to Valence.
Research and development expenses as a percentage of total revenue for the three
months ended June 30, 1998 decreased slightly to 5.2% from 5.4% for the three
months ended June 30, 1997.
General and Administrative
General and administrative expenses for the second quarter were $1,368,305
compared to $490,373 for the same quarter last year, an increase of 179.0% which
is primarily attributable to Valence's operations. General and administrative
expenses as a percentage of total revenue for the three months ended June 30,
1998 decreased to 11.8% from 23.2% for the three months ended June 30, 1997, as
general and administrative expenses are leveraged over a larger revenue base.
Other Income/Interest Income, net
Net interest income for the second quarter of $184,906 decreased from net
interest income of $272,597 for the second quarter of 1997. The decrease is
primarily due to lower average cash and investment balances during the current
quarter as compared to the prior year due to cash paid in conjunction with the
acquisition of Valence and for the acquisition of new technologies.
Income Tax Expense
Income tax expense for the second quarter was $222,762 compared to $498,064
for the same quarter last year, a decrease of 55.3%. The effective tax rate for
the three months ended June 30, 1998, which is based on current estimates of the
annual effective income tax rate, was 23.6% compared to 37.0% for the three
months ended June 30, 1997. Lower statutory tax rates in the Asian countries
where Valence has its principal business operations resulted in a lower
consolidated tax rate for the Company.
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
Revenues
Total revenues for the six months ended June 30, 1998 were $18,682,766
including revenues generated by Valence since February 1, 1998. This contrasts
with the six month period ended June 30, 1997 when the revenues of $4,327,899
were all generated from the Company's licensing activities. Chip and licensing
revenue of $7,406,428 increased 71.1% compared to the same period last year.
Licensing revenue decreased from the same period last year, but the decrease was
offset by the custom ASIC chip design and chip sales related to Valence's
activities. Revenue generated from product and component sales is primarily
attributable to Valence; and therefore, is not comparable to last year.
Gross Margin
Gross margin for the six month period ended June 30, 1998 decreased to
36.9% from 97.3% for the same period in 1997. This decrease results from the
shift in the Company's revenue base towards product and electronic component
sales that have significantly lower margins compared with the Company's historic
technology licensing revenue base. The Company's gross margins in the future
will depend on the revenue mix between product and electronic component sales
and revenues from licensing and chip activities.
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13
However, the Company expects product and electronic component sales to
contribute a significant portion of revenues in the near term, resulting in
lower anticipated margins compared to its historical margins.
Sales and Marketing
Sales and marketing expenses for the first six months of 1998 were
$2,700,527 compared to $789,894 for the same prior year period, an increase of
241.9% which is primarily due to sales and marketing activities attributed to
Valence. Sales and marketing expenses as a percentage of total revenue for the
six months ended June 30, 1998 decreased to 14.5% from 18.3% for the six months
ended June 30, 1997 due to the leveraging of these expenses over a wider revenue
base.
Research and Development
Research and development expenses for the six months ended June 30, 1998
were $998,710 compared to $298,379 for the same period last year, an increase of
234.7% which is primarily due to research and development activities attributed
to Valence. Research and development expenses as a percentage of total revenue
for the six months ended June 30, 1998 decreased to 5.3% from 6.9% for the six
months ended June 30, 1997.
General and Administrative
General and administrative expenses for the first six months of 1998 were
$2,621,128 compared to $1,205,533 for the comparable prior year period, an
increase of 117.4% which is primarily attributable to Valence's operations.
General and administrative expenses as a percentage of total revenue for the six
months ended June 30, 1998 decreased to 14.0% from 27.9% for the six months
ended June 30, 1997, as general and administrative expenses are leveraged over a
larger revenue base.
Acquired In-Process Research and Development
Acquired in-process research and development costs of $18,510,378 during
the six month period ended June 30, 1998 represented an allocation of a portion
of the purchase price for certain assets associated with the VIP technology and
for the acquisition of the outstanding shares of Valence Technology, Inc. to
in-process research and development costs, which, based on management
assumptions, had no future alternative use. (See Note 2 to the Interim
Consolidated Financial Statements.)
Other Income / Interest Income, net
Net interest and other income resulted in net other income of $382,398, a
decrease from the net interest income amount of $530,241 for the first half of
1997. The decrease is primarily due to lower average cash and investment
balances during the fiscal year to date as compared to the prior year due to
cash paid in conjunction with the acquisition of Valence and for the acquisition
of new technologies.
Income Tax Expense (Benefit)
The income tax benefit for the six months ended June 30, 1998 was $61,006
compared to expense of $906,225 for the same period last year. Lower statutory
tax rates in the Asian countries where Valence has its principal business
operations contributed to a lower consolidated tax rate.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal source of liquidity at June 30, 1998 consisted of
cash, cash equivalents and investments aggregating $19.2 million, as well as
borrowings available under its credit facility. The Company's cash, cash
equivalents and investments serve as collateral for borrowings under the
Company's credit facility. At June 30, 1997, the Company had cash, cash
equivalents and long term investments of approximately $25.0 million.
The Company has primarily financed its operations through the cash provided
by its operations and proceeds from its initial public offering of Common Stock
in August 1996. The Company's operating activities provided
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$503,606 in cash for the six months ended June 30, 1998 and $690,305 for the six
months ended June 30, 1997. The $186,699 decrease in cash provided by operations
was primarily due to the increase in prepaid expenses and other current assets
and the decrease in accounts payable resulting from the payment of acquisition
related expenses and the payment of estimated corporate income taxes, all of
which were partially offset by the decrease in accounts receivable.
As described above, the Company acquired Valence and additional
technologies during the first six months of Fiscal 1998. (See Note 2 to the
Interim Consolidated Financial Statements.)
On March 4, 1998, the Company obtained a revolving line of credit with a
bank which expires on June 1, 2000 and is secured by certain of the Company's
investments. The total availability under the line of credit is the lesser of
$10 million or a percentage of the fair market value of the collateral. The line
of credit bears interest at the bank's prime rate or LIBOR plus 0.75%. The
Company had $7.0 million outstanding under the line of credit as of June 30,
1998. As a result of the acquisition of Valence, the Company provided Valence
$7.0 million to pay off its short-term debt and other obligations. These funds
were provided by borrowings on the above-referenced line of credit.
The Company anticipates that its primary uses of working capital in future
periods will be to acquire new technologies, to provide Valence with additional
working capital and to fund increased costs for additional sales headcount and
marketing activities associated with the introduction of new technologies and
products into the market. The Company also anticipates making additional capital
expenditures for the improvement of its operating system infrastructure and
management reporting systems in the United States and Hong Kong. Management
currently estimates these capital expenditures could aggregate $1,500,000
through 1999.
Based on current plans and business conditions, the Company believes that
its cash, cash equivalents, investments and/or available borrowings under its
line of credit, together with any amounts generated from operations, will be
sufficient to meet the Company's operating and capital requirements for the
foreseeable future. However, there can be no assurance that the Company will not
be required to seek other financing sooner or that such financing, if required,
will be available on terms satisfactory to the Company.
FORWARD-LOOKING STATEMENTS AND FACTORS WHICH MAY AFFECT FUTURE RESULTS
Included in this Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations are a number of forward-looking statements
that are subject to certain risks and uncertainties that could cause the
Company's actual results and financial position to be affected negatively as
events unfold in the markets for the Company's products. These events include,
but are not limited to, the risks involved in the expansion of the Company's
business through acquisitions of new companies like Valence or new technologies
like VIP and Circle Surround, as well as the risks discussed below. The Company
assumes no obligation to update the forward-looking information in this Report
or the factors listed below to reflect actual results or changes in the factors
affecting such forward-looking information.
Quarterly Fluctuations
The Company's operating results may fluctuate from those in prior quarters
and will continue to be subject to quarterly and other fluctuations due to a
variety of factors, including the extent to which the Company's licensees
incorporate SRS or the Company's other technologies into their products, the
gain or loss of significant customers, competitive pressures on selling prices,
the acceptance of new or enhanced versions of the Company's technologies, the
rate that the Company's semiconductor licensees manufacture and distribute chips
to original equipment manufacturers ("OEMs"), the ability of the Company to
secure one-time license fees for its technologies from new and existing
licensees and general business conditions, particularly those affecting the
consumer electronics market. Due to the Company's dependence on the consumer
electronics market, the substantial seasonality of sales in the market could
impact the Company's revenues and net income. In particular, the Company
believes that there is seasonality relating to the Christmas season as well as
the Chinese New Year within the Asia-Pacific region which fall into the fourth
and first quarters, respectively.
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Changes to the Business Model/Integration of Valence/Refinement of Asian
Strategy
From the Company's inception in 1993 to 1997, the Company derived
substantially all of its revenues from licensing activities. As a result of the
acquisition of Valence, the Company has added business operations engaged in the
design and sale of ASICs and other semiconductor products; the design,
manufacture and sale of consumer electronics products; and the distribution of
components and products within mainland China and throughout Asia. These
operations differ substantially from the Company's previous business model, and
future operating results could be affected by a variety of factors, including
the timing of customer orders, the timing of development revenue, changes in the
mix of products distributed and the mix of distribution channels employed, the
emergence of new industry standards, product obsolescence and changes in pricing
policies by the Company, its competitors or its suppliers.
The Company's future success will depend in large part on its ability to
successfully integrate the operations of Valence with those of the Company. The
degree to which the Company can successfully integrate such operations will
depend on a number of factors, including the Company's ability to expand the
scope of its operations beyond technology licensing into the new business of
manufacturing electronic and semiconductor products and the Company's ability to
increase its market penetration in China. The integration of certain operations
following the acquisition will require the dedication of management and other
personnel resources which may temporarily distract from the day-to-day business
of the combined company. The geographic separation of these operations is likely
to place additional strain on the Company's resources. In addition, the
Company's significant operations in China and Asia may require refinement to
adapt to the changing and expanding market conditions in that region. This
refinement may impact certain of the Company's current business directions,
including Valence, as the Company attempts to position itself to maximize
penetration of these rapidly developing markets. The Company's operations in
Asia, and internationally in general, also are subject to risks of unexpected
changes in, or impositions of, legislative or regulatory requirements.
The acquisition of Valence has added significant diversity to the Company's
overall business structure and the Company's opportunities. The Company
recognizes that in the presence of such corporate diversity, and in particular
with regard to the semiconductor industry, there will always exist a potential
for a conflict among sales channels between the Company and certain of the
Company's technology licensees. Although the operations of the Company's
licensing business and those of Valence are generally complementary, there can
be no assurances that sales channel conflicts will not arise. If such potential
conflicts do materialize, the Company may or may not be able to mitigate the
effect of such perceived conflicts which, if not resolved, may impact the
results of operations.
Currency Risk/Stability of Asian Markets
The Company expects that international sales will continue to represent
a significant portion of total revenues. To date, all of the Company's revenues
have been denominated in U.S. dollars and most costs have been incurred in U.S.
dollars. It is the Company's expectation that licensing revenues will continue
to be denominated in U.S. dollars for the foreseeable future. With its
acquisition of Valence and the Company's anticipated expansion of its business
in China and other parts of Asia, the Company's consolidated operations and
financial results could be significantly affected by risks associated with
international activities, including economic and labor conditions, political
instability, tax laws (including U.S. taxes on foreign subsidiaries) and changes
in the value of the U.S. dollar versus the local currency in which the products
are sold. In addition, the Company's valuation of assets recorded as a result of
the Valence acquisition may also be adversely impacted by the currency
fluctuations relative to the U.S. dollar. The Company intends to actively
monitor its foreign exchange exposure and to implement strategies to reduce its
foreign exchange risk at such time that the Company determines the benefits of
such strategies outweigh the associated costs. However, there is no guarantee
that the Company will take steps to insure against such risks, and should such
risks occur, there is no guarantee that the Company will not be significantly
impacted. Countries in the Asia Pacific region have recently experienced
weakness in their currency, banking and equity markets. These weaknesses could
adversely affect consumer demand for Valence's products, the U.S. dollar value
of the Company's and its subsidiaries' foreign currency denominated sales, the
availability and supply of product components to Valence and ultimately, the
Company's consolidated results of operations.
Competitive Pressures
The Company's existing and potential competitors include both large and
emerging domestic and international companies that have substantially greater
financial, manufacturing, technical, marketing, distribution
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and other resources. Competitors of the Company may also include a number of
smaller companies that may have greater flexibility to address specific market
needs. In addition, the markets in which the Company competes are intensely
competitive and are characterized by rapid technological changes, declining
average sales prices and rapid product obsolescence.
Importance of Intellectual Property
The Company's ability to compete may be affected by its ability to protect
its proprietary information. The Company has filed several U.S. and foreign
patent applications and to date has a number of issued U.S. and foreign patents
covering various aspects of its technologies. There can be no assurance that the
steps taken by the Company to protect its intellectual property will be adequate
to prevent misappropriation of its technology or that the Company's competitors
will not independently develop technologies that are substantially equivalent or
superior to the Company's technology. In addition, the laws of certain foreign
countries may not protect the Company's intellectual property rights to the same
extent as do the laws of the U.S. The semiconductor industry is characterized by
frequent claims and litigation regarding patent and other property rights. The
Company is not currently a party to any claims of this nature. There can be no
assurances that third parties will not assert additional claims or initiate
litigation against the Company or its customers with respect to existing or
future products. In addition, the Company may initiate claims or litigation
against third parties for infringement of the Company's proprietary rights or to
determine the scope and validity of the proprietary rights of the Company or
others.
Management of Growth; Dependence on Key Personnel
The Company has recently experienced rapid growth and expansion with the
acquisition of Valence. This acquisition has placed, and will continue to place,
a significant strain on its administrative, operational and financial resources,
and has increased, and will continue to increase, the level of responsibility
for both existing and new management personnel. The Company's future success
depends in part on the continued service of its key engineering, sales,
marketing and executive personnel, including highly skilled semiconductor design
personnel. The Company anticipates that any future growth will require it to
recruit and hire a number of new personnel in engineering, operations, finance,
sales and marketing. Competition for such personnel is intense, and there can be
no assurance that the Company can retain and recruit necessary personnel to
operate its business and support future growth. The Company's ability to manage
its growth successfully also will require the Company to continue to expand and
improve its administrative, operational, management and financial systems and
controls.
Volatility of Stock Price
The trading price of the Common Stock has been, and will likely continue to
be, subject to wide fluctuations in response to quarterly variations in the
Company's operating results, announcements of new products or technological
innovations by the Company or its competitors, general market fluctuations and
other events and factors. Changes in earnings estimates made by brokerage firms
and industry analysts relating to the markets in which the Company does
business, or relating to the Company specifically, have in the past resulted in,
and could in the future result in, an immediate and adverse effect on the market
price of the Common Stock.
Year 2000 Compliance
Many of the world's computer systems currently record years in a two-digit
format. Such computer systems will be unable to properly interpret dates beyond
the year 1999, which could lead to business disruptions in the U.S. and
internationally (the "Year 2000" issue). The potential costs and uncertainties
associated with the Year 2000 issue will depend on a number of factors,
including software, hardware and the nature of the industry in which the Company
operates. Additionally, companies must coordinate with other entities with which
they electronically interact, such as customers and creditors.
The Company and its subsidiaries have evaluated all significant internal
operating systems and have determined that their Year 2000 compliance efforts
will not have a material impact on the results of operations.
In addition, the Company and its subsidiaries are actively working with all
of their major suppliers and customers to assess their Year 2000 compliance
efforts and the Company's exposure to them. At this time, it is
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not possible to quantify the aggregate cost to the Company and its subsidiaries
related to the Year 2000 compliance issues facing the Company's major suppliers
and customers.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
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PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
SALES OF UNREGISTERED SECURITIES
During the second quarter of Fiscal 1998, the Company acquired certain
assets, including the Circle Surround technology, of Rocktron Corporation
("Rocktron"), pursuant to an Asset Purchase Agreement dated May 21, 1998 (the
"Circle Surround Acquisition") for an aggregate purchase price of $800,000. In
connection with the Circle Surround Acquisition, the Company paid to Rocktron
$500,000 in cash and issued to Rocktron 35,294 shares of the Company's common
stock, $.001 par value per share. In addition, the Company agreed to pay
Rocktron royalties based upon certain percentages (ranging from 5-50%) of
licensing royalties generated from use of the Circle Surround technology over a
ten year period. The securities were issued in reliance on the private offering
exemption set forth in Section 4(2) of the Securities Act of 1933, as amended,
on the basis that they were issued under circumstances not involving a public
offering.
USE OF PROCEEDS
The effective date of the Company's initial public offering of its Common
Stock was August 8, 1996 (SEC Registration No. 333-4974-LA). During the second
quarter of Fiscal 1998, the Company utilized $500,000 of the $22,052,955 net
offering proceeds as follows:
DIRECT OR INDIRECT PAYMENTS TO
DIRECTORS, OFFICERS, GENERAL
PARTNERS OF THE ISSUER OR THEIR
ASSOCIATES TO PERSONS OWNING TEN
PERCENT OR MORE OF ANY CLASS OF
EQUITY SECURITIES OF THE ISSUER, DIRECT OR INDIRECT
AND TO AFFILIATES OF THE ISSUER PAYMENTS TO OTHERS
-------------------------------- ------------------
Construction of plant, building and
facilities -- --
Purchase and installation of machinery and
equipment -- --
Purchase of real estate -- --
Acquisition of other business(es)/assets -- 8,394,222(1)
Repayment of indebtedness -- --
Working capital -- --
Temporary investment (cash and municipal
bonds) -- 13,658,733(2)
- -------------------------------
(1) In connection with the Circle Surround Acquisition, the Company utilized
$500,000 of the net offering proceeds as part of the consideration to
acquire assets related to the Circle Surround technology. During the first
quarter of Fiscal 1998, the Company utilized an aggregate of $7,894,222 in
connection with two other acquisitions (see Note 2 to the Interim
Consolidated Financial Statements).
(2) The remaining funds are temporarily invested in cash and municipal bonds
pending application.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of SRS Labs, Inc. was held on June 11,
1998 for the purpose of (i) electing two Class II Directors to the Board of
Directors; (ii) voting on a proposal to approve an amendment to the SRS Labs,
Inc. Amended and Restated 1996 Long-Term Incentive Plan (the "Incentive Plan")
to increase the number of shares of common
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stock available for issuance thereunder by 2,500,000; and (iii) voting on a
proposal to approve an amendment to the Incentive Plan to allow directors of the
Company and any Subsidiary of the Company to participate in the Incentive Plan.
John AuYeung and John Tu were elected to serve as Class II Directors of the
Company for three year terms expiring at the 2001 Annual Meeting of
Stockholders. Jeffrey I. Scheinrock and Thomas W.T. Wan continued in office as
Class I Directors, and Stephen V. Sedmak and Thomas C.K. Yuen continued in
office as Class III Directors. The tabulation of the votes cast for the election
of Mr. AuYeung and Mr. Tu was as follows:
Votes Votes
For Withheld
---------- ----------
Mr. AuYeung 10,182,460 31,481
Mr. Tu 9,901,090 312,851
The amendment to the Incentive Plan to increase by 2,500,000 the number of
common shares available for issuance was approved. The tabulation of the votes
was as follows:
Votes Votes Broker
For Against Abstentions Non-Votes
--------- --------- ----------- ---------
6,864,052 1,424,325 11,333 1,914,231
The amendment to the Incentive Plan to allow directors of the Company and
its Subsidiaries to participate in the Incentive Plan was approved. The
tabulation of the votes was as follows:
Votes Votes Broker
For Against Abstentions Non-Votes
--------- -------- ----------- ---------
9,140,072 1,055,441 18,428 0
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. The exhibits listed below are filed with the U.S. Securities
and Exchanges Commission (the "Commission") as part of this Report.
Exhibit
No. Description
------- -----------
2.1 Asset Purchase Agreement dated as of May 21, 1998, by and
between Rocktron Corporation and the Company.
10.1 Registration Rights Agreement dated as of May 21, 1998,
between Rocktron Corporation and the Company.
27 Financial Data Schedule
(b) Reports on Form 8-K
Complying with the undertaking set forth in its Current Report on Form 8-K
dated March 12, 1998 and filed with the Commission on March 13, 1998 related to
the acquisition of Valence, the Company filed with the Commission on May 18,
1998 a Current Report on Form 8-K/A dated May 18, 1998, filing the following
financial information relating to the acquisition of Valence: (i) audited
consolidated financial statements of Valence for the ten months ended January
31, 1998 and for the year ended March 31, 1997, and the related Independent
Auditors' Report and (ii) unaudited pro forma consolidated condensed financial
statements of SRS Labs, Inc. for the twelve months ended December 31, 1997 and
the three months ended March 31, 1998 reflecting the acquisition of Valence. No
other reports on Form 8-K were filed during the three month period ended June
30, 1998.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SRS LABS, INC.,
a Delaware Corporation
Date: August 14, 1998 By: /s/ JANET M. BISKI
------------------------------------
Janet M. Biski
Vice President, Chief Financial Officer and
Secretary (Principal Financial and
Accounting Officer)
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EXHIBIT INDEX
Exhibit
No. Description
------- -----------
2.1 Asset Purchase Agreement dated as of May 21, 1998, by and
between Rocktron Corporation and the Company.
10.1 Registration Rights Agreement dated as of May 21, 1998,
between Rocktron Corporation and the Company.
27 Financial Data Schedule