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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
--------------
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to___________
COMMISSION FILE NUMBER 0-21123
SRS LABS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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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)
--------------
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 October 31, 1999,
11,714,609 shares of the issuer's common stock, par value $.001 per share, were
outstanding, including 36,100 shares of the issuer's common stock designated as
treasury stock.
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SRS LABS, INC.
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 1999
INDEX
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Consolidated Balance Sheets as of September 30, 1999 (Unaudited)
and December 31, 1998 3
Consolidated Statements of Operations for the three months and
nine months ended September 30, 1999 and 1998 (Unaudited) 4
Consolidated Statements of Comprehensive Income (Loss) for
the three months and nine months ended September 30, 1999
and 1998 (Unaudited) 5
Consolidated Statements of Cash Flows for the nine months ended
September 30, 1999 and 1998 (Unaudited) 6
Notes to the Interim Consolidated Financial Statements (Unaudited) 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations. 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 21
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. 22
Item 2. Changes in Securities and Use of Proceeds. 22
Item 6. Exhibits and Reports on Form 8-K. 23
SIGNATURES 23
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
SRS LABS, INC.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
1999 1998
------------ ------------
(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 9,565,940 $ 12,341,242
Investments available for sale 3,006,045 1,519,425
Accounts receivable, net 4,732,727 5,320,686
Inventories, net 4,367,025 4,632,968
Prepaid expenses and other current assets 1,031,224 3,244,233
Deferred income taxes 17,456 17,456
------------ ------------
TOTAL CURRENT ASSETS 22,720,417 27,076,010
Investments available for sale 7,889,687 10,570,192
Furniture, fixtures & equipment, net 1,175,949 1,219,433
Intangible assets, net 5,819,299 6,669,671
------------ ------------
TOTAL ASSETS $ 37,605,352 $ 45,535,306
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 2,855,125 $ 10,632,505
Accrued liabilities 1,418,786 422,843
Line of credit 8,028,444 8,000,000
Income taxes payable 393,225 376,545
------------ ------------
TOTAL CURRENT LIABILITIES 12,695,580 19,431,893
Deferred income taxes 31,240 31,240
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; 11,714,609 (at September 30, 1999)
and 11,688,893 (at December 31, 1998) shares issued
and outstanding 11,715 11,689
Additional paid-in capital 39,227,213 39,170,103
Deferred stock option compensation 461,324 313,302
Cumulative other comprehensive income 52,082 141,389
Retained deficit (14,744,771) (13,564,310)
Less treasury stock at cost, 36,100 (at September 30,
1999) and zero (at December 31, 1998) shares (129,031) --
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 24,878,532 26,072,173
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 37,605,352 $ 45,535,306
============ ============
See accompanying notes to consolidated financial statements
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SRS LABS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- -----------------------------
1999 1998 1999 1998
----------- ----------- ------------ ------------
REVENUES
Chip and licensing revenue 4,829,847 $ 3,935,479 $ 12,923,851 $ 11,341,907
Product and component sales 5,174,772 7,382,323 13,001,555 18,658,661
----------- ----------- ------------ ------------
TOTAL REVENUES 10,004,619 11,317,802 25,925,406 30,000,568
COST OF SALES 6,064,191 7,810,345 16,242,610 19,596,284
----------- ----------- ------------ ------------
GROSS MARGIN 3,940,428 3,507,457 9,682,796 10,404,284
Sales and marketing 1,351,882 1,176,466 4,025,818 3,876,993
Research and development 866,149 577,816 2,295,510 1,576,526
General and administrative 1,494,879 1,536,407 5,044,255 4,157,535
Acquired in-process research and development -- -- -- 18,510,378
----------- ----------- ------------ ------------
INCOME (LOSS) FROM OPERATIONS 227,518 216,768 (1,682,787) (17,717,148)
OTHER INCOME, NET 190,728 11,728 396,131 394,126
INCOME (LOSS) BEFORE INCOME TAX EXPENSE
(BENEFIT) 418,246 228,496 (1,286,656) (17,323,022)
INCOME TAX EXPENSE (BENEFIT) 107,824 36,986 (105,843) (24,020)
----------- ----------- ------------ ------------
NET INCOME (LOSS) $ 310,422 $ 191,510 $ (1,180,813) $(17,299,002)
=========== =========== ============ ============
NET INCOME (LOSS) PER COMMON SHARE
Basic $ 0.03 $ 0.02 $ (0.10) $ (1.53)
=========== =========== ============ ============
Diluted $ 0.03 $ 0.02 $ (0.10) $ (1.53)
=========== =========== ============ ============
WEIGHTED AVERAGE SHARES USED IN THE
CALCULATION OF NET INCOME (LOSS) PER
COMMON SHARE
Basic 11,682,336 11,619,090 11,683,634 11,339,653
=========== =========== ============ ============
Diluted 12,108,558 11,619,090 11,683,634 11,339,653
=========== =========== ============ ============
See accompanying notes to consolidated financial statements
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SRS LABS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------------
1999 1998 1999 1998
--------- -------- ----------- ------------
Net income (loss) $ 310,422 $191,510 $(1,180,813) $(17,299,002)
Other comprehensive loss
Unrealized (loss) gain on investments
available for sale, net of tax (18,477) 41,422 (89,307) (16,336)
--------- -------- ----------- ------------
Comprehensive income (loss) $ 291,945 $232,932 $(1,270,120) $(17,315,338)
========= ======== =========== ============
See accompanying notes to consolidated financial statements
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SRS LABS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
September 30,
-----------------------------
1999 1998
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,180,813) $(17,299,002)
Adjustments to reconcile net loss to net cash (used in) provided
by operating activities:
Depreciation and amortization 1,572,928 1,300,758
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 -- (77,438)
Amortization of premium on investments available for sale 42,515 39,464
Accretion of consideration due on asset purchase -- 8,196
Increase in deferred stock option compensation 148,022 75,406
Changes in operating assets and liabilities, net of the effect of
acquisitions:
Accounts receivable 587,959 1,560,735
Inventories 265,943 (307,698)
Prepaid expenses and other current assets 2,213,009 (437,722)
Accounts payable (7,777,380) (1,750,143)
Accrued liabilities 995,943 695,550
Income taxes payable 79,094 (467,447)
------------ ------------
Net cash (used in) provided by operations (3,052,780) 1,516,037
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture, fixtures and equipment (330,851) (166,042)
Proceeds from sales of investments available for sale -- 8,317,572
Cash paid for acquisitions, less cash acquired -- (6,911,216)
Proceeds from investment maturities
1,000,001 --
Expenditures related to patents (348,221) (576,830)
------------ ------------
Net cash provided by investing activities 320,929 663,484
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from line of credit 28,444 8,000,000
Payments on subsidiary debt -- (6,846,737)
Payment of consideration due on asset purchase -- (91,707)
Repurchase of common stock (129,031) --
Proceeds from exercise of stock options 57,136 168,371
------------ ------------
Net cash (used in) provided by financing activities (43,451) 1,229,927
------------ ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (2,775,302) 3,409,448
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 12,341,242 4,446,753
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 9,565,940 $ 7,856,201
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 364,085 $ 239,716
Income taxes $ -- $ 640,000
See accompanying notes to consolidated financial statements
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SRS LABS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Nine Months Ended September 30,
-------------------------------
1999 1998
--------- --------
Additional consideration accrued for asset purchase $ -- $ 8,196
Unrealized gain (loss) on investments, net $ (89,307) $(16,336)
The Company acquired the stock of Valence Technology Inc. ("Valence") during
March 1998 (Note 2) and issued 1,680,611 shares of common stock in payment of
$12,105,778 of the acquisition price.
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, including acquisition costs (21,879,033)
------------
Liabilities assumed $ 15,579,314
============
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).
In February 1998, the Company issued 25,000 shares of common stock and warrants
to purchase 100,000 shares of common stock in conjunction with the acquisition
of Voice Intelligibility Processor ("VIP"). The shares and warrants have an
ascribed fair value of $176,575 and $341,957, respectively (Note 2).
In May 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).
In January 1999, the Company received certain computer equipment and a fully
paid-up license for MPEG-1 Technology Core from DVS Inc. in payment for $300,000
of license fees due to the Company for the use of its technologies.
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SRS LABS, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL/BASIS OF PRESENTATION
SRS Labs, Inc. is a developer and provider of technology solutions for the
consumer electronics, computer, game and telecommunications markets. The
Company's principal business activities in these markets include:
o Developing and licensing audio and voice technologies to consumer
electronic manufacturers and semiconductor manufacturers around the world;
and
o Through its subsidiary, Valence Technology Inc. and its foreign
subsidiaries, designing and selling technology solutions through custom
application specific integrated circuits ("ASICs") to consumer electronic
manufacturers; and designing, distributing and manufacturing components,
sub-assemblies and electronics products for manufacturers and retailers
within the Company's targeted markets.
The accompanying interim consolidated financial statements have been
prepared by the Company without audit (except for the balance sheet information
as of December 31, 1998) 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. In the opinion of management,
all adjustments (which include only normal recurring adjustments) considered
necessary for a fair presentation have been included.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. Therefore, the interim financial statements
should be read in conjunction with the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 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 the following business activities:
(i) the development and marketing of technology in the form of integrated
circuits (ASICs) to consumer electronic manufacturers and (ii) the sale of
consumer electronic and telecommunications products and components. 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 with a fair value of
$12,105,778. The Company's consolidated statement of operations for the nine
months ended September 30, 1998 includes a charge of $17.5 million for the
write-off of acquired in-process research and development expense associated
with the Valence acquisition. 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 the 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 the 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
Acquisition costs 1,478,633
-------------
Excess of purchase price over net assets acquired $ 23,382,068
=============
Allocation to:
In-process research and development $ 17,471,668
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.
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 Statement of Financial Accounting Standards ("SFAS") No. 115. As
of September 30, 1999, the Company's available-for-sale investments had a cost
of $10,807,458 and an estimated fair value of $10,895,732, based on quoted
market prices. The unrealized gains on these investments of $88,274, net of
income taxes of $36,192, are reported as cumulative other comprehensive income
in the accompanying consolidated balance sheets.
4. INVENTORIES
Inventories, which consist of finished goods, are stated at the lower of
cost or net realizable value. Cost is calculated using the weighted average
method and is comprised of material costs and, where applicable, subcontracting
and overhead costs that have been incurred in bringing the inventories to their
present location and condition. Net realizable value represents the estimated
selling price less estimated costs to completion and costs to be incurred in
selling and distribution.
5. NET INCOME (LOSS) PER COMMON SHARE
The Company computes earnings per share (EPS) in accordance with SFAS No.
128, "Earnings per Share". SFAS No. 128 requires the Company to disclose basic
and diluted earnings per share.
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SRS LABS, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
6. CONTINGENCIES
The Company is subject to legal proceedings and claims that arise in the
normal course of business. While the outcome of these proceedings and claims
cannot be predicted with certainty, management does not believe that the outcome
of any of these matters will have a material adverse effect on the Company's
consolidated financial position or results of operations.
7. STOCKHOLDERS' EQUITY
During the fiscal year ended December 31, 1998 ("Fiscal 1998"), the
Company's Board of Directors authorized the repurchase of up to 500,000 of the
outstanding shares of the Company's common stock. As of September 30, 1999,
36,100 shares had been repurchased at a cost of $129,031. Such repurchased
shares are reflected as treasury stock in the accompanying consolidated balance
sheets.
8. SEGMENT INFORMATION
The Company operates in two business segments: (i) the development and
marketing of technology either in the form of integrated circuits through
Valence (ASICs) or the licensing of technologies developed by the Company to
consumer electronic manufacturers and semiconductor manufacturers and (ii) the
sale of consumer electronic products and components. The Company does not
allocate operating expenses or specific assets to these segments. Therefore,
segment information includes only net revenues, cost of sales and gross margin.
Prior to the acquisition of Valence, the Company operated in the single business
segment of licensing audio technologies.
Three Months Ended September 30, 1999
---------------------------------------
Chips and Product and
Licensing Component Sales Total
---------- --------------- -----------
Net revenues $4,831,772 $5,172,847 $10,004,619
Cost of sales 1,227,489 4,836,702 6,064,191
---------- ---------- -----------
Gross margin $3,604,283 $ 336,145 $ 3,940,428
========== ========== ===========
Three Months Ended September 30, 1998
---------------------------------------
Chips and Product and
Licensing Component Sales Total
---------- --------------- -----------
Net revenues $3,935,479 $7,382,323 $11,317,802
Cost of sales 878,958 6,931,387 7,810,345
---------- ---------- -----------
Gross margin $3,056,521 $ 450,936 $ 3,507,457
========== ========== ===========
Nine Months Ended September 30, 1999
-----------------------------------------
Chips and Product and
Licensing Component Sales Total
----------- --------------- -----------
Net revenues $12,925,776 $12,999,630 $25,925,406
Cost of sales 3,854,755 12,387,855 16,242,610
----------- ----------- -----------
Gross margin $ 9,071,021 $ 611,775 $ 9,682,796
=========== =========== ===========
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SRS LABS, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Nine Months Ended September 30, 1998
-----------------------------------------
Chips and Product and
Licensing Component Sales Total
----------- --------------- -----------
Net revenues $11,341,907 $18,658,661 $30,000,568
Cost of sales 2,732,736 16,863,548 19,596,284
----------- ----------- -----------
Gross margin $ 8,609,171 $ 1,795,113 $10,404,284
=========== =========== ===========
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
SRS Labs, Inc. is a developer and provider of technology solutions for the
consumer electronics, computer, game and telecommunications markets. The
Company's principal business activities in these markets include:
o Developing and licensing audio and voice technologies to consumer
electronic manufacturers and semiconductor manufacturers around the world;
and
o Through its subsidiary, Valence Technology Inc. and its foreign
subsidiaries, designing and selling technology solutions through custom
application specific integrated circuits ("ASICs") to consumer electronic
manufacturers; and designing, distributing and manufacturing components,
sub-assemblies and electronics products for manufacturers and retailers
within the Company's targeted markets.
From the Company's inception in 1993 until February 1998, the Company
derived substantially all of its revenue from royalties received from technology
licenses. On March 2, 1998, the Company acquired all of the outstanding capital
stock of Valence Technology Inc., a British Virgin Islands holding company with
its principal business operations in Hong Kong and China ("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 had a
material impact on the Company's financial statements for the fiscal year ended
December 31, 1998 ("Fiscal 1998") and will continue to have a material impact
for the reporting periods thereafter; accordingly, current and future financial
statements may not be directly comparable to the Company's historical financial
statements.
SRS Labs, Inc. currently operates in two business segments: (a) the
development and marketing of technology in the forms of integrated circuits
designed and distributed through Valence and the licensing of technologies
developed by the Company to consumer electronic manufacturers and semiconductor
manufacturers and (b) the sale of consumer electronic products and components. A
summary of the Company's operations and activities by business segment is
included in the notes to the interim consolidated financial statements.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1998
Revenues
Chip and licensing revenue consists of design fees and sales of custom
application specific integrated circuits (ASICs) by Valence to consumer
electronic manufacturers and sales of general purpose ASICs designed by the
Company under the brand name ASP Microelectronics. Licensing revenues are
royalties and technology transfer fees that are currently generated primarily
from the license of the Company's audio technologies. License and royalty
agreements generally provide for the license of technologies for a specified
period of time for either a single fee or a fee based on the number of units
distributed by the licensee. Product and component sales primarily represent the
distribution of semiconductor products, manufacturing components and
sub-assemblies to consumer electronic manufacturers for the Hong Kong and China
markets. Certain sub-assemblies sold by the Company are incorporated in
electronic home entertainment products under the Valence brand name.
Total revenues for the three months ended September 30, 1999 were
$10,004,619 compared to $11,317,802 for the three months ended September 30,
1998. Excluding chip design revenue, licensing revenue decreased 36.8% from the
same period last year due to the following factors: (a) the shift in the PC
market to lower cost models which cannot bear the cost of performance
enhancement technologies such as those offered by SRS Labs; (b) the Asian
financial crisis which reduced demand for consumer electronics products in the
region and negatively impacted the sales of semiconductor ICs that include the
Company's audio technologies; (c) the trend by consumer
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electronic manufacturers to initially adopt the Company's new technologies into
their higher end models with limited volume potential for the short-term; and
(d) the absence of technology transfer fees due to the overall economic
conditions in Asia and Europe. The licensing revenue decrease was offset by an
increase of 62.2% in the custom ASIC chip design and chip sales related to
Valence's activities. Revenue from product and component sales decreased to
$5,174,772 for the quarter ended September 30, 1999 from $7,382,323 for the same
prior year quarter primarily due to the Company's decision to focus on higher
margin revenue and de-emphasize the lower margin distribution activities.
Gross Margin
Cost of sales consists primarily of fabrication costs, assembly and test
costs, and the cost of materials and overhead from operations. Gross margin as a
percentage of total revenue for the three months ended September 30, 1999
increased to 39.4% from 31.0% for the same period in fiscal 1998. The increase
resulted from the shift in the Company's revenue base towards higher margin chip
and licensing sales and away from lower margin sales from the distribution of
components. The Company is continuing efforts to focus on higher margin
activities, but expects that gross margins in future quarters will continue to
be heavily impacted by the cost of procuring and manufacturing products for
sale.
Sales and Marketing
Sales and marketing expenses consist primarily of employee salaries and
sales consultants' fees and related expenses, sales commissions and product
promotion. Sales and marketing expenses were $1,351,882 for the three months
ended September 30, 1999 compared to $1,176,466 for the same prior year period,
an increase of 14.9%. The increase was primarily due to an increase in headcount
and additional selling expenses related to higher chip sales. As a percentage of
total revenues, sales and marketing expenses increased to 13.5% for the quarter
ended September 30, 1999 from 10.4% for the same prior year quarter.
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 $866,149 for the three months ended September 30, 1999 compared to $577,816
for the same prior year period, an increase of 49.9%. The increase is primarily
attributable to headcount added to develop, enhance and implement new audio and
voice technologies and to develop software and Internet applications for the
Company's technologies. As a percentage of total revenues, research and
development expenses increased to 8.7% for the quarter ended September 30, 1999
from 5.1% for the same prior year quarter. Management believes research and
development expenses will increase in the future to support the Company's
product development efforts.
General and Administrative
General and administrative expenses consist primarily of employee-related
expenses, legal costs associated with the administration of intellectual
property and other professional fees. General and administrative expenses were
$1,494,879 for the three months ended September 30, 1999 compared to $1,536,407
for the same prior year period, a decrease of 2.7%. The decrease was primarily
attributable to corporate headcount reductions and management's efforts to
better manage outside professional fees. As a percentage of total revenues,
general and administrative expenses increased to 14.9% for the quarter ended
September 30, 1999 from 13.6% for the same prior year quarter.
As part of the Valence acquisition, the Company allocated a portion of the
purchase price to various intangible assets totaling approximately $5,910,400.
This amount was capitalized and is being amortized on a straight line basis over
periods ranging from three to eleven years with the related amortization expense
of $332,796 and $326,497 for the quarters ended September 30, 1999 and September
30, 1998, respectively, included in general and administrative expenses. See
Note 2 of the notes to the interim consolidated financial statements for more
information concerning the purchase price allocation associated with the Valence
acquisition.
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Other Income, Net
Net other income consists primarily of interest income, interest expense,
realized gains and losses on the sale of investments and foreign currency
transaction gains and losses. Net other income was $190,728 for the three months
ended September 30, 1999 compared to $11,728 for the same prior year period, a
increase of 1,526.3%. The increase is primarily attributable to higher average
cash and investment balances during the current year quarter as compared to the
prior year quarter, lower interest expense during the current year quarter
compared to the comparable prior year period and the recognition of foreign
exchange gain during the current quarter compared to none in the comparable
prior year period.
Provision for Income Taxes
The income tax provision for the three months ended September 30, 1999 was
$107,824 compared to $36,986 for the same prior year period. During the third
quarter of 1999, the Company recognized no additional tax benefit in connection
with taxable losses related to domestic operations and recorded a tax provision
at statutory tax rates in the Asian countries where Valence has its principal
business operations.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1998
Impact of Valence Acquisition
The Company's consolidated financial results for the nine month period
ended September 30, 1998 include the results of the Valence operations beginning
as of February 1, 1998. Accordingly, results for the nine months ended September
30, 1999 may not be directly comparable to the results for the nine months ended
September 30, 1998.
Revenues
Total revenues for the nine months ended September 30, 1999 were
$25,925,406 compared to $30,000,568 for the nine months ended September 30,
1998. Excluding chip design revenue, licensing revenue decreased 37.0% from the
same period last year due to the following factors: (a) the shift in the PC
market to lower cost models which cannot bear the cost of performance
enhancement technologies such as those offered by SRS Labs; (b) the Asian
financial crisis which reduced demand for consumer electronics products in the
region and negatively impacted the sales of semiconductor ICs that include the
Company's audio technologies; (c) the trend by consumer electronic manufacturers
to initially adopt the Company's new technologies into their higher end models
with limited volume potential for the short-term; and (d) and the absence of
technology transfer fees due to the economic conditions in Europe and Asia. The
licensing revenue decrease was offset by an increase of 45.2% in the custom ASIC
chip design and chip sales related to Valence's activities. Revenue from product
and component sales decreased to $13,001,555 for the nine months ended September
30, 1999 from $18,658 ,661 for the same prior year period primarily due to the
Company's decision to focus on higher margin revenue and de-emphasize certain
lower margin distribution activities.
Gross Margin
Gross margin as a percentage of total revenue for the nine months ended
September 30, 1999 increased to 37.3% from 34.7% for the same period in 1998.
The increase resulted from the shift in the Company's revenue base towards ASIC
and general purpose IC chip sales, which have significantly higher margins than
the Company's distribution revenue base. The Company expects that gross margins
in future quarters will continue to be impacted by the cost of procuring and
manufacturing products for sale.
Sales and Marketing
Sales and marketing expenses were $4,025,818 for the nine months ended
September 30, 1999 compared to $3,876,993 for the same prior year period, a
increase of 3.8%. During the nine-month period ended September 30, 1999, sales
and marketing expenses included the cost for additional headcount needed to
promote the Company's new technologies and increased promotional activities
related to product sales in China. These increases were
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partially offset by reductions in cooperative advertising activities related to
the Company's technologies and in travel expenses for sales and marketing
personnel. As a percentage of sales, sales and marketing expenses increased to
15.5% for the nine-month period ended September 30, 1999 from 12.9% for the same
prior year period, primarily due to the lower revenue base.
Research and Development
Research and development expenses were $2,295,510 for the nine months ended
September 30, 1999 compared to $1,576,526 for the same prior year period, an
increase of 45.6%. The increase is primarily attributable to headcount added to
support the increased ASIC design activity, to develop, enhance and implement
new audio and voice technologies and to develop software and Internet
applications for the Company's technologies. As a percentage of total revenues,
research and development expenses increased to 8.9% for the nine-month period
ended September 30, 1999 from 5.3% for the same prior year period.
General and Administrative
General and administrative expenses were $5,044,255 for the nine months
ended September 30, 1999 compared to $4,157,535 for the same prior year period,
an increase of 21.3%. The increase was primarily attributable to increased
headcount added to subsidiary operations to support new business development,
costs incurred for due diligence activities related to potential acquisitions
that did not occur and higher costs associated with year end reporting
activities required of a public company due to the expanded scope of the
Company's operations. As a percentage of total revenues, general and
administrative expenses increased to 19.5% for the nine month period ended
September 30, 1999 from 13.9% for the same prior year period.
Amortization expense related to intangible assets associated with the
Valence acquisition was $998,388 and $860,291 for the nine-month periods ended
September 30, 1999 and 1998, respectively, and is included in general and
administrative expenses. See Note 2 of the notes to the interim consolidated
financial statements for more information concerning the purchase price
allocation associated with the Valence acquisition.
Acquired In-Process Research and Development
The Company's Consolidated Statement of Operations for the nine months
ended September 30, 1998 includes the one-time charge of $18,510,378 for the
write-off of acquired in-process research and development expenses associated
with the Valence acquisition and the acquisition of certain assets associated
with the VIP technology. The in-process research and development expenses arose
from new product projects that were under development at the date of the
acquisition and expected to eventually lead to new products but had not yet
established technological feasibility and for which no future alternative use
was identified. The valuation of the in-process research and development
projects was based upon the discounted expected future net cash flows of the
products over the products' expected lives, reflecting the estimated stages of
completion of the projects and the estimated costs to complete the projects.
New product development projects underway at Valence at the time of the
Valence acquisition included, among others, (a) ASICs for consumer electronics,
computing and voice and audio applications, (b) home entertainment systems, (c)
digital multimedia players and (d) digital power amplifiers. The Company
estimated that these projects were approximately 63% complete at the date of
acquisition and estimated that the cost to complete these projects will
aggregate approximately $7 million and will be incurred over a three-year
period.
New product development projects utilizing the VIP technology at the time
of the VIP acquisition included, among others, digital and analog sound
reinforcement, wireless and non-wireless telecommunications applications,
hearing aid applications, headphone and microphone applications. The Company
estimated that these projects were approximately 62% complete at the date of
acquisition and estimated that the cost to complete these projects will
aggregate approximately $525,000 and will be incurred over a two-year period.
Uncertainties that could impede the progress of converting a development
project to a developed technology include the availability of financial
resources to complete the project, failure of the technology to function
properly,
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continued economic feasibility of developed technologies, customer acceptance,
customer demand and customer qualification of such new technology and general
competitive conditions in the industry. There can be no assurance that the
acquired in-process research and development projects will be pursued or
successfully completed and commercially introduced.
Other Income, Net
Net other income consists primarily of interest income, interest expense,
realized gains and losses on the sale of investments and foreign currency
transaction gains and losses. Net other income was $396,131 for the nine months
ended September 30, 1999 compared to $394,126 for the same prior year period, an
increase of .5%.
Provision for Income Taxes
The income tax benefit for the nine months ended September 30, 1999 was
$(105,843) compared to $(24,020) for the same prior year period. Related to
domestic operations, the Company recognized tax benefits in connection with
federal refundable taxes which could be recovered through a net operating loss
carry back. In addition, the Company recorded a tax provision at statutory tax
rates in the Asian countries where Valence has its principal business
operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal source of liquidity at September 30, 1999 consisted
of cash, cash equivalents and investments aggregating $20.5 million, as well as
borrowings available under its credit facility. At December 31, 1998, the
Company had cash, cash equivalents and long term investments of approximately
$24.4 million, as well as borrowings available under its credit facility.
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 utilized $(3,052,780) in cash
for the nine months ended September 30, 1999 and provided $1,516,037 for the
nine months ended September 30, 1998. The use of cash in operations for the
nine-month period ended September 30, 1999 was primarily due to the reduction in
accounts payable related to major suppliers of the Company's component
distribution business, as well as the Company's loss from operations. Partially
offsetting this decrease was an increase in cash due to a reduction in accounts
receivable and other current assets that resulted from the collection of certain
large balances due from SRS Labs, Inc. and Valence customers that were
outstanding at December 31, 1998.
As described above, the Company acquired Valence and additional
technologies during the first quarter of Fiscal 1998. (See Note 2 to the interim
consolidated financial statements.)
On July 6, 1999, the Company replaced its then existing revolving line of
credit with another revolving line of credit with a bank which expires on April
1, 2001 and is secured by certain of the Company's cash, cash equivalents and
investments. As of September 30, 1999, approximately $3.2 million in cash and
cash equivalents and $10.9 million in investments were pledged as collateral for
the line of credit. The total availability under the line of credit is the
lesser of $10 million or a percentage of the fair market value of the
collateral. The line of credit bears interest at the bank's prime rate or the
LIBOR interest rate as determined by the bank.. The Company had $8.0 million
outstanding under the line of credit as of September 30, 1999. As a result of
the acquisition of Valence, the Company provided Valence $8.0 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 and engineering
headcount and marketing activities associated with the introduction of new
technologies and products into the market.
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
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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.
YEAR 2000 READINESS DISCLOSURE
The Company is currently in the process of addressing a problem that is
facing all users of automated information systems. The "Year 2000 issue" arises
out of the fact that 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 Company and its subsidiaries have identified the following areas which
could be impacted by the Year 2000 issue: Company products; internally used
systems and software; products or services provided by key third parties; and
the ability of chip partners, licensees or customers to process business
transactions relating to chip design and licensing revenue and product and
component sales.
During Fiscal 1998, the Company and its subsidiaries reviewed its internal
systems including those which support manufacturing process control and
financial and general business operations. The review consisted of an evaluation
of significant internal hardware systems and major software application programs
for their ability to accurately recognize and process dates properly in the Year
2000 and beyond. As a result of this evaluation, the Company identified certain
systems which require upgrades to be Year 2000 ready, including certain business
software applications. The Company is in the process of installing a new
computer system in its overseas operation and has been assured by the software
and hardware providers that these systems will be fully compliant with the Year
2000. The Company believes that installation will be complete by the beginning
of December 1999. The Company's products do not have any material Year 2000
problems.
In addition, the Company and its subsidiaries are in the process of
assessing and documenting the compliance of their major customers, suppliers and
vendors. Management believes that third-party relationships upon which the
Company relies represent the greatest risk with respect to the Year 2000 issue,
because the Company cannot guarantee that third parties will be able to
adequately assess and address their Year 2000 compliance issues in a timely
manner. As a consequence, the Company can give no assurances that issues related
to Year 2000 would not have a material adverse effect on future results of
operations or financial condition.
Total costs relating to the Company's compliance efforts, based on
management's best estimates, are estimated to be approximately $350,000.
Should the Company not be completely successful in mitigating internal and
external Year 2000 risks, the likely worst case scenario could be a system
failure causing disruptions of operations, including, among other things, a
temporary inability to process transactions, manufacture products, send invoices
or engage in similar normal business activities at the Company or its vendors
and suppliers. The Company currently is developing a contingency plan with
respect to potential Year 2000 failures of its suppliers or customers. However,
if such failures would occur, depending upon their duration and severity, there
is no guarantee that the contingency plan would mitigate the effects of these
failures, and they could have a material adverse effect on the Company's
business, results of operations and financial condition.
The information set forth above under this caption "Year 2000 Readiness
Disclosure" relates to the Company's efforts to address the Year 2000 concerns
regarding the Company's (a) operations, (b) products and technologies licensed
or sold to third parties and (c) major suppliers and customers. Such statements
are intended as Year 2000 Statements and Year 2000 Readiness Disclosures and are
subject to the Year 2000 Information Readiness Act."
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FORWARD-LOOKING INFORMATION AND CERTAIN FACTORS
Included in this Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations are certain forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995,
reflecting management's current expectations. Examples of such forward-looking
statements include the expectations of the Company with respect to its strategy
and the shift in revenue mix which is expected to be weighted more toward chip
and electronic component sales and less to licensing an distribution. Although
the Company believes that its expectations are based upon reasonable
assumptions, there can be no assurances that the Company's financial goals will
be realized. Such forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of the Company, or industry results, to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements. Numerous factors may affect the Company's
actual results and may cause results to differ materially from those expressed
in forward-looking statements made by or on behalf of the Company. Such factors
include, among others, those set forth below. The Company assumes no obligation
to update the forward-looking information to reflect actual results or changes
in the factors affecting such forward-looking information.
Quarterly Fluctuations
The Company's operating results may fluctuate from those in prior quarters
and will continue to be subject to quarterly and other fluctuations due to a
variety of factors, including the extent to which the Company's licensees
incorporate the Company's technologies into their products, the timing of orders
from and the shipments to major customers, the timing of new product
introductions by the Company, the gain or loss of significant customers,
competitive pressures on selling prices, the market acceptance of new or
enhanced versions of the Company's technologies, the rate that the Company's
semiconductor licensees manufacture and distribute chips to consumer electronic
manufacturers, and fluctuations in general economic conditions, particularly
those affecting the consumer electronics market. In addition, due to the
Company's dependence on the consumer electronics market, the substantial
seasonality of sales in the market has impacted the Company's revenues and net
income. In particular, the Company believes that there is seasonality relating
to the Christmas season, generally, and the Chinese New Year within the Asia
region, which fall into the fourth and first quarters, respectively. As a
result, the Company believes that period-to-period comparisons of its results of
operations are not necessarily meaningful and should not be relied upon as
indications of future performance.
Changes to the Business Model/Integration of Valence/Refinement of Asian
Strategy
From the Company's inception in 1993 through 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 components and 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 integration of certain operations following the Valence acquisition has
required, and will continue to require, the dedication of management and other
personnel resources which may temporarily distract them from the day-to-day
business of the combined company. The geographic separation of these operations
places additional strain on the Company's resources. In addition, the Company's
significant operations in China and Asia have required refinement to adapt to
the changing 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 selected growth
segments in that region and to identify and focus on those segments that
contribute the highest margins. 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.
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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, 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 licensing
revenues have been denominated in U.S. dollars and most costs have been incurred
in U.S. dollars. It is the Company's expectation that licensing revenues will
continue to be denominated in U.S. dollars for the foreseeable future. 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 continues to actively
monitor its foreign exchange exposure and to evaluate strategies to reduce its
foreign exchange risk. At such time that the Company determines the benefits of
such strategies outweigh the associated costs, the Company intends to implement
appropriate strategies. 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 continue to experience weakness in their currency,
banking and equity markets. These weaknesses could adversely affect consumer
demand for Valence's products, the U.S. dollar value of the Company's and its
subsidiaries' foreign currency denominated sales, the availability and supply of
product components to Valence and ultimately, the Company's consolidated results
of operations.
Competitive Pressures
The Company's existing and potential competitors include both large and
emerging domestic and international companies that have substantially greater
financial, manufacturing, technical, marketing, distribution and other
resources. The Company's present or future competitors may be able to develop
products and technologies comparable or superior to those offered by the
Company, and to adapt more quickly than the Company to new technologies or
evolving market needs. The Company believes that the competitive factors
affecting the market for the Company's products and technologies include product
performance, price and quality; product functionality and features; and the ease
of integration and implementation of the products and technologies with other
hardware and software components in the manufacturer's products. In addition,
the markets in which the Company competes are intensely competitive and are
characterized by rapid technological changes, declining average sales prices and
rapid product obsolescence. Accordingly, there can be no assurance that the
Company will be able to continue to compete effectively in its respective
markets, that competition will not intensify or that future competition will not
have a material adverse effect on the Company's business, operating results,
cash flows and financial condition.
Importance of Intellectual Property
The Company's ability to compete may be affected by its ability to protect
its proprietary information. The Company has filed several U.S. and foreign
patent applications and to date has a number of issued U.S. and foreign patents
covering various aspects of its technologies. There can be no assurance that the
steps taken by the Company to protect its intellectual property will be adequate
to prevent misappropriation of its technology or that the Company's competitors
will not independently develop technologies that are substantially equivalent or
superior to the Company's technology. In addition, the laws of certain foreign
countries may not protect the Company's intellectual property rights to the same
extent as do the laws of the U.S. The semiconductor industry is characterized by
frequent claims and litigation regarding patent and other property rights. There
can be no assurances that third parties will not assert additional claims or
initiate litigation against the Company or its
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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 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 IC
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 effect on the market price of
the Common Stock.
Acquisitions
From time-to-time, the Company expects to make acquisitions of businesses
or technologies that are complementary to its business strategy. Such future
acquisitions would expose the Company to risks commonly encountered in
acquisitions of businesses. Such risks include, among others, difficulty of
assimilating the operations, information systems and personnel of the acquired
businesses; the potential disruption of the Company's ongoing business; and the
inability of management to maximize the financial and strategic position of the
Company through successful incorporation of the acquired technologies, employees
and customers. There can be no assurance that any potential acquisition will be
consummated or, if consummated, that it will not have a material adverse effect
on the Company's business, financial condition and results of operations.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to a variety of risks, including foreign currency
fluctuations and changes in interest rates affecting the cost of its debt.
Foreign Currency
The Company has subsidiary operations in Hong Kong and China, and
accordingly, the Company is exposed to transaction gains and losses that could
result from changes in foreign currency exchange rates. The Company uses the
local currency (Hong Kong dollars) as the functional currency for its
subsidiaries. Translation adjustments resulting from the process of translating
foreign currency financial statements into U.S. dollars were nil in Fiscal 1998
and for the nine month period ended September 30, 1999 due to the fact that the
value of the Hong Kong dollar is currently pegged to the U.S. dollar and the
exchange rate remained constant throughout the period. Under the current
circumstances, the Company believes that the foreign currency market risk is not
material to its consolidated results of operations. The Company continues to
actively monitor its foreign exchange exposure and to evaluate possible
strategies to reduce its risk. At such time that the benefits of such strategies
outweigh the associated costs, the Company intends to implement appropriate
strategies. 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.
Interest Rates
The Company's line of credit bears interest based on the lending bank's
prime rate or LIBOR base rate as determined by the bank. The interest rate on
the balance of $8 million outstanding at September 30, 1999 was 6.25%. The
Company believes that if interest rates were to increase by as much as 10%, the
short term impact on the Company's consolidated financial statements would not
be material. If circumstances in the market change materially, the Company
intends to evaluate possible strategies to reduce its risk related to changes in
interest rates.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 23, 1999, Dolby Laboratories, Inc. filed a civil lawsuit in the
United States District Court for the Central District of California against the
Company and Smart Devices, Inc. ("Smart Devices"). Smart Devices is a licensee
of the Company under the SRS(R) and CIRCLE SURROUND(R) technologies. The
complaint seeks both preliminary and permanent injunctions, monetary damages in
an unspecified amount and further equitable relief, based upon allegations of
false advertising, unfair competition, trademark infringement and false labeling
relating to the CIRCLE SURROUND EX trademark. On May 17, 1999, the Company filed
an answer to such complaint generally denying the allegations made by the
plaintiff under each claim for relief and denying that the plaintiff is entitled
to any relief under each stated claim for relief. In addition, the Company also
responded by alleging affirmative defenses to each claim for relief. The Company
is not providing a defense for Smart Devices. Although the Company cannot
predict the likely outcome of the lawsuit at this time, it intends to vigorously
defend the case and believes that the final outcome will not have a material
adverse effect on the Company's consolidated financial condition.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
USE OF PROCEEDS
The effective date of the Company's initial public offering of its Common
Stock was August 8, 1996 (SEC Registration No. 333-4974-LA). Since August, 1996,
the Company utilized approximately $2,763,001 of the $22,052,955 net offering
proceeds for working capital purposes 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 -- $ 2,763,001
Temporary investment (cash and municipal
bonds) $10,895,732
- ---------
(1) During the second quarter of Fiscal 1998, the Company utilized $500,000 of
the net offering proceeds as part of the consideration to acquire assets
related to the Circle Surround technology. During the first quarter of
Fiscal 1998, the Company utilized an aggregate of $7,894,222 in connection
with two other acquisitions (see Note 2 to the Interim Consolidated
Financial Statements).
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits. The exhibits listed below are hereby filed with the U.S.
Securities and Exchange Commission (the "Commission") as part of this Report.
Exhibit
No. Description
- ------- -----------
3.1 Bylaws of SRS Labs, Inc., as amended
10.1 Employment Agreement, dated August 27, 1999, by and between the
Company and James F. Gardner
27 Financial Data Schedule.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed with the Commission during the
nine-month period ended September 30, 1999.
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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: November 12, 1999 By: /s/ JAMES F. GARDNER
--------------------
James F. Gardner
Vice President, Chief Financial
Officer, Secretary and
Treasurer (Principal Financial
and Accounting Officer)
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EXHIBIT INDEX
Exhibit
No. Description
- ------- -----------
3.1 Bylaws of SRS Labs, Inc., as amended
10.1 Employment Agreement, dated August 27, 1999, by and between the
Company and James F. Gardner
27 Financial Data Schedule.