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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
________________
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to ______________
Commission File Number 0-21123
SRS LABS, INC.
(Exact name of registrant as specified in its charter)
________________
Delaware 33-0714264
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2909 Daimler Street, Santa Ana, California 92705
(Address of principal executive offices) (Zip Code)
(949) 442-1070
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changes since last
report)
________________
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] 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, 2001, 12,667,369
of the issuer's common stock, par value $.001 per share, were outstanding. In
addition, as of July 31, 2001, 71,100 shares of the issuer's common stock were
held as treasury shares.
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SRS LABS, INC.
Form 10-Q
For the Period Ended June 30, 2001
Index
Page
--------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.................................................................................. 4
Condensed Consolidated Balance Sheets as of June 30, 2001 (Unaudited) and December 31, 2000................ 4
Condensed Consolidated Statements of Operations for the three months and six months ended June 30, 2001
and 2000 (Unaudited)....................................................................................... 5
Condensed Consolidated Statements of Comprehensive Loss for the three months and six months ended June
30, 2001 and 2000 (Unaudited).............................................................................. 5
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2001 and 2000
(Unaudited)................................................................................................ 6
Notes to the Condensed 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............................................ 21
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders................................................... 22
Item 6. Exhibits and Reports on Form 8-K...................................................................... 22
SIGNATURES....................................................................................................... 23
2
FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended,
and Section 27A of the Securities Act of 1933, as amended, reflecting
management's current expectations. Examples of such forward-looking statements
include the expectations of the Company with respect to its strategy. Although
the Company believes that its expectations are based upon reasonable
assumptions, there can be no assurances that the Company's financial goals will
be realized. Such forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of the Company, or industry results, to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements. Numerous factors may affect the Company's
actual results and may cause results to differ materially from those expressed
in forward-looking statements made by or on behalf of the Company. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words, "believes," "anticipates," "plans," "expects" and similar
expressions are intended to identify forward-looking statements. The important
factors discussed in Part I, Item 2, Management's Discussion and Analysis of
Financial Condition and Results of Operations - Factors That May Affect Future
Results", herein, among others, could cause actual results to differ materially
from those indicated by forward-looking statements made herein and presented
elsewhere by management. Such forward-looking statements represent management's
current expectations and are inherently uncertain. Investors are warned that
actual results may differ from management's expectations. The Company assumes no
obligation to update the forward-looking information to reflect actual results
or changes in the factors affecting such forward-looking information.
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
SRS LABS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2001 2000
------------ ------------
(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 16,267,354 $ 24,128,480
Investments available for sale 4,591,715 5,713,881
Accounts receivable, net 1,251,662 787,908
Inventories, net 2,209,880 3,068,478
Prepaid expenses and other current assets 604,435 847,953
Deferred income taxes 38,116 38,116
------------ ------------
TOTAL CURRENT ASSETS 24,963,162 34,584,816
Investments available for sale -- 582,849
Furniture, fixtures & equipment, net 1,744,550 1,808,624
Intangible assets, net 3,026,770 3,692,218
Deferred income taxes 900,839 900,839
------------ ------------
TOTAL ASSETS $ 30,635,321 $ 41,569,346
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,198,252 $ 1,603,401
Accrued liabilities 2,003,149 1,974,357
Line of credit -- 8,000,000
Income taxes payable 1,102,684 1,093,107
------------ ------------
TOTAL CURRENT LIABILITIES 4,304,085 12,670,865
Minority interest 478,295 595,428
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock - $.001 par value; 2,000,000 shares authorized;
no shares issued and outstanding -- --
Common stock - $.001 par value; 56,000,000 shares authorized;
12,718,394 and 12,652,844 shares issued; and 12,647,294 and
12,581,744 shares outstanding at June 30, 2001 and
December 31, 2000, respectively 12,719 12,653
Additional paid-in capital 55,106,791 55,060,403
Deferred stock option compensation 422,225 376,052
Cumulative other comprehensive loss (62,267) (64,950)
Accumulated deficit (29,363,246) (26,817,824)
Less treasury stock at cost, 71,100 shares at June 30, 2001
and December 31, 2000, respectively (263,281) (263,281)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 25,852,941 28,303,053
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 30,635,321 $ 41,569,346
============ ============
See accompanying notes to the condensed interim consolidated
financial statements
4
SRS LABS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ --------------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
REVENUES
Chip and licensing revenue.................................... $ 3,125,407 $ 2,860,253 $ 5,373,801 $ 5,739,332
Product and component sales................................... 1,718,968 3,732,953 3,801,455 8,044,426
----------- ----------- ----------- -----------
TOTAL REVENUES............................................. 4,844,375 6,593,206 9,175,256 13,783,758
COST OF SALES................................................. 2,335,065 4,267,465 4,636,355 9,116,166
----------- ----------- ----------- -----------
GROSS MARGIN.................................................. 2,509,310 2,325,741 4,538,901 4,667,592
EXPENSES
Sales and marketing........................................... 1,154,036 1,422,744 2,545,416 2,707,477
Research and development...................................... 896,884 984,908 1,774,978 1,924,097
General and administrative.................................... 1,568,940 4,195,373 3,130,866 5,613,960
Non-cash stock issuance cost.................................. -- -- -- 3,111,859
----------- ----------- ----------- -----------
TOTAL EXPENSES............................................. 3,619,860 6,603,025 7,451,260 13,357,393
----------- ----------- ----------- -----------
LOSS FROM OPERATIONS....................................... (1,110,550) (4,277,284) (2,912,359) (8,689,801)
OTHER INCOME, NET............................................. 245,009 308,413 479,050 517,976
MINORITY INTEREST............................................. 44,810 -- 117,638 --
----------- ----------- ----------- -----------
(820,731) (3,968,871) (2,315,671) (8,171,825)
LOSS BEFORE INCOME TAX EXPENSE...............................
INCOME TAX EXPENSE............................................ 159,157 138,491 229,751 276,584
----------- ----------- ----------- -----------
NET LOSS...................................................... $ (979,888) $(4,107,362) $(2,545,422) $(8,448,409)
=========== =========== =========== ===========
Net loss per common share
Basic and diluted.......................................... $ (0.08) $ (0.33) $ (0.20) $ (0.69)
=========== =========== =========== ===========
Weighted average shares used in the calculation of
net loss per common share
Basic and diluted.......................................... 12,625,783 12,492,205 12,597,526 12,198,822
=========== =========== =========== ===========
See accompanying notes to the condensed interim consolidated financial
statements
SRS LABS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- ----------------------------
2001 2000 2001 2000
--------- ----------- ----------- -----------
Net loss.......................................... $(979,888) $(4,107,362) $(2,545,422) $(8,448,409)
Other comprehensive income (loss)
Foreign currency translation.................. -- (1,544) -- 1,269
Unrealized (loss) gain on investments
available for sale, net of tax.............. (5,613) (920) 2,683 (12,064)
--------- ----------- ----------- -----------
Comprehensive loss................................ $(985,501) $(4,109,826) $(2,542,739) $(8,459,204)
========= =========== =========== ===========
See accompanying notes to condensed interim consolidated financial statements
5
SRS LABS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
--------------------------------------------
2001 2000
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................................... $(2,545,422) $(8,448,409)
Adjustments to reconcile net loss to net cash used in operating
activities:
Non-cash stock issuance cost........................................... -- 3,111,859
Depreciation and amortization.......................................... 1,070,815 1,387,323
Minority interest...................................................... (117,638) --
Other.................................................................. 3,877 127
Amortization of premium on investments available for sale.............. 9,562 18,370
Increase in deferred stock option compensation......................... 46,173 57,342
Changes in operating assets and liabilities:
Accounts receivable................................................ (463,755) 515,191
Inventories........................................................ 858,598 (378,578)
Prepaid expenses and other current assets.......................... 243,518 (158,190)
Accounts payable................................................... (405,149) 78,948
Accrued liabilities................................................ 28,792 1,059,075
Income taxes payable............................................... 7,713 (22,862)
----------- -----------
Net cash used in operating activities.................................. (1,262,916) (2,779,804)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture, fixtures and equipment............................... (267,344) (338,800)
Proceeds from sale of investments available for sale........................ 1,700,000 1,500,000
Expenditures related to patents and intangible assets....................... (73,948) (1,346,025)
----------- -----------
Net cash provided by (used in) investing activities.................... 1,358,708 (184,825)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of Common Stock.......................................... -- 5,000,291
Principal payment on line of credit......................................... (8,000,000) --
Proceeds from exercise of stock options..................................... 43,082 1,180,562
----------- -----------
Net cash (used in) provided by financing activities.................... (7,956,918) 6,180,853
----------- -----------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........................ (7,861,126) 3,216,224
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............................. 24,128,480 15,969,678
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................................... $16,267,354 $19,185,902
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest............................................................... $ 151,667 $ 284,264
Income taxes........................................................... $ 164,235 $ 177,191
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
Unrealized gain (loss) on investments, net.............................. $ 2,683 $ (12,064)
See accompanying notes to condensed interim consolidated financial statements
6
SRS LABS, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. General/Basis of Presentation
SRS Labs, Inc. ("SRS Labs") is a developer and provider of technology
solutions for the consumer electronics, home theater, computer, game, Internet
and telecommunications markets. SRS Labs' principal business activities in these
markets include:
. Developing and licensing audio and voice technologies to original
equipment manufacturers ("OEMs") and semiconductor manufacturers around
the world;
. Through its majority-owned subsidiary, SRSWOWcast.com, Inc., now
conducting business under the name SRSWOWcast Technologies
("SRSWOWcast"), developing audio and voice enhancement technology
solutions dedicated to the Internet and telecommunications markets; and
. Through its wholly-owned subsidiary, ValenceTech Limited and its foreign
subsidiaries (collectively "Valence"), designing and selling technology
solutions through custom application specific integrated circuits
("ASICs") to OEMs; and designing, distributing and manufacturing
components, sub-assemblies and electronics products for the OEM and
retail communities within the Company's targeted markets.
SRS Labs and its majority-owned and wholly-owned subsidiaries together are
hereby collectively referred to as the "Company".
The accompanying condensed interim consolidated financial statements have
been prepared by the Company without audit in conformity with accounting
principles generally accepted in the United States for interim financial
information and with the rules and regulations of the U.S. Securities and
Exchange Commission ("SEC"). In the opinion of management, all adjustments
(which include only normal recurring adjustments) considered necessary for a
fair presentation have been included. Certain accounts as previously reported
have been reclassified to conform to the current period presentation.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. Therefore, the condensed interim consolidated
financial statements should be read in conjunction with the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2000. Current and
future financial statements may not be directly comparable to the Company's
historical financial statements. The results of operations for the interim
periods are not necessarily indicative of the results to be expected for the
full year.
2. Investments Available for Sale
The Company has classified its investments as available-for-sale in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 115
"Accounting for Certain Investments in Debt and Equity Securities". As of June
30, 2001, the Company's available-for-sale investments had a cost of $4,551,413
and an estimated fair value of $4,591,715, based on quoted market prices. The
unrealized gains on these investments of $40,302 net of income taxes of $16,524
are reported as a separate component of stockholders' equity.
3. 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.
7
SRS LABS, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. Minority Interest in Consolidated Subsidiary
Minority interest in consolidated subsidiary represents the minority
stockholders' proportionate share of the equity of SRSWOWcast. At June 30, 2001,
the Company owned approximately 87% of the outstanding capital stock of
SRSWOWcast.
5. Net Loss Per Common Share
The Company computes earnings per share ("EPS") in accordance with SFAS No.
128, "Earnings per Share". SFAS 128 requires the Company to disclose basic and
diluted earnings per share. The Company's basic EPS is computed by dividing net
loss for the period by the weighted average number of outstanding common shares
for that period. Diluted EPS amounts are the same as basic EPS for all periods
presented as the effect of including common share equivalents have not been
included as their inclusion would have been anti-dilutive.
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 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 for a period from December 23, 1998 to December 31, 1999. As of June 30,
2001, 71,100 shares had been repurchased at a cost of $263,281. Such repurchased
shares are reflected as treasury stock in the accompanying consolidated balance
sheets.
In March 2000, the Company entered into a technology and marketing alliance
with Microsoft Corporation ("Microsoft"). In conjunction with this transaction,
Microsoft purchased 290,529 shares of the Company's common stock for $17.21 per
share or approximately $5,000,000 in the aggregate. The difference between the
purchase price received and the fair value of the common stock on the date of
purchase, totaling approximately $555,000, was recorded as non-cash stock
issuance cost by the Company during the quarter ended March 31, 2000. Also in
connection with this transaction, Microsoft has a three year warrant to purchase
100,000 shares of common stock of the Company and a three year warrant to
purchase up to 2,500,000 shares of common stock of the Company's majority-owned
subsidiary, SRSWOWcast. The fair value of these warrants, aggregating
approximately $2,555,000, was recorded as non-cash stock issuance cost by the
Company during the quarter ended March 31, 2000.
During the fiscal year ended December 31, 2000, the Company's majority-owned
subsidiary SRSWOWcast and certain investors, which included shareholders,
directors and an executive officer of the Company, entered into a Series A
Preferred Stock and Warrant Purchase Agreement (the "Private Placement
Agreement") relating to the purchase and sale of 3,000,000 shares of SRSWOWcast
Series A Convertible Preferred Stock ("Preferred Stock") for a purchase price of
$2.00 per share or $6,000,000 in the aggregate (the "Private Placement").
Pursuant to the Private Placement Agreement, investors received an immediately
exercisable, three year warrant evidencing a right to purchase one-tenth of a
share of SRSWOWcast's common stock for each share of Preferred Stock purchased
by such investor, exercisable at $2.50 per whole share. The fair value of the
warrants was zero at the date of issuance. In accordance with Staff Accounting
Bulletin ("SAB") No. 51 issued by the SEC, "Accounting for Sales of Stock by a
Subsidiary" the Company recorded $5,154,995 of additional paid-in capital
associated with the Private Placement.
8
SRS LABS, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. Segment Information
The Company operates in three business segments: (i) the development and
marketing of technology either in the form of ASICs through Valence or the
licensing of technologies developed by the Company to original equipment
manufacturers and semiconductor manufacturers; (ii) the sale of consumer
electronic products and components; and (iii) the SRSWOWcast Internet-based
business. The Company's Internet-based business generated insignificant revenues
and incurred net losses of $321,272 and $879,617 for the three month and six
month periods ended June 30, 2001. The Company does not allocate corporate
operating expenses or specific assets to these segments. Therefore, segment
information includes only net revenues, cost of sales and gross margin for those
segments. These losses were composed primarily of sales and marketing expenses
and general and administrative expenses associated with the development of web
content, and the promotion and launch of the Company's website.
Three Months Ended June 30, 2001
---------------------------------------------------------------
Chips and Product and
Licensing Component Sales Total
------------------ ----------------------- ------------------
Net revenues........................... $3,125,407 $1,718,968 $4,844,375
Cost of sales.......................... 584,416 1,750,649 2,335,065
---------- ---------- ----------
Gross margin........................... $2,540,991 $ (31,681) $2,509,310
========== ========== ==========
Three Months Ended June 30, 2000
--------------------------------------------------------------
Chips and Product and
Licensing Component Sales Total
------------------ ---------------------- ------------------
Net revenues............................ $2,860,253 $3,732,953 $6,593,206
Cost of sales........................... 900,663 3,366,802 4,267,465
---------- ---------- ----------
Gross margin............................ $1,959,590 $ 366,151 $2,325,741
========== ========== ==========
Six Months Ended June 30, 2001
--------------------------------------------------------------
Chips and Product and
Licensing Component Sales Total
------------------ ---------------------- ------------------
Net revenues........................... $5,373,801 $3,801,455 $9,175,256
Cost of sales.......................... 1,002,798 3,633,557 4,636,355
---------- ---------- ----------
Gross margin........................... $4,371,003 $ 167,898 $4,538,901
========== ========== ==========
Six Months Ended June 30, 2000
--------------------------------------------------------------
Chips and Product and
Licensing Component Sales Total
------------------ ---------------------- ------------------
Net revenues............................ $5,739,332 $8,044,426 $13,783,758
Cost of sales........................... 1,783,663 7,332,503 9,116,166
---------- ---------- -----------
Gross margin............................ $3,955,669 $ 711,923 $ 4,667,592
========== ========== ===========
9. Recent Accounting Pronouncements
On January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities" as amended by SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities -
an amendment of FASB Statement No. 133" which requires derivatives to be
reported as assets or liabilities in the balance sheet at fair value. The
amendment included expanding the normal purchase and sale exemption for supply
contracts, permitting the offsetting of certain intercompany foreign currency
derivatives and thus reducing the number of third party derivatives, permitting
hedge accounting for foreign-currency denominated assets and liabilities and
redefining interest rate risk to reduce sources of ineffectiveness. The
adoption of SFAS No. 133, as amended by SFAS No. 138, did not have a material
impact on the Company's consolidated results of operations, financial position
or cash flows.
In December 1999, the SEC staff issued SAB No. 101, "Revenue Recognition in
Financial Statements". SAB No. 101 summarizes the SEC staff's views in applying
generally accepted accounting principles to revenue recognition in financial
statements. The implementation of SAB No. 101 in the fourth quarter of 2000 did
not have a material effect on the Company's consolidated results of operations,
financial position or cash flows.
9
SRS LABS, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141 "Business Combinations", which, among other things, will require that
the purchase method of accounting be used for all business combinations
initiated after June 30, 2001, will no longer permit the use of the pooling-of-
interests method of accounting for business combinations and broadens the
criteria for recording intangible assets separate from goodwill. Management
does not believe the adoption of SFAS No. 141 will have a material impact on the
Company's consolidated results of operations, financial position or cash flows.
In July 2001, FASB issued SFAS No. 142 "Goodwill and Other Intangible
Assets", which, among other things, establishes new standards for goodwill
acquired in a business combination, eliminates the amortization of goodwill and
requires the carrying value of goodwill and identifiable intangibles to be
evaluated for impairment on an annual basis. Identifiable intangible assets with
a determinable useful life will continue to be amortized over that period. SFAS
No. 142 is effective for fiscal years beginning after December 15, 2001.
Management does not believe the adoption of SFAS No. 142 will have a material
impact on the Company's consolidated results of operations, financial position
or cash flows.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
This information should be read in conjunction with the unaudited condensed
interim consolidated financial statements and the notes thereto included in this
Quarterly Report, and the audited consolidated financial statements and notes
thereto and Management's Discussion and Analysis of Financial Condition and
Results of Operations contained in the Company's Annual Report on Form 10-K for
the year ended December 31, 2000.
Overview
SRS Labs, Inc. ("SRS Labs") is a developer and provider of audio and voice
technology solutions for the consumer electronics, home theater, computer, game,
Internet and telecommunications markets. SRS Labs' principal business activities
in these markets include:
. Developing and licensing audio and voice technologies to original equipment
manufacturers ("OEMs") and semiconductor manufacturers around the world;
. Through its majority-owned subsidiary, SRSWOWcast.com, Inc., now conducting
business under the name SRSWOWcast Technologies ("SRSWOWcast"), developing
audio and voice enhancement technology solutions dedicated to the Internet
and telecommunications markets; and
. Through its wholly-owned subsidiary, ValenceTech Limited and its foreign
subsidiaries (collectively "Valence"), designing and selling technology
solutions through custom application specific integrated circuits ("ASICs")
to OEMs; and designing, distributing and manufacturing components, sub-
assemblies and finished goods for targeted markets within selected OEM and
retail communities.
SRS Labs and its majority-owned and wholly-owned subsidiaries together are
hereby collectively referred to as the "Company".
The Company was formed in 1993 by purchasing all rights and assets of
various audio and speaker technologies from the Hughes Aircraft Company. The
Company successfully completed its initial public offering in August 1996,
raising approximately $22 million. From the Company's inception in 1993 until
February 1998, the Company derived substantially all of its revenues from audio
technology licensing activities for the consumer electronics, computer and game
markets. The primary technologies that contributed to revenue were SRS(R) (Sound
Retrieval System(R)) ("SRS"), which produces a 3D sound-enhanced stereo image
from any mono or stereo source, and TruSurround, a "virtual" audio technology
which processes multi-channel surround sound through any standard pair of stereo
speakers.
On March 2, 1998, the Company acquired 100% of the outstanding stock of
Valence Technology Inc., a British Virgin Islands holding company with its
principal business operations in Hong Kong and the Peoples Republic of China
(the "PRC"). This acquisition significantly expanded the Company's business
activities from the original licensing model to include the design, manufacture
and marketing of chips, components and products.
In addition to the acquisition of Valence Technology, Inc. during the
fiscal year ended December 31, 1998 ("Fiscal 1998"), the Company acquired two
additional technologies. In the first quarter of Fiscal 1998, the Company
acquired certain rights to Voice Intelligibility Processor ("VIP"), a patented
voice processing technology that improves the intelligibility of the spoken
voice, especially in high ambient noise environments and, in the following
quarter, acquired certain rights to Circle Surround, a patented audio delivery
system that allows multi-channel surround sound to be encoded into a two-channel
stereo format and allows an encoded two-channel audio source to be decoded into
a multi-channel surround format.
During the fiscal year ended December 31, 1999 ("Fiscal 1999"), the Company
re-engineered its business model and operational structure. Valence Technology,
Inc., while continuing to expand its ASICs business, exited certain of the lower
margin distribution product lines and directed more of its resources to develop
and market solutions that integrate the SRS technologies. With respect to its
licensing business, the Company changed its focus from entering into technology
licenses with PC chip manufacturers to developing a new business model which
focuses on Internet radio. This new focus resulted in the Company launching the
WOWThing product family and establishing a new wholly-owned subsidiary,
SRSWOWcast, to be the platform to launch this business. In March 2000, Microsoft
11
Corporation ("Microsoft") and the Company entered into a strategic alliance
whereby Microsoft and the Company entered into a License Agreement relating to
the Company's WOW Technology. The License Agreement has facilitated the
incorporation of the WOW Technology into the Windows 2000 Media Player and a
click-through hyper-link on the interface of the Windows Media Player to the
SRSWOWcast website. In addition, Microsoft made an equity investment into the
Company and was granted a warrant to purchase additional shares of the Company's
common stock as well as a warrant to purchase shares of common stock in
SRSWOWcast.
During the fiscal year ended December 31, 2000, SRSWOWcast and certain
investors, which included shareholders, directors and an executive officer of
the Company, entered into a Series A Preferred Stock and Warrant Purchase
Agreement (the "Private Placement Agreement") relating to the purchase and sale
of 3,000,000 shares of SRSWOWcast Series A Convertible Preferred Stock
("Preferred Stock") for a purchase price of $2.00 per share or $6,000,000 in the
aggregate (the "Private Placement"). Pursuant to the Private Placement
Agreement, investors received an immediately exercisable, three year warrant
evidencing a right to purchase one-tenth of a share of SRSWOWcast's common stock
for each share of Preferred Stock purchased by such investor, exercisable at
$2.50 per whole share. The fair value of the warrants was zero at the date of
issuance. In accordance with Staff Accounting Bulletin ("SAB") No. 51 issued by
the U.S. Securities and Exchange Commission ("SEC"), "Accounting for Sales of
Stock by a Subsidiary" the Company recorded $5,154,995 of additional paid-in
capital associated with the Private Placement.
Recently, the Company changed its Internet strategy in order to focus on the
licensing of the Company's audio and voice enhancement technology solutions for
Internet streaming, wireless, Voice over Internet Protocol ("VoIP") and
telephony applications. To implement this strategy, the Company has established
a direct sales force to market the technology solutions to web portals, encoding
companies, service providers, wireless technology providers and broadcasting
companies. Consistent with the hardware licensing trademark policy, the Company
will actively promote the use of its trademarks and logos and will direct its
customers to display the appropriate SRS technology logo.
The Company currently operates in three business segments: (a) the development
and marketing of technology in the form of integrated circuits, distributed
through Valence and the licensing of technologies developed by the Company to
OEMs and semiconductor manufacturers, (b) the sale of consumer electronic
products and components and (c) the SRSWOWcast Internet-based business. A
summary of the Company's operations and activities by business segment is
included in the accompanying notes to the condensed interim consolidated
financial statements.
Results of Operations
Three Months Ended June 30, 2001 Compared To Three Months Ended June 30, 2000
Revenues
Chip and licensing revenue consists of design fees and sales of custom ASICs
by Valence to OEMs and sales of general purpose integrated circuits ("IC"s)
designed by the Company under the brand name ASP Microelectronics. Licensing
revenues are royalties generated primarily from the license of the Company's
audio and voice technologies. License and royalty agreements generally provide
for the license of technologies for a specified period of time for either a
single fee or a fee based on the number of units distributed by the licensee.
Product and component sales primarily represent (a) the manufacture and sale of
Valence's own branded product line of amplifiers, and game products, (b) the
manufacture and sale of SRS Labs' products incorporating one or more of the
Companies licensed audio technologies and (c) the distribution of semiconductor
products, manufacturing components and sub-assemblies to OEMs for the Hong Kong
and the PRC markets.
Total revenues for the three months ended June 30, 2001 were $4,844,375
consisting of chip and licensing revenue of $3,125,407 and product and component
revenue of $1,718,968. This contrasts with the three months ended June 30, 2000,
where total revenues were $6,593,206 consisting of chip and licensing revenue of
$2,860,253 and product and component revenues of $3,732,953. Total revenues
decreased by $1,748,831, or 26.5% for the three months ended June 30, 2001
compared to the same period in 2000. Chip and licensing revenue increased by
$265,154 or 9.3% for the three months ended June 30, 2001, with revenue from
custom ASIC chip design and chip sales related to Valence's activities
decreasing by 37.4% which was offset by an increase in licensing revenue of
12
248.7% compared to the same period in 2000. The decrease in ASIC chip design and
chip sales was primarily due to recent global weakness in the semiconductor
industry. The increase in licensing revenues during the quarter was the result
of new licensing contracts signed since the first half of 2000. Product and
component revenues decreased by $2,013,985 or 54.0% from the same prior year
period which was due both to recent global weakness in the semiconductor
industry and the Company's decision to focus on higher margin chip and licensing
revenues and de-emphasize certain lower margin distribution activities. Revenues
generated by the Company's Internet-based business were not significant during
the three months ended June 30, 2001.
Gross Margin
Cost of sales consists primarily of fabrication costs, assembly and test
costs, and the cost of materials and overhead from operations. For the three
months ended June 30, 2001, the gross margin percentage increased to 51.8%,
compared to 35.3% for the same period in the prior year. The increase in margin
percentage is attributable to a reduction in lower margin product and component
revenues and a significant increase in licensing revenue, the most profitable
component of the Company's revenues.
Sales and Marketing
Sales and marketing expenses consist primarily of employee salaries and sales
consultants' fees and related expenses, sales commissions, advertising, and
product promotion costs. Sales and marketing expenses were $1,154,036 for the
three months ended June 30, 2001 compared to $1,422,744 for the same prior year
period, a decrease of $268,708, or 18.9%. The decrease is due primarily to a
reduction in spending at Valence associated with revenue declines related to the
recent global weakness in the semiconductor industry and spending and headcount
reductions at SRSWOWcast related to the change in Internet strategy from a
content development model to focus on licensing of audio and voice technology
solutions.
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 $896,884 for the three months ended June 30, 2001 compared to $984,908 for
the same prior year period, a decrease of $88,024, or 8.9%. Research and
development costs as a percentage of revenues increased from 14.9% of revenues
for the quarter ended June 30, 2000 to 18.5% of revenues for the same period
this year. Research and development expenses may increase in the future as a
result of ongoing product development efforts.
General and Administrative
General and administrative expenses consist primarily of employee-related
expenses, professional fees and patent and intangible asset amortization costs.
General and administrative expenses were $1,568,940 for the quarter ended June
30, 2001 compared to $4,195,373 for the same prior year period, for a decrease
of $2,626,433 or 62.6%. The decrease is due primarily to a reduction in
significant one time costs being incurred in the quarter ended June 30, 2000
(totaling approximately $2,177,000) including costs associated with the
resignation of an employee of Valence, the accelerated amortization of
intangible assets deemed to relate to outdated technologies and costs associated
with a postponed IPO involving Valence (see discussion below under IPO Related
Expenses) plus a general reduction in overall general and administrative
expenses due to headcount reductions. As a percentage of total revenues, general
and administrative expenses decreased from 63.6% for the quarter ended June 30,
2000, to 32.4% for the same period this year.
Other Income, Net
Other income, net consists primarily of interest income, interest expense and
foreign currency translation gains and losses. Net other income was $245,009 for
the three months ended June 30, 2001 compared to $308,413 for the same prior
year period, a decrease of 20.6%. The decrease is primarily due to lower
interest income, net of interest expense that is attributable to lower average
cash and investment balances being invested at lower average interest
13
rates during the current year quarter. Other income, net may decline in the
future as interest rates continue to decrease.
Minority Interest
Minority interest represents the minority shareholders' proportionate share of
losses in SRSWOWcast. Losses in SRSWOWcast are expected to continue as a result
of expenditures exceeding revenues in an effort to support the expansion and
growth of SRSWOWcast business operations. Should losses continue in SRSWOWcast,
the minority interest adjustment in the consolidated statement of operations
will continue to reduce the Company's net losses by the minority shareholders'
proportionate share of SRSWOWcast's net losses to the extent of their
investment.
Provision for Income Taxes
The income tax expense for the three months ended June 30, 2001 was $159,157
compared to $138,491 for the same prior year period. The increase is primarily
due to higher levels of licensing revenues sourced from countries withholding
foreign tax.
Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000
Revenues
Total revenues for the six months ended June 30, 2001 were $9,175,256
consisting of chip and licensing revenue of $5,373,801 and product and component
revenue of $3,801,455. This contrasts with the six months ended June 30, 2000,
where total revenues were $13,783,758 consisting of chip and licensing revenue
of $5,739,332 and product and component revenues of $8,044,426. Total revenues
decreased by $4,608,502, or 33.4% for the six months ended June 30, 2001
compared to the same period in 2000. Chip and licensing revenue decreased by
$365,531 or 6.4% for the six months ended June 30, 2001, with revenue from
custom ASIC chip design and chip sales related to Valence's activities
decreasing by 45.1% which was partially offset by an increase in licensing
revenue of 170.0% compared to the same period in 2000. The decrease in ASIC chip
design and chip sales was primarily due to recent global weakness in the
semiconductor industry. The increase in licensing revenues during the six months
ended June 30, 2001 was the result of new licensing contracts signed since the
first half of 2000. Product and component revenues decreased by $4,242,971 or
52.7% from the same prior year period which was due both to recent global
weakness in the semiconductor industry and the Company's decision to focus on
higher margin chip and licensing revenues and de-emphasize certain lower margin
distribution activities. Revenues generated by the Company's Internet-based
business were not significant during the six months ended June 30, 2001.
Gross Margin
For the six months ended June 30, 2001, the gross margin percentage increased
to 49.5%, compared to 33.9% for the same period in the prior year. The increase
in margin percentage is attributable to a shift in the revenue mix during the
period from lower margin product and component revenues to a higher percentage
of revenues in the higher margin chip and licensing category from the same prior
year period.
Sales and Marketing
Sales and marketing expenses were $2,545,416 for the six months ended June 30,
2001, compared to $2,707,477 for the same period in the prior year, a decrease
of $162,061 or 6.0%. The decrease is due primarily to reductions in spending
during the second quarter of 2001 at SRSWOWcast compared to the second quarter
of the prior year period when there were significant early stage development and
promotion costs incurred for the creation of the SRSWOWcast website, and
creation of program content for the website.
Research and Development
Research and development costs were $1,774,978 for the six months ended June
30, 2001, compared to $1,924,097 for the same period in the prior year, a
decrease of $149,119, or 7.8%. Research and development costs as a percentage
of revenues increased from 14.0% of revenues for the six months ended June 30,
2000 to 19.3% of
14
revenues for the same period this year. Research and development costs may
increase in the future as a result of ongoing product development efforts.
General and Administrative
General and administrative costs were $3,130,866 for the six months ended June
30, 2001, compared to $5,613,960 for the same period in the prior year, a
decrease of $2,483,094, or 44.2%. The decrease is due primarily to a reduction
in significant one time costs being incurred in the six months ended June 30,
2000 (totaling approximately $2,177,000) including costs associated with the
resignation of an employee of Valence, the accelerated amortization of
intangible assets deemed to relate to outdated technologies and costs associated
with a postponed IPO involving Valence (see discussion below under IPO Related
Expenses) plus a general reduction in overall general and administrative
expenses due to headcount reductions. As a percentage of total revenues, general
and administrative expenses decreased from 40.7% of revenues for the six month
period ended June 30, 2000, to 34.1% of revenues for the same period this year.
IPO Related Expenses
On March 3, 2000, the Company filed an application to list the common shares
of Valence on the Growth Enterprise Market of the Hong Kong Stock Exchange (the
"GEM"), in order to sell a minority interest in Valence to the public. The
initial public offering was targeted for completion in the second quarter of
2000. However, due to negative market conditions affecting equity markets
worldwide, including the GEM, the Company elected to postpone the offering
indefinitely. Offering costs incurred by the Company, comprised primarily of
legal, accounting and underwriting fees, totaled $1,142,175 as of June 30, 2000.
These costs are included in general and administrative expense in the
accompanying financial statements.
Non-cash Stock Issuance Costs
In March 2000, the Company entered into a technology and marketing alliance
with Microsoft Corporation. In conjunction with this transaction, Microsoft
purchased shares of common stock of the Company and was granted a warrant to
purchase additional shares of common stock of the Company and a warrant to
purchase shares of common stock of SRSWOWcast. As a result of the transaction,
the Company recognized one-time, non-cash charges totaling $3,111,859 (see Note
7 of the Notes to the Condensed Interim Consolidated Financial Statements for
more information concerning the Microsoft transaction).
Other Income, Net
Other income, net was $479,050 for the six months ended June 30, 2001,
compared to $517,976 for the same period in the prior year, a decrease of
$38,926 or 7.5%. The decrease is due primarily to lower interest income, net of
interest expense that is attributable to lower average cash and investment
balances being invested at lower average interest rates during the current year
period. Other income, net may decline in the future as interest rates continue
to decrease.
Minority Interest
Minority interest represents the minority shareholders' proportionate share of
losses in SRSWOWcast. Losses in SRSWOWcast are expected to continue as a result
of expenditures exceeding revenues in an effort to support the expansion and
growth of SRSWOWcast business operations. Should losses continue in SRSWOWcast,
the minority interest adjustment in the consolidated statement of operations
will continue to reduce the Company's net losses by the minority shareholders'
proportionate share of SRSWOWcast's net losses to the extent of their
investment.
Provision for Income Taxes
The income tax expense for the six months ended June 30, 2001 was $229,751
compared to $276,584 for the same period in the prior year. The decrease is
primarily attributable to lower results in the first quarter of 2001 at Valence
resulting in reduced tax expense for the quarter when compared to the same
period in the prior year period.
15
New Accounting Pronouncements
On January 1, 2001, the Company adopted Statement of Financial Accounting
Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities" as amended by SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities - an amendment of FASB Statement No.
133" which requires derivatives to be reported as assets or liabilities in the
balance sheet at fair value. The amendment included expanding the normal
purchase and sale exemption for supply contracts, permitting the offsetting of
certain intercompany foreign currency derivatives and thus reducing the number
of third party derivatives, permitting hedge accounting for foreign-currency
denominated assets and liabilities and redefining interest rate risk to reduce
sources of ineffectiveness. The adoption of SFAS No. 133, as amended by SFAS
No. 138, did not have a material impact on the Company's consolidated results of
operations, financial position or cash flows.
In December 1999, the SEC staff issued SAB No. 101, "Revenue Recognition in
Financial Statements". SAB No. 101 summarizes the SEC staff's views in applying
generally accepted accounting principles to revenue recognition in financial
statements. The implementation of SAB No. 101 in the fourth quarter of 2000 did
not have a material effect on the Company's consolidated results of operations,
financial position or cash flows.
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141 "Business Combinations", which, among other things, will require that
the purchase method of accounting be used for all business combinations
initiated after June 30, 2001, will no longer permit the use of the pooling-of-
interests method of accounting for business combinations and broadens the
criteria for recording intangible assets separate from goodwill. Management
does not believe the adoption of SFAS No. 141 will have a material impact on the
Company's consolidated results of operations, financial position or cash flows.
In July 2001, FASB issued SFAS No. 142 "Goodwill and Other Intangible Assets",
which, among other things, establishes new standards for goodwill acquired in a
business combination, eliminates the amortization of goodwill and requires the
carrying value of goodwill and identifiable intangibles to be evaluated for
impairment on an annual basis. Identifiable intangible assets with a
determinable useful life will continue to be amortized over that period. SFAS
No. 142 is effective for fiscal years beginning after December 15, 2001.
Management does not believe the adoption of SFAS No. 142 will have a material
impact on the Company's consolidated results of operations, financial position
or cash flows.
Liquidity and Capital Resources
The Company's principal source of liquidity at June 30, 2001 consisted of
cash, cash equivalents and investments aggregating $20,859,069, as well as
borrowings available under its credit facilities. At December 31, 2000, the
Company had cash, cash equivalents and investments of $30,425,210. During the
six months ended June 30, 2001 the Company used $8,000,000 to repay its line of
credit. Since April 2, 2001 the Company no longer has any external bank debt
outstanding. In March 2000, the Company sold shares of its common stock to
Microsoft Corporation, for aggregate cash proceeds of $5,000,000 (see Note 7 to
the Condensed Interim Consolidated Financial Statements). In November 2000, the
Company's wholly-owned subsidiary, SRSWOWcast sold to investors 3,000,000 shares
of its Series A Convertible Preferred Stock for an aggregate amount of
$6,000,000 and granted warrants to purchase shares of SRSWOWcast common stock to
such investors at an exercise price of $2.50 per share (the "SRSWOWcast
Investment"). All remaining proceeds from the SRSWOWcast Investment will be used
exclusively by SRSWOWcast (see Note 7 to the Condensed Interim Consolidated
Financial Statements).
The Company's operating activities utilized $1,262,916 in cash for the six
months ended June 30, 2001, and $2,779,804 for the six months ended June 30,
2000. The use of cash in operations was primarily due to the Company's loss from
operations for the period, after adjustment for non-cash charges related to
depreciation and amortization. The net decrease in cash and cash equivalents of
$7,861,126 for the period is primarily attributable to the repayment of the line
of credit during the period.
In March 1998, the Company obtained a revolving line of credit (and letter of
credit facility) with a bank which was secured by certain of the Company's cash,
cash equivalents and investments. This line of credit expired on April 1, 2001
and was fully repaid on April 2, 2001. The total availability under the line of
credit was the lesser of $10,000,000 or a percentage of the fair market value of
the collateral. Interest on the line of credit was at the bank's prime rate or
LIBOR plus 0.75%. On April 1, 2001, the Company entered into a new revolving
line of credit with
16
the same bank on substantially the same terms and conditions as the previous
revolving line of credit except the total availability under the new line of
credit was reduced to the lesser of $5,000,000 or a percentage of the fair
market value of the collateral. The collateral requirements under the above-
referenced credit facility may have the effect of restricting the amounts of
cash available to pay dividends. At June 30, 2001, the Company had no borrowings
outstanding under the new revolving line of credit.
In November 1999, Valence obtained a credit facility with a bank that provided
for borrowings aggregating approximately $5,000,000. In January 2001, the credit
facility was renegotiated to reduce the amount available to borrow under the new
credit facility and to provide for a variety of import/export trade instruments
up to $2,000,000 at interest rates ranging from 1% over the Hong Kong Dollar
prime rate to 1.75% over LIBOR. The new facility is subject to
renewal/expiration on or before October 31, 2001 and is collateralized by
certain of Valence's assets on deposit with the bank. At June 30, 2001, the
Company was contingently liable under an outstanding letter of credit in the
amount of $1,000,000 under this credit facility. This outstanding letter of
credit expires July 31, 2001.
The Company anticipates that its primary uses of working capital in future
periods will be to acquire new technologies and to fund increased costs for
additional sales and engineering headcount and marketing activities associated
with the introduction of new technologies and products into the market. The
Company also expects to fund increased costs associated with the ongoing
expansion and promotion of its SRSWOWcast operations.
Based on current plans and business conditions, the Company expects that its
cash, cash equivalents, investments and/or available borrowings under its credit
facilities, together with any amounts generated from operations, will be
sufficient to meet the Company's cash requirements for the next 12 months.
However, there can be no assurance that the Company will not be required to seek
other financing sooner or that such financing, if required, will be available on
terms satisfactory to the Company.
Factors That May Affect Future Results
Quarterly Fluctuations
The Company's operating results may fluctuate from those in prior quarters and
will continue to be subject to quarterly and other fluctuations due to a variety
of factors, including the extent to which the Company's licensees incorporate
the Company's technologies into their products; the timing of orders from and
the shipments to major customers; the timing of new product introductions by the
Company; the gain or loss of significant customers; competitive pressures on
selling prices; the market acceptance of new or enhanced versions of the
Company's technologies; the rate that the Company's semiconductor licensees
manufacture and distribute chips to product manufacturers; results of operations
of SRSWOWcast; and fluctuations in general economic conditions, particularly
those affecting the consumer electronics market. Due to the Company's dependence
on the consumer electronics market, the substantial seasonality of sales in the
market has impacted the Company's revenues and net income. In particular, the
Company believes that there is seasonality relating to the Christmas season,
generally, and the Chinese New Year within the Asia region, which fall into the
fourth and first quarters, respectively. As a result, the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
Valence's Business
The Company derives a significant amount of its revenue from Valence's ASIC
and component distribution business. Valence's engineering team focuses on the
design of custom ASICs to meet specific customers' requirements and outsources
the production of the design to mask houses, foundries and packaging houses
located primarily in Asia. The operations of Valence could be affected by a
variety of factors, including global demand within the semiconductor market, 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 ASIC business' revenue is concentrated in a limited number of customers in
the areas of consumer electronics, communications products, computers and
computer peripherals. As such, the loss of any such customers or any bad debt
arising from them may have a material adverse impact on the Company's financial
condition and
17
results of operation. Beginning in Fiscal 1999, Valence began to exit from
certain lower margin product offerings in the distribution side of the business
and has begun developing and distributing products that are related to or
incorporate the Company's proprietary technologies. As a result, the immediate
loss in revenue of the low margin distribution business will not be entirely
offset by the new proprietary technology based products, which will take time to
develop and be introduced into the marketplace. There can be no assurance that
the Company will be able to quickly introduce new products to offset the loss in
revenue or that the new products developed will receive a favorable market
acceptance.
The acquisition of Valence has added significant diversity to the Company's
overall business structure and the Company's opportunities. The Company
recognizes that in the presence of such corporate diversity, and in particular
with regard to the semiconductor industry, there will always exist a potential
for a conflict among sales channels between the Company and certain of the
Company's technology licensees. Although the operations of the Company's
licensing business and those of Valence are generally complementary, there can
be no assurances that sales channel conflicts will not arise. If such potential
conflicts do materialize, the Company may or may not be able to mitigate the
effect of such perceived conflicts, which, if not resolved, may impact the
results of operations.
Internet Business
In Fiscal 1999, the Company launched its Internet business with the formation
of SRSWOWcast. In Fiscal 2000, SRSWOWcast commenced operations with a business
plan which focused on developing and acquiring audio based content to attract
visitor traffic to its website in order to sell advertising and e-commerce
products. In 2001, the Company changed its Internet strategy to focus on
licensing of the Company's audio and voice enhancement technology solutions for
Internet streaming, wireless, VoIP and telephony applications. There can be no
assurance that this new business model will develop a sufficient customer base
to be able to generate meaningful revenue.
Product Business
In Fiscal 1999, the Company developed and marketed on its e-commerce site,
www.wowthing.com, its first consumer audio product, the WOWThing Processor Box.
The WOWThing Processor Box enhances the sound quality of music downloaded over
the Internet as well as audio performance of computer and home entertainment
products and speakers. This was the Company's first entry into the consumer
market in the United States which is both competitive and demands products with
short life cycles.
The Company intends to expand its offerings of high-end audio enhancement
products in 2001 and in future years. There can be no assurance that the
Company will be able to develop an effective distribution channel and build
brand recognition as a product manufacturer. As the business increases, it is
anticipated that significant capital will be required to finance product
inventory and account receivables. As a result, the Company is subject to risks
of product obsolescence, bad debt and insufficient financial resources to grow
the business.
The Company also recognizes that as new consumer audio products are developed
and marketed by the Company, there will always exist a potential for a conflict
and competition between the Company and certain of the Company's technology
licensees. Although the intended products of the Company and those of its
licenses do not generally overlap, there can be no assurance that the Company's
products will not compete with those of their licensees. If such conflicts do
materialize, it is uncertain whether the Company will be able to mitigate the
effect of such conflicts, which if not resolved, may impact the results of
operations.
Economic Risks Associated with Doing Business in Asia, Particularly in Hong
Kong and the PRC
The Company's significant operations in the PRC and Asia have required, and
will continue to require, refinement to adapt to the changing market conditions
in the region. The Company's operations in Asia, and internationally in general,
are subject to risks of unexpected changes in, or impositions of legislative or
regulatory requirements.
The PRC economy has experienced significant growth in the past decade, but
such growth has been uneven across geographic and economic sectors and has
recently been slowing. There can be no assurance that such growth will not
continue to decrease or that any slow down will not have a negative effect on
the Company's business, including Valence. The PRC economy has also experienced
deflation in the past which may continue in the future.
18
The current economic situation may adversely affect the Company's profitability
over time as expenditures for consumer electronics products and information
technology may decrease due to the results of slowing domestic demand and
deflation.
Hong Kong is a Special Administrative Region of the PRC with its own
government and legislature. Hong Kong enjoys a high degree of autonomy from the
PRC under the principle of "one country, two systems". The Company can give no
assurance that Hong Kong will continue to enjoy autonomy from the PRC.
The Hong Kong dollar has remained relative constant due to the US dollar peg
and currency board system that has been in effect in Hong Kong since 1983. Since
mid-1997, interest rates in Hong Kong have fluctuated significantly and real
estate and retail sales have declined. The Company can give no assurance that
the Hong Kong economy will not worsen or that the historical currency peg of the
Hong Kong dollar to the U.S. dollar will be maintained. Continued recession in
Hong Kong, deflation or the discontinuation of the currency peg could adversely
affect the Company's business.
Currency Risk/Stability of Asian Markets
The Company expects that international sales will continue to represent a
significant portion of total revenues. To date, all of the Company's licensing
revenues have been denominated in U.S. dollars and most costs have been incurred
in U.S. dollars. It is the Company's expectation that licensing revenues will
continue to be denominated in U.S. dollars for the foreseeable future. Because
Valence and its subsidiaries' business is primarily focused in Asia and because
of the Company's anticipated expansion of its business in the PRC and other
parts of Asia, the Company's consolidated operations and financial results could
be significantly affected by risks associated with international activities,
including economic and labor conditions, political instability, tax laws
(including U.S. taxes on foreign subsidiaries) and changes in the value of the
U.S. dollar versus the local currency in which the products are sold. In
addition, the Company's valuation of assets recorded as a result of the Valence
acquisition may also be adversely impacted by the currency fluctuations relative
to the U.S. dollar. The Company intends to actively monitor its foreign exchange
exposure and to implement strategies to reduce its foreign exchange risk at such
time that the Company determines the benefits of such strategies outweigh the
associated costs. However, there is no guarantee that the Company will take
steps to insure against such risks, and should such risks occur, there is no
guarantee that the Company will not be significantly impacted. Countries in the
Asia Pacific region have experienced weakness in their currency, banking and
equity markets. These weaknesses could adversely affect consumer demand for
Valence's products, the U.S. dollar value of the Company's and its subsidiaries'
foreign currency denominated sales, the availability and supply of product
components to Valence and ultimately, the Company's consolidated results of
operations.
Competitive Pressures
The Company's existing and potential competitors include both large and
emerging domestic and international companies that have substantially greater
financial, manufacturing, technical, marketing, distribution and other
resources. The Company's present or future competitors may be able to develop
products and technologies comparable or superior to those offered by the
Company, and to adapt more quickly than the Company to new technologies or
evolving market needs. The Company believes that the competitive factors
affecting the market for the Company's products and technologies include product
performance, price and quality; product functionality and features; the ease of
integration; and implementation of the products and technologies with other
hardware and software components in the OEM's products. In addition, the markets
in which the Company competes are intensely competitive and are characterized by
rapid technological changes, declining average sales prices and rapid product
obsolescence. Accordingly, there can be no assurance that the Company will be
able to continue to compete effectively in its respective markets, that
competition will not intensify or that future competition will not have a
material adverse effect on the Company's business, operating results, cash flows
and financial condition.
Importance of Intellectual Property
The Company's ability to compete may be affected by its ability to protect its
proprietary information. The Company has filed several U.S. and foreign patent
applications and to date has a number of issued U.S. and foreign patents
covering various aspects of its technologies. There can be no assurance that the
steps taken by the Company
19
to protect its intellectual property will be adequate to prevent
misappropriation of its technology or that the Company's competitors will not
independently develop technologies that are substantially equivalent or superior
to the Company's technology. In addition, the laws of certain foreign countries
may not protect the Company's intellectual property rights to the same extent,
as do the laws of the U.S. The semiconductor industry is characterized by
frequent claims and litigation regarding patent and other property rights. The
Company is not currently a party to any claims of this nature. There can be no
assurances that third parties will not assert additional claims or initiate
litigation against the Company or its customers with respect to existing or
future products. In addition, the Company may initiate claims or litigation
against third parties for infringement of the Company's proprietary rights or to
determine the scope and validity of the proprietary rights of the Company or
others.
Management of Growth; Dependence on Key Personnel
The continued growth of the Company and its subsidiaries has placed, and will
continue to place, a significant strain on its administrative, operational and
financial resources, and has increased, and will continue to increase, the level
of responsibility for both existing and new management personnel. The Company's
future success depends in part on the continued service of its key engineering,
sales, marketing and executive personnel, including highly skilled semiconductor
design personnel. The Company anticipates that any future growth will require it
to recruit and hire a number of new personnel in engineering, operations,
finance, sales and marketing. Competition for such personnel is intense, and
there can be no assurance that the Company can retain and recruit necessary
personnel to operate its business and support future growth. The Company's
ability to manage its growth successfully also will require the Company to
continue to expand and improve its administrative, operational, management and
financial systems and controls.
Volatility of Stock Price
The trading price of the Common Stock has been, and will likely continue to
be, subject to wide fluctuations in response to quarterly variations in the
Company's operating results, announcements of new products or technological
innovations by the Company or its competitors, strategic alliances between the
Company and third parties, general market fluctuations and other events and
factors. Changes in earnings estimates made by brokerage firms and industry
analysts relating to the markets in which the Company does business, or relating
to the Company specifically, have in the past resulted in, and could in the
future result in, an immediate and adverse effect on the market price of the
Common Stock.
Acquisitions
From time to time, the Company expects to make acquisitions of businesses or
technologies that are complementary to its business strategy. Such future
acquisitions would expose the Company to risks commonly encountered in
acquisitions of businesses. Such risks include, among others, difficulty of
assimilating the operations, information systems and personnel of the acquired
businesses, the potential disruption of the Company's ongoing business; and the
inability of management to maximize the financial and strategic position of the
Company through successful incorporation of the acquired technologies, employees
and customers. There can be no assurance that any potential acquisition will be
consummated or, if consummated, that it will not have a material adverse effect
on the Company's business, financial condition and results of operations.
Acquired In-Process Research and Development
Uncertainties that could impede the progress of converting a development
project to a developed technology include the availability of financial
resources to complete the project, failure of the technology to function
properly, continued economic feasibility of developed technologies, customer
acceptance, customer demand and customer qualification of such new technology
and general competitive conditions in the industry. There can be no assurance
that the acquired in-process research and development projects associated with
the acquisitions of Valence and VIP will be successfully completed and
commercially introduced.
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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 investment returns and the
cost of its debt.
Foreign Currency
The Company has subsidiary operations in Hong Kong and accordingly, the
Company is exposed to translation gains and losses that could result from
changes in foreign currency exchange rates. The Company uses the local currency
(Hong Kong dollars) as the functional currency for its Asian subsidiaries.
Translation adjustments resulting from the process of translating foreign
currency financial statements into U.S. dollars were not significant in Fiscal
1999 and for the six months ended June 30, 2001, due to the fact that the value
of the Hong Kong dollar is currently pegged to the U.S. dollar, and the exchange
rate remained constant throughout such periods. Under the current circumstances,
the Company believes that the foreign currency market risk is not material. The
Company actively monitors its foreign exchange exposure and, should
circumstances change, intends to implement strategies to reduce its risk at such
time that it determines that the benefits of such strategies outweigh the
associated costs. There can be no assurance that management's efforts to reduce
foreign exchange exposure will be successful.
Interest Rates
The Company's exposure to market risk for changes in interest rates, relates
primarily to our invested balances of cash, cash equivalents and investments.
The Company's investment policy specifies excess funds are to be invested in a
manner that preserves capital, provides liquidity and generates the highest
available after-tax return. To limit exposure to market risk, the Company places
its cash in banks, cash equivalents in high quality, short-term commercial paper
and investments consist of short-term municipal bonds. We do not invest in any
derivative instruments. The fair value of the Company's cash, cash equivalents
and investments or related income would not be significantly impacted by either
a 100 basis point increase or decrease in interest rates as most investments are
at fixed rates and are relatively short term. All cash, cash equivalents and
investments are carried at market value, which approximates cost.
The Company's credit facilities bear interest based on the lending bank's
prime rate or LIBOR plus 0.75%. The outstanding balance of the line of credit
was fully repaid on April 2, 2001.
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PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Annual Meeting of Stockholders of SRS Labs, Inc. was held on June 14, 2001
for the purpose of (a) electing one Class II Director to the Board of Directors
and (b) voting on a proposal to approve an amendment to the SRS Labs, Inc.
Amended and Restated 1996 Non-employee Directors' Stock Option Plan (the "Option
Plan") to increase the number of shares of Common Stock available for issuance
thereunder by 250,000.
John Tu was elected to serve as a Class II Director of the Company for a
three-year term expiring at the 2004 Annual Meeting of Stockholders. Gareth C.
C. Chang, Robert Pfannkuck and Jeffrey I. Scheinrock continued in office as
Class I Directors and Stephen V. Sedmak, Sam Yau and Thomas C.K. Yuen continued
in office as Class III Directors. The tabulation of the votes cast for the
election of Mr. Tu was as follows:
Votes For Votes Withheld
--------- --------------
9,349,703 11,380
The proposal to amend the Option Plan was approved. The tabulation of votes
was as follows:
Votes For Votes Against Abstentions Broker Non-Votes
--------- ------------- ----------- ----------------
9,262,300 83,480 15,303 0
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits. The exhibits listed below are hereby filed with the U.S.
Securities and Exchange Commission (the "Commission") as part of this
Report.
Exhibit
Number Description
- ----------- -----------
10.1 SRS Labs, Inc. Amended and Restated 1996 Non-employee Directors
Stock Option Plan, as amended, previously filed with the
Commission as Appendix B to the Company's Definitive Proxy
Statement dated and filed with the Commission on April 30,
2001, which is incorporated herein by reference.
(b) Reports on Form 8-K. No reports on Form 8-K were filed with the Commission
during the quarter for which this report is filed.
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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 10, 2001 By: /s/ DARRELL E. BAKER
-------------------------------------
Darrell E. Baker
Vice President - Finance,
Secretary and acting Treasurer,
(Authorized Signatory,
Principal Financial Officer and
Principal Accounting Officer)
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EXHIBIT INDEX
Exhibit
Number Description
- --------- -----------
10.1 SRS Labs, Inc. Amended and Restated 1996 Non-employee Directors
Stock Option Plan, as amended, previously filed with the
Commission as Appendix B to the Company's Definitive Proxy
Statement dated and filed with the Commission on April 30, 2001,
which is incorporated herein by reference.
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