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Table of Contents

 

 

 

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 March 31, 2012

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period          to        

 

Commission File Number 0-21123

 

GRAPHIC

 

SRS LABS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

33-0714264

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
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)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o
(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

As of April 27, 2012, 14,433,090 of the issuer’s common stock, par value $.001 per share, were outstanding.

 

 

 



Table of Contents

 

SRS LABS, INC.

 

Quarterly Report on Form 10-Q

For the Three Months Ended March 31, 2012

Index

 

PART I-FINANCIAL INFORMATION

 

Item 1.

Financial Statements

4

 

Condensed Consolidated Balance Sheets as of March 31, 2012 (Unaudited) and December 31, 2011

4

 

Condensed Consolidated Statements of Operations for the three months ended March 31, 2012 and 2011 (Unaudited)

5

 

Condensed Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2012 (Unaudited)

6

 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011 (Unaudited)

7

 

Notes to the Condensed Consolidated Financial Statements (Unaudited)

8

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

11

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

14

Item 4.

Controls and Procedures

14

PART II-OTHER INFORMATION

 

Item 1.

Legal Proceedings

14

Item 1A.

Risk Factors

14

Item 6.

Exhibits

22

 

 

 

SIGNATURES

23

 

2



Table of Contents

 

FORWARD-LOOKING INFORMATION

 

As used herein, the “Company,” “SRS Labs,” “SRS,” “we,” “us,” and “our” means SRS Labs, Inc., the parent company, and its wholly-owned subsidiaries, SRSWOWcast.com, Inc., Shenzhen Representative Office of SRS Labs, Inc. (a Chinese company), Shanghai Representative Office of SRS Labs, Inc. (a Chinese company), SRS Labs Japan, KK (a Japanese company), and SRS International Hungary LLC (a Hungarian company).

 

This Quarterly Report on Form 10-Q contains forward-looking statements regarding our assumptions, projections, expectations, targets, intentions or beliefs about future events. All statements other than statements of historical facts included in this Quarterly Report, including, but not limited to, those relating to our future operating results, profitability, growth and capital requirements, our investment and expansion plans, changes in our competitive position, changes in economic conditions or capital markets, the impact and timing of pending merger transaction with DTS, Inc. (“DTS”), and changes in customer usage patterns and preferences, are forward-looking statements. In some cases, you can identify forward-looking statements by terms such as may, will, should, could, expect, plan, intend, forecast, anticipate, believe, estimate, predict, potential, likely or similar expressions or variations of these terms. The forward-looking statements contained in this Quarterly Report involve known and unknown risks, uncertainties and situations that may cause our or our industry’s actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Factors that might cause actual events or results to differ materially from those indicated by these forward-looking statements may include the matters listed in Part II, Item 1A, “Risk Factors” of this Quarterly Report, including, but not limited to, the ability to satisfy the conditions for the closing of the DTS transaction and the impact of the related lawsuits; the ability to successfully complete the DTS transaction and attain the anticipated synergies of such transaction; the loss of any significant customer; the acceptance of new SRS Labs products and technologies; our ability to increase our brand awareness and enter into new or expanded license arrangements; the impact of competitive products and pricing; general economic and business conditions that may adversely impact sales of consumer products incorporating our technologies or that otherwise may impact our operating results and future performance; the timely development and release of technologies by the Company; and other factors identified from time to time in our filings with the Securities and Exchange Commission (“SEC”).

 

Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for management to predict all such factors.

 

3



Table of Contents

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

SRS LABS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

 

March 31,
2012

 

December 31,
2011

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

$

16,329,093

 

$

5,850,224

 

Accounts receivable, net

 

1,321,329

 

1,430,997

 

Prepaid expenses and other current assets

 

1,656,634

 

1,804,610

 

Short-term investments

 

18,537,000

 

27,837,000

 

Total Current Assets

 

37,844,056

 

36,922,831

 

 

 

 

 

 

 

Long-term investments

 

4,527,763

 

4,626,763

 

Property and equipment, net

 

1,149,353

 

1,247,343

 

Intangible assets, net

 

2,563,855

 

2,518,041

 

Deferred income taxes, net

 

12,758,304

 

11,782,197

 

Total Assets

 

$

58,843,331

 

$

57,097,175

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Accounts payable

 

$

1,123,574

 

$

556,342

 

Accrued liabilities

 

2,969,802

 

2,079,555

 

Deferred revenue

 

706,487

 

360,004

 

Total Current Liabilities

 

4,799,863

 

2,995,901

 

 

 

 

 

 

 

Commitments and contingencies (Note 4)

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Equity

 

 

 

 

 

Preferred stock—$0.001 par value; 2,000,000 shares authorized; no shares issued and outstanding

 

 

 

Common stock—$0.001 par value; 56,000,000 shares authorized; 15,171,946 shares issued and 14,323,715 shares outstanding at March 31, 2012 and 15,154,926 shares issued and 14,306,695 shares outstanding at December 31, 2011

 

15,173

 

15,156

 

Additional paid-in capital

 

73,369,311

 

72,615,408

 

Treasury stock at cost, 848,231 shares at March 31, 2012 and December 31, 2011

 

(5,905,422

)

(5,905,422

)

Accumulated deficit

 

(13,435,594

)

(12,623,868

)

Total Stockholders’ Equity

 

54,043,468

 

54,101,274

 

Total Liabilities and Stockholders’ Equity

 

$

58,843,331

 

$

57,097,175

 

 

See accompanying notes to the condensed consolidated financial statements

 

4



Table of Contents

 

SRS LABS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2012

 

2011

 

Revenues

 

$

8,963,261

 

$

8,181,193

 

Cost of sales

 

107,968

 

147,131

 

Gross profit

 

8,855,293

 

8,034,062

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Sales and marketing

 

3,749,845

 

3,801,717

 

Research and development

 

2,402,897

 

2,313,675

 

General and administrative

 

3,547,989

 

1,668,187

 

Total operating expenses

 

9,700,731

 

7,783,579

 

 

 

 

 

 

 

Operating (loss) income

 

(845,438

)

250,483

 

Other income, net

 

33,712

 

44,667

 

(Loss) income before income taxes

 

(811,726

)

295,150

 

Income taxes

 

 

2,783

 

Net (loss) income

 

$

(811,726

)

$

292,367

 

 

 

 

 

 

 

Net (loss) income per common share:

 

 

 

 

 

Basic

 

$

(0.06

)

$

0.02

 

Diluted

 

$

(0.06

)

$

0.02

 

 

 

 

 

 

 

Weighted average shares used in the per common share calculation:

 

 

 

 

 

Basic

 

14,317,006

 

14,866,238

 

Diluted

 

14,317,006

 

15,884,335

 

 

 See accompanying notes to the condensed consolidated financial statements

 

5



Table of Contents

 

SRS LABS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited)

 

 

 

Common Stock

 

Additional
Paid-In

 

Treasury

 

Accumulated

 

 

 

 

 

Shares

 

Amount

 

Capital

 

Stock

 

Deficit

 

Total

 

BALANCE, December 31, 2011

 

14,306,695

 

$

15,156

 

$

72,615,408

 

$

(5,905,422

)

$

(12,623,868

)

$

54,101,274

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Proceeds from exercise of stock options

 

17,020

 

17

 

85,100

 

 

 

85,117

 

Share-based compensation

 

 

 

668,803

 

 

 

668,803

 

Net loss

 

 

 

 

 

(811,726

)

(811,726

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, March 31, 2012

 

14,323,715

 

$

15,173

 

$

73,369,311

 

$

(5,905,422

)

$

(13,435,594

)

$

54,043,468

 

 

See accompanying notes to the condensed consolidated financial statements

 

6



Table of Contents

 

SRS LABS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2012

 

2011

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net (loss) income

 

$

(811,726

)

$

292,367

 

Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:

 

 

 

 

 

Depreciation and amortization

 

298,822

 

249,698

 

Provision for doubtful accounts

 

18,171

 

 

Deferred taxes

 

(976,106

)

(812,014

)

Share-based compensation

 

668,803

 

628,219

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

91,497

 

(702,046

)

Prepaid expenses and other current assets

 

147,975

 

(74,898

)

Accounts payable

 

567,232

 

206,441

 

Accrued liabilities

 

890,248

 

(10,983

)

Deferred revenue

 

346,483

 

(75,653

)

Net cash provided by (used in) operating activities

 

1,241,399

 

(298,869

)

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

Purchase of short-term and long-term investments

 

(150,000

)

(1,644,000

)

Proceeds from sale of short-term investments

 

9,549,000

 

3,996,000

 

Purchase of property and equipment

 

(20,315

)

(508,695

)

Expenditures related to intangible assets

 

(226,332

)

(84,409

)

Net cash provided by investing activities

 

9,152,353

 

1,758,896

 

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

Proceeds from exercise of stock options

 

85,117

 

403,431

 

Purchase of treasury stock

 

 

(259,805

)

Net cash provided by financing activities

 

85,117

 

143,626

 

 

 

 

 

 

 

Net Increase in Cash and Cash Equivalents

 

10,478,869

 

1,603,653

 

Cash and Cash Equivalents, Beginning of Period

 

5,850,224

 

10,697,827

 

Cash and Cash Equivalents, End of Period

 

$

16,329,093

 

$

12,301,480

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Income taxes

 

$

871,594

 

$

759,527

 

 

See accompanying notes to the condensed consolidated financial statements

 

7



Table of Contents

 

SRS LABS, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

1.             Basis of Presentation and Summary of Significant Accounting Policies and Estimates

 

As used herein, the  “Company,” “SRS Labs,” “SRS,” “we,” “us,” and “our” means SRS Labs, Inc., the parent company, and its wholly-owned subsidiaries, SRSWOWcast.com, Inc., Shenzhen Representative Office of SRS Labs, Inc. (a Chinese company), Shanghai Representative Office of SRS Labs, Inc. (a Chinese company), SRS Labs Japan, KK (a Japanese company), and SRS International Hungary LLC (a Hungarian company).  The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the rules and regulations of the SEC for interim reporting. In the opinion of management, all adjustments (which include normal recurring adjustments) considered necessary for a fair presentation of our financial position and results of operations have been included.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to SEC rules and regulations for presentation of interim financial information. Therefore, the unaudited condensed interim consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. Current and future financial statements may not be directly comparable to the Company’s historical financial statements. The results of operations for the interim period are not necessarily indicative of the results to be expected for any other interim period or for the full year.  The condensed consolidated balance sheet as of December 31, 2011 was derived from the Company’s audited consolidated financial statements for the year ended December 31, 2011.

 

Estimates

 

The preparation of financial statements in accordance with GAAP requires management to make use of certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources.  By their nature, estimates are subject to an inherent degree of uncertainty.  Actual results could differ materially from those estimates. See our audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011 for an additional discussion of the significant accounting policies and estimates used in the preparation of our financial statements.

 

Cash and Cash Equivalents

 

Cash and cash equivalents include short-term, highly liquid investments that are readily convertible to known amounts of cash and are so near maturity that they present insignificant risk of changes in value because of interest rates. Cash and cash equivalents generally consist of cash, money market funds and instruments with original maturities of three months or less when purchased.  The Company places its cash in banks and its cash and cash equivalents and money market funds at certain financial institutions in excess of amounts insured by federal agencies.  The Company does not believe that it is subject to any unusual financial risk beyond the normal risk associated with commercial banking relationships.  The Company performs periodic evaluations of the relative credit standing of these financial institutions.  The Company has not experienced any losses on its cash and cash equivalents.

 

Short-term and Long-term Investments

 

Short-term investments consist of certificates of deposit and U.S. treasury bills that mature within one year.  Long-term investments consist of approximately $3.9 million of certificates of deposit that mature beyond one year and an investment in a long term fund, which invests in foreign start-up companies principally based in China.  We have a total capital commitment up to $1.0 million in connection with this fund, and our investment in this fund as of March 31, 2012 totaled $592,763.  All of the certificates of deposit are fully FDIC insured. The Company has not experienced any losses on its short and long-term investments.

 

8



Table of Contents

 

Revenue Recognition

 

Our revenues consist primarily of royalties generated from the license of SRS Labs’ audio and voice technologies.  Our license agreements typically have multi-year or automatic renewal terms, and either require: (a) per-unit royalty payments for all products implementing our technologies and/or solutions; (b) fixed annual or quarterly royalty payments; or (c) a minimum fixed annual or quarterly royalty payment, which allows the licensee to ship up to a pre-determined number of units during the specified time period, with additional per-unit royalty payments thereafter.  The majority of our license agreements are per-unit royalty arrangements, which are generally reported by the licensee in the quarter following shipment of the consumer electronics devices and are therefore typically recognized by us following shipment of the devices by the original equipment manufacturer (“OEM”).  Revenues associated with fixed royalty payments are recognized ratably over the term of the license agreement.  We also sell some of our products and solutions via the Internet.  Revenues associated with those sales are recognized upon shipment and were not material in the three months ended March 31, 2012 or 2011. The Company may offer customer support or license support programs in the form of assisting the licensee with implementing the Company’s technology into the manufactured products of the licensee to ensure that the licensee receives the maximum benefit from the Company’s technology.  Such customer support is not contractually mandated and is generally provided on a discretionary basis to assist the customer and to improve customer relations.  Such customer support generally does not extend past the time in which the licensed technology is placed in service or implemented in any given device by the licensee.  In this regard, any support services occur during a finite period prior to the sale or revenue recognition.

 

Customer Concentrations

 

For the three months ended March 31, 2012 and 2011, one customer, Samsung, accounted for approximately 45% and 46%, respectively, of our revenues.  The revenue from Samsung is derived from multiple technology license agreements with various divisions of Samsung.

 

Reclassifications

 

Certain amounts in the prior year financial statements have been reclassified to conform to the current presentation.

 

Income Taxes

 

The Company currently has net operating loss carryforwards and tax credits to offset income taxes.  Due to our licensees being located in foreign countries, they may be obligated to withhold foreign taxes based upon local and country requirements of the taxing authority.

 

2.                                      Intangible Assets

 

Intangible assets consist of the following:

 

 

 

March 31,
2012

 

December 31,
2011

 

Patents

 

$

4,929,016

 

$

4,750,888

 

Accumulated amortization

 

(2,849,717

)

(2,756,169

)

Patents, net

 

2,079,299

 

1,994,719

 

Other intangibles

 

1,900,906

 

1,852,703

 

Accumulated amortization

 

(1,416,350

)

(1,329,381

)

Other intangibles, net

 

484,556

 

523,322

 

Intangible assets, net

 

$

2,563,855

 

$

2,518,041

 

 

Amortization expense associated with our intangibles was $180,517 and $170,448 in the three months ended March 31, 2012 and 2011, respectively.  Amortization expense is included in general and administrative expenses in the accompanying condensed consolidated statements of operations.

 

3.                                      Net (Loss) Income Per Common Share

 

Basic net (loss) income per common share is computed by dividing net (loss) income available to common stockholders by the weighted average number of common shares outstanding during each period. Diluted net (loss) income per common share reflects the maximum dilution, based on the average price of the Company’s common stock during each period, and is computed similar to basic net (loss) income per common share except that the denominator is increased to include the number of additional shares that would have been outstanding if potentially dilutive stock options had been exercised.

 

9



Table of Contents

 

Basic and diluted net (loss) income per share are as follows:

 

 

 

For the Three Months
Ended March 31,

 

 

 

2012

 

2011

 

BASIC EPS

 

 

 

 

 

Net (loss) income

 

$

(811,726

)

$

292,367

 

Weighted average common shares outstanding

 

14,317,006

 

14,866,238

 

Basic net (loss) income per share

 

$

(0.06

)

$

0.02

 

 

 

 

 

 

 

DILUTED EPS

 

 

 

 

 

Net (loss) income

 

$

(811,726

)

$

292,367

 

Weighted average common shares outstanding

 

14,317,006

 

14,866,238

 

Dilutive common equivalent shares outstanding:

 

 

 

 

 

Options

 

 

1,018,097

 

Restricted stock

 

 

 

Total diluted potential common shares

 

14,317,006

 

15,884,335

 

Diluted net (loss) income per share

 

$

(0.06

)

$

0.02

 

 

For the three months ended March 31, 2012 and 2011, there were outstanding options and restricted stock to purchase an aggregate of 5,038,517 shares and 1,214,420 shares, respectively, of the Company’s common stock that were not included in the computation of dilutive net (loss) income per share above because they would be anti-dilutive.

 

4.                                      Commitments and Contingencies

 

Two putative class action lawsuits have been filed by purported shareholders of SRS, challenging the proposed merger pursuant to which SRS would become a wholly-owned subsidiary of DTS (the “Merger”).  The lawsuits seek, among other things, to enjoin the defendants from completing the Merger pursuant to the terms of the Agreement and Plan of Merger and Reorganization, dated April 16, 2012, by and among DTS, DTS Merger Sub, Inc. and DTS LLC (the “Merger Agreement”).  If the plaintiffs are successful in obtaining an injunction prohibiting us from completing the Merger pursuant to the terms of the Merger Agreement, such an injunction may prevent the completing of the Merger in the expected timeframe (or altogether).

 

The first putative class action was filed in the Superior Court of the State of California, County of Orange, purportedly on behalf of the public holders of SRS common stock, against SRS, DTS and the members of the board of directors of SRS, alleging, among other things, that the directors, aided and abetted by SRS and DTS, breached their fiduciary duties to the stockholders of SRS in connection with the proposed Merger (the “California Complaint”).  The California Complaint seeks, among other things, to enjoin the defendants from completing the Merger pursuant to the terms of the Merger Agreement, absent implementation of a process to obtain a potentially higher price and/or require additional disclosures by the Company.  The California Complaint also seeks recovery of attorneys’ fees and costs of same.

 

The second putative class action was filed in the Court of Chancery of the State of Delaware purportedly on behalf of the public stockholders of SRS against DTS, DTS Merger Sub, Inc., DTS, LLC, SRS and the members of the board of directors of SRS, alleging, among other things, that the directors breached their fiduciary duties to the stockholders of SRS in connection with the proposed Merger (the “Delaware Complaint”).  It also alleges that all the defendants aided and abetted the directors’ alleged breaches of fiduciary duties.  The Delaware Complaint seeks, among other things, to enjoin the defendants from completing the Merger pursuant to the terms of the Merger Agreement, absent implementation of any and all methods to obtain a potentially higher price for stockholders, or, if the Merger is consummated, to rescind the Merger and award actual and punitive damages.  The Delaware Complaint also seeks recover of attorneys’ fees and expenses.

 

In addition, from time to time, the Company is subject to other legal proceedings and claims that arise in the normal course of business. While the outcome of these proceedings and claims cannot be predicted, except as set forth above, we currently are not a party to any other legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, is expected to have a material adverse effect on the Company’s consolidated financial position or results of operations.

 

5.                                      Segment Information

 

The Company operates in one reportable segment as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011. The following schedule presents the Company’s revenue by geographic area. Licensing-related revenue is summarized based on the location of the licensee’s corporate headquarters. For product and online sales, revenue is allocated to the United States. The China region includes all licensees with corporate headquarters located in mainland China. The Asia Pacific region includes all licensees with corporate headquarters located in Taiwan, Hong Kong and India.

 

 

 

Three Months Ended
March 31,

 

 

 

2012

 

%

 

2011

 

%

 

Geographic Area Revenues:

 

 

 

 

 

 

 

 

 

Korea

 

$

4,175,242

 

47

%

$

3,829,923

 

47

%

United States

 

2,350,323

 

26

 

1,993,237

 

24

 

China

 

998,718

 

11

 

468,929

 

6

 

Japan

 

542,322

 

6

 

819,277

 

10

 

Asia Pacific

 

522,110

 

6

 

898,997

 

11

 

Europe

 

374,546

 

4

 

170,830

 

2

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

8,963,261

 

100

%

$

8,181,193

 

100

%

 

6.                                      Fair Value Measurements

 

The Company measures the fair value of applicable financial and non-financial assets based on the following levels of inputs.

 

·                  Level 1 inputs: Level 1 inputs are quoted market prices in active markets for identical assets or liabilities that are accessible at the measurement date.

 

·                  Level 2 inputs: Level 2 inputs are from other than quoted market prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.

 

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·                  Level 3 inputs: Level 3 inputs are unobservable and should be used to measure fair value to the extent that observable inputs are not available.

 

The hierarchy noted above requires us to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value. There were no transfers between Level 1, Level 2 and/or Level 3 during the three months ended March 31, 2012. Financial assets measured at fair value on a recurring basis as of March 31, 2012 are classified below:

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

11,925,000

 

$

 

$

 

$

11,925,000

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

11,925,000

 

$

 

$

 

$

11,925,000

 

 

7.                                      Revolving Line of Credit

 

The Company has a $5.0 million revolving line of credit, which is available until June 30, 2012, to be used for working capital purposes.  As of March 31, 2012, the Company had no borrowings from the revolving line of credit.

 

8.                                      Subsequent Events

 

On April 16, 2012, the Company and DTS entered into the Merger Agreement under which DTS will acquire all outstanding shares of SRS in a cash-and-stock transaction valued at $9.50 per share in cash or 0.31127 of a share of DTS common stock per share in stock, or a total of approximately $148 million in aggregate equity value as of April 16, 2012, including acquired net cash of approximately $38 million as of December 31, 2011. Under the terms of the Merger Agreement, 50% of the total shares of the Company’s common stock issued and outstanding immediately prior to the effective time of the Merger will be converted into the right to receive the cash component of the Merger consideration and 50% of the total shares of the shares of the Company’s common stock issued and outstanding immediately prior to the effective time of the Merger will be converted into the right to receive the stock component of the Merger consideration. All SRS stock options and restricted stock units will fully vest immediately prior to and be canceled upon the closing of the Merger, and the holders thereof will be entitled to receive the $9.50 price per share (less the exercise price of any option) payable in cash.

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This information should be read in conjunction with the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2011, and the unaudited condensed interim consolidated financial statements and notes thereto included in this Quarterly Report.

 

Overview

 

We are the recognized global leader in the practical application of psychoacoustics, the science behind how the human ear operates, and in the post processing segment of the market for audio delivery.  Our award-winning audio enhancement technologies and solutions dramatically restore audio and voice to its natural state, the way it was originally recorded, in both dimension and clarity, thus providing a superior consumer experience for a wide variety of consumer electronic devices such as televisions, personal computers and mobile phones.

 

Our operations are conducted through SRS Labs, Inc., the parent company, and its wholly-owned subsidiaries, SRSWOWcast.com, Inc., Shenzhen Representative Office of SRS Labs, Inc., Shanghai Representative Office of SRS Labs, Inc., SRS Labs Japan, KK and SRS International Hungary LLC. Our business is focused on developing and licensing audio, voice and surround sound technology solutions to many of the world’s leading OEMs, software providers and semiconductor companies, and limited sales and marketing of standalone software and hardware products through the Internet.

 

During the three months ended March 31, 2012 and 2011, licensing revenues from the home entertainment market represented 61% and 64%, respectively, of our total revenues in such periods.  In the home entertainment market, our technologies have achieved broad market acceptance in the television sector.  We plan to continue to leverage our success in the television sector to expand our audio technologies into a variety of other consumer electronics devices, including personal computers (“PCs”), mobile phones, portable media devices and automotive audio systems, but our technologies to date have only been incorporated in products representing only a small portion of the total market opportunity.  The consumer electronics market in general is characterized by rapid technological changes, short product life cycles, seasonality, significant price erosion and competition, any of which may impede our ability to gain broad market acceptance for our technologies in other consumer electronics devices.  Nonetheless, we plan to continue to seek other opportunities where we can continue to leverage our core technologies and expertise.  If we are able to successfully gain broad market share for our technologies in any other market, it could significantly improve our revenues and brand name recognition.

 

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Critical Accounting Policies

 

Our critical accounting policies have been disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011. Our discussion and analysis of our results of operations and liquidity and capital resources are based on our unaudited consolidated financial statements for the three months ended March 31, 2012 and 2011, which have been prepared in accordance with GAAP.

 

The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. We base our estimates on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may materially differ from our estimates.

 

Results of Operations

 

Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011

 

Revenues

 

Our revenues consist primarily of royalties generated from the license of SRS Labs’ audio and voice technologies.  Our license agreements typically have multi-year or automatic renewal terms, and either require: (a) per-unit royalty payments for all products implementing our technologies and/or solutions; (b) fixed annual or quarterly royalty payments; or (c) a minimum fixed annual or quarterly royalty payment, which allows the licensee to ship up to a pre-determined number of units during the specified time period, with additional per-unit royalty payments thereafter.  The majority of our license agreements are per-unit royalty arrangements, which are generally reported by the licensee in the quarter following shipment of the consumer electronics devices and are therefore typically recognized by us following shipment of the devices by the OEM.  Revenues associated with fixed royalty payments are recognized ratably over the term of the license agreement.  We also sell some of our products and solutions via the Internet.  Revenues associated with those sales are recognized upon shipment and were not material in the three months ended March 31, 2012 or 2011. We may offer customer support or license support programs in the form of assisting the licensee with implementing our technology into the manufactured products of the licensee to ensure that the licensee receives the maximum benefit from our technology.  Such customer support is not contractually mandated and generally provided on a discretionary basis to assist the customer and improve customer relations.  Such customer support generally does not extend past the time in which the licensed technology is placed in service or implemented in any given device by the licensee.  In this regard, any support services are not contractual and occur during a finite period prior to the sale or revenue recognition.

 

Our revenues were $8,963,261 for the three months ended March 31, 2012, compared to $8,181,193 for the three months ended March 31, 2011, an increase of $782,068 or 10%.  Revenues in the personal computer market increased by $518,683 in the current quarter primarily due to increased volume shipment of personal computers by our existing licensees.  In the personal telecommunications market, revenue increased by $272,525 in the current quarter primarily due to increased royalties from higher volumes from our existing licensees in mobile phones and tablets. Revenues from the home entertainment market increased by $254,134 in the current quarter primarily due to increased shipments from Samsung and other existing licensees.  In the automotive market, revenues decreased by $172,861 in the current quarter primarily due to lower revenues from our Japanese customers who provide line install, dealer option and aftermarket automotive audio systems to many of the significant Japanese automotive manufacturers.  Overall, we have not experienced a material change in our per unit license rates in the current period other than volume pricing discounts provided pursuant to existing contractual obligations.

 

The following table presents our licensing revenues mix by market:

 

 

 

Three Months Ended
March 31,

 

 

 

2012

 

2011

 

Home entertainment (TVs, set top boxes)

 

61

%

64

%

PC (software, hardware)

 

17

 

12

 

Personal telecommunications (mobile phones, tablets, PDAs)

 

16

 

14

 

Automotive

 

4

 

7

 

Portable media devices (digital media players, headphones)

 

2

 

3

 

 

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Sales and Marketing

 

Sales and marketing expenses consist primarily of employee salaries and benefits, sales consultants’ fees and related expenses, sales commissions, tradeshow costs and costs associated with branding activities. Sales and marketing expenses were $3,749,845 for the three months ended March 31, 2012, compared to $3,801,717 for the same prior year period, a decrease of $51,872 or 1%.  This decrease was primarily related to a decrease in tradeshow related costs.  Included in sales and marketing expenses is share-based compensation expense of $245,736 and $219,749 for the three months ended March 31, 2012 and 2011, respectively.  As a percentage of total revenues, sales and marketing expenses decreased from 46% for the quarter ended March 31, 2011 to 42% for the same period this year.

 

Research and Development

 

Research and development expenses consist primarily of salaries and related costs of employees engaged in ongoing research, design and development activities and costs for engineering materials and supplies, and consulting fees. Research and development expenses were $2,402,897 for the three months ended March 31, 2012, compared to $2,313,675 for the same prior year period, an increase of $89,222 or 4%.  This increase was primarily attributable to consulting fees associated with the continued research and development of new, advanced audio rendering technologies.  Included in research and development expenses is share-based compensation expense of $149,610 and $148,806 for the three months ended March 31, 2012 and 2011, respectively.  As a percentage of total revenues, research and development expenses decreased from 28% for the quarter ended March 31, 2011 to 27% for the same period this year.

 

General and Administrative

 

General and administrative (“G&A”) expenses consist primarily of employee-related expenses, attorneys’ fees, accounting fees, depreciation of the Company’s assets, patent amortization, and other professional fees. G&A expenses were $3,547,989 for the three months ended March 31, 2012, compared to $1,668,187 for the same prior year period, an increase of $1,879,802 or 113%.  The increase was primarily attributable to transaction costs of $1,525,849 related to the proposed Merger with DTS, and also to a lesser extent, costs associated with the continued development of the Company’s international tax structure.  Included in G&A expenses was share-based compensation expense of $273,457 and $259,664 for the three months ended March 31, 2012 and 2011, respectively.  As a percentage of total revenues, G&A expenses increased from 20% for the quarter ended March 31, 2011 to 40% for the same period this year.

 

Other Income, Net

 

Other income, net consists primarily of interest income. Other income, net was $33,712 for the three months ended March 31, 2012, compared to $44,667 for the same prior year period, a decrease of $10,955 or 25%.  We have primarily invested our cash in low-risk, highly liquid investments such as fully insured certificates of deposits and assets backed by the United States Treasury.  We continue to monitor our cash assets to maximize our interest income while maintaining an acceptable level of risk.  The Company did not realize any losses on its investments in the current or prior year periods.

 

Income Taxes

 

Income tax expense for the three months ended March 31, 2012 was $0, compared to $2,783 for the same prior year period.  We reduced our tax provision and our valuation allowance on our deferred tax assets by $976,107 and $812,014 for the three months ended March 31, 2012 and 2011, respectively, based on our assessment of the future estimated realization of such assets.

 

Liquidity and Capital Resources

 

Our principal source of liquidity to fund ongoing operations at March 31, 2012 consisted of cash, cash equivalents and short-and long-term investments of $39,393,856.  At March 31, 2012, we had cash and cash equivalents of $16,329,093, short-term investments of $18,537,000 and long-term investments of $4,527,763.  Cash and cash equivalents generally consist of cash and money market funds with original maturities of three months or less. The money market funds are primarily invested in U.S. government obligations.  Short-term investments consist of certificates of deposit and treasury bills with maturities less than 12 months.  Long-term investments primarily consist of certificates of deposit that mature beyond one year.  The cash and certificates of deposit are substantially all FDIC insured.  The Company has not experienced any losses on its cash and cash equivalents or its short and long-term investments in the current period.

 

Net cash provided by operating activities was $1,241,399 and net cash used in operating activities was $298,869 for the three months ended March 31, 2012 and 2011, respectively.  The increase in our cash flows from operating activities was primarily the result of changes in our working capital, specifically, an increase in our accounts payable and accrued liabilities of $1,457,480 during the three months ended March 31, 2012 compared to an increase of $195,458 during the three months ended March 31, 2011, due to accrued professional fees for the current period associated with the proposed Merger with DTS.  These increases were offset by net loss of $811,726 during the three months ended March 31, 2012, compared to net income of $292,367 during the three months ended March 31, 2011.

 

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Net cash provided by investing activities was $9,152,353 and $1,758,896 during the three months ended March 31, 2012 and 2011, respectively.  The increase in cash provided by investing activities during the three months ended March 31, 2012 was attributable primarily to the proceeds of short-term certificates of deposits that matured in the current period.

 

We believe our existing cash, cash equivalents, and short and long-term investment balances together with cash generated from operating activities, will be sufficient to meet our anticipated cash needs for at least the next twelve months.  Our future capital requirements will depend on many factors, including our level of revenues, the timing and extent of spending to support product development efforts, the impact of existing adverse economic conditions, the expansion of sales and marketing activities, the timing of introductions of new products, continuing market acceptance of our products, and potential acquisitions of businesses or technologies.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

 

Except as follows, there have been no material changes to the information called for by this Item 3 from the disclosures set forth in Part II, Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. As of March 31, 2012, the Company had $22.5 million in short and long-term investments held in certificates of deposit (“CDs”) and U.S. treasuries, all of which are federally insured.  The CDs had stated interest rates when purchased, and we plan to hold the CDs to maturity.  As of March 31, 2012, the Company has $16.3 million in cash and cash equivalents, primarily held in money market funds, which are invested in U.S. government obligations.  We have not realized any losses on any of our investments in the current or prior year periods. We believe that we have limited our exposure to interest rate risk as a result of investing in only federally insured CDs and U.S. government obligations.  Because of the conservative nature of these investments, interest rate fluctuations and exposure to interest rate risk has been minimal and immaterial.

 

Item 4.  Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures. Our Chief Executive Officer and President and our Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15 (e) and 15d-15 (e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q and, based on this evaluation, have concluded that our disclosure controls and procedures are effective.

 

Changes in Internal Controls. There have been no changes in our internal controls over financial reporting that occurred during our first quarter ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

PART II OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

The information set forth under Note 4 of Notes to Unaudited Condensed Consolidated Financial Statements, included in Part I, Item 1 of this report, is incorporated herein by reference.

 

Item 1A. Risk Factors

 

You should carefully consider the risk factors described below, as well as the other information included in this Quarterly Report on Form 10-Q, and in our other filings with the SEC, prior to making a decision to invest in our securities. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known or that we currently believe to be less significant may also adversely affect us.

 

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Risk Factors Relating to our Business

 

We are exposed to risks in our licensing business related to product and customer concentration.

 

Currently, we generate a majority of our revenue in the home entertainment market, principally through the inclusion of SRS technology inside flat panel LCD and plasma televisions. We expect that the consumer home entertainment market will continue to account for a significant portion of our licensing revenues for the foreseeable future. Consumer spending on home entertainment products is subject to significant fluctuations, and there is significant price competition for such products. Retail prices for certain consumer electronics products that include our audio technology have decreased significantly, and we expect that this trend will continue for the foreseeable future. In addition, from time to time, certain of our OEM and semiconductor manufacturer customers may account for a significant portion of our revenues. For example, for the quarter ended March 31, 2012, Samsung accounted for approximately 45% of our consolidated revenues. OEM and semiconductor manufacturers could develop their own technologies or decide to exclude our audio rendering technology from their products altogether in an effort to reduce cost, our revenues and profitability could be adversely impacted.  The loss of any key customer in the future could have a material adverse effect on our financial condition and results of operations.

 

General economic conditions may reduce our revenues and harm our business.

 

Our business is exposed to adverse changes in general economic conditions because products that incorporate our technologies are entertainment-oriented and generally discretionary goods. The current slowdown or decline in U.S. and foreign economic growth has adversely affected consumer confidence, disposable income and spending. As a result, sales by our licensees of consumer electronics and other products incorporating our technologies may not grow as rapidly as in prior periods or may even decrease, which could adversely affect our licensing revenue.

 

Our business is highly dependent on the consumer electronics market, which is characterized by short product life cycles, rapid technological changes, fluctuations in demand, seasonality and declining retail prices and is subject to risks related to product transitions.

 

The consumer electronics market is characterized by intense competition, rapidly evolving technology, and ever-changing consumer preferences. These factors result in the frequent introduction of new products, short product life cycles and significant price competition. As a result, we may need to develop new products or technologies or modify our existing technologies to integrate with the new products and technologies developed by our customers. If we are unable to develop the necessary technologies to meet the changing needs of our customers on a timely basis, or at all, or to provide such technologies at competitive prices, our customers may reduce their use of our technologies and our revenues may decline. In addition, the dynamic nature of this market limits our ability and the ability of our customers to accurately forecast quarterly and annual sales. If we, or our customers, are unable to adequately manage product transitions, our business and results of operations could be negatively affected.

 

We depend on the sale by our licensees of products that incorporate our technologies, and a reduction in those sales would adversely affect our licensing revenue.

 

We derive most of our revenue from the licensing of our technologies to consumer electronics product manufacturers. We do not manufacture consumer electronics products ourselves and our licensing revenue is dependent on sales by our licensees of products that incorporate our technologies. We cannot control these manufacturers’ product development or commercialization efforts or predict their success. In addition, our license agreements, which typically require manufacturers of consumer electronics products and media software vendors to pay us a specified royalty for every electronics product shipped that incorporates our technologies, do not require these manufacturers to include our technologies in any specific number or percentage of units, and only a few of these agreements guarantee us a minimum aggregate licensing fee. Accordingly, if our licensees sell fewer products incorporating our technologies, decline to actively market products incorporating our technologies, encounter quality issues with their products or otherwise face significant economic difficulties, our revenue will decline. Changes in consumer tastes or trends, changes in industry standards or adverse changes in business and economic conditions may also adversely affect our licensing revenue.

 

Pricing pressures on the consumer electronics product manufacturers, who incorporate our technologies into their products, could limit the licensing fees we charge for our technologies, which could reduce our revenues.

 

The markets for the consumer electronics products in which our technologies are incorporated are intensely competitive and price sensitive. Retail prices for consumer electronics products that include our technologies have decreased significantly, and we expect prices to continue to decrease for the foreseeable future. In response, manufacturers have sought to reduce their product costs, which can result in downward pressure on the licensing fees we charge our customers who incorporate our technologies into their products. Alternatively, our customers may seek to eliminate our technologies in their products in favor of internally developed technologies. A decline in the licensing fees we charge could materially and adversely affect our operating results.

 

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We face intense competition from companies with greater brand recognition and resources.

 

The digital audio, consumer electronics and entertainment markets are intensely competitive, subject to rapid change, and significantly affected by new product introductions and other market activities of industry participants.

 

Some of our current and potential competitors enjoy notable competitive advantages, including:

 

·                  greater name recognition;

 

·                  a longer operating history;

 

·                  more developed distribution channels and deeper relationships with consumer electronics products designers and manufacturers;

 

·                  a more extensive customer base;

 

·                  broader product and service offerings;

 

·                  greater resources for competitive activities, such as research and development, strategic acquisitions, alliances, joint ventures, sales and marketing, and lobbying on industry and government standards; and

 

·                  more technicians and engineers.

 

As a result, these current and potential competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards, or customer requirements.  In addition, decoding and encoding technologies of certain of our competitors have become industry standards in certain consumer electronic products that may offer such competitors an advantage.

 

We may also experience competition from certain of our customers who decide to develop their own audio technologies instead of licensing our technologies for certain or all of their products.  Increased competition could result in pricing pressures, decreased gross margins and loss of market share and may materially and adversely affect our business, financial condition and results of operations.

 

Inaccurate licensee royalty reporting and unauthorized use of our intellectual property could materially adversely affect our operating results.

 

Our licensing revenue is generated primarily from consumer electronics product manufacturers who license our technologies and incorporate them in their products. Under a significant percentage of our existing arrangements, these licensees typically pay us a specified royalty for every product they ship that incorporates our technologies. We rely on our licensees to accurately report the number of units shipped that incorporate our technologies. We calculate our license fees, prepare our financial reports, projections and budgets, and direct our sales and product development efforts based on these reports we receive from our licensees. However, it can be difficult for us to independently determine whether or not our licensees are reporting shipments accurately. This is especially true with respect to software incorporating our technologies because software can be copied relatively easily and we often do not have easy ways to determine how many copies have been made. Most of our license agreements permit us to audit our licensees’ records, but audits are generally expensive and time consuming and initiating audits could harm our customer relationships. We expect that we will continue to be subject to understatement and non-reporting of royalty bearing revenues by licensees, which could adversely affect our operating results. Conversely, to the extent that our licensees overstate the number of products incorporating our technologies, negative corrections could result in reductions of royalty revenue in subsequent periods. Some of our licensees may begin to more closely scrutinize their past licensing statements which may result in an increased receipt of negative corrective statements.

 

We also may experience problems with non-licensee consumer electronics product manufacturers and media software vendors, particularly in emerging economies, incorporating our technologies or incorporating our technologies and trademarks into their products without our authorization and without paying us any licensing fees. This unauthorized use of our intellectual property could adversely affect our operating results.

 

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Our business and future prospects depend upon the strength of our brand. Awareness of our brand depends to a significant extent upon decisions by our customers to display our trademarks on their products, and if our customers do not display our trademarks on their products, our ability to increase our brand awareness may be harmed.

 

Maintaining the SRS brand and our position as an industry standard is critical to maintaining and expanding our licensing revenues and entering into new or broadening existing licensing relationships.  Because we engage in relatively little direct brand advertising, the promotion of our brand depends upon consumer electronics industry participants displaying our trademarks on their products that incorporate our technologies.  Although we do generally require our customers to place our brand on their products, some are not required to do so. If our customers choose for any reason not to display our trademarks on their products, our ability to maintain or increase our brand awareness may be harmed, which would have an adverse effect on our business and prospects. In addition, if we fail to maintain high quality standards for our products, or the products that incorporate our technologies through the quality control evaluation process that we require of our licensees, the strength of our brand could be adversely affected.

 

Licensee products that incorporate our technologies, from time to time, experience quality problems that could damage our brand, decrease revenues and increase operating expenses.

 

Licensee products that incorporate our technologies often are complex and sometimes contain undetected software or hardware errors, particularly when first introduced or when new versions are released. In addition, those products are often combined with, or incorporated into, products from other companies, sometimes making it difficult to identify the source of a problem. Any negative publicity or negative impact relating to these product problems (even if unrelated to our technologies) could adversely affect the perception of our brand. In addition, these errors could result in loss of, or delay in, market acceptance of those products or our technologies, or cause delays in delivering them and meeting customer demands, any of which could reduce our revenue and raise significant customer relations issues. Although we generally attempt to contractually limit our liability for our licensees’ defective products, we may elect to help reengineer those products, which could increase our expenses and adversely affect our operating results.

 

Current and future industry standards may limit our business opportunities.

 

Technology standards are important in the audio and video industry as they help to assure compatibility across a system or series of products. Generally, standards adoption occurs on either a mandatory basis, requiring a particular technology to be available in a particular product or medium, or an optional basis, meaning that a particular technology may be, but is not required to be, utilized. Certain of our competitors have been selected as mandatory industry standards, which may provide them with a competitive advantage over our technologies, making it easier to expand or gain market share.  As new technologies emerge, new standards relating to these technologies may develop. We may not be successful in our efforts to include our technologies in any such standards, which would cause our future revenue growth to be lower than expected and could have a material adverse affect on our business.

 

The automotive industry and the consumer electronics industry in general may be negatively impacted by the devastating effects of the earthquake and subsequent tsunami in Japan.

 

The earthquake and subsequent tsunami in Japan in March 2011 have resulted in extensive and severe structural damage in Japan, including heavy damage to manufacturing facilities, roads and railways. As a result, Japanese automobile manufacturers and other manufacturers of consumer electronics products and components in Asia have been adversely impacted by these events. During the year ended December 31, 2011 and the quarter ended March 31, 2012, our royalties generated from the automotive segment were negatively impacted by these events. We have not experienced a significant decline in other segments; however, we anticipate that many manufacturers of consumer electronics in Asia may have been adversely affected by these events; which, in turn, may adversely impact our revenues in future periods.

 

We are subject to risks associated with substantial international operations.

 

We conduct sales and customer support operations in a number of countries throughout the world that require refinement to adapt to the changing market conditions on a regional basis. In addition, many of our significant customers are headquartered in the Asia region, particularly Korea and Japan. Approximately 69%, 74% and 72% of our revenues were derived from customers with headquarters located in the Asia markets during the years ended December 31, 2011, 2010, and 2009, respectively. We expect to continue to derive a significant portion of our revenues from sales to customers in these markets for the foreseeable future. Also, a substantial number of products incorporating our technologies are manufactured, assembled and tested by third parties in Asia. As a result, we are subject to a number of risks of conducting business outside of the United States, any of which could have a material adverse impact on our business and results of operations, including:

 

·                  global economic downturn;

 

·                  political, social and economic instability and the risk of war, terrorist activities or other international incidents in Asia and elsewhere abroad;

 

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·      currency fluctuations;

 

·                  difficulties and costs of staffing and managing foreign operations;

 

·                  unexpected changes in, or impositions of, government requirements;

 

·                  adverse changes in tariffs and other protectionist laws and business practices that favor local competitors;

 

·                  potentially longer payment cycles and greater difficulty in collecting receivables from foreign entities;

 

·                  the burdens of complying with a variety of non-U.S. laws and reduced protection of our intellectual property in some countries;

 

·                  potentially adverse tax consequences and the complexities of foreign value added tax systems; and

 

·                  other factors beyond our control, including major health concerns and natural disasters, including but not limited, to the impact on our future revenues as a result of the recent earthquake, tsunami and related events in Japan.

 

Our technologies have a long and unpredictable sales cycle, which can result in uncertainty and delays in generating additional revenues.

 

Historically, because of the complexity of our technologies, it can take a significant amount of time and effort to explain the benefits of our technologies to potential new customers and to negotiate a sale. For example, it typically takes six to nine months after our first contact with a prospective customer before we start licensing our technology to that customer and another six to nine months to begin generating revenues. In addition, purchases of our products are usually made in connection with new design starts by our customers, the timing of which is outside of our control. Accordingly, we may be unable to predict accurately the timing of any significant future sales of our products. We may also spend substantial time and management attention on potential license agreements that are not consummated, or in which the consumer electronic product ultimately does not sell in large quantities, thereby foregoing other higher revenue opportunities.

 

If our patents and other intellectual property rights do not adequately protect our products, we may lose market share to our competitors and be unable to operate our business profitably.

 

Our ability to compete may be affected by our ability to protect our proprietary information. We have filed numerous U.S. and foreign patent applications and to date have a number of issued U.S. and foreign patents covering various aspects of our technologies. We cannot guarantee that the steps taken by us to protect our intellectual property will be adequate to prevent misappropriation of our technology or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology. In addition, the laws of certain foreign countries may not protect our intellectual property rights to the same extent as do the laws of the U.S. It is possible that third parties may assert claims or initiate litigation against us or our customers with respect to existing or future products. In addition, we may initiate claims or litigation against third parties for infringement of our proprietary rights or to determine the scope and validity of our proprietary rights. Litigation in the technology industry is common.  Claims and litigation brought against us or initiated by us could be costly and time consuming and could divert our management from our business. The outcome of any litigation is uncertain and could require us to pay significant damages or could prevent us from licensing some or all of our technologies, which could significantly harm our business and results of operations.

 

We may pursue the acquisition of technologies, products or businesses, which could adversely impact our business, financial condition and results of operations.

 

In April 2012, we entered into a definitive agreement in connection with the Merger with DTS and may consider other opportunities to acquire technologies, products or businesses that could enhance our technical capabilities, complement our current technologies, or expand the breadth of our markets. We have a limited history of acquiring and integrating businesses. Acquisitions and strategic investments, including the Merger with DTS, involve numerous risks, including:

 

·                  problems assimilating the purchased technologies, products or business operations;

 

·                  significant future charges relating to in-process research and development and the amortization of intangible assets;

 

·                  significant amount of goodwill that is not amortizable and is subject to annual impairment review;

 

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·                  problems maintaining uniform standards, procedures, controls, and policies;

 

·                  unanticipated costs associated with the acquisition, including accounting and legal charges, capital expenditures, and transaction expenses;

 

·                  diversion of management’s attention from our core business;

 

·                  adverse effects on existing business relationships with customers;

 

·                  risks associated with entering markets in which we have no or limited prior experience;

 

·                  unanticipated or unknown liabilities relating to the acquired businesses;

 

·                  the need to integrate accounting, management information, manufacturing, human resources and other administrative systems to permit effective management; and

 

·                  the potential loss of key employees of acquired organizations.

 

We may not be able to identify or consummate the Merger or any acquisitions.  Even if we are able to consummate the Merger or an acquisition, the anticipated benefit of such transaction may not materialize, and we may not properly integrate the operations of such transaction.  In addition, our management team may be distracted from our day-to-day operations.  As a result, our business may be disrupted, and our operating results may suffer.

 

In addition, if we finance acquisitions by issuing equity or convertible debt securities, our existing stockholders would be diluted.  Foreign acquisitions involve unique risks in addition to those mentioned above, including those related to integration of operations across different geographies, cultures and languages, currency risks and risks associated with the particular economic, political and regulatory environment in specific countries.

 

If we lose the services of our key personnel and/or key consultants, or if we are unable to attract and retain other key personnel, we may not be able to manage our operations or meet our growth objectives.

 

Our future success depends to a large extent upon the continued service of key personnel, including engineering, sales and administrative staff. We anticipate that any future growth will require us to recruit and hire a number of new personnel in engineering, operations, finance, sales and marketing. Competition for such personnel can be intense, and it is possible that we may not be able to recruit and retain necessary personnel to operate our business and support future growth.

 

The market price of our common stock is volatile and your investment in our common stock could suffer a decline in value.

 

The trading price of our common stock has been, and will likely continue to be, subject to wide fluctuations in response to quarterly variations in our operating results, announcements of new products or technological innovations by us or our competitors, strategic alliances between us and third parties, general market fluctuations and other events and factors. Changes in earnings estimates made by brokerage firms and industry analysts relating to the markets in which we do business, or relating to us specifically, have in the past resulted in, and could in the future result in, an immediate and adverse effect on the market price of the common stock. Even though our stock is quoted on The NASDAQ Global Market, our stock has had and may continue to have low trading volume and high volatility. The historically low trading volume of our stock makes it more likely that a severe fluctuation in volume, either up or down, will significantly impact the stock price. Because of the relatively low trading volume of our stock, our stockholders may have difficulty selling our common stock. In addition, the stock market in general, and The NASDAQ Global Market and the market for technology and small market cap companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Further, the market prices of securities of technology companies have been particularly volatile. These broad market and industry factors may materially harm the market price of our common stock, regardless of our operating performance.

 

Our certificate of incorporation and bylaws as well as Delaware law contain provisions that could discourage transactions resulting in a change in control, which may negatively affect the market price of our common stock.

 

Our certificate of incorporation, our bylaws and Delaware law contain provisions that might enable our management to discourage, delay or prevent a change in control. In addition, these provisions could limit the price that investors would be willing to pay in the future for shares of our common stock.

 

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Risk Factors Relating to the Merger

 

Completion of the Merger is subject to many conditions and if these conditions are not satisfied or waived, the Merger will not be completed.  Failure to complete the Merger could have material and adverse effects on SRS and the trading price of shares of SRS’s common stock.

 

The Merger Agreement is subject to many conditions which must be satisfied or waived in order to complete the Merger. The mutual conditions of the parties include, among others (i) adoption of the Merger Agreement by the affirmative vote of the holders representing a majority of the outstanding shares of SRS common stock entitled to vote thereon at the special meeting of our stockholders; (ii) the expiration or termination of any waiting period applicable to the Merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the rules and regulations promulgated thereunder (the “HSR Act”); (iii) the effectiveness of the registration statement on Form S-4, to be filed by DTS for purposes of registering the DTS common stock to be issued in connection with the Merger; and (iv) the absence of any law or order, writ, injunction, judgment, decree or ruling in effect, or pending or threatened by the Antitrust Division of the U.S. Department of Justice or the Federal Trade Commission, which prohibits, renders illegal or enjoins or threatens to prohibit, render illegal or enjoin, the consummation of the transactions contemplated by the Merger Agreement. In addition, each party’s obligation to consummate the Merger is subject to certain other conditions, including, among others, (w) the accuracy of the other party’s representations and warranties in the Merger Agreement (subject to customary materiality qualifiers and other customary exceptions); (x) the other party’s compliance with its covenants and agreements contained in the Merger Agreement (subject to customary materiality qualifiers); (y) the absence of any event arising during the period from the date of the Merger Agreement until the effective time of the Merger that, individually or in the aggregate, has had or is reasonably likely to have a material adverse effect on the other party; and (z) the receipt of an opinion of counsel to the effect that the transactions effected pursuant to the Merger Agreement will qualify as a “reorganization” within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended. SRS’s obligation to consummate the Merger is also subject to the approval for listing on the NASDAQ Global Select Market of DTS common stock to be issued as consideration to SRS’s stockholders in the Merger.

 

In addition, the Merger Agreement contains certain termination rights for both DTS and SRS, including the right of each party to terminate the Merger Agreement if the Merger has not been consummated by December 31, 2012, subject to each party’s right to extend such date for an additional 180 days if, among other things, all closing conditions other than receipt of antitrust approvals under the HSR Act have been satisfied by December 31, 2012. In some circumstances, upon termination of the Merger Agreement, SRS will be required to pay to DTS a termination fee of $7,495,000.

 

If the Merger is not completed on a timely basis, or at all, SRS’s ongoing business may be adversely affected. Additionally, in the event the Merger is not completed, SRS will be subject to a number of risks without realizing any of the benefits of having completed the Merger, including (i) the payment of certain fees and costs relating to the Merger, such as legal, accounting, financial advisor and printing fees; (ii) the potential decline in the market price of SRS’s common stock; (iii) the risk that SRS may not find a party willing to enter into a merger agreement on terms equivalent to or more attractive than the terms set forth in the Merger Agreement; and (iv) the loss of time and resources.

 

The announcement and pendency of the Merger could have an adverse effect on SRS’s stock price, business, financial condition, results of operations or business prospects.

 

Whether or not the Merger is completed, the announcement and pendency of the Merger could disrupt SRS’s business in the following ways, among others:

 

·      SRS employees may experience uncertainty regarding their future roles with SRS, which might adversely affect SRS’s ability to retain, recruit and motivate key personnel;

 

·      the attention of SRS’s management may be directed towards the completion of the Merger and transaction-related considerations and may be diverted from the day-to-day business operations of SRS, and matters related to the Merger may require commitments of time and resources that could otherwise have been devoted to other opportunities that might have been beneficial to SRS;

 

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·      customers, suppliers, licensees and other third parties with business relationships with SRS may decide not to renew or seek to terminate, change and/or renegotiate their relationships with SRS as a result of the Merger, whether pursuant to the terms of their existing agreements with SRS or otherwise; and

 

·      under the Merger Agreement, SRS is subject to certain restrictions on the conduct of its business prior to completing the Merger which may affect its ability to execute certain of its business strategies.

 

Any of these matters could adversely affect the stock price or business of, or harm the financial condition, results of operations or business prospects of, SRS.

 

Lawsuits have been filed against SRS, the members of the SRS board of directors, DTS and certain subsidiaries of DTS challenging the Merger, and an adverse ruling may prevent the Merger from being completed in a timely manner if at all.

 

DTS, SRS and the members of the board of directors of SRS and, in one instance, DTS Merger Sub, Inc. and DTS LLC, have been named as defendants in two putative class action lawsuits brought by purported stockholders of SRS challenging the Merger and seeking, among other things, to enjoin DTS and SRS from completing the Merger pursuant to the terms of the Merger Agreement.

 

One of the conditions to the completion of the Merger is that no law or order, writ, injunction, decree or ruling shall be in effect that prevents completion of the Merger. Consequently, if a settlement or other resolution is not reached in the lawsuits referenced above and the plaintiffs secure injunctive or other relief prohibiting, delaying or otherwise adversely affecting DTS’s and SRS’s ability to complete the Merger, then such injunctive or other relief may prevent the Merger from becoming effective within the expected timeframe or at all. Such lawsuits also could result in a diversion of management's attention and obligate the Company to pay monetary damages, which could adversely impact the Company’s results of operations and financial condition.

 

The Merger Agreement and a voting agreement contains provisions that could discourage a potential competing acquiror of SRS.

 

SRS has agreed that it will not solicit, initiate or take any action outside of the ordinary course of business to encourage any offers, proposals or inquiries by a third party, enter into, continue or otherwise participate in any discussions or negotiations or furnish to any person any non-public information or data regarding any alternative acquisition proposal or approve or recommend any alternative acquisition proposal. These restrictions are, however, subject to certain limited exceptions, including the ability of SRS to take certain actions in response to an unsolicited alternative acquisition proposal if our board of directors determines in good faith, after consultation with its financial advisor and outside legal counsel that the alternative acquisition proposal is a superior proposal (as defined in the Merger Agreement) or is reasonably likely to result in a superior proposal. SRS is subject to such “no-shop” provisions until the earlier of (i) the effective time of the Merger and (ii) the termination of the Merger Agreement in accordance with its terms.  SRS also agreed that its board of directors will not fail to recommend that SRS’s stockholders approve the Merger, withdraw or adversely modify its recommendation to SRS’s stockholders to approval the Merger or approve or recommend any alternative acquisition proposal, subject to limited exceptions, including that, at any time prior to SRS’s stockholders approving the Merger, the SRS board may change its recommendation if it concludes in good faith, after consultation with its outside legal counsel, that it is necessary to take such action in order to comply with its fiduciary obligations to SRS’s stockholders under applicable law and certain other conditions specified in the Merger Agreement are satisfied.  In addition, under specified circumstances, SRS may be required to pay a termination fee of $7,495,000 to DTS if the Merger Agreement is terminated, including if SRS terminates the Merger Agreement to accept a superior proposal or if DTS terminates the Merger Agreement because a triggering event (as defined in the Merger Agreement) has occurred.

 

Pursuant to a voting agreement, certain stockholders of SRS have agreed not to take any actions that SRS is prohibited from taking pursuant to the “no-shop” provisions contained in the Merger Agreement.  In addition, subject to the terms and conditions of the voting agreement, the holders of approximately 20% of SRS’s outstanding common stock on April 16, 2012, the date of the Merger Agreement, have agreed, among other things, to vote in favor of the Merger.

 

These provisions may discourage a potential competing acquiror that might have an interest in acquiring all or a significant part of SRS from considering or proposing a potential acquisition even if it were prepared to pay consideration with a higher price per share than that to be paid in connection with the Merger, or may result in a potential competing acquiror proposing to pay a lower per share price to acquire SRS than it might otherwise have proposed to pay.

 

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Item 6.  Exhibits

 

The exhibits listed below are hereby filed with the SEC as part of this report.

 

Exhibit
Number

 

Description

2.1

 

Agreement and Plan of Merger and Reorganization, by and among DTS, Inc., DTS Merger Sub, Inc., DTS LLC and SRS Labs, Inc., dated as of April 16, 2012, previously filed with the SEC as Exhibit 2.1 to the Company’s Current Report on Form 8-K, filed with the SEC on April 17, 2012, which is incorporated herein by reference.**

2.2

 

Voting Agreement, dated April 16, 2012, by and among DTS, Inc., Thomas C.K Yuen, Misako Yuen, The Thomas and Misako Yuen Family Foundation and the Thomas Yuen Family Trust, previously filed with the SEC as Exhibit 2.2 to the Company’s Current Report on Form 8-K, filed with the SEC on April 17, 2012, which is incorporated herein by reference.

10.1

 

Amendment to Employment Agreement, dated March 30, 2012, by and between SRS Labs, Inc. and Thomas C.K. Yuen.

10.2

 

Amendment to Employment Agreement, dated March 30, 2012, by and between SRS Labs, Inc. and Alan Kraemer.

31.1

 

Certification of Chief Executive Officer of SRS Labs, Inc., pursuant to Rule 13a-14 of the Securities Exchange Act.

31.2

 

Certification of Chief Financial Officer of SRS Labs, Inc., pursuant to Rule 13a-14 of the Securities Exchange Act.

32.1

 

Certification of Chief Executive Officer of SRS Labs, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

 

Certification of Chief Financial Officer of SRS Labs, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS*

 

XBRL Instance Document

101.SCH*

 

XBRL Taxonomy Extension Schema

101.CAL*

 

XBRL Taxonomy Extension Calculation Linkbase

101.DEF*

 

XBRL Taxonomy Extension Definition Linkbase

101.LAB*

 

XBRL Taxonomy Extension Label Linkbase

101.PRE*

 

XBRL Taxonomy Extension Presentation Linkbase

 


*                    Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under these sections.

**             Schedules and exhibits omitted pursuant to Item 601(b)(2) of Regulation S-K.  SRS Labs, Inc. agrees to furnish supplementally a copy of any omitted schedule or exhibit to the SEC upon request.

 

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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:  May 9, 2012

By:

/S/ THOMAS C.K. YUEN

 

Thomas C.K. Yuen

 

Chairman of the Board and Chief Executive Officer

 

(Principal Executive Officer)

 

 

 

 

Date:  May 9, 2012

By:

/S/ WALTER J. McBRIDE

 

Walter J. McBride

 

Chief Financial Officer

 

(Principal Financial Officer)

 

 

 

 

Date:  May 9, 2012

By:

/S/ MARIA OPPEGARD

 

Maria Oppegard

 

Vice President, Finance and Chief Accounting Officer

 

(Principal Accounting Officer)

 

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EXHIBIT INDEX

 

The exhibits listed below are hereby filed with the SEC as part of this Report.

 

Exhibit
Number

 

Description

2.1

 

Agreement and Plan of Merger and Reorganization, by and among DTS, Inc., DTS Merger Sub, Inc., DTS LLC and SRS Labs, Inc., dated as of April 16, 2012, previously filed with the SEC as Exhibit 2.1 to the Company’s Current Report on Form 8-K, filed with the SEC on April 17, 2012, which is incorporated herein by reference.**

2.2

 

Voting Agreement, dated April 16, 2012, by and among DTS, Inc., Thomas C.K Yuen, Misako Yuen, The Thomas and Misako Yuen Family Foundation and the Thomas Yuen Family Trust, previously filed with the SEC as Exhibit 2.2 to the Company’s Current Report on Form 8-K, filed with the SEC on April 17, 2012, which is incorporated herein by reference.

10.1

 

Amendment to Employment Agreement, dated March 30, 2012, by and between SRS Labs, Inc. and Thomas C.K. Yuen.

10.2

 

Amendment to Employment Agreement, dated March 30, 2012, by and between SRS Labs, Inc. and Alan Kraemer.

31.1

 

Certification of Chief Executive Officer of SRS Labs, Inc., pursuant to Rule 13a-14 of the Securities Exchange Act.

31.2

 

Certification of Chief Financial Officer of SRS Labs, Inc., pursuant to Rule 13a-14 of the Securities Exchange Act.

32.1

 

Certification of Chief Executive Officer of SRS Labs, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

 

Certification of Chief Financial Officer of SRS Labs, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS*

 

XBRL Instance Document

101.SCH*

 

XBRL Taxonomy Extension Schema

101.CAL*

 

XBRL Taxonomy Extension Calculation Linkbase

101.DEF*

 

XBRL Taxonomy Extension Definition Linkbase

101.LAB*

 

XBRL Taxonomy Extension Label Linkbase

101.PRE*

 

XBRL Taxonomy Extension Presentation Linkbase

 


*                    Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under these sections.

**             Schedules and exhibits omitted pursuant to Item 601(b)(2) of Regulation S-K.  SRS Labs, Inc. agrees to furnish supplementally a copy of any omitted schedule or exhibit to the SEC upon request.

 

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