-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, I4hLRtFSjrJxPFGc6mNp4IXsREp/cSTpuWRIJ/56gjtk4yNcMaXK11JpUrOu5tud k33aNIZX3d5DOq/eCrgbLw== 0000892569-99-001466.txt : 19990518 0000892569-99-001466.hdr.sgml : 19990518 ACCESSION NUMBER: 0000892569-99-001466 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SRS LABS INC CENTRAL INDEX KEY: 0001016470 STANDARD INDUSTRIAL CLASSIFICATION: PATENT OWNERS & LESSORS [6794] IRS NUMBER: 330714264 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-21123 FILM NUMBER: 99627008 BUSINESS ADDRESS: STREET 1: 2909 DAIMIER ST CITY: SANTA ANA STATE: CA ZIP: 92705 BUSINESS PHONE: 9494421070 MAIL ADDRESS: STREET 1: 2909 DAIMLER ST CITY: SANTA ANA STATE: CA ZIP: 92705 10-Q 1 FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 1999 1 ================================================================================ 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, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to___________ COMMISSION FILE NUMBER 0-21123 SRS LABS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) -------------- DELAWARE 33-0714264 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 2909 DAIMLER STREET, SANTA ANA, CALIFORNIA 92705 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (949) 442-1070 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) NOT APPLICABLE (FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGES SINCE LAST REPORT) -------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: as of May 7, 1999, 11,697,944 shares of the issuer's common stock, par value $.001 per share, were outstanding. ================================================================================ 2 SRS LABS, INC. FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 1999 INDEX
Page ---- PART I - FINANCIAL INFORMATION Item 1. Financial Statements. Consolidated Balance Sheets as of March 31, 1999 (Unaudited) and December 31, 1998 3 Consolidated Statements of Operations for the three months ended March 31, 1999 and 1998 (Unaudited) 4 Consolidated Statements of Comprehensive Loss for the three months ended March 31, 1999 and 1998 (Unaudited) 5 Consolidated Statements of Cash Flows for the three months ended March 31, 1999 and 1998 (Unaudited) 6 Notes to the Interim Consolidated Financial Statements (Unaudited) 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk. 18 PART II - OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds. 19 Item 6. Exhibits and Reports on Form 8-K. 19 SIGNATURES 20
2 3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. SRS LABS, INC. CONSOLIDATED BALANCE SHEETS
March 31, December 31, 1999 1998 ------------ ------------- (Unaudited) ASSETS CURRENT ASSETS Cash and cash equivalents $ 11,159,639 $ 12,341,242 Investments available for sale 3,039,915 1,519,425 Accounts receivable, net 2,715,337 5,320,686 Inventories, net 5,621,161 4,632,968 Prepaid expenses and other current assets 3,634,707 3,244,233 Deferred income taxes 17,456 17,456 ------------ ------------ TOTAL CURRENT ASSETS 26,188,215 27,076,010 Investments available for sale 9,022,113 10,570,192 Furniture, fixtures & equipment, net 911,304 1,219,433 Intangible assets, net 6,586,865 6,669,671 ------------ ------------ TOTAL ASSETS $ 42,708,497 $ 45,535,306 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 7,917,636 $ 10,632,505 Accrued liabilities 1,829,070 422,843 Line of credit 8,000,000 8,000,000 Income taxes payable 287,872 376,545 ------------ ------------ TOTAL CURRENT LIABILITIES 18,034,578 19,431,893 Deferred income taxes 31,240 31,240 STOCKHOLDERS' EQUITY Preferred stock - $.001 par value; 2,000,000 shares authorized; no shares issued and outstanding -- -- Common stock - $.001 par value; 56,000,000 shares authorized; 11,697,944 (at March 31, 1999) and 11,688,893 (at December 31, 1998) shares issued and outstanding 11,698 11,689 Additional paid-in capital 39,207,565 39,170,103 Deferred stock option compensation 403,863 313,302 Cumulative other comprehensive income 133,473 141,389 Retained deficit (15,061,420) (13,564,310) Less treasury stock at cost, 12,000 (at March 31, 1999) and zero (at December 31, 1998) shares (52,500) -- ------------ ------------ TOTAL STOCKHOLDERS' EQUITY 24,642,679 26,072,173 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 42,708,497 $ 45,535,306 ============ ============
See accompanying notes to consolidated financial statements 3 4 SRS LABS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended March 31, ------------------------------- 1999 1998 ------------ ------------- REVENUES Chip and licensing revenue $ 4,104,067 $ 2,881,961 Product and component sales 3,612,774 4,175,435 ------------ ------------ TOTAL REVENUES 7,716,841 7,057,396 COST OF SALES 5,275,642 4,398,416 ------------ ------------ GROSS MARGIN 2,441,199 2,658,980 Sales and marketing 1,571,999 1,188,894 Research and development 640,018 399,079 General and administrative 2,139,545 1,252,823 Acquired in-process research and development -- 18,510,378 ------------ ------------ LOSS FROM OPERATIONS (1,910,363) (18,692,194) OTHER INCOME, NET 103,347 197,492 ------------ ------------ LOSS BEFORE INCOME TAX BENEFIT (1,807,016) (18,494,702) INCOME TAX BENEFIT (309,906) (283,768) ------------ ------------ NET LOSS $ (1,497,110) $(18,210,934) ============ ============ NET LOSS PER COMMON SHARE Basic $ (0.13) $ (1.68) ============ ============ Diluted $ (0.13) $ (1.68) ============ ============ WEIGHTED AVERAGE SHARES USED IN THE CALCULATION OF NET LOSS PER COMMON SHARE Basic 11,681,419 10,852,052 ============ ============ Diluted 11,681,419 10,852,052 ============ ============
See accompanying notes to consolidated financial statements 4 5 SRS LABS, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (UNAUDITED)
Three Months Ended March 31, ------------------------------ 1999 1998 ------------ ------------ Net loss $ (1,497,110) $(18,210,934) Other comprehensive income (loss) Unrealized gain (loss) on investments available for sale, net of tax (7,916) 40,414 ------------ ------------ Comprehensive loss $ (1,505,026) $(18,170,520) ============ ============
See accompanying notes to consolidated financial statements 5 6 SRS LABS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended March 31, ------------------------------ 1999 1998 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (1,497,110) $(18,210,934) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 499,913 359,399 Deferred income taxes -- (335,000) Write-off of acquired in-process research and development -- 18,510,378 Amortization of premium on investments available for sale 14,171 56,197 Accretion of consideration due on asset purchase -- 4,098 Increase in deferred stock option compensation 90,561 26,670 Changes in operating assets and liabilities, net of the effect of acquisitions: Accounts receivable 2,305,349 1,448,496 Inventories (988,193) 2,262,754 Prepaid expenses and other current assets (219,882) 398,660 Accounts payable (2,714,869) (2,123,534) Accrued liabilities 1,463,578 153,648 Income taxes payable (83,171) (446,163) ------------ ------------ Net cash provided by (used in) operations (1,129,653) 2,104,669 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of furniture, fixtures and equipment (28,425) (72,640) Proceeds from sales of investments available for sale -- 7,467,571 Cash paid for acquisitions, less cash acquired -- (6,911,216) Expenditures related to patents (8,496) -- ------------ ------------ Net cash provided by (used in) investing activities (36,921) 483,715 CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from line of credit -- 7,000,000 Payments on subsidiary debt -- (6,755,382) Payment of consideration due on asset purchase -- (55,918) Repurchase of stock (52,500) -- Exercise of stock options 37,471 147,865 ------------ ------------ Net cash provided by (used in) financing activities (15,029) 336,565 ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,181,603) 2,924,949 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 12,341,242 4,446,753 ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $ 11,159,639 $ 7,371,702 ============ ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 112,307 $ -- Income taxes $ -- $ 330,000
See accompanying notes to consolidated financial statements 6 7 SRS LABS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended March 31, ---------------------------- 1999 1998 -------- ------- SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Unrealized gain (loss) on investments, net $(7,916) $40,414
The Company acquired the stock of Valence Technology Inc. ("Valence") during March 1998 (Note 2) and issued 1,680,611 shares of common stock in payment of $12,105,778 of the acquisition price. In conjunction with the acquisition, certain liabilities were assumed as follows: Fair value of assets acquired $ 14,076,279 Acquired in-process research and development costs 17,471,668 Acquired intangible assets 5,910,400 Total consideration, including acquisition costs (21,879,033) ------------ Liabilities assumed $ 15,579,314 ============
The Company issued 125,000 shares of common stock in consideration for certain non-competition agreements with the key employees of Valence. The shares have an ascribed fair value of $900,400 (Note 2). In February 1998, the Company issued 25,000 shares of common stock and warrants to purchase 100,000 shares of common stock in conjunction with the acquisition of Voice Intelligibility Processor ("VIP"). The shares and warrants have an ascribed fair value of $176,575 and $341,957, respectively (Note 2). In May 1998, the Company issued 35,294 shares of common stock in conjunction with the acquisition of certain rights associated with the Circle Surround technology. The shares have an ascribed fair value of $300,000 (Note 2). In January 1999, the Company received certain computer equipment and a fully paid-up license for MPEG-1 Technology Core from DVS Inc. in payment for $300,000 of license fees due to the Company for the use of its technologies. See accompanying notes to consolidated financial statements 7 8 SRS LABS, INC. NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. GENERAL/BASIS OF PRESENTATION SRS Labs, Inc. is a developer and provider of technology solutions for the consumer electronics, computer, game and telecommunications markets. The Company's principal business activities in these markets include: - Developing and licensing audio and voice technologies to original equipment manufacturers ("OEMs") and semiconductor manufacturers around the world; and - Through its subsidiary, Valence Technology Inc. and its foreign subsidiaries, 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. The accompanying interim consolidated financial statements have been prepared by the Company without audit (except for the balance sheet information as of December 31, 1998) in conformity with generally accepted accounting principles for interim financial information and with the rules and regulations of the U.S. Securities and Exchange Commission. In the opinion of management, all adjustments (which include only normal recurring adjustments) considered necessary for a fair presentation have been included. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. Therefore, the interim financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. Current and future financial statements may not be directly comparable to the Company's historical financial statements. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. 2. ACQUISITIONS On March 2, 1998, the Company acquired (the "Acquisition") all of the outstanding shares of capital stock of Valence Technology Inc., a British Virgin Islands holding company with its principal business operations in Hong Kong and China ("Valence"). Valence, which conducts its business through its subsidiaries based in Hong Kong and China, is engaged in the following business activities: (i) the development and marketing of technology in the form of integrated circuits (ASICs) to original equipment manfacturers and (ii) the sale of consumer electronic and telecommunications products and components. The aggregate purchase price of $19,500,000 consisted of approximately $7,400,000 in cash and 1,680,611 shares of the Company's common stock with a fair value of $12,105,778. The Company's consolidated statement of operations for the three months ended March 31, 1998 includes a charge of $17.5 million for the write-off of acquired in-process research and development expense associated with the Valence acquisition. The acquisition was accounted for as a purchase having an effective date of February 1, 1998. In connection with such acquisition, three of the four management shareholders and their respective sole shareholders, each of whom was a key employee of Valence or one of its subsidiaries, entered into non-competition agreements with the Company. In consideration for these agreements and for a nominal cash payment equal to the par value of the shares, the Company issued 125,000 additional shares of its common stock in aggregate to such three shareholders. 8 9 SRS LABS, INC. NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) The following summarizes the consideration granted for the acquisition of Valence and non-compete agreements, the allocation of the purchase price and other purchase accounting adjustments:
Cash $ 7,394,222 Common stock 13,006,178 ----------- Total purchase price 20,400,400 Deficiency in net assets acquired 1,503,035 Acquisition costs 1,478,633 ----------- Excess of purchase price over net assets acquired $23,382,068 =========== Allocation to: In-process research and development $17,471,668 Intangible assets 5,910,400 ----------- $23,382,068 ===========
The resulting intangible assets are being amortized on a straight-line basis over periods ranging from three to eleven years. On February 28, 1998, the Company acquired certain rights to a proprietary technology, Voice Intelligibility Processor, ("VIP") from a third party. The aggregate consideration, including acquisition costs, was $1,138,710 and was comprised of $620,178 in cash, 25,000 shares of the Company's common stock with a fair value of $176,575 and warrants to purchase 100,000 shares of the Company's common stock at $9.47 per share with a fair value of $341,957. The purchase price allocated to in-process research and development was charged to the Company's operations, resulting in a charge of $1,038,710. The remainder of the purchase price was allocated to an intangible asset and is being amortized over eight years. On May 21, 1998, the Company acquired certain rights to a proprietary technology, Circle Surround, from a third party. The aggregate consideration, including acquisition costs, was $834,985 and was comprised of $534,985 in cash and 35,294 shares of the Company's common stock with a fair value of $300,000. The purchase price was allocated to an intangible asset and is being amortized over ten years. 3. INVESTMENTS AVAILABLE FOR SALE The Company has classified its investments as available-for-sale in accordance with SFAS No. 115. As of March 31, 1999, the Company's available-for-sale investments had a cost of $11,835,803 and an estimated fair value of $12,062,028, based on quoted market prices. The unrealized gains on these investments of $226,225, net of income taxes of $92,752, are reported as a separate component of stockholders' equity. 4. INVENTORIES Inventories, which consist of finished goods, are stated at the lower of cost or net realizable value. Cost is calculated using the weighted average method and is comprised of material costs and, where applicable, subcontracting and overhead costs that have been incurred in bringing the inventories to their present location and condition. Net realizable value represents the estimated selling price less estimated costs to completion and costs to be incurred in selling and distribution. 9 10 SRS LABS, INC. NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 5. NET LOSS PER COMMON SHARE The Company computes earnings per share (EPS) in accordance with Statement of Financial Accounting Standards No. 128, "Earnings per Share" (FAS 128). FAS 128 requires the Company to disclose basic and diluted earnings per share. 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. As of March 31, 1999, 12,000 shares had been repurchased at a cost of $52,500. Such repurchased shares are reflected as treasury stock in the accompanying consolidated balance sheets. 8. SEGMENT INFORMATION The Company operates in two business segments: (i) the development and marketing of technology either in the form of integrated circuits through Valence (ASICs) or the licensing of technologies developed by the Company to original equipment manufacturers and semiconductor manufacturers and (ii) the sale of consumer electronic products and components. The Company does not allocate operating expenses or specific assets to these segments. Therefore, segment information includes only net revenues, cost of sales and gross margin. Prior to the acquisition of Valence, the Company operated in the single business segment of licensing audio technologies.
Three Months Ended March 31, 1999 --------------------------------------------------------- Chips and Product and Licensing Component Sales Total ------------- --------------- ------------- Net revenues $ 4,104,067 $ 3,612,774 $ 7,716,841 Cost of sales 1,737,578 3,538,064 5,275,642 ------------- ------------- ------------- Gross margin $ 2,366,489 $ 74,710 $ 2,441,199 ============= ============= =============
Three Months Ended March 31, 1998 --------------------------------------------------------- Chips and Product and Licensing Component Sales Total ------------- --------------- ------------- Net revenues $ 2,881,961 $ 4,175,435 $ 7,057,396 Cost of sales 671,932 3,726,484 4,398,416 ------------- ------------- ------------- Gross margin $ 2,210,029 $ 448,951 $ 2,658,980 ============= ============= =============
10 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW SRS Labs, Inc. is a developer and provider of technology solutions for the consumer electronics, computer, game and telecommunications markets. The Company's principal business activities in these markets include: - Developing and licensing audio and voice technologies to original equipment manufacturers ("OEMs") and semiconductor manufacturers around the world; and - Through its subsidiary, Valence Technology Inc. and its foreign subsidiaries, 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. From the Company's inception in 1993 until February 1998, the Company derived substantially all of its revenue from royalties received from technology licenses. On March 2, 1998, the Company acquired all of the outstanding capital stock of Valence Technology, Inc., a British Virgin Islands holding company with its principal business operations in Hong Kong and China ("Valence") for an aggregate purchase price, excluding non-compete agreements and acquisition costs, of $19,500,000 consisting of approximately $7,400,000 in cash and approximately 1,680,611 shares of the Company's common stock, $.001 par value per share (the "Common Stock"). The acquisition was accounted for as a purchase with an effective date of February 1, 1998. The acquisition of Valence had a material impact on the Company's financial statements for the fiscal year ended December 31, 1998 ("Fiscal 1998") and will continue to have a material impact for the reporting periods thereafter; accordingly, current and future financial statements may not be directly comparable to the Company's historical financial statements. During the first quarter of Fiscal 1998, the Company acquired certain rights to Voice Intelligibility Processor ("VIP"), which is a patented voice processing technology that improves the intelligibility of the spoken voice, especially in high ambient noise environments. Aggregate consideration, including acquisition costs, was $1,138,710 and was comprised of $620,178 in cash, 25,000 shares of Common Stock and warrants to purchase 100,000 shares of Common Stock at $9.47 per share. During the second quarter of Fiscal 1998, the Company acquired certain rights to Circle Surround, which is a patented audio delivery system that allows multi-channel surround sound to be encoded into a two-channel stereo format and allows an encoded two-channel audio source or a traditional stereo audio source to be decoded into a multi-channel surround format. The aggregate purchase price, including acquisition costs, was $834,985 and was comprised of $534,985 in cash and 35,294 shares of Common Stock. SRS currently operates in two business segments: (a) the development and marketing of technology in the forms of integrated circuits designed and distributed through Valence and the licensing of technologies developed by the Company to OEMs and semiconductor manufacturers and (b) the sale of consumer electronic products and components. A summary of the Company's operations and activities by business segment is included in the notes to the interim consolidated financial statements. RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31, 1998 Impact of Valence acquisition The Company's consolidated financial results for the three month period ended March 31, 1998 include the results of the Valence operations beginning as of February 1, 1998. Accordingly, results for the three months ended March 31, 1999 may not be directly comparable to the results for the three months ended March 31, 1998. 11 12 Revenues Chip and licensing revenue consists of design fees and sales of custom application specific integrated circuits (ASICs) by Valence to OEM manufacturers 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 technologies. License and royalty agreements generally provide for the license of technologies for a specified period of time for either a single fee or a fee based on the number of units distributed by the licensee. Product and component sales primarily represent the distribution of semiconductor products, manufacturing components and sub-assemblies to OEMs for the Hong Kong and China markets. Total revenues for the three months ended March 31, 1999 were $7,716,841 compared to $7,057,396 for the three months ended March 31, 1998. Excluding chip design revenue, licensing revenue decreased 50.3% from the same period last year due to the following factors: (a) the shift in the PC market to lower cost models which cannot bear the cost of performance enhancement technologies such as those offered by SRS Labs; (b) the Asian financial crisis which reduced demand for consumer electronics products in the region and negatively impacted the sales of semiconductor ICs that include the Company's audio technologies; and (c) the trend by consumer electronic manufacturers to initially adopt the Company's new technologies into their higher end models with limited volume potential for the short term. The licensing revenue decrease was offset by an increase of 134.8% in the custom ASIC chip design and chip sales related to Valence's activities. Revenue from product and component sales decreased to $3,612,774 for the quarter ended March 31, 1999 from $4,175,435 for the same prior year quarter primarily due to the Company's decision to focus on higher margin revenue and deemphasize certain lower margin distribution activities. The Company expects that the revenue mix in future quarters will continue to be weighted more towards chip and electronic component sales and less to licensing. Gross Margin Cost of sales consists primarily of fabrication costs, assembly and test costs, and the cost of materials and overhead from operations. Gross margin for the three months ended March 31, 1999 decreased to 31.6% from 37.7% for the same period in 1998. The decrease resulted from the shift in the Company's revenue base towards ASIC and general purpose IC chip sales, which have significantly lower margins than the Company's historic licensing revenue base. The Company expects that, consistent with trends in the revenue mix, gross margins in future quarters will continue to be impacted by the cost of procuring and manufacturing products for sale as opposed to licensing transactions which typically have higher gross margins. Sales and Marketing Sales and marketing expenses consist primarily of employee salaries and sales consultants' fees and related expenses, sales commissions and product promotion. Sales and marketing expenses were $1,571,999 for the three months ended March 31, 1999 compared to $1,188,894 for the same prior year period, an increase of 32.2%. The increase was primarily due to additional sales and marketing headcount needed to promote the Company's new technologies, increased promotional activities related to product sales in the PRC and increased selling expenses related to higher chip sales. As a percentage of total revenues, sales and marketing expenses increased to 20.4% for the quarter ended March 31, 1999 from 16.8% for the same prior year quarter. Research and Development Research and development expenses consist of salaries and related costs of employees engaged in ongoing research, design and development activities and costs for engineering materials and supplies. Research and development expenses were $640,018 for the three months ended March 31, 1999 compared to $399,079 for the same prior year period, an increase of 60.4%. The increase is primarily attributable to headcount added to support the increased ASIC design activity, to develop, enhance and implement new audio and voice technologies and to develop software and Internet applications for the Company's technologies. As a percentage of total revenues, research and development expenses increased to 8.3% for the quarter ended March 31, 1999 from 5.7% for the same prior year quarter. Management believes research and development expenses will increase in the future as a result of the Company's product development efforts. 12 13 General and Administrative General and administrative expenses consist primarily of employee-related expenses, legal costs associated with the administration of intellectual property and other professional fees. General and administrative expenses were $2,139,545 for the three months ended March 31, 1999 compared to $1,252,823 for the same prior year period, an increase of 70.8%. The increase was primarily attributable to increased corporate headcount added to manage the acquired operations and to support new business development, costs incurred for due diligence activities related to potential acquisitions that did not occur and higher costs associated with year end reporting activities required of a public company due to the expanded scope of the Company's operations. As a percentage of total revenues, general and administrative expenses increased to 27.7% for the quarter ended March 31, 1999 from 17.8% for the same prior year quarter. As part of the Valence acquisition, the Company allocated a portion of the purchase price to various intangible assets totaling approximately $5,910,400. This amount was capitalized and is being amortized on a straight line basis over periods ranging from three to eleven years with the related amortization expense of $332,796 and $200,998 for the quarters ended March 31, 1999 and March 31, 1998, respectively, included in general and administrative expenses. See Note 2 of the notes to the interim consolidated financial statements for more information concerning the purchase price allocation associated with the Valence acquisition. Acquired In-Process Research and Development The Company's Consolidated Statement of Operations for the three months ended March 31, 1998 includes the one-time charge of $18,510,378 for the write-off of acquired in-process research and development expenses associated with the Valence acquisition and the acquisition of certain assets associated with the VIP technology. The in-process research and development expenses arose from new product projects that were under development at the date of the acquisition and expected to eventually lead to new products but had not yet established technological feasibility and for which no future alternative use was identified. The valuation of the in-process research and development projects was based upon the discounted expected future net cash flows of the products over the products' expected lives, reflecting the estimated stages of completion of the projects and the estimated costs to complete the projects. New product development projects underway at Valence at the time of the Valence acquisition included, among others, (a) ASICs for consumer electronics, computing and voice and audio applications, (b) home entertainment systems, (c) digital multimedia players and (d) digital power amplifiers. The Company estimated that these projects were approximately 63% complete at the date of acquisition and estimated that the cost to complete these projects will aggregate approximately $7 million and will be incurred over a three-year period. New product development projects utilizing the VIP technology at the time of the VIP acquisition included, among others, digital and analog sound reinforcement, wireless and non-wireless telecommunications applications, hearing aid applications, headphone and microphone applications. The Company estimated that these projects were approximately 62% complete at the date of acquisition and estimated that the cost to complete these projects will aggregate approximately $525,000 and will be incurred over a two-year period. Uncertainties that could impede the progress of converting a development project to a developed technology include the availability of financial resources to complete the project, failure of the technology to function properly, continued economic feasibility of developed technologies, customer acceptance, customer demand and customer qualification of such new technology and general competitive conditions in the industry. There can be no assurance that the acquired in-process research and development projects will be pursued or successfully completed and commercially introduced. 13 14 Other Income, Net Net other income consists primarily of interest income, interest expense, realized gains and losses on the sale of investments and foreign currency transaction gains and losses. Net other income was $103,347 for the three months ended March 31, 1999 compared to $197,492 for the same prior year period, a decrease of 47.7%. The decrease is primarily attributable to lower average cash and investment balances during the current year quarter as compared to the prior year quarter due to the cash paid in conjunction with the acquisitions of Valence and VIP and interest expense on the outstanding borrowings under the Company's line of credit obtained during the first quarter of Fiscal 1998. Provision for Income Taxes The income tax benefit for the three months ended March 31, 1999 was $309,906 compared to $283,768 for the same prior year period. Related to domestic operations, the Company recognized tax benefits in connection with federal refundable taxes which could be recovered through a net operating loss carryback. In addition, the Company recorded a tax provision at statutory tax rates in the Asian countries where Valence has its principal business operations LIQUIDITY AND CAPITAL RESOURCES The Company's principal source of liquidity at March 31, 1999 consisted of cash, cash equivalents and investments aggregating $23.2 million, as well as borrowings available under its credit facility. At December 31, 1998, the Company had cash, cash equivalents and long term investments of approximately $24.4 million. The Company has primarily financed its operations through the cash provided by its operations and proceeds from its initial public offering of Common Stock in August 1996. The Company's operating activities utilized $1,129,653 in cash for the three months ended March 31, 1999 and provided $2,104,669 for the three months ended March 31, 1998. The use of cash in operations for the quarter ended March 31, 1999 was primarily due to the Company's loss from operations. In addition, cash increased due to a reduction in accounts receivable of $2.3 million which was primarily due to the collection of certain large balances due from SRS and Valence customers that were outstanding at December 31, 1998. This increase was partially offset by a decrease in cash due to a net decrease in accounts payable and accrued liabilities of $1.3 million due to payments made to certain major component suppliers. In addition, cash was used to increase inventory by approximately $988,000 in anticipation of customer demand. As described above, the Company acquired Valence and additional technologies during the first quarter of Fiscal 1998. (See Note 2 to the interim consolidated financial statements.) On March 4, 1998, the Company obtained a revolving line of credit with a bank which expires on June 1, 2000 and is secured by certain of the Company's cash, cash equivalents and investments. As of March 31, 1999, approximately $817,000 in cash and cash equivalents and $11.1 million in investments were pledged as collateral for the line of credit. The total availability under the line of credit is the lesser of $10 million or a percentage of the fair market value of the collateral. The line of credit bears interest at the bank's prime rate or LIBOR plus 0.75%. The Company had $8.0 million outstanding under the line of credit as of March 31, 1999. As a result of the acquisition of Valence, the Company provided Valence $8.0 million to pay off its short-term debt and other obligations. These funds were provided by borrowings on the above-referenced line of credit. The Company anticipates that its primary uses of working capital in future periods will be to acquire new technologies, to provide Valence with additional working capital and to fund increased costs for additional sales and engineering headcount and marketing activities associated with the introduction of new technologies and products into the market. Based on current plans and business conditions, the Company believes that its cash, cash equivalents, investments and/or available borrowings under its line of credit, together with any amounts generated from 14 15 operations, will be sufficient to meet the Company's operating and capital requirements for the foreseeable future. However, there can be no assurance that the Company will not be required to seek other financing sooner or that such financing, if required, will be available on terms satisfactory to the Company. YEAR 2000 READINESS DISCLOSURE The Company is currently in the process of addressing a problem that is facing all users of automated information systems. The "Year 2000 issue" arises out of the fact that many of the world's computer systems currently record years in a two-digit format. Such computer systems will be unable to properly interpret dates beyond the year 1999, which could lead to business disruptions in the U.S. and internationally. The Company and its subsidiaries have identified the following areas which could be impacted by the Year 2000 issue: Company products; internally used systems and software; products or services provided by key third parties; and the ability of chip partners, licensees or customers to process business transactions relating to chip design and licensing revenue and product and component sales. During Fiscal 1998, the Company and its subsidiaries reviewed its internal systems including those which support manufacturing process control and financial and general business operations. The review consisted of an evaluation of significant internal hardware systems and major software application programs for their ability to accurately recognize and process dates properly in the Year 2000 and beyond. As a result of this evaluation, the Company identified certain systems which require upgrades to be Year 2000 ready, including certain business software applications. The Company is in the process of installing a new computer system in its overseas operation and has been assured by the software and hardware providers that these systems will be fully compliant with the Year 2000. The Company's products do not have any material Year 2000 problems. In addition, the Company and its subsidiaries are in the process of assessing the compliance of their major customers, suppliers and vendors. Management believes that third-party relationships upon which the Company relies represent the greatest risk with respect to the Year 2000 issue, because the Company cannot guarantee that third parties will be able to adequately assess and address their Year 2000 compliance issues in a timely manner. As a consequence, the Company can give no assurances that issues related to Year 2000 would not have a material adverse effect on future results of operations or financial condition. Total costs relating to the Company's compliance efforts, based on management's best estimates, are estimated to be as high as $350,000. Should the Company not be completely successful in mitigating internal and external Year 2000 risks, the likely worst case scenario could be a system failure causing disruptions of operations, including, among other things, a temporary inability to process transactions, manufacture products, send invoices or engage in similar normal business activities at the Company or its vendors and suppliers. The Company currently does not have a contingency plan with respect to potential Year 2000 failures of its suppliers or customers and, at the present time, does not intend to develop one. If these failures would occur, depending upon their duration and severity, they could have a material adverse effect on the Company's business, results of operations and financial condition. The information set forth above under this caption "Year 2000 Readiness Disclosure" relates to the Company's efforts to address the Year 2000 concerns regarding the Company's (a) operations, (b) products and technologies licensed or sold to third parties and (c) major suppliers and customers. Such statements are intended as Year 2000 Statements and Year 2000 Readiness Disclosures and are subject to the Year 2000 Information Readiness Act." FORWARD-LOOKING INFORMATION AND CERTAIN FACTORS Included in this Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations are certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, reflecting management's current expectations. Examples of such forward-looking statements include the expectations of the Company with respect to its strategy and the shift in revenue mix which is expected to be weighted more toward chip and electronic component sales and less to licensing. Although the Company believes 15 16 that its expectations are based upon reasonable assumptions, there can be no assurances that the Company's financial goals will be realized. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Numerous factors may affect the Company's actual results and may cause results to differ materially from those expressed in forward-looking statements made by or on behalf of the Company. Such factors include, among others, those set forth below. The Company assumes no obligation to update the forward-looking information to reflect actual results or changes in the factors affecting such forward-looking information. Quarterly Fluctuations The Company's operating results may fluctuate from those in prior quarters and will continue to be subject to quarterly and other fluctuations due to a variety of factors, including the extent to which the Company's licensees incorporate the Company's technologies into their products, the timing of orders from and the shipments to major customers, the timing of new product introductions by the Company, the gain or loss of significant customers, competitive pressures on selling prices, the market acceptance of new or enhanced versions of the Company's technologies, the rate that the Company's semiconductor licensees manufacture and distribute chips to original equipment manufacturers ("OEMs"), and fluctuations in general economic conditions, particularly those affecting the consumer electronics market. In addition, due to the Company's dependence on the consumer electronics market, the substantial seasonality of sales in the market has impacted the Company's revenues and net income. In particular, the Company believes that there is seasonality relating to the Christmas season, generally, and the Chinese New Year within the Asia region, which fall into the fourth and first quarters, respectively. As a result, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Changes to the Business Model/Integration of Valence/Refinement of Asian Strategy From the Company's inception in 1993 through 1997, the Company derived substantially all of its revenues from licensing activities. As a result of the acquisition of Valence, the Company has added business operations engaged in the design and sale of ASICs and other semiconductor products; the design, manufacture and sale of consumer electronics components and products; and the distribution of components and products within mainland China and throughout Asia. These operations differ substantially from the Company's previous business model, and future operating results could be affected by a variety of factors, including the timing of customer orders, the timing of development revenue, changes in the mix of products distributed and the mix of distribution channels employed, the emergence of new industry standards, product obsolescence and changes in pricing policies by the Company, its competitors or its suppliers. The integration of certain operations following the Valence acquisition has required, and will continue to require, the dedication of management and other personnel resources which may temporarily distract them from the day-to-day business of the combined company. The geographic separation of these operations is likely to place additional strain on the Company's resources. In addition, the Company's significant operations in China and Asia have required refinement to adapt to the changing market conditions in that region. This refinement may impact certain of the Company's current business directions, including Valence, as the Company attempts to position itself to maximize penetration of selected growth segments in that region. The Company's operations in Asia, and internationally in general, also are subject to risks of unexpected changes in, or impositions of, legislative or regulatory requirements. The acquisition of Valence has added significant diversity to the Company's overall business structure and the Company's opportunities. The Company recognizes that in the presence of such corporate diversity, and in particular with regard to the semiconductor industry, there will always exist a potential for a conflict among sales channels between the Company and certain of the Company's technology licensees. Although the operations of the Company's licensing business and those of Valence are generally complementary, there can be no assurances that sales channel conflicts will not arise. If such potential conflicts do materialize, the Company may or may not be able to mitigate the effect of such perceived conflicts, which, if not resolved, may impact the results of operations. 16 17 Currency Risk/Stability of Asian Markets The Company expects that international sales will continue to represent a significant portion of total revenues. To date, all of the Company's licensing revenues have been denominated in U.S. dollars and most costs have been incurred in U.S. dollars. It is the Company's expectation that licensing revenues will continue to be denominated in U.S. dollars for the foreseeable future. With its acquisition of Valence and the Company's anticipated expansion of its business in China and other parts of Asia, the Company's consolidated operations and financial results could be significantly affected by risks associated with international activities, including economic and labor conditions, political instability, tax laws (including U.S. taxes on foreign subsidiaries) and changes in the value of the U.S. dollar versus the local currency in which the products are sold. In addition, the Company's valuation of assets recorded as a result of the Valence acquisition may also be adversely impacted by the currency fluctuations relative to the U.S. dollar. The Company intends to actively monitor its foreign exchange exposure and to implement strategies to reduce its foreign exchange risk at such time that the Company determines the benefits of such strategies outweigh the associated costs. However, there is no guarantee that the Company will take steps to insure against such risks, and should such risks occur, there is no guarantee that the Company will not be significantly impacted. Countries in the Asia Pacific region have recently experienced weakness in their currency, banking and equity markets. These weaknesses could adversely affect consumer demand for Valence's products, the U.S. dollar value of the Company's and its subsidiaries' foreign currency denominated sales, the availability and supply of product components to Valence and ultimately, the Company's consolidated results of operations. Competitive Pressures The Company's existing and potential competitors include both large and emerging domestic and international companies that have substantially greater financial, manufacturing, technical, marketing, distribution and other resources. The Company's present or future competitors may be able to develop products and technologies comparable or superior to those offered by the Company, and to adapt more quickly than the Company to new technologies or evolving market needs. The Company believes that the competitive factors affecting the market for the Company's products and technologies include product performance, price and quality; product functionality and features; and the ease of integration and implementation of the products and technologies with other hardware and software components in the 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 to protect its intellectual property will be adequate to prevent misappropriation of its technology or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technology. In addition, the laws of certain foreign countries may not protect the Company's intellectual property rights to the same extent as do the laws of the U.S. The semiconductor industry is characterized by frequent claims and litigation regarding patent and other property rights. There can be no assurances that third parties will not assert additional claims or initiate litigation against the Company or its customers with respect to existing or future products. In addition, the Company may initiate claims or litigation against third parties for infringement of the Company's proprietary rights or to determine the scope and validity of the proprietary rights of the Company or others. Management of Growth; Dependence on Key Personnel The Company has experienced rapid growth and expansion with the acquisition of Valence. This acquisition has placed, and will continue to place, a significant strain on its administrative, operational and financial resources, and has increased, and will continue to increase, the level of responsibility for both existing and new management 17 18 personnel. The Company's future success depends in part on the continued service of its key engineering, sales, marketing and executive personnel, including highly skilled semiconductor design personnel. The Company anticipates that any future growth will require it to recruit and hire a number of new personnel in engineering, operations, finance, sales and marketing. Competition for such personnel is intense, and there can be no assurance that the Company can retain and recruit necessary personnel to operate its business and support future growth. The Company's ability to manage its growth successfully also will require the Company to continue to expand and improve its administrative, operational, management and financial systems and controls. Volatility of Stock Price The trading price of the Common Stock has been, and will likely continue to be, subject to wide fluctuations in response to quarterly variations in the Company's operating results, announcements of new products or technological innovations by the Company or its competitors, general market fluctuations and other events and factors. Changes in earnings estimates made by brokerage firms and industry analysts relating to the markets in which the Company does business, or relating to the Company specifically, have in the past resulted in, and could in the future result in, an immediate 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. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to a variety of risks, including foreign currency fluctuations and changes in interest rates affecting the cost of its debt. Foreign Currency The Company has subsidiary operations in Hong Kong and China, and accordingly, the Company is exposed to transaction gains and losses that could result from changes in foreign currency exchange rates. The Company uses the local currency (Hong Kong dollars) as the functional currency for its subsidiaries. Translation adjustments resulting from the process of translating foreign currency financial statements into U.S. dollars were nil in Fiscal 1998 and in the three month period ended March 31, 1999 due to the fact that the value of the Hong Kong dollar is currently pegged to the U.S. dollar and the exchange rate remained constant throughout the period. Under the current circumstances, the Company believes that the foreign currency market risk is not material. 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 line of credit bears interest based on the lending bank's prime rate or LIBOR. The interest rate on the balance of $8 million outstanding at March 31, 1999 was 5.72%. The Company believes that if interest rates were to increase by as much as 10%, the impact on the Company's consolidated financial statements would not be material. 18 19 PART II - OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS SECURITIES SOLD On December 31, 1998, the Company and Samsung Electronics Co., Ltd. ("Samsung") entered into a License Agreement (the "License Agreement") relating to the Company's Voice Intelligibility Processor (VIP(TM)) technology. In connection with the License Agreement and as consideration for the marketing efforts to be provided by Samsung, the Company on March 5, 1999 granted to Samsung an option (the "Option") to purchase an aggregate of 50,000 shares (the "Shares") of common stock, par value $.001 per share, of the Company ("Common Stock"), at a purchase price of $3.94 per Share. The Option vests pro rata in three annual installments commencing on the first anniversary of the date of grant. In addition, under the License Agreement, the Company has agreed to grant to Samsung additional options to purchase up to an aggregate of 200,000 shares of Common Stock if certain goals are met by Samsung. Each such additional option shall be granted in 50,000 share increments and shall vest in the same manner as the option described above. The date of grant for each such option shall be the date during the two week period commencing on the date specified in the License Agreement that the closing price of a share of Common Stock is the lowest. Such last sale price on such date shall then become the exercise price for that option. The shares of Common Stock to be issued to Samsung upon exercise of all such options shall be issued in reliance on the private offering exemption set forth in Section 4(2) of the Securities Act of 1933, as amended, on the basis that they were issued under circumstances not involving a public offering. USE OF PROCEEDS The effective date of the Company's initial public offering of its Common Stock was August 8, 1996 (SEC Registration No. 333-4974-LA). There has been no change in the Company's use of its aggregate net offering proceeds of $22,052,955 since the disclosure set forth in the Company's Quarterly Report on Form 10-Q for the Quarterly Period Ended June 30, 1998. As noted in such prior Quarterly Report, the Company utilized an aggregate of $8,394,222 in connection with three acquisitions (see Note 2 to the interim consolidated financial statements herein) with the remaining funds being temporarily invested in cash and municipal bonds pending application. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. The exhibits listed below are hereby filed with the U.S. Securities and Exchange Commission (the "Commission") as part of this Report. Exhibit No. Description ------- ----------- 10.1 Severance Agreement, dated February 23, 1999, by and between the Company and Thomas R. Parkinson. 27 Financial Data Schedule. (b) Reports on Form 8-K No reports on Form 8-K were filed with the Commission during the three month period ended March 31, 1999. 19 20 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 14, 1999 By: /s/ JOHN AUYEUNG ------------------------------- John AuYueng Executive Vice President, Chief Operating Officer, Secretary, Acting Chief Financial Officer and Acting Treasurer (Principal Financial and Accounting Officer) 20 21 EXHIBIT INDEX Exhibit No. Description - ------- ----------- 10.1 Severance Agreement, dated February 23, 1999, by and between the Company and Thomas R. Parkinson. 27 Financial Data Schedule. EX-10.1 2 SEVERANCE AGREEMENT DATED FEBRUARY 23, 1999 1 SEVERANCE AGREEMENT Thomas R. Parkinson ("Parkinson") and SRS Labs, Inc. ("SRS Labs"), hereby agree to terminate their employment relationship on the following basis: 1. Parkinson has resigned his employment as President and Chief Operating Officer of SRS Labs voluntarily effective February 5, 1999. His personnel records will be marked accordingly. Should any employer or prospective employer inquire of the Chief Executive Officer of SRS Labs or his designated representative regarding Parkinson's reason for leaving the employment of SRS Labs, then "voluntary resignation" will be given as the reason. 2. Parkinson represents to SRS Labs that he is signing this Agreement voluntarily and with a full understanding of its terms, for the purpose of being allowed to resign his employment with SRS Labs and receiving severance benefits as described in this Agreement. Based on that representation and in addition to regular pay through February 15th, 1999, and pay for accrued vacation, Parkinson will be provided the following benefits: (a) Expenses in the amount of $7,000 to cover (i) January 1999 living expenses, (ii) lease-cancelling expenses, and (iii) moving expenses. SRS Labs will also reimburse Parkinson for any outstanding business expenses submitted to and approved by SRS Labs; (b) Notwithstanding his voluntary resignation, Parkinson will be paid three months' severance benefits, in the gross amount of $75,000, less required legal deductions, as severance pay. Such severance amounts will sent by mail to Parkinson in three equal monthly installments of $25,000, less required legal deductions, commencing on March 1, 1999, and continuing on the first day of each month thereafter through May 1, 1999, unless Parkinson revokes this Agreement as described in Paragraph 8 below; (c) Medical coverage through May 15th, 1999; and (d) SRS Labs will vest 52,500 SRS Labs stock options, previously issued to Parkinson on July 7, 1998, immediately upon action by the Board of Directors of SRS Labs, in addition to the already-vested option to purchase 8,750 shares granted to Parkinson on December 23, 1998. All such options shall expire if not exercised on or before December 31st, 1999. In addition, Parkinson agrees that he has been paid all other sums owed to him at the time of his termination, which sums include all salary, all bonuses, all personal days, and all accrued, unused vacation pay. By signing this Agreement, Parkinson acknowledges receipt of all sums owed to him at termination. Parkinson further agrees that he will be entitled to no other payments from SRS Labs and/or any parent, related, or subsidiary companies, and/or the officers, directors, or employees of any of them, other than those set forth in this Paragraph. 2 3. In exchange for such severance pay and grant of stock options, Parkinson agrees to, and by signing this document does, acknowledge that he resigned his employment with SRS Labs voluntarily effective February 5, 1999. In addition, Parkinson agrees to, and hereby does, waive and release all claims (known or unknown), including but not limited to claims under the California Fair Employment and Housing Act, the Civil Rights of 1964, the Age Discrimination in Employment Act, and/or the Americans with Disabilities Act, which he has or might have had against SRS Labs and any parent, related, or subsidiary companies, and the officers, directors, employees, former employees, representatives, and agents of any of them (collectively, the "Releasees"), regarding any aspect of his employment with SRS Labs or the termination of that employment. Furthermore, Parkinson hereby represents that he will not hereafter file any claims, charges or complaints against the Releasees, or any of them, regarding any aspect of his employment with SRS Labs or the termination of that employment with any state or federal administrative agency or court. 4. Parkinson waives all rights and benefits afforded by Section 1542 of the Civil Code of the State of California, and does so understanding the significance of that waiver. Section 1542 provides: "A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor." In order to achieve a full and complete release of the Releasees, Parkinson acknowledges that this Agreement is intended to include in its effect all claims that Parkinson does not know or suspect to exist in his favor at the time that he signs this Agreement. 5. Parkinson represents and agrees that he has kept and will keep the fact, amount and terms of this Agreement completely confidential, and that he will not hereafter disclose any information concerning this Agreement to any person, including but not limited to any past or present employee of SRS Labs or any parent, related, or subsidiary companies, other than members of his immediate family. Before Parkinson tells his immediate family anything about this Agreement, he will inform them of this confidentiality clause and have them agree to follow it. 6. Parkinson represents and agrees that he will not criticize, denigrate, or otherwise disparage or cause disparagement to SRS Labs or any other Releasee. Parkinson further represents and agrees that he will not engage in any conduct or take any action to encourage any person or entity to initiate litigation or assert any other kind of claim against SRS Labs or any other Releasee. 7. Parkinson represents and agrees that any disclosure of information or other action contrary to the terms of Paragraphs 5 and/or 6 by him would cause SRS Labs and/or other Releasees injury and damage, the actual amount of which would be impractical or extremely difficult to determine. Accordingly, Parkinson agrees that SRS Labs shall be entitled to recover from him liquidated damages in the amount of Five -2- 3 Thousand Dollars ($5,000) for each instance in which Parkinson discloses any information or takes any other action in violation of the terms of Paragraphs 5 and/or 6. 8. Parkinson is hereby advised (a) to consult with an attorney prior to signing this Agreement and (b) that he has 21 days in which to consider and accept this Agreement by signing and returning this Agreement to SRS Labs c/o Tom Yuen. In addition, Parkinson has a period of seven (7) days following his execution of this Agreement in which he may revoke this Agreement. If Parkinson does not advise SRS Labs (by a writing received by Tom Yuen within such seven (7) day period) of his intent to revoke the Agreement, the Agreement will become effective and enforceable. If Parkinson revokes the Agreement, then no amounts will be paid or options granted to him under Paragraph 2 above, or otherwise. 9. Parkinson understands and agrees that, in the course of his employment with SRS Labs, Parkinson has acquired privileged and/or confidential, proprietary information and trade secrets concerning the operations, future plans, and methods of doing business of SRS Labs (Trade Secrets), which information Parkinson understands and agrees would be extremely damaging to SRS Labs if disclosed to a competitor or made available to any other person or corporation. Parkinson understands and agrees that such Trade Secrets have been divulged to Parkinson in confidence and Parkinson understands and agrees that Parkinson will keep such Trade Secrets secret and confidential, and will not, directly or indirectly, use or disclose for his own benefit or the benefit of another, any of such Trade Secrets. 10. Parkinson further agrees that he will not, for a period of eighteen (18) months from the date he signs this Agreement, solicit or participate in or assist in any way in the solicitation of any other employees of SRS Labs, or of any of its parent, related, or subsidiary companies, for the purpose of inducing them to sever their employment relationship with SRS Labs or any of its parent, related, or subsidiary companies. 11. In view of the nature of Parkinson's employment and the information and Trade Secrets which Parkinson has received during the course of his employment, Parkinson likewise agrees that SRS Labs would be irreparably harmed by any violation or threatened violation of Paragraphs 10 and/or 11, and that, therefore, SRS Labs shall be entitled to damages and an injunction prohibiting Parkinson from any violation or threatened violation of those Paragraphs. The undertakings set forth in Paragraphs 10 and/or 11 shall survive the termination of other arrangements contained in this Agreement. 12. This Agreement contains all of the terms, promises, representations and understandings made between the parties. Parkinson agrees that no promises, representations or inducements have been made to him which caused him to sign this Agreement other than those which are expressly set forth above. 13. This Agreement is the sole and entire agreement between the parties, and supersedes all prior agreements and understandings, oral or written, express or implied, between the parties. It is expressly understood and agreed that this Agreement constitutes a novation and accord and satisfaction of the letters of May 15, 1998, and June 4, 1998, from Tom Yuen to Parkinson, that any contract created by such -3- 4 letters is hereby extinguished, and that he will not claim monies and/or stock options, and no monies or stock options will be paid or granted to him, under those letters. 14. Any dispute regarding any aspect of the formation, interpretation or application this Agreement or any act which allegedly has or would violate this Agreement will be submitted to arbitration in Orange County, California, before a retired judicial officer employed by, and such arbitration shall be conducted in accordance with, the rules of the Judicial Arbitration and Mediation Service ("JAMS/ENDISPUTE"). Such arbitration shall be the exclusive remedy for any such claim or dispute. The party losing the arbitration shall reimburse the party who prevailed for all expenses of the prevailing party, including but not limited to attorneys' fees and costs as determined by the arbitrator, in such arbitration. Should Parkinson or SRS Labs hereinafter institute any legal action or administrative proceeding against the other with respect to any claim waived by this Agreement or pursue any dispute or matter covered by this Paragraph by any method other than said arbitration, the responding party shall be entitled to recover from the other party all damages, costs, expenses and attorneys' fees incurred as a result of such action or proceeding. SRS LABS, INC. By: /s/ THOMAS C.K. YUEN /s/ THOMAS R. PARKINSON ------------------------- ------------------------- Thomas C.K. Yuen Tom Parkinson Title: Chief Executive Officer Dated: 2/23/99 Dated: 2/20/99 -4- EX-27 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM BALANCE SHEET AND STATEMENT OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999. 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 11,159,639 12,062,028 2,715,337 0 5,621,161 26,188,215 911,304 0 42,708,497 18,034,578 0 0 0 11,698 24,630,981 42,708,497 3,612,774 7,716,841 5,275,642 4,351,562 0 129,798 (103,347) (1,807,016) (309,906) (1,497,110) 0 0 0 (1,497,110) (0.13) (0.13)
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