-----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, FdhTY9sXEpHVdnccLyuT0/bDoWNRjLOsWvdReAXRVMwcnJDj1lV26oFLzhKzkDHr qR9y2nxwMQ6CUeXarpsylA== 0001095811-00-001490.txt : 20000516 0001095811-00-001490.hdr.sgml : 20000516 ACCESSION NUMBER: 0001095811-00-001490 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20000331 FILED AS OF DATE: 20000515 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: 633630 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 QUARTER ENDED 3/31/2000 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, 2000 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 5, 2000, 12,564,273 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, 2000 Index
PAGE ---- PART I - FINANCIAL INFORMATION Item 1. Financial Statements. 3 Consolidated Balance Sheets as of March 31, 2000 (Unaudited) and December 31, 1999 3 Consolidated Statements of Operations for the three months ended March 31, 2000 and 1999 (Unaudited) 4 Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2000 and 1999 (Unaudited) 5 Consolidated Statements of Cash Flows for the three months ended March 31, 2000 and 1999 (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. 20 SIGNATURES 21
FORWARD-LOOKING INFORMATION This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, reflecting management's current expectations. Examples of such forward-looking statements include the expectations of the Company with respect to its strategy. Although the Company believes that its expectations are based upon reasonable assumptions, there can be no assurances that the Company's financial goals will be realized. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Numerous factors may affect the Company's actual results and may cause results to differ materially from those expressed in forward-looking statements made by or on behalf of the Company. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words, "believes," "anticipates," "plans," "expects" and similar expressions are intended to identify forward-looking statements. The important factors discussed in Part I, Item 2, Management Discussion and Analysis of Financial Condition and Results of Operation - Factors That May Affect Future Results", herein, among others, could cause actual results to differ materially from those indicated by forward-looking statements made herein and presented elsewhere by management. Such forward-looking statements represent management's current expectations and are inherently uncertain. Investors are warned that actual results may differ from management's expectations. The Company assumes no obligation to update the forward-looking information to reflect actual results or changes in the factors affecting such forward-looking information. 2 3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. SRS LABS, INC. CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31, 2000 1999 ------------ ------------ (UNAUDITED) ASSETS CURRENT ASSETS Cash and cash equivalents $ 21,086,022 $ 15,969,678 Investments available for sale 3,221,617 3,011,250 Accounts receivable, net 2,434,338 2,495,157 Inventories, net 2,446,185 2,726,193 Prepaid expenses and other current assets 1,101,393 729,881 Deferred income taxes 81,467 81,467 ------------ ------------ TOTAL CURRENT ASSETS 30,371,022 25,013,626 Investments available for sale 4,593,045 6,331,483 Furniture, fixtures & equipment, net 1,220,296 1,166,757 Intangible assets, net 5,135,670 5,425,273 Deferred income taxes 740,889 740,889 Other assets 422,493 422,493 ------------ ------------ TOTAL ASSETS $ 42,483,415 $ 39,100,521 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 2,290,615 $ 2,882,686 Accrued liabilities 1,324,215 1,658,964 Line of credit 8,000,000 8,000,000 Income taxes payable 1,431,425 1,518,548 ------------ ------------ TOTAL CURRENT LIABILITIES 13,046,255 14,060,198 STOCKHOLDERS' EQUITY Preferred stock - $.001 par value; 2,000,000 shares authorized; no shares issued and outstanding -- -- Common stock - $.001 par value; 56,000,000 shares authorized; 12,398,107 and 11,890,691 shares issued; and 12,327,007 and 11,819,591 shares outstanding at March 31, 2000 and December 31, 1999, respectively 12,399 11,891 Additional paid-in capital 49,034,525 40,312,336 Deferred stock option compensation 292,431 264,557 Cumulative other comprehensive income 10,642 23,330 Retained deficit (19,649,556) (15,308,510) Less treasury stock at cost, 71,100 shares at March 31, 2000 and December 31, 1999 (263,281) (263,281) ------------ ------------ TOTAL STOCKHOLDERS' EQUITY 29,437,160 25,040,323 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 42,483,415 $ 39,100,521 ============ ============
See accompanying notes to the interim consolidated financial statements 3 4 SRS LABS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, -------------------------------- 2000 1999 ------------ ------------ REVENUES Chip and licensing revenue $ 2,879,079 $ 3,581,158 Product and component sales 4,311,473 4,073,412 ------------ ------------ TOTAL REVENUES 7,190,552 7,654,570 COST OF SALES 4,848,701 5,093,785 ------------ ------------ GROSS MARGIN 2,341,851 2,560,785 Sales and marketing 1,284,734 1,284,332 Research and development 939,189 1,089,906 General and administrative 1,418,587 2,121,559 Non-cash stock issuance cost 3,111,859 -- ------------ ------------ LOSS FROM OPERATIONS (4,412,518) (1,935,012) OTHER INCOME, NET 209,564 127,978 ------------ ------------ LOSS BEFORE INCOME TAX (EXPENSE) BENEFIT (4,202,954) (1,807,034) INCOME TAX (EXPENSE) BENEFIT (138,093) 309,924 ------------ ------------ NET LOSS $ (4,341,047) $ (1,497,110) ============ ============ NET LOSS PER COMMON SHARE Basic $ (0.36) $ (0.13) ============ ============ Diluted $ (0.36) $ (0.13) ============ ============ WEIGHTED AVERAGE SHARES USED IN THE CALCULATION OF NET LOSS PER COMMON SHARE Basic 11,982,392 11,681,419 ============ ============ Diluted 11,982,392 11,681,419 ============ ============
See accompanying notes to the interim consolidated financial statements 4 5 SRS LABS, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, ------------------------------ 2000 1999 ----------- ----------- Net loss $(4,341,047) $(1,497,110) Other comprehensive income (loss) Foreign currency translation (1,544) -- Unrealized loss on investments available for sale, net of tax (11,144) (7,916) ----------- ----------- Comprehensive loss $(4,353,735) $(1,505,026) =========== ===========
See accompanying notes to the interim consolidated financial statements 5 6 SRS LABS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, -------------------------------- 2000 1999 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (4,341,047) $ (1,497,110) Adjustments to reconcile net loss to net cash used in operating activities: Non-cash stock issuance cost 3,111,859 -- Depreciation and amortization 558,498 499,913 Other (1,210) -- Amortization of premium on investments available for sale 9,185 14,171 Increase in deferred stock option compensation 27,874 90,561 Changes in operating assets and liabilities: Accounts receivable 60,819 2,305,349 Inventories 280,008 (988,193) Prepaid expenses and other current assets (371,512) (219,882) Accounts payable (592,071) (2,714,869) Accrued liabilities (334,749) 1,463,578 Income taxes payable (79,379) (83,171) ------------ ------------ Net cash used in operating activities (1,671,725) (1,129,653) CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of furniture, fixtures and equipment (202,769) (28,425) Proceeds from sale of investments available for sale 1,500,000 -- Expenditures related to patents and intangible assets (120,000) (8,496) ------------ ------------ Net cash provided by (used in) investing activities 1,177,231 (36,921) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from sale of Common Stock 5,000,291 -- Purchase of treasury stock -- (52,500) Proceeds from exercise of stock options 610,547 37,471 ------------ ------------ Net cash provided by (used in) financing activities 5,610,838 (15,029) ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 5,116,344 (1,181,603) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 15,969,678 12,341,242 ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $ 21,086,022 $ 11,159,639 ============ ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 140,695 $ 112,307 Income taxes $ 177,191 $ --
See accompanying notes to the interim consolidated financial statements 6 7 SRS LABS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, -------------------- 2000 1999 -------- ------- SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Unrealized loss on investments, net $(11,144) $(7,916)
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 the interim 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: o Developing and licensing audio and voice technologies to original equipment manufacturers ("OEMs") and semiconductor manufacturers around the world; and o Through its subsidiary, ValenceTech Limited and its foreign subsidiaries (collectively "Valence"), designing and selling technology solutions through custom application specific integrated circuits ("ASICs") to OEMs; and designing, distributing and manufacturing components, sub-assemblies and electronics products for the OEM and retail communities within the Company's targeted markets. The accompanying interim consolidated financial statements have been prepared by the Company without audit (except for the balance sheet information as of December 31, 1999) in conformity with accounting principles generally accepted in the United States for interim financial information and with the rules and regulations of the U.S. Securities and Exchange Commission. In the opinion of management, all adjustments (which include only normal recurring adjustments) considered necessary for a fair presentation have been included. Certain accounts as previously reported have been reclassified to conform to the current period presentation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. Therefore, the 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, 1999. Current and future financial statements may not be directly comparable to the Company's historical financial statements. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. 2. INVESTMENTS AVAILABLE FOR SALE The Company has classified its investments as available-for-sale in accordance with Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities". As of March 31, 2000, the Company's available-for-sale investments had a cost of $7,785,825 and an estimated fair value of $7,814,662, based on quoted market prices. The unrealized gains on these investments of $28,837 net of income taxes of $11,824, are reported as a separate component of stockholders' equity. 3. INVENTORIES Inventories, which consist of finished goods, are stated at the lower of cost or net realizable value. Cost is calculated using the weighted average method and is comprised of material costs and, where applicable, subcontracting and overhead costs that have been incurred in bringing the inventories to their present location and condition. Net realizable value represents the estimated selling price less estimated costs to completion and costs to be incurred in selling and distribution. 4. 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. 5. 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. 8 9 SRS LABS, INC. NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 6. 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, 2000, 71,100 shares had been repurchased at a cost of $263,281. Such repurchased shares are reflected as treasury stock in the accompanying consolidated balance sheets. In March 2000, the Company entered into a technology and marketing alliance with Microsoft Corporation ("Microsoft"). In conjunction with this transaction, Microsoft purchased 290,529 shares of the Company's common stock for $17.21 per share or $5,000,000 in the aggregate. The difference between the purchase price and the fair value of the common stock on the date of purchase, totaling approximately $555,000, was recorded as non-cash stock issuance cost by the Company during the quarter ended March 31, 2000. The Company also granted Microsoft warrants to purchase up to 200,000 shares of common stock of the Company and the Company's wholly-owned subsidiary, SRSWOWcast.com, Inc., granted a warrant to purchase up to 1,250,000 shares of its common stock. The fair value of these warrants, aggregating approximately $2,555,000, has been recorded as non-cash stock issuance cost by the Company during the quarter ended March 31, 2000. 7. SEGMENT INFORMATION The Company operates in two business segments: (a) 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 (b) 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.
THREE MONTHS ENDED MARCH 31, 2000 -------------------------------------------- CHIPS AND PRODUCT AND LICENSING COMPONENT SALES TOTAL ---------- --------------- ---------- Net revenues $2,879,079 $4,311,473 $7,190,552 Cost of sales 883,000 3,965,701 4,848,701 ---------- ---------- ---------- Gross margin $1,996,079 $ 345,772 $2,341,851 ========== ========== ========== THREE MONTHS ENDED MARCH 31, 2000 -------------------------------------------- CHIPS AND PRODUCT AND LICENSING COMPONENT SALES TOTAL ---------- --------------- ---------- Net revenues $3,581,158 $4,073,412 $7,654,570 Cost of sales 1,064,716 4,029,069 5,093,785 ---------- ---------- ---------- Gross margin $2,516,442 $ 44,343 $2,560,785 ========== ========== ==========
9 10 SRS LABS, INC. NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 8. SUBSEQUENT EVENTS On March 3, 2000, ValenceTech Limited (the successor entity to Valence Technology Inc. for purposes of listing common shares on the Growth Enterprise Market of the Hong Kong Stock Exchange (the "GEM)) filed an application to list its common shares on the GEM in connection with an initial public offering. The Company estimates that the completion of the offering will occur during the second quarter of Fiscal 2000. As contemplated in the offering documents, approximately one-third of the net proceeds of the offering is earmarked to be repatriated to the Company. The amount of such repatriation is currently not determinable. In April 2000, in connection with the capitalization of ValenceTech Limited, the Company paid approximately $428,000 for 100% of the common stock of ValenceTech Limited. 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: o Developing and licensing audio and voice technologies to original equipment manufacturers ("OEMs") and semiconductor manufacturers around the world; and o Through its subsidiary, ValenceTech Limited and its foreign subsidiaries (collectively, "Valence"), designing and selling technology solutions through custom application specific integrated circuits ("ASICs") to OEMS; and designing, distributing and manufacturing components, sub-assemblies and finished goods for the OEM and retail communities within the Company's targeted markets. The Company was formed in 1993 by purchasing all rights and assets of various audio and speaker technologies from the Hughes Aircraft Company. The Company successfully completed its initial public offering in August 1996, raising approximately $22 million. From the Company's inception in 1993 until February 1998, the Company derived substantially all of its revenues from audio technology licensing activities for the consumer electronics, computer and game markets. The primary technologies that contributed to revenue were SRS(R) (Sound Retrieval System(R)) ("SRS"), which produces a 3D sound-enhanced stereo image from any mono or stereo source, and TruSurroundTM, a "virtual" audio technology which processes multi-channel surround sound through any standard pair of stereo speakers. On March 2, 1998, the Company acquired 100% of the outstanding stock of Valence Technology Inc., a British Virgin Islands holding company with its principal business operations in Hong Kong and China. This acquisition significantly expanded the Company's business activities from the original licensing model to include the design, manufacture and marketing of chips, components and products. In addition to the acquisition of Valence Technology, Inc. during the fiscal year ended December 31, 1998 ("Fiscal 1998"), the Company acquired two additional technologies. In the first quarter of Fiscal 1998, the Company acquired certain rights to Voice Intelligibility Processor ("VIP"), a patented voice processing technology that improves the intelligibility of the spoken voice, especially in high ambient noise environments and, in the following quarter, acquired certain rights to Circle Surround, a patented audio delivery system that allows multi-channel surround sound to be encoded into a two-channel stereo format and allows an encoded two-channel audio source to be decoded into a multi-channel surround format. During the fiscal year ended December 31, 1999 ("Fiscal 1999"), the Company re-engineered its business model and operational structure. Valence Technology, Inc., while continuing to expand its ASICs business, exited certain of the lower margin distribution product lines and directed more of its resources to develop and market solutions that integrate the SRS technologies. In addition, the Company began to explore the feasibility of selling a minority interest in Valence Technology Inc. to the public in Asia by listing such shares on a foreign exchange. This strategy materialized when ValenceTech Limited, the ultimate successor corporation to Valence Technology Inc. ("ValenceTech"), filed an application to list on the Growth Enterprise Market of the Hong Kong Stock Exchange on March 3, 2000. The Company anticipates retaining 75% ownership of ValenceTech Limited upon completion of an initial public offering in Asia targeted for the second quarter of the fiscal year ended December 31, 2000. In connection with the capitalization of ValenceTech, in April 2000, the Company paid approximately $428,000 for 100% of the common stock of ValenceTech. With respect to its licensing business, the Company changed its focus from entering into technology licenses with PC chip manufacturers to developing a new business model which focuses on Internet radio. This new focus resulted in the Company launching the WOWThing product family and establishing a new wholly-owned subsidiary, SRSWOWcast.com, Inc., to be the platform to launch this business. In March 2000, Microsoft Corporation ("Microsoft") and the Company entered into a strategic alliance whereby Microsoft and the Company entered into a License Agreement relating to the Company's WOW Technology. The License Agreement will facilitate the incorporation of the WOW Technology into the Windows 2000 Media Player and provide a click-through hyper-link on the interface of the Windows Media Player to the SRSWOWcast.com website. In addition, Microsoft made an equity investment into the Company and was granted a warrant to purchase additional shares of the Company's common stock as well as a warrant to purchase shares of common stock in SRSWOWcast.com, Inc. 11 12 The Company's technologies also were implemented in new consumer products in Fiscal 1999. Among the most notable implementations included the Kenwood receiver (CircleSurround), the Sony Walkman (SRS Headphones), Philips (TruSurround) and Sony (SRS Headphone) DVD players, as well as Hitachi TVs (Focus). In addition to these new implementations, the Company entered into new licenses with key industry manufacturers including Loewe, ST Microelectronics and TCE in Europe; Yamaha and Marantz in Japan; Konka and TCL in China; Samsung and LG in Korea and Cirrus Logic, Lucent and Peavey in the United States. SRS currently operates in two business segments: (a) the development and marketing of technology in the forms of integrated circuits design 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 and geographic area is included in the accompanying notes to the interim consolidated financial statements. RESULTS OF OPERATIONS Three Months Ended March 31, 2000 Compared To Three Months Ended March 31, 1999 - ------------------------------------------------------------------------------- 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 (a) the manufacture and sale of Valence's own branded product line of VCD players, amplifiers, and game products and (b) 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, 2000 were $7,190,552 compared to $7,654,570 for the three months ended March 31, 1999, a decrease of $464,018. This minor decrease in revenues is due primarily to the timing of ASIC orders placed by one of the Company's larger customers. Gross Margin Cost of sales consists primarily of fabrication costs, assembly and test costs, and the cost of materials and overhead from operations. The gross margin percentage decreased slightly from 33.5% for the quarter ended March 31, 1999, to 32.6% for the same period in 2000. The decrease is attributable primarily to efforts by Valence to clear older technologies from its inventories through aggressive pricing, and due to higher ASIC fabrication costs. The higher ASIC fabrication costs are attributable to higher worldwide demand for semiconductors, and limited fabrication capacity. 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 $1,284,734 for the three months ended March 31, 2000 compared to $1,284,332 for the same prior year period. Sales and marketing expenses increased slightly from 16.7% of revenues for the quarter ended March 31, 1999 to 17.9% for the same period this year. Sales and marketing expenses may increase in the future as a result of anticipated spending associated with the launch and promotional activities of its wholly-owned subsidiary, SRSWOWcast.com, Inc. 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 $939,189 for the three months ended March 31, 2000 compared to $1,089,906 for the same prior year period, a decrease of 13.8%. Research and development costs decreased slightly from 14.2% of revenues for the quarter ended March 31, 1999, to 13.0% of revenue for the same period this year. Research and development expenses may increase in the future as a result of ongoing 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 $1,418,587 for the three months ended March 31, 2000 compared to $2,121,559 for the same prior year period, a decrease of 33%. The decrease was primarily attributable to lower employee related expenses, bad debt expense, and lower legal and professional fees. As a percentage of total revenues, general and administrative expenses decreased from 27.7% for the quarter ended March 31, 1999, to 19.7% for the same period this year. As part of the acquisition of Valence Technology Inc., 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 $322,796 for the quarters ended March 31, 2000 and March 31, 1999, respectively, and is included in general and administrative expenses. Non-cash Stock Issuance Costs In March 2000, the Company entered into a technology and marketing alliance with Microsoft Corporation. In conjunction with this transaction, Microsoft purchased shares of common stock of the Company and was issued warrants to purchase additional shares of the Company and its subsidiary. As a result of the transaction, the Company recognized one-time, non-cash charges totaling $3,111,859. See Note 6 of the Notes to the Interim Consolidated Financial Statements for more information concerning the Microsoft transaction. Other Income, Net Net other income consists primarily of interest income, interest expense and foreign currency transaction gains and losses. Net other income was $209,564 for the three months ended March 31, 2000 compared to $127,978 for the same prior year period, an increase of 63.7%. The increase is primarily due to higher interest income which is attributable to higher average cash and investment balances during the current year quarter. Provision for Income Taxes The income tax expense for the three months ended March 31, 2000 was $138,093 compared to a tax benefit of $309,906 for the same prior year period. Commencing in the fiscal year ending December 31, 2000, the Company recorded a tax provision at statutory tax rates in the Asian countries where Valence has its principal business operations. In Fiscal 1999, the Company recognized tax benefits related to domestic operations in connection with federal refundable taxes which could be recovered through a net operating loss carryback. LIQUIDITY AND CAPITAL RESOURCES The Company's principal source of liquidity at March 31, 2000 consisted of cash, cash equivalents and investments aggregating $28,900,684, as well as borrowings available under its credit facilities. At December 31, 1999, the Company had cash, cash equivalents and long-term investments of $25,312,411. In March 2000, the Company sold shares of its common stock to Microsoft Corporation, for aggregate cash proceeds of $5,000,000. See Note 6 to the Interim Consolidated Financial Statements. The Company's operating activities utilized $1,671,725 in cash for the three months ended March 31, 2000, and $1,129,653 for the three months ended March 31, 1999. The use of cash in operations was primarily due to the Company' s loss from operations for the quarter, after adjustment for non-cash charges related to the Microsoft transaction. The net increase in cash and cash equivalents of $5,116,344 for the quarter is attributable primarily to proceeds from sale of long-term investments, proceeds from stock option exercises and proceeds from the sale of common stock to Microsoft. In March, 1998, the Company obtained a revolving line of credit (and letter of credit facility) with a bank which expires on April 1, 2001 and is secured by certain of the Company's cash, cash equivalents and investments. As of March 31, 2000, approximately $1.4 million in cash and cash equivalents and $7.8 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%. As of March 31, 2000, the Company had $8.0 million outstanding under the line of credit and was contingently liable for $1.0 million under an irrevocable letter of credit which expires July 31, 2000. The collateral requirements under the above referenced credit facility may have the effect of restricting the amounts of cash available to pay dividends. 13 14 In November 1999, Valence obtained a credit facility with a bank that provides for borrowings aggregating approximately $5,000,000. The facility has no fixed expiration date and is collateralized by certain of Valence's assets on deposit with the bank. The facility provides for a variety of import/export trade instruments which bear interest rates ranging from 1% over the Hong Kong Dollar prime rate to 1.75% over LIBOR. The facility also provides for a revolving line of credit of up to $3,500,000 which bears interest at 1.25% over the related collateral deposit interest rate. At March 31, 2000, there were no obligations outstanding under this credit facility. The Company anticipates that its primary uses of working capital in future periods will be to acquire new technologies and to fund increased costs for additional sales and engineering headcount and marketing activities associated with the introduction of new technologies and products into the market. Based on current plans and business conditions, the Company expects that its cash, cash equivalents, investments and/or available borrowings under its credit facilities, together with any amounts generated from operations, will be sufficient to meet the Company's cash requirements for the next 12 months. However, there can be no assurance that the Company will not be required to seek other financing sooner or that such financing, if required, will be available on terms satisfactory to the Company. Subsequent Events On March 3, 2000, ValenceTech Limited (the successor entity to Valence Technology Inc. for purposes of listing common shares on the Growth Enterprise Market of the Hong Kong Stock Exchange (the "GEM)) filed an application to list its common shares on the GEM in connection with an initial public offering. The Company estimates that the completion of the offering will occur during the second quarter of Fiscal 2000. As contemplated in the offering documents, approximately one-third of the net proceeds of the offering is earmarked to be repatriated to the Company. The amount of such repatriation is currently not determinable. In connection with the capitalization of ValenceTech in April 2000, the Company paid approximately $428,000 for 100% of the common stock of ValenceTech Limited. FACTORS THAT MAY AFFECT FUTURE RESULTS Quarterly Fluctuations The Company's operating results may fluctuate from those in prior quarters and will continue to be subject to quarterly and other fluctuations due to a variety of factors, including the extent to which the Company's licensees incorporate the Company's technologies into their products; the timing of orders from and the shipments to major customers; the timing of new product introductions by the Company; the gain or loss of significant customers; competitive pressures on selling prices; the market acceptance of new or enhanced versions of the Company's technologies; the rate that the Company's semiconductor licensees manufacture and distribute chips to product manufacturers; and fluctuations in general economic conditions, particularly those affecting the consumer electronics market. Due to the Company's dependence on the consumer electronics market, the substantial seasonality of sales in the market has impacted the Company's revenues and net income. In particular, the Company believes that there is seasonality relating to the Christmas season, generally, and the Chinese New Year within the Asia region, which fall into the fourth and first quarters, respectively. As a result, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Valence's Business The Company derives a significant amount of its revenue from Valence's ASIC and component distribution business. Valence's engineering team focuses on the design of custom ASIC to meet specific customers' requirements and outsources the production of the design to mask houses, foundaries and packaging houses located primarily in Asia. The operations of Valence 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 ASIC business' revenue is concentrated in a limited number of customers in the areas of consumer electronics, communications products, computers and computer peripherals. As such, the loss of any such customers or any bad debt arising from them may have a material adverse impact on the Company's financial condition and results of operation. Beginning in Fiscal 1999, Valence began to exit from certain lower margin product offerings in the distribution side of the business and has begun developing 14 15 and distributing products that are related to or incorporate the Company's proprietary technologies. As a result, the immediate loss in revenue of the low margin distribution business will not be entirely offset by the new proprietary technology based products, which will take time to develop and be introduced into the marketplace. There can be no assurance that the Company will be able to quickly introduce new products to offset the loss in revenue or that the new products developed will receive a favorable market acceptance. The public offering of common shares of ValenceTech Limited in Hong Kong is intended to bring new capital to grow Valence's core business while, at the same time, adding significant value to the Company's shareholders. Although the Company expects that such offering will be completed during the second quarter of Fiscal 2000, there is no assurance that the offering will be completed during that time period or at all. Changes in the economic environment of Hong Kong and/or the PRC may adversely affect the offering or, if the offering is completed, may adversely affect the market price of the common shares. The acquisition of Valence has added significant diversity to the Company's overall business structure and the Company's opportunities. The Company recognizes that in the presence of such corporate diversity, and in particular with regard to the semiconductor industry, there will always exist a potential for a conflict among sales channels between the Company and certain of the Company's technology licensees. Although the operations of the Company's licensing business and those of Valence are generally complementary, there can be no assurances that sales channel conflicts will not arise. If such potential conflicts do materialize, the Company may or may not be able to mitigate the effect of such perceived conflicts, which, if not resolved, may impact the results of operations. Internet Business In Fiscal 1999, the Company launched its Internet business with the formation of SRSWOWcast.com, Inc. SRSWOWcast.com plans to develop and acquire engaging and audio based content to generate and retain visitor traffic to its web site. The revenue of SRSWOWcast.com will, in turn, depend on fees charged to third party businesses for advertising on the site as well as e-commerce products sold to visitors to the site. The Company has planned for other Internet subsidiaries in different geographical regions to be launched at a later date by duplicating the business model of SRSWOWcast.com and with content that is adapted for local culture and taste. However, there can be no assurance that SRSWOWcast.com and other planned subsidiaries or business ventures will be able to develop or acquire the content necessary to attract significant Internet traffic or able to generate substantial revenue from advertising and e-commerce. Product Business In Fiscal 1999, the Company developed and marketed on its e-commerce site, www.wowthing.com, its first consumer audio product, the WOWThing Processor Box. The WOWThing Processor Box enhances the sound quality of music downloaded over the Internet as well as audio performance of computer and home entertainment products and speakers. This was the Company's first entry into the consumer market in the United States which is both competitive and demands products with short life cycles. The Company intends to expand its offerings of high-end audio enhancement products in the year 2000 and beyond. There can be no assurance that the Company will be able to develop an effective distribution channel and build brand recognition as a product manufacturer. And as the business increases, it is anticipated that significant capital will be required to finance product inventory and account receivables. As a result, the Company is subject to risks of product obsolescence, bad debt and insufficient financial resources to grow the business. The Company also recognizes that as new consumer audio products are developed and marketed by the Company, there will always exist a potential for a conflict and competition between the Company and certain of the Company's technology licensees. Although the intended products of the Company and those of its licenses do not generally overlap, there can be no assurance that the Company's products will not compete with those of their licensees. If such conflicts do materialize, it is uncertain whether the Company will be able to mitigate the effect of such conflicts, which if not resolved, may impact the results of operations. Economic Risks Associated with Doing Business in Asia, Particularly in Hong Kong and the PRC The Company's significant operations in China and Asia have required, and will continue to require, refinement to adapt to the changing market conditions in the region. The Company's operations in Asia, and internationally in general, are subject to risks of unexpected changes in, or impositions of legislative or regulatory requirements. 15 16 The PRC economy has experienced significant growth in the past decade, but such growth has been uneven across geographic and economic sectors and has recently been slowing. There can be no assurance that such growth will not continue to decrease or that any slow down will not have a negative effect on the Company's business, including Valence. The PRC economy is also experiencing deflation which may continue in the future. The current economic situation may adversely affect the Company's profitability over time as expenditures for consumer electronics products and information technology may decrease due to the results of slowing domestic demand and deflation. Hong Kong is a Special Administrative Region of the PRC with its own government and legislature. Hong Kong enjoys a high degree of autonomy from the PRC under the principle of "one country, two systems". The Company can give no assurance that Hong Kong will continue to enjoy autonomy from the PRC. The Hong Kong dollar has remained relative constant due to the US dollar peg and currency board system that has been in effect in Hong Kong since 1983. Since mid-1997, interest rates in Hong Kong have fluctuated significantly and real estate and retail sales have declined. The Company can give no assurance that the Hong Kong economy will not worsen or that the historical currency peg of the Hong Kong dollar to the U.S. dollar will be maintained. Continued recession in Hong Kong, deflation or the discontinuation of the currency peg could adversely affect the Company's business. Currency Risk/Stability of Asian Markets The Company expects that international sales will continue to represent a significant portion of total revenues. To date, all of the Company's licensing revenues have been denominated in U.S. dollars and most costs have been incurred in U.S. dollars. It is the Company's expectation that licensing revenues will continue to be denominated in U.S. dollars for the foreseeable future. Because Valence and its subsidiaries' business is primarily focused in Asia and because of the Company's anticipated expansion of its business in 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 experienced weakness in their currency, banking and equity markets. These weaknesses could adversely affect consumer demand for Valence's products, the U.S. dollar value of the Company's and its subsidiaries' foreign currency denominated sales, the availability and supply of product components to Valence and ultimately, the Company's consolidated results of operations. Competitive Pressures The Company's existing and potential competitors include both large and emerging domestic and international companies that have substantially greater financial, manufacturing, technical, marketing, distribution and other resources. The Company's present or future competitors may be able to develop products and technologies comparable or superior to those offered by the Company, and to adapt more quickly than the Company to new technologies or evolving market needs. The Company believes that the competitive factors affecting the market for the Company's products and technologies include product performance, price and quality; product functionality and features; the ease of integration; and implementation of the products and technologies with other hardware and software components in the OEM's products. In addition, the markets in which the Company competes are intensely competitive and are characterized by rapid technological changes, declining average sales prices and rapid product obsolescence. Accordingly, there can be no assurance that the Company will be able to continue to compete effectively in its respective markets, that competition will not intensify or that future competition will not have a material adverse effect on the Company's business, operating results, cash flows and financial condition. Importance of Intellectual Property The Company's ability to compete may be affected by its ability to protect its proprietary information. The Company has filed several U.S. and foreign patent applications and to date has a number of issued U.S. and foreign patents covering various aspects of its technologies. There can be no assurance that the steps taken by the Company 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 16 17 Company's intellectual property rights to the same extent, as do the laws of the U.S. The semiconductor industry is characterized by frequent claims and litigation regarding patent and other property rights. The Company is not currently a party to any claims of this nature. There can be no assurances that third parties will not assert additional claims or initiate litigation against the Company or its customers with respect to existing or future products. In addition, the Company may initiate claims or litigation against third parties for infringement of the Company's proprietary rights or to determine the scope and validity of the proprietary rights of the Company or others. Management of Growth; Dependence on Key Personnel The continued growth of the Company and its subsidiaries has placed, and will continue to place, a significant strain on its administrative, operational and financial resources, and has increased, and will continue to increase, the level of responsibility for both existing and new management personnel. The Company's future success depends in part on the continued service of its key engineering, sales, marketing and executive personnel, including highly skilled semiconductor design personnel. The Company anticipates that any future growth will require it to recruit and hire a number of new personnel in engineering, operations, finance, sales and marketing. Competition for such personnel is intense, and there can be no assurance that the Company can retain and recruit necessary personnel to operate its business and support future growth. The Company's ability to manage its growth successfully also will require the Company to continue to expand and improve its administrative, operational, management and financial systems and controls. Volatility of Stock Price The trading price of the Common Stock has been, and will likely continue to be, subject to wide fluctuations in response to quarterly variations in the Company's operating results, announcements of new products or technological innovations by the Company or its competitors, strategic alliances between the Company and third parties, general market fluctuations and other events and factors. Changes in earnings estimates made by brokerage firms and industry analysts relating to the markets in which the Company does business, or relating to the Company specifically, have in the past resulted in, and could in the future result in, an immediate and adverse effect on the market price of the Common Stock. Acquisitions From time-to-time, the Company expects to make acquisitions of businesses or technologies that are complementary to its business strategy. Such future acquisitions would expose the Company to risks commonly encountered in acquisitions of businesses. Such risks include, among others, difficulty of assimilating the operations, information systems and personnel of the acquired businesses, the potential disruption of the Company's ongoing business; and the inability of management to maximize the financial and strategic position of the Company through successful incorporation of the acquired technologies, employees and customers. There can be no assurance that any potential acquisition will be consummated or, if consummated, that it will not have a material adverse effect on the Company's business, financial condition and results of operations. Acquired In-Process Research and Development Uncertainties that could impede the progress of converting a development project to a developed technology include the availability of financial resources to complete the project, failure of the technology to function properly, continued economic feasibility of developed technologies, customer acceptance, customer demand and customer qualification of such new technology and general competitive conditions in the industry. There can be no assurance that the acquired in-process research and development projects associated with the acquisitions of Valence and VIP will be successfully completed and commercially introduced. 17 18 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 Asian subsidiaries. Translation adjustments resulting from the process of translating foreign currency financial statements into U.S. dollars were not significant in Fiscal 1999 and for the quarter ended March 31, 2000, due to the fact that the value of the Hong Kong dollar is currently pegged to the U.S. dollar, and the exchange rate remained constant throughout such periods. Under the current circumstances, the Company believes that the foreign currency market risk is not material. The Company actively monitors its foreign exchange exposure and, should circumstances change, intends to implement strategies to reduce its risk at such time that it determines that the benefits of such strategies outweigh the associated costs. There can be no assurance that management's efforts to reduce foreign exchange exposure will be successful. INTEREST RATES The Company's credit facilities bear interest based on the lending bank's prime rate or LIBOR plus 0.75%. The interest rate on the balance of $8.0 million outstanding at March 31, 2000 was 6.81%. If interest rates were to increase by 10%, the impact on the Company's consolidated financial statements would be additional interest expense of approximately $13,900 per quarter. 18 19 PART II - OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. SECURITIES SOLD On March 8, 2000, the Company entered into a technology and marketing alliance with Microsoft Corporation ("Microsoft"). In connection with this transaction, on March 9, 2000, Microsoft purchased 290,529 shares of the Company's common stock for $17.21 per share or $5,000,000 in the aggregate. In connection with this transaction, the Company and its wholly-owned subsidiary, SRSWOWcast.com, Inc. each granted warrants to purchase shares of their common stock to Microsoft. The Company issued to Microsoft on March 8, 2000 a three-year warrant to purchase up to 200,000 shares of the common stock of the Company at an exercise price per share of $17.21, subject to adjustment as set forth in the SRS Labs, Inc. Common Stock Purchase Warrant Agreement dated March 8, 2000. SRSWOWcast.com, Inc. also issued to Microsoft on March 8, 2000 a three-year warrant to purchase up to 1,250,000 shares of its common stock at a price per share equal to the lesser of (a) $4.00 or (b) the price per share in a future financing, as described in the SRSWOWcast.com, Inc. Common Stock Purchase Warrant Agreement dated March 8, 2000, subject to adjustment as set forth in such Warrant Agreement. The above-referenced securities were issued in reliance on the private offering exemption set forth in Section 4(2) of the Securities Act of 1933, as amended, on the basis that they were issued under circumstances not involving a public offering. USE OF PROCEEDS The effective date of the Company's initial public offering of its Common Stock was August 8, 1996 (SEC Registration No. 333-4974-LA). During the first quarter of Fiscal 2000, the Company utilized approximately $1,528,071 of the $22,052,955 net offering proceeds for working capital. The table below sets forth at March 31, 2000, the amount of the net offering proceeds used for the purposes noted in the table.
Direct or indirect payments to directors, Officers, general partners of the issuer or their associates, to persons owning ten percent or more of any class of equity securities Direct or indirect of the issuer, and to affiliates of the issuer Payments to others ----------------------------------------------- ------------------ Construction of plant, building and Facilities -- -- Purchase and installation of machinery and Equipment -- -- Purchase of real estate -- -- Acquisition of other business(es)/assets -- $8,394,222(1) Repayment of indebtedness -- -- Working capital -- $5,844,071 Temporary investment (cash and municipal bonds) -- $7,814,662
- --------------------- (1) During the second quarter of Fiscal 1998, the Company utilized $500,000 of the net offering proceeds as part of the consideration to acquire assets related to the Circle Surround technology. During the first quarter of Fiscal 1998, the Company utilized an aggregate of $7,894,222 in connection with two other acquisitions. 19 20 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 Common Stock Purchase Agreement dated as of March 8, 2000 by and among SRS Labs, Inc., SRSWOWcast.com, Inc. and Microsoft Corporation. 10.2 Common Stock Purchase Warrant dated March 8, 2000 granted to Microsoft Corporation by SRS Labs, Inc. 10.3 Common Stock Purchase Warrant dated March 8, 2000 granted to Microsoft Corporation by SRSWOWcast.com, Inc. 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, 2000. 20 21 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 15, 2000 By: /s/ JOHN AUYEUNG ---------------------------------- John AuYueng Executive Vice President, Chief Operating Officer, Chief Financial Officer, Treasurer and Secretary (Authorized Signatory and Principal Financial Officer) 21 22 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION ------- ----------- 10.1 Common Stock Purchase Agreement dated as of March 8, 2000 by and among SRS Labs, Inc., SRSWOWcast.com, Inc. and Microsoft Corporation. 10.2 Common Stock Purchase Warrant dated March 8, 2000 granted to Microsoft Corporation by SRS Labs, Inc. 10.3 Common Stock Purchase Warrant dated March 8, 2000 granted to Microsoft Corporation by SRSWOWcast.com, Inc. 27 Financial Data Schedule. EX-10.1 2 EXHIBIT 10.1 1 EXHIBIT 10.1 COMMON STOCK PURCHASE AGREEMENT This COMMON STOCK PURCHASE AGREEMENT (this "AGREEMENT") is made as of this 8th day of March, 2000 between SRS Labs, Inc., a Delaware corporation (the "COMPANY"), its wholly owned subsidiary, SRS WOWcast.com, Inc., a Delaware corporation ("SUB"), and Microsoft Corporation, a Washington corporation (the "PURCHASER"). RECITALS WHEREAS, concurrently with this Agreement the Company and the Purchaser are entering into a License Agreement. WHEREAS, concurrently with this Agreement the Company and Sub are issuing to Purchaser warrants to acquire their common stock, respectively (the "WARRANTS"); and WHEREAS, in connection with the Warrants and the License Agreement, the Company desires to sell to the Purchaser, and the Purchaser desires to purchase from the Company, shares of the Company's common stock, $.001 par value per share (the "COMMON STOCK"), on the terms and conditions set forth in this Agreement; NOW, THEREFORE, in consideration of the foregoing recitals, the mutual promises hereinafter set forth, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: SECTION 1 AGREEMENT TO PURCHASE AND SELL COMMON STOCK AND WARRANTS 1.1 AGREEMENT TO PURCHASE AND SELL COMMON STOCK. Upon the terms and subject to the conditions of this Agreement, the Company hereby agrees to sell to the Purchaser at the Closing (as defined below), and the Purchaser agrees to purchase from the Company at the Closing, shares of its Common Stock, (the "SHARES") for an aggregate purchase price of $5,000,004 at a price per Share equal to $17.21, or 290,529 shares. 1.2 AGREEMENT TO GRANT A COMPANY WARRANT AND A SUB WARRANT. 1.2.1 AGREEMENT TO GRANT THE COMPANY WARRANT. Upon the terms and conditions of this Agreement and the Warrant Agreement by and between the Company and the Purchaser, the Company agrees to grant to the Purchaser and the Purchaser agrees to accept, a Warrant in the form attached hereto as Exhibit A (the "COMPANY WARRANT"). 1.2.2 AGREEMENT TO GRANT THE SUB WARRANT. Upon the terms and conditions of this Agreement and the Warrant Agreement by and between Sub and the Purchaser, Sub agrees to grant to the Purchaser and the Purchaser agrees to accept, a Warrant in the form attached hereto as Exhibit B (the "SUB WARRANT"). 2 SECTION 2 CLOSING DATE; DELIVERY 2.1 CLOSING DATE. The Closing of the purchase and sale of the Shares hereunder (the "CLOSING") shall be held at the offices of Paul, Hastings, Janofsky & Walker, LLP in Costa Mesa, California one (1) business day after the execution of this Agreement or at such time as the Company and the Purchaser mutually agree (the date of the Closing being hereinafter referred to as the "CLOSING DATE"). 2.2 DELIVERY. At the Closing, the Company will deliver to the Purchaser a certificate or certificates representing the Shares against payment of the aggregate purchase price of $5,000,004 by wire transfer of immediately available funds to an account designated by the Company. The certificate or certificates representing the Shares shall be subject to a legend restricting transfer under the Securities Act of 1933, as amended (the "SECURITIES ACT") and applicable state securities laws and referring to restrictions on transfer herein, such legend to be substantially as follows: THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY STATE SECURITIES LAW. NO TRANSFER OF THE SHARES REPRESENTED BY THIS CERTIFICATE SHALL BE VALID OR EFFECTIVE UNLESS (A) SUCH TRANSFER IS MADE PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT AND IN COMPLIANCE WITH ANY APPLICABLE STATE SECURITIES LAWS, OR (B) THE HOLDER SHALL DELIVER TO THE COMPANY AN OPINION OF COUNSEL IN FORM AND SUBSTANCE REASONABLY ACCEPTABLE TO THE COMPANY THAT SUCH PROPOSED TRANSFER IS EXEMPT FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND OF ANY APPLICABLE STATE SECURITIES LAWS. The Company agrees to remove the legend set forth in the preceding paragraph upon receipt of an opinion of counsel in form and substance reasonably satisfactory to the Company that the Shares are eligible for transfer without registration or qualification under the Securities Act and under any applicable state securities laws. SECTION 3 REPRESENTATIONS AND WARRANTIES OF THE COMPANY AND SUB The Company and Sub hereby represent and warrant to the Purchaser as follows: 3.1 ORGANIZATION. The Company and Sub are corporations duly organized and validly existing under the laws of the State of Delaware and each is in good standing under such laws. The Company and Sub have the requisite corporate power to own and operate their properties and assets, and to carry on their business as presently conducted and as proposed to be conducted. -2- 3 3.2 AUTHORIZATION. All corporate action on the part of the Company necessary for the authorization, execution, delivery and performance of this Agreement, the LicenseAgreement and the Warrant issued by the Company, the authorization, sale, issuance and delivery of the Shares hereunder, and the performance of the Company's obligations hereunder and under said agreements has been taken. This Agreement, the License Agreement and the Warrant issued by the Company constitute legal, valid and binding obligations of the Company enforceable in accordance with their respective terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and rules of law governing specific performance, injunctive relief or other equitable remedies. Upon their issuance and delivery pursuant to this Agreement, the Shares will be validly issued, fully paid and nonassessable. The issuance and sale of the Shares will not give rise to any preemptive rights or rights of first refusal on behalf of any person in existence on the date hereof. All corporate action on the part of Sub necessary for the authorization, execution, delivery and performance of this Agreement and the Warrant issued by Sub, the authorization, sale, issuance and delivery of the shares of Sub issuable upon exercise of the Warrant issued thereby, and the performance of Sub's obligations hereunder and under said Warrant has been taken. This Agreement and the Warrant issued by Sub constitute legal, valid and binding obligations of Sub enforceable in accordance with their respective terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and rules of law governing specific performance, injunctive relief or other equitable remedies. Upon their issuance and delivery pursuant to the Warrant issued by Sub, the shares of common stock of Sub issuable under such Warrant will be validly issued, fully paid and nonassessable. The issuance and sale of the shares of Sub issuable under its Warrant will not give rise to any preemptive rights or rights of first refusal on behalf of any person in existence on the date hereof. 3.3 NO CONFLICT. The execution and delivery of this Agreement, the License Agreement and the Warrants do not, and the consummation of the transactions contemplated hereby and thereby will not, conflict with, or result in any violation of, or default (with or without notice or lapse of time, or both), or give rise to a right of termination, cancellation or acceleration of any obligation or to a loss of a material benefit under any provision of the Certificate of Incorporation or Bylaws of the Company or Sub or any mortgage, indenture, lease or other agreement or instrument, permit, concession, franchise, license, judgment, order, decree, statute, law, ordinance, rule or regulation applicable to the Company or Sub, their properties or assets, the effect of which could have a material effect on the Company or Sub or their subsidiaries, taken as a whole, or materially impair or restrict the Company's or Sub's power to perform its obligations as contemplated under said agreement. 3.4 SEC DOCUMENTS. The Company has filed all required reports, schedules, forms, statements and other documents with the Securities and Exchange Commission (the "SEC") since August 8, 1996 (the "SEC DOCUMENTS"). As of their respective dates, the SEC Documents complied in all material respects with requirements of the Securities Act or the Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT"), as the case may be and the rules and regulations of the SEC promulgated thereunder applicable to such SEC Documents, and none of the SEC Documents contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. Except to the extent that information contained in any SEC Document has been revised or superseded by a later Filed SEC Document (as -3- 4 defined below), none of the SEC Documents contains any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary in order to make the statements therein not misleading. The financial statements of the Company included in the SEC Documents comply as to form in all material respects with applicable accounting requirements and the published rules and regulations of the SEC with respect thereto, have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") (except, in the case of unaudited statements as permitted by Form 10Q of the SEC) applied on a consistent basis during the periods involved (except as may be indicated in the notes thereto) and fairly present the consolidated financial position of the Company and its consolidated subsidiaries as of the dates thereof and the consolidated results of their operation and cashflows for the periods then ending in accordance with GAAP (subject, in the case of the unaudited statements, to normal year end audit adjustments). Except as set forth in the Filed SEC Documents (as defined below), neither the Company nor any of its subsidiaries has any liabilities or obligations of any nature (whether accrued, absolute, contingent or otherwise) required by GAAP to be set forth on a consolidated balance sheet of the Company and its consolidated subsidiaries or in the notes thereto and which can reasonably be expected to have a material adverse effect on the Company and its subsidiaries taken as a whole. 3.5 ABSENCE OF CERTAIN CHANGES OR EVENTS. Except as disclosed in the SEC Documents filed and publicly available prior to the date of this Agreement (the "FILED SEC DOCUMENTS"), since the date of the most recent audited financial statements included in the Filed SEC Documents, Company has conducted its business only in the ordinary course, and there has not been (i) any declaration, setting aside or payment of any dividend or distribution (whether in cash, stock or property) with respect to any of the Company's capital stock, (ii) any split, combination or reclassification of any of its capital stock or any issuance or the authorization of any issuance of any other securities in respect of, in lieu of or in substitution for shares of its capital stock, (iii) any damage, destruction or loss, whether or not covered by insurance, that has or is likely to have a material adverse effect on the Company and its subsidiaries taken as a whole, or (iv) any change in accounting methods, principles or practices by the Company materially affecting its assets, liabilities, or business, except insofar as may have been required by a change in GAAP. 3.6 GOVERNMENTAL CONSENT, ETC. No consent, approval or authorization of or designation, declaration or filing with any governmental authority on the part of the Company or Sub is required in connection with the valid execution and delivery of this Agreement, or the offer, sale or issuance of the Shares or the shares of Sub issuable under its Warrant, or the consummation of any other transaction contemplated hereby, except such filings as may be required to be made with the SEC, the National Association of Securities Dealers, Inc. and applicable state securities laws. 3.7 LITIGATION. Except as is disclosed in the Filed SEC Documents, there is no suit, action or proceeding pending or affecting the Company or any of its subsidiaries that, individually or in the aggregate, could (i) have a material adverse effect on the Company and its subsidiaries taken as a whole or Sub, (ii) impair the ability of the Company or Sub to perform its obligations under this Agreement, the License Agreement and the Warrants, or (iii) prevent the consummation of any of the transactions contemplated by said agreements, nor is there any judgment, decree, injunction, rule or order of any governmental entity or arbitrator outstanding against the Company or any of its subsidiaries or Sub having, or which, insofar as reasonably can be foreseen in the future have, any such effect. -4- 5 SECTION 4 REPRESENTATIONS AND WARRANTIES OF THE PURCHASER The Purchaser hereby represents and warrants to the Company as follows: 4.1 ORGANIZATION. The Purchaser is a corporation duly organized and validly existing and in good standing under the laws of the State of Washington, with all requisite corporate power and authority to own, lease and operate its properties and to conduct its business as presently conducted. 4.2 AUTHORITY. All corporate action on the part of the Purchaser necessary for the authorization, execution, delivery and performance of this Agreement and the License Agreement, and the performance of the Purchaser's obligations hereunder and under the License Agreement, by the Purchaser has been taken. This Agreement and the License Agreement have been duly executed and delivered by the Purchaser and constitute legal, valid and binding obligations of the Purchaser, enforceable in accordance with their respective terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and rules of law governing specific performance, injunctive relief or other equitable remedies. The execution and delivery of said Agreements do not, and the consummation of the transactions contemplated hereby and thereby will not, conflict with or result in any violation of any obligation under any provision of the Articles of Incorporation or Bylaws of the Purchaser or any judgment, order, decree, statute, law, ordinance, rule or regulation applicable to the Purchaser. 4.3 INVESTMENT. The Purchaser is acquiring the Shares, the Company Warrant and the Sub Warrant, and, upon exercise of the Company Warrant, will acquire the shares of Common Stock issuable upon exercise of the Company Warrant, and, upon exercise of the Sub Warrant, will acquire the shares of common stock of Sub, for investment for its own account, not as a nominee or agent, and not with a view to, or for resale in connection with, any distribution thereof. The Purchaser understands that the Shares, the Company Warrant, the Sub Warrant, the share of Common Stock issuable upon exercise of the Company Warrant and the shares of common stock of Sub issuable on exercise of the Sub Warrant, have not been registered under the Securities Act or registered or qualified under any applicable securities laws, by reason of a specific exemption from the registration provisions of the Securities Act or applicable state securities law which depends upon, among other things, the bona fide nature of the investment intent and the accuracy of the Purchaser's representations and warranties contained herein. 4.4 DISCLOSURE OF INFORMATION. The Purchaser has had full access to all information it considers necessary or appropriate to make an informed investment decision with respect to the Shares, the Company Warrant, the Sub Warrant, the shares of Common Stock issuable upon the exercise of the Company Warrant and the shares of common stock of Sub issuable upon exercise of the Sub Warrant to be purchased or acquired by the Purchaser under this Agreement. The Purchaser further has had an opportunity to ask questions and receive answers from the Company and Sub regarding the terms and conditions of the offering of the Shares and the shares of common stock of Sub and to obtain additional information necessary to verify any information furnished to the Purchaser or to which the Purchaser had access. -5- 6 4.5 INVESTMENT EXPERIENCE. The Purchaser understands that the purchase of the Shares involves substantial risk. The Purchaser has experience as an investor in securities of companies and acknowledges that it is able to fend for itself, can bear the economic risk of its investment in the Shares and has such knowledge and experience in financial or business matters that it is capable of evaluating the merits and risks of this investment in the Shares and protecting its own interests in connection with this investment. 4.6 ACCREDITED INVESTOR STATUS. The Purchaser is an "ACCREDITED INVESTOR" within the meaning of Regulation D promulgated under the Securities Act. 4.7 RESTRICTED SECURITIES. The Purchaser understands that (i) the Shares to be purchased by the Purchaser hereunder and the shares of Common Stock purchased pursuant to the exercise of the Company Warrant, (ii) the shares of common stock of Sub to be purchased pursuant to the exercise of the Sub Warrant and (iii) the Company Warrant and the Sub Warrant are characterized as "RESTRICTED SECURITIES" under the Securities Act inasmuch as they are being acquired from the Company in a transaction not involving a public offering and that under the Securities Act and applicable regulations thereunder such securities may be resold without registration under the Securities Act only in certain limited circumstances. The Purchaser is familiar with Rule 144 of the SEC, as presently in effect, and understands the resale limitations imposed thereby and by the Securities Act. The Purchaser understands that the Company and Sub each is under no obligation to register or qualify under Federal or state securities law any of such securities. SECTION 5 CONDITIONS TO OBLIGATION OF THE PURCHASER The Purchaser's obligation to purchase the Shares at the Closing is, at the option of the Purchaser, which may waive any such conditions, subject to the fulfillment on or prior to the Closing Date of the following conditions: 5.1 REPRESENTATIONS AND WARRANTIES. Each of the representations and warranties of the Company contained in Section 3 will be true and correct on and as of the date hereof and on and as of the Closing Date with the same effect as though such representations and warranties had been made as of the Closing Date. The Purchaser shall have received a certificate signed by a duly authorized officer of Company to such effect on the Closing Date. 5.2 COVENANTS. All covenants, agreements and conditions contained in this Agreement to be performed by the Company on or prior to the Closing Date shall have been performed or complied with in all material respects. The Purchaser shall have received a certificate signed by a duly authorized officer of Company to such effect on the Closing Date. 5.3 NO ORDER PENDING. There shall not then be in effect any order enjoining or restraining the transactions contemplated by this Agreement. 5.4 NO LAW PROHIBITING OR RESTRICTING SALE OF THE SHARES. There shall not be in effect any law, rule or regulation prohibiting or restricting the sale of the Shares, or requiring any consent -6- 7 or approval of any Person which shall not have been obtained to issue the Shares with full benefits afforded the Common Stock. 5.5 DUE DILIGENCE. Purchaser shall have complete its due diligence inquiry regarding the Company and Sub to its reasonable satisfaction. 5.6 LICENSE AGREEMENT, WARRANTS. The Company shall have executed and delivered the License Agreement and the Company Warrant and Sub shall have executed and delivered the Sub Warrant. 5.7 CONSENTS. All third-party consents, approvals, assignments, waivers, authorizations or other certificates required for the execution of the Agreement and the transactions contemplated hereby or reasonably deemed necessary by Purchaser's legal counsel in form and substance reasonably satisfactory to the Purchaser shall have been obtained. SECTION 6 CONDITIONS TO OBLIGATION OF THE COMPANY AND SUB The Company's obligation to sell and issue the Shares and issue the Company Warrant and Sub's obligation to issue its Warrant at the Closing are, at the option of the Company, which may waive any such conditions, subject to the fulfillment on or prior to the Closing Date of the following conditions: 6.1 REPRESENTATIONS AND WARRANTIES. The representations and warranties of the Purchaser contained in Section 4 will be true and correct on and as of the date hereof and on and as of the Closing Date with the same effect as though such representations and warranties had been made as of the Closing Date. The Company shall have received a certificate signed by a duly authorized officer of the Purchaser to such effect on the Closing Date. 6.2 COVENANTS. All covenants, agreements and conditions contained in this Agreement to be performed by the Purchaser on or prior to the Closing Date shall have been performed or complied with in all material respects. The Company shall have received a certificate signed by a duly authorized officer of the Purchaser to such effect on the Closing Date. 6.3 NO ORDER PENDING. There shall not then be in effect any order enjoining or restraining the transactions contemplated by this Agreement. 6.4 NO LAW PROHIBITING OR RESTRICTING THE SALE OF THE SHARES. There shall not be in effect any law, rule or regulation prohibiting or restricting the sale of the Shares, or requiring any consent or approval of any person which shall not have been obtained to (i) issue the Shares with full benefits afforded the Common Stock, (ii) issue the shares of common stock of Sub pursuant to the Sub Warrant with full benefits afforded the shares of common stock of Sub or (iii) grant the Company Warrant or the Sub Warrant (except as otherwise provided in this Agreement). -7- 8 6.5 LICENSE AGREEMENT. The Purchaser shall have executed and delivered the License Agreement. 6.8 CONSENTS. All third-party consents, approvals, assignments, waivers, authorizations or other certificates required for the execution of the Agreement and the transactions contemplated hereby shall have been obtained. SECTION 7 MISCELLANEOUS 7.1 BEST EFFORTS. Each of the Company, the Purchaser and Sub shall use its best efforts to take all actions required under any law, rule or regulation adopted subsequent to the date hereto to ensure that the conditions to the Closing set forth herein are satisfied on or before the Closing Date. 7.2 LAW GOVERNING. This Agreement shall be construed and enforced in accordance with, and governed by, the laws of the State of Delaware (not including the choice of law rules thereof) regardless of the jurisdiction of creation or domicile of the Company or its successors or of the holder at any time hereof. The exclusive jurisdiction for all actions and proceedings arising out of or relating to this Agreement which are not subject to arbitration pursuant to Section 7.12 shall be in any Delaware state or federal court thereof. 7.3 SURVIVAL. The representations and warranties in Sections 3 and 4 of this Agreement shall survive the Closing. 7.4 SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and assigns. 7.5 ENTIRE AGREEMENT; AMENDMENT. This Agreement and the other documents delivered or contemplated by this Agreement constitute the full and entire understanding and agreement between the parties with regard to the subject matter hereof and thereof and supersede all prior agreements and understandings among the parties relating to the subject matter hereof. Neither this Agreement nor any term of such other documents delivered or contemplated by this Agreement may be amended, waived, discharged or terminated other than by a written instrument signed by the party against whom enforcement of any such amendment, waiver, discharge or termination is sought. 7.6 NOTICES. All notices, requests, demands or other communications which are required or may be given pursuant to the terms of this Agreement shall be in writing and shall be deemed to have been duly given: (i) on the date of delivery if personally delivered by hand, (ii) upon the third day after such notice is (a) deposited in the United States mail, if mailed by registered or certified mail, postage prepaid, return receipt requested, or (b) sent by a nationally recognized overnight express courier, or (iii) by facsimile upon written confirmation (other than the automatic confirmation that is received -8- 9 from the recipient's facsimile machine) of receipt by the recipient of such notice: (a) if to the Company or Sub, to them at: SRS Labs, Inc. 2909 Daimler Street Santa Ana, California 92705 Facsimile Number (949) 852-1099 Attention: Chief Operating Officer with a copy to: John F. Della Grotta, Esq. Paul, Hastings, Janofsky & Walker LLP Seventeenth Floor 695 Town Center Drive Costa Mesa, California 92626-1924 Facsimile Number: (714) 979-1921 (b) if to the Purchaser, to it at: Microsoft Corporation One Microsoft Way Building 8 North Office 2211 Redmond, WA 98052 Facsimile Number: (425) 936-7329 Attention: Chief Financial Officer with a copy addressed as set forth above but to the attention of General Counsel, Finance and Operations, and with an additional copy to: Richard B. Dodd, Esq. Preston Gates & Ellis LLP 5000 Columbia Center 701 Fifth Avenue Seattle, WA 98104-7078 Facsimile Number (206) 623-7022 7.7 BROKERS. (a) Neither the Company nor Sub has engaged, consented to or authorized any broker, finder or intermediary to act on its behalf, directly or indirectly, as a broker, finder or intermediary in connection with the transactions contemplated by this Agreement. The Company and Sub hereby agree to indemnify and hold harmless the Purchaser from and against all fees, -9- 10 commissions or other payments owing to any party acting on behalf of the Company or Sub hereunder. (b) The Purchaser has not engaged, consented to or authorized any broker, finder or intermediary to act on its behalf, directly or indirectly, as a broker, finder or intermediary in connection with the transactions contemplated by this Agreement. The Purchaser hereby agrees to indemnify and hold harmless the Company and Sub from and against all fees, commissions or other payments owing to any party acting on behalf of the Purchaser hereunder. 7.8 FEES, COSTS AND EXPENSES. All fees, costs and expenses (including attorneys' fees and expenses) incurred by either party hereto in connection with the preparation, negotiation and execution of this Agreement, the License Agreement, the Company Warrant and the Sub Warrant and the consummation of the transactions contemplated hereby and thereby, shall be the sole and exclusive responsibility of such party. 7.9 SEVERABILITY. If any term, provision, covenant or restriction of this Agreement, the License Agreement, the Company Warrant or the Sub Warrant (or any such agreement in it entirety) is held by a court of competent jurisdiction to be invalid, void or unenforceable, the remainder of the terms, provisions, covenants and restriction of this Agreement (or such other agreements) shall remain in full force and effect and shall in no way be affected, impaired or invalidated. 7.10 FURTHER ASSURANCES. The parties will from time to time subsequent to the Closing, at the respective parties' request and without further consideration, execute and deliver such other documents and instruments, as such requesting party may reasonably request in order to more fully carry out the intentions of the parties under this Agreement and under the documents contemplated by this Agreement (including, without limitation, the License Agreement, the Company Warrant and the Sub Warrant). 7.11 INITIAL PUBLIC ANNOUNCEMENT. The Company and the Purchaser shall agree on the form and content of the initial public announcement which shall be made concerning this Agreement, the License Agreement, the Company Warrants and the Sub Warrant and the transactions contemplated hereby and thereby, and neither the Company nor the Purchaser shall make such public announcement without the consent of the other, except as required by law. It is contemplated that no announcement will be made prior to the execution of this Agreement. 7.12 ARBITRATION. In the event a dispute occurs with respect to any claim, dispute or other matter arising out of or relating to this Agreement, the parties hereto will promptly attempt to settle such dispute through consultation and negotiation in good faith and in a spirit of mutual cooperation. If agreement is reached concerning the resolution of such dispute, then such agreement shall be final, conclusive and binding on the parties hereto. If, on or before the tenth day after written notice of such dispute is given by one party to the other parties, such dispute has not been resolved by the agreement of all the parties, such dispute shall be settled by an expedited arbitration proceeding conducted in accordance with the then-current CPR Non-Administered Arbitration Rules and the Federal Rules of Evidence in Wilmington, Delaware by a panel of three arbitrators who shall have experience relating to the dispute or matter to be -10- 11 resolved. Each of the Company and the holder shall select an arbitrator, and those two arbitrators shall select a third arbitrator. The parties hereto shall provide such arbitrators with such information as may be reasonably requested in connection with the arbitration of such dispute and shall otherwise cooperate with each other and such arbitrators in good faith and with the goal of resolving such dispute as promptly as reasonably practicable. The arbitrators' decision and award with respect to the dispute referred to shall be final and binding on the parties hereto and may be entered in any court with jurisdiction, and the parties hereto shall abide by such decision and award. The cost of the arbitration proceeding and any proceeding in court to confirm or to vacate any arbitration award, as applicable (including, without limitation, attorneys' fees and costs), shall be borne by the unsuccessful party (if any) and shall be awarded as part of the arbitrators' award; provided however, that if the arbitrators do not find one party to be unsuccessful then the cost of the arbitral proceeding shall be paid equally by the parties hereto. [the remainder of this page has been intentionally omitted] -11- 12 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective authorized officers as of the date set forth above. SRS LABS, INC., a Delaware corporation By: /s/ THOMAS C. K. YUEN ------------------------------------ Name: Thomas C. K. Yuen Title: Chairman of the Board and Chief Executive Officer SRS WOWCAST, INC., a Delaware corporation By: /s/ THOMAS C. K. YUEN ------------------------------------ Name: Thomas C. K. Yuen Title: Chairman of the Board and Chief Executive Officer MICROSOFT CORPORATION, a Washington corporation By: /s/ AMAR NEHRU ------------------------------------ Name: Amar Nehru Title: Corporate Development Vice President -12- EX-10.2 3 EXHIBIT 10.2 1 EXHIBIT 10.2 NEITHER THIS WARRANT NOR ANY OF THE SECURITIES ISSUABLE UPON EXERCISE HEREOF HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY STATE SECURITIES LAW. NO TRANSFER OF THIS WARRANT OR OF THE SECURITIES ISSUABLE UPON EXERCISE HEREOF SHALL BE VALID OR EFFECTIVE UNLESS (A) SUCH TRANSFER IS MADE PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT AND IN COMPLIANCE WITH ANY APPLICABLE STATE SECURITIES LAW, OR (B) THE HOLDER SHALL DELIVER TO THE COMPANY AN OPINION OF COUNSEL IN FORM AND SUBSTANCE REASONABLY ACCEPTABLE TO THE COMPANY THAT SUCH TRANSFER IS EXEMPT FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND OF ANY APPLICABLE STATE SECURITIES LAW. WARRANT NO. M-1 MARCH 8, 2000 SRS LABS, INC. COMMON STOCK PURCHASE WARRANT SRS Labs, Inc., a Delaware corporation (the "COMPANY"), hereby grants to Microsoft Corporation, a Washington corporation ("MICROSOFT"), or its permitted assigns or transferees (Microsoft and each such permitted assignee or transferee being referred to herein as a "HOLDER" and collectively as the "HOLDERS") the right to purchase, at any time after the Original Issue Date (as defined below) and from time to time on and after the date hereof until the Expiration Date (as defined below), up to 200,000 fully paid and non-assessable shares of Common Stock of the Company, $.001 par value per share (the "COMMON STOCK"), on the terms and subject to the conditions set forth below, provided that, (1) in the event that holder has exercised its right to acquire common shares of SRS WOWcast.com, Inc. ("SUB") pursuant to the warrant issued by Sub of even date herewith (the "SUB WARRANT"), this Common Stock Purchase Warrant (hereinafter, this "WARRANT") shall be terminated and become void and (2) in the event that the Company and Sub provide certification reasonably satisfactory to holder that Sub has obtained financing in a single transaction or series of related transactions with a party or parties other than the Company or Microsoft in an amount in excess of $ 5,000,000 through the sale of equity securities of Sub or debt securities convertible into equity securities of Sub, this Warrant shall be exercisable for up to 100,000 fully paid and non-assessable shares of Common Stock of the Company; provided further, that if the condition in this clause (2) is satisfied than the condition in clause (1) that the Sub Warrant not have been previously exercised shall no longer apply. This Warrant was originally issued on March 8, 2000 (the "ORIGINAL ISSUE DATE"). This Warrant shall expire and be of no further force or effect on the date (the "EXPIRATION DATE") three (3) years from the Original Issue Date. Appropriate provisions shall be made in accordance with Section 3.2 below so that holder shall have the right to receive a similar 2 warrant for the remainder of such term in the event of a merger, consolidation, reorganization or similar transaction. 1. EXERCISE OF WARRANT. 1.1 EXERCISE AND VESTING. Subject to adjustment as hereinafter provided, the rights represented by this Warrant are exercisable on and after the Original Issue Date until the Expiration Date, at a price per share (the "EXERCISE PRICE") of the Common Stock issuable hereunder (hereinafter, "WARRANT SHARES") equal to the price per share of Common Stock paid by holder in its purchase of Common Stock pursuant to the Common Stock Purchase Agreement among the Company, holder and Sub dated March 8, 2000. The Exercise Price shall be payable in cash, by certified or official bank check or wire transfer as hereinafter provided or in accordance with Section 1.2 below. Subject to termination and reduction in the number of Warrant Shares for which this Warrant is exercisable pursuant to the first paragraph of this Warrant, this Warrant is fully vested. Upon surrender of this Warrant with a duly executed Notice of Exercise in the form of Annex A hereto, together with payment, if applicable, of the Exercise Price for the Warrant Shares purchased, at the Company's principal executive offices presently located at 2909 Daimler Street, Santa Ana, CA 92705, or at such other address as the Company shall have advised the holder in writing (the "DESIGNATED OFFICE"), the holder shall be entitled to receive a certificate or certificates for the Warrant Shares so purchased. The Company agrees that the Warrant Shares shall be deemed to have been issued to the holder as of the close of business on the date on which this Warrant shall have been surrendered together with the Notice of Exercise and payment, if applicable, for such Warrant Shares. 1.2 RIGHT TO CONVERT. (a) Subject to the provisions of Section 1.1, at any time or from time on or prior to the Expiration Date, the holder of this Warrant shall also have the right to convert this Warrant or any portion thereof (the "CONVERSION RIGHT"), without payment by the holder of this Warrant of the Exercise Price in cash or any other consideration (other than the surrender of rights to receive Warrant Shares hereunder), into shares of Common Stock as provided in this Section 1.2. Upon exercise of the Conversion Right with respect to a particular number of Warrant Shares (the "CONVERTED WARRANT SHARES"), the Company shall deliver to the holder of this Warrant (without payment by the holder of this Warrant of the Exercise Price in cash or any other consideration (other than the surrender of rights to receive Warrant Shares hereunder)) that number of shares of Common Stock computed using the following formula: Y(A-B) X = ------ A Where X equals the number of Shares to be delivered upon exercise in accordance with this Section 1.2 Y equals the number of Converted Warrant Shares -2- 3 A equals the Current Market Price, as defined below, and B equals the applicable Exercise Price No fractional Warrant Shares shall be issuable upon exercise of the Conversion Right, and if the number of Warrant Shares to be issued determined in accordance with the following formula is other than a whole number, the Company shall pay to the holder of this Warrant an amount in cash equal to the Current Market Price of the resulting fractional Warrant Share on the Conversion Date. (b) The Conversion Right may be exercised by the holder of this Warrant by the surrender of this Warrant as provided in Section 1.1, together with a written statement specifying that the holder of this Warrant thereby intends to exercise the Conversion Right and indicating the number of Converted Warrant Shares which are covered by the exercise of the Conversion Right. Such conversion shall be effective upon receipt by the Corporation of this Warrant, together with the aforesaid written statement, or on such later date as is specified therein (the "CONVERSION DATE"). The Corporation shall issue to the holder of this Warrant as of the Conversion Date a certificate for the Warrant Shares issuable upon exercise of the Conversion Right and, if applicable, a new warrant of like tenor evidencing the balance of the Warrant Shares remaining subject to this Warrant. (c) The term "CURRENT MARKET PRICE" for the Common Stock as of a specified date shall mean: (i) if the Common Stock is publicly traded on such date, the average closing bid price per share over the preceding 5 trading days as reported on the principal stock exchange or quotation system on which the Common Stock is listed or quoted; or (ii) if the Common Stock is not publicly traded on such date, such value as shall be determined in good faith by the Company's Board of Directors, provided that if such value is not acceptable to the holder, the Company and the holder agree to submit such determination to binding arbitration pursuant to Section 12. -3- 4 2. TRANSFER; ISSUANCE OF STOCK CERTIFICATES; RESTRICTIVE LEGENDS. 2.1. TRANSFER. Subject to compliance with the restrictions on transfer set forth in this Section 2, each transfer of this Warrant and all rights hereunder, in whole or in part, shall be registered on the books of the Company to be maintained for such purpose, upon surrender of this Warrant at the Designated Office, together with a written assignment of this Warrant in the form of Annex B hereto duly executed by the holder or its agent or attorney. Upon such surrender and delivery, the Company shall execute and deliver a new Warrant or Warrants in the name of the assignee or assignees and in the denominations specified in such instrument of assignment, and shall issue to the assignor a new Warrant evidencing the portion of this Warrant not so assigned, if any. A Warrant, if properly assigned in compliance with the provisions hereof, may be exercised by the new holder for the purchase of Warrant Shares without having a new Warrant issued. All Warrants issued upon any assignment of Warrants shall be the valid obligations of the Company, evidencing the same rights, and entitled to the same benefits as the Warrants surrendered upon such registration of transfer or exchange. 2.2 STOCK CERTIFICATES. Certificates for the Warrant Shares shall be delivered to the holder within a reasonable time after the rights represented by this Warrant shall have been exercised pursuant to Section 1, and a new Warrant representing the share, shares or fraction of a share of Common Stock, if any, with respect to which this Warrant shall not then have been exercised shall also be issued to the holder within such time. The issuance of certificates for Warrant Shares upon the exercise of this Warrant shall be made without charge to the holder hereof including, without limitation, any tax that may be payable in respect thereof; provided, however, that the Company shall not be required to pay any income tax to which the holder hereof may be subject in connection with the issuance of this Warrant or the Warrant Shares. 2.3. RESTRICTIVE LEGENDS. (a) Except as otherwise provided in this Section 2, each certificate for Warrant Shares initially issued upon the exercise of this Warrant, and each certificate for Warrant Shares issued to any subsequent transferee of any such certificate, shall be stamped or otherwise imprinted with a legend in substantially the following form: THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY STATE SECURITIES LAW. NO TRANSFER OF THE SHARES REPRESENTED BY THIS CERTIFICATE SHALL BE VALID OR EFFECTIVE UNLESS (A) SUCH TRANSFER IS MADE PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT AND IN COMPLIANCE WITH ANY APPLICABLE STATE SECURITIES LAWS, OR (B) THE HOLDER SHALL DELIVER TO THE COMPANY AN OPINION OF COUNSEL IN FORM AND SUBSTANCE REASONABLY ACCEPTABLE TO THE COMPANY THAT SUCH PROPOSED TRANSFER IS EXEMPT FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND OF ANY APPLICABLE STATE SECURITIES LAWS. -4- 5 (b) Except as otherwise provided in this Section 2, each Warrant shall be stamped or otherwise imprinted with a legend in substantially the following form: NEITHER THIS WARRANT NOR ANY OF THE SECURITIES ISSUABLE UPON EXERCISE HEREOF HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY STATE SECURITIES LAW. NO TRANSFER OF THIS WARRANT OR OF THE SECURITIES ISSUABLE UPON EXERCISE HEREOF SHALL BE VALID OR EFFECTIVE UNLESS (A) SUCH TRANSFER IS MADE PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT AND IN COMPLIANCE WITH ANY APPLICABLE STATE SECURITIES LAW, OR (B) THE HOLDER SHALL DELIVER TO THE COMPANY AN OPINION OF COUNSEL IN FORM AND SUBSTANCE REASONABLY ACCEPTABLE TO THE COMPANY THAT SUCH TRANSFER IS EXEMPT FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND OF ANY APPLICABLE STATE SECURITIES LAW. Notwithstanding the foregoing, the legend requirements of this Section 2.3 shall terminate as to any particular Warrant or Warrant Share when the Company shall have received from the holder thereof an opinion of counsel in form and substance reasonably acceptable to the Company that such legend is not required in order to ensure compliance with the Securities Act and any applicable state securities laws. Whenever the restrictions imposed by this Section 2.3 shall terminate, the holder hereof or of Warrant Shares, as the case may be, shall be entitled to receive from the Company without cost to such holder a new Warrant or certificate for Warrant Shares of like tenor, as the case may be, without such restrictive legend. 3. ADJUSTMENT OF NUMBER OF SHARES; EXERCISE PRICE; NATURE OF SECURITIES ISSUABLE UPON EXERCISE OF WARRANTS. 3.1 EXERCISE PRICE; ADJUSTMENT OF NUMBER OF SHARES. The Exercise Price set forth in Section 1 hereof and the number of shares purchasable hereunder shall be subject to adjustment from time to time as hereinafter provided. 3.2 REORGANIZATION, RECLASSIFICATION, CONSOLIDATION, MERGER OR SALE. If any capital reorganization or reclassification of the capital stock of the Company, or any consolidation or merger of the Company with another entity, or the sale of all or substantially all of the Company's assets to another person or entity (collectively referred to as a "TRANSACTION") shall be effected in such a way that holders of Common Stock shall be entitled to receive stock, securities, cash or assets with respect to or in exchange for Common Stock, then, as a condition of such Transaction, reasonable, lawful and adequate provisions shall be made whereby the holder of this Warrant shall thereafter have the right to purchase and receive upon the basis and upon the terms and conditions specified in this Warrant, upon exercise of this Warrant and in lieu of the Warrant Shares immediately theretofore purchasable and receivable upon the exercise of the rights represented hereby, such number, amount and like kind of shares of stock, securities, cash or assets as may be issued or payable pursuant to the terms of the Transaction with respect to or in exchange for the number of shares of Common Stock immediately theretofore purchasable and receivable upon the exercise of the rights represented hereby as if such shares -5- 6 were outstanding immediately prior to the Transaction, and in any such case appropriate provision shall be made with respect to the rights and interest of the holders to the end that the provisions hereof (including, without limitation, provisions for adjustments of the Exercise Price and of the number of Warrant Shares purchasable and receivable upon the exercise of this Warrant and the remaining term of this Warrant) shall thereafter be applicable, as nearly as may be practicable, in relation to any shares of stock or securities thereafter deliverable upon the exercise hereof. 3.3 STOCK SPLITS, STOCK DIVIDENDS AND REVERSE STOCK SPLITS. In case at any time the Company shall subdivide its outstanding shares of Common Stock into a greater number of shares, or shall declare and pay any stock dividend with respect to its outstanding stock that has the effect of increasing the number of outstanding shares of Common Stock, the Exercise Price in effect immediately prior to such subdivision or stock dividend shall be proportionately reduced and the number of Warrant Shares purchasable pursuant to this Warrant immediately prior to such subdivision or stock dividend shall be proportionately increased, and conversely, in case at any time the Company shall combine its outstanding shares of Common Stock into a smaller number of shares, the Exercise Price in effect immediately prior to such combination shall be proportionately increased and the number of Warrant Shares purchasable upon the exercise of this Warrant immediately prior to such combination shall be proportionately reduced. 3.4 ISSUANCE OF ADDITIONAL SHARES OF COMMON STOCK. If at any time prior to the Expiration Date the Company shall issue any Additional Shares of Common Stock for a consideration per share (the "SUBSEQUENT ISSUE PRICE") less than the Exercise Price as in effect immediately prior to such issuance, the Exercise Price shall be reduced to the price calculated by dividing (i) an amount equal to the sum of (x) the number of shares of Common Stock outstanding immediately prior to such issuance multiplied by the Exercise Price then in effect plus (y) the aggregate consideration, if any, received by the Company in connection with such issuance by (ii) the total number of shares of Common Stock outstanding immediately after such issuance. -6- 7 The foregoing is illustrated by the following formula: NEP = ((SOB*OEP) + (SI*IP))/SOA Where "NEP" means New Exercise Price of the Warrant after adjustment pursuant to this section "OEP" means Old Exercise Price of the Warrant prior to adjustment pursuant to this section "SOA" means the total number of shares of Common Stock outstanding immediately after such issuance "SOB" means the number of shares of Common Stock outstanding immediately prior to such issuance "SI" means the Additional Shares of Common Stock issued "IP" means the price or other consideration received for the issuance of the Additional Shares of Common Stock "CMP" means Current Market Price as defined in Section 1.2 For purposes of this Section 3.4, "ADDITIONAL SHARES OF COMMON STOCK" shall mean all shares of Common Stock issued or issuable by the Company, including shares issuable under Convertible Securities, as defined below, after the Original Issue Date, other than (i) shares of Common Stock issuable under the Company's Amended and Restated 1996 Long-Term Incentive Plan and the Company's Amended and Restated 1996 Nonemployee Directors Plan, in each case as amended from time to time (collectively the "PLANS"), (ii) upon exercise of any option, warrant, or convertible security of the company outstanding prior to issuance of this Warrant, and (iii) shares issued by the Company in an underwritten public offering. For purposes of this Section 3.4, in the case of securities convertible to or exchangeable for Common Stock ("CONVERTIBLE SECURITIES"), there shall be determined the price per share for which Additional Shares of Common Stock are issuable upon the conversion or exchange thereof, such determination to be made by dividing (i) the total amount received or receivable by the Company as consideration for the issue or sale of such Convertible Securities, plus the minimum aggregate amount of additional consideration, if any, payable to the Company upon conversion or exchange thereof by (ii) the maximum aggregate number of additional Shares of Common Stock issuable upon conversion or exchange of all such Convertible Securities for such minimum aggregate amount of additional consideration; and such issue or sale shall be deemed to be an issue or sale for cash (as of the date of issue or sale of such Convertible Securities, whether or not then exercisable or convertible) of such maximum number of Additional Shares of Common Stock at the price per share so determined. If any rights of conversion or exchange evidenced by Convertible Securities the issuance of which resulted in an adjustment to the Exercise Price and the number of Warrant Shares issuable hereunder pursuant to this Section 3.4 shall expire without having been exercised, or if any such Convertible Securities are exercised for a consideration greater than or for a number of -7- 8 Additional Shares of Common Stock less than those used for purposes of determining the adjustment to the Exercise Price provided in this Section 3.4, the adjusted Exercise Price shall forthwith be readjusted to such Exercise Price as would have been in effect had an adjustment with respect to such Convertible Securities been made on the basis that the only Additional Shares of Common Stock issued or sold were those issued upon the conversion or exchange of such Convertible Securities, and that they were issued or sold for the consideration actually received by the Company upon such exercise, plus the consideration, if any, actually received by the Company for the granting of such Convertible Securities. In addition, upon adjustment of the Exercise Price under this Section 3.4, the holder hereof shall thereafter be entitled to purchase at the Exercise Price resulting from such adjustment a number of Warrant Shares obtained by multiplying the Exercise Price immediately prior to such issuance by the number of Warrant Shares purchasable pursuant hereto immediately prior to such issuance and dividing the product thereof by the Exercise Price resulting from such adjustment. The provisions of this Section 3.4 shall not apply to any issuance of Common Stock (i) for which an adjustment is provided for under Sections 3.2 or 3.3, (ii) upon exercise of any option, warrant, or convertible security of the Company outstanding prior to the issuance of this Warrant, (iii) pursuant to the Plans or (iv) by the Company in an underwritten public offering. Notwithstanding anything to the contrary in this Section 3.4, in no event shall (i) the Exercise Price be increased or (ii) the number of Warrant Shares purchasable hereunder be decreased pursuant to the provisions of this Section 3.4. 3.5 COMPANY TO PREVENT DILUTION. In case at any time or from time to time conditions arise by reason of action taken by the Company which are not adequately covered by this Section 3, and which are reasonably expected to materially and adversely affect the exercise rights of the holder hereof, unless the adjustment necessary shall be agreed by the Company and the holder hereof, the Board of Directors of the Company shall appoint a firm of independent certified public accountants of national standing, reasonably acceptable to the holder, who at the Company's expense shall give their opinion upon the adjustment necessary with respect to the Exercise Price and the number of Warrant Shares purchasable upon exercise of this Warrant, if any, so as to preserve, without dilution, the exercise rights of the holder hereof. In the event that the holder disputes such adjustment, the holder shall be entitled to select an additional firm of independent certified public accountants of national standing and paid for by the holder to calculate such adjustment and the Company and the holder shall use their good faith best efforts to agree on such adjustment based on the reports of the two accounting firms. In the event that the Company and the holder are still unable to reach agreement as to such adjustment, the Company and the holder agree to submit such determination to binding arbitration pursuant to Section 12. Upon determination of such adjustment, the Board of Directors shall forthwith make the adjustments described therein. 3.6 DISSOLUTION, LIQUIDATION OR WIND-UP. In case the Company shall, at any time prior to the exercise of this Warrant, dissolve, liquidate or wind up its affairs, the holder hereof shall be entitled, upon the exercise of this Warrant, to receive, in lieu of the Warrant Shares which the holder would have been entitled to receive, the same kind and amount of assets as would have been issued, distributed or paid to such holder upon any such dissolution, liquidation or winding up with respect to such Warrant Shares, had such holder hereof been the -8- 9 holder of record of the Warrant Shares receivable upon the exercise of this Warrant on the record date for the determination of those persons entitled to receive any such liquidating distribution. 3.7 ACCOUNTANT'S CERTIFICATE. In each case of an adjustment in the Exercise Price, number of Warrant Shares or other stock, securities or property receivable upon the exercise of this Warrant, the Company shall compute, and upon the holder's request shall at the Company's expense cause independent public accountants of recognized standing selected by the Company and reasonably acceptable to the holder to certify such computation, such adjustment in accordance with the terms of this Warrant and prepare a certificate setting forth such adjustment and showing in detail the facts upon which such adjustment is based, including a statement of (i) the number of shares of Common Stock of each class outstanding or deemed to be outstanding, (ii) the adjusted Exercise Price and (iii) the number of Warrant Shares issuable upon exercise of this Warrant. The Company will forthwith mail a copy of each such certificate to the holder hereof. In the event that the holder disputes such adjustment, the holder shall be entitled to select an additional firm of independent certified public accountants of national standing and paid for by the holder to certify such adjustment and the Company and the holder shall use their good faith best efforts to agree on such adjustment based on the reports of the two accounting firms. In the event that the Company and the holder are still unable to reach agreement as to such adjustment, the Company and the holder agree to submit such determination to binding arbitration pursuant to Section 12. Upon determination of such adjustment, the Board of Directors shall forthwith make the adjustments described therein. 3.8 DEFINITION OF COMMON STOCK. As used in this Section 3, the term "COMMON STOCK" shall mean and include the Company's authorized common stock of any class or classes and any securities convertible into or exchangeable for such common stock. 4. ANTI-DILUTION. In the event that the Company at any time after the Original Issue Date shall pay a special dividend or make any other distribution with respect to its Common Stock (or any other shares of the capital stock of the Company for which this Warrant becomes exercisable pursuant to Section 3 above) other than in the ordinary course of business in the form of cash or other property (other than (i) a distribution to which the provisions of Section 3.2 apply or (ii) a stock dividend subject to the provisions of Section 3.3 above), at the election of the holder, either: (i) The Exercise Price in effect immediately prior to the record date with respect to such distribution or issuance (the "ADJUSTMENT DATE") shall forthwith be adjusted effective on the Adjustment Date to a price determined by multiplying such Exercise Price by a fraction (x) the numerator of which shall be the average closing price of the Company's Common Stock as publicly reported on the primary exchange or automated inter-dealer quotation system on which it is listed (the "EXCHANGE") on the next trading day following the Adjustment Date (the "POST-EVENT MARKET PRICE"), and (y) the denominator of which shall be the average closing price of the Company's Common Stock as publicly reported on the Exchange over the ten trading days preceding the Adjustment Date (the "PRE-EVENT MARKET PRICE") and after each such adjustment of the Exercise Price, the total number of shares then issuable upon exercise of the Warrant shall -9- 10 be adjusted by multiplying such number of shares issuable upon exercise of the Warrant by a fraction (x) the numerator of which shall be the amount obtained by subtracting the Exercise Price in effect immediately prior to the Adjustment Date from the Pre-Event Market Price for the Company's Common Stock and (y) the denominator of which shall be the amount obtained by subtracting the Exercise Price in effect immediately following the Adjustment Date from the Post-Event Market Price for the Company's Common Stock; or (ii) The Company shall deliver to the holder hereof a dilution fee (a "DILUTION FEE") payable in cash on the date of payment of such dividend or other distribution equal to the number of shares of Common Stock (or such other shares of stock) issuable upon exercise of this Warrant on such date multiplied by the amount of cash and the fair value of any other property distributed with respect to each share of Common Stock (or such other stock). The fair value of any such other property shall mean the fair market value thereof on the record date for such dividend, as determined by the Board of Directors of the Company in good faith and supported, upon the request of the holder, by an opinion of an investment banking firm or appraisal firm of recognized national standing selected by the Company and acceptable to the holder. Notwithstanding the foregoing, in no event shall the Exercise Price be increased or the number of Warrant Shares issuable upon exercise hereof be reduced pursuant to the provisions of this Section 4. 5. REGISTRATION; EXCHANGE AND REPLACEMENT OF WARRANT; RESERVATION OF SHARES. The Company shall keep at the Designated Office a register in which the Company shall provide for the registration, transfer and exchange of this Warrant. The Company shall not at any time, except upon the dissolution, liquidation or winding-up of the Company, close such register so as to result in preventing or delaying the exercise or transfer of this Warrant. The Company may deem and treat the person in whose name this Warrant is registered as the holder and owner hereof for all purposes and shall not be affected by any notice to the contrary, until presentation of this Warrant for registration or transfer as provided in this Section 5. Upon receipt by the Company of evidence reasonably satisfactory to it of the loss, theft, destruction or mutilation of this Warrant, and upon surrender and cancellation of this Warrant, if mutilated, the Company will make and deliver a new Warrant of like tenor, in lieu of this Warrant without requiring the posting of any bond or the giving of any security. The Company shall at all times reserve and keep available out of its authorized shares of Common Stock, solely for the purpose of issuance upon the exercise of this Warrant, such number of shares of Common Stock as shall be issuable upon the exercise hereof. The Company covenants and agrees that, upon exercise of this Warrant and payment of the Exercise -10- 11 Price therefor, if applicable, all Warrant Shares issuable upon such exercise shall be duly and validly issued, fully paid and non-assessable. 6. COMPANY INFORMATION. The Company shall deliver to each holder hereof or of Warrant Shares one copy of each of the following items: (i) as soon as available, and in any event within fifty (50) days after the end of each fiscal quarter of the Company, its Form 10-Q as filed with the Commission for such quarter or if the Company is not publicly traded its unaudited interim consolidated balance sheets of the Company and its subsidiaries as at the end of such quarter and the related consolidated statements of income, cash flow and stockholders' equity of the Company and its subsidiaries for the period from the beginning of the current fiscal year to the end of such quarter, all in reasonable detail and certified by a principal financial officer of the Company, as prepared in accordance with GAAP consistently applied (subject to year end adjustments and the absence of footnotes), and fairly presenting the consolidated financial position and results of operations of the Company and its subsidiaries for such periods; (ii) within ninety-five (95) days after the end of each fiscal year of the Company, its Form 10-K as filed with the Commission for such fiscal year or if the Company is not publicly traded its consolidated balance sheets of the Company and its subsidiaries as at the end of such year and the related consolidated statements of income, cash flow and stockholders' equity of the Company and its subsidiaries for such fiscal year, setting forth in each case in comparative form the consolidated figures for the previous fiscal year, all in reasonable detail and accompanied by a report thereon of independent public accountants of recognized national standing selected by the Company, which report shall state that such consolidated financial statements present fairly the financial position of the Company and its subsidiaries as at the dates indicated and the results of their operations and changes in their financial position for the periods indicated in conformity with GAAP applied on a basis consistent with prior years (except as otherwise specified in such report) and that the audit by such accountants in connection with such consolidated financial statements has been made in accordance with generally accepted auditing standards; and (iii) promptly upon their becoming available, copies of all financial statements, reports, proxy statements, notices, documents or other communications sent or made available generally by the Company or by any subsidiary of the Company to any class of its security holders of the Company. -11- 12 7. NOTICES. All notices, requests, consents and other communications hereunder shall be in writing and shall be deemed to have been duly made when delivered personally, or mailed by registered or certified mail, return receipt requested, or telecopied or telexed and confirmed in writing and delivered personally or mailed by registered or certified mail, return receipt requested: (a) If to the holder of this Warrant, to the address of such holder as shown on the books of the Company; or (b) If to the Company, to the address set forth in Section 1 of this Warrant; or at such other address as the holder or the Company may hereafter have advised the other. 8. SUCCESSORS. All the covenants, agreements, representations and warranties contained in this Warrant shall bind the parties hereto and their respective heirs, executors, administrators, distributees, successors, assigns and transferees. 9. LAW GOVERNING. This Warrant shall be construed and enforced in accordance with, and governed by, the laws of the State of Delaware (not including the choice of law rules thereof) regardless of the jurisdiction of creation or domicile of the Company or its successors or of the holder at any time hereof. The exclusive jurisdiction for all actions and proceedings arising out of or relating to this Agreement which are not subject to arbitration pursuant to Section 12 shall be in any Delaware state or federal court thereof. 10. ENTIRE AGREEMENT; AMENDMENTS AND WAIVERS. This Warrant sets forth the entire understanding of the parties with respect to the transactions contemplated hereby. The failure of any party to seek redress for the violation or to insist upon the strict performance of any term of this Warrant shall not constitute a waiver of such term and such party shall be entitled to enforce such term without regard to such forbearance. This Warrant may be amended, and any breach of or compliance with any covenant, agreement, warranty or representation may be waived, only if the Company has obtained the written consent or written waiver of the holder, and then such consent or waiver shall be effective only in the specific instance and for the specific purpose for which given. -12- 13 11. SEVERABILITY; HEADINGS. If any term of this Warrant as applied to any person or to any circumstance is prohibited, void, invalid or unenforceable in any jurisdiction, such term shall, as to such jurisdiction, be ineffective to the extent of such prohibition or invalidity without in any way affecting any other term of this Warrant or affecting the validity or enforceability of this Warrant or of such provision in any other jurisdiction. The Section headings in this Warrant have been inserted for purposes of convenience only and shall have no substantive effect. 12 ARBITRATION. In the event a dispute occurs with respect to any claim, dispute or other matter arising out of or relating to this Warrant, the parties hereto will promptly attempt to settle such dispute through consultation and negotiation in good faith and in a spirit of mutual cooperation. If agreement is reached concerning the resolution of such dispute, then such agreement shall be final, conclusive and binding on the parties hereto. If, on or before the tenth day after written notice of such dispute is given by one party to the other parties, such dispute has not been resolved by the agreement of all the parties, such dispute shall be settled by an expedited arbitration proceeding conducted in accordance with the then-current CPR Non-Administered Arbitration Rules and the Federal Rules of Evidence in Wilmington, Delaware by a panel of three arbitrators who shall have experience relating to the dispute or matter to be resolved. Each of the Company and the holder shall select an arbitrator, and those two arbitrators shall select a third arbitrator. The parties hereto shall provide such arbitrators with such information as may be reasonably requested in connection with the arbitration of such dispute and shall otherwise cooperate with each other and such arbitrators in good faith and with the goal of resolving such dispute as promptly as reasonably practicable. The arbitrators' decision and award with respect to the dispute referred to shall be final and binding on the parties hereto and may be entered in any court with jurisdiction, and the parties hereto shall abide by such decision and award. The cost of the arbitration proceeding and any proceeding in court to confirm or to vacate any arbitration award, as applicable (including, without limitation, attorneys' fees and costs), shall be borne by the unsuccessful party (if any) and shall be awarded as part of the arbitrators' award; provided however, that if the arbitrators do not find one party to be unsuccessful then the cost of the arbitral proceeding shall be paid equally by the parties hereto. [remainder of page intentionally blank] -13- 14 IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed as of the date first written above. SRS LABS, INC. By: /s/ THOMAS C. K. YUEN ------------------------------ Name: Thomas C. K. Yuen Title: CEO Accepted and agreed: MICROSOFT CORPORATION By: /s/ AMAR NEHRU --------------------------- Amar Nehru Corporate Development Vice President -14- 15 ANNEX A NOTICE OF EXERCISE (TO BE EXECUTED UPON PARTIAL OR FULL EXERCISE OF THE WITHIN WARRANT) The undersigned hereby irrevocably elects to exercise the right to purchase ___________ shares of Common Stock of [Company] covered by the within Warrant according to the conditions hereof and herewith makes payment of the Exercise Price of such shares in full in the amount of $____________________. By: --------------------------------- (Signature of Registered Holder) Dated: ----------------------- 16 ANNEX B ASSIGNMENT FORM FOR VALUE RECEIVED the undersigned registered owner of this Warrant hereby sells, assigns and transfers unto the Assignee named below all of the rights of the undersigned under this Warrant, with respect to the number of shares of Common Stock set forth below: No. of Shares of Name and Address of Assignee Common Stock - ---------------------------- -------------- and does hereby irrevocably constitute and appoint ________ _____________ attorney-in-fact to register such transfer onto the books of [Company] maintained for the purpose, with full power of substitution in the premises. Dated: Print Name: ------------------- --------------------------------- Signature: ---------------------------------- Witness: ------------------------------------ NOTICE: The signature on this assignment must correspond with the name as written upon the face of this Warrant in every particular, without alteration or enlargement or any change whatsoever. EX-10.3 4 EXHIBIT 10.3 1 EXHIBIT 10.3 NEITHER THIS WARRANT NOR ANY OF THE SECURITIES ISSUABLE UPON EXERCISE HEREOF HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY STATE SECURITIES LAW. NO TRANSFER OF THIS WARRANT OR OF THE SECURITIES ISSUABLE UPON EXERCISE HEREOF SHALL BE VALID OR EFFECTIVE UNLESS (A) SUCH TRANSFER IS MADE PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT AND IN COMPLIANCE WITH ANY APPLICABLE STATE SECURITIES LAW, OR (B) THE HOLDER SHALL DELIVER TO THE COMPANY AN OPINION OF COUNSEL IN FORM AND SUBSTANCE REASONABLY ACCEPTABLE TO THE COMPANY THAT SUCH TRANSFER IS EXEMPT FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND OF ANY APPLICABLE STATE SECURITIES LAW. WARRANT NO. M-1 MARCH 8, 2000 SRS WOWCAST.COM, INC. COMMON STOCK PURCHASE WARRANT SRS WOWcast.com, Inc., a Delaware corporation (the "COMPANY"), hereby grants to Microsoft Corporation, a Washington corporation ("MICROSOFT"), or its permitted assigns or transferees (Microsoft and each such permitted assignee or transferee being referred to herein as a "HOLDER" and collectively as the "HOLDERS") the right to purchase, at any time after the Original Issue Date (as defined below) and from time to time on and after the date hereof until the Expiration Date (as defined below), up to 1,250,000 fully paid and non-assessable shares of Common Stock of the Company, $.001 par value per share (the "COMMON STOCK"), on the terms and subject to the conditions set forth below, provided that, (1) in the event that holder has exercised its right to acquire common shares of SRS Labs, Inc. ("PARENT") pursuant to the warrant issued by Parent of even date herewith (the "PARENT WARRANT"), this Common Stock Purchase Warrant (hereinafter, this "WARRANT") shall be terminated and become void and (2) in the event that the Company and Parent provide certification reasonably satisfactory to holder that the Company has obtained financing in a single transaction or series of related transactions with a party or parties other than the Company or Microsoft in an amount in excess of $ 5,000,000 through the sale of equity securities of the Company or debt securities convertible into equity securities of the Company (a "FINANCING"), this Warrant shall be exercisable for up to 1,250,000 fully paid and non-assessable shares of Common Stock of the Company; provided further, that if the condition in this clause (2) is satisfied than the condition in clause (1) that the Parent Warrant not have been previously exercised shall no longer apply. This Warrant was originally issued on March 8, 2000 (the "ORIGINAL ISSUE DATE"). This Warrant shall expire and be of no further force or effect on the date (the "EXPIRATION DATE") three (3) years from the Original Issue Date. Appropriate provisions shall be made in accordance with Section 3.2 below so that holder shall have the right to receive a similar 2 warrant for the remainder of such term in the event of a merger, consolidation, reorganization or similar transaction. 1. EXERCISE OF WARRANT. 1.1 EXERCISE AND VESTING. Subject to adjustment as hereinafter provided, the rights represented by this Warrant are exercisable on and after the Original Issue Date until the Expiration Date, at a price per share (the "EXERCISE PRICE") of the Common Stock issuable hereunder (hereinafter, "WARRANT SHARES") equal to the lesser of (a) Four Dollars ($4.00) or (b) the price per share of Common Stock in the Financing, which amount shall be calculated by dividing (i) the total amount received or receivable by the Company as consideration for the Financing, plus the minimum aggregate amount of additional consideration, if any, payable to the Company upon conversion or exchange for Common Stock of instruments issued in the Financing by (ii) the maximum aggregate number of additional shares of Common Stock issuable upon conversion or exchange of all such instruments issued in the Financing for such minimum aggregate amount of additional consideration. The Exercise Price shall be payable in cash, by certified or official bank check or wire transfer as hereinafter provided or in accordance with Section 1.2 below. Subject to termination and reduction in the number of Warrant Shares for which this Warrant is exercisable pursuant to the first paragraph of this Warrant, this Warrant is fully vested. Upon surrender of this Warrant with a duly executed Notice of Exercise in the form of Annex A hereto, together with payment, if applicable, of the Exercise Price for the Warrant Shares purchased, at the Company's principal executive offices presently located at 2909 Daimler Street, Santa Ana, CA 92705, or at such other address as the Company shall have advised the holder in writing (the "DESIGNATED OFFICE"), the holder shall be entitled to receive a certificate or certificates for the Warrant Shares so purchased. The Company agrees that the Warrant Shares shall be deemed to have been issued to the holder as of the close of business on the date on which this Warrant shall have been surrendered together with the Notice of Exercise and payment, if applicable, for such Warrant Shares. 1.2 RIGHT TO CONVERT. (a) Subject to the provisions of Section 1.1, at any time or from time on or prior to the Expiration Date, the holder of this Warrant shall also have the right to convert this Warrant or any portion thereof (the "CONVERSION RIGHT"), without payment by the holder of this Warrant of the Exercise Price in cash or any other consideration (other than the surrender of rights to receive Warrant Shares hereunder), into shares of Common Stock as provided in this Section 1.2. Upon exercise of the Conversion Right with respect to a particular number of Warrant Shares (the "CONVERTED WARRANT SHARES"), the Company shall deliver to the holder of this Warrant (without payment by the holder of this Warrant of the Exercise Price in cash or any other consideration (other than the surrender of rights to receive Warrant Shares hereunder)) that number of shares of Common Stock computed using the following formula: Y(A-B) ------ X= A -2- 3 Where X equals the number of Shares to be delivered upon exercise in accordance with this Section 1.2 Y equals the number of Converted Warrant Shares A equals the Current Market Price, as defined below, and B equals the applicable Exercise Price No fractional Warrant Shares shall be issuable upon exercise of the Conversion Right, and if the number of Warrant Shares to be issued determined in accordance with the following formula is other than a whole number, the Company shall pay to the holder of this Warrant an amount in cash equal to the Current Market Price of the resulting fractional Warrant Share on the Conversion Date. (b) The Conversion Right may be exercised by the holder of this Warrant by the surrender of this Warrant as provided in Section 1.1, together with a written statement specifying that the holder of this Warrant thereby intends to exercise the Conversion Right and indicating the number of Converted Warrant Shares which are covered by the exercise of the Conversion Right. Such conversion shall be effective upon receipt by the Corporation of this Warrant, together with the aforesaid written statement, or on such later date as is specified therein (the "CONVERSION DATE"). The Corporation shall issue to the holder of this Warrant as of the Conversion Date a certificate for the Warrant Shares issuable upon exercise of the Conversion Right and, if applicable, a new warrant of like tenor evidencing the balance of the Warrant Shares remaining subject to this Warrant. (c) The term "CURRENT MARKET PRICE" for the Common Stock as of a specified date shall mean: (i) if the Common Stock is publicly traded on such date, the average closing bid price per share over the preceding 5 trading days as reported on the principal stock exchange or quotation system on which the Common Stock is listed or quoted; or (ii) if the Common Stock is not publicly traded on such date, such value as shall be determined in good faith by the Company's Board of Directors, provided that if such value is not acceptable to the holder, the Company and the holder agree to submit such determination to binding arbitration pursuant to Section 12. -3- 4 2. TRANSFER; ISSUANCE OF STOCK CERTIFICATES; RESTRICTIVE LEGENDS. 2.1. TRANSFER. Subject to compliance with the restrictions on transfer set forth in this Section 2, each transfer of this Warrant and all rights hereunder, in whole or in part, shall be registered on the books of the Company to be maintained for such purpose, upon surrender of this Warrant at the Designated Office, together with a written assignment of this Warrant in the form of Annex B hereto duly executed by the holder or its agent or attorney. Upon such surrender and delivery, the Company shall execute and deliver a new Warrant or Warrants in the name of the assignee or assignees and in the denominations specified in such instrument of assignment, and shall issue to the assignor a new Warrant evidencing the portion of this Warrant not so assigned, if any. A Warrant, if properly assigned in compliance with the provisions hereof, may be exercised by the new holder for the purchase of Warrant Shares without having a new Warrant issued. All Warrants issued upon any assignment of Warrants shall be the valid obligations of the Company, evidencing the same rights, and entitled to the same benefits as the Warrants surrendered upon such registration of transfer or exchange. 2.2 STOCK CERTIFICATES. Certificates for the Warrant Shares shall be delivered to the holder within a reasonable time after the rights represented by this Warrant shall have been exercised pursuant to Section 1, and a new Warrant representing the share, shares or fraction of a share of Common Stock, if any, with respect to which this Warrant shall not then have been exercised shall also be issued to the holder within such time. The issuance of certificates for Warrant Shares upon the exercise of this Warrant shall be made without charge to the holder hereof including, without limitation, any tax that may be payable in respect thereof; provided, however, that the Company shall not be required to pay any income tax to which the holder hereof may be subject in connection with the issuance of this Warrant or the Warrant Shares. 2.3. RESTRICTIVE LEGENDS. (a) Except as otherwise provided in this Section 2, each certificate for Warrant Shares initially issued upon the exercise of this Warrant, and each certificate for Warrant Shares issued to any subsequent transferee of any such certificate, shall be stamped or otherwise imprinted with a legend in substantially the following form: THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY STATE SECURITIES LAW. NO TRANSFER OF THE SHARES REPRESENTED BY THIS CERTIFICATE SHALL BE VALID OR EFFECTIVE UNLESS (A) SUCH TRANSFER IS MADE PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT AND IN COMPLIANCE WITH ANY APPLICABLE STATE SECURITIES LAWS, OR (B) THE HOLDER SHALL DELIVER TO THE COMPANY AN OPINION OF COUNSEL IN FORM AND SUBSTANCE REASONABLY ACCEPTABLE TO THE COMPANY THAT SUCH PROPOSED TRANSFER IS EXEMPT FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND OF ANY APPLICABLE STATE SECURITIES LAWS. -4- 5 (b) Except as otherwise provided in this Section 2, each Warrant shall be stamped or otherwise imprinted with a legend in substantially the following form: NEITHER THIS WARRANT NOR ANY OF THE SECURITIES ISSUABLE UPON EXERCISE HEREOF HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY STATE SECURITIES LAW. NO TRANSFER OF THIS WARRANT OR OF THE SECURITIES ISSUABLE UPON EXERCISE HEREOF SHALL BE VALID OR EFFECTIVE UNLESS (A) SUCH TRANSFER IS MADE PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT AND IN COMPLIANCE WITH ANY APPLICABLE STATE SECURITIES LAW, OR (B) THE HOLDER SHALL DELIVER TO THE COMPANY AN OPINION OF COUNSEL IN FORM AND SUBSTANCE REASONABLY ACCEPTABLE TO THE COMPANY THAT SUCH TRANSFER IS EXEMPT FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND OF ANY APPLICABLE STATE SECURITIES LAW. Notwithstanding the foregoing, the legend requirements of this Section 2.3 shall terminate as to any particular Warrant or Warrant Share when the Company shall have received from the holder thereof an opinion of counsel in form and substance reasonably acceptable to the Company that such legend is not required in order to ensure compliance with the Securities Act and any applicable state securities laws. Whenever the restrictions imposed by this Section 2.3 shall terminate, the holder hereof or of Warrant Shares, as the case may be, shall be entitled to receive from the Company without cost to such holder a new Warrant or certificate for Warrant Shares of like tenor, as the case may be, without such restrictive legend. 3. ADJUSTMENT OF NUMBER OF SHARES; EXERCISE PRICE; NATURE OF SECURITIES ISSUABLE UPON EXERCISE OF WARRANTS. 3.1 EXERCISE PRICE; ADJUSTMENT OF NUMBER OF SHARES. The Exercise Price set forth in Section 1 hereof and the number of shares purchasable hereunder shall be subject to adjustment from time to time as hereinafter provided. 3.2 REORGANIZATION, RECLASSIFICATION, CONSOLIDATION, MERGER OR SALE. If any capital reorganization or reclassification of the capital stock of the Company, or any consolidation or merger of the Company with another entity, or the sale of all or substantially all of the Company's assets to another person or entity (collectively referred to as a "TRANSACTION") shall be effected in such a way that holders of Common Stock shall be entitled to receive stock, securities, cash or assets with respect to or in exchange for Common Stock, then, as a condition of such Transaction, reasonable, lawful and adequate provisions shall be made whereby the holder of this Warrant shall thereafter have the right to purchase and receive upon the basis and upon the terms and conditions specified in this Warrant, upon exercise of this Warrant and in lieu of the Warrant Shares immediately theretofore purchasable and receivable upon the exercise of the rights represented hereby, such number, amount and like kind of shares of stock, securities, cash or assets as may be issued or payable pursuant to the terms of the Transaction with respect to or in exchange for the number of shares of Common Stock immediately theretofore purchasable and receivable upon the exercise of the rights represented hereby as if such shares -5- 6 were outstanding immediately prior to the Transaction, and in any such case appropriate provision shall be made with respect to the rights and interest of the holders to the end that the provisions hereof (including, without limitation, provisions for adjustments of the Exercise Price and of the number of Warrant Shares purchasable and receivable upon the exercise of this Warrant and the remaining term of this Warrant) shall thereafter be applicable, as nearly as may be practicable, in relation to any shares of stock or securities thereafter deliverable upon the exercise hereof. 3.3 STOCK SPLITS, STOCK DIVIDENDS AND REVERSE STOCK SPLITS. In case at any time the Company shall subdivide its outstanding shares of Common Stock into a greater number of shares, or shall declare and pay any stock dividend with respect to its outstanding stock that has the effect of increasing the number of outstanding shares of Common Stock, the Exercise Price in effect immediately prior to such subdivision or stock dividend shall be proportionately reduced and the number of Warrant Shares purchasable pursuant to this Warrant immediately prior to such subdivision or stock dividend shall be proportionately increased, and conversely, in case at any time the Company shall combine its outstanding shares of Common Stock into a smaller number of shares, the Exercise Price in effect immediately prior to such combination shall be proportionately increased and the number of Warrant Shares purchasable upon the exercise of this Warrant immediately prior to such combination shall be proportionately reduced. 3.4 ISSUANCE OF ADDITIONAL SHARES OF COMMON STOCK. If at any time prior to the Expiration Date the Company shall issue any Additional Shares of Common Stock for a consideration per share (the "SUBSEQUENT ISSUE PRICE") less than the Exercise Price as in effect immediately prior to such issuance, the Exercise Price shall be reduced to the price calculated by dividing (i) an amount equal to the sum of (x) the number of shares of Common Stock outstanding immediately prior to such issuance multiplied by the Exercise Price then in effect plus (y) the aggregate consideration, if any, received by the Company in connection with such issuance by (ii) the total number of shares of Common Stock outstanding immediately after such issuance. -6- 7 The foregoing is illustrated by the following formula: NEP = ((SOB*OEP) + (SI*IP))/SOA Where "NEP" means New Exercise Price of the Warrant after adjustment pursuant to this section "OEP" means Old Exercise Price of the Warrant prior to adjustment pursuant to this section "SOA" means the total number of shares of Common Stock outstanding immediately after such issuance "SOB" means the number of shares of Common Stock outstanding immediately prior to such issuance "SI" means the Additional Shares of Common Stock issued "IP" means the price or other consideration received for the issuance of the Additional Shares of Common Stock "CMP" means Current Market Price as defined in Section 1.2 For purposes of this Section 3.4, "ADDITIONAL SHARES OF COMMON STOCK" shall mean all shares of Common Stock issued or issuable by the Company, including shares issuable under Convertible Securities, as defined below, after the Original Issue Date, other than (i) shares of Common Stock issuable under the Company's 2000 Long Term Incentive Plan and the Company's 2000 Supplemental Incentive Plan, in each case as amended from time to time (collectively the "PLANS"), (ii) upon exercise of any option, warrant, or convertible security of the company outstanding prior to issuance of this Warrant, and (iii) shares issued by the Company in an underwritten public offering. For purposes of this Section 3.4, in the case of securities convertible to or exchangeable for Common Stock ("CONVERTIBLE SECURITIES"), there shall be determined the price per share for which Additional Shares of Common Stock are issuable upon the conversion or exchange thereof, such determination to be made by dividing (i) the total amount received or receivable by the Company as consideration for the issue or sale of such Convertible Securities, plus the minimum aggregate amount of additional consideration, if any, payable to the Company upon conversion or exchange thereof by (ii) the maximum aggregate number of additional Shares of Common Stock issuable upon conversion or exchange of all such Convertible Securities for such minimum aggregate amount of additional consideration; and such issue or sale shall be deemed to be an issue or sale for cash (as of the date of issue or sale of such Convertible Securities, whether or not then exercisable or convertible) of such maximum number of Additional Shares of Common Stock at the price per share so determined. If any rights of conversion or exchange evidenced by Convertible Securities the issuance of which resulted in an adjustment to the Exercise Price and the number of Warrant Shares -7- 8 issuable hereunder pursuant to this Section 3.4 shall expire without having been exercised, or if any such Convertible Securities are exercised for a consideration greater than or for a number of Additional Shares of Common Stock less than those used for purposes of determining the adjustment to the Exercise Price provided in this Section 3.4, the adjusted Exercise Price shall forthwith be readjusted to such Exercise Price as would have been in effect had an adjustment with respect to such Convertible Securities been made on the basis that the only Additional Shares of Common Stock issued or sold were those issued upon the conversion or exchange of such Convertible Securities, and that they were issued or sold for the consideration actually received by the Company upon such exercise, plus the consideration, if any, actually received by the Company for the granting of such Convertible Securities. In addition, upon adjustment of the Exercise Price under this Section 3.4, the holder hereof shall thereafter be entitled to purchase at the Exercise Price resulting from such adjustment a number of Warrant Shares obtained by multiplying the Exercise Price immediately prior to such issuance by the number of Warrant Shares purchasable pursuant hereto immediately prior to such issuance and dividing the product thereof by the Exercise Price resulting from such adjustment. The provisions of this Section 3.4 shall not apply to any issuance of Common Stock (i) for which an adjustment is provided for under Sections 3.2 or 3.3, (ii) upon exercise of any option, warrant, or convertible security of the Company outstanding prior to the issuance of this Warrant, (iii) pursuant to the Plans or (iv) by the Company in an underwritten public offering. Notwithstanding anything to the contrary in this Section 3.4, in no event shall (i) the Exercise Price be increased or (ii) the number of Warrant Shares purchasable hereunder be decreased pursuant to the provisions of this Section 3.4. 3.5 COMPANY TO PREVENT DILUTION. In case at any time or from time to time conditions arise by reason of action taken by the Company which are not adequately covered by this Section 3, and which are reasonably expected to materially and adversely affect the exercise rights of the holder hereof, unless the adjustment necessary shall be agreed by the Company and the holder hereof, the Board of Directors of the Company shall appoint a firm of independent certified public accountants of national standing, reasonably acceptable to the holder, who at the Company's expense shall give their opinion upon the adjustment necessary with respect to the Exercise Price and the number of Warrant Shares purchasable upon exercise of this Warrant, if any, so as to preserve, without dilution, the exercise rights of the holder hereof. In the event that the holder disputes such adjustment, the holder shall be entitled to select an additional firm of independent certified public accountants of national standing and paid for by the holder to calculate such adjustment and the Company and the holder shall use their good faith best efforts to agree on such adjustment based on the reports of the two accounting firms. In the event that the Company and the holder are still unable to reach agreement as to such adjustment, the Company and the holder agree to submit such determination to binding arbitration pursuant to Section 12. Upon determination of such adjustment, the Board of Directors shall forthwith make the adjustments described therein. 3.6 DISSOLUTION, LIQUIDATION OR WIND-UP. In case the Company shall, at any time prior to the exercise of this Warrant, dissolve, liquidate or wind up its affairs, the holder hereof shall be entitled, upon the exercise of this Warrant, to receive, in lieu of the Warrant Shares which the holder would have been entitled to receive, the same kind and amount of assets -8- 9 as would have been issued, distributed or paid to such holder upon any such dissolution, liquidation or winding up with respect to such Warrant Shares, had such holder hereof been the holder of record of the Warrant Shares receivable upon the exercise of this Warrant on the record date for the determination of those persons entitled to receive any such liquidating distribution. 3.7 ACCOUNTANT'S CERTIFICATE. In each case of an adjustment in the Exercise Price, number of Warrant Shares or other stock, securities or property receivable upon the exercise of this Warrant, the Company shall compute, and upon the holder's request shall at the Company's expense cause independent public accountants of recognized standing selected by the Company and reasonably acceptable to the holder to certify such computation, such adjustment in accordance with the terms of this Warrant and prepare a certificate setting forth such adjustment and showing in detail the facts upon which such adjustment is based, including a statement of (i) the number of shares of Common Stock of each class outstanding or deemed to be outstanding, (ii) the adjusted Exercise Price and (iii) the number of Warrant Shares issuable upon exercise of this Warrant. The Company will forthwith mail a copy of each such certificate to the holder hereof. In the event that the holder disputes such adjustment, the holder shall be entitled to select an additional firm of independent certified public accountants of national standing and paid for by the holder to certify such adjustment and the Company and the holder shall use their good faith best efforts to agree on such adjustment based on the reports of the two accounting firms. In the event that the Company and the holder are still unable to reach agreement as to such adjustment, the Company and the holder agree to submit such determination to binding arbitration pursuant to Section 12. Upon determination of such adjustment, the Board of Directors shall forthwith make the adjustments described therein. 3.8 DEFINITION OF COMMON STOCK. As used in this Section 3, the term "COMMON STOCK" shall mean and include the Company's authorized common stock of any class or classes and any securities convertible into or exchangeable for such common stock. 4. ANTI-DILUTION. In the event that the Company at any time after the Original Issue Date shall pay a special dividend or make any other distribution with respect to its Common Stock (or any other shares of the capital stock of the Company for which this Warrant becomes exercisable pursuant to Section 3 above) other than in the ordinary course of business in the form of cash or other property (other than (i) a distribution to which the provisions of Section 3.2 apply or (ii) a stock dividend subject to the provisions of Section 3.3 above), at the election of the holder, either: (i) The Exercise Price in effect immediately prior to the record date with respect to such distribution or issuance (the "ADJUSTMENT DATE") shall forthwith be adjusted effective on the Adjustment Date to a price determined by multiplying such Exercise Price by a fraction (x) the numerator of which shall be the average closing price of the Company's Common Stock as publicly reported on the primary exchange or automated inter-dealer quotation system on which it is listed (the "EXCHANGE") on the next trading day following the Adjustment Date (the "POST-EVENT MARKET PRICE"), and (y) the denominator of which shall be the average closing price of the Company's Common Stock as publicly reported on the Exchange over the ten trading days preceding the -9- 10 Adjustment Date (the "PRE-EVENT MARKET PRICE") and after each such adjustment of the Exercise Price, the total number of shares then issuable upon exercise of the Warrant shall be adjusted by multiplying such number of shares issuable upon exercise of the Warrant by a fraction (x) the numerator of which shall be the amount obtained by subtracting the Exercise Price in effect immediately prior to the Adjustment Date from the Pre-Event Market Price for the Company's Common Stock and (y) the denominator of which shall be the amount obtained by subtracting the Exercise Price in effect immediately following the Adjustment Date from the Post-Event Market Price for the Company's Common Stock; or (ii) The Company shall deliver to the holder hereof a dilution fee (a "DILUTION FEE") payable in cash on the date of payment of such dividend or other distribution equal to the number of shares of Common Stock (or such other shares of stock) issuable upon exercise of this Warrant on such date multiplied by the amount of cash and the fair value of any other property distributed with respect to each share of Common Stock (or such other stock). The fair value of any such other property shall mean the fair market value thereof on the record date for such dividend, as determined by the Board of Directors of the Company in good faith and supported, upon the request of the holder, by an opinion of an investment banking firm or appraisal firm of recognized national standing selected by the Company and acceptable to the holder. Notwithstanding the foregoing, in no event shall the Exercise Price be increased or the number of Warrant Shares issuable upon exercise hereof be reduced pursuant to the provisions of this Section 4. 5. REGISTRATION; EXCHANGE AND REPLACEMENT OF WARRANT; RESERVATION OF SHARES. The Company shall keep at the Designated Office a register in which the Company shall provide for the registration, transfer and exchange of this Warrant. The Company shall not at any time, except upon the dissolution, liquidation or winding-up of the Company, close such register so as to result in preventing or delaying the exercise or transfer of this Warrant. The Company may deem and treat the person in whose name this Warrant is registered as the holder and owner hereof for all purposes and shall not be affected by any notice to the contrary, until presentation of this Warrant for registration or transfer as provided in this Section 5. Upon receipt by the Company of evidence reasonably satisfactory to it of the loss, theft, destruction or mutilation of this Warrant, and upon surrender and cancellation of this Warrant, if mutilated, the Company will make and deliver a new Warrant of like tenor, in lieu of this Warrant without requiring the posting of any bond or the giving of any security. The Company shall at all times reserve and keep available out of its authorized shares of Common Stock, solely for the purpose of issuance upon the exercise of this Warrant, such number of shares of Common Stock as shall be issuable upon the exercise hereof. The -10- 11 Company covenants and agrees that, upon exercise of this Warrant and payment of the Exercise Price therefor, if applicable, all Warrant Shares issuable upon such exercise shall be duly and validly issued, fully paid and non-assessable. 6. COMPANY INFORMATION. The Company shall deliver to each holder hereof or of Warrant Shares one copy of each of the following items: (i) as soon as available, and in any event within fifty (50) days after the end of each fiscal quarter of the Company, its Form 10-Q as filed with the Commission for such quarter or if the Company is not publicly traded its unaudited interim consolidated balance sheets of the Company and its subsidiaries as at the end of such quarter and the related consolidated statements of income, cash flow and stockholders' equity of the Company and its subsidiaries for the period from the beginning of the current fiscal year to the end of such quarter, all in reasonable detail and certified by a principal financial officer of the Company, as prepared in accordance with GAAP consistently applied (subject to year end adjustments and the absence of footnotes), and fairly presenting the consolidated financial position and results of operations of the Company and its subsidiaries for such periods; (ii) within ninety-five (95) days after the end of each fiscal year of the Company, its Form 10-K as filed with the Commission for such fiscal year or if the Company is not publicly traded its consolidated balance sheets of the Company and its subsidiaries as at the end of such year and the related consolidated statements of income, cash flow and stockholders' equity of the Company and its subsidiaries for such fiscal year, setting forth in each case in comparative form the consolidated figures for the previous fiscal year, all in reasonable detail and accompanied by a report thereon of independent public accountants of recognized national standing selected by the Company, which report shall state that such consolidated financial statements present fairly the financial position of the Company and its subsidiaries as at the dates indicated and the results of their operations and changes in their financial position for the periods indicated in conformity with GAAP applied on a basis consistent with prior years (except as otherwise specified in such report) and that the audit by such accountants in connection with such consolidated financial statements has been made in accordance with generally accepted auditing standards; and (iii) promptly upon their becoming available, copies of all financial statements, reports, proxy statements, notices, documents or other communications sent or made available generally by the Company or by any subsidiary of the Company to any class of its security holders of the Company. -11- 12 7. NOTICES. All notices, requests, consents and other communications hereunder shall be in writing and shall be deemed to have been duly made when delivered personally, or mailed by registered or certified mail, return receipt requested, or telecopied or telexed and confirmed in writing and delivered personally or mailed by registered or certified mail, return receipt requested: (a) If to the holder of this Warrant, to the address of such holder as shown on the books of the Company; or (b) If to the Company, to the address set forth in Section 1 of this Warrant; `or at such other address as the holder or the Company may hereafter have advised the other. 8. SUCCESSORS. All the covenants, agreements, representations and warranties contained in this Warrant shall bind the parties hereto and their respective heirs, executors, administrators, distributees, successors, assigns and transferees. 9. LAW GOVERNING. This Warrant shall be construed and enforced in accordance with, and governed by, the laws of the State of Delaware (not including the choice of law rules thereof) regardless of the jurisdiction of creation or domicile of the Company or its successors or of the holder at any time hereof. The exclusive jurisdiction for all actions and proceedings arising out of or relating to this Agreement which are not subject to arbitration pursuant to Section 12 shall be in any Delaware state or federal court thereof. 10. ENTIRE AGREEMENT; AMENDMENTS AND WAIVERS. This Warrant sets forth the entire understanding of the parties with respect to the transactions contemplated hereby. The failure of any party to seek redress for the violation or to insist upon the strict performance of any term of this Warrant shall not constitute a waiver of such term and such party shall be entitled to enforce such term without regard to such forbearance. This Warrant may be amended, and any breach of or compliance with any covenant, agreement, warranty or representation may be waived, only if the Company has obtained the written consent or written waiver of the holder, and then such consent or waiver shall be effective only in the specific instance and for the specific purpose for which given. -12- 13 11. SEVERABILITY; HEADINGS. If any term of this Warrant as applied to any person or to any circumstance is prohibited, void, invalid or unenforceable in any jurisdiction, such term shall, as to such jurisdiction, be ineffective to the extent of such prohibition or invalidity without in any way affecting any other term of this Warrant or affecting the validity or enforceability of this Warrant or of such provision in any other jurisdiction. The Section headings in this Warrant have been inserted for purposes of convenience only and shall have no substantive effect. 12. ARBITRATION. In the event a dispute occurs with respect to any claim, dispute or other matter arising out of or relating to this Warrant, the parties hereto will promptly attempt to settle such dispute through consultation and negotiation in good faith and in a spirit of mutual cooperation. If agreement is reached concerning the resolution of such dispute, then such agreement shall be final, conclusive and binding on the parties hereto. If, on or before the tenth day after written notice of such dispute is given by one party to the other parties, such dispute has not been resolved by the agreement of all the parties, such dispute shall be settled by an expedited arbitration proceeding conducted in accordance with the then-current CPR Non-Administered Arbitration Rules and the Federal Rules of Evidence in Wilmington, Delaware by a panel of three arbitrators who shall have experience relating to the dispute or matter to be resolved. Each of the Company and the holder shall select an arbitrator, and those two arbitrators shall select a third arbitrator. The parties hereto shall provide such arbitrators with such information as may be reasonably requested in connection with the arbitration of such dispute and shall otherwise cooperate with each other and such arbitrators in good faith and with the goal of resolving such dispute as promptly as reasonably practicable. The arbitrators' decision and award with respect to the dispute referred to shall be final and binding on the parties hereto and may be entered in any court with jurisdiction, and the parties hereto shall abide by such decision and award. The cost of the arbitration proceeding and any proceeding in court to confirm or to vacate any arbitration award, as applicable (including, without limitation, attorneys' fees and costs), shall be borne by the unsuccessful party (if any) and shall be awarded as part of the arbitrators' award; provided however, that if the arbitrators do not find one party to be unsuccessful then the cost of the arbitral proceeding shall be paid equally by the parties hereto. [remainder of page intentionally blank] -13- 14 IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed as of the date first written above. SRS WOWCAST.COM, INC. By: /s/ THOMAS C. K. YUEN ------------------------------------ Name: Thomas C. K. Yuen Title: CEO Accepted and agreed: MICROSOFT CORPORATION By: /s/ AMAR NEHRU ------------------------------- Amar Nehru Corporate Development Vice President -14- 15 ANNEX A NOTICE OF EXERCISE (TO BE EXECUTED UPON PARTIAL OR FULL EXERCISE OF THE WITHIN WARRANT) The undersigned hereby irrevocably elects to exercise the right to purchase ___________ shares of Common Stock of [Company] covered by the within Warrant according to the conditions hereof and herewith makes payment of the Exercise Price of such shares in full in the amount of $____________________. By: --------------------------------------- (Signature of Registered Holder) Dated: ------------------------ 16 ANNEX B ASSIGNMENT FORM FOR VALUE RECEIVED the undersigned registered owner of this Warrant hereby sells, assigns and transfers unto the Assignee named below all of the rights of the undersigned under this Warrant, with respect to the number of shares of Common Stock set forth below: No. of Shares of Name and Address of Assignee Common Stock - ---------------------------- -------------- and does hereby irrevocably constitute and appoint ________ _____________ attorney-in-fact to register such transfer onto the books of [Company] maintained for the purpose, with full power of substitution in the premises. Dated: Print Name: -------------------------- ------------------------------ Signature: ------------------------------- Witness: --------------------------------- NOTICE: The signature on this assignment must correspond with the name as written upon the face of this Warrant in every particular, without alteration or enlargement or any change whatsoever. EX-27 5 FINANCIAL DATA SCHEDULE
5 3-MOS DEC-31-2000 JAN-01-2000 MAR-31-2000 21,086,022 7,814,662 3,297,163 862,825 2,446,185 30,371,023 2,560,791 1,340,594 42,483,415 13,046,255 0 0 0 12,399 29,424,760 42,483,415 6,623,473 7,190,552 4,848,701 6,754,369 0 (86,135) 139,028 (4,202,954) (138,093) (4,341,047) 0 0 0 (4,341,047) (.36) (.36)
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