SRS Labs 10-K 2009
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2008
Commission File Number: 0-21123
SRS LABS, INC.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act:
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The aggregate market value of the registrants voting common stock held by non-affiliates of the registrant was approximately $83,892,280 (computed using the closing price of $6.45 per share of common stock on June 30, 2008, as reported by the NASDAQ Stock Market).
As of February 2, 2009, 14,419,418 shares of the registrants common stock, par value $0.001 per share, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrants definitive proxy statement prepared in connection with the Annual Meeting of Stockholders to be held in 2009 are incorporated by reference in Part III of this Form 10-K.
SRS LABS, INC.
Annual Report on Form 10-K
As used herein, the Company, SRS Labs, SRS, we, us, or our means SRS Labs, Inc., its wholly-owned subsidiaries, SRSWOWcast.com, Inc., and Shenzhen Representative Office of SRS Labs, Inc., and for the applicable periods, its former subsidiary, ValenceTech Limited (collectively with its direct and indirect wholly-owned subsidiaries, Valence), and the former joint venture with Coming Home Studios LLC, CHS/SRS LLC. SRS®, Circle Surround®, Circle Surround II, CS Auto, Xspace 3D, SRS WOW®, SRS WOW XT, SRS WOW HD, SRS TruBass®, SRS FOCUS, SRS Headphone, SRS Dialog Clarity, SRS TruSurround® XT, TruSurround® HD, SRS 3D®, SRS Auto, VIP, TruSurround HD4, CircleCinema, iWOW, SRS Circle Surround Xtract, SRS Headphone 360, SRS Mobile HD, SRS Premium Sound, SRS TruChat, SRS TruGaming, SRS TruMedia, SRS TruTools, SRS TruVoice, SRS XTract, TruVolume, TruThunder, SRS TruSpeak, Cinema Sound, SRS Noise Reduction, SRS Audio Sandbox® and SRS Headphone Pro® are our U.S. trademarks. All other trademarks and trade names appearing are the property of their respective owners.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements in this Annual Report on Form 10-K contain forward-looking statements regarding our assumptions, projections, expectations, targets, intentions or beliefs about future events, which involve risks and uncertainties. All statements other than statements of historical facts included in this Annual Report, including statements relating to expectation of future financial performance and capital requirements, continued growth, changes in economic conditions or capital markets, changes in customer usage patterns and preferences and the impact of recent accounting pronouncements, are forward-looking statements. In some cases, you can identify forward-looking statements by terms such as may, will, should, expect, plan, intend, forecast, anticipate, believe, estimate, predict, potential, continue or the negative of these terms or other comparable terminology. The forward-looking statements contained in this Annual Report involve known and unknown risks, uncertainties and situations that may cause our or our industrys actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Factors that might cause actual events or results to differ materially from those indicated by these forward-looking statements may include the matters listed in this Annual Report, including, but not limited to, those listed under Risk Factors in Item 1A.
We are the recognized global leader in the practical application of psychoacoustics, the science behind how the human ear operates, and in the post processing segment of the market for audio delivery. Our award-winning audio enhancement technologies and solutions dramatically restore audio and voice to its natural state, the way it was originally recorded, in both dimension and clarity, thus providing a superior consumer experience for a wide variety of consumer electronic (CE) devices such as televisions, personal computers and mobile phones.
Our mission is to be the dominant worldwide provider of audio and voice solutions that allow consumers to effortlessly experience rich, natural sound, the way their ears were meant to hear it.
Our operations are conducted through SRS Labs, Inc., the parent company, and its wholly-owned subsidiaries, SRSWOWcast.com, Inc. and Shenzhen Representative Office of SRS Labs, Inc. (a Chinese company). Our business is focused on developing and licensing audio, voice and surround sound technology solutions to many of the worlds leading original equipment manufacturers (OEMs), software providers and semiconductor companies, and limited sales and marketing of standalone software and hardware products through the Internet.
Prior to September 29, 2006, we were also a developer and provider of application specific integrated circuits and standard integrated circuits through our former wholly-owned subsidiary, Valence.
Valence: Through our former subsidiary, Valence, we operated a fabless semiconductor business which developed, designed and marketed standard and custom analog integrated circuits, digital signal processors (DSPs), and mixed signal integrated circuits primarily to OEMs and original design manufacturers (ODMs) in the Asia Pacific region. On February 23, 2006, our Board of Directors (the Board) approved a plan to sell Valence in order to focus managements attention and financial resources on our licensing business. On July 14, 2006, we entered into a definitive Sale and Purchase Agreement to sell Valence to Noblehigh Enterprises Inc. The sale transaction was completed on September 29, 2006 and, accordingly, the results of the operations of Valence through the date of sale are included as discontinued operations in the accompanying consolidated statements of operations for all periods presented.
CHS/SRS LLC: In September 2004, we entered into a strategic alliance with Coming Home Studios LLC (CHS) to use and promote SRS Labs technologies, to promote CHS productions and to promote each companys respective brands. In connection with the strategic alliance, SRS and CHS established a joint venture, CHS/SRS, LLC (the Joint Venture), to produce and distribute nine concert videos featuring our Circle Surround technology. On February 23, 2006, the Board authorized management to take all reasonable steps to divest our entire equity interest in the Joint Venture. On June 30, 2006, we completed the sale of our interest in the Joint Venture to CHS and, accordingly, the results of the operations of the Joint Venture through the date of sale are included as discontinued operations in the accompanying consolidated statements of operations for all periods presented.
Further financial information for mix of revenues by market sectors, geographic areas and customer concentration is included in this Annual Report on Form 10-K under Item 8. Financial Statements and Supplemental Data and in Notes 1 and 8 to the Notes to Consolidated Financial Statements. Reference also is made to Item 1A. Risk Factors for a discussion relating to certain risks relating to our business.
We were incorporated in the State of California on June 23, 1993 and reincorporated in the State of Delaware on June 28, 1996. Our executive offices are located at 2909 Daimler Street, Santa Ana, California 92705. Our telephone number is (949) 442-1070.
Our Products and Technologies
Our licensing business is focused on developing and marketing audio rendering, voice and surround sound technologies and solutions to OEMs, ODMs, semiconductor manufacturers, and software providers in the home entertainment, personal computers, personal telecommunications, automotive, portable media devices and broadcast markets. Our portfolio of licensable technologies includes a wide range of techniques for the processing and delivery of audio, voice and surround sound, including the following:
· Surround SoundOur surround sound technologies include SRS TruSurround XT, TruSurround HD, TruSurround HD4, Circle Surround, Circle Surround II and Circle Surround Automotive. Circle Surround, is a complete encoding and decoding format. Circle Surround encoding enables the distribution of up to 6.1 channels of audio over existing two-channel carriers such as digital media files, standard definition and high-definition television, FM radio and CDs. Circle Surround decoding decodes Circle Surround encoded material for multi-channel playback or creates up to 6.1 channels of audio from older formats of material, including mono, stereo, 4-channel surround or other matrix surround formats.
· Audio RenderingOur audio rendering technologies optimize device audio output and enable the presentation of 3D and multichannel audio content over two speakers. These technologies include the ability to render 5.1 multichannel content over two speakers, to create a wider sound stage for more natural audio, to improve the perceived bass response in small speakers, to dynamically position audio sources in a virtual 3D space using headphones, and to reposition the audio image for non-optimally placed speakers. Our audio technologies include SRS Xspace 3D, SRS WOW, SRS WOW XT, SRS WOW HD, SRS TruBass, SRS FOCUS, SRS Headphone, SRS DialogClarity, TruVolume (also known as VIQ), and SRS 3D Sound.
· Voice ProcessingOur TruVoice (also known as VIP and VIP+) and Noise Reduction technologies dramatically reduce noise to produce a much clearer and crisper dialog over wireless communication devices and improve the intelligibility of the human voice in a variety of listening situations, including high ambient background environments.
· Solutions SuiteOur solutions suites combine several of our technologies in order to deliver a comprehensive, easier to deploy package of post processing audio enhancement products. Solution suites also enable us to impact the performance of the OEM products by employing multiple technologies and techniques to enhance and control the overall audio fidelity and performance of the product. Our solution suites include SRS Premium Sound and SRS Premium Voice for personal computers, TruMedia, TruVoice, and TruTools for mobile phones, and CinemaSound for home entertainment products among others
Our portfolio of technologies and solution suites addresses a broad spectrum of product applications within the vertical markets that we have targeted. Our technologies may be implemented in a variety of methods, including discrete analog components, chip modules, analog semiconductors, digital signal processors (DSPs) and software. These various implementation options offer customers flexibility when incorporating our technologies into products.
Our Customers and Markets
We license our technologies both in the U.S. and internationally. The following table presents our revenue by geographic area. Licensing-related revenue is summarized based on the location of the licensees corporate headquarters. For standalone software and hardware product and online sales, revenue is allocated to the Americas.
Through our licensing business, we market our portfolio of technologies and solution suites to the following markets: home entertainment, personal computers, personal telecommunications, automotive and portable media devices. Our license agreements typically have multi-year or automatic renewal terms, and either require: (a) per-unit royalty payments for all products implementing our technologies and/or solutions; (b) fixed annual or quarterly royalty payments; or (c) a minimum fixed annual or quarterly royalty payment, which allows the licensee to ship up to a predetermined number of units during the specified time period with additional per-unit royalty payments thereafter. The license agreements also generally specify the use of our trademarks and logos on the product, within the packaging and in the users manual, and require our review and approval of the product to guarantee the quality of the technology implementation and the correct usage of our logos and trademarks. We believe these terms ensure the quality and consistency of the technology and elevate the awareness of the SRS brand in the marketplace. We also sell some of our products and solutions via the Internet. Revenues associated with those sales are recognized upon shipment have not historically been material.
The following chart shows the percentage of our licensing revenue we received in 2008 and 2007 from each of these markets.
Home entertainment products represent the largest current market for our technologies and have, in recent years, been the largest revenue contributor. Manufacturers in this market utilize our technologies and solutions to improve functionality and product performance and/or to differentiate their products from their competitors. In many instances, manufacturers license multiple technologies from us for multiple product lines and divisions. Product categories within this market include flat panel televisions (such as LCD and Plasma televisions) and set-top boxes (STBs).
Televisions. Our audio technologies and solution suites are widely used by television manufacturers as a solution to audio challenges that manufacturers encounter in todays flat panel television designs and/or as a differentiating feature. As television makers continue to migrate to models with thinner digital displays, they are finding that they have less room for speakers, which may compromise the overall audio quality of the television. We provide manufacturers with patented solutions for accurately presenting surround sound, improving bass response, increasing dialog clarity, automatic volume control, and creating a more natural sound stage. These solutions improve the audio quality of the television set without the expense of additional equipment or designing for larger speakers. During 2008, we signed contracts to license audio enhancement technologies to Vizio, General Displays and Technologies, TCL Electronics Ltd and Nexgen Mediatech, among others.
Set-top Boxes. Although STBs receive and present surround sound content, they are typically connected to televisions with two-channel speakers. Our SRS TruSurround XT technology creates a surround sound experience over any existing two-speaker system, including the internal speakers of a television. This technology also creates a virtual surround experience from stereo material. Our TruVolume technology creates a level volume user experience to offset decibel fluctuations during channel changes, changes among different input devices and changes between the program and commercial.
MP3 (audio) and MP4 (audio and video) players and other portable media players enable consumers to enjoy audio and video content while on the go. The audio contents are stored in a compressed industry standard MP3 audio standard. As such, when the contents are decoded and played back through miniature earphones, the contents generally suffer loss of audio quality. Our technologies, such as SRS WOW and SRS WOW HD, are capable of improving the audio quality during playback. Our Mobile HD technologies also enable rendering of surround sound through earphones when playing back surround sound encoded contents often used along with contemporary video contents. Associated with the increasing popularity of MP3 and MP4 players, there has been a noticeable growth in the market for accessories, such as portable media adapters, docking stations and miniature speaker systems. The small footprint of these devices limits speaker size and speaker spacing. Our solutions enable vendors of these devices to increase the quality of their audio output generally without increasing hardware component costs.
We provide the personal telecommunications market (mobile phones) with both voice and audio rendering technologies and solution suites. Mobile phones are incorporating more multimedia features and functionality at a rapid pace. New services include digital music downloads, ring-tones and true-tones, streaming video, gaming and television viewing. Our strong presence in the home entertainment market, our suite of voice technologies, and our entry into the mobile market with customers like NEC present growth opportunities for us. Our solutions address specific needs in the mobile market. For example, our technologies address needs like voice intelligibility in noisy environments, clarity of dialog in video content, poor bass-response of small speakers, hampered stereo imaging in narrow-set speakers, and 3D positioning audio for interactive gaming. Our technologies are licensed by telecommunications companies such as Motorola, Samsung and NEC.
We have invested in research to create solutions specific to the needs of the automotive market. Within vehicles, audio and video content is played from multiple sources and then presented on both speakers and headphones. Stereo content from sources like CDs, MP3 players, mobile television and radio needs to be presented on multiple speakers in the car, some of which may not be optimally placed and may not have strong bass response. Surround sound content from DVDs, radio and downloaded music needs to be rendered on both car speakers and on rear-seat headphones with a maximum sweet spot. Our automotive solutions such as SRS CS Auto, SRS Circle Surround II and SRS TruSurround XT meet these needs and provide manufacturers in this segment with a fully tunable solution. Our technologies are licensed by companies such as Fujitsu-ten, Panasonic, Clarion and Kenwood and used on automobiles manufactured by companies such as Toyota, Subaru, Nissan and Honda.
Personal computers (PCs) and in particular mobile PCs such as laptops, notebooks and the new genre of Ultra Mobile Devices (also known as netbooks) have become very popular as more users utilize their PCs as their main entertainment device at home or on the go. At home, PCs are often used as media hubs. PC users can enjoy and manage collections of music and movies, along with downloaded and recorded television programming. This content is now being distributed through the home using networked media adapter products. Throughout these systems, there is a need for optimizing playback on the computer speakers, presenting a closer assimilation to a typical home theater experience but on a laptop including transmitting surround sound around the home and enjoying content on headphones. On the go, users have to rely on the audio output capabilities of their PCs which are often inadequate given the inherent challenges in todays tiny PC enclosures. We believe our technology solutions are well positioned to fill the need to deliver better sound, with deeper base, clarity and volume. During 2008, we signed contracts to provide audio enhancement technology suites to Hewlett Packard, NEC, and BenQ, among others.
For fiscal year 2008 and 2007, Samsung accounted for approximately 42% and 28%, respectively, of our consolidated revenues. For fiscal year 2006, Samsung and Sony each accounted for approximately 17% and 11% of our consolidated revenues, respectively. Given the significant amount of revenues derived from Samsung, the loss of such customer or the uncollectibility of related receivables could have a material adverse effect on our consolidated financial condition and consolidated results of operations. During 2007, we were informed by Sony that they were no longer using our technology in the majority of their televisions. We are working with Sony to re-establish this relationship; however, we cannot guarantee that we will be successful in regaining any significant business from Sony.
Our sales strategy is to identify high-growth markets, develop needed technology solutions and features, and work with software and semiconductor platform partners to make these technologies widely available and easy to implement by OEMs and ODMs. We believe that we will continue to strengthen our market position as the leader in audio and voice technologies by employing the strategy of providing a stream of patented audio and voice technologies, penetrating new licensing accounts, expanding relationships with existing licensees, creating a broad platform of software and semiconductor partners, and developing strong awareness of the SRS brand.
The mission of our licensing platform efforts is to achieve broad coverage for our technology solutions within all of our targeted product markets in order to expand sales and licensing opportunities. By developing strong relationships with leading software and semiconductor companies, we believe our audio technologies and solution suites can be delivered to customers worldwide across high growth and high volume product applications.
We work together with our platform partners (leading semiconductor manufacturers and middleware or firmware software providers) to provide our mutual customers with the technology that best fits their needs. We also together solicit other new customers to consider using the platform. Many times, a platform will become enabled with our technology due to customer requests.
As a technology licensing company, the strength of our brand is an important asset. Since brand recognition drives licensing sales, we have invested in strategies designed to increase consumer awareness of SRS Labs with the ultimate goal of establishing our brand with both product manufacturers and consumers around the world as a recognized symbol for high-quality audio. The four primary vehicles that we use to further the proliferation of our brand are: (a) placement of the SRS logo by OEMs on products and in co-marketing programs; (b) public relations and New Media outreach programs; c) online branding programs; and (d) use, and recognition of use, of SRS technology by content and broadcast professionals
OEM Marketing Programs. In the majority of products that use SRS technologies, our logo is either prominently displayed on the product itself or, in the case of software products and mobile phones, featured in the graphical user interface. We believe this logo exposure is a key tool in reaching consumers worldwide. In addition, we work with our OEM customers as they prepare for launching new products that feature SRS technologies by supplying complete SRS corporate and technology tool kits with a wide array of material, including SRS logos, illustrations, technology explanations and suggested demonstration material.
Public Relations (PR) and New Media Outreach Programs. We believe in the endorsement power of opinion leaders and expert groups in the CE and IT industries. As such, we have an active and expanding PR program, both online and in print, to promote SRS technologies and solutions found in our own products or products of OEMs that feature SRS technologies and solutions. Similarly, we have found the viral nature of the New Media very effective in promoting our brand and innovations and therefore, have recently focused on multiple programs to systematically reach and work with bloggers and relevant social networks.
Online Branding Programs. Online exposure has also been an important part of our branding strategy. One benefit of our relationship with Microsoft is that the SRS logo displayed in the audio control panel of Microsofts Windows Media Player links to an SRS technology page. As a result, we have received significant traffic and opportunities to create brand awareness with consumers and educate consumers on the benefits of our technology. Our online efforts also include the direct sale of the iWOW family of products including plug-in software for both the PC and Mac platforms, as well as a unique adapter for the Apple iPod. Revenue from the sale of these products has not been significant historically, but we believe gives us a valuable demonstration platform to showcase our audio technologies.
Use of SRS Technology by Content and Broadcast Professionals. We develop, license and sell professional hardware and software products to enable content companies, broadcasters and music publishers to encode their material using our Circle Surround technology. When Circle Surround is professionally used, the SRS and Circle Surround logos are often displayed within the content itself, on the packaging material or, in the case of radio, an announcement that the broadcast is being delivered in SRS Circle Surround. We have concentrated on three key market sectors in the professional audio space: television, radio and music; and we have developed a line of hardware and software products to address these markets. These products are sold directly to professional customers and are also available from selected dealers and distributors servicing the professional audio and broadcast markets. We did not generate significant revenue from the sale of professional hardware equipment in 2008; however, we believe that these facilitate the licensing of our technology to OEMs that benefit from enhanced audio transmissions.
Sales and Marketing
We have two primary types of revenue agreements with our licenseesdirect and non-direct. Under a non-direct agreement, royalty revenue may be collected by our platform partner, who include and enable our technology within their solution, at the time the chip is sold to an OEM or ODM. The platform partner remits the royalty to us on behalf of the licensee. Most often, however, we license our technologies to OEMs and ODMs under direct agreements and collect revenue directly from them. These licensing arrangements with OEMs or ODMs authorize them to design, build and sell products containing our technology. Under this licensing approach, the licensees are free to choose a semiconductor solution from the platform partner that best suits their technical and cost requirements. We receive royalties directly from the licensed OEM or ODM for the use of our technologies in licensed products manufactured and shipped by the OEM or ODM. Many major OEMs have licenses or purchase products manufactured by a licensed ODM for the use of one or more of our technologies and for the use and display of our trademarks.
Our process for selecting particular platform partners for distributing our technologies is based on several criteria including: (a) segment leadershipwe target platform partners that hold preeminent positions in market segments characterized by high growth, volume and/or margins; (b) volumewe seek platforms that will maximize exposure of our technologies to a large number of potential OEMs; (c) synergywe seek platforms which serve to position our technologies with compatible and additive technologies for integrated delivery; and (d) convergence potentialwe target arrangements that will enable us to establish a presence on platforms that intersect several functional features.
To implement our licensing sales strategy within our identified markets, we have established a direct sales force and an international network of independent sales agents. In North America, we employ a direct sales force to market our portfolio of audio and voice technologies to the OEM community. Internationally, we maintain offices in Japan, Taiwan, China, Spain and Korea to support our multi-national OEM customers. We actively promote the use of our trademarks and logos and require customers to prominently display the appropriate SRS technology or solution logos on products and packaging and in advertising. We plan to continue to work closely with our licensees to enhance their success in selling finished products and semiconductor products that incorporate our technologies through a variety of licensee support programs. These programs include engineering support, sales training, tradeshow support, publicity and media relations programs, customized marketing materials, advertising, and support at speaking engagements and industry conferences, as well as, conducting in-person technology demonstrations or presentations for the press and other companies to promote our technologies and products.
We also regularly participate in tradeshows and conferences to increase awareness of who we are and what we do and to market our technologies and products. We work closely with our licensees and platform partners to actively explore additional opportunities to place our technologies in new products and/or markets.
Research and Development
We license our products in markets that are characterized by rapidly changing technology and continuous improvements in products and services. Our research and development expenditures in 2008, 2007 and 2006 were $3,747,495, $3,107,482 and $2,572,577, respectively. These expenses generally consist of salaries and related costs of employees and consultants engaged in ongoing research, design and development activities and costs for engineering materials and supplies.
As of December 31, 2008, we had 20 employees in our research and development group, representing 36% of our total employees. Our software, hardware and application engineers focus on developing intellectual property, technology solutions and consumer products. All engineers are based in the U.S. and support our licensing business.
Competition in the audio, voice and surround sound technology licensing business includes other licensing companies who offer competing technologies as well as the internal engineering departments of our current or prospective licensees, who may develop audio technologies for use in their own products.
In the field of audio improvement, we compete directly with other audio providers, including Dolby, DTS and Emersys. Additionally, some of our OEM customers maintain their own audio improvement technologies. Because our audio technologies work with any existing recorded material, whether mono, stereo or surround sound, most of our audio technologies can be used either as an alternative or as a complement to most competing audio technologies.
Many of our competitors have, or may have, substantially greater resources than us to devote to advancing their existing technologies and developing and marketing new products and technologies. We believe that we compete based primarily on the quality, efficiency, and performance of our proprietary technologies, brand name awareness, the ease, customization capabilities, and cost of implementing our technologies, the ability to meet OEMs needs to differentiate their products, and the strength of our licensee relationships. We believe we compete favorably based on these factors; however, we cannot guarantee that we will continue to be competitive with the existing or future products or technologies of our competitors.
Intellectual Property Rights and Proprietary Information
We operate in industries where innovation, investment in new ideas and protection of intellectual property rights are important for success. We rely on a variety of intellectual property protections for our products and services, including patent, copyright, trademark and trade secret laws and contractual obligations. We pursue a policy of enforcing such rights. We cannot guarantee, however, that our intellectual property rights will adequately protect our competitive position or that competitors will not be able to produce non-infringing competitive products or services. We cannot guarantee that third parties will not assert infringement claims against us, or that if required to obtain any third party licenses as a result of an infringement dispute, we will be able to obtain such licenses.
In order to protect the underlying technology concepts, we have filed and/or obtained patents for all of our marketed technologies including technologies marketed under the following trademarks: TruSurround XT, Circle Surround, SRS WOW, TruVoice, TruMedia and TruVolume. In addition, we have numerous issued patents and patents pending for speaker and other acoustic reproduction technologies. We pursue a general practice of filing patent applications for our technologies in the United States and various foreign countries where our licensees manufacture, distribute or sell licensed products. We continue to update and add new applications to our patent portfolio to address changing worldwide market conditions and our new technological innovations. The range of expiration dates for our patents extend between the years 2009 to 2018. We have multiple patents covering unique aspects and improvements for many of our technologies. Accordingly, the expiration of any single patent should not significantly affect our intellectual property position or the ability to generate licensing revenue.
We also routinely file U.S. federal and foreign trademark applications for the various word names and logos used to market our technology solutions to licensees and the general public. The duration of the U.S. and foreign registered trademarks can typically be maintained indefinitely, provided that proper maintenance fees are paid and the trademarks are continually used or licensed by us.
Due to the dependence on the consumer electronics market, we experience seasonal fluctuation in sales and earnings. In particular, we believe that our business experiences seasonality relating to the holiday season, resulting in higher revenues in the fourth and first quarters. As we have moved toward diversifying our key market segments in the consumer electronics industry, we expect our business to be less seasonal.
As of December 31, 2008, we employed 55 persons, including 12 in finance and administration, 20 in research and development, engineering and product development, and 23 in sales and marketing. None of our employees are covered by a collective bargaining agreement or are presently represented by a labor union. We have not experienced a work stoppage and believe we have good relations with our employees.
Our Internet address is www.srslabs.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, are available free of charge on our website as soon as reasonably practicable after we electronically file such material with or furnish it to the Securities and Exchange Commission (SEC). Our SEC reports can be accessed through the investor relations section of our website. Additionally, the Companys Code of Ethics and Committee Charters are available on our website. The information found on our website is not incorporated in and is not part of this or any other report we file with or furnish to the SEC.
You should carefully consider the risk factors described below, as well as the other information included in this Annual Report on Form 10-K, prior to making a decision to invest in our securities. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known or that we currently believe to be less significant may also adversely affect us.
We are exposed to risks in our licensing business related to product and customer concentration.
Currently, we generate a majority of our revenue in the home entertainment market, principally through the inclusion of SRS technology inside flat panel LCD and plasma televisions. We expect that the consumer home entertainment market will continue to account for a significant portion of our licensing revenues for the foreseeable future. In addition to significant fluctuations in consumer spending on consumer electronic products, retail prices for certain consumer electronics products that include our audio technology have decreased significantly. We expect that this trend will continue for the foreseeable future. In addition, from time to time, certain of our OEM and semiconductor manufacturer customers may account for a significant portion of our revenues. For example, for the year ended December 31, 2008, Samsung accounted for approximately 42% of our consolidated revenues. These manufacturers could develop their own technologies or decide to exclude our audio rendering technology from their products altogether in an effort to reduce cost. For example, during 2007, we were informed by Sony that they were no longer using our technology in the majority of their televisions. The loss of any key customer could have a material adverse affect on our financial condition and results of operations.
General economic conditions may reduce our revenues and harm our business.
Our business is exposed to adverse changes in general economic conditions, because products that incorporate our technologies are entertainment-oriented and generally discretionary goods. The current slowdown or decline in U.S. and foreign economic growth has adversely affected consumer confidence, disposable income and spending. As a result, sales by our licensees of consumer electronics and other products incorporating our technologies may not grow as rapidly as in prior periods or may even decrease, which could adversely affect our licensing revenue.
Our business is highly dependent on the consumer electronics market, which is characterized by short product life cycles, fluctuations in demand and seasonality, and is subject to risks related to product transitions and supply of other components.
The consumer electronics market is characterized by intense competition, rapidly evolving technology, and ever-changing consumer preferences. These factors result in the frequent introduction of new products, short product life cycles and significant price competition. As a result, we may need to develop new products or technologies to integrate with the new
products and technologies developed by our customers. If we are unable to develop the necessary technologies to meet the changing needs of our customers or provide such technologies at competitive prices, our customers may reduce their use of our technologies and our revenues may decline. In addition, the dynamic nature of this market limits our ability and the ability of our customers to accurately forecast quarterly and annual sales. If we, or our customers, are unable to adequately manage product transitions, our business and results of operations could be negatively affected.
We depend on the sale by our licensees of products that incorporate our technologies, and a reduction in those sales would adversely affect our licensing revenue.
We derive most of our revenue from the licensing of our technologies to consumer electronics product manufacturers. We do not manufacture consumer electronics products ourselves and our licensing revenue is dependent on sales by our licensees of products that incorporate our technologies. We cannot control these manufacturers product development or commercialization efforts or predict their success. In addition, our license agreements, which typically require manufacturers of consumer electronics products and media software vendors to pay us a specified royalty for every electronics product shipped that incorporates our technologies, do not require these manufacturers to include our technologies in any specific number or percentage of units, and only a few of these agreements guarantee us a minimum aggregate licensing fee. Accordingly, if our licensees sell fewer products incorporating our technologies, decline to actively market products incorporating our technologies or otherwise face significant economic difficulties, our revenue will decline. Changes in consumer tastes or trends, changes in industry standards or adverse changes in business and economic conditions may also adversely affect our licensing revenue.
Pricing pressures on the consumer electronics product manufacturers, who incorporate our technologies into their products, could limit the licensing fees we charge for our technologies, which could reduce our revenues.
The markets for the consumer electronics products in which our technologies are incorporated are intensely competitive and price sensitive. Retail prices for consumer electronics products that include our technologies have decreased significantly, and we expect prices to continue to decrease for the foreseeable future. In response, manufacturers have sought to reduce their product costs, which can result in downward pressure on the licensing fees we charge our customers who incorporate our technologies into their products. Alternatively, our customers may seek to eliminate our technologies in their products in favor of internally developed technologies. A decline in the licensing fees we charge could materially and adversely affect our operating results.
We face intense competition from companies with greater brand recognition and resources.
The digital audio, consumer electronics and entertainment markets are intensely competitive, subject to rapid change, and significantly affected by new product introductions and other market activities of industry participants
Many of our current and potential competitors enjoy notable competitive advantages, including:
· greater name recognition;
· a longer operating history;
· more developed distribution channels and deeper relationships with consumer electronics products designers and manufacturers;
· a more extensive customer base;
· broader product and service offerings;
· greater resources for competitive activities, such as research and development, strategic acquisitions, alliances, joint ventures, sales and marketing, and lobbying industry and government standards; and
· more technicians and engineers.
As a result, these current and potential competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards, or customer requirements.
Inaccurate licensee royalty reporting and unauthorized use of our intellectual property could materially adversely affect our operating results.
Our licensing revenue is generated primarily from consumer electronics product manufacturers who license our technologies and incorporate them in their products. Under a significant percentage of our existing arrangements, these licensees typically pay us a specified royalty for every product they ship that incorporates our technologies. We rely on our licensees to accurately report the number of units shipped that incorporate our technologies. We calculate our license fees, prepare our financial reports, projections and budgets, and direct our sales and product development efforts based on these reports we receive from our licensees. However, it can be difficult for us to independently determine whether or not our licensees are reporting shipments accurately. This is especially true with respect to software incorporating our technologies because software can be copied relatively easily and we often do not have easy ways to determine how many copies have been made. Most of our license agreements permit us to audit our licensees records, but audits are generally expensive and time consuming and initiating audits could harm our customer relationships. We expect that we will continue to be subject to understatement and non-reporting of royalty bearing revenues by licensees, which could adversely affect our operating results. Conversely, to the extent that our licensees overstate the number of products incorporating our technologies, negative corrections could result in reductions of royalty revenue in subsequent periods. Some of our licensees may begin to more closely scrutinize their past licensing statements which may result in an increased receipt of negative corrective statements.
We also may experience problems with non-licensee consumer electronics product manufacturers and media software vendors, particularly in emerging economies, incorporating our technologies or incorporating our technologies and trademarks into their products without our authorization and without paying us any licensing fees. This unauthorized use of our intellectual property could adversely affect our operating results.
Our business and future prospects depend upon the strength of our brand. Awareness of our brand depends to a significant extent upon decisions by our customers to display our trademarks on their products, and if our customers do not display our trademarks on their products, our ability to increase our brand awareness may be harmed.
Because we engage in relatively little direct brand advertising, the promotion of our brand depends upon consumer electronics industry participants displaying our trademarks on their products that incorporate our technologies. Although we do generally require our customers to place our brand on their products, some are not required to do so. Maintaining the SRS brand and our position as an industry standard is critical to maintaining and expanding our licensing revenues and entering into new or broadening existing licensing relationships. If our customers choose for any reason not to display our trademarks on their products, our ability to maintain or increase our brand awareness may be harmed, which would have an adverse effect on our business and prospects. In addition, if we fail to maintain high quality standards for our products, or the products that incorporate our technologies through the quality control evaluation process that we require of our licensees, the strength of our brand could be adversely affected.
Licensee products that incorporate our technologies, from time to time, experience quality problems that could damage our brand, decrease revenues and increase operating expenses.
Licensee products that incorporate our technologies often are complex and sometimes contain undetected software or hardware errors, particularly when first introduced or when new versions are released. In addition, those products are often combined with, or incorporated into, products from other companies, sometimes making it difficult to identify the source of a problem. Any negative publicity or negative impact relating to these product problems (even if unrelated to our technologies) could adversely affect the perception of our brand. In addition, these errors could result in loss of, or delay in, market acceptance of those products or our technologies, or cause delays in delivering them and meeting customer demands, any of which could reduce our revenue and raise significant customer relations issues. Although we generally attempt to contractually limit our liability for our licensees defective products, we may elect to help reengineer those products, which could increase our expenses and adversely affect our operating results.
We are subject to risks associated with substantial international operations.
We conduct sales and customer support operations in a number of countries throughout the world that require refinement to adapt to the changing market conditions on a regional basis. In addition, many of our significant customers are headquartered in the Asia Pacific region, particularly Korea and Japan. Approximately 88%, 90% and 91% of our revenues were derived from customers with headquarters located in the Asia Pacific markets during the years ended December 31, 2008, 2007 and 2006, respectively. We expect to continue to derive a significant portion of our revenues from sales to customers in these markets for the foreseeable future. Also, a substantial number of products incorporating our technologies are manufactured, assembled and tested by third parties in Asia. As a result, we are subject to a number of risks of conducting
business outside of the United States, any of which could have a material adverse impact on our business and results of operations, including:
· global economic downturn;
· political, social and economic instability, and the risk of war, terrorist activities or other international incidents in Asia and elsewhere abroad;
· currency fluctuations;
· difficulties and costs of staffing and managing foreign operations;
· unexpected changes in, or impositions of, government requirements;
· adverse changes in tariffs and other protectionist laws and business practices that favor local competitors;
· potentially longer payment cycles and greater difficulty in collecting receivables from foreign entities;
· the burdens of complying with a variety of non-U.S. laws and reduced protection of our intellectual property in some countries;
· potentially adverse tax consequences and the complexities of foreign value added tax systems; and
· other factors beyond our control, including natural disasters and major health concerns.
We have a long and unpredictable sales cycle, which can result in uncertainty and delays in generating additional revenues.
Historically, because of the complexity of our technologies, it can take a significant amount of time and effort to explain the benefits of our technologies to potential new customers and to negotiate a sale. For example, it typically takes six to nine months after our first contact with a prospective customer before we start licensing our technology to that customer and another six to nine months to begin generating revenues. In addition, purchases of our products are usually made in connection with new design starts by our customers, the timing of which is outside of our control. Accordingly, we may be unable to predict accurately the timing of any significant future sales of our products. We may also spend substantial time and management attention on potential license agreements that are not consummated, or in which the consumer electronic product ultimately does not sell in large quantities, thereby foregoing other higher revenue opportunities.
If our patents and other intellectual property rights do not adequately protect our products, we may lose market share to our competitors and be unable to operate our business profitably.
Our ability to compete may be affected by our ability to protect our proprietary information. We have filed numerous U.S. and foreign patent applications and to date have a number of issued U.S. and foreign patents covering various aspects of our technologies. We cannot guarantee that the steps taken by us to protect our intellectual property will be adequate to prevent misappropriation of our technology or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology. In addition, the laws of certain foreign countries may not protect our intellectual property rights to the same extent as do the laws of the U.S. It is possible that third parties may assert claims or initiate litigation against us or our customers with respect to existing or future products. In addition, we may initiate claims or litigation against third parties for infringement of our proprietary rights or to determine the scope and validity of our proprietary rights. Litigation in the technology industry is common. Claims and litigation brought against us or initiated by us could be costly and time consuming and could divert our management from our business. The outcome of any litigation is uncertain and could require us to pay significant damages or could prevent us from licensing some or all of our technologies, which could significantly harm our business and results of operations.
If we lose the services of our key personnel, or if we are unable to attract and retain other key personnel, we may not be able to manage our operations or meet our growth objectives.
Our future success depends to a large extent upon the continued service of key personnel, including engineering, sales and administrative staff. We anticipate that any future growth will require us to recruit and hire a number of new personnel in engineering, operations, finance, sales and marketing. Competition for such personnel can be intense, and it is possible that we may not be able to recruit and retain necessary personnel to operate our business and support future growth.
The market price of our common stock is volatile and your investment in our common stock could suffer a decline in value.
The trading price of our common stock has been, and will likely continue to be, subject to wide fluctuations in response to quarterly variations in our operating results, announcements of new products or technological innovations by us or our competitors, strategic alliances between us and third parties, general market fluctuations and other events and factors. Changes in earnings estimates made by brokerage firms and industry analysts relating to the markets in which we do business, or relating to us specifically, have in the past resulted in, and could in the future result in, an immediate and adverse effect on the market price of the common stock. Even though our stock is quoted on the NASDAQ Global Market, our stock has had and may continue to have low trading volume and high volatility. The historically low trading volume of our stock makes it more likely that a severe fluctuation in volume, either up or down, will significantly impact the stock price. Because of the relatively low trading volume of our stock, our stockholders may have difficulty selling our common stock. In addition, the stock market in general, and the NASDAQ Global Market and the market for technology and small market cap companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Further, the market prices of securities of technology companies have been particularly volatile. These broad market and industry factors may materially harm the market price of our common stock, regardless of our operating performance.
Our certificate of incorporation and bylaws as well as Delaware law contain provisions that could discourage transactions resulting in a change in control, which may negatively affect the market price of our common stock.
Our certificate of incorporation, our bylaws and Delaware law contain provisions that might enable our management to discourage, delay or prevent a change in control. In addition, these provisions could limit the price that investors would be willing to pay in the future for shares of our common stock.
Our worldwide headquarters are located in Santa Ana, California, in a 23,400 square foot facility consisting of office and warehouse space. The lease for the facility expires in May 2013. We lease this facility from Daimler Commerce Partners, L.P., the general partner of which is Conifer Investments, Inc. (Conifer). The sole shareholders of Conifer are Thomas C.K. Yuen, our Chairman, Chief Executive Officer and President, and his spouse, Misako Yuen, as co-trustees of the Thomas Yuen Family Trust. Mr. and Mrs. Yuen also serve as the executive officers of Conifer. Mr. and Mrs. Yuen, as co-trustees of the trust, beneficially own a significant amount of our outstanding shares of common stock. We paid the Daimler Commerce Partners rent of $235,170, $230,256, and $230,256 in 2008, 2007, and 2006, respectively. We believe the terms and conditions of the lease are competitive based on a review of similar properties in the area with similar terms and conditions.
Additionally, we entered into three new leases in 2008 for our international operations in Taiwan, China, and Japan. The leases for our offices in Taiwan and Japan expire in April 2009 and October 2009, respectively, and the lease term for our office in China expires in April 2013. In total, we paid rent of $294,702, $230,256 and $230,256 during 2008, 2007 and 2006, respectively, for all of our facilities. We believe that our current facilities are adequate to support our current requirements.
On June 8, 2007, we sent a letter to Sony Corporation (Sony) relating to the possible infringement of several SRS patents by Sonys S-Force technology. Sony responded to the letter by filing a Complaint for Declaratory Relief in the U.S. District Court in the Southern District of New York on July 6, 2007. In November 2007, Sony and SRS entered into a standstill agreement for the purpose of conducting discussions towards an amicable resolution of the dispute, and the Complaint for Declaratory Relief was dismissed. While the standstill agreement has expired, the parties continue to negotiate regarding this matter. In October 2008, the outside patent counsel hired to evaluate the Sony S-Force technology informed us that they had completed their evaluation based on the information provided by Sony. Based on their study, they confirmed
our position that the S-Force technology infringes our patents. The basis for this infringement position has been provided to Sony for their review. We cannot assure you that we will prevail in this matter and are unable to determine at this time the impact that this matter may have, if any, on our consolidated financial position, results of operations or cash flows.
From time to time, we may be involved in other litigation matters and disputes arising in the normal course of business. Any such matters and disputes could be costly and time consuming, subject us to damages or equitable remedies, and divert our management and key personnel from our business operations.
Market for Common Stock
Our common stock trades on the NASDAQ Global Market under the symbol SRSL. The table below reflects the high and low sales prices of our common stock as reported by The NASDAQ Stock Market for the periods indicated.
At February 2, 2009, the closing sale price of our common stock was $4.98 per share.
At February 2, 2009, there were 399 stockholders of record.
We have never paid cash dividends on our common stock. We currently intend to retain our available funds for future growth and, therefore, we do not anticipate paying any dividends in the foreseeable future.
Securities Authorized for Issuance Under Equity Compensation Plans
The following equity compensation plans have been approved by our stockholders: the SRS Labs, Inc. Stock Option, Nonqualified Stock Option and Restricted Stock Purchase Plan (the 1993 Plan), the SRS Labs, Inc. Amended and Restated 1996 Long-Term Incentive Plan (the 1996 Plan), the SRS Labs, Inc. Amended and Restated 1996 Non-employee Directors Stock Option Plan (the Non-employee Directors Plan) and the SRS Labs, Inc. 2006 Stock Incentive Plan (the 2006 Plan). A description of the material features of each of these plans is included in Note 7 to the Notes to Consolidated Financial Statements under the caption Stock Award/Option Plans/Warrants. The 1993 Plan expired on December 10, 2003 and no options or other rights to acquire equity are outstanding under that plan. On June 22, 2006, our stockholders voted to approve the 2006 Plan, and to discontinue the issuance of any awards under the 1996 Plan. We do not have any equity compensation plans other than those approved by our stockholders. The following table sets forth information regarding the number of shares of our common stock that may be issued pursuant to our equity compensation plans or arrangements as of December 31, 2008.
Equity Compensation Plan Information
(1) Represents shares of common stock that may be issued pursuant to outstanding options granted under the following plans: 1,344,698 shares under the 1996 Plan, 147,500 shares under the Non-employee Directors Plan and 1,387,340 shares under the 2006 Plan.
(2) Represents shares of common stock that may be issued pursuant to future grants under the following plans: 310,000 shares under the Non-employee Directors Plan and 1,862,660 shares under the 2006 Plan.
Issuer Purchases of Equity Securities
On November 3, 2008, our Board of Directors approved a stock repurchase program. Under the stock repurchase program, we may acquire up to $15.0 million of our outstanding common stock. The stock repurchase program commenced November 7, 2008 and is expected to continue for a six month period. As of December 31, 2008, total purchases under the program since inception were 1,456,944 shares at an average purchase price of $5.18 per share, or an aggregate repurchase price of $7,541,563,.
The following table details the repurchases that were made under the program during the three months ended December 31, 2008:
Stock Price Performance Graph
The following graph illustrates a comparison of the total return of our common stock with the total return for the S & P Smallcap 600 Index and a peer group selected by us for the five year period ended December 31, 2008. The comparison assumes $100 was invested on December 31, 2003 in our common stock and in each of the indices shown and assumes that all of the dividends were reinvested.
The comparisons in the table are required by the SEC and are not intended to forecast or be indicative of possible future performance of our common stock. This graph shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (Exchange Act) or otherwise subject to the liabilities under that of Securities Act of 1933, as amended, or the Exchange Act.
* $100 invested on 12/31/03 in stock or index-including reinvestment of dividends. Fiscal year ended is December 31.
The following selected financial information as of and for the dates and periods indicated have been derived from our audited consolidated financial statements. The information set forth below is not necessarily indicative of results of future operations, and should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this Annual Report on Form 10-K and our consolidated financial statements and related notes included elsewhere in this Report.
We are the recognized global leader in the practical application of psychoacoustics, the science behind how the human ear operates, and in the post processing segment of the market for audio delivery. Our award-winning audio enhancement technologies and solutions dramatically restore audio and voice to its natural state, the way it was originally recorded, in both dimension and clarity, thus providing a superior consumer experience for a wide variety of CE devices such as televisions, personal computers and mobile phones.
Our mission is to be the dominant worldwide provider of audio and voice solutions that allow consumers to effortlessly experience rich, natural sound, the way their ears were meant to hear it.
Our operations are conducted through SRS Labs, Inc., the parent company, and its wholly-owned subsidiaries, SRSWOWcast.com, Inc. and Shenzhen Representative Office of SRS Labs, Inc. (a Chinese company). Our business is focused on developing and licensing audio, voice and surround sound technology solutions to many of the worlds leading OEMs, software providers and semiconductor companies, and limited sales and marketing of stand alone software and hardware products through the Internet.
Prior to September 29, 2006, we were also a developer and provider of application specific integrated circuits and standard integrated circuits through our former wholly-owned subsidiary, Valence.
Valence: Through our former subsidiary, Valence, we operated a fabless semiconductor business which developed, designed and marketed standard and custom analog integrated circuits, digital signal processors and mixed signal integrated circuits primarily to OEMs and ODMs in the Asia Pacific region. On February 23, 2006, our Board approved a plan to sell Valence in order to focus managements attention and financial resources on our licensing business. On July 14, 2006, we entered into a definitive Sale and Purchase Agreement to sell Valence to Noblehigh Enterprises Inc. (Noblehigh). The sale transaction was completed on September 29, 2006, and accordingly, the results of the operations of Valence through the date of sale were included as discontinued operations in the accompanying consolidated statement of operations for the year ended December 31, 2006.
CHS/SRS LLC: In September 2004, we entered into a strategic alliance with Coming Home Studios LLC (CHS) to use and promote SRS Labs technologies, to promote CHS productions and to promote each companys respective brands. In connection with the strategic alliance, SRS and CHS established a joint venture, CHS/SRS, LLC (the Joint Venture), to produce and distribute nine concert videos featuring our Circle Surround technology. On February 23, 2006, our Board authorized management to take all reasonable steps to divest our entire equity interest in the Joint Venture. On June 30, 2006, we completed the sale of our interest in the Joint Venture to CHS and, accordingly, the results of the operations of the Joint Venture through the date of sale were included as discontinued operations in the accompanying consolidated statements of operations for all periods presented.
Critical Accounting Policies
Our discussion and analysis of our results of operations and liquidity and capital resources are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. We base our estimates on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from our estimates.
The following represents a summary of our critical accounting policies, defined as those policies that we believe are: (a) the most important to the portrayal of our financial condition and results of operations, and (b) that require managements most difficult, subjective or complex judgments, often as a result of the need to make estimates about the matters that are
inherently uncertain. Our most critical accounting estimates include revenue recognition; valuation of accounts receivable, which impacts operating expenses; valuation of intangible, capitalization of software and long lived assets, which primarily impacts operating expenses when we impair assets or accelerate their depreciation; recognition and measurement of current and deferred income tax assets and liabilities, which impacts our tax provision; and share-based compensation, which impacts operating expenses. We discuss each of these policies below, as well as the estimates and judgments involved. We also have other policies that we consider key accounting policies; however, these policies do not meet the definition of critical accounting estimates, because they do not generally require us to make estimates or judgments that are difficult or subjective.
Our license agreements typically have multi-year or automatic renewal terms, and either require: a) per-unit royalty payments for all products implementing our technologies and/or solutions; b) fixed annual or quarterly royalty payments; or c) a minimum fixed annual or quarterly royalty payment, which allows the licensee to ship up to a pre-determined number of units during the specified time period, with additional per-unit royalty payments thereafter. Royalties for per-unit arrangements are reported in the quarter following shipment of the consumer electronics device and are therefore recognized by us one quarter following shipment by the OEM. Revenues associated with fixed royalty payments are recognized ratably over the term of the agreement. We also sell some of our products and solutions via the Internet. Revenues associated with those sales are recognized upon shipment and are not material.
We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history, the customers current credit worthiness and various other factors, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain allowances for doubtful accounts based upon specific customer circumstances, current economic trends, historical experience and the age of past due receivables. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Unanticipated changes in the liquidity or financial position of our customers may require additional provisions for doubtful accounts.
Intangible Assets and Impairment of Long-Lived Assets
Costs paid by the Company related to the establishment and purchase of patents, primarily legal costs, are capitalized and amortized, depending on the estimated life of the technology patented. These assets are being amortized over ten years. The Company evaluates the recoverability of long-lived assets with finite lives in accordance with Statement of Financial Accounting Standard (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144). The Company assesses potential impairments to its long-lived assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. An impairment loss is recognized when the carrying amount of the long-lived asset is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Any required impairment loss is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value and is recorded as a reduction in the carrying value of the related asset and a charge to operating results. Based upon the most recent assessment as of December 31, 2008, the Company has determined there was no impairment in the value of long-lived assets.
In preparing our consolidated financial statements, we estimate our income taxes in each of the countries in which we operate. The process used to make these estimates includes an assessment of the current tax expense, the results from tax examinations and the effects of temporary differences resulting from the different treatment of transactions for tax and financial accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes (SFAS No. 109), which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS No. 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. We evaluate the reliability of our deferred tax assets by assessing our valuation allowance and by adjusting the amount of such allowance, if necessary. At December 31, 2008, we had net deferred tax assets primarily resulting from temporary differences between the book and tax bases of assets and liabilities, and loss and credit carry forwards. We continue to provide a valuation allowance our deferred tax assets based on an assessment of the likelihood of their realization. In reaching our conclusion, we evaluated certain relevant criteria including deferred tax liabilities that can be
used to offset deferred tax assets, estimates of future taxable income of appropriate character within the carry-forward period available under the tax law, and tax planning strategies. Our judgments regarding future taxable income may change due to market conditions, changes in U.S. or international tax laws, and other factors. These changes, if any, may require material adjustments to these deferred tax assets, resulting either in a tax benefit, if it is estimated that future taxable income is likely, or a reduction in the value of the deferred tax assets, if it is determined that their value is impaired, resulting in a reduction in net income or an increase in net loss in the period when such determinations are made.
Our income tax provision is based on calculations and assumptions that will be subject to examination by the taxing authorities in the jurisdictions in which we operate. Should the actual results differ from our estimates, we would have to adjust the income tax provision in the period in which the facts and circumstances that give rise to the revision become known. Tax law and rate changes are reflected in the income tax provision in the period in which such changes are enacted.
On January 1, 2006, we adopted the provisions of SFAS No. 123(R), Share-Based Payment (SFAS No. 123R) using the modified prospective application transition method. SFAS No. 123R requires measurement of all employee share-based compensation awards using a fair-value method and recording of such expense in the consolidated financial statements over the requisite service period. In 2008, 2007 and 2006, we recorded share-based compensation expense of $1,777,468, $1,727,017 and $1,460,910, respectively, under the fair-value provisions of SFAS No. 123R.
To determine the expected term of our employee stock options granted in fiscal 2008, we examined the historical term for our stock options and those of our peers. To determine the risk-free interest rate, we utilized an average interest rate based on U.S. Treasury instruments whose term was consistent with the expected term of our awards. To determine the expected stock price volatility, we examined the historical volatilities for our common stock and those of our peers. See Note 7 (Stockholders Equity and Share-Based Compensation) of our Notes to Consolidated Financial Statements for further discussion.
Results of Operations
The following table sets forth certain consolidated operating data as a percentage of revenues for the years ended December 31, 2008, 2007 and 2006:
Percentage of Total Revenue
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
Total revenues for fiscal 2008 were $18,332,678 compared to $18,851,940 in fiscal 2007, a decrease of $519,262, or 3%. This decrease was primarily attributable to decreases in royalties related to the sales of personal computers, set top boxes, CRT televisions and personal media devices containing our technologies. The decrease in revenues in the personal computer market from fiscal 2007 to fiscal 2008 was $649,153, of which $594,378 related to decreased royalties from Toshiba, while revenues in the personal media devices market decreased by $155,086 during the same period, related to several customers. We expect that during 2009, our revenues in the personal computer segment will increase, primarily due to the signing of several new licensees, including Hewlett Packard, NEC Computers and BenQ. In the home entertainment market, total revenues decreased $209,120 from fiscal 2007 to fiscal 2008. Within this market, revenues related to set-top boxes decreased $139,219 and revenues from CRT televisions decreased $124,062. Some of these decreases were offset by increased revenues in the amount of $145,942 related to flat panel televisions and monitors. The majority of the increase in flat panel televisions and monitors revenues were the direct result of our receipt of larger royalty payments from some of the multi-national television OEMs, including Samsung, offset by a decrease in revenues from Sony, Toshiba and LG. While we continue to have good relationships with many of the major global television OEMs, we cannot guarantee that we will be successful in growing or maintaining this market of our business. Home entertainment continues to represent our largest revenue market and we anticipate that during fiscal 2009 this trend will continue. While there may be changes in the royalty amounts reported from each of our licensees in this segment, we are pleased that we have been able to enter into license agreements with several new television licensees during 2008, such as Vizio and General Displays and Technologies. Revenues in the automotive market increased by $160,356 in 2008 as compared to 2007 primarily due to increased revenues from several customers in Japan who provide line install, dealer option and after market automotive audio systems to many of the significant Japanese automotive manufactures, including Toyota, Honda, Subaru and Nissan. In the personal telecommunications segment, revenues increased $298,741 from 2007 to 2008. This increase was primarily due to increased revenues from Samsung Mobile. We anticipate that during 2009 we will continue to experience increased revenues in this segment as compared to 2008. This was in large part due to the signing of several new licensees, including Samsung and BBK. During the second half of 2008 and continuing into 2009, there have been many news reports of a slow down in the global economy and decreased purchasing by consumers. We continue to monitor relevant information regarding consumer
purchasing and information provided by industry observers and others. At this time we can not determine the impact that may result from these events. Our goals include working with our existing licensees to continue to provide value to them, while attempting to obtain new licensees to increase our market penetration in all of our segments. While we continue to pursue these goals, there can be no assurance that they will be met.
The following table represents our mix of licensing revenues by market source:
Sales and Marketing
Sales and marketing expenses consist primarily of employee salaries, sales consultants fees and related expenses, sales commissions and costs associated with branding activities. Sales and marketing expenses were $9,415,238 for fiscal year 2008, as compared to $6,717,906 for fiscal year 2007. Overall sales and marketing expenses were $2,697,332, or 40%, higher in fiscal 2008. This increase was primarily attributable to higher payroll and related costs, including one-time recruitment and severance costs of approximately $525,000, associated with hiring an additional eleven sales and marketing employees and full-time consultants in 2008 including our Vice President of Sales and our Vice President of Marketing. In addition to increasing the sales and marketing personnel, we have also increased our branding efforts. In 2009, we expect that sales and marketing expenses will increase as we hire additional sales personnel to penetrate target markets and key regions and as we continue to increase our marketing efforts to cultivate and elevate the SRS brand globally. We recorded $458,610 in share-based compensation expense for sales and marketing personnel during 2008 as compared to $495,132 in 2007. As a percentage of total revenues, sales and marketing expenses increased from 36% for fiscal year 2007 to 51% for fiscal year 2008.
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 $3,747,495 for fiscal year 2008, as compared to $3,107,482 for fiscal year 2007. The overall increase in research and development expenses of $640,013, or 21%, was primarily attributable to hiring an additional five engineers in 2008, as well as incurring additional travel costs associated with supporting our global licensees. We recorded $399,630 in share-based compensation expense for engineering personnel during 2008 as compared to $428,516 in 2007. We expect that research and development expenses will increase as we continue to expand our intellectual property portfolio, which we believe is critical to our business, and as we seek to accelerate the implementation of our technology with a greater number of customers and devices. As a percentage of total revenues, research and development expenses increased from 16% for fiscal year 2007 to 21% for fiscal year 2008.
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 and costs associated with being a publicly held company. General and administrative expenses were $5,913,081 for fiscal year 2008 as compared to $5,443,735 for fiscal year 2007. The overall increase of $469,346, or 9%, was primarily attributable to an increase in professional fees and expenses of $166,000, associated with our Dutch Auction repurchase program, which was terminated in September 2008. We also incurred increased professional and legal fees associated with corporate matters and an increase in share-based compensation expense. We recorded $919,228 in stock-based compensation expense during 2008 as compared to $803,369 in 2007. As a percentage of total revenues, general and administrative expenses increased from 29% for fiscal year 2007 to 32% for fiscal year 2008.
Interest income was $1,275,047 for fiscal year 2008, compared to $2,041,288 for fiscal year 2007, a decrease of $766,242, or 38%. This decrease was primarily attributable to the decrease in interest income due to lower interest rates and lower cash balances.
Provision for Income Taxes
The income tax provision for fiscal 2008 was $117,543 compared to $45,558 for fiscal 2007, representing an increase of $71,985, or 158%. The current and prior year provision consists primarily of estimated taxes payable to the state of California. The increase in the provision is the result of change in California tax law in fiscal 2008, whereby net operating loss carryforwards may not be used in 2008 or 2009 and research and development credits are limited to 50% of the Companys net tax.
We had federal and state net operating loss carryforwards at December 31, 2008 of $11,239,216 and $5,598,943, respectively. The net operating loss carryforwards began to expire in 2005 and will continue through 2028. In addition, we had federal foreign tax credit carryforwards of approximately $5,125,790 at December 31, 2008, which begin to expire in 2014, and federal and state tax capital loss carryforwards of approximately $16,219,585, which begin to expire in 2011. As of December 31, 2008, we continued to have a valuation allowance of $13,944,301 against our deferred tax assets, which was established primarily due to our cumulative losses in recent years and based on our assessment of our future ability to realize certain deferred tax assets.
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
Total revenues for fiscal 2007 were $18,851,940 compared to $18,547,529 in fiscal 2006, an increase of $304,411, or 2%. This increase was primarily attributable to increases in royalties related to the sales of flat panel televisions and monitors, which grew by $2,699,310, or 31%, and increases in the automotive market, which grew by $275,793, or 26%. The majority of the increases in flat panel televisions and monitors revenues were the direct result of our receipt of larger royalty payments from many of the multinational television OEMs, including Samsung, LG and Toshiba, or their respective chip manufacturers, offset by a decrease in revenues from Sony. Additionally, during the second half of 2007, we established direct relationships with many of the China based TV manufacturers which require such companies to pay royalties directly to SRS, rather than through an Integrated Chip (IC) provider. This had a negative impact on our revenues during this time period as royalties were earned at the time that TVs were shipped to retail, rather than when the ICs were shipped to manufacturing. Revenues in the automotive market also increased in 2007 as compared to 2006. This increase was primarily due to increased revenues from several customers in Japan who provide line install, dealer option and after market automotive audio systems to many of the significant Japanese automotive manufactures, including Toyota, Honda, Subaru and Nissan. Revenues in our portable media devices segment and personal telecommunications segments fell by 39% and 13%, respectively. The decrease in revenue in portable media devices was primarily attributable to the loss of one customer. Revenues from that customer continued in the first and second quarters of fiscal 2006 but no substantive revenues were received from that customer in the third and fourth quarters of 2006 or during the first three quarters of 2007. However, during 2007, we were able to secure a new design win from this customer and started to receive limited royalties during the fourth quarter of 2007. The decrease in personal telecommunications revenues was primarily attributable to one customer who has experienced a decrease in its sales of handset units. We continue to be included in the customers products; however, sales of these products were at lower levels in 2007 than during 2006. The following table represents our mix of licensing revenues by market source:
Sales and Marketing
Sales and marketing expenses consist primarily of employee salaries, sales consultants fees and related expenses, sales commissions and costs associated with branding activities. Sales and marketing expenses were $6,717,906 for fiscal year 2007, as compared to $7,345,133 for fiscal year 2006. Overall sales and marketing expenses were $627,227, or 9%, lower in fiscal 2007 due in large part to a decrease in headcount and payroll related costs in the marketing department, reduced sales commissions and reduced company wide bonuses. We recorded $495,132 in stock-based compensation expense for sales and marketing personnel during 2007 as compared to $515,762 in 2006. As a percentage of total revenues, sales and marketing expenses decreased from 39% for fiscal year 2006 to 36% for fiscal year 2007.
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 $3,107,482 for fiscal year 2007, as compared to $2,572,577 for fiscal year 2006. The overall increase in research and development expenses of $534,905, or 21%, was primarily attributable to hiring an additional three engineers in 2007, as well as incurring additional expenditures as a result of expanding our intellectual property portfolio. We recorded $428,516 in stock-based compensation expense for engineering personnel during 2007 as compared to $331,480 in 2006. As a percentage of total revenues, research and development expenses increased from 14% for fiscal year 2006 to 16% for fiscal year 2007.
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 and costs associated with being a publicly held company. General and administrative expenses were $5,443,735 for fiscal year 2007 as compared to $5,660,260 for fiscal year 2006. The overall decrease of $216,525, or 4%, was primarily attributable to a decrease in consultants fees and costs associated with the separation of our former Chief Financial Officer in the first quarter of 2006, coupled with reduced bonus expense. These decreases in costs were offset partially by an increase in stock-based compensation expense due to stock option grants in 2007. We recorded $803,369 in stock-based compensation expense for corporate employees and directors during 2007 as compared to $512,525 in 2006. As a percentage of total revenues, general and administrative expenses decreased from 31% for fiscal year 2006 to 29% for fiscal year 2007.
Interest income was $2,041,288 for fiscal year 2007, compared to $1,135,870 for fiscal year 2006, an increase of $905,418, or 80%. This increase was primarily attributable to the increase in interest income due to higher interest rates and higher cash balances.
Provision for Income Taxes
The income tax provision for fiscal 2007 was $45,558 compared to $868,203 for fiscal 2006, representing a decrease of $822,645, or 95%. The fiscal 2007 provision consisted primarily of estimated sales tax payable to the state of California. The fiscal 2006 provision consisted primarily of taxes paid on licensing revenues sourced from countries requiring foreign tax withholdings, principally Korea and Taiwan.
We had federal and state net operating loss carryforwards at December 31, 2007 of $13,596,056 and $5,206,235, respectively. The net operating loss carryforwards began to expire in 2005 and will continue through 2026. In addition, we had federal foreign tax credit carryforwards of approximately $3,412,608, at December 31, 2007, which begin to expire in 2014, and federal and state tax capital loss carryforwards of approximately $16,219,585, which begin to expire in 2011. As of December 31, 2007, we continued to have a valuation allowance of $13,935,219 against our deferred tax assets, which was established primarily due to our cumulative losses in recent years and based on our assessment of our future ability to realize certain deferred tax assets.
Selected Quarterly Operating Results
The following table sets forth certain quarterly summary consolidated financial data for the eight quarters in the period ended December 31, 2008. The quarterly information is based upon financial statements prepared by us on a basis consistent with our audited consolidated financial statements and, in managements opinion, includes all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the information for the periods presented. This information should be read in conjunction with our audited consolidated financial statements and notes thereto appearing elsewhere in this Report. Our quarterly operating results have varied significantly in the past and are expected to vary significantly in the future. Due to rounding differences, the quarters in a given year may not add precisely to the annual numbers for that year.
Liquidity and Capital Resources
At December 31, 2008, cash and cash equivalents, short-term investments and investments available for sale were $39,435,087 compared to $45,067,166 as of December 31, 2007, a decrease of $5,632,079. Our cash and cash equivalents were $31,599,087 as of December 31, 2008, a decrease of $8,016,204 from cash and cash equivalents of $39,615,291 held at December 31, 2007. The decrease in cash and cash equivalents was primarily a result of the purchase of treasury stock and short-term investments, partially offset against the proceeds received from the sale of the investments available for sale and positive cash flow generated by operating activities. Cash and cash equivalents generally consist of cash, certificates of deposits, money market funds and other money market instruments with original maturities of three months or less. The money market funds are primarily invested in US government obligations. The cash and certificates of deposit are FDIC insured. We held $7,836,000 in short-term investments at December 31, 2008. Short-term investments consist of certificates of deposit with original maturities ranging from 6 to 12 months. In fiscal 2008, 2007 and 2006, operations were funded primarily from cash from operating activities.
Net cash provided by operating activities was $2,629,133 and $6,558,565 for 2008 and 2007, respectively. The $3,929,432 decrease in net cash provided by operating activities in fiscal 2008, compared to fiscal 2007, was primarily a result of a decrease in net income, from $5,414,435 during the year ended December 31, 2007 to $270,887 for the year ended December 31, 2008. Offsetting the decrease in net income, accounts receivable decreased by $794,524 during the year ended December 31, 2008 compared to an increase of $65,867 during the same period in the prior year, due to increased collection efforts in 2008. Additionally, accrued liabilities increased $306,960 during the year ended December 31, 2008 as compared to decreasing $605,928 in the same period in the prior year. The increase in accrued liabilities in 2008 primarily relates to the timing of payments to vendors and an increase in accrued commissions, due to hiring additional sales representatives in 2008.
Net cash used in investing activities was $3,310,826 and $850,927 in 2008 and 2007, respectively. The $2,459,899 increase in cash used in investing activities in 2008, compared to 2007, was primarily due to the purchase of $7,836,000 in short-term investments offset by the sale of investments available for sale of $5,500,000.
Net cash used in financing activities was $7,334,511 and $1,103,772 during 2008 and 2007, respectively. The $6,230,739 increase in cash used in financing activities in 2008, compared to 2007, was primarily due to an increase in treasury stock repurchased offset by a decrease in stock option exercises. We expect to continue to use a portion of our cash to conduct market repurchases under the stock repurchase program approved by our Board of Directors on November 3, 2008. Under the stock repurchase program, we are seeking to acquire up to $15.0 million of the Companys outstanding stock. To date, we have repurchased 1.5 million shares of our common stock at an aggregate purchase price of $7.5 million under the program. The repurchase program commenced on November 7, 2008 and will remain open for a period of up to six months.
We believe our existing cash, cash equivalents and short-term investment balances together with cash generated from operating activities will be sufficient to meet our anticipated cash needs for at least the next twelve months. Our future capital requirements will depend on many factors, including our level of revenues, the timing and extent of spending to support product development efforts, the expansion of sales and marketing activities, the timing of introductions of new products and the continuing market acceptance of our products.
Contractual Cash Obligations and Contingent Liabilities and Commitments
We have contractual obligations and commitments with regards to operating lease arrangements. The following table quantifies our expected contractual obligations and commitments subsequent to December 31, 2008:
Recent Accounting Pronouncements
In May 2008, the Financial Accounting Standards Board (FASB) issued SFAS No. 162, Hierarchy of Generally Accepted Accounting Principles (SFAS No. 162). This statement is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles. This statement became effective on November 15, 2008. The adoption of SFAS No. 162 did not have a material impact on our consolidated financial position or results of operations.
In April 2008, the FASB issued FASB Staff Position (FSP) SFAS No. 142-3, Determination of the Useful Life of Intangible Assets (FSP No. 142-3). This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141 (revised 2007), Business Combinations (SFAS No. 141(R))and other GAAP. This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption was prohibited. We are currently evaluating the impact of SFAS FSP 142-3, but does not expect the adoption of this pronouncement will have a material impact on its consolidated financial position, results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 141(R), which replaces SFAS No. 141. SFAS No. 141(R) retains the purchase method of accounting for acquisitions, but requires a number of changes, including changes in the way assets and liabilities are recognized in the purchase accounting. It also changes the recognition of assets acquired and liabilities assumed arising from contingencies, requires the capitalization of in-process research and development at fair value, and requires the expensing of acquisition-related costs as incurred. SFAS No. 141R became effective for us beginning January 1, 2009 and will be applied prospectively to business combinations completed on or after that date.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS No. 159). SFAS No. 159 permits entities to choose to measure financial assets and liabilities (except for those that are specifically scoped out of the Statement) at fair value. The election to measure a financial asset or liability at fair value can be made on an instrument-by-instrument basis and is irrevocable. The difference between carrying value and fair value at the election date is recorded as a transition adjustment to opening retained earnings. Subsequent changes in fair value are recognized in earnings. The effective date for this statement was as of the beginning of an entitys first fiscal year that began after November 15, 2007. Accordingly, we adopted SFAS No. 159 effective January 1, 2008. The adoption of SFAS No. 159 did not have a material effect on our consolidated financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No. 157). The purpose of SFAS No. 157 is to define fair value, establish a framework for measuring fair value and enhance disclosures about fair value measurements. The measurement and disclosure requirements became effective for us beginning January 1, 2008. The adoption of SFAS No. 157 did not have a material effect on our consolidated financial position or results of operations.
Our exposure to market risk includes changes in interest rates, which relates primarily to our invested balances of cash, cash equivalents and investments. Our investment policy specifies excess funds are to be invested in a manner that preserves capital, provides liquidity and generates the highest available after-tax return. To limit exposure to market risk, we place our cash in banks, cash equivalents in certificates of deposits with original maturities of three months or less and money market funds, which are primarily invested in US government obligations. Short-term investments consist of certificates of deposits with original maturities ranging from 6 to 12 months. We do not invest in any derivative instruments. All cash, cash equivalents and investments are carried at fair value, which approximates cost.
The financial statement information, including the Report of Independent Registered Public Accounting Firm, required by this Item 8 is set forth on pages 37 to 56 of this Annual Report on Form 10-K and is hereby incorporated into this Item 8 by reference. The quarterly financial information required by this Item 8 is set forth in Item 7 of this Annual Report on Form 10-K and is hereby incorporated into this Item 8 by reference.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Subject to the limitations noted above, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective to meet the objective for which they were designed and operate at the reasonable assurance level.
Managements Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company as defined in Rule 13a-15(f) or 15d-15(f) of the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2008 using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in its report, Internal Control-Integrated Framework. Based on this assessment and those criteria, management concluded that our internal control over financial reporting was effective as of December 31, 2008.
Attestation Report of Independent Registered Public Accounting Firm
Our internal control over financial reporting has been audited by Squar, Milner, Peterson, Miranda & Williamson, LLP, an independent registered public accounting firm, as stated in their report, which is included herein on page 35.
Changes in Internal Controls
There have been no changes in our internal controls over financial reporting that occurred during our fourth quarter ended December 31, 2008 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
The information set forth under the captions Election of Directors, Information About the Board of Directors and Committees of the Board, Executive Officers and Transactions with Management and OthersSection 16(a) Beneficial Ownership Reporting Compliance in our definitive proxy statement (the Proxy Statement) for the Annual Meeting of Stockholders that is scheduled to occur in June 2009 is incorporated herein by reference. The Proxy Statement will be filed with the SEC no later than 120 days after the end of fiscal year 2008.
Except as specifically provided, the information set forth under the captions Compensation of Executive Officers and Information About the Board of Directors and Committees of the BoardCompensation of Directors in the Proxy Statement is incorporated herein by reference. The Proxy Statement will be filed with the SEC no later than 120 days after the end of fiscal year 2008.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information regarding security ownership of certain beneficial owners and management is incorporated by reference to the information set forth under the caption Security Ownership of Certain Beneficial Owners and Management in the Proxy Statement. The Proxy Statement will be filed with the SEC no later than 120 days after the end of fiscal year 2008.
Information regarding equity compensation plans required by this Item 12 is included in Item 5 of Part II of this Annual Report on Form 10-K and is incorporated into this Item by reference.
The information set forth under the captions Transactions with Management and Others and Information About the Board of Directors and Committees of the Board in the Proxy Statement is incorporated herein by reference. The Proxy Statement will be filed with the SEC no later than 120 days after the end of fiscal year 2008.
Information regarding principal accounting fees and services is incorporated by reference to the information set forth under the caption Relationship of the Company with Independent Registered Public Accounting Firm in the Proxy Statement. The Proxy Statement will be filed with the SEC no later than 120 days after the end of fiscal year 2008.
(1) Financial Statements
(2) Financial Statement Schedule
The financial statement schedule included on page 56 to this Annual Report on Form 10-K and in Part II, Item 8 herein is filed as part of this Annual Report on Form 10-K. All other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or related notes.
The exhibits listed below are hereby filed with the SEC as part of this Annual Report on Form 10-K. We will furnish a copy of any exhibit upon request, but a reasonable fee will be charged to cover our expenses in furnishing such exhibit.
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
To the Board of Directors and Stockholders
SRS Labs, Inc.
Santa Ana, California
We have audited the accompanying consolidated balance sheets of SRS Labs, Inc. and Subsidiaries (collectively the Company) as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2008. We also have audited the Companys internal control over financial reporting as of December 31, 2008, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Our audit also included the financial statement schedule listed in Item 15(2) herein. The Companys management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in Item 9A. Our responsibility is to express an opinion on these financial statements and an opinion on the Companys internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of SRS Labs, Inc. and Subsidiaries as of December 31, 2008 and 2007, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Also, in our opinion, the aforementioned financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the financial information set forth therein.
Newport Beach, California
February 23, 2009
SRS LABS, INC. AND SUBSIDIARIES
See accompanying notes to the consolidated financial statements
SRS LABS, INC. AND SUBSIDIARIES
See accompanying notes to consolidated financial statements
SRS LABS, INC. AND SUBSIDIARIES
AND COMPREHENSIVE INCOME