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** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 

**ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF**

**THE SECURITIES EXCHANGE ACTOF 1934**

 

**For thefiscal year ended December 31, 2009**

 

**CommissionFile Number: 0-21123**

 

 

**SRSLABS, INC.**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**  (State of incorporation)                                                 | ** ** | **33-0714264**  (I.R.S. Employer Identification No.) |
|----------------------------------------------------------------------------------------|------------|------------------------------------------------------|
| ** **                                                                             | ** ** | ** **                                           |
| **2909 Daimler Street, Santa Ana, California**(Address of principal executive offices) | ** ** | **92705**  (Zip Code)                                |

 

**(949) 442-1070**

(Registrant’s telephonenumber, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

| **Title  of each class**                 | ** ** | **Name  of each exchange on which registered**           |
|------------------------------------------|------------|----------------------------------------------------------|
| Common Stock, Par Value $0.001 Per Share |       | The NASDAQ Stock Market LLC  (NASDAQ Global Market) |

 

Indicate by check mark if the registrant is a well-known seasonedissuer, as defined in Rule 405 of the Securities Act. Yes o  No x

 

Indicate by check mark if the registrant is not required to filereports 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 allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past90 days. Yes x  No o

 

Indicate by check mark whether the registrant has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T (§ 229.405 of this chapter) during the preceeding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files). Yes o No o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K (§229.405 of this chapter) is not containedherein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part IIIof this Form 10-K or any amendment to this Form 10-K. o

 

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

 

| Large accelerated filer o                |   | Accelerated filer x         |
|-----------------------------------------------|--------|----------------------------------|
|                                          |   |                             |
| Non-accelerated filer o                  |   | Smaller reporting company o |
| (Do not check if a smaller reporting company) |   |                             |

 

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

 

The aggregate market value of the registrant’s voting common stock heldby non-affiliates of the registrant was approximately $77,416,760 (computedusing the closing price of $6.65 per share of common stock on June 30,2009, as reported by The NASDAQ Stock Market).

 

As of February 2, 2010, 14,563,715 shares of the registrant’scommon stock, par value $0.001 per share, were outstanding.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portions of the registrant’s definitive proxy statement prepared inconnection with the Annual Meeting of Stockholders to be held in 2010 areincorporated by reference in Part III of this Form 10-K.

 

 

 

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**SRS LABS, INC.**

**AnnualReport on Form 10-K**

**Table of Contents**

 
| ** **        | ** **                                                                                                          | **Page** |
|-------------------|---------------------------------------------------------------------------------------------------------------------|----------|
| **PART I**   | ** **                                                                                                          |
| Item 1.      | Business                                                                                                            | 4        |
| Item 1A.     | Risk Factors                                                                                                        | 10       |
| Item 1B.     | Unresolved Staff  Comments                                                                                          | 14       |
| Item 2.      | Properties                                                                                                          | 14       |
| Item 3.      | Legal Proceedings                                                                                                   | 15       |
| Item 4.      | Submission of  Matters to a Vote of Security Holders                                                                | 15       |
| **PART II**  |                                                                                                                |
| Item 5.      | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities | 16       |
| Item 6.      | Selected Financial  Data                                                                                            | 18       |
| Item 7.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         | 19       |
| Item 7A.     | Quantitative  and Qualitative Disclosures About Market Risk                                                         | 25       |
| Item 8.      | Financial  Statements and Supplementary Data                                                                        | 25       |
| Item 9.      | Changes In and  Disagreements with Accountants on Accounting and Financial Disclosures                              | 26       |
| Item 9A.     | Controls and  Procedures                                                                                            | 26       |
| Item 9B.     | Other Information                                                                                                   | 27       |
| **PART III** |                                                                                                                |
| Item 10.     | Directors,  Executive Officers and Corporate Governance                                                             | 27       |
| Item 11.     | Executive  Compensation                                                                                             | 27       |
| Item 12.     | Security  Ownership of Certain Beneficial Owners and Management and Related  Stockholders Matters                   | 27       |
| Item 13.     | Certain  Relationships and Related Transactions, and Director Independence                                          | 27       |
| Item 14.     | Principal  Accounting Fees and Services                                                                             | 27       |
| **PART IV**  |                                                                                                                |
| Item 15.     | Exhibits and  Financial Statement Schedule                                                                          | 28       |
| Signatures        | 32                                                                                                                  |

 

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As used herein,the “Company,” “SRS Labs,” “SRS,” “we,” “us,” or “our” means SRS Labs, Inc.,its wholly-owned subsidiaries, SRSWOWcast.com, Inc., ShenzhenRepresentative Office of SRS Labs, Inc., Shanghai Representative Office ofSRS Labs, Inc, and SRS Labs Japan, KK. Circle Surround®, Circle Surround IITM,CS AutoTM, SRS WOW®, SRS WOW XTTM, SRS WOW HDTM, SRS TruBass®, SRS FOCUS®, SRSHeadphoneTM, SRS Dialog ClarityTM, SRS TruSurround® XT, TruSurround® HD, SRS3D®, SRS AutoTM, VIPTM, TruSurround HD4TM, CircleCinemaTM, iWOWTM, SRS Headphone 360TM,SRS Premium SoundTM, SRS TruChatTM, SRS TruGamingTM, SRS TruMediaTM, SRS TruToolsTM,SRS TruVoiceTM, TruVolumeTM, TruThunderTM, SRS TruSpeakTM, Cinema SoundTM, SRS NoiseReductionTM, SRS Audio Sandbox®, SRS Headphone Pro®  , MyVolumeTM, SRS HD Audio LabTM, SRS SoundTM,SRS StudioSoundTM, SRS StudioSound HDTM, SRS TheaterSoundTM, SRS TRuEQTM andTruCircleTM  are our U.S. trademarks. Allother trademarks and trade names appearing are the property of their respectiveowners.

 

**SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

Some of the statements in this Annual Report on Form 10-K containforward-looking statements regarding our assumptions, projections,expectations, targets, intentions or beliefs about future events, which involverisks and uncertainties. All statements other than statements of historicalfacts included in this Annual Report, including statements relating toexpectation of future financial performance and capital requirements, continuedgrowth, changes in economic conditions or capital markets, changes in customerusage patterns and preferences and the impact of recent accountingpronouncements, are forward-looking statements. In some cases, you can identifyforward-looking statements by terms such as may, will, should, expect, plan,intend, forecast, anticipate, believe, estimate, predict, potential, continueor the negative of these terms or other comparable terminology. Theforward-looking statements contained in this Annual Report involve known andunknown risks, uncertainties and situations that may cause our or our industry’sactual results, level of activity, performance or achievements to be materiallydifferent from any future results, levels of activity, performance orachievements expressed or implied by these statements. Factors that might causeactual events or results to differ materially from those indicated by theseforward-looking statements may include the matters listed in this AnnualReport, including, but not limited to, those listed under “Risk Factors” inItem 1A.

 

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**PART I**

 

**Item 1. Business**

 

**Overview**

 

We are the recognized global leader in the practical application of psychoacoustics*,* the science behind how the human ear operates, andin the post processing segment of the market for audio delivery.  Our award-winning audio enhancementtechnologies and solutions dramatically restore audio and voice to its natural state, the way it was originally recorded, in both dimension andclarity, thus providing a superiorconsumer 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 voicesolutions 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 parentcompany, and its wholly-owned subsidiaries, SRSWOWcast.com, Inc., ShenzhenRepresentative Office of SRS Labs, Inc. (a Chinese company), ShanghaiRepresentative Office of SRS Labs, Inc. (a Chinese company) and SRS LabsJapan, KK (a Japanese company). Our business is focused on developing andlicensing audio, voice and surround sound technology solutions to many of theworld’s leading original equipment manufacturers (“OEMs”), software providersand semiconductor companies.  We alsosell and market   stand-alone softwareand hardware products through the Internet.

 

Further financial information regarding mix of revenues by marketsectors, geographic areas and customer concentration is included in this AnnualReport on Form 10-K under “Item 8. Financial Statements andSupplemental Data” and in Notes 1 and 7 to the Notes to ConsolidatedFinancial Statements. We also refer you to “Item 1A. Risk Factors” for adiscussion of certain risks relating to our business.

 

We were incorporated in the State of California on June 23, 1993and reincorporated in the State of Delaware on June 28, 1996. Ourexecutive offices are located at 2909 Daimler Street, Santa Ana, California92705. Our telephone number is (949) 442-1070.

 

**Our Products and Technologies**

 

Our licensing business is focused on developing and marketing audiorendering, voice and surround sound technologies and solutions to OEMs,original design manufacturers (“ODMs”), semiconductor manufacturers, andsoftware providers in the home entertainment, personal computers, personaltelecommunications, automotive, portable media devices and broadcast markets.Our portfolio of licensable technologies includes a wide range of advancedtechnologies and proprietary techniques for the processing and delivery ofaudio, voice and surround sound, including the following:

·                  *Surround Sound*—Our surroundsound technologies include SRS TruSurround XT, TruSurround HD, TruSurround HD4,Circle Surround, Circle Surround II, Circle Surround Automotive and CircleSurround Automotive DX.  Circle Surround,is a complete encoding and decoding format. Circle Surround *encoding* enables the distribution of up to6.1 channels of audio over existing two-channel carriers such as digital mediafiles, standard definition and high-definition television, FM radio and CDs.Circle Surround *decoding* decodesCircle Surround encoded material for multi-channel playback or creates up to6.1 channels of audio from older formats of material, including mono, stereo,4-channel surround or other matrix surround formats.

 

·                  *AudioRendering*—Our audio rendering technologies optimize deviceaudio output and enable the presentation of 3D and multichannel audio contentover two speakers. These technologies include the ability to render 5.1multichannel content over two speakers, to create a wider sound stage for morenatural audio, to improve the perceived bass response in small speakers, todynamically position audio sources in a virtual 3D space using headphones, andto reposition the audio image for non-optimally placed speakers. Our audiorendering technologies include SRS WOW, SRS WOW XT, SRS WOW HD, SRS 3D Sound,SRS TruBass, SRS FOCUS, SRS Xspace 3D, SRS Headphone, SRS DialogClarity,and SRS TruVolume. TruVolume is the de facto industry standard for volumeleveling in the TV and set-top-box applications, effectively eliminating thevolume fluctuations between programming and commercials as well as duringchannel changing.

 

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·                  *VoiceProcessing*—Our TruVoice (also known as VIP and VIP+) and SRSNoise Reduction technologies dramatically reduce noise to produce a muchclearer and crisper dialog over wireless communication devices and improve theintelligibility of the human voice in a variety of listening situations,including high ambient background environments. Our Max-V voice and audioenhancement technology drastically increases the capabilities of built-inspeakers in devices in delivering higher volume while limiting adverse effectssuch as clipping and distortion.

 

·                  *Solutions**Suite*—Our solutions suites combine several of ourtechnologies in order to deliver a comprehensive, easier to deploy package ofpost processing audio enhancement products. Solution suites also enable us toimpact the performance of the OEM products by employing multiple technologiesand techniques to enhance and control the overall audio fidelity andperformance of the product. Our solution suites include SRS Premium Sound andSRS Premium Voice for personal computers, SRS TruMedia, SRS TruVoice, and SRSTruTools for mobile phones, and StudioSound HD and TheaterSound for homeentertainment products among others.

 

Our portfolio of technologies and solution suites addresses a broadspectrum of product applications within the vertical markets that we havetargeted. 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 implementationoptions offer customers flexibility when incorporating our technologies intoproducts.

 

**Our Customers and Markets**

 

We license our technologies both in the U.S. and internationally. Thefollowing table presents our revenue by geographic area. Licensing-relatedrevenue is summarized based on the location of the licensee’s corporateheadquarters. For standalone software and hardware product and online sales,revenue is allocated to the Americas. The Americas region includes North,Central and South America. In 2008, the Greater China region was broken downinto the China and Asia Pacific region. The China region includes all licenseeswith their corporate headquarters located in mainland China.  The Asia Pacific region includes alllicensees with their corporate headquarters located in Taiwan and Hong Kong.

 
| ** **                          | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------|------------|---------------------------------------------|------------|
| ** **                          | ** ** | **2009**                                    | ** ** | **%** | ** ** | **2008** | ** ** | **%** | ** ** | **2007** | ** ** | **%** | ** ** |
| ***Geographic Area Revenue:*** |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Korea                               |       | $                                           | 11,551,403 |   | 46 | % | $ | 9,624,459 |   | 52 | % | $ | 7,834,730 |   | 42 | % |
| Americas                            |       | 6,440,033                                   |       | 26 |   | 1,744,502 |   | 10 |   | 1,837,096 |   | 9 |   |
| Japan                               |       | 4,375,139                                   |       | 17 |   | 5,357,286 |   | 29 |   | 7,346,548 |   | 39 |   |
| China                               |       | 1,548,496                                   |       | 6 |   | 838,754 |   | 5 |   | 843,931 |   | 5 |   |
| Asia Pacific                        |       | 647,220                                     |       | 3 |   | 430,598 |   | 2 |   | 805,660 |   | 4 |   |
| Europe                              |       | 402,286                                     |       | 2 |   | 337,079 |   | 2 |   | 183,975 |   | 1 |   |
| Total                               |       | $                                           | 24,964,577 |   | 100 | % | $ | 18,332,678 |   | 100 | % | $ | 18,851,940 |   | 100 | % |

 

Through our licensing business, we market our portfolio of technologiesand solution suites to the following markets: home entertainment, personalcomputers, 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 productsimplementing our technologies and/or solutions; (b) fixed annual orquarterly royalty payments; or (c) a minimum fixed annual or quarterlyroyalty payment, which allows the licensee to ship up to a predetermined numberof units during the specified time period with additional per-unit royaltypayments thereafter. The license agreements also generally specify the use ofour trademarks and logos on the product, within the packaging and in the user’smanual, and require our review and approval of the product to guarantee thequality of the technology implementation and the correct usage of our logos andtrademarks. We believe these terms ensure the quality and consistency of thetechnology and elevate the awareness of the SRS brand in the marketplace. Wealso sell some of our products and solutions via the Internet.  Revenues associated with those sales arerecognized upon shipment and have not historically been material.

 

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The following chart shows the percentage of our licensing revenue wereceived in 2009 and 2008 from each of these markets.

 
| **2009** | **2008** |
|----------|----------|
|     |     |
|          |          |
|     |     |

**Home Entertainment**

 

Home entertainment products currently represent the largest market forour technologies and have, in recent years, been the largest revenuecontributor. Manufacturers in this market utilize our technologies andsolutions to improve functionality and product performance and/or todifferentiate their products from their competitors.  In many instances, manufacturers licensemultiple technologies from us for multiple product lines and divisions. Productcategories within this market include televisions (such as LCD and plasmatelevisions) and set-top boxes (“STBs”).

 

*Televisions.*  Our audio technologies and solution suitesare widely used by television manufacturers as a solution to audio challengesthat manufacturers encounter in today’s flat panel television designs and/or asa differentiating feature. As television makers continue to migrate to modelswith thinner digital displays, they are finding that they have less room forspeakers, which may compromise the overall audio quality of the television. Weprovide manufacturers with patented solutions for accurately presentingsurround sound, improving bass response, increasing dialog clarity, improvingvolume consistencies among channels and programming, and creating a morenatural sound stage. These solutions improve the audio quality of thetelevision set without the expense of additional hardware or designing forlarger speakers.  Our technologies suitedfor televisions are currently licensed by companies such as, Samsung, VIZIO,LG, Sharp, and Sony.

 

*Set-top Boxes.*  Although STBs receive and present surroundsound content, they are typically connected to televisions with two-channelspeakers. Our TruVolume technology serves as our lead technology in the STBcategory as it creates a level volume user experience to offset levelfluctuations during channel changes, changes among different input devices andchanges between the program and commercial. Additionally, our SRS surroundsound technology creates a surround sound experience over any existingtwo-speaker system, including the internal speakers of a television. Thistechnology also creates a virtual surround experience from stereomaterial.   Our technologies suited forSTBs are currently licensed by companies such as EchoStar and Motorola.

 

**Personal Computers**

 

Personal computers (“PCs”), especially mobile PCs such as laptops,notebooks and the new genre of Ultra Mobile Devices (also known as net books)have become very popular as more users utilize their PCs as their mainentertainment device at home or on the go. At home, PCs are often used as mediahubs. PC users can enjoy and manage collections of music and movies, along withdownloaded and recorded television programming. This content is now beingdistributed through the home using networked media adapter products. Throughoutthese systems, there is a need for optimizing playback on the computerspeakers, presenting a closer assimilation to a typical home theaterexperience, including transmitting surround sound around the home and enjoyingcontent playback on headphones. On the go, users have to rely on the audiooutput capabilities of their PCs which are often inadequate given the inherentchallenges in today’s tiny PC enclosures. We believe our technology solutionsare well positioned to fill the need to deliver better sound, with deeper bass,clarity and volume.  Our SRS PremiumSound and SRS Premium Voice suites address many of the usage cases above,overcoming related challenges and limitations. Our technologies suited for PCs are currently licensed by companies suchas Dell, Hewlett Packard, LG, and AsusTek.

 

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**Personal Telecommunications**

 

We provide the personal telecommunications market (mobile phones) withboth voice and audio rendering technologies and solution suites. Given thegrowth of smart and featured phones, more mobile phones are incorporatingadvanced audio and multimedia features and functionality at a rapid pace. Newservices include digital music downloads, streaming audio and video content,gaming, and television viewing. Our solutions are focused on the specific needsin the mobile market which have not previously been addressed. For example, ourtechnologies deliver upon  needs likevoice intelligibility in noisy environments, louder speaker performance,clarity of dialog in video content, poor bass-response of small speakers,hampered stereo imaging in narrowly spaced speakers, and 3D positioningaudio for interactive gaming. We believe we can leverage our strong presence inthe home entertainment market and our suite of voice technologies to providegood opportunities for growth in the personal telecommunications market.  Our technologies are licensed by telecommunicationscompanies such as Motorola, Samsung and NEC.

 

**Automotive**

 

We have invested in research to create solutions specific to the needsof the automotive market. Within vehicles, audio and video content is playedfrom multiple sources and then presented on both speakers and headphones.Stereo content from sources like CDs, MP3 players, mobile television and radioneeds to be presented on multiple speakers in the car, some of which may not beoptimally placed and may not have strong bass response. Surround sound contentfrom DVDs, radio and downloaded music needs to be rendered on both car speakersand on rear-seat headphones with a maximum sweet spot. Our automotive solutionssuch as SRS CS Auto, SRS CS Auto DX, SRS Focus and SRS TruSurround XT addressthese needs and provide manufacturers in this segment with a fully tunablesolution. Our technologies are currently licensed by companies such asFujitsu-ten, Panasonic, Clarion and Kenwood and used on automobilesmanufactured by companies such as Toyota, Subaru, Nissan and Honda.

 

**Portable Media**

 

MP3 (audio) and MP4 (audio and video) players and other portable mediaplayers enable consumers to enjoy audio and video content while on the go. Theaudio contents are stored in a compressed industry standard MP3 audio standard.As such, when the content is decoded and played back through miniatureearphones, the audio generally suffers a loss of quality. Our technologies,such as SRS WOW and SRS WOW HD, are capable of improving the audio qualityduring playback. Our TruMedia suite of technologies also enable rendering ofsurround sound through earphones or using external speakers when playing backsurround sound encoded contents often used along with contemporary videocontents. Associated with the increasing popularity of MP3 and MP4 players, therehas been a noticeable growth in the market for accessories, such as portablemedia adapters, docking stations and miniature speaker systems. The smallfootprint of these devices limits speaker size and speaker spacing. Oursolutions enable vendors of these devices to increase the quality of theiraudio output without significantly increasing hardware component costs.

 

**Customer Concentration**

 

For fiscal year 2009, 2008, and 2007, Samsung accounted forapproximately 39%, 42%, and 28%, respectively, of our consolidatedrevenues.  Given the significant amountof revenues derived from Samsung, the loss of that customer or theuncollectibility of related receivables could have a material adverse effect onour consolidated financial condition and consolidated results of operations.

 

**Our Strategy**

 

Our sales strategy is to identify high-growth markets, develop neededtechnology solutions and features, and work with software and semiconductorplatform partners to make these technologies widely available and easy toimplement by OEMs and ODMs. We believe that we will continue tostrengthen our market position as the leader in audio and voice technologies byemploying the strategy of providing a stream of patented audio and voicetechnologies, penetrating new licensing accounts, expanding relationships withexisting licensees, creating a broad platform of software and semiconductorpartners, and developing strong awareness of the SRS brand.

 

The mission of our licensing platform efforts is to achieve broadcoverage for our technology solutions within all of our targeted productmarkets in order to expand sales and licensing opportunities. By developingstrong relationships with leading software and semiconductor companies, webelieve our audio technologies and solution suites can be delivered tocustomers worldwide across high growth and high volume product applications.

 

We work together with our platform partners (leading semiconductormanufacturers and middleware or firmware software providers) to provide ourmutual customers with the technology that best fits their needs. We alsotogether solicit other new customers to consider using the platform. Manytimes, a platform will become enabled with our technology due to customerrequests.

 

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As a technology licensing company, the strength of our brand is animportant asset. Since brand recognition drives licensing sales, we have investedin strategies designed to increase consumer awareness of SRS Labs with theultimate goal of establishing our brand with both product manufacturers andconsumers around the world as a recognized symbol for high-quality audio. Thesix 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-marketingprograms; (b) public relations and new media outreach programs; c) onlinebranding programs; (d) cable television and movie theatre advertising; (e) participationin and/or sponsorship of industry events such as tradeshows and (f) use,and recognition of use, of SRS technology by content and broadcastprofessionals.

 

*OEM Marketing Programs.*  In the majority of products that use SRStechnologies, our logo is either prominently displayed on the product itselfor, in the case of software products and mobile phones, featured in thegraphical user interface. We believe this logo exposure is a key tool inreaching consumers worldwide. In addition, we work with our OEM customers asthey prepare for launching new products that feature SRS technologies bysupplying complete SRS corporate and technology tool kits with a wide array ofmaterial, including SRS logos, illustrations, technology explanations andsuggested demonstration material.

 

*Public Relations (“PR”) and New Media OutreachPrograms.*We believe in theendorsement power of opinion leaders and expert groups in the CE and ITindustries. As such, we have an active and expanding PR program, both onlineand in print, to promote SRS technologies and solutions found in our ownproducts or products of OEMs that feature SRS technologies and solutions.Similarly, we have found the viral nature of the new media very effective inpromoting our brand and innovations and therefore, have recently focused onmultiple programs to systematically reach and work with bloggers and relevantsocial networks.

 

*Online Branding Programs.*  Online exposure has also been an importantpart of our branding strategy. One benefit of our relationship with Microsoftis that the SRS logo displayed in the audio control panel of Microsoft’sWindows Media Player links to an SRS technology page. As a result, we havereceived significant traffic and opportunities to create brand awareness withconsumers and educate consumers on the benefits of our technology. Our onlineefforts also include the direct sale of the iWOW family of products includingplug-in software for both the PC and Mac platforms, as well as a unique adapterfor the Apple iPod. Revenue from the sale of these products has not beensignificant historically, but we believe these products gives us a valuabledemonstration platform to showcase our audio technologies.

 

*Cable Television and Movie Theater Advertising.*For technologies that appeal directly to consumers such as ourTruVolume volume leveling solution, we have promoted the applicable solutionbrand and the SRS corporate brand directly to consumers with professionallydirected and produced 30-second commercials. Similarly, we have taken themessage directly to consumers who frequent the movie theaters to promote ourbrand and our TruVolume technology in the theater before the main show beginsand in public areas inside the theaters, including on the TV screens above theconcession stands and lobbies.

 

*Participation in and/or Sponsorship of IndustryEvents.*We participate in severaltrade and industry events each year to promote our brand and our technologysolutions. We also sponsor events related to our strategic segments byproviding both financial resources to the event organizers and offering ourinsight into the forces that drive the CE industry through speaking engagementsand participation in discussion panels. Some of the popular events SRSparticipates or sponsors include the Consumer Electronics Show (CES), theMobile World Congress, DisplaySearch, CTIA, and SINOCES in China.

 

*Use of SRS Technology by Content and BroadcastProfessionals.*  We develop,license and sell professional hardware and software products to enable contentcompanies, broadcasters and music publishers to encode their material using ourCircle Surround technology. When Circle Surround is professionally used, theSRS and Circle Surround logos are often displayed within the content itself or,on the packaging material and, in the case of radio, an announcement is madethat the broadcast is being delivered in SRS Circle Surround. We haveconcentrated on three key sectors in the professional audio market: television,radio and music; and we have developed a line of hardware and software productsto address these sectors. These products are sold directly to professionalcustomers and are also available from selected dealers and distributorsservicing the professional audio and broadcast markets. We did not generatesignificant revenue from the sale of professional hardware equipment in 2009;however, we believe that such sales facilitate the licensing of our technologyto OEMs that benefit from enhanced audio transmissions.

 

**Sales and Marketing**

 

We have two primary types of revenue agreements with ourlicensees—direct and non-direct. Under a non-direct agreement, royalty revenuemay be collected by our platform partner, who include and enable our technologywithin their solution, at the time the chip is sold to an OEM or ODM. Theplatform partner remits the royalty to us on behalf of the licensee. Mostoften, however, we license our technologies to OEMs and ODMs underdirect agreements and collect revenue directly from them. These licensing arrangementswith OEMs or ODMs authorize them to design, build and sell productscontaining our technology. Under this licensing approach, the licensees arefree to choose a semiconductor solution from the platform partner that bestsuits their technical and cost requirements. We receive royalties directly fromthe licensed OEM or ODM for the use of our technologies in licensed productsmanufactured and shipped by the OEM or ODM. Many major OEMs have licensesor purchase products manufactured by a licensed ODM for the use of one or moreof our technologies and for the use and display of our trademarks.

 

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Our process for selecting particular platform partners for distributingour technologies is based on several criteria including: (a) segmentleadership—we target platform partners that hold preeminent positions in marketsegments characterized by high growth, volume and/or margins; (b) volume—weseek platforms that will maximize exposure of our technologies to a largenumber of potential OEMs; (c) synergy—we seek platforms which serve toposition our technologies with compatible and additive technologies forintegrated delivery; and (d) convergence potential—we target arrangementsthat will enable us to establish a presence on platforms that intersect severalfunctional features.

 

To implement our licensing sales strategy within our identifiedmarkets, we have established a direct sales force and an international networkof independent sales agents. In North America, we employ a direct sales forceto market our portfolio of audio and voice technologies to the OEM community.Internationally, we maintain offices in Japan, Taiwan, China and Korea tosupport our multi-national OEM customers. We actively promote the use of ourtrademarks and logos and require customers to prominently display theappropriate SRS technology or solution logos on products and packaging and inadvertising. We plan to continue to work closely with our licensees to enhancetheir success in selling finished products and semiconductor products thatincorporate 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, aswell as, conducting in-person technology demonstrations or presentations forthe press and other companies to promote our technologies and products.

 

We also regularly participate in tradeshows and conferences to increaseawareness of who we are and what we do and to market our technologies andproducts. We work closely with our licensees and platform partners to activelyexplore additional opportunities to place our technologies in new productsand/or markets.

 

**Research and Development**

 

We license our products in markets that are characterized by rapidlychanging technology and continuous improvements in products and services. Ourresearch and development expenditures in 2009, 2008 and 2007 were $5,721,195,$3,942,635, and $3,107,482, respectively. These expenses generally consist ofsalaries and related costs of employees and consultants engaged in ongoingresearch, design and development activities and costs for engineering materialsand supplies.

 

As of December 31, 2009, we had 37 employees in our research anddevelopment group, representing 43% of our total employees. Our software,hardware and application engineers generally focus on developing intellectualproperty, technology solutions and consumer products.  Engineers are based in our offices throughoutthe world and support our licensing business.

 

**Competition**

 

Competition in the audio, voice and surround sound technology licensingbusiness includes other licensing companies who offer competing technologies aswell as the internal engineering departments of our current or prospectivelicensees and platform providers, who may develop audio technologies for use intheir own products.

 

In the field of audio improvement, we compete directly with other audioproviders, including Dolby and DTS. Additionally, some of our OEM customersmaintain or are developing their own audio improvement technologies. Becauseour audio technologies work with any existing recorded material, whether mono,stereo or surround sound, most of our audio technologies can be used either asan alternative or as a complement to most competing audio technologies.

 

Many of our competitors have, or may have, substantially greaterresources than us to devote to advancing their existing technologies anddeveloping and marketing new products and technologies. We believe that wecompete based primarily on the quality, efficiency, and performance of ourproprietary technologies, brand name awareness, the ease, customizationcapabilities, and cost of implementing our technologies, the ability to meetOEMs’ needs to differentiate their products, and the strength of our licenseerelationships. We believe we compete favorably based on these factors; however,we cannot guarantee that we will continue to be competitive with the existingor future products or technologies of our competitors.

 

**Intellectual Property Rights and ProprietaryInformation**

 

We operate in industries where innovation, investment in new ideas andprotection of intellectual property rights are important for success. We relyon a variety of intellectual property protections for our products andservices, including patent, copyright, trademark and trade secret laws andcontractual obligations. We pursue a policy of enforcing such rights. We cannotguarantee, however, that our intellectual property rights will adequatelyprotect our competitive position or that competitors will not be able toproduce non-infringing competitive products or services. We cannot guaranteethat third parties will not assert infringement claims against us, or that ifrequired to obtain any third party licenses as a result of an infringementdispute, we will be able to obtain such licenses.

 

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In order to protect the underlying technology concepts, we have filedand/or obtained patents for all of our marketed technologies includingtechnologies marketed under the following trademarks: TruSurround XT, CircleSurround, SRS WOW, TruVoice, TruMedia and TruVolume. In addition, we hold numerousissued patents and patents pending for speaker and other acoustic reproductiontechnologies. We pursue a general practice of filing patent applications forour technologies in the United States and various foreign countries where ourlicensees manufacture, distribute or sell licensed products. We continue toupdate and add new applications to our patent portfolio to address changingworldwide market conditions and our new technological innovations. The range ofexpiration dates for our patents extend between the years 2010 to 2019. We havemultiple patents covering unique aspects and improvements for many of ourtechnologies. Accordingly, the expiration of any single patent should notsignificantly affect our intellectual property position or the ability togenerate licensing revenue.

 

We also routinely file U.S. federal and foreign trademarkapplications for the various word names and logos used to market our technologysolutions to licensees and the general public. The duration of the U.S. andforeign registered trademarks can typically be maintained indefinitely,provided that proper maintenance fees are paid and the trademarks arecontinually used or licensed by us.

 

**Seasonality**

 

Due to the dependence on the consumer electronics market, we generallyexperience seasonal fluctuation in sales and earnings. In particular, webelieve that our business experiences seasonality relating to the holidayseason, resulting in higher revenues in the fourth and first quarters. As wehave moved toward diversifying our key market segments in the consumerelectronics industry, we expect our business to be less seasonal.

 

**Employees**

 

As of December 31, 2009, we employed 86 persons, including 11 infinance and administration, 37 in research and development, engineering andproduct development, and 38 in sales and marketing. None of our employeesare covered by a collective bargaining agreement or are presently representedby a labor union. We have not experienced a work stoppage and believe wehave good relations with our employees. In addition to our direct hire employees, as of December 31, 2009,we had consulting agreements that provide to us 4 full time consultants inresearch and development and 14 consultants in sales and marketing, all of whomare located outside of the United States.

 

**Available Information**

 

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, areavailable free of charge on our website as soon as reasonably practicable afterwe electronically file such material with or furnish it to the Securities andExchange Commission (“SEC”). Our SEC reports can be accessed through theinvestor relations section of our website. Additionally, the Company’s Code ofEthics and Committee Charters are available on our website.  The information found on our website is notincorporated in and is not part of this or any other report we file with orfurnish to the SEC.

 

**Item 1A. Risk Factors**

 

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

 

***We are exposed to risks in ourlicensing business related to product and customer concentration.***

 

Currently, we generate a majority of our revenue in the homeentertainment market, principally through the inclusion of SRS technologyinside flat panel LCD and plasma televisions. We expect that the consumer homeentertainment market will continue to account for a significant portion of ourlicensing revenues for the foreseeable future. Consumer spending on homeentertainment products is subject to significant fluctuations, and there issignificant price competition for such products. Retail prices for certainconsumer electronics products that include our audio technology have decreasedsignificantly, and we expect that this trend will

 

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continuefor the foreseeable future. In addition, from time to time, certain of our OEMand semiconductor manufacturer customers may account for a significant portionof our revenues. For example, for the year ended December 31, 2009,Samsung accounted for approximately 39% of our consolidated revenues. Thesemanufacturers could develop their own technologies or decide to exclude ouraudio rendering technology from their products altogether in an effort toreduce cost, our revenues and profitability could be adversely impacted.  For example, during 2007, we were informed bySony that they were no longer using our technology in the majority of theirtelevisions.  The loss of any keycustomer in the future could have a material adverse affect on our financialcondition and results of operations.

 

***General economic conditions may reduce our revenues and harm ourbusiness.***

 

Ourbusiness is exposed to adverse changes in general economic conditions, becauseproducts that incorporate our technologies are entertainment-oriented andgenerally discretionary goods. The current slowdown or decline in U.S. andforeign economic growth has adversely affected consumer confidence, disposableincome and spending. As a result, sales by our licensees of consumerelectronics and other products incorporating our technologies may not grow asrapidly as in prior periods or may even decrease, which could adversely affectour licensing revenue.

 

***Our business is highly dependent onthe consumer electronics market, which is characterized by short product lifecycles, fluctuations in demand and seasonality, declining retail prices and issubject to risks related to product transitions.***

 

The consumer electronics market is characterized by intensecompetition, rapidly evolving technology, and ever-changing consumerpreferences. These factors result in the frequent introduction of new products,short product life cycles and significant price competition. As a result, wemay need to develop new products or technologies to integrate with the newproducts and technologies developed by our customers. If we are unable todevelop the necessary technologies to meet the changing needs of our customersor provide such technologies at competitive prices, our customers may reducetheir use of our technologies and our revenues may decline. In addition, thedynamic nature of this market limits our ability and the ability of ourcustomers to accurately forecast quarterly and annual sales. If we, or ourcustomers, are unable to adequately manage product transitions, our businessand results of operations could be negatively affected.

 

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

 

Wederive most of our revenue from the licensing of our technologies to consumerelectronics product manufacturers. We do not manufacture consumer electronicsproducts ourselves and our licensing revenue is dependent on sales by ourlicensees of products that incorporate our technologies. We cannot controlthese manufacturers’ product development or commercialization efforts orpredict their success. In addition, our license agreements, which typicallyrequire manufacturers of consumer electronics products and media softwarevendors to pay us a specified royalty for every electronics product shippedthat incorporates our technologies, do not require these manufacturers toinclude our technologies in any specific number or percentage of units, andonly a few of these agreements guarantee us a minimum aggregate licensing fee.Accordingly, if our licensees sell fewer products incorporating ourtechnologies, decline to actively market products incorporating ourtechnologies or otherwise face significant economic difficulties, our revenuewill decline. Changes in consumer tastes or trends, changes in industrystandards or adverse changes in business and economic conditions may also adverselyaffect our licensing revenue.

 

***Pricing pressures on the consumerelectronics product manufacturers, who incorporate our technologies into theirproducts, could limit the licensing fees we charge for our technologies, whichcould reduce our revenues.***

 

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

 

***We face intense competition fromcompanies with greater brand recognition and resources.***

 

The digital audio, consumer electronics and entertainment markets areintensely competitive, subject to rapid change, and significantly affected bynew product introductions and other market activities of industry participants

 

Many of our current and potential competitors enjoy notable competitiveadvantages, including:

 

·                  greater name recognition;

 

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·                  a longer operating history;

 

·                  more developed distributionchannels and deeper relationships with consumer electronics products designersand manufacturers;

 

·                  a more extensive customerbase;

 

·                  broader product and serviceofferings;

 

·                  greater resources forcompetitive activities, such as research and development, strategic acquisitions,alliances, joint ventures, sales and marketing, and lobbying industry andgovernment standards; and

 

·                  more technicians andengineers.

 

As a result, these current and potential competitors may be able torespond more quickly and effectively than we can to new or changingopportunities, technologies, standards, or customer requirements.

 

***Inaccurate licensee royalty reporting andunauthorized use of our intellectual property could materially adversely affectour operating results.***

 

Ourlicensing revenue is generated primarily from consumer electronics productmanufacturers who license our technologies and incorporate them in theirproducts. Under a significant percentage of our existing arrangements, theselicensees typically pay us a specified royalty for every product they ship thatincorporates our technologies. We rely on our licensees to accurately reportthe number of units shipped that incorporate our technologies. We calculate ourlicense fees, prepare our financial reports, projections and budgets, anddirect our sales and product development efforts based on these reports wereceive from our licensees. However, it can be difficult for us toindependently determine whether or not our licensees are reporting shipmentsaccurately. This is especially true with respect to software incorporating ourtechnologies because software can be copied relatively easily and we often donot have easy ways to determine how many copies have been made. Most of ourlicense agreements permit us to audit our licensees’ records, but audits aregenerally expensive and time consuming and initiating audits could harm ourcustomer relationships. We expect that we will continue to be subject tounderstatement and non-reporting of royalty bearing revenues by licensees,which could adversely affect our operating results. Conversely, to the extentthat our licensees overstate the number of products incorporating ourtechnologies, negative corrections could result in reductions of royaltyrevenue in subsequent periods. Some of our licensees may begin to more closelyscrutinize their past licensing statements which may result in an increasedreceipt of negative corrective statements.

 

Wealso may experience problems with non-licensee consumer electronics productmanufacturers and media software vendors, particularly in emerging economies,incorporating our technologies or incorporating our technologies and trademarksinto their products without our authorization and without paying us anylicensing fees. This unauthorized use of our intellectual property couldadversely affect our operating results.

 

***Our business and future prospectsdepend upon the strength of our brand. Awareness of our brand depends to asignificant extent upon decisions by our customers to display our trademarks ontheir products, and if our customers do not display our trademarks on theirproducts, our ability to increase our brand awareness may be harmed.***

 

Becausewe engage in relatively little direct brand advertising, the promotion of ourbrand depends upon consumer electronics industry participants displaying ourtrademarks on their products that incorporate our technologies.  Although we do generally require ourcustomers 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 criticalto maintaining and expanding our licensing revenues and entering into new orbroadening existing licensing relationships. If our customers choose for any reason not to display our trademarks on theirproducts, our ability to maintain or increase our brand awareness may beharmed, which would have an adverse effect on our business and prospects. Inaddition, if we fail to maintain high quality standards for our products, orthe products that incorporate our technologies through the quality controlevaluation process that we require of our licensees, the strength of our brandcould be adversely affected.

 

***Licensee products that incorporateour technologies, from time to time, experience quality problems that coulddamage our brand, decrease revenues and increase operating expenses.***

 

Licenseeproducts that incorporate our technologies often are complex and sometimescontain undetected software or hardware errors, particularly when firstintroduced or when new versions are released. In addition, those products areoften combined with, or incorporated into, products from other companies,sometimes making it difficult to identify the source of a problem. Any negative

 

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publicity or negativeimpact relating to these product problems (even if unrelated to ourtechnologies) could adversely affect the perception of our brand. In addition,these errors could result in loss of, or delay in, market acceptance of thoseproducts or our technologies, or cause delays in delivering them and meetingcustomer demands, any of which could reduce our revenue and raise significant customerrelations issues. Although we generally attempt to contractually limit ourliability for our licensees’ defective products, we may elect to helpreengineer those products, which could increase our expenses and adverselyaffect our operating results.

 

***We are subject to risks associatedwith substantial international operations.***

 

We conduct sales and customer support operations in a number ofcountries throughout the world that require refinement to adapt to the changingmarket conditions on a regional basis. In addition, many of our significantcustomers are headquartered in the Asia region, particularly Korea and Japan.Approximately 72%, 88% and 90% of our revenues were derived from customers withheadquarters located in the Asia markets during the years ended December 31,2009, 2008 and 2007, respectively. We expect to continue to derive asignificant portion of our revenues from sales to customers in these marketsfor the foreseeable future. Also, a substantial number of productsincorporating our technologies are manufactured, assembled and tested by thirdparties in Asia. As a result, we are subject to a number of risks of conductingbusiness outside of the United States, any of which could have a materialadverse impact on our business and results of operations, including:

 

·                  global economic downturn;

 

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

 

·      currencyfluctuations;

 

·                  difficulties and costs ofstaffing and managing foreign operations;

 

·                  unexpected changes in, orimpositions of, government requirements;

 

·                  adverse changes in tariffsand other protectionist laws and business practices that favor localcompetitors;

 

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

 

·                  the burdens of complyingwith a variety of non-U.S. laws and reduced protection of our intellectualproperty in some countries;

 

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

 

·                  other factors beyond ourcontrol, including natural disasters and major health concerns.

 

***Our technologies have a long andunpredictable sales cycle, which can result in uncertainty and delays ingenerating additional revenues.***

 

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

 

***If our patents and otherintellectual property rights do not adequately protect our products, we maylose market share to our competitors and be unable to operate our businessprofitably.***

 

Our ability to compete may be affected by our ability to protect ourproprietary information. We have filed numerous U.S. and foreign patentapplications and to date have a number of issued U.S. and foreign patentscovering various aspects of our technologies. We cannot guarantee that thesteps taken by us to protect our intellectual property will be adequate toprevent 

 

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misappropriationof our technology or that our competitors will not independently developtechnologies that are substantially equivalent or superior to our technology.In addition, the laws of certain foreign countries may not protect ourintellectual property rights to the same extent as do the laws of the U.S. Itis possible that third parties may assert claims or initiate litigation againstus or our customers with respect to existing or future products. In addition,we may initiate claims or litigation against third parties for infringement ofour proprietary rights or to determine the scope and validity of ourproprietary rights. Litigation in the technology industry is common.  Claims and litigation brought against us orinitiated by us could be costly and time consuming and could divert our managementfrom our business. The outcome of any litigation is uncertain and could requireus to pay significant damages or could prevent us from licensing some or all ofour technologies, which could significantly harm our business and results ofoperations.

 

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

 

Our future success depends to a large extent upon the continued serviceof key personnel, including engineering, sales and administrative staff. Weanticipate that any future growth will require us to recruit and hire a numberof new personnel in engineering, operations, finance, sales and marketing.Competition for such personnel can be intense, and it is possible that we maynot be able to recruit and retain necessary personnel to operate our businessand support future growth.

 

***The market price of our common stockis volatile and your investment in our common stock could suffer a decline invalue.***

 

The trading price of our common stock has been, and will likelycontinue to be, subject to wide fluctuations in response to quarterlyvariations in our operating results, announcements of new products ortechnological innovations by us or our competitors, strategic alliances betweenus and third parties, general market fluctuations and other events and factors.Changes in earnings estimates made by brokerage firms and industry analystsrelating to the markets in which we do business, or relating to usspecifically, 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. Eventhough our stock is quoted on The NASDAQ Global Market, our stock has had andmay continue to have low trading volume and high volatility. The historicallylow trading volume of our stock makes it more likely that a severe fluctuationin volume, either up or down, will significantly impact the stock price.Because of the relatively low trading volume of our stock, our stockholders mayhave difficulty selling our common stock. In addition, the stock market in general, and TheNASDAQ Global Market and the market for technology and small market capcompanies in particular, has experienced extreme price and volume fluctuationsthat have often been unrelated or disproportionate to the operating performanceof those companies. Further, the market prices of securities of technologycompanies have been particularly volatile. These broad market and industryfactors may materially harm the market price of our common stock, regardless ofour operating performance.

 

***Our certificate of incorporation andbylaws as well as Delaware law contain provisions that could discouragetransactions resulting in a change in control, which may negatively affect themarket price of our common stock.***

 

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

 

**Item 1B.  Unresolved Staff Comments.**

 

None.

 

**Item 2.  Properties**

 

Our worldwide headquarters are located in Santa Ana, California, in a23,400 square foot facility consisting of office and warehouse space. The leasefor the facility expires in May 2013. We lease this facility from Daimler Commerce Partners, L.P., thegeneral partner of which is Conifer Investments, Inc. (“Conifer”). Thesole shareholders of Conifer are Thomas C.K. Yuen, our Chairman, ChiefExecutive Officer and President, and his spouse, Misako Yuen, as co-trustees ofthe Thomas Yuen Family Trust. Mr. and Mrs. Yuen also serve as theexecutive officers of Conifer. Mr. and Mrs. Yuen, as co-trustees ofthe trust, beneficially own a significant amount of our outstanding shares ofcommon stock. We paid the Daimler Commerce Partners rent of $238,680, $235,170 and$230,256, in 2009, 2008 and 2007, respectively. We believe the terms andconditions of the lease are competitive based on a review of similar propertiesin the area with similar terms and conditions.

 

We entered into two new leases in 2009 for our international operationsin Shanghai, China, and Tokyo, Japan. The leases for our offices in Shanghai and Tokyo expire in October 2010and August 2011, respectively. Additionally, we lease space in Shenzhen, China and Taipei, Taiwan.  In total, we paid rent of $426,651, $294,702and $230,256 during 2009, 2008 and 2007, respectively, for all of ourfacilities.  We believe that our currentfacilities are adequate to support our current requirements.

 

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**Item 3.  Legal Proceedings**

 

On June 8, 2007, wesent a letter to Sony Corporation (“Sony”) relating to the possibleinfringement of several SRS patents by Sony’s S-Force technology. Sonyresponded to the letter by filing a Complaint for Declaratory Relief in theU.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 thepurpose of conducting discussions towards an amicable resolution of thedispute, and the Complaint for Declaratory Relief wasdismissed.  While the standstill agreement has expired, the partiescontinue to evaluate the related technologies, patents and claims.  Ourdiscussions with Sony are ongoing; however, we cannot assure you that we will prevailin this matter and are unable to determine at this time the impact that thismatter may have, if any, on our consolidated financial position, results ofoperations or cash flows.

 

Fromtime to time, we may be involved in other litigation matters and disputesarising in the normal course of business. Any such matters and disputes couldbe costly and time consuming, subject us to damages or equitable remedies, anddivert our management and key personnel from our business operations.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

 

None.

 

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**PART II**

 

**Item 5.  Market for Registrant’s Common Equity, Related StockholderMatters and Issuer Purchases of Equity Securities**

 

**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 asreported by The NASDAQ Stock Market for the periods indicated.

 
| ** **           | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------------|------------|----------|------------|---------|------------|
| **Fiscal Year 2009** |       |     |       |    |       |
| First Quarter        |       | $        | 5.59       |    | $          | 4.27 |   |
| Second Quarter       |       | $        | 7.08       |    | $          | 4.93 |   |
| Third Quarter        |       | $        | 7.74       |    | $          | 6.10 |   |
| Fourth Quarter       |       | $        | 7.49       |    | $          | 6.34 |   |
|                 |       |     |       |    |       |
| **Fiscal Year 2008** |       |     |       |    |       |
| First Quarter        |       | $        | 5.50       |    | $          | 3.90 |   |
| Second Quarter       |       | $        | 7.25       |    | $          | 5.29 |   |
| Third Quarter        |       | $        | 6.19       |    | $          | 2.75 |   |
| Fourth Quarter       |       | $        | 5.55       |    | $          | 3.55 |   |

 

At February 2, 2010, the closing sale price of our common stockwas $6.91 per share.

 

**Holders**

 

At February 2, 2010, there were 396 stockholders of record.

 

**Dividend Policy**

 

We have never paid cash dividends on our common stock. We currentlyintend to retain our available funds for future growth and, therefore, we donot anticipate paying any dividends in the foreseeable future.

 

**Securities Authorized for Issuance Under EquityCompensation Plans**

 

The following equity compensation plans have been approved by ourstockholders: the SRS Labs, Inc. Stock Option, Nonqualified Stock Optionand Restricted Stock Purchase Plan (the “1993 Plan”), the SRS Labs, Inc.Amended and Restated 1996 Long-Term Incentive Plan (the “1996 Plan”), the SRSLabs, Inc. Amended and Restated 1996 Non-employee Directors’ Stock OptionPlan (the “Non-employee Directors Plan”) and the SRS Labs, Inc. 2006 StockIncentive Plan (the “2006 Plan”). A description of the material features ofeach of these plans is included in Note 6 to the Notes to ConsolidatedFinancial Statements under the caption “Stock Award/Option Plans/Warrants.” The1993 Plan expired on December 10, 2003 and no options or other rights toacquire equity are outstanding under that plan. On June 22, 2006, ourstockholders voted to approve the 2006 Plan, and to discontinue the issuance ofany awards under the 1996 Plan. We do not have any equity compensation plansother than those approved by our stockholders. The following table sets forthinformation regarding the number of shares of our common stock that may beissued pursuant to our equity compensation plans or arrangements as of December 31,2009.

 

**Equity Compensation Plan Information**

 
| ** **                                                   | ** ** | **(a)**                                                                                                                                          | ** ** | **(b)**                                                                                                     | ** ** | **(c)**                                                                                                                                                                                                        | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Plan category**                                       | ** ** | **Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities remaining  available for future issuance  under equity compensation plans  (excluding securities  reflected in column(a))** | ** ** |
| Equity compensation plans approved  by security holders |       | 3,948,378                                                                                                                                        | (1)        | $                                                                                                           | 6.05       |                                                                                                                                                                                                           | 941,241    | (2) |
|                                                              |            |                                                                                                                                                  |            |                                                                                                             |            |                                                                                                                                                                                                                |            |  |

 

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(1)                                 Representsshares of common stock that may be issued pursuant to outstanding optionsgranted under the following plans: 1,194,698 shares under the 1996 Plan,177,500 shares under the Non-employee Directors Plan and 2,576,180 shares underthe 2006 Plan.

 

(2)                                 Representsshares of common stock that may be issued pursuant to future grants under thefollowing plans: 280,000 shares under the Non-employee Directors Plan and661,241 shares under the 2006 Plan.

 

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**Issuer Purchases of Equity Securities**

 

On November 3, 2008, our Board of Directors approved a stockrepurchase program. The stock repurchase program commenced November 7,2008 and ended on May 6, 2009.  Nopurchases were made under the program during fiscal year 2009.

 

**Stock Price Performance Graph**

 

The following graph illustrates a comparison of the total return of ourcommon stock with the total return for the S & P Smallcap 600 Indexand a peer group selected by us for the five year period ended December 31,2009. The peer groupwas limited to publicly traded companies in the audio enhancements andtechnology business and consisted of the following companies: Dolby, DTS, QSoundand DivX.  The comparison assumes $100 wasinvested on December 31, 2004 in our common stock and in each of theindices shown and assumes that all of the dividends were reinvested.

 

The comparisons in the table are required by the SEC and are notintended to forecast or be indicative of possible future performance of ourcommon stock. This graph shall not be deemed “filed” for purposes of Section 18of the Securities Exchange Act of 1934, as amended (“Exchange Act”), orotherwise subject to the liabilities under the Securities Act of 1933, as amended,or the Exchange Act.

 

**COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN***

Among SRS Labs, Inc., The S&P Smallcap 600 Index

And A Peer Group

 

 

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*$100 invested on 12/31/04 in stock or index, including reinvestment ofdividends. Fiscal year ending December 31.

 

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**Item 6.  Selected Financial Data**

 

The following selected financial information as of and for the datesand periods indicated have been derived from our audited consolidated financialstatements. The information set forth below is not necessarily indicative ofresults of future operations, and should be read in conjunction with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” in Part II,Item 7 of this Annual Report on Form 10-K and our consolidatedfinancial statements and related notes included elsewhere in this Report.

 
| ** **                                                                              | ** ** | **Years Ended December 31,**        | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                              | ** ** | **2009**                                 | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                              | ** ** | **(In thousands except per share data)** | ** ** |
| **Consolidated Statement of  Operations Data:**                                         |       |                                     |       |   |   |   |   |   |   |   |   |
| Revenues                                                                                |       | $                                        | 24,965     |   | $ | 18,333 |   | $ | 18,852 |   | $ | 18,547 |   | $ | 14,608 |   |
| Cost of sales                                                                           |       | 286                                      |       | 144 |   | 164 |   | 171 |   | 236 |   |
| Gross profit                                                                            |       | 24,679                                   |       | 18,189 |   | 18,688 |   | 18,376 |   | 14,372 |   |
| Operating expenses:                                                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Sales and marketing                                                                     |       | 11,415                                   |       | 9,220 |   | 6,718 |   | 7,345 |   | 5,192 |   |
| Research and development                                                                |       | 5,721                                    |       | 3,943 |   | 3,107 |   | 2,573 |   | 2,224 |   |
| General and administrative                                                              |       | 5,657                                    |       | 5,913 |   | 5,444 |   | 5,660 |   | 5,170 |   |
| Total operating expenses                                                                |       | 22,793                                   |       | 19,076 |   | 15,269 |   | 15,578 |   | 12,586 |   |
| Operating income (loss)                                                                 |       | 1,886                                    |       | (887 | ) | 3,419 |   | 2,798 |   | 1,786 |   |
| Interest income                                                                         |       | 348                                      |       | 1,275 |   | 2,041 |   | 1,136 |   | 673 |   |
| Income from continuing operations before income  taxes                                  |       | 2,234                                    |       | 388 |   | 5,460 |   | 3,934 |   | 2,459 |   |
| Income taxes                                                                            |       | 98                                       |       | 117 |   | 46 |   | 868 |   | 796 |   |
| Income from continuing operations                                                       |       | 2,136                                    |       | 271 |   | 5,414 |   | 3,066 |   | 1,663 |   |
| Discontinued operations:                                                                |       |                                     |       |   |   |   |   |   |   |   |   |
| Income (loss) from discontinued operations, net of  income taxes (benefit)         |       | —                                   |       | — |   | — |   | 1,017 |   | (3,087 | ) |
| Gain on disposal of discontinued operations                                             |       | —                                   |       | — |   | — |   | 625 |   | — |   |
| Income (loss) from discontinued operations                                              |       | —                                   |       | — |   | — |   | 1,642 |   | (3,087 | ) |
| Net income (loss)                                                                       |       | $                                        | 2,136      |   | $ | 271 |   | $ | 5,414 |   | $ | 4,708 |   | $ | (1,424 | ) |
| Income from continuing operations per common  share:                                    |       |                                     |       |   |   |   |   |   |   |   |   |
| Basic                                                                                   |       | $                                        | 0.15       |   | $ | 0.02 |   | $ | 0.34 |   | $ | 0.21 |   | $ | 0.12 |   |
| Diluted                                                                                 |       | $                                        | 0.14       |   | $ | 0.02 |   | $ | 0.32 |   | $ | 0.20 |   | $ | 0.11 |   |
| Income (loss) from discontinued operations per  common share:                           |       |                                     |       |   |   |   |   |   |   |   |   |
| Basic                                                                                   |       | $                                        | 0.00       |   | $ | 0.00 |   | $ | 0.00 |   | $ | 0.11 |   | $ | (0.22 | ) |
| Diluted                                                                                 |       | $                                        | 0.00       |   | $ | 0.00 |   | $ | 0.00 |   | $ | 0.11 |   | $ | (0.22 | ) |
| Net income (loss) per common share:                                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Basic                                                                                   |       | $                                        | 0.15       |   | $ | 0.02 |   | $ | 0.34 |   | $ | 0.31 |   | $ | (0.10 | ) |
| Diluted                                                                                 |       | $                                        | 0.14       |   | $ | 0.02 |   | $ | 0.32 |   | $ | 0.30 |   | $ | (0.10 | ) |
| Weighted average number of common shares used in  the calculation of per share amounts: |       |                                     |       |   |   |   |   |   |   |   |   |
| Basic                                                                                   |       | 14,460                                   |       | 15,589 |   | 16,154 |   | 14,956 |   | 14,118 |   |
| Diluted                                                                                 |       | 14,813                                   |       | 15,842 |   | 16,990 |   | 15,466 |   | 15,199 |   |
| **Consolidated Balance Sheet  Data:**                                                   |       |                                     |       |   |   |   |   |   |   |   |   |
| Working capital                                                                         |       | $                                        | 38,923     |   | $ | 37,519 |   | $ | 39,272 |   | $ | 34,697 |   | $ | 8,849 |   |
| Total assets                                                                            |       | 51,749                                   |       | 46,882 |   | 51,383 |   | 45,049 |   | 35,065 |   |
| Stockholders’ equity                                                               |       | 48,394                                   |       | 43,769 |   | 49,007 |   | 42,744 |   | 30,813 |   |

 

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**Item 7. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations**

 

**Overview**

 

Weare the recognized global leader in the practical application of psychoacoustics*,* the science behind how the human ear operates, andin the post processing segment of the market for audio delivery.  Our award-winning audio enhancementtechnologies and solutions dramatically restore audio and voice to its natural state, the way it was originally recorded, in both dimension andclarity, thus providing a superiorconsumer experience for a wide variety of CE devices such astelevisions, personal computers and mobile phones.

 

Our mission is to be the dominant worldwide provider of audio and voicesolutions 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 parentcompany, and its wholly-owned subsidiaries, SRSWOWcast.com, Inc., ShenzhenRepresentative Office of SRS Labs, Inc. (a Chinese company) ShanghaiRepresentative Office of SRS Labs, Inc (a Chinese company) and SRS Labs Japan,KK (a Japanese company). Our business is focused on developing and licensingaudio, voice and surround sound technology solutions to many of the world’sleading OEMs, software providers and semiconductor companies, and limited salesand marketing of standalone software and hardware products through theInternet.

 

**Critical Accounting Policies**

 

Our discussion and analysis of our results of operations and liquidityand capital resources are based on our consolidated financial statements, whichhave been prepared in accordance with accounting principles generally acceptedin the United States (“GAAP”).

 

The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and disclosure of contingent assets andliabilities. We base our estimates on historical and anticipated results andtrends and on various other assumptions that we believe are reasonable underthe circumstances, including assumptions as to future events. These estimatesform the basis for making judgments about the carrying value of assets andliabilities that are not readily apparent from other sources. By their nature,estimates are subject to an inherent degree of uncertainty. Actual results maydiffer 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 conditionand results of operations, and (b) that require management’s mostdifficult, subjective or complex judgments, often as a result of the need tomake estimates about the matters that are inherently uncertain. Our mostcritical accounting estimates include revenue recognition; valuation ofaccounts receivable, which impacts operating expenses; valuation of intangiblesand long lived assets, which primarily impacts operating expenses when weimpair assets or accelerate their depreciation; recognition and measurement ofcurrent and deferred income tax assets and liabilities, which impacts our taxprovision; and share-based compensation, which impacts operating expenses. Wediscuss each of these policies below, as well as the estimates and judgmentsinvolved. We also have other policies that we consider key accounting policies;however, these policies do not meet the definition of critical accountingestimates, because they do not generally require us to make estimates orjudgments that are difficult or subjective.

 

*RevenueRecognition*

 

Our license agreements typically have multi-year or automatic renewalterms, and either require: a) per-unit royalty payments for all productsimplementing our technologies and/or solutions; b) fixed annual or quarterlyroyalty 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 duringthe specified time period, with additional per-unit royalty paymentsthereafter.  Royalties for per-unitarrangements are reported in the quarter following shipment of the consumerelectronics device and are therefore recognized by us one quarter followingshipment by the OEM.  Revenues associatedwith fixed royalty payments are recognized ratably over the term of theagreement.  We also sell some of ourproducts and solutions via the Internet. Revenues associated with those sales are recognized upon shipment andare not material.

 

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*AccountsReceivable*

 

We perform ongoing credit evaluations of our customers and adjustcredit limits based upon payment history, the customer’s current creditworthiness and various other factors, as determined by our review of theircurrent credit information. We continuously monitor collections and paymentsfrom our customers and maintain allowances for doubtful accounts based uponspecific customer circumstances, current economic trends, historical experienceand the age of past due receivables. While such credit losses have historicallybeen within our expectations and the provisions established, we cannotguarantee that we will continue to experience the same credit loss rates thatwe have in the past. Unanticipated changes in the liquidity or financialposition of our customers may require additional provisions for doubtfulaccounts.

 

*IntangibleAssets and Impairment of Long-Lived Assets*

 

Costs paid by the Company related to the establishment and purchase ofpatents, primarily legal costs, are capitalized and amortized, depending on theestimated life of the technology patented. These assets are being amortizedover ten years. The Company evaluates the recoverability of long-lived assetswith finite lives. The Company assesses potential impairments to its long-livedassets when there is evidence that events or changes in circumstances indicatethat the carrying amount of an asset may not be recovered. An impairment lossis recognized when the carrying amount of the long-lived asset is notrecoverable and exceeds its fair value. The carrying amount of a long-livedasset is not recoverable if it exceeds the sum of the undiscounted cash flowsexpected to result from the use and eventual disposition of the asset. Anyrequired impairment loss is measured as the amount by which the carrying amountof a long-lived asset exceeds its fair value and is recorded as a reduction inthe carrying value of the related asset and a charge to operating results.Based upon the most recent assessment as of December 31, 2009, the Companyhas determined there was no impairment in the value of long-lived assets.

 

*IncomeTaxes*

 

In preparing our consolidated financial statements, we estimate ourincome taxes in each of the countries in which we operate. The process used tomake these estimates includes an assessment of the current tax expense, theresults from tax examinations and the effects of temporary differencesresulting from the different treatment of transactions for tax and financialaccounting purposes. These differences result in deferred tax assets andliabilities, which are included in our consolidated balance sheet. The Company accounts for deferred incometaxes utilizing an asset and liability method, whereby deferred tax assets andliabilities are recognized based on the tax effects of temporary differencesbetween the financial statements and the tax bases of assets and liabilities,as measured by current enacted tax rates. Deferred tax assets arereduced by a valuation allowance if it is more likely than not that someportion or all of the deferred tax asset will not be realized. We evaluate therealizability of our deferred tax assets by assessing our valuation allowanceand by adjusting the amount of such allowance, if necessary. At December 31,2009, we had net deferred tax assets primarily resulting from temporarydifferences between the book and tax bases of assets and liabilities, and lossand credit carry forwards. We continue to provide a valuation allowance ourdeferred tax assets based on an assessment of the likelihood of theirrealization. In reaching our conclusion, we evaluated certain relevant criteriaincluding deferred tax liabilities that can be used to offset deferred taxassets, estimates of future taxable income of appropriate character within thecarry-forward period available under the tax laws, and tax planning strategies.Our judgments regarding future taxable income may change due to marketconditions, changes in U.S. or international tax laws, the Company’s businessand results of operations, and other factors. These changes, if any, may requirematerial adjustments to these deferred tax assets, resulting either in a taxbenefit, if it is estimated that future taxable income is likely, or areduction in the value of the deferred tax assets, if it is determined thattheir value is impaired, resulting in a reduction in net income or an increasein net loss in the period when such determinations are made.

 

Our income tax provision is based on calculations and assumptions thatwill be subject to examination by the taxing authorities in the jurisdictionsin which we operate. Should the actual results differ from our estimates, wewould have to adjust the income tax provision in the period in which the factsand circumstances that give rise to the revision become known. Tax law and ratechanges are reflected in the income tax provision in the period in which suchchanges are enacted.

 

*Share-BasedCompensation*

 

The Company accounts for share-based compensation awards using thefair-value method and records such expense in the consolidated financial statementsover the requisite service period. In 2009, 2008 and 2007, we recordedshare-based compensation expense of $1,956,057, $1,777,468 and $1,727,017,respectively.

 

To determine the expected term of our employee stock options granted infiscal year 2009, we examined the historical term for our stock options andthose of our peers. To determine the risk-free interest rate, we utilized anaverage interest rate based on U.S. Treasury instruments whose term wasconsistent with the expected term of our awards. To determine the expectedstock price volatility, we examined the historical volatilities for our commonstock and those of our peers. See Note 6 (“Stockholders’ Equity andShare-Based Compensation”) of our Notes to Consolidated Financial Statements forfurther discussion.

 

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**Results of Operations**

 

The following table sets forth certain consolidated operating data as apercentage of revenues for the years ended December 31, 2009, 2008 and2007:

 

**Percentageof Total Revenue**

** **
| ** **                 | ** ** | **Years Ended  December 31,** | ** ** |
|----------------------------|------------|------------------------------------|------------|
| ** **                 | ** ** | **2009**                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues                   |       | 100                                | %          | 100 | % | 100 | % |
| Cost of sales              |       | 1                                  |       | 1 |   | 1 |   |
| Gross margin               |       | 99                                 |       | 99 |   | 99 |   |
| Operating expenses:        |       |                               |       |   |   |   |   |
| Sales and marketing        |       | 46                                 |       | 50 |   | 36 |   |
| Research and development   |       | 23                                 |       | 22 |   | 16 |   |
| General and administrative |       | 22                                 |       | 32 |   | 29 |   |
| Total operating expenses   |       | 91                                 |       | 104 |   | 81 |   |
| Operating income (loss)    |       | 8                                  |       | (5 | ) | 18 |   |
| Interest income            |       | 1                                  |       | 7 |   | 11 |   |
| Income before income taxes |       | 9                                  |       | 2 |   | 29 |   |
| Income taxes               |       | 0                                  |       | 1 |   | 0 |   |
| Net income                 |       | 9                                  | %          | 1 | % | 29 | % |

 

**Year Ended December 31, 2009 Compared to YearEnded December 31, 2008**

 

*Revenues*

 

Total revenues for the year ended December 31, 2009 (“fiscal year2009”) were $24,964,577 compared to $18,332,678 in the year ended December 31,2008 (“fiscal year 2008”), an increase of $6,631,899 or 36%. This increase wasprimarily attributable to increases in royalties related to the sales oftelevisions, set-top-boxes, personal computers and mobile devices containingour technologies by our licensees. In the home entertainment segment, royaltyrevenues increased $4,227,065 from fiscal year 2008 to fiscal 2009, of which$3,375,008 resulted from royalties related to sales of flat panel televisionsand monitors.  We noted increases inroyalty revenues from several of our largest television customers; includingSamsung and Vizio, as well as increases in revenues related China based OEMs. Revenues related to set-top boxes increased by $852,057 from fiscal year 2008to fiscal year 2009, primarily due to our agreement with EchoStar, which weentered into in March 2009.  Revenuegrowth in the home entertainment segment during 2009 was also positivelyimpacted by our royalty compliance program, through which we were able toidentify and collect approximately $1,200,000 of previously under reportedroyalties in fiscal year 2009.  Theincrease in revenues in the personal computer market from fiscal year 2008 tofiscal year 2009 was $2,040,992.   Wenoted increased revenues from many of our licensees, including Hewlett Packard,Dell, AsusTek, and BenQ among others.  Weexpect that during 2010, our revenues in the personal computer segment willcontinue to increase as our solutions are deployed on a larger number of products.  In the personal telecommunications segment,revenues increased $1,270,997 from 2008 to 2009.  This increase was primarily due to increasedrevenues from Samsung Mobile.  Weanticipate that during 2010 we will continue to experience increased revenuesin this segment as compared to 2009. Revenues in the automotive market decreased by $293,484 in 2009 ascompared to 2008 primarily due to the global decrease of new car sales.  Revenues in the portable media devices marketdecreased by $553,672 in 2009 as compared to 2008 due to decreased revenuesfrom MP3/MP4 players.

 

The following table represents our mix of licensing revenues by marketsource:

 
| ** **                                                | ** ** | **Years Ended  December 31,** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| Home entertainment (TV, set-top box)                      |       | 68                                 | %          | 69 | % |
| PC (software, hardware)                                   |       | 12                                 |       | 5 |   |
| Personal telecommunications (mobile phone, PDA)           |       | 11                                 |       | 9 |   |
| Automotive                                                |       | 5                                  |       | 8 |   |
| Portable media devices (digital media player,  headphone) |       | 4                                  |       | 9 |   |
|                                                      |       | 100                                | %          | 100 | % |

 

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*Sales andMarketing*

 

Sales expenses consist primarily of employee salaries, salesconsultants’ fees and related expenses, commissions, training, and travel andentertainment expenses.  Marketingexpenses consist primarily of employee salaries and related expenses, marketresearch, advertising and co-marketing, and costs associated with brandbuilding activities.  Sales and marketingexpenses were $11,415,115 for fiscal year 2009, as compared to $9,220,098 forfiscal year 2008. Overall sales and marketing expenses were $2,195,017, or 24%,higher in fiscal 2009.  This increase wasprimarily attributable to higher payroll and related costs associated withincreasing the size of our sales and marketing staff by approximately 21% in2009.  In addition to increasing thesales and marketing personnel, we have also increased our branding efforts bycreating new marketing assets, through both direct and co-marketing activities,and increased our participation in trade show activities.  We recorded $511,301 in share-basedcompensation expense for sales and marketing personnel during 2009 as comparedto $458,610 in 2008. As a percentage of total revenues, sales and marketingexpenses decreased from 50% for fiscal year 2008 to 46% for fiscal year 2009.

 

*Researchand Development*

 

Research and development expenses consist of salaries and related costsof employees engaged in ongoing research, design and development activities,customer support, technology porting activities, and costs for engineeringmaterials and supplies. Research and development expenses were $5,721,195 forfiscal year 2009, as compared to $3,942,635 for fiscal year 2008. The overallincrease in research and development expenses of $1,778,560, or 45%, wasprimarily attributable to increasing the size of our research and developmentstaff by approximately 41% in 2009. We recorded $457,464 in share-basedcompensation expense for engineering personnel during 2009 as compared to$399,630 in 2008. We expect that research and development expenses willcontinue to increase in absolute costs as we plan to continue to add to ourengineering team in order to support our global licensees and to accelerate theimplementation of our technologies with a greater number of customers anddevices.  As a percentage of totalrevenues, research and development expenses increased from 22% for fiscal year2008 to 23% for fiscal year 2009.

 

*Generaland Administrative*

 

General and administrative expenses consist primarily ofemployee-related expenses, legal costs associated with the administration ofintellectual property, facilities costs, insurance, public company costs, anddepreciation and amortization. General and administrative expenses were $5,656,616for fiscal year 2009 as compared to $5,913,081 for fiscal year 2008. Theoverall decrease $256,456 or 4%, was primarily attributable to a decrease inprofessional fees and expenses of $166,000, associated with our Dutch Auctionrepurchase program, which was terminated in September 2008.  We recorded $987,292 in stock-basedcompensation expense during 2009 as compared to $919,228 in 2008. As apercentage of total revenues, general and administrative expenses decreasedfrom 32% for fiscal year 2008 to 22% for fiscal year 2009.

 

*Interest Income*

 

Interest income was $347,528 for fiscal year 2009, compared to$1,275,047 for fiscal year 2008, a decrease of $927,519, or 73%.  Our goal during 2009 was to ensure assetprotection of our cash, and as such we invested our cash in low-risk, highliquidity investments such as fully insured certificates of deposits and assetsbacked by the United States Treasury.  Wecontinue to monitor our cash assets to maximize our interest income while maintainingan acceptable level of risk.  During 2009and 2008, the company did not incur any losses related to our cash andinvestments.

 

*Provisionfor Income Taxes*

 

Theincome tax provision for fiscal 2009 was $98,006 compared to $117,543 forfiscal year 2008, representing a decrease of $19,537, or 17%. The current andprior year provision consists primarily of estimated taxes payable to the stateof California.

 

We had federal and state net operating loss carryforwards at December 31,2009 of $8,463,418 and $5,598,943, respectively. The net operating losscarryforwards begin to expire in 2014 and will continue through 2027. Inaddition, we had federal foreign tax credit carryforwards of approximately$7,376,260 at December 31, 2009, which begin to expire in 2014, andfederal and state tax capital loss carryforwards of approximately $16,219,585,which begin to expire in 2011. As of December 31, 2009, we continued tohave a valuation allowance of $13,313,163 against our deferred tax assets,which was established primarily due to our cumulative losses in recent yearsand based on our assessment of our future ability to realize certain deferredtax assets.

 

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**Year Ended December 31, 2008 Compared to YearEnded December 31, 2007**

 

*Revenues*

 

Total revenues for fiscal year 2008 were $18,332,678 compared to$18,851,940 in the year ended December 31, 2007 (“fiscal year 2007”), adecrease of $519,262, or 3%. This decrease was primarily attributable todecreases in royalties related to the sales of personal computers, set topboxes, CRT televisions and personal media devices containing ourtechnologies.  The decrease in revenuesin the personal computer market from fiscal year 2007 to fiscal year 2008 was$649,153, of which $594,378 related to decreased royalties from Toshiba, whilerevenues in the personal media devices market decreased by $155,086 during thesame period, related to several customers. In the home entertainment market, total revenues decreased $209,120 fromfiscal 2007 to fiscal 2008.  Within thismarket, revenues related to set-top boxes decreased $139,219 and revenues fromCRT televisions decreased $124,062.  Someof these decreases were offset by increased revenues in the amount of $145,942related to flat panel televisions and monitors. The majority of the increase in flat panel televisions and monitorsrevenues were the direct result of our receipt of larger royalty payments fromsome of the multi-national television OEMs, including Samsung, offset by adecrease in revenues from Sony, Toshiba and LG. Home entertainment continues torepresent our largest revenue market.  Weentered into license agreements with several new television licensees during2008, including Vizio.  Revenues in theautomotive market increased by $160,356 in 2008 as compared to 2007 primarilydue to increased revenues from several customers in Japan who provide lineinstall, dealer option and aftermarket automotive audio systems to many of thesignificant Japanese automotive manufactures, including Toyota, Honda, Subaruand Nissan. In the personal telecommunications segment, revenues increased$298,741 from 2007 to 2008.  Thisincrease was primarily due to increased revenues from Samsung Mobile.

 

The following table represents our mix of licensing revenues by marketsource:

 
| ** **                                                | ** ** | **Years Ended  December 31,** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                | ** ** | **2008**                           | ** ** | **2007** | ** ** |
| Home entertainment (TV, set-top box)                      |       | 69                                 | %          | 68 | % |
| Portable media devices (digital media player,  headphone) |       | 9                                  |       | 9 |   |
| Personal telecommunications (mobile phone, PDA)           |       | 9                                  |       | 7 |   |
| Automotive                                                |       | 8                                  |       | 7 |   |
| PC (software, hardware)                                   |       | 5                                  |       | 9 |   |
|                                                      |       | 100                                | %          | 100 | % |

 

*Sales andMarketing*

 

Sales and marketing expenses were $9,220,098 for fiscal year 2008, ascompared to $6,717,906 for fiscal year 2007. Overall sales and marketingexpenses were $2,502,192, or 37%, higher in fiscal year 2008.  This increase was primarily attributable tohigher payroll and related costs, including one-time recruitment and severancecosts of approximately $525,000, associated with hiring an additional elevensales and marketing employees and full-time consultants in 2008 including ourVice President of Sales and our Vice President of Marketing.  We recorded $458,610 in share-based compensationexpense for sales and marketing personnel during 2008 as compared to $495,132in 2007. As a percentage of total revenues, sales and marketing expensesincreased from 36% for fiscal year 2007 to 50% for fiscal year 2008.

 

*Researchand Development*

 

Research and development expenses were $3,942,635 for fiscal year 2008,as compared to $3,107,482 for fiscal year 2007. The overall increase inresearch and development expenses of $835,153, or 27%, was primarilyattributable to hiring an additional five engineers in 2008, as well asincurring additional travel costs associated with supporting our globallicensees. We recorded $399,630 in share-based compensation expense forengineering personnel during 2008 as compared to $428,516 in 2007.  As a percentage of total revenues, researchand development expenses increased from 16% for fiscal year 2007 to 22% forfiscal year 2008.

 

*Generaland Administrative*

 

General and administrative expenses were $5,913,081 for fiscal year2008 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 feesand 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 withcorporate matters and an increase in share-based compensation expense.  We recorded $919,228 in stock-basedcompensation expense during 2008 as compared to $803,369 in 2007. As apercentage of total revenues, general and administrative expenses increasedfrom 29% for fiscal year 2007 to 32% for fiscal year 2008.

 

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*Interest Income*

 

Interest income was $1,275,047 for fiscal year 2008, compared to$2,041,288 for fiscal year 2007, a decrease of $766,241, or 38%. This decreasewas primarily attributable to the decrease in interest income due to lowerinterest rates and lower cash balances.

 

*Provisionfor Income Taxes*

 

Theincome tax provision for fiscal year 2008 was $117,543 compared to $45,558 forfiscal year 2007, representing an increase of $71,985, or 158%. The current andprior year provision consists primarily of estimated taxes payable to the stateof California. The increase in the provision is the result of change inCalifornia tax law in fiscal year 2008, whereby net operating losscarryforwards may not be used in 2008 or 2009 and research and developmentcredits are limited to 50% of the Company’s net tax.

 

**Selected Quarterly Operating Results**

 

The following table sets forth certain quarterly summary consolidatedfinancial data for the eight quarters in the period ended December 31,2009. The quarterly information is based upon financial statements prepared byus on a basis consistent with our audited consolidated financial statementsand, in management’s opinion, includes all adjustments, consisting only ofnormal recurring adjustments necessary for a fair presentation of theinformation for the periods presented. This information should be read inconjunction with our audited consolidated financial statements and notesthereto appearing elsewhere in this Report. Our quarterly operating resultshave varied significantly in the past and are expected to vary significantly inthe future. Due to rounding differences, the quarters in a given year may notadd precisely to the annual numbers for that year.

 
| ** **                          | ** ** | **Three Months Ended**                                     | ** ** |
|-------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                          | ** ** | **Mar 31,  2009**                                               | ** ** | **June 30,  2009** | ** ** | **Sep 30,  2009** | ** ** | **Dec 31,  2009** | ** ** | **Mar 31,  2008** | ** ** | **June 30,  2008** | ** ** | **Sep 30,  2008** | ** ** | **Dec 31,  2008** | ** ** |
| ** **                          | ** ** | **(In thousands except per share amounts)** | ** ** |
| Revenues                            |       | $                                                                    | 5,704      |   | $ | 5,055 |   | $ | 7,230 |   | $ | 6,975 |   | $ | 4,941 |   | $ | 4,178 |   | $ | 4,319 |   | $ | 4,894 |   |
| Gross profit                        |       | 5,632                                                                |       | 4,993 |   | 7,162 |   | 6,891 |   | 4,915 |   | 4,138 |   | 4,297 |   | 4,839 |   |
| Operating expenses                  |       | 5,346                                                                |       | 5,275 |   | 5,745 |   |   | 6,428 |   | 4,509 |   | 4,864 |   | 4,924 |   | 4,779 |   |
| Net income (loss)                   |       | $                                                                    | 386        |   | $ | (198 | ) | $ | 1,475 |   | $ | 473 |   | $ | 858 |   | $ | (408 | ) | $ | (316 | ) | $ | 137 |   |
| Net income (loss) per common share: |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                               |       | $                                                                    | 0.03       |   | $ | (0.01 | ) | $ | 0.10 |   | $ | 0.03 |   | $ | 0.05 |   | $ | (0.03 | ) | $ | (0.02 | ) | $ | 0.01 |   |
| Diluted                             |       | $                                                                    | 0.03       |   | $ | (0.01 | ) | $ | 0.10 |   | $ | 0.03 |   | $ | 0.05 |   | $ | (0.03 | ) | $ | (0.02 | ) | $ | 0.01 |   |

 

**Liquidity and Capital Resources**

 

At December 31, 2009, cash and cash equivalents, short andlong-term investments were $41,489,164 compared to $39,435,087 as of December 31,2008, an increase of $2,054,077. Our cash and cash equivalents were $27,988,164as of December 31, 2009, a decrease of $3,610,923 from cash and cashequivalents of $31,599,087 held at December 31, 2008. The decrease in cashand cash equivalents was primarily a result of the purchase of short andlong-term investments, partially offset by positive cash flow generated byoperating activities.  Cash and cashequivalents generally consist of cash, certificates of deposits, and moneymarket funds with original maturities of three months or less. The money marketfunds are primarily invested in US government obligations.  The cash and certificates of deposit are FDICinsured. We held $12,963,000 in short-term investments and $538,000 inlong-term investments at December 31, 2009.  Short-term investments consist ofcertificates of deposit with original maturities ranging from 6 to 12months.  Long-term investments consist ofcertificates of deposit with original maturities ranging from 18 months to 2years.   In fiscal 2009, 2008 and 2007,our operations were funded primarily from cash from operating activities.

 

Net cash provided byoperating activities was $2,776,720 and $2,629,133 for 2009 and 2008,respectively. The $147,587 increase in net cash provided by operatingactivities in fiscal 2009, compared to fiscal year 2008, was primarily a resultof an increase in net income, from $270,887 during the year ended December 31,2008 to $2,135,630 for the year ended December 31, 2009.  Offsetting the increase in net income was adecrease of deferred revenue by $608,570, due to the recognition of revenuefrom prepaid royalties.  Prepaid expensesalso increased $283,056 due to timing of payments to vendors.

 

Net cash used in investing activities was $6,920,993 and $3,310,826 in2009 and 2008, respectively. The $3,610,167 increase in cash used in investingactivities in 2009, compared to 2008, was primarily due to the purchase of$5,665,000 in short and long-term investments.

 

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Net cash provided by financing activities was $533,350 in 2009.  Net cash used in financing activities was$7,334,511 during 2008.  In 2009, theCompany did not repurchase any of its outstanding common stock and stock optionexercises increased.

 

Webelieve our existing cash, cash equivalents, short and long-term investmentbalances together with cash generated from operating activities will besufficient to meet our anticipated cash needs for at least the next twelvemonths. Our future capital requirements will depend on many factors, includingour level of revenues, the timing and extent of spending to support productdevelopment efforts, the expansion of sales and marketing activities, thetiming of introductions of new products and the continuing market acceptance ofour products.

 

**Contractual Cash Obligations and ContingentLiabilities and Commitments**

 

We have contractual obligations and commitments with regards tooperating lease arrangements. The following table quantifies our expectedcontractual obligations and commitments subsequent to December 31, 2009:

 
| ** **                       | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **More than  3 years** | ** ** |
| Operating lease obligations      |       | $                                         | 1,166,162  |   | $ | 419,699 |   | $ | 746,463 |   | $ | — |   |
|                                  |            |                                           |            |  |  |  |  |  |  |  |  |  |  |

 

**Recent Accounting Pronouncements**

 

In January 2010, theFinancial Accounting Standards Board (“FASB”) issued guidance to amend the disclosurerequirements related to recurring and nonrecurring fair value measurements. Theguidance requires new disclosures on the transfers of assets and liabilitiesbetween Level 1 (quoted prices in active market for identical assets orliabilities) and Level 2 (significant other observable inputs) of the fairvalue measurement hierarchy, including the reasons and the timing of thetransfers. Additionally, the guidance requires a roll forward of activities onpurchases, sales, issuance, and settlements of the assets and liabilitiesmeasured using significant unobservable inputs (Level 3 fair valuemeasurements). The guidance will become effective for us with the reportingperiod beginning January 1, 2010, except for the disclosure on the rollforward activities for Level 3 fair value measurements, which will becomeeffective for us January 1, 2011. Other than requiring additional disclosures, adoption of this newguidance will not have a material impact on the Company’s consolidatedfinancial statements.

 

EffectiveSeptember 2009, the Company revised references to authoritative accountingliterature in accordance with FASB Accounting Standards Codification (the “Codification”)*. *TheCodification became the source of authoritative GAAP recognized by the FASB tobe applied by nongovernmental entities. Rules and interpretive releases ofthe SEC under authority of federal securities laws are also sources ofauthoritative GAAP for SEC registrants. On the effective date, the Codificationsuperseded all then-existing non-SEC accounting and reporting standards. Allother non-grandfathered non-SEC accounting literature not included in theCodification became non-authoritative. The adoptionof this new guidance did not have a material impact on the Company’sconsolidated financial statements. In April 2009, FASB issued guidance inorder to establish principles and requirements for reviewing and reportingsubsequent events and requires disclosure of the date through which subsequentevents are evaluated and whether the date corresponds with the time at whichthe financial statements were available for issue (as defined) or were issued.The adoption of this new guidance did not have a material impact on the Company’sconsolidated financial statements.

 

**Item 7A.  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

Our exposure to market risk includes changes in interest rates, whichrelates primarily to our invested balances of cash, cash equivalents andinvestments. Our investment policy specifies excess funds are to be invested ina manner that preserves capital, provides liquidity and generates the highestavailable after-tax return. To limit exposure to market risk, we place our cashin banks, cash equivalents in certificates of deposits with original maturitiesof three months or less and money market funds, which are primarily invested inUS government obligations.  Short-terminvestments consist of certificates of deposits with original maturitiesranging from 6 to 12 months.  We do notinvest in any derivative instruments. All cash, cash equivalents and investmentsare carried at fair value, which approximates cost.

 

**Item 8.  Financial Statements and Supplementary Data**

 

The financial statement information, including the Report ofIndependent Registered Public Accounting Firm, required by this Item 8 isset forth on pages 34 to 48 of this Annual Report on Form 10-K and ishereby incorporated into this Item 8 by reference. The quarterly financialinformation required by this Item 8 is set forth in Item 7 of thisAnnual Report on Form 10-K and is hereby incorporated into thisItem 8 by reference.

 

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**Item 9.  Changes in and Disagreements with Accountantson Accounting and Financial Disclosures**

 

None.

 

**Item 9A.   Controls and Procedures**

 

*Evaluationof Disclosure Controls and Procedures*

 

We maintain “disclosure controls and procedures,” as such term isdefined 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 inreports that we file or submit under the Exchange Act is recorded, processed,summarized, and reported within the time periods specified in SEC rules andforms, and that such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosure. Indesigning and evaluating our disclosure controls and procedures, managementrecognized that disclosure controls and procedures, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of the disclosure controls and procedures are met.Additionally, in designing disclosure controls and procedures, our managementnecessarily was required to apply its judgment in evaluating the cost-benefitrelationship of possible disclosure controls and procedures. The design of anydisclosure controls and procedures also is based in part upon certainassumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions.

 

Subject to the limitations noted above, our management, with theparticipation of our Chief Executive Officer and Chief Financial Officer, hasevaluated the effectiveness of the design and operation of our disclosurecontrols and procedures as of the end of the year covered by this Annual Reporton Form 10-K. Based on that evaluation, the Chief Executive Officer andChief Financial Officer have concluded that, as of such date, our disclosurecontrols and procedures were effective to meet the objective for which theywere designed and operate at the reasonable assurance level.

 

*Management’sReport on Internal Control over Financial Reporting*

 

Our management is responsible for establishing and maintaining adequateinternal control over financial reporting for the Company as defined in Rule 13a-15(f) or15d-15(f) of the Exchange Act. Internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles, andincludes those policies and procedures that: (i) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of our assets; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that our receipts and expenditures are being made only inaccordance with authorizations of our management and directors; and (iii) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of our assets that could have a material effecton our financial statements.

 

Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate.

 

Our management assessed the effectiveness of the Company’s internalcontrol over financial reporting as of December 31, 2009 using thecriteria set forth by the Committee of Sponsoring Organizations of the TreadwayCommission in its report, *InternalControl-Integrated Framework*. Based on this assessment and thosecriteria, management concluded that our internal control over financialreporting was effective as of December 31, 2009.

 

*AttestationReport of Independent Registered Public Accounting Firm*

 

Our internal control over financial reporting has been audited bySquar, Milner, Peterson, Miranda & Williamson, LLP, anindependent registered public accounting firm, as stated in their report, whichis included herein on page 33.

 

*Changes inInternal Controls*

 

There have been no changes in our internal controls over financialreporting that occurred during our fourth quarter ended December 31, 2009that have materially affected, or are reasonably likely to materially affect,our internal controls over financial reporting.

 

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**Item 9B.  Other Information**

 

None.

 

**PART III**

 

**Item 10.  Directors, Executive Officers and CorporateGovernance**

 

The information set forth under the captions “Election of Directors,” “InformationAbout the Board of Directors and Committees of the Board,” “Executive Officers”and “Transactions with Management and Others—Section 16(a) BeneficialOwnership Reporting Compliance” in our definitive proxy statement for theAnnual Meeting of Stockholders to be held in 2010 (the “Proxy Statement”) isincorporated herein by reference. The Proxy Statement will be filed with theSEC no later than 120 days after the end of fiscal year 2009.

 

**Item 11.  Executive Compensation**

 

Except as specifically provided, the information set forth under thecaptions “Compensation of Executive Officers” and “Information About the Boardof Directors and Committees of the Board—Compensation of Directors” in theProxy Statement is incorporated herein by reference.

 

**Item 12.  Security Ownership of Certain BeneficialOwners and Management and Related Stockholder Matters**

 

Information regarding security ownership of certain beneficial ownersand management is incorporated by reference to the information set forth underthe caption “Security Ownership of Certain Beneficial Owners and Management” inthe Proxy Statement.

 

Information regarding equity compensation plans required by thisItem 12 is included in Item 5 of Part II of this Annual Reporton Form 10-K and is incorporated into this Item by reference.

 

**Item 13.  Certain Relationships and RelatedTransactions, and Director Independence**

 

The information set forth under the captions “Transactions withManagement and Others” and “Information About the Board of Directors andCommittees of the Board” in the Proxy Statement is incorporated herein byreference.

 

**Item 14.  Principal Accounting Fees and Services**

 

Information regarding principal accounting fees and services isincorporated by reference to the information set forth under the caption “Relationshipof the Company with Independent Registered Public Accounting Firm” in the ProxyStatement.

 

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**PART IV**

 

**Item 15. Exhibits and Financial Statement Schedule**

 

**(1)****                                ****Financial Statements**

 
| ** **                                                                                                                                | **Page** |
|-------------------------------------------------------------------------------------------------------------------------------------------|----------|
| Report of Independent Registered Public Accounting  Firm—Squar, Milner, Peterson, Miranda & Williamson, LLP            | 33       |
| Consolidated  Balance Sheets as of December 31, 2009 and 2008                                                                        | 34       |
| Consolidated Statements of Operations for the years  ended December 31, 2009, 2008 and 2007                                          | 35       |
| Consolidated Statements of Stockholders’ Equity and  Comprehensive Income for the years ended December 31, 2009, 2008 and  2007 | 36       |
| Consolidated Statements of Cash Flows for the years  ended December 31, 2009, 2008 and 2007                                          | 37       |
| Notes to Consolidated Financial Statements                                                                                                | 38       |

 

**(2)****                                ****Financial Statement Schedule**

 
| ** **                                                                                                                      | **Page** |
|---------------------------------------------------------------------------------------------------------------------------------|----------|
| Schedule II—Valuation and Qualifying Accounts and  Reserves for the years ended December 31, 2009, 2008 and 2007 | 48       |

 

The financial statement schedule included on page 48 to thisAnnual Report on Form 10-K and in Part II, Item 8 herein isfiled as part of this Annual Report on Form 10-K. All other schedules areomitted because they are not applicable or the required information is shown inthe consolidated financial statements or related notes.

 

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**(3)****                                ****Exhibits**

 

The exhibits listed below are hereby filed with the SEC as part of thisAnnual Report on Form 10-K. We will furnish a copy of any exhibit uponrequest, but a reasonable fee will be charged to cover our expenses infurnishing such exhibit.

** **
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Certificate  of Incorporation of the Company, previously filed with the SEC as  Exhibit 3.1 to the Company’s Registration Statement on Form SB-2,  specifically included in Amendment No. 1 to such Registration Statement  filed with the SEC on July 3, 1996 (File No. 333-4974-LA) (the  “Registration Statement Amendment No. 1”), which is incorporated herein  by reference.                                                                               |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 3.2                 |       | Bylaws  of the Company, previously filed with the SEC as Exhibit 3.1 to the  Company’s Quarterly Report on Form 10-Q for the period ended  September 30, 1999, filed with the SEC on November 12, 1999, which  is incorporated herein by reference.                                                                                                                                                                                                                                  |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| ** **          | ** ** | **Material Contracts Relating to Management Compensation  Plans or Arrangements**                                                                                                                                                                                                                                                                                                                                                                                                                             |
| ** **          | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.1                |       | Employment  Agreement dated July 1, 1996, between the Company and Thomas C.K. Yuen,  previously filed with the SEC as Exhibit 10.8 to the Registration  Statement Amendment No. 1, which is incorporated herein by reference.                                                                                                                                                                                                                                                                  |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.2                |       | Amendment  to Employment Agreement dated as of March 14, 1997, between the Company  and Thomas C.K. Yuen, previously filed with the SEC as Exhibit 10.2 to  the Company’s Annual Report on Form 10-KSB for the fiscal year ended  December 31, 1996, filed with the SEC on March 31, 1997 (the “1996  Annual Report”), which is incorporated herein by reference.                                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.3                |       | Employment  Agreement dated July 1, 1996, between the Company and Alan D. Kraemer,  previously filed with the SEC as Exhibit 10.11 to the Registration  Statement Amendment No. 1, which is incorporated herein by reference.                                                                                                                                                                                                                                                                  |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.4                |       | SRS  Labs, Inc. Amended and Restated 1996 Non-employee Directors Stock Option  Plan, as amended, previously filed with the SEC as Appendix B to the  Company’s Definitive Proxy Statement dated and filed with the SEC on  April 30, 2003, which is incorporated herein by reference.                                                                                                                                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.5                |       | Form of  Indemnification Agreement, previously filed with the SEC as  Exhibit 10.20 to the Registration Statement Amendment No. 1, which  is incorporated herein by reference.                                                                                                                                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.6                |       | Non-employee Director  Compensation Policy adopted by the Company’s Board of Directors on  January 28, 2005, previously filed with the SEC as Exhibit 10.1 to  the Company’s Current Report on Form 8-K filed with the SEC on  February 3, 2005, which is incorporated herein by reference.                                                                                                                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.7                |       | Form of  Non-Employee Director Stock Option Agreement under the SRS Labs, Inc.  Amended and Restated 1996 Non-Employee Directors’ Stock Option Plan (Initial  Appointment), previously filed with the SEC as Exhibit 10.2 to the  Company’s Current Report on Form 8-K filed with the SEC on  February 3, 2005, which is incorporated herein by reference.                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.8                |       | Form of  Non-Employee Director Stock Option Agreement under the SRS Labs, Inc.  Amended and Restated 1996 Non-Employee Directors’ Stock Option Plan  (Re-Election), previously filed with the SEC as Exhibit 10.3 to the  Company’s Current Report on Form 8-K filed with the SEC on  February 3, 2005, which is incorporated herein by reference.                                                                                                                         |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.9                |       | Form of  Non-Employee Director Stock Option Agreement under the SRS Labs, Inc.  Amended and Restated 1996 Long-Term Incentive Plan, previously filed with the  SEC as Exhibit 10.4 to the Company’s Current Report on Form 8-K  filed with the SEC on February 3, 2005, which is incorporated herein by  reference.                                                                                                                                                             |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.10               |       | Form of  Nonqualified Stock Option Agreement under the SRS Labs, Inc. Amended and  Restated 1996 Long-Term Incentive Plan dated March 29, 2005 (Current  participants under this plan include the following officers: Thomas C.K.  Yuen, Ulrich E. Gottschling, Sarah Yang and Alan D. Kraemer), previously  filed with the SEC as Exhibit 10.1 to the Company’s Current Report  Form 8-K filed with the SEC on April 4, 2005, which is incorporated  herein by reference. |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.11               |       | SRS  Labs, Inc. Amended and Restated Change in Control Protection Plan  approved August 3, 2009, previously filed with the SEC as  Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed  with the SEC on August 6, 2009, which                                                                                                                                                                                                                                     |

 

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| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       | is  incorporated herein by reference.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.12               |       | Form of  Participation Agreement under the SRS Labs, Inc. Amended and Restated  Change in Control Protection Plan for Selected Executive Officers (Current  participants under this plan include the following officers: Thomas C.K.  Yuen, Ulrich E. Gottschling, Sarah Yang, Jeff Klaas and Alan D. Kraemer)  previously filed with the SEC as Exhibit 10.2 to the Company’s Quarterly  Report on Form 10-Q filed with the SEC on August 6, 2009, which is  incorporated herein by reference. |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.13               |       | SRS  Labs, Inc. Amended and Restated 1996 Long-Term Incentive Plan, as  amended, approved April 27, 2005, previously filed with the SEC as  Exhibit 10.5 to the Form 8-K filed with the SEC on May 3,  2005, which is incorporated herein by reference.                                                                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.14               |       | Offer  Letter dated April 22, 2008 by and between the Company and Jeff Klaas,  previously filed with the SEC as Exhibit 10.15 to the Company’s Annual  Report on Form 10-K for the fiscal period ended December 31, 2008,  filed with the SEC on February 24, 2009 which is incorporated herein by  reference.                                                                                                                                                                                  |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.15               |       | Employment  Letter Agreement dated December 21, 2005 by and between the Company and  Ulrich E. Gottschling, previously filed with the SEC as Exhibit 99.1 to  the Company’s Current Report on Form 8-K filed with the SEC on  December 29, 2005, which is incorporated herein by reference.                                                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.16               |       | Form of  Nonqualified Stock Option Agreement under the SRS Labs, Inc. 1996  Amended and Restated Long-Term Incentive Plan, as amended, previously filed  with the SEC as Exhibit 99.8 to the Company’s Current Report on Form 8-K  filed with the SEC on January 18, 2006, which is incorporated herein by  reference.                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.17               |       | SRS  Labs, Inc. Profit Sharing and Bonus Plan, as amended on June 20,  2007, previously filed with the SEC as Exhibit 10.1 to the Company’s  Current Report on Form 8-K filed with the SEC on June 25, 2007,  which is incorporated herein by reference.                                                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.18               |       | SRS  Labs, Inc. 2006 Stock Incentive Plan, as amended on December 17,  2007, previously filed with the SEC as Exhibit 10.1 to the Company’s  Current Report on Form 8-K filed with the SEC on December 21, 2007,  which is incorporated herein by reference.                                                                                                                                                                                                                                    |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.19               |       | Form of Stock Option  Award Agreement under the SRS Labs, Inc. 2006 Stock Incentive Plan,  previously filed with the SEC as Exhibit 10.9 to the Company’s Quarterly  Report on Form 10-Q, Amendment No. 1, filed with the SEC on  September 22, 2006, which is incorporated herein by reference.                                                                                                                                                                                           |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.20               |       | Form of  Restricted Share Award Agreement under the SRS Labs, Inc. 2006 Stock  Incentive Plan, previously filed with the SEC as Exhibit 10.10 to the  Company’s Quarterly Report on Form 10-Q, Amendment No. 1, filed  with the SEC on September 22, 2006, which is incorporated herein by  reference.                                                                                                                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.21               |       | Form of  Restricted Share Unit Award Agreement under the SRS Labs, Inc. 2006  Stock Incentive Plan, previously filed with the SEC as Exhibit 10.11 to  the Company’s Quarterly Report on Form 10-Q, Amendment No. 1, filed  with the SEC on September 22, 2006, which is incorporated herein by  reference.                                                                                                                                                                                |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.22               |       | Form of  SAR Award Agreement under the SRS Labs, Inc. 2006 Stock Incentive Plan,  previously filed with the SEC as Exhibit 10.12 to Amendment No. 1  to the Company’s Quarterly Report on Form 10-Q, Amendment No. 1,  filed with the SEC on September 22, 2006, which is incorporated herein  by reference.                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.23               |       | SRS  Labs, Inc. Patent Reward Program, previously filed as Exhibit 10.2  to the Company’s Form 8-K filed with the SEC on June 28, 2006,  which is incorporated herein by reference.                                                                                                                                                                                                                                                                                                                  |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| ** **          | ** ** | **Other Material Contracts**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| ** **          | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.24               |       | Industrial  Real Estate Lease dated May 27, 2008, between the Company and Daimler  Commerce Partners, L.P., previously filed with the SEC as  Exhibit 10.25 to the Company’s Annual Report on Form 10-K for the  fiscal period ended December 31, 2008, filed with the SEC on  February 24, 2009 which is incorporated herein by reference.                                                                                                                                                |

 

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| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.25               |       | Stock  Divestment Agreement dated July 1, 1996, between the Company, Thomas  C.K. Yuen, Stephen V. Sedmak and Walter W. Cruttenden III, previously filed  with the SEC as Exhibit 10.17 to the Company’s Registration Statement on  Form SB-2, specifically included in Amendment No. 2 to such  Registration Statement file with the SEC on August 2, 1996 (File  No. 333-4974-LA), which is incorporated herein by reference. |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| ** **          | ** ** | **Other Exhibits**                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| ** **          | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 21                  |       | Subsidiaries  of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 23.1                |       | Consent  of Independent Registered Public Accounting Firm, Squar, Milner, Peterson,  Miranda & Williamson, LLP, dated February 22, 2010.                                                                                                                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 31.1                |       | Certification  of the Chief Executive Officer of SRS Labs, Inc., pursuant to  Section 302 of the Sarbanes- Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 31.2                |       | Certification  of the Chief Financial Officer of SRS Labs, Inc., pursuant to  Section 302 of the Sarbanes- Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 32.1                |       | Certification  of Chief Executive Officer of SRS Labs, Inc., pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 32.2                |       | Certification  of Chief Financial Officer of SRS Labs, Inc., pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                            |

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 
|                           | SRS  Labs, Inc. |
|--------------------------------|----------------------|
|                           |                 |   |
|                           |                 |   |
| Dated:  February 23, 2010 | By:                  | /S/ THOMAS C.K. YUEN |
| * *                       | * *             | *Chairman of the Board and Chief Executive  Officer* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

 
| **Name**               | ** ** | **Capacity**                                                                                | ** ** | **Date**               |
|------------------------|------------|---------------------------------------------------------------------------------------------|------------|------------------------|
| ** **             | ** ** | ** **                                                                                  | ** ** | ** **             |
| /s/ THOMAS C.K. YUEN   |       | Director,  Chairman of the Board and Chief Executive Officer (Principal Executive  Officer) |       | February 23, 2010 |
| Thomas C.K. Yuen       |       |                                                                                        |       |
|                   |       |                                                                                        |       |                   |
| /s/ ULRICH GOTTSCHLING |       | Chief  Financial Officer (Principal Financial and Accounting Officer)                       |       | February 23, 2010 |
| Ulrich Gottschling     |       |                                                                                        |       |
|                   |       |                                                                                        |       |                   |
| /s/ DAVID R. DUKES     |       | Director                                                                                    |       | February 23, 2010 |
| David R. Dukes         |       |                                                                                        |       |                   |
|                   |       |                                                                                        |       |                   |
| /s/ WINSTON E. HICKMAN |       | Director                                                                                    |       | February 23, 2010 |
| Winston E. Hickman     |       |                                                                                        |       |                   |
|                   |       |                                                                                        |       |                   |
| /s/ CAROL L. MILTNER   |       | Director                                                                                    |       | February 23, 2010 |
| Carol L. Miltner       |       |                                                                                        |       |                   |
|                   |       |                                                                                        |       |                   |
| /s/ SAM YAU            |       | Director                                                                                    |       | February 23, 2010 |
| Sam Yau                |       |                                                                                        |       |                   |

 

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Stockholders

SRSLabs, Inc.

SantaAna, California

 

We have audited the accompanying consolidated balance sheets of SRSLabs, Inc. and Subsidiaries (collectively the Company) as of December 31,2009 and 2008, and the related consolidated statements of operations,stockholders’ equity and comprehensive income, and cash flows for each of thethree years in the period ended December 31, 2009. We also have auditedthe Company’s internal control over financial reporting as of December 31,2009, based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission. Our audit also included the financialstatement schedule listed in Item 15(2) herein. The Company’smanagement is responsible for these financial statements, for maintainingeffective internal control over financial reporting, and for its assessment ofthe effectiveness of internal control over financial reporting included inItem 9A. Our responsibility is to express an opinion on these financialstatements and an opinion on the Company’s internal control over financialreporting based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audits to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement and whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audits of the financial statements included examining,on a test basis, evidence supporting the amounts and disclosures in thefinancial statements, assessing the accounting principles used and significantestimates made by management, and evaluating the overall financial statementpresentation. Our audit of internal control over financial reporting includedobtaining an understanding of internal control over financial reporting,assessing the risk that a material weakness exists, and testing and evaluatingthe design and operating effectiveness of internal control based on theassessed risk. Our audits also included performing such other procedures as weconsidered necessary in the circumstances. We believe that our audits provide areasonable basis for our opinions.

 

A company’s internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles. A company’s internalcontrol over financial reporting includes those policies and procedures that (a) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the Company; (b) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (c) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the financial statements referred to above presentfairly, in all material respects, the consolidated financial position of SRSLabs, Inc. and Subsidiaries as of December 31, 2009 and 2008, and theconsolidated results of their operations and their cash flows for each of thethree years in the period ended December 31, 2009, in conformity withaccounting principles generally accepted in the United States of America. Alsoin our opinion, the Company maintained, in all material respects, effectiveinternal control over financial reporting as of December 31, 2009, basedon criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.

 

Also, in our opinion, the aforementioned financial statement schedule,when considered in relation to the basic consolidated financial statementstaken as a whole, presents fairly, in all material respects, the financialinformation set forth therein.

 
| /s/ SQUAR, MILNER, PETERSON, MIRANDA & WILLIAMSON, LLP |   |
|----------------------------------------------------------------------|--------|
| Squar, Milner, Peterson, Miranda & Williamson, LLP     |   |

 

NewportBeach, California

February 22,2010

 

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**SRSLABS, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                   | ** ** | **December 31,  2009** | ** **  | **December 31,  2008** | ** **  |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|-------------|-----------------------------|-------------|
| **ASSETS**                                                                                                                                                                   |       |                        |        |                        |        |
| **Current Assets**                                                                                                                                                           |       |                        |        |                        |        |
| Cash and cash equivalents                                                                                                                                                    |       | $                           | 27,988,164  |                        | $           | 31,599,087 |   |
| Accounts receivable, net                                                                                                                                                     |       | 179,114                     |        | 332,711                     |        |
| Prepaid expenses and other current assets                                                                                                                                    |       | 1,147,151                   |        | 864,095                     |        |
| Short-term investments                                                                                                                                                       |       | 12,963,000                  |        | 7,836,000                   |        |
| **Total Current Assets**                                                                                                                                                     |       | 42,277,429                  |        | 40,631,893                  |        |
|                                                                                                                                                                         |       |                        |        |                        |        |
| Long-term investments                                                                                                                                                        |       | 538,000                     |        | —                      |        |
| Property and equipment, net                                                                                                                                                  |       | 599,794                     |        | 423,921                     |        |
| Intangible assets, net                                                                                                                                                       |       | 2,702,160                   |        | 2,354,725                   |        |
| Deferred income taxes, net                                                                                                                                                   |       | 5,631,442                   |        | 3,471,421                   |        |
| **Total Assets**                                                                                                                                                             |       | $                           | 51,748,825  |                        | $           | 46,881,960 |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                               |       |                        |        |                        |        |
|                                                                                                                                                                         |       |                        |        |                        |        |
| **Current Liabilities**                                                                                                                                                      |       |                        |        |                        |        |
| Accounts payable                                                                                                                                                             |       | $                           | 583,157     |                        | $           | 314,382 |   |
| Accrued liabilities                                                                                                                                                          |       | $                           | 1,577,891   |                        | 996,268     |   |
| Deferred revenue                                                                                                                                                             |       | 1,193,454                   |        | 1,802,024                   |        |
| **Total Current Liabilities**                                                                                                                                                |       | $                           | 3,354,502   |                        | 3,112,674   |   |
|                                                                                                                                                                         |       |                        |        |                        |        |
| Commitments and contingencies (Note 4)                                                                                                                                  |       |                        |        |                        |        |
|                                                                                                                                                                         |       |                        |        |                        |        |
| **Stockholders’ Equity**                                                                                                                                                |       |                        |        |                        |        |
| Preferred stock—$0.001 par value; 2,000,000 shares  authorized; no shares issued and outstanding                                                                        |       | —                      |        | —                      |        |
| Common stock—$0.001 par value; 56,000,000 shares  authorized; 14,563,715 and 14,419,418 shares issued and outstanding at  December 31, 2009 and 2008, respectively |       | 14,565                      |        | 14,420                      |        |
| Additional paid-in capital                                                                                                                                                   |       | 65,128,337                  |        | 62,639,075                  |        |
| Accumulated deficit                                                                                                                                                          |       |                        | (16,748,579 | )                           | (18,884,209 | ) |
| **Total Stockholders’ Equity**                                                                                                                                          |       |                        | 48,394,323  |                        | 43,769,286  |   |
| **Total Liabilities and  Stockholders’ Equity**                                                                                                                         |       | $                           | 51,748,825  |                        | $           | 46,881,960 |   |

 

See accompanying notes tothe consolidated financial statements

 

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**SRSLABS, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                                  | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                  | ** ** | **2009**                                    | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues                                                    |       | $                                           | 24,964,577 |   | $ | 18,332,678 |   | $ | 18,851,940 |   |
| Cost of sales                                               |       | 285,543                                     |       | 143,481 |   | 164,112 |   |
| Gross profit                                                |       | 24,679,034                                  |       | 18,189,197 |   | 18,687,828 |   |
| Operating expenses:                                         |       |                                        |       |   |   |   |   |
| Sales and marketing                                         |       | 11,415,115                                  |       | 9,220,098 |   | 6,717,906 |   |
| Research and development                                    |       | 5,721,195                                   |       | 3,942,635 |   | 3,107,482 |   |
| General and administrative                                  |       | 5,656,616                                   |       | 5,913,081 |   | 5,443,735 |   |
| Total operating expenses                                    |       | 22,792,926                                  |       | 19,075,814 |   | 15,269,123 |   |
| Operating income (loss)                                     |       | 1,886,108                                   |       | (886,617 | ) | 3,418,705 |   |
| Interest income                                             |       | 347,528                                     |       | 1,275,047 |   | 2,041,288 |   |
| Income before income taxes                                  |       | 2,233,636                                   |       | 388,430 |   | 5,459,993 |   |
| Income taxes                                                |       | 98,006                                      |       | 117,543 |   | 45,558 |   |
| Net income                                                  |       | $                                           | 2,135,630  |   | $ | 270,887 |   | $ | 5,414,435 |   |
| Net income per common share:                                |       |                                        |       |   |   |   |   |
| Basic                                                       |       | $                                           | 0.15       |   | $ | 0.02 |   | $ | 0.34 |   |
| Diluted                                                     |       | $                                           | 0.14       |   | $ | 0.02 |   | $ | 0.32 |   |
| Weighted average shares used in the per share  calculation: |       |                                        |       |   |   |   |   |
| Basic                                                       |       | 14,460,490                                  |       | 15,588,815 |   | 16,154,313 |   |
| Diluted                                                     |       | 14,813,372                                  |       | 15,842,336 |   | 16,989,839 |   |

 

See accompanying notes toconsolidated financial statements

 

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**SRSLABS, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

 

**ANDCOMPREHENSIVE INCOME**

 
| ** **                                                          | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Accumulated**        | ** ** | **Treasury** | ** ** | ** ** | ** **  | **Comprehensive** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|---------------------------------------|------------|------------------------|------------|--------------|------------|------------|-------------|-------------------|------------|
| ** **                                                          | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**                           | ** ** | **Income (Loss)** | ** ** | **Deficit**  | ** ** | **Stock**  | ** **  | **Total**         | ** ** | **Income** | ** ** |
|                                                                |       |                  |       |                    |       |                                  |       |                   |       |         |       |       |        |              |       |   |   |
| BALANCE,  December 31, 2006                                    |       | 15,886,938            |       | 16,562                  |       | 70,574,176                            |       | (273,295               | )          | (24,569,531  | )          | (3,003,445 | )           | 42,744,467        |       | 4,930,583 |   |
| Proceeds  from exercise of stock options                       |       | 385,341               |       | 385                     |       | 1,842,579                             |       | —                 |       | —       |       | —     |        | 1,842,964         |       |   |   |
| Purchase  of treasury stock                                         |       | (493,564              | )          | —                  |       | —                                |       | —                 |       | —       |       | (2,946,736 | )           | (2,946,736        | )          |   |   |
| Share-based  compensation                                           |       | —                |       | —                  |       | 1,727,017                             |       | —                 |       | —       |       | —     |        | 1,727,017         |       |   |   |
| Unrealized  gain on investments available for sale, net of tax |       | —                |       | —                  |       | —                                |       | 225,170                |       | —       |       | —     |        | 225,170           |       | 225,170 |   |
| Net  income                                                         |       | —                |       | —                  |       | —                                |       | —                 |       | 5,414,435    |       | —     |        | 5,414,435         |       | 5,414,435 |   |
| BALANCE,  December 31, 2007                               |       | 15,778,715            |       | 16,947                  |       | 74,143,772                            |       | (48,125                | )          | (19,155,096  | )          | (5,950,181 | )           | 49,007,317        |       | 5,639,605 |   |
| Proceeds  from exercise of stock options                       |       | 116,847               |       | 117                     |       | 329,051                               |       | —                 |       | —       |       | —     |        | 329,168           |       |   |   |
| Purchase  of treasury stock                                         |       | (1,476,144            | )          | —                  |       | —                                |       | —                 |       | —       |       | (7,663,679 | )           | (7,663,679        | )          |   |   |
| Cancellation  of treasury stock                                |       | —                |       | (2,644                  | )          | (13,611,216                           | )          | —                 |       | —       |       | 13,613,860 |        | —            |       |   |   |
| Share-based  compensation                                           |       | —                |       | —                  |       | 1,777,468                             |       | —                 |       | —       |       | —     |        | 1,777,468         |       |   |   |
| Unrealized  gain on investments available for sale, net of tax |       | —                |       | —                  |       | —                                |       | 48,125                 |       | —       |       | —     |        | 48,125            |       | 48,125 |   |
| Net  income                                                         |       | —                |       | —                  |       | —                                |       | —                 |       | 270,887      |       | —     |        | 270,887           |       | 270,887 |   |
| BALANCE,  December 31, 2008                               |       | 14,419,418            |       | 14,420                  |       | 62,639,075                            |       | —                 |       | (18,884,209  | )          | —     |        | 43,769,286        |       | 319,012 |   |
| Proceeds  from exercise of stock options                       |       | 144,297               |       | 145                     |       | 533,205                               |       | —                 |       | —       |       | —     |        | 533,350           |       |   |   |
| Share-based  compensation                                           |       | —                |       | —                  |       | 1,956,057                             |       | —                 |       | —       |       | —     |        | 1,956,057         |       |   |   |
| Net  income                                                         |       | —                |       | —                  |       | —                                |       | —                 |       | 2,135,630    |       | —     |        | 2,135,630         |       | 2,135,630 |   |
| BALANCE,  December 31, 2009                               |       | 14,563,715            |       | $                       | 14,565     |                                  | $          | 65,128,337             |       | —       |       | $          | (16,748,579 | )                 | —     |   | $ | 48,394,323 |   | $ | 2,135,630 |   |
|                                                                     |            |                       |            |                         |            |                                       |            |                        |            |              |            |            |             |                   |            |  |  |  |  |  |  |  |

 

See accompanying notes toconsolidated financial statements

 

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**SRSLABS, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Cash Flows from Operating  Activities:**                                         |       |                              |       |   |   |   |   |
| Net income                                                                         |       | $                                 | 2,135,630  |   | $ | 270,887 |   | $ | 5,414,435 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                              |       |   |   |   |   |
| Depreciation and amortization                                                      |       | 704,718                           |       | 660,954 |   | 733,873 |   |
| Provision for doubtful accounts                                                    |       | 47,527                            |       | 11,190 |   | 108,321 |   |
| Deferred taxes                                                                     |       | (2,160,021                        | )          | (1,695,219 | ) | (1,389,790 | ) |
| Share-based compensation                                                           |       | 1,956,057                         |       | 1,777,468 |   | 1,727,017 |   |
| Loss on disposition of furniture, fixtures and  equipment                          |       | 14,818                            |       | — |   | 10,459 |   |
| Write-off of intangible assets                                                     |       | 13,149                            |       | 42,569 |   | 34,058 |   |
| Changes in operating assets and liabilities:                                       |       |                              |       |   |   |   |   |
| Accounts receivable                                                                |       | 106,070                           |       | 794,524 |   | (65,867 | ) |
| Prepaid expenses and other current assets                                          |       | (283,056                          | )          | 29,293 |   | (84,448 | ) |
| Accounts payable                                                                   |       | 268,775                           |       | (214,681 | ) | (80,836 | ) |
| Accrued liabilities                                                                |       | 581,623                           |       | 306,960 |   | (605,928 | ) |
| Deferred revenue                                                                   |       | (608,570                          | )          | 645,188 |   | 757,271 |   |
| Net cash provided by operating activities                                          |       | 2,776,720                         |       | 2,629,133 |   | 6,558,565 |   |
| **Cash Flows from Investing  Activities:**                                         |       |                              |       |   |   |   |   |
| Proceeds from sale of investments available for  sale                              |       | —                            |       | 5,500,000 |   | — |   |
| Purchase of short and long-term investments                                        |       | (5,665,000                        | )          | (7,836,000 | ) | — |   |
| Purchase of property and equipment                                                 |       | (417,191                          | )          | (302,602 | ) | (147,466 | ) |
| Expenditures related to intangible assets                                          |       | (856,402                          | )          | (672,224 | ) | (703,461 | ) |
| Proceeds from property and equipment                                               |       | 17,600                            |       | — |   | — |   |
| Net cash used in investing activities                                              |       | (6,920,993                        | )          | (3,310,826 | ) | (850,927 | ) |
| **Cash Flows from Financing  Activities:**                                         |       |                              |       |   |   |   |   |
| Purchase of treasury stock                                                         |       | —                            |       | (7,663,679 | ) | (2,946,736 | ) |
| Proceeds from exercise of stock options                                            |       | 533,350                           |       | 329,168 |   | 1,842,964 |   |
| Net cash provided by (used in) financing  activities                               |       | 533,350                           |       | (7,334,511 | ) | (1,103,772 | ) |
| **Net (Decrease) Increase in Cash  and Cash Equivalents**                          |       | (3,610,923                        | )          | (8,016,204 | ) | 4,603,866 |   |
| **Cash and Cash Equivalents,  Beginning of Year**                                  |       | 31,599,087                        |       | 39,615,291 |   | 35,011,425 |   |
| **Cash and Cash Equivalents, End  of Year**                                        |       | $                                 | 27,988,164 |   | $ | 31,599,087 |   | $ | 39,615,291 |   |
| **Supplemental Disclosures of  Cash Flow Information:**                            |       |                              |       |   |   |   |   |
| Cash paid during the year for:                                                     |       |                              |       |   |   |   |   |
| Income taxes                                                                       |       | $                                 | 2,203,771  |   | $ | 2,377,114 |   | $ | 1,392,197 |   |
| **Supplemental Disclosure of  Non-Cash Investing/Financing Activities:**           |       |                              |       |   |   |   |   |
| Unrealized gain on investments, net                                                |       | $                                 | —     |   | $ | 48,125 |   | $ | 225,170 |   |
| Retirement of treasury stock                                                       |       | $                                 | —     |   | $ | 13,613,860 |   | $ | — |   |

 

See accompanying notes toconsolidated financial statements

 

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**SRSLABS, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**1. Organization and Significant Accounting Policies**

 

*Organization*

 

SRS Labs, Inc. (collectively with its subsidiaries, the “Company,”“SRS Labs,” “SRS”, “us”, “we” or “our”) is the recognized global leader in thepractical application of psychoacoustics*,* the science behind how the humanear operates, and in the post processing segment of the market for audiodelivery.  Our award-winning audioenhancement technologies and solutions dramatically restore audio and voice toits natural state, the way it was originally recorded,in both dimension and clarity, thus providing a superior consumer experience for a wide variety of consumerelectronic devices such as televisions, personal computers and mobile phones.

 

Our operations are conducted through SRS Labs, Inc., the parentcompany, and its wholly-owned subsidiaries, SRSWOWcast.com, Inc., ShenzhenRepresentative Office of SRS Labs, Inc. (a Chinese company), ShanghaiRepresentative Office of SRS Labs, Inc (a Chinese company) and SRS Labs Japan,KK (a Japanese company). Our business is focused on developing and licensingaudio, voice and surround sound technology solutions to many of the world’sleading original equipment manufacturers (“OEMs”), software providers andsemiconductor companies, and limited sales and marketing of stand-alonesoftware and hardware products through the Internet.

 

*Basis ofPresentation*

 

The consolidated financial statements have been prepared in accordancewith accounting principles generally accepted in the United States of Americaand include the Company and its wholly-owned subsidiaries SRSWOWcast, ShenzhenRepresentative Office of SRS Labs, Inc., Shanghai Representative Office ofSRS Labs, Inc. and SRS Labs Japan, KK after elimination of allintercompany accounts and transactions. Certain amounts in the notes to the consolidated financial statementshave been reclassified in order to conform to the current year presentation.

 

*Use ofEstimates*

 

The preparation of the Company’s consolidated financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities as of the date of the financial statements and thereported revenues and expenses during the reporting periods. Some of theestimates needed to be made by management include the allowance for doubtfulaccounts, estimated useful lives of property and equipment and intangibleassets, valuation of equity instruments associated with share-basedcompensation and the valuation allowance for the Company’s deferred tax asset.Actual results could materially differ from these estimates.

 

*Cash andCash Equivalent; Short-term and Long-term Investments*

 

Cash and cash equivalents generally consist of cash, certificates ofdeposit, and money market funds with original maturities of three months orless at the date of purchase.  The moneymarket funds are primarily invested in U.S. government obligations.  Short-term investments consist ofcertificates of deposit with original maturities ranging from 6 to 12 months.Long-term investments consist of certificates of deposits with originalmaturities ranging from 18 to 24 months.

 

*Propertyand Equipment*

 

Property and equipment are stated at cost, net of accumulateddepreciation and amortization. The cost of additions and improvements arecapitalized, while repairs and maintenance are expensed as incurred.Depreciation and amortization are calculated using the straight-line method,which amortizes cost over the lesser of the estimated useful lives of therespective assets or the term of the related lease. Useful lives range fromthree to five years.

 

*IntangibleAssets*

 

Costs paid by the Company related to the establishment, transfer andpurchase of patents and other intangibles, primarily legal costs, arecapitalized and amortized, depending on the estimated useful life of thetechnology patented. These assets are being amortized using the straight linemethod over three to ten years.

 

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*Impairmentof Long-Lived Assets*

 

The Company evaluates the recoverability of long-lived assets withfinite lives.  The Company assessespotential impairments to its long-lived assets when there is evidence thatevents or changes in circumstances indicate that the carrying amount of anasset may not be recovered. An impairment loss is recognized when the carryingamount 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 thesum of the undiscounted cash flows expected to result from the use and eventualdisposition of the asset. Any required impairment loss is measured as theamount by which the carrying amount of a long-lived asset exceeds its fairvalue and is recorded as a reduction in the carrying value of the related assetand a charge to operating results. Based upon the most recent assessment as of December 31,2009, management has determined there was no impairment in the carrying valueof long-lived assets.

 

*RevenueRecognition*

 

Our license agreements typically have multi-year or automatic renewalterms, and either require: a) per-unit royalty payments for all productsimplementing our technologies and/or solutions; b) fixed annual or quarterlyroyalty payments; or c) a minimum fixed annual or quarterly royalty payment,which allow the licensee to ship up to a pre-determined number of units duringthe specified time period, with additional per-unit royalty paymentsthereafter.  Royalties for per-unitarrangements are reported in the quarter following shipment of the consumerelectronics device and are therefore recognized by us generally one quarterfollowing shipment by the OEM.  Revenuesassociated with fixed royalty payments are generally recognized ratably overthe term of the agreement.  We also sellsome of our products and solutions via the Internet.  Revenues associated with those sales arerecognized upon shipment and are not material.

 

*Researchand Development*

 

Research and development expenses include costs and expenses associatedwith the development of our design methodology and the design and developmentof new products, including initial nonrecurring engineering and productverification charges. Research and development is expensed as incurred.

 

*IncomeTaxes*

 

Deferred taxes on income result from temporary differences between thereporting of income for financial statement and tax reporting purposes. A valuationallowance related to a deferred tax asset is recorded when it is more likelythan not that some or all of the deferred tax asset will not be realized.

 

We provide tax contingencies, if any, for federal, state, local andinternational exposures relating to audit results, tax planning initiatives andcompliance responsibilities.  Thedevelopment of these reserves requires judgments about tax issues, potentialoutcomes and timing.  Although theoutcome of these tax audits is uncertain, in management’s opinion adequateprovisions for income taxes have been made for potential liabilities emanatingfrom these reviews.  If actual outcomesdiffer materially from these estimates, they could have a material impact onour results of operations.

 

*Income PerCommon Share*

 

Basic net income or loss per common share is computed by dividing netincome or loss available to common stockholders by the weighted average numberof common shares outstanding during each year. Diluted net income or loss percommon share reflects the maximum dilution, based on the average price of ourcommon stock each period and is computed similar to basic income or loss pershare except that the denominator is increased to include the number ofadditional shares that would have been outstanding if potentially dilutivestock options and warrants had been exercised.

 

Basicand diluted net income per share for the years ended December 31, 2009,2008 and 2007 are as follows:

 
| ** **                                               | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                               | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| BASIC EPS                                                |       |                              |       |   |   |   |   |
| Numerator:                                               |       |                              |       |   |   |   |   |
| Net income                                               |       | $                                 | 2,135,630  |   | $ | 270,887 |   | $ | 5,414,435 |   |
| Denominator: Weighted average common shares  outstanding |       | 14,460,490                        |       | 15,588,815 |   | 16,154,313 |   |
| Net income per share                                     |       | $                                 | 0.15       |   | $ | 0.02 |   | $ | 0.34 |   |
| DILUTED EPS                                              |       |                              |       |   |   |   |   |
| Numerator:                                               |       |                              |       |   |   |   |   |
| Net income                                               |       | $                                 | 2,135,630  |   | $ | 270,887 |   | $ | 5,414,435 |   |
| Denominator: Weighted average common shares  outstanding |       | 14,460,490                        |       | 15,588,815 |   | 16,154,313 |   |
| Common equivalent shares outstanding: Dilutive  options  |       | 352,883                           |       | 253,521 |   | 835,526 |   |
| Total diluted common shares                              |       | 14,813,372                        |       | 15,842,336 |   | 16,989,839 |   |
| Net income per share                                     |       | $                                 | 0.14       |   | $ | 0.02 |   | $ | 0.32 |   |

 

There were options outstanding at December 31, 2009, 2008 and 2007to purchase 2,311,784, 2,201,570 and 542,660 shares of the Company’s commonstock, respectively, that were not included above because they would beanti-dilutive.

 

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*Share-BasedCompensation*

 

The Company measures all employee stock-based compensation awards usinga fair-value method and recording of such expense in the consolidated financialstatements over the requisite service period. We recorded stock-basedcompensation expense of $1,956,057, $1,777,468 and $1,727,017 in 2009, 2008 and2007, respectively. See Note 6.

 

*Fair Valueof Financial Instruments*

 

Effective January 1,2008, the Company measures the fair value of applicable financial andnon-financial assets based on the following levels of inputs.

 

·                  *Level 1 inputs:* Level 1 inputs are quoted market pricesin active markets for identical assets or liabilities that are accessible atthe measurement date.

 

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

 

·                  *Level 3 inputs:* Level 3 inputs are unobservable andshould be used to measure fair value to the extent that observable inputs arenot available.

 

Thehierarchy noted above requires us to minimize the use of unobservable inputsand to use observable market data, if available, when determining fair value.

 

Financial assets carried at fair value as of December 31, 2009 areclassified below:

 
| ** **         | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|--------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Money market funds |       | $           | 27,988,164 |        | $          | —      |       | $         | —     |   | $ | 27,988,164 |   |
| Total              |       | $           | 27,988,164 |        | $          | —      |       | $         | —     |   | $ | 27,988,164 |   |

 

*CustomerConcentration*

 

For fiscal years 2009, 2008 and 2007, Samsung accounted forapproximately 39%, 42% and 28%, respectively, of the Company’s consolidatedrevenues.  Given the significant amountof revenues derived from Samsung, the loss of such customer or theuncollectibility of related receivables could have a material adverse effect onour consolidated financial condition and consolidated results of operations.

 

*Concentrationsof Credit Risk*

 

Financial instruments, which potentially subject the Company toconcentrations of credit risk, consist primarily of cash equivalents,investments and accounts receivable. Due to the relative short nature of suchinvestments, the carrying amount approximates fair value. The Company placesits cash in banks and its cash equivalents in certificates of deposit and moneymarket funds at certain financial institutions in excess of amounts insured byfederal agencies. The Company does not believe that it is subject to anyunusual financial risk beyond the normal risk associated with commercialbanking relationships. The Company performs periodic evaluations of therelative credit standing of these financial institutions.  The Company has not experienced anysignificant losses on its cash equivalents or investments.

 

The Company’s accounts receivable are derived from sales to OEMs,original design manufacturers (“ODMs”) and platform partners primarily inAsia, North America and Europe. Customers’ headquarters geographically locatedin the Asia Pacific markets accounted for approximately 72%, 88% and 90%, ofthe Company’s revenues in 2009, 2008 and 2007, respectively, and are expectedto continue to account for a substantial percentage of revenues in the future.The Company makes periodic evaluations of the creditworthiness of its customersand manages its exposure to losses from bad debts by limiting the amount ofcredit extended whenever deemed necessary and generally does not requirecollateral. The Company maintains an allowance for estimated uncollectibleaccounts receivable, as appropriate, and such losses have historically beenminimal and within management’s expectations.

 

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*RecentAccounting Pronouncements*

 

In January 2010, theFinancial Accounting Standards Board (“FASB”) issued guidance to amend the disclosurerequirements related to recurring and nonrecurring fair value measurements. Theguidance requires new disclosures on the transfers of assets and liabilitiesbetween Level 1 (quoted prices in active market for identical assets orliabilities) and Level 2 (significant other observable inputs) of the fairvalue measurement hierarchy, including the reasons and the timing of thetransfers. Additionally, the guidance requires a roll forward of activities onpurchases, sales, issuance, and settlements of the assets and liabilitiesmeasured using significant unobservable inputs (Level 3 fair valuemeasurements). The guidance will become effective for us with the reportingperiod beginning January 1, 2010, except for the disclosure on the rollforward activities for Level 3 fair value measurements, which will becomeeffective for us January 1, 2011. Other than requiring additional disclosures, adoption of this newguidance will not have a material impact on the Company’s consolidatedfinancial statements.

 

EffectiveSeptember 2009, the Company revised references to authoritative accountingliterature in accordance with FASB Accounting Standards Codification (the “Codification”)*. *TheCodification became the source of authoritative GAAP recognized by the FASB tobe applied by nongovernmental entities. Rules and interpretive releases ofthe SEC under authority of federal securities laws are also sources ofauthoritative GAAP for SEC registrants. On the effective date, the Codificationsuperseded all then-existing non-SEC accounting and reporting standards. Allother non-grandfathered non-SEC accounting literature not included in theCodification became non-authoritative. The adoption of this new guidance did not have a materialimpact on the Company’s consolidated financial statements.

 

In April 2009, FASBissued guidance in order to establish principles and requirements for reviewingand reporting subsequent events and requires disclosure of the date throughwhich subsequent events are evaluated and whether the date corresponds with thetime at which the financial statements were available for issue (as defined) orwere issued. The adoption of this new guidance did not have a material impacton the Company’s consolidated financial statements.  Subsequent events were evaluated through February 22,2010.

 

**2. Property and Equipment**

 

Property and equipment, net, consist of the following:

 
| ** **                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **2009**              | ** ** | **2008** | ** ** |
| Property and equipment                         |       | $                     | 540,934    |   | $ | 1,299,121 |   |
| Computer equipment                             |       | 588,346               |       | 534,960 |   |
| Leasehold improvements                         |       | 379,495               |       | 202,854 |   |
|                                           |       | 1,508,775             |       | 2,036,935 |   |
| Less accumulated depreciation and amortization |       | (908,981              | )          | (1,613,014 | ) |
|                                           |       | $                     | 599,794    |   | $ | 423,921 |   |

 

Depreciation and amortization expense for property and equipmenttotaling $208,901, $188,407 and $216,948 for the years ended December 31,2009, 2008 and 2007, respectively, is reflected in general and administrativeexpenses.

 

**3. Intangible Assets**

 

Intangible assets, net consist of the following:

 
| ** **                                                  | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **2009**              | ** ** | **2008** | ** ** |
| Patents                                                     |       | $                     | 4,100,363  |   | $ | 3,618,338 |   |
| Accumulated amortization                                    |       | (2,072,763            | )          | (1,785,531 | ) |
| Patents, net                                                |       | 2,027,600             |       | 1,832,807 |   |
| Other intangibles:                                          |       |                  |       |   |   |
| License agreements acquired in purchase of  SRSWOWcast      |       | 640,071               |       | 640,071 |   |
| Capitalized software and hardware for several  technologies |       | 851,508               |       | 582,800 |   |
| Total other intangibles                                     |       | 1,491,579             |       | 1,222,871 |   |
| Accumulated amortization, other intangibles                 |       | (817,019              | )          | (700,953 | ) |
| Other intangibles, net                                      |       | 674,560               |       | 521,918 |   |
| Intangible assets, net                                      |       | $                     | 2,702,160  |   | $ | 2,354,725 |   |

 

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Amortization periods range from three to ten years depending on theestimated useful life of the asset. Amortization expense consists of thefollowing:

 
| ** **                                                  | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                  | ** ** | **2009**                                    | ** ** | **2008** | ** ** | **2007** | ** ** |
| Patents                                                     |       | $                                           | 287,232    |   | $ | 284,244 |   | $ | 296,118 |   |
| Other intangibles:                                          |       |                                        |       |   |   |   |   |
| License agreements acquired in purchase of  SRSWOWcast      |       | 64,007                                      |       | 64,007 |   | 64,007 |   |
| Capitalized software and hardware for several  technologies |       | 144,579                                     |       | 124,296 |   | 156,800 |   |
| Total intangible amortization expense                       |       | $                                           | 495,818    |   | $ | 472,547 |   | $ | 516,925 |   |

 

As of December 31, 2009, the weighted average remaining usefullife of the Company’s patents and intangible assets was approximately6 years. The following table shows the estimated amortization expense forthose assets for each of the five succeeding fiscal years and thereafter.

 
| **Years Ending December 31,** | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|------------|------------|
| 2010                                         |       | $          | 572,823    |   |
| 2011                                         |       | 543,757    |       |
| 2012                                         |       | 450,617    |       |
| 2013                                         |       | 287,772    |       |
| 2014                                         |       | 240,051    |       |
| Thereafter                                   |       | 607,140    |       |
| Total                                        |       | $          | 2,702,160  |   |

 

**4. Commitments and Contingencies**

 

*Leases*

 

The Company leases office space and certain equipment undernon-cancelable operating leases expiring through 2009. The Company leases itscorporate office and storage facilities located in Santa Ana, California, undera lease agreement with a partnership that is affiliated with a principalstockholder, who is also an executive officer and a director, of the Company.The lease term is until May 2013. We paid rent of $238,680, $235,170 and $230,256 in 2009, 2008 and 2007,respectively, under this lease agreement.

 

We entered into two new leases in 2009 for our international operationsin Shanghai, China, and Tokyo, Japan. The leases for our offices in Shanghai and Tokyo expire in October 2010and August 2011, respectively. Additionally, we lease space in Shenzhen, China and Taipei, Taiwan.  In total, we paid rent of $426,651, $294,702and $230,256 during 2009, 2008 and 2007, respectively, for all of ourfacilities.  We believe that our currentfacilities are adequate to support our current requirements

 

Future annual minimum lease payments under non-cancelable operatingleases for the remaining periods at December 31, 2009 are as follows:

 
| **Years Ending December 31,** | ** ** | **Facility** | ** ** | **Office  Equipment** | ** ** | **Total** | ** ** |
|----------------------------------------------|------------|--------------|------------|-----------------------|------------|-----------|------------|
| 2010                                         |       | $            | 398,427    |                  | $          | 21,272    |       | $ | 419,699 |   |
| 2011                                         |       | 338,797      |       | 2,029                 |       | 340,826   |       |
| 2012                                         |       | 288,608      |       | —                |       | 288,608   |       |
| 2013                                         |       | 117,029      |       | —                |       | 117,029   |       |
| Total                                        |       | $            | 1,142,861  |                  | $          | 23,301    |       | $ | 1,166,162 |   |

 

*Litigation*

 

OnJune 8, 2007, we sent a letter to Sony Corporation (“Sony”) relating tothe possible infringement of several SRS patents by Sony’s S-Force technology.Sony responded to the letter by filing a Complaint for Declaratory Relief inthe 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 agreementfor the purpose of conducting discussions towards an amicable resolution of thedispute, and the Complaint for Declaratory Relief wasdismissed.  While the standstill agreement has expired, the partiescontinue to evaluatethe related technologies, patents and claims.  Our discussions with Sonyare ongoing; however, we cannot assure you that we will prevail in this matterand 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 cashflows.

 

Fromtime to time, the Company may be involved in other litigation matters anddisputes arising in the normal course of business. Any such matters anddisputes could be costly and time consuming, subject the Company to damages orequitable remedies, and divert our management and key personnel from ourbusiness operations.

 

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*Indemnifications*

 

The Company enters into standard license agreements in its ordinarycourse of business. Pursuant to these agreements, the Company agrees to indemnifyits customers for losses suffered or incurred by them as a result of anypatent, copyright, or other intellectual property infringement claim by anythird party with respect to the Company’s products. These agreements generallyhave perpetual terms. The maximum amount of indemnification the Company couldbe required to make under these agreements is generally limited to the licensefees received by the Company. The Company estimates the fair value of itsindemnification obligation as insignificant, based upon its history oflitigation concerning product and patent infringement claims. Accordingly, theCompany has no liabilities recorded for indemnification under these agreementsas of December 31, 2009 and 2008.

 

The Company has agreements whereby its officers and directors areindemnified for certain events or occurrences while the officer or director is,or was, serving at our request in such capacity. The maximum potential amountof future payments the Company could be required to make under these indemnificationagreements is unlimited; however, the Company has a directors’ and officers’insurance policy that reduces its exposure and enables the Company to recover aportion of any future amounts paid. As a result of the insurance policycoverage, the Company believes the estimated fair value of theseindemnification agreements is minimal. Currently, the Company has noliabilities recorded for these agreements as of December 31, 2009 and2008.

 

*Warranties*

 

The Company offers its customers a warranty that its software productswill substantially conform to their functional specifications. To date, therehave been no payments or material costs incurred related to fulfilling thesewarranty obligations. Accordingly, the Company has no liabilities recorded forthese warranties as of December 31, 2009 and 2008.

 

*Employment Contracts*

 

The Company has employment agreements with its Chief Executive Officerand one other employee (collectively “Agreements”). Each of the Agreements wasentered into for an initial term that has since expired and all are nowautomatically renewed annually on various anniversary dates. Under the terms ofeach of the Agreements, the Company may be obligated to pay a severance paymentranging from one to two years of the respective employee’s base salary,depending on the date of termination, if the employee is terminated by theCompany without cause.

 

*Amended and Restated Change in Control Plan*

 

The Compensation Committee of the Board, the sponsor of the Company’sAmended and Restated Change in Control Protection Plan (the “Change in ControlPlan”), has designated certain of its executive officers as participants in theChange in Control Plan. The Change in Control Plan generally provides that if aparticipant’s employment is terminated without cause or if the participantresigns for good reason during a two-year period following a change in control,as defined in the Change in Control Plan, the participant will be entitled toreceive a severance payment. Under the Change in Control Plan, the size of theseverance payment that would be due to a participant upon the occurrence of acovered termination ranges from to one to two times the participant’s averagetaxable income during the five years preceding the change in control, dependingon the participant’s position with the Company. The Change in Control Plan alsoprovides that the Company will pay a participant’s COBRA premiums for a periodof 18 months following a covered termination.

 

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**5. Income Taxes**

 

The components of income from continuing operations before income taxesare as follows:

 
| ** **    | ** ** | **Year Ended December 31,** | ** ** |
|---------------|------------|--------------------------------------------|------------|
| ** **    | ** ** | **2009**                                   | ** ** | **2008** | ** ** | **2007** | ** ** |
| United States |       | $                                          | 2,233,636  |   | $ | 388,430 |   | $ | 5,459,993 |   |
|               |            |                                            |            |  |  |  |  |  |  |  |

 

The provision for income taxes on continuing operations consists of thefollowing:

 
| ** **                         | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|
| ** **                         | ** ** | **2009**                                   | ** ** | **2008** | ** ** | **2007** | ** ** |
| Current:                           |       |                                       |       |   |   |   |   |
| Federal                            |       | $                                          | —     |   | $ | — |   | $ | — |   |
| State                              |       | 98,006                                     |       | 144,923 |   | 45,558 |   |
| Foreign                            |       | 2,160,021                                  |       | 1,667,839 |   | 1,389,372 |   |
| Total                              |       | 2,258,027                                  |       | 1,812,762 |   | 1,434,930 |   |
| Deferred:                          |       |                                       |       |   |   |   |   |
| Federal                            |       | (1,528,883                                 | )          | (1,704,301 | ) | (234,654 | ) |
| State                              |       | —                                     |       | — |   | — |   |
| Foreign                            |       | —                                     |       | — |   | — |   |
| Change in valuation allowance, net |       | (631,138                                   | )          | 9,082 |   | (1,154,718 | ) |
| Total                              |       | (2,160,021                                 | )          | (1,695,219 | ) | (1,389,372 | ) |
| Total income tax provision         |       | $                                          | 98,006     |   | $ | 117,543 |   | $ | 45,558 |   |

 

Thereconciliation of the income tax expense computed at U.S. federal statutoryrates to the provision for income taxes is as follows:

 
| ** **                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                 | ** ** | **2009**                                   | ** ** | **2008** | ** ** | **2007** | ** ** |
| Tax at U.S. federal statutory rates        |       | $                                          | 759,436    |   | $ | 179,821 |   | $ | 1,856,398 |   |
| State income taxes, net of federal benefit |       | 130,320                                    |       | 30,857 |   | 151,796 |   |
| Nondeductible expenses                     |       | 39,433                                     |       | 32,692 |   | 9,983 |   |
| Change in valuation allowance, net         |       | (631,138                                   | )          | 9,082 |   | (1,154,718 | ) |
| Research and development credit            |       | (199,984                                   | )          | (131,768 | ) | (110,996 | ) |
| Foreign tax rate differential and other    |       | (61                                        | )          | (3,141 | ) | (706,905 | ) |
| Total income tax expense                   |       | $                                          | 98,006     |   | $ | 117,543 |   | $ | 45,558 |   |

 

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Deferredincome taxes reflect the net tax effects of temporary differences between thecarrying amounts of assets and liabilities for financial reporting purposes andthe amounts used for income tax purposes. Significant components of the Company’sdeferred tax assets are as follows:

 
| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2009**              | ** ** | **2008** | ** ** |
| Deferred tax assets:             |       |                  |       |   |   |
| Depreciation and amortization    |       | $                     | 504,561    |   | $ | 705,430 |   |
| Accruals                         |       | 663,537               |       | 915,872 |   |
| Net operating loss carryforwards |       | 16,492                |       | 883,338 |   |
| Tax credit carryforwards         |       | 8,871,580             |       | 6,553,617 |   |
| Capital loss carryforwards       |       | 6,460,261             |       | 6,460,261 |   |
| Other                            |       | 2,428,174             |       | 1,897,204 |   |
| Valuation allowance              |       | (13,313,163           | )          | (13,944,301 | ) |
| Total net deferred tax assets    |       | $                     | 5,631,442  |   | $ | 3,471,421 |   |

 

The Company has federal and state net operating loss carryforwards at December 31,2009 of $8,463,418 and $5,598,943, respectively. Approximately $8.0 milliondollars of the net operating losses have not been recognized relating to excesstax benefits.  These net operating losscarryforwards will begin to expire in 2014 and will continue to expire through2027. The Company also has federal and state research credits of approximately$1,054,315 and $462,917, respectively, which will begin to expire in 2011 andwill continue to expire through 2029 for federal and carryforward indefinitelyfor state purposes. In addition, the Company has federal foreign tax creditcarryforwards of $7,376,260 at December 31, 2009, which will begin toexpire in 2014 and will continue to expire through 2019. The Company also hasfederal and state capital loss carryforwards at December 31, 2009 of$16,219,585, which will expire in 2011.

 

As of December 31, 2009, a valuation allowance of $13,313,163 hasbeen provided based on the Company’s assessment of the future realizability ofdeferred tax assets. The valuation allowance on deferred tax assets relates tofuture deductible temporary differences, capital loss carryforwards, foreigntax credit carryforwards, research and development credit carryforwards, andnet operating loss carryforwards for which the Company has concluded it is morelikely than not that these items will not be realized in the ordinary course ofoperations. Management periodically evaluates the recoverability of thedeferred tax assets and recognizes the tax benefit only as reassessmentdemonstrates they are realizable. At such time it is determined that it is morelikely than not that the deferred tax assets are realizable, the valuationallowance is adjusted. This assessment is based on projections of futuretaxable income, which is impacted in future periods by income before taxes andstock option exercises. The amount of the net deferred tax assets consideredrealizable, however, could be reduced in the near term if actual futureearnings are lower than estimated, or if there are differences in the timing oramount of future reversals of existing taxable temporary differences.  The Company’s deferred tax asset at December 31,2009 do not include approximately $3.2 million of excess tax benefits fromemployee stock option exercises that are a component of the Company’s netoperating loss carryovers.

 

Theuse of loss carryforwards and tax credit carry forwards may become limited inthe event of an ownership change as defined under Internal Revenue Codesection 382. The Company commissioned a section 382 study in 2008, whichconfirmed that there have been no ownership changes through 2007.  Further, due to a change in California taxlaw in fiscal year 2008, net operating loss carryforwards may not be used in2008 or 2009 and research and development credits are limited to fifty percentof the Company’s net tax.

 

The Company determined at the beginning of fiscal year 2007 that it didnot have any unrecorded tax contingencies and therefore a rollforward of thetax contingency reserve that reconciles the beginning and ending balance of thereserve was not necessary as there was no tax contingency reserve. The Companywill recognize interest and penalties related to unrecognized tax benefitswithin the income tax expense line in the accompanying consolidated statementof operations. As of December 31, 2009, the Company has not recognizedliabilities for penalty and interest as the Company does not have liability forunrecognized tax benefits. The tax years 2005 through 2008 remain open toexamination by the major taxing jurisdictions.

 

Revenue is recognized grossof foreign withholding taxes that are remitted by our licensees directly toforeign tax authorities. Withholding taxes were $2.2 million, $1.7 million and$1.4 million in 2009, 2008 and 2007, respectively. 

 

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**6. Stockholders’ Equity and Share-Based Compensation**

 

*Stock Award/Option Plans/Warrants*

 

In July 1996, the Board adopted and the Company’s stockholders approvedthe 1996 Long-Term Incentive Plan (as amended and restated, the “1996 Plan”),for which 1,000,000 shares of the Company’s common stock were initiallyreserved for issuance to officers, employees and consultants of the Company.The number of shares reserved for issuance under the 1996 Plan was increased inJune 1997, June 1998, June 2000 and June 2003 by 1,000,000,2,500,000, 2,500,000 and 1,500,000 shares, respectively.  The Compensation Committee or, in the absenceof a Compensation Committee, the Board, as a whole, has been appointed toadminister the 1996 Plan. Options issued under the 1996 Plan vest in the mannerprescribed by the Compensation Committee or the Board, as applicable. As of December 31,2009, options to purchase 1,194,698 shares of the Company’s common stock wereoutstanding under the 1996 Plan. No additional options have been, or will be,granted under the 1996 Plan since the date of stockholder approval of the 2006Plan (defined below).

 

In July 1996, the Board adopted and the Company’s stockholdersapproved the 1996 Non-employee Directors Stock Option Plan (the “Non-employeeDirectors Plan”), a non-discretionary formula plan for which 120,000 shares ofthe Company’s common stock were reserved for issuance to the Company’snon-employee directors. A committee consisting of all directors who are noteligible to participate in the Non-employee Directors Plan administers theNon-employee Directors Plan. With the exception of the initial option grantedto a non-employee director, which vests immediately, options granted under theNon-employee Directors Plan vest over a three-year period, the firstinstallment vesting on the date of grant. In June 1999, the Company’sstockholders approved the Amended and Restated 1996 Non-employee Directors’Stock Option Plan (the “Amended Non-employee Directors Plan”). Among thechanges set forth in the Amended Non-employee Directors Plan was to increase by130,000 the number of shares of common stock that may be issued under the plan.In June 2001, the Board adopted and the Company’s stockholders approved anamendment to the Amended Non-employee Directors Plan to increase the number ofshares reserved for issuance under the plan by 250,000. As of December 31,2009, options to purchase 177,500 shares of common stock were outstanding underthe Amended Non-employee Directors Plan. There are 280,000 shares of commonstock available for grant under the Non-employee Directors Plan as of December 31,2009.

 

On June 22, 2006, the Board adopted and the Company’s stockholdersapproved the 2006 Stock Incentive Plan (the “2006 Plan”), for which 1,500,000shares of the Company’s common stock were initially reserved for issuance underthe plan. Either the Board or a committee appointed by the Board (the “Committee”)will administer the 2006 Plan. The Compensation Committee is currently actingas the Committee for purposes of the 2006 Plan. Under the 2006 Plan, theCommittee may grant options that are intended to qualify as incentive stockoptions. Additionally, the Committee may also grant share appreciation rights,restricted shares, restricted share units, unrestricted shares, deferred shareunits, and performance awards. The vesting period is dependent on the type ofaward granted and may be determined by the Committee. In June 2008, theBoard adopted and the Company’s stockholders approved an amendment to the 2006Plan to increase the number of shares reserved for issuance under the plan by1,750,000. As of December 31, 2009, options to purchase 2,576,180 sharesof common stock were outstanding under the 2006 Plan. There are 661,241 sharesof common stock available for grant under the 2006 Plan as of December 31,2009.

 

*Share-Based Compensation*

 

We account forstock-based compensation by measuring all employee stock-based compensationawards using a fair-value method and record such expense in the consolidatedfinancial statements over the requisite service period.

 

Total compensation cost recognized in 2009 and 2008 is as follows:

 
| ** **                         | ** ** | **Years Ended  December 31,** | ** ** |
|------------------------------------|------------|-----------------------------------------|------------|
| ** **                         | ** ** | **2009**                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Sales and marketing                |       | $                                       | 511,301    |   | 458,610 |   | 495,132 |   |
| Research and development           |       | 457,464                                 |       | 399,630 |   | 428,516 |   |
| General and administrative         |       | 987,292                                 |       | 919,228 |   | 803,369 |   |
| Total compensation cost recognized |       | 1,956,057                               |       | 1,777,468 |   | 1,727,017 |   |
|                                    |            |                                         |            |  |  |  |  |  |

 

Option awards are granted with an exercise price equal to the marketprice of the Company’s stock at the date of grant. Option awards generally havea term of 10 years and vest and become exercisable over a four-yearservice period.

 

The fair value of each share-based award is estimated on the grant dateusing the Black-Scholes-Merton (“BSM”) option-pricing model. Expectedvolatilities are based on the historical volatility of the Company’s stockprice. The expected term for optionsgranted in 2009 and 2008 was calculated based upon the historical term of theCompany’s option grants and review of the terms of the Company’s peers.  The expected term for options granted in 2007is derived using the simplified method.  Therisk-free rate for

 

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periodswithin the contractual life of the option is based on the U.S. Treasuryinterest rates in effect at the time of grant. The fair value of optionsgranted was estimated using the following weighted-average assumptions:

 
| ** **               | ** ** | **Years Ended  December 31,** | ** ** |
|--------------------------|------------|-----------------------------------------|------------|
| ** **               | ** ** | **2009**                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Expected term (in years) |       | 4.23                                    |       | 4.67 |   | 6.25 |   |
| Expected volatility      |       | 54                                      | %          | 56 | % | 56 | % |
| Risk-free interest rate  |       | 1.96                                    | %          | 3.4 | % | 4.8 | % |
| Dividend yield           |       | 0.00                                    | %          | 0.00 | % | 0.00 | % |

 

The following table summarizes the weighted-average fair value of stockoptions granted and the total intrinsic value of stock options exercised duringthe years ended December 31, 2009, 2008 and 2007:

 
| ** **                                   | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                   | ** ** | **2009**                                    | ** ** | **2008** | ** ** | **2007** | ** ** |
| Weighted-average fair value at date of grant |       | $                                           | 2.86       |   | $ | 2.80 |   | $ | 5.66 |   |
| Intrinsic value of options exercised         |       | $                                           | 464,136    |   | $ | 192,314 |   | $ | 2,846,841 |   |

 

A summary of option activity under the stock option plans and changesduring the year ended December 31, 2009 is presented below:

 
| ** **                                  | ** ** | ** ** | ** ** | **Weighted-Average** | ** ** | ** **                                          | ** ** |
|---------------------------------------------|------------|------------|------------|----------------------|------------|-----------------------------------------------------|------------|
| ** **                                  | ** ** | **Shares** | ** ** | **Exercise  Price**  | ** ** | **Remaining  Contractual  Term (in Yrs)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| Outstanding, January 1, 2009           |       | 2,879,538  |       | $                    | 5.83       |                                                |       |   |   |   |
| Granted                                     |       | 1,306,800  |       | 6.31                 |       |                                                |       |   |   |
| Cancelled/Forfeited                         |       | (93,663    | )          | 6.57                 |       |                                                |       |   |   |
| Exercised                                   |       | (144,297   | )          | 3.70                 |       |                                                |       |   |   |
| Outstanding, December 31, 2009         |       | 3,948,378  |       | $                    | 6.05       |                                                | 7.13       |   | $ | 6,339,904 |   |
| Options exercisable, December 31, 2009 |       | 1,988,474  |       | $                    | 5.77       |                                                | 5.27       |   | $ | 4,039,205 |   |

 

A summary of theactivity of the Company’s non-vested shares during the year ended December 31,2009 is presented below:

 
| ** **                        | ** ** | ** ** | ** ** | ** **                           | ** ** | ** **                             | ** ** | **Remaining**          | ** ** |
|-----------------------------------|------------|------------|------------|--------------------------------------|------------|----------------------------------------|------------|------------------------|------------|
| ** **                        | ** ** | ** ** | ** ** | **Weighted-Average**                 | ** ** | **Unrecognized**                       | ** ** |
| ** **                        | ** ** | **Shares** | ** ** | **Grant Date  Fair Value** | ** ** | **Remaining  Years to Vest** | ** ** | **Compensation  Cost** | ** ** |
| Nonvested, January 1, 2009   |       | 1,274,504  |       | $                                    | 3.41       |                                   |       |                   |       |   |
| Granted                           |       | 1,306,800  |       | 2.76                                 |       |                                   |       |                   |       |
| Vested                            |       | (562,042   | )          | 3.42                                 |       |                                   |       |                   |       |
| Forfeited                         |       | (59,358    | )          | 3.06                                 |       |                                   |       |                   |       |
| Nonvested, December 31, 2009 |       | 1,959,904  |       | $                                    | 2.97       |                                   | 3.07       |                   | $          | 5,947,974 |   |
|                                   |            |            |            |                                      |            |                                        |            |                        |            |  |  |

 

The following table summarizes information concerning currentlyoutstanding and exercisable options and warrants at December 31, 2009.

 
| **Range of Exercise Prices** | ** ** | **Number of  Options  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual Life  (in Years)** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Exercisable  As of  12/31/2009** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|---------------------------------------------|------------|------------------------------------------|------------|--------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------|------------|--------------------------------------------|------------|
| $1.91–$3.80                            |       | 390,014                                  |       | 2.1                                                                      |       | $                                          | 2.82       |                                    | 390,014    |                                       | $          | 2.82 |   |
| $3.81–$5.70                            |       | 1,404,504                                |       | 7.6                                                                      |       | 4.92                                       |       | 600,078                                 |       | 4.92                                       |       |
| $5.71–$7.60                            |       | 1,694,840                                |       | 8.0                                                                      |       | 6.63                                       |       | 681,246                                 |       | 6.11                                       |       |
| $7.61–$9.50                            |       | 294,020                                  |       | 7.1                                                                      |       | 9.29                                       |       | 202,136                                 |       | 9.29                                       |       |
| $9.51–$11.40                           |       | 145,000                                  |       | 7.0                                                                      |       | 10.62                                      |       | 95,000                                  |       | 10.61                                      |       |
| $17.10–$19.00                          |       | 20,000                                   |       | 0.2                                                                      |       | 19.00                                      |       | 20,000                                  |       | 19.00                                      |       |
|                                        |       | 3,948,378                                |       | 7.1                                                                      |       | $                                          | 6.05       |                                    | 1,988,474  |                                       | $          | 5.77 |   |

 

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The total shares subject to options exercisable as of December 31,2009, 2008, and 2007 were 1,988,474, 1,605,034, and 1,492,892, respectively,with weighted average exercise prices of $5.77, $5.41 and $4.67, respectively.

 

**7. Segment Information**

 

The Company’s revenue is solely derived from licensing related revenue.The following schedule presents the Company’s revenue by geographic area. Forproduct sales, revenue is allocated based on the country to which product wasshipped. Licensing-related revenue is summarized based on the location of thelicensee’s corporate headquarters. For product and online sales, revenue isallocated to the Americas. The Americas region includes North, Central andSouth America. In 2008, the Greater China region was broken down into the Chinaand Asia Pacific region. The China region includes all licensees with theircorporate headquarters located in mainland China.  The Asia Pacific region includes alllicensees with their corporate headquarters located in Taiwan and Hong Kong.

 
| ** **                          | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------|------------|---------------------------------------------|------------|
| ** **                          | ** ** | **2009**                                    | ** ** | **%** | ** ** | **2008** | ** ** | **%** | ** ** | **2007** | ** ** | **%** | ** ** |
| ***Geographic Area Revenue:*** |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Korea                               |       | $                                           | 11,551,403 |   | 46 | % | $ | 9,624,459 |   | 52 | % | $ | 7,834,730 |   | 42 | % |
| Americas                            |       | 6,440,033                                   |       | 26 |   | 1,744,502 |   | 10 |   | 1,837,096 |   | 9 |   |
| Japan                               |       | 4,375,139                                   |       | 17 |   | 5,357,286 |   | 29 |   | 7,346,548 |   | 39 |   |
| China                               |       | 1,548,496                                   |       | 6 |   | 838,754 |   | 5 |   | 843,931 |   | 5 |   |
| Asia Pacific                        |       | 647,220                                     |       | 3 |   | 430,598 |   | 2 |   | 805,660 |   | 4 |   |
| Europe                              |       | 402,286                                     |       | 2 |   | 337,079 |   | 2 |   | 183,975 |   | 1 |   |
| Total                               |       | $                                           | 24,964,577 |   | 100 | % | $ | 18,332,678 |   | 100 | % | $ | 18,851,940 |   | 100 | % |

 

**8. Employee Benefit Plan**

 

The Company’s employees based in the United States may participate in asalary deferral plan (the “401(k) Plan”) in which eligible employees cancontribute up to 75% of their eligible compensation. The Company also maycontribute on a discretionary basis. The Company’s matching contribution vestsratably over a four year period. During the years ended December 31, 2009,2008 and 2007, the Company contributed approximately $153,141, $121,723 and$126,675, respectively, to the 401(k) Plan.

 

**SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS AND RESERVES**

 
| ** **                                 | ** ** | **Balance at  Beginning  of Period** | ** ** | **Additions  Charged to  Expense** | ** ** | **Deductions** | ** ** | **Balance  at End  of Period** | ** ** |
|--------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------|------------|----------------|------------|------------------------------------------|------------|
| For the year ended December 31, 2009: |       |                                           |       |                                    |       |           |       |                                     |       |
| Allowance for doubtful accounts            |       | $                                              | —     |                                    | $          | 60,000         |       | $                                        | 12,473     |   | $ | 47,527 |   |
| For the year ended December 31, 2008: |       |                                           |       |                                    |       |           |       |                                     |       |
| Allowance for doubtful accounts            |       | $                                              | 72,714     |                                    | $          | 11,189         |       | $                                        | 83,903     |   | $ | — |   |
| For the year ended December 31, 2007: |       |                                           |       |                                    |       |           |       |                                     |       |
| Allowance for doubtful accounts            |       | $                                              | 39,256     |                                    | $          | 108,321        |       | $                                        | 74,863     |   | $ | 72,714 |   |

 

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**EXHIBITINDEX**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Certificate  of Incorporation of the Company, previously filed with the SEC as  Exhibit 3.1 to the Company’s Registration Statement on Form SB-2,  specifically included in Amendment No. 1 to such Registration Statement  filed with the SEC on July 3, 1996 (File No. 333-4974-LA) (the  “Registration Statement Amendment No. 1”), which is incorporated herein  by reference.                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 3.2                 |       | Bylaws  of the Company, previously filed with the SEC as Exhibit 3.1 to the  Company’s Quarterly Report on Form 10-Q for the period ended  September 30, 1999, filed with the SEC on November 12, 1999, which  is incorporated herein by reference.                                                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| ** **          | ** ** | **Material Contracts Relating to Management  Compensation Plans or Arrangements**                                                                                                                                                                                                                                                                                                                                                                                                                            |
| ** **          | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.1                |       | Employment  Agreement dated July 1, 1996, between the Company and Thomas C.K. Yuen,  previously filed with the SEC as Exhibit 10.8 to the Registration  Statement Amendment No. 1, which is incorporated herein by reference.                                                                                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.2                |       | Amendment  to Employment Agreement dated as of March 14, 1997, between the Company  and Thomas C.K. Yuen, previously filed with the SEC as Exhibit 10.2 to  the Company’s Annual Report on Form 10-KSB for the fiscal year ended  December 31, 1996, filed with the SEC on March 31, 1997 (the “1996  Annual Report”), which is incorporated herein by reference.                                                                                                    |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.3                |       | Employment  Agreement dated July 1, 1996, between the Company and Alan D. Kraemer,  previously filed with the SEC as Exhibit 10.11 to the Registration  Statement Amendment No. 1, which is incorporated herein by reference.                                                                                                                                                                                                                                                                 |
| 10.4                |       | SRS  Labs, Inc. Amended and Restated 1996 Non-employee Directors Stock Option  Plan, as amended, previously filed with the SEC as Appendix B to the  Company’s Definitive Proxy Statement dated and filed with the SEC on  April 30, 2003, which is incorporated herein by reference.                                                                                                                                                                                                    |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.5                |       | Form of  Indemnification Agreement, previously filed with the SEC as  Exhibit 10.20 to the Registration Statement Amendment No. 1, which  is incorporated herein by reference.                                                                                                                                                                                                                                                                                                                |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.6                |       | Non-employee  Director Compensation Policy adopted by the Company’s Board of Directors on  January 28, 2005, previously filed with the SEC as Exhibit 10.1 to  the Company’s Current Report on Form 8-K filed with the SEC on  February 3, 2005, which is incorporated herein by reference.                                                                                                                                                                                    |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.7                |       | Form of  Non-Employee Director Stock Option Agreement under the SRS Labs, Inc.  Amended and Restated 1996 Non-Employee Directors’ Stock Option Plan (Initial  Appointment), previously filed with the SEC as Exhibit 10.2 to the  Company’s Current Report on Form 8-K filed with the SEC on  February 3, 2005, which is incorporated herein by reference.                                                                                                                |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.8                |       | Form of  Non-Employee Director Stock Option Agreement under the SRS Labs, Inc.  Amended and Restated 1996 Non-Employee Directors’ Stock Option Plan (Re-Election),  previously filed with the SEC as Exhibit 10.3 to the Company’s Current  Report on Form 8-K filed with the SEC on February 3, 2005, which is  incorporated herein by reference.                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.9                |       | Form of  Non-Employee Director Stock Option Agreement under the SRS Labs, Inc.  Amended and Restated 1996 Long-Term Incentive Plan, previously filed with the  SEC as Exhibit 10.4 to the Company’s Current Report on Form 8-K  filed with the SEC on February 3, 2005, which is incorporated herein by  reference.                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.10               |       | Form of Nonqualified Stock Option Agreement under the SRS  Labs, Inc. Amended and Restated 1996 Long-Term Incentive Plan dated  March 29, 2005 (Current participants under this plan include the  following officers: Thomas C.K. Yuen, Ulrich E. Gottschling, Sarah Yang and  Alan D. Kraemer), previously filed with the SEC as Exhibit 10.1 to the  Company’s Current Report Form 8-K filed with the SEC on April 4,  2005, which is incorporated herein by reference. |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.11               |       | SRS  Labs, Inc. Amended and Restated Change in Control Protection Plan  approved August 3, 2009, previously filed with the SEC as  Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed  with the SEC on August 6, 2009, which is incorporated herein by  reference.                                                                                                                                                                                              |

 

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| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.12               |       | Form of Participation  Agreement under the SRS Labs, Inc. Amended and Restated Change in  Control Protection Plan for Selected Executive Officers (Current participants  under this plan include the following officers: Thomas C.K. Yuen, Ulrich E.  Gottschling, Sarah Yang, Jeff Klaas and Alan D. Kraemer) previously filed  with the SEC as Exhibit 10.2 to the Company’s Quarterly Report on  Form 10-Q filed with the SEC on August 6, 2009, which is  incorporated herein by reference. |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.13               |       | SRS  Labs, Inc. Amended and Restated 1996 Long-Term Incentive Plan, as  amended, approved April 27, 2005, previously filed with the SEC as Exhibit 10.5  to the Form 8-K filed with the SEC on May 3, 2005, which is  incorporated herein by reference.                                                                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.14               |       | Offer  Letter dated April 22, 2008 by and between the Company and Jeff Klaas,  previously filed with the SEC as Exhibit 10.15 to the Company’s Annual  Report on Form 10-K for the fiscal period ended December 31, 2008,  filed with the SEC on February 24, 2009 which is incorporated herein by  reference.                                                                                                                                                                                  |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.15               |       | Employment  Letter Agreement dated December 21, 2005 by and between the Company and  Ulrich E. Gottschling, previously filed with the SEC as Exhibit 99.1 to  the Company’s Current Report on Form 8-K filed with the SEC on  December 29, 2005, which is incorporated herein by reference.                                                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.16               |       | Form of  Nonqualified Stock Option Agreement under the SRS Labs, Inc. 1996  Amended and Restated Long-Term Incentive Plan, as amended, previously filed  with the SEC as Exhibit 99.8 to the Company’s Current Report on  Form 8-K filed with the SEC on January 18, 2006, which is  incorporated herein by reference.                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.17               |       | SRS  Labs, Inc. Profit Sharing and Bonus Plan, as amended on June 20,  2007, previously filed with the SEC as Exhibit 10.1 to the Company’s  Current Report on Form 8-K filed with the SEC on June 25, 2007,  which is incorporated herein by reference.                                                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.18               |       | SRS  Labs, Inc. 2006 Stock Incentive Plan, as amended on December 17,  2007, previously filed with the SEC as Exhibit 10.1 to the Company’s  Current Report on Form 8-K filed with the SEC on December 21, 2007,  which is incorporated herein by reference.                                                                                                                                                                                                                                    |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.19               |       | Form of Stock Option  Award Agreement under the SRS Labs, Inc. 2006 Stock Incentive Plan,  previously filed with the SEC as Exhibit 10.9 to the Company’s Quarterly  Report on Form 10-Q, Amendment No. 1, filed with the SEC on September 22,  2006, which is incorporated herein by reference.                                                                                                                                                                                           |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.20               |       | Form of  Restricted Share Award Agreement under the SRS Labs, Inc. 2006 Stock  Incentive Plan, previously filed with the SEC as Exhibit 10.10 to the  Company’s Quarterly Report on Form 10-Q, Amendment No. 1, filed  with the SEC on September 22, 2006, which is incorporated herein by  reference.                                                                                                                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.21               |       | Form of  Restricted Share Unit Award Agreement under the SRS Labs, Inc. 2006  Stock Incentive Plan, previously filed with the SEC as Exhibit 10.11 to  the Company’s Quarterly Report on Form 10-Q, Amendment No. 1, filed  with the SEC on September 22, 2006, which is incorporated herein by  reference.                                                                                                                                                                                |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.22               |       | Form of  SAR Award Agreement under the SRS Labs, Inc. 2006 Stock Incentive Plan,  previously filed with the SEC as Exhibit 10.12 to Amendment No. 1  to the Company’s Quarterly Report on Form 10-Q, Amendment No. 1,  filed with the SEC on September 22, 2006, which is incorporated herein  by reference.                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.23               |       | SRS  Labs, Inc. Patent Reward Program, previously filed as Exhibit 10.2  to the Company’s Form 8-K filed with the SEC on June 28, 2006,  which is incorporated herein by reference.                                                                                                                                                                                                                                                                                                                  |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| ** **          | ** ** | **Other Material Contracts**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| ** **          | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.24               |       | Industrial  Real Estate Lease dated May 27, 2008, between the Company and Daimler  Commerce Partners, L.P., previously filed with the SEC as  Exhibit 10.25 to the Company’s Annual Report on Form 10-K for the  fiscal period ended December 31, 2008, filed with the SEC on  February 24, 2009 which is incorporated herein by reference.                                                                                                                                                |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.25               |       | Stock  Divestment Agreement dated July 1, 1996, between the Company, Thomas  C.K. Yuen, Stephen V. Sedmak and Walter W. Cruttenden III, previously filed  with the SEC as Exhibit 10.17 to the Company’s Registration Statement on  Form SB-2, specifically included in Amendment No. 2 to such  Registration Statement file with the SEC on August 2, 1996 (File  No. 333-4974-LA), which is incorporated herein by reference.                                                            |

 

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| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                         |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                                                              |
| ** **          | ** ** | **Other Exhibits**                                                                                                                                                                      |
| ** **          | ** ** | ** **                                                                                                                                                                              |
| 21                  |       | Subsidiaries  of the Company.                                                                                                                                                           |
|                |       |                                                                                                                                                                                    |
| 23.1                |       | Consent  of Independent Registered Public Accounting Firm, Squar, Milner, Peterson,  Miranda & Williamson, LLP, dated February 22, 2010.                             |
|                |       |                                                                                                                                                                                    |
| 31.1                |       | Certification  of the Chief Executive Officer of SRS Labs, Inc., pursuant to  Section 302 of the Sarbanes- Oxley Act of 2002.                                                 |
|                |       |                                                                                                                                                                                    |
| 31.2                |       | Certification  of the Chief Financial Officer of SRS Labs, Inc., pursuant to  Section 302 of the Sarbanes- Oxley Act of 2002.                                                 |
|                |       |                                                                                                                                                                                    |
| 32.1                |       | Certification  of Chief Executive Officer of SRS Labs, Inc., pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|                |       |                                                                                                                                                                                    |
| 32.2                |       | Certification  of Chief Financial Officer of SRS Labs, Inc., pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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