Table of Contents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

**x****      QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For thequarterly period ended June 30, 2010**

** **

**OR**

** **

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

 

**For the transition period         to        **

 

**CommissionFile Number 0-21123**

 

 

**SRSLABS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                    | ** ** | **33-0714264**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

**2909 Daimler Street, Santa Ana, California 92705**

(Address of principal executive offices) (Zip Code)

 

**(949) 442-1070**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the registrant has submittedelectronically and posted on its corporate website, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T (§232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files).  Yes o No 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 ExchangeAct. (Check one):

 

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

 

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

 

Asof July 30, 2010, 14,684,289 of the issuer’s common stock, par value $.001per share, were outstanding.

 

 

 

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**SRS LABS, INC.**

 

**Quarterly Report on Form 10-Q**

**For the Three and Six Months Ended June 30, 2010**

**Index**

 
| **PART I-FINANCIAL  INFORMATION** | ** **                                                                                                                  |
|----------------------------------------|-----------------------------------------------------------------------------------------------------------------------------|
| Item 1.                                | Financial Statements                                                                                                        | 4 |
|                                   | Condensed  Consolidated Balance Sheets as of June 30, 2010 (Unaudited) and  December 31, 2009                     | 4 |
|                                   | Condensed Consolidated Statements of Operations for  the three and six months ended June 30, 2010 and 2009 (Unaudited) | 5 |
|                                   | Condensed  Consolidated Statements of Stockholders’ Equity for the six months ended  June 30, 2010 (Unaudited)    | 6 |
|                                   | Condensed  Consolidated Statements of Cash Flows for the six months ended June 30,  2010 and 2009 (Unaudited)          | 7 |
|                                   | Notes to the Condensed Consolidated Financial  Statements (Unaudited)                                                       | 8 |
| Item 2.                                | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                 | 11 |
| Item 3.                                | Quantitative  and Qualitative Disclosures About Market Risk                                                                 | 15 |
| Item 4.                                | Controls and Procedures                                                                                                     | 15 |
| **PART II-OTHER  INFORMATION**    | ** **                                                                                                                  |
| Item 1.                                | Legal Proceedings                                                                                                           | 16 |
| Item 1A.                               | Risk Factors                                                                                                                | 16 |
| Item 5                                 | Other Information                                                                                                           | 20 |
| Item 6.                                | Exhibits                                                                                                                    | 21 |
|                                   |                                                                                                                        |   |
| SIGNATURES                             | 22                                                                                                                          |

 

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**FORWARD-LOOKING INFORMATION**

 

Asused herein, the “Company,” “SRS Labs,” “SRS,” “we,” “us,” or “our” means SRSLabs, Inc., the parent company, and its wholly-owned subsidiaries,SRSWOWcast.com, Inc., Shenzhen Representative Office of SRSLabs, Inc. (a Chinese company), Shanghai Representative Office of SRSLabs, Inc. (a Chinese company) and SRS Labs Japan, KK (a Japanesecompany).

 

ThisQuarterly Report on Form 10-Q contains forward-looking statementsregarding our assumptions, projections, expectations, targets, intentions orbeliefs about future events. All statements other than statements of historicalfacts included in this Quarterly Report, including, but not limited to,  those relating to our future operatingresults, profitability, growth and capital requirements, our investment andexpansion plans, changes in our competitive position, the outcome of certaindisputes, changes in economic conditions or capital markets and changes incustomer usage patterns and preferences, are forward-looking statements. Insome cases, you can identify forward-looking statements by terms such as may,will, should, could, expect, plan, intend, forecast, anticipate, believe,estimate, predict, potential, likely or similar expressions or variations ofthese terms. The forward-looking statements contained in this Quarterly Reportinvolve known and unknown risks, uncertainties and situations thatmay cause our or our industry’s actual results, level of activity,performance or achievements to be materially different from any future results,levels of activity, performance or achievements expressed or implied by thesestatements. Factors that might cause actual events or results to differmaterially from those indicated by these forward-looking statementsmay include the matters listed in Part II, Item 1A, “Risk Factors”of this Quarterly Report, including, but not limited to, the loss of anysignificant customer; the acceptance of new SRS Labs products and technologies;our ability to increase our brand awareness and enter into new or expandedlicense arrangements; the impact of competitive products and pricing; generaleconomic and business conditions that may adversely impact sales of consumerproducts incorporating our technologies or that otherwise may impact ouroperating results and future performance; the timely development and release oftechnologies by the Company; and other factors identified from time to time inour filings with the Securities and Exchange Commission (“SEC”).

 

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

 

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**PART I — FINANCIALINFORMATION**

 

**Item 1. Financial Statements**

 

**SRSLABS, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                 | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                 | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                 |       |                    |       |                        |       |
| **Current Assets**                                                                                                                                                                         |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                  |       | $                       | 15,680,996 |                        | $          | 27,988,164 |   |
| Accounts receivable, net                                                                                                                                                                   |       | 857,279                 |       | 179,114                     |       |
| Prepaid expenses and other current assets                                                                                                                                                  |       | 985,547                 |       | 1,147,151                   |       |
| Short-term investments                                                                                                                                                                     |       | 12,383,000              |       | 12,963,000                  |       |
| **Total Current Assets**                                                                                                                                                                   |       | 29,906,822              |       | 42,277,429                  |       |
|                                                                                                                                                                                       |       |                    |       |                        |       |
| Long-term investments                                                                                                                                                                      |       | 14,261,000              |       | 538,000                     |       |
| Property and equipment, net                                                                                                                                                                |       | 701,281                 |       | 599,794                     |       |
| Intangible assets, net                                                                                                                                                                     |       | 2,963,718               |       | 2,702,160                   |       |
| Deferred income taxes, net                                                                                                                                                                 |       | 7,116,153               |       | 5,631,442                   |       |
| **Total Assets**                                                                                                                                                                           |       | $                       | 54,948,974 |                        | $          | 51,748,825 |   |
| ** **                                                                                                                                                                                 |       |                    |       |                        |       |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                                             |       |                    |       |                        |       |
|                                                                                                                                                                                       |       |                    |       |                        |       |
| **Current Liabilities**                                                                                                                                                                    |       |                    |       |                        |       |
| Accounts payable                                                                                                                                                                           |       | $                       | 603,621    |                        | $          | 583,157 |   |
| Accrued liabilities                                                                                                                                                                        |       | 1,358,525               |       | 1,577,891                   |       |
| Deferred revenue                                                                                                                                                                           |       | 804,954                 |       | 1,193,454                   |       |
| **Total Current Liabilities**                                                                                                                                                              |       | $                       | 2,767,100  |                        | $          | 3,354,502 |   |
|                                                                                                                                                                                       |       |                    |       |                        |       |
| 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; 14,684,289 and 14,563,715 shares issued and outstanding at June 30,  2010 and December 31, 2009, respectively |       | 14,685                  |       | 14,565                      |       |
| Additional paid-in capital                                                                                                                                                                 |       | 66,818,592              |       | 65,128,337                  |       |
| Accumulated deficit                                                                                                                                                                        |       | (14,651,403             | )          | (16,748,579                 | )          |
| **Total Stockholders’ Equity**                                                                                                                                                        |       | 52,181,874              |       | 48,394,323                  |       |
| **Total Liabilities and  Stockholders’ Equity**                                                                                                                                       |       | $                       | 54,948,974 |                        | $          | 51,748,825 |   |

 

See accompanying notes to the condensed consolidated financialstatements

 

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**SRS LABS, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                   | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                   | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                   | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                     |       | $                                | 7,161,030  |                           | $          | 5,055,528 |   | $ | 15,546,422 |   | $ | 10,759,538 |   |
| Cost of sales                                                |       | 99,870                           |       | 62,201                         |       | 164,355 |   | 134,173 |   |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Gross profit                                                 |       | 7,061,160                        |       | 4,993,327                      |       | 15,382,067 |   | 10,625,365 |   |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Operating expenses:                                          |       |                             |       |                           |       |   |   |   |   |
| Sales and marketing                                          |       | 3,221,144                        |       | 2,711,351                      |       | 6,641,687 |   | 5,450,491 |   |
| Research and development                                     |       | 1,826,118                        |       | 1,189,517                      |       | 3,716,112 |   | 2,364,183 |   |
| General and administrative                                   |       | 1,431,833                        |       | 1,373,757                      |       | 2,997,131 |   | 2,805,884 |   |
| Total operating expenses                                     |       | 6,479,095                        |       | 5,274,625                      |       | 13,354,930 |   | 10,620,558 |   |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Operating income (loss)                                      |       | 582,065                          |       | (281,298                       | )          | 2,027,137 |   | 4,807 |   |
| Other income, net                                            |       | 71,863                           |       | 92,185                         |       | 101,502 |   | 196,818 |   |
| Income (loss) before income taxes                            |       | 653,928                          |       | (189,113                       | )          | 2,128,639 |   | 201,625 |   |
| Income taxes                                                 |       | 23,095                           |       | 9,139                          |       | 31,463 |   | 14,075 |   |
| Net income (loss)                                            |       | $                                | 630,832    |                           | $          | (198,252 | ) | $ | 2,097,176 |   | $ | 187,550 |   |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Net income (loss) per common share:                          |       |                             |       |                           |       |   |   |   |   |
| Basic                                                        |       | $                                | 0.04       |                           | $          | (0.01 | ) | $ | 0.14 |   | $ | 0.01 |   |
| Diluted                                                      |       | $                                | 0.04       |                           | $          | (0.01 | ) | $ | 0.14 |   | $ | 0.01 |   |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Weighted average shares used in the per share  calculations: |       |                             |       |                           |       |   |   |   |   |
| Basic                                                        |       | 14,637,238                       |       | 14,429,972                     |       | 14,604,933 |   | 14,424,724 |   |
| Diluted                                                      |       | 15,642,573                       |       | 14,429,972                     |       | 15,479,199 |   | 14,685,986 |   |

 

 See accompanying notes to thecondensed consolidated financial statements

 

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**SRS LABS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTSOF STOCKHOLDERS’ EQUITY**

**(Unaudited)**

** **
| ** **                              | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated** | ** ** | ** **  | ** ** |
|-----------------------------------------|------------|-----------------------|------------|-------------------------|------------|-----------------|------------|-------------|------------|
| ** **                              | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**     | ** ** | **Deficit** | ** ** | **Total** | ** ** |
| BALANCE, December 31, 2009         |       | 14,563,715            |       | $                       | 14,565     |            | $          | 65,128,337  |       | $ | (16,748,579 | ) | $ | 48,394,323 |   |
| Proceeds from exercise of stock options |       | 120,574               |       | 120                     |       | 563,334         |       | —      |       | 563,454 |   |
| Share-based compensation                |       | —                |       | —                  |       | 1,126,921       |       | —      |       | 1,126,921 |   |
| Net income                              |       | —                |       | —                  |       | —          |       | 2,097,176   |       | 2,097,176 |   |
|                                    |       |                  |       |                    |       |            |       |        |       |   |   |
| BALANCE, June 30, 2010             |       | 14,684,289            |       | $                       | 14,685     |            | $          | 66,818,592  |       | $ | (14,651,403 | ) | $ | 52,181,874 |   |

 

See accompanying notes to the condensed consolidated financialstatements

 

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**SRS LABS, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                                      | ** ** | **2009** | ** ** |
| **Cash Flows from Operating  Activities:**                                         |       |                                          |       |   |   |
| Net income                                                                         |       | $                                             | 2,097,176  |   | $ | 187,550 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                          |       |   |   |
| Depreciation and amortization                                                      |       | 437,530                                       |       | 338,726 |   |
| Provision for doubtful accounts                                                    |       | —                                        |       | 25,527 |   |
| Deferred taxes                                                                     |       | (1,484,711                                    | )          | (1,018,331 | ) |
| Share-based compensation                                                           |       | 1,126,921                                     |       | 947,363 |   |
| Loss on disposition of property and equipment                                      |       | —                                        |       | 3,361 |   |
| Write-off of intangible assets                                                     |       | —                                        |       | 3,750 |   |
| Changes in operating assets and liabilities:                                       |       |                                          |       |   |   |
| Accounts receivable                                                                |       | (678,165                                      | )          | (75,766 | ) |
| Prepaid expenses and other current assets                                          |       | 161,603                                       |       | (69,623 | ) |
| Accounts payable                                                                   |       | 20,464                                        |       | 186,492 |   |
| Accrued liabilities                                                                |       | (219,366                                      | )          | 2,077 |   |
| Deferred revenue                                                                   |       | (388,500                                      | )          | (317,993 | ) |
| Net cash provided by operating activities                                          |       | 1,072,953                                     |       | 213,133 |   |
|                                                                               |       |                                          |       |   |   |
| **Cash Flows from Investing  Activities:**                                         |       |                                          |       |   |   |
| Purchase of short-term and long-term investments                                   |       | (13,822,000                                   | )          | (4,669,000 | ) |
| Proceeds from sale of short-term investments                                       |       | 679,000                                       |       | — |   |
| Proceeds from sale of property and equipment                                       |       | —                                        |       | 17,600 |   |
| Purchase of property and equipment                                                 |       | (236,864                                      | )          | (121,102 | ) |
| Expenditures related to intangible assets                                          |       | (563,711                                      | )          | (331,913 | ) |
| Net cash used in investing activities                                              |       | (13,943,575                                   | )          | (5,104,415 | ) |
|                                                                               |       |                                          |       |   |   |
| **Cash Flows from Financing  Activities:**                                         |       |                                          |       |   |   |
| Proceeds from exercise of stock options                                            |       | 563,454                                       |       | 140,139 |   |
| Net cash provided by financing activities                                          |       | 563,454                                       |       | 140,139 |   |
|                                                                               |       |                                          |       |   |   |
| **Net Decrease in Cash and Cash  Equivalents**                                     |       | (12,307,168                                   | )          | (4,751,143 | ) |
| **Cash and Cash Equivalents,  Beginning of Period**                                |       | 27,988,164                                    |       | 31,599,087 |   |
| **Cash and Cash Equivalents, End  of Period**                                      |       | $                                             | 15,680,996 |   | $ | 26,847,944 |   |
|                                                                               |       |                                          |       |   |   |
| **Supplemental Disclosure of Cash  Flow Information:**                             |       |                                          |       |   |   |
| Cash paid during the period for:                                                   |       |                                          |       |   |   |
| Income taxes                                                                       |       | $                                             | 1,421,276  |   | $ | 1,049,182 |   |

 

See accompanying notes to the condensed consolidated financialstatements

 

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**SRS LABS, INC.AND SUBSIDIARIES**

**NOTES TO THE CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

**1.             Basis ofPresentation and Summary of Significant Accounting Policies and Estimates**

 

Asused herein, the  “Company,” “SRS Labs,” “SRS,”“we,” “us,” or “our” means SRS Labs, Inc., the parent company, and itswholly-owned subsidiaries, SRSWOWcast.com, Inc., Shenzhen RepresentativeOffice of SRS Labs, Inc. (a Chinese company), Shanghai RepresentativeOffice of SRS Labs, Inc. (a Chinese company) and SRS Labs Japan, KK (aJapanese company).  The accompanyingunaudited condensed consolidated financial statements have been prepared by theCompany in conformity with accounting principles generally accepted in theUnited States of America (“GAAP”) for interim financial information and therules and regulations of the SEC for interim reporting. In the opinion ofmanagement, all adjustments (which include normal recurring adjustments)considered necessary for a fair presentation of our financial position andresults of operations have been included.

 

Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with GAAP have been condensed or omitted pursuant to SECrules and regulations for presentation of interim financial information.Therefore, the unaudited condensed interim consolidated financial statementsshould be read in conjunction with the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2009. Current and future financialstatements may not be directly comparable to the Company’s historical financialstatements. The results of operations for the interim period are notnecessarily indicative of the results to be expected for any other interimperiod or for the full year.  Amountsrelated to disclosure of December 31, 2009 balances within these condensedconsolidated financial statements were derived from the audited consolidatedfinancial statements for the year ended December 31, 2009.

 

**Estimates**

 

Thepreparation of financial statements in accordance with GAAP requires managementto make use of certain estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reported periods. We base our estimates onhistorical experience and on various other assumptions that we believe are reasonableunder the circumstances, the results of which form the basis for makingjudgments about carrying values of assets and liabilities that are not readilyapparent from other sources.  By theirnature, estimates are subject to an inherent degree of uncertainty.  Actual results could differ materially fromthose estimates. See the audited consolidated financial statements and notesthereto included in our Annual Report on Form 10-K for the year endedDecember 31, 2009 for an additional discussion of the significantaccounting policies and estimates used in the preparation of our financialstatements.

 

**Cash and Cash Equivalents**

 

Cashand cash equivalents include short-term, highly liquid investments that arereadily convertible to known amounts of cash and are so near maturity that theypresent insignificant risk of changes in value because of interest rates. Cashand cash equivalents generally consist of cash, money market funds andinstruments with original maturities of three months or less when purchased.  The Company places its cash in banks and itscash and cash equivalents and money market funds at certain financialinstitutions in excess of amounts insured by federal agencies.  The Company does not believe that it issubject to any unusual financial risk beyond the normal risk associated withcommercial banking relationships.  TheCompany performs periodic evaluations of the relative credit standing of thesefinancial institutions.  The Company hasnot experienced any losses on its cash equivalents.

 

**Short-term and Long-term Investments**

 

Short-terminvestments consist of certificates of deposit with original maturities rangingfrom six to twelve months.  Long-terminvestments consist of certificates of deposit with maturities ranging fromeighteen to twenty-four months.  All ofthe certificates of deposit are fully FDIC insured. The Company has notexperienced any losses on its short and long-term investments.

 

**RevenueRecognition**

 

Ourrevenues consist primarily of royalties generated from the license of SRS Labs’audio and voice technologies.  Ourlicense agreements typically have multi-year or automatic renewal terms, andeither 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 allow the licensee to ship up to a pre-determined numberof units during the specified time period, with additional per-unit royaltypayments thereafter.  The majority of ourlicense agreements are per-unit royalty arrangements, which are generallyreported by the licensee in the quarter following shipment of the consumerelectronics devices and are therefore typically recognized by us followingshipment of the devices by the original equipment manufacturer (“OEM”).  

 

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Revenuesassociated with fixed royalty payments are recognized ratably over the term ofthe license agreement.  We also sell someof our products and solutions via the Internet. Revenues associated with those sales are recognized upon shipment andwere not material in the three months ended June 30, 2010 or 2009. TheCompany may offer customer support or license support programs in the form ofassisting the licensee with implementing the Company’s technology into themanufactured products of the licensee to ensure that the licensee receives themaximum benefit from the Company’s technology. Such customer support is not contractually mandated and is generallyprovided on a discretionary basis to assist the customer and to improvecustomer relations.  Such customersupport generally does not extend past the time in which the licensedtechnology is placed in service or implemented in any given device by thelicensee.  In this regard, any supportservices occur during a finite period prior to the sale or revenue recognition.

 

**CustomerConcentrations**

 

Forthe three months ended June 30, 2010 and 2009, one customer, Samsung,accounted for approximately 42% and 44%, respectively, of our revenues.  For the six months ended June 30, 2010and 2009, one customer, Samsung, accounted for approximately 40% and 42%,respectively, of our revenue.  Therevenue from Samsung is derived from multiple technology license agreementswith various divisions of Samsung.

 

**Reclassifications**

 

Certainamounts in the financial statements have been reclassified to conform to thecurrent presentation.

 

**IncomeTaxes**

 

TheCompany currently has net operating loss carryforwards to offset income taxes.Consequently, no significant provision is reflected in the accompanying interimconsolidated financial statements.  Dueto our licensees being located in foreign countries, they may be obligated towithhold foreign taxes based upon local and country requirements of the taxingauthority.  Refer to our Annual Report onForm 10-K for the year ended December 31, 2009 for additionaldisclosure in this regard.

 

**2.             Intangible Assets**

 

Intangibleassets consist of the following:

 
| ** **               | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|--------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Patents                  |       | $                       | 4,301,692  |                        | $          | 4,100,363 |   |
| Accumulated amortization |       | (2,232,240              | )          | (2,072,763                  | )          |
| Patents, net             |       | 2,069,452               |       | 2,027,600                   |       |
| Other intangibles        |       | 1,853,960               |       | 1,491,579                   |       |
| Accumulated amortization |       | (959,694                | )          | (817,019                    | )          |
| Other intangibles, net   |       | 894,266                 |       | 674,560                     |       |
| Intangible assets, net   |       | $                       | 2,963,718  |                        | $          | 2,702,160 |   |

 

Amortizationexpense associated with our intangibles was $164,218 and $123,219 in the threemonths ended June 30, 2010 and 2009, respectively, and $302,164 and$239,177 in the six months ended June 30, 2010 and 2009,respectively.  Amortization expense isincluded in general and administrative expenses in the accompanying condensedconsolidated statements of operations.

 

**3.**             **Net Income Per CommonShare**

 

Basicnet income per common share is computed by dividing net income or lossavailable to common stockholders by the weighted average number of commonshares outstanding during each year. Diluted net income per common sharereflects the maximum dilution, based on the average price of the Company’scommon stock during each period, and is computed similar to basic income orloss per share except that the denominator is increased to include the numberof additional shares that would have been outstanding if potentially dilutivestock options and warrants had been exercised.

 

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Basicand diluted net income per share are as follows:

 
| ** **                                               | ** ** | **For the Three Months** | ** ** | **For the Six Months** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                               | ** ** | **Ended June 30,**            | ** ** | **Ended June 30,**          | ** ** |
| ** **                                               | ** ** | **2010**                                | ** ** | **2009**                              | ** ** | **2010** | ** ** | **2009** | ** ** |
| BASIC EPS                                                |       |                                    |       |                                  |       |   |   |   |   |
| Net income (loss)                                        |       | $                                       | 630,832    |                                  | $          | (198,252 | ) | $ | 2,097,176 |   | $ | 187,550 |   |
| Denominator: weighted average common shares  outstanding |       | 14,637,238                              |       | 14,429,972                            |       | 14,604,933 |   | 14,424,724 |   |
| Net income (loss) per share                              |       | $                                       | 0.04       |                                  | $          | (0.01 | ) | $ | 0.14 |   | $ | 0.01 |   |
|                                                     |       |                                    |       |                                  |       |   |   |   |   |
| DILUTED EPS                                              |       |                                    |       |                                  |       |   |   |   |   |
| Net income (loss)                                        |       | $                                       | 630,832    |                                  | $          | (198,252 | ) | $ | 2,097,176 |   | $ | 187,550 |   |
| Denominator: weighted average common shares  outstanding |       | 14,637,238                              |       | 14,429,972                            |       | 14,604,933 |   | 14,424,724 |   |
| Common equivalent shares outstanding:                    |       |                                    |       |                                  |       |   |   |   |   |
| Options                                                  |       | 1,005,336                               |       | —                                |       | 874,266 |   | 261,262 |   |
| Total diluted shares                                     |       | 15,642,573                              |       | 14,429,972                            |       | 15,479,199 |   | 14,685,986 |   |
| Net income (loss) per share                              |       | $                                       | 0.04       |                                  | $          | (0.01 | ) | $ | 0.14 |   | $ | 0.01 |   |

 

Therewere outstanding options to purchase an aggregate of 1,207,680 and 3,459,086shares of the Company’s common stock for the three months ended June 30,2010 and 2009, respectively, that were not included in the table above becausethey would be anti-dilutive.  There wereoutstanding options to purchase an aggregate of 1,253,993 and 2,705,647 sharesof the Company’s common stock for the six months ended June 30, 2010 and2009, respectively, that were not included in the table above because theywould be anti-dilutive.

 

**4.**             **Commitments andContingencies**

 

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 negotiate regarding this matter.  In October 2009, anindependent third party hired to evaluate the Sony S-Force technology informedus that they had completed their evaluation based on the information providedby Sony.  Based on their study, they confirmed SRS’ position that theS-Force technology infringes our patents.  The basis for thisinfringement position has been provided to Sony for theirreview.  Sony has not agreed with the position of the independentthird party.  SRS continues to evaluateits alternatives in this matter and cannot assure you that it will prevail inthis dispute.  While SRS is currently insettlement negotiations with Sony, no assurance can be given that suchsettlement will be entered into on favorable terms, or at all.  As a result, SRS is unable to determine atthis time the impact that this matter may have, if any, on its consolidatedfinancial position, results of operations 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.

 

**5.             SegmentInformation**

 

TheCompany operates in one reportable segment as disclosed in our Annual Report onForm 10-K for the year ended December 31, 2009.  The following schedule presents theCompany’s revenue by geographic area. Licensing-related revenue is summarized based on the location of thelicensee’s corporate headquarters.  Forproduct and online sales, revenue is allocated to the United States.  The China region includes all licensees withtheir corporate headquarters located in mainland China.  The Asia Pacific region includes alllicensees with their corporate headquarters located in Taiwan and Hong Kong.Substantially all of the Company’s revenues during the three and six monthsended June 30, 2010 and 2009 were denominated in U.S. Dollars.

 

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| ** **                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                   | ** ** | **2010**                                        | ** ** | **%**                                         | ** ** | **2009** | ** ** | **%** | ** ** | **2010** | ** ** | **%** | ** ** | **2009** | ** ** | **%** | ** ** |
| **Geographic Area Revenue:** |       |                                            |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Korea                        |       | $                                               | 3,385,582  |                                          | 47         | % | $ | 2,794,662 |   | 55 | % | $ | 7,030,664 |   | 45 | % | $ | 5,554,680 |   | 52 | % |
| United States                |       | 1,641,150                                       |       | 23                                            |       | 1,105,622 |   | 22 |   | 3,834,449 |   | 25 |   | 2,014,106 |   | 18 |   |
| Japan                        |       | 1,018,623                                       |       | 14                                            |       | 673,046 |   | 14 |   | 2,443,532 |   | 16 |   | 1,918,207 |   | 18 |   |
| Asia Pacific                 |       | 496,655                                         |       | 7                                             |       | 68,325 |   | 1 |   | 943,441 |   | 6 |   | 213,766 |   | 2 |   |
| China                        |       | 475,395                                         |       | 7                                             |       | 345,683 |   | 7 |   | 939,133 |   | 6 |   | 877,091 |   | 8 |   |
| Europe                       |       | 143,625                                         |       | 2                                             |       | 68,190 |   | 1 |   | 355,203 |   | 2 |   | 181,688 |   | 2 |   |
| Total                        |       | $                                               | 7,161,030  |                                          | 100        | % | $ | 5,055,528 |   | 100 | % | $ | 15,546,422 |   | 100 | % | $ | 10,759,538 |   | 100 | % |

 

**6.             Fair Value Measurements**

 

The Company measures the fair valueof applicable financial and non-financial assets based on the following levelsof inputs.

 

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

 

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

 

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

 

The hierarchy noted above requires us tominimize the use of unobservable inputs and to use observable market data, ifavailable, when determining fair value. There were no transfers between Level 1and Level 2 and/or Level 3 during the three months ended June 30,2010.  Financial assets carried at fairvalue as of June 30, 2010 are classified below:

 
| ** **         | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|--------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Money market funds |       | $           | 15,680,996 |        | $          | —      |       | $         | —     |   | $ | 15,680,996 |   |
| Total              |       | $           | 15,680,996 |        | $          | —      |       | $         | —     |   | $ | 15,680,996 |   |

 

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

 

Thisinformation should be read in conjunction with the audited consolidatedfinancial statements and notes thereto and Management’s Discussion and Analysisof Financial Condition and Results of Operations contained in our Annual Reporton Form 10-K for the year ended December 31, 2009, and the unauditedcondensed interim consolidated financial statements and notes thereto includedin this Quarterly Report.

 

**Overview**

 

Weare the recognized global leader in the practical application ofpsychoacoustics*,* the sciencebehind how the human ear operates, and in the post processing segment of themarket for audio delivery.  Our award-winning audio enhancementtechnologies and solutions dramatically restore audio and voice to its naturalstate, the way it was originally recorded, in both dimension and clarity, thusproviding a superior consumer experience for a wide variety of consumerelectronic devices such as televisions, personal computers and mobile phones.

 

Ouroperations are conducted through SRS Labs, Inc., the parent company, andits wholly-owned subsidiaries, SRSWOWcast.com, Inc., ShenzhenRepresentative Office of SRS Labs, Inc., Shanghai Representative Office ofSRS Labs, Inc. and SRS Labs Japan, KK. Our business is focused ondeveloping and licensing audio, voice and surround sound technology solutionsto many of the world’s leading OEMs, software providers and semiconductorcompanies, and limited sales and marketing of standalone software and hardwareproducts through the Internet.

 

Duringthe three months ended June 30, 2010 and 2009, licensing revenues from thehome entertainment market represented 58% and 69%, respectively, of our totalrevenues in such periods.  In the homeentertainment market, our technologies have achieved broad market acceptance inthe television sector.  We plan tocontinue to leverage our success in the television sector to expand our audiotechnologies into a variety of other consumer electronics devices, includingPCs, mobile phones, portable media devices and 

 

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automotiveaudio systems, but our technologies to date have only been incorporated inproducts representing only a small portion of the total marketopportunity.  The consumer electronicsmarket in general is characterized by rapid technological changes, shortproduct life cycles, seasonality, significant price erosion and competition,any of which may impede our ability to gain broad market acceptance for ourtechnologies in other consumer electronics devices.  Nonetheless, we plan to continue to seekother opportunities where we can continue to leverage our core technologies andexpertise.  If we are able tosuccessfully gain broad market share for our technologies in any other market,it could significantly improve our revenues and brand name recognition.

 

**CriticalAccounting Policies**

 

Our critical accountingpolicies have been disclosed in our Form 10-K for the year ended December 31,2009. Our discussion and analysis ofour results of operations and liquidity and capital resources are based on ourunaudited consolidated financial statements for the three and six months ended June 30,2010 and 2009, which have been prepared in accordance with GAAP.

 

The preparation of thesefinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets, liabilities, revenues and expenses, anddisclosure of contingent assets and liabilities. We base our estimates onhistorical and anticipated results and trends and on various other assumptionsthat we believe are reasonable under the circumstances, including assumptionsas to future events. These estimates form the basis for making judgments aboutthe carrying value of assets and liabilities that are not readily apparent fromother sources. By their nature, estimates are subject to an inherent degree ofuncertainty. Actual results may materially differ from our estimates.

 

**Results of Operations**

 

***Three Months Ended June 30, 2010 Compared to Three Months EndedJune 30, 2009***

 

*Revenues*

 

Ourrevenues consist primarily of royalties generated from the license of SRS Labs’audio and voice technologies.  Ourlicense agreements typically have multi-year or automatic renewal terms, andeither 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 allow the licensee to ship up to a pre-determined numberof units during the specified time period, with additional per-unit royaltypayments thereafter.  The majority of ourlicense agreements are per-unit royalty arrangements, which are generallyreported by the licensee in the quarter following shipment of the consumerelectronics devices and are therefore typically recognized by us followingshipment of the devices by the OEM.  Revenuesassociated with fixed royalty payments are recognized ratably over the term ofthe license agreement.  We also sell someof our products and solutions via the Internet. Revenues associated with those sales are recognized upon shipment andwere not material in the three months ended June 30, 2010 or 2009. We mayoffer customer support or license support programs in the form of assisting thelicensee with implementing our technology into the manufactured products of thelicensee to ensure that the licensee receives the maximum benefit from ourtechnology.  Such customer support is notcontractually mandated and generally provided on a discretionary basis toassist the customer and improve customer relations.  Such customer support generally does notextend past the time in which the licensed technology is placed in service orimplemented in any given device by the licensee.   In this regard, any support services are notcontractual and occur during a finite period prior to the sale or revenuerecognition.

 

Ourrevenues were $7,161,030 for the three months ended June 30, 2010,compared to $5,055,528 for the three months ended June 30, 2009, anincrease of $2,105,502 or 42%.  In thepersonal computer market, our total revenues increased by $751,469 in thecurrent quarter, primarily due to revenues generated from new licensees, suchas Elitegroup Computer Systems, and increased revenues due to increased volumefrom our existing customers, including Dell and AsusTek.  Revenues from the home entertainment marketincreased by $699,301 in the current quarter. Within this market, revenues from televisions increased by $560,404mainly due to increased royalties due to volume increases from existinglicensees such as Samsung, due to increased demand for flat paneltelevisions.  We have not experienced amaterial change in our per unit license rates in the current periods other thanvolume pricing discounts provided pursuant to existing contractualobligations.  In the automotive market,revenues increased by $477,470 in the current quarter primarily due to higherrevenues from our Japanese customers who provide line install, dealer optionand aftermarket automotive audio systems to many of the significant Japaneseautomotive manufacturers.  Additionally,through our royalty compliance program, we were able to identify and collectapproximately $175,490 of previously under reported royalties from a customerin the automotive  market segment.Revenues recovered pursuant to our royalty compliance program vary considerablyfrom period to period.  Revenues in thepersonal telecommunications market increased by $159,954 in the current quarterprimarily due to new licensees.

 

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Thefollowing table presents our licensing revenues mix by market:

 
| ** **                                                | ** ** | **Three Months Ended June 30,** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| Home entertainment (TV, set top box)                      |       | 58                                                  | %          | 69 | % |
| PC (software, hardware)                                   |       | 18                                                  |       | 10 |   |
| Personal telecommunications (mobile phone, PDA)           |       | 12                                                  |       | 13 |   |
| Automotive                                                |       | 9                                                   |       | 3 |   |
| Portable media  devices (digital media player, headphone) |       | 3                                                   |       | 5 |   |

 

*Salesand Marketing*

 

Salesand marketing expenses consist primarily of employee salaries and benefits,sales consultants’ fees and related expenses, sales commissions, tradeshowcosts and costs associated with branding activities. Sales and marketingexpenses were $3,221,144 for the three months ended June 30, 2010,compared to $2,711,351 for the same prior year period, an increase of $509,793or 19%.  This increase was primarilyrelated to payroll and related costs associated with the addition of sevensales and marketing personnel since June 30, 2009 and also due toincreased commission and bonuses largely related to increased revenue andhigher net income in the current quarter. Additionally, the Company increased its participation in globaltradeshows in the current period. Included in sales and marketing expenses is share-based compensationexpense of $168,594 and $131,101 for the three months ended June 30, 2010 and2009, respectively.  We expect that salesand marketing expenses will continue to increase as we hire additional salesand marketing personnel to penetrate target markets and key regions in order togain broad market share for our technologies and as we continue to increase ourmarketing efforts to cultivate and elevate the SRS brand globally.  As a percentage of total revenues, sales andmarketing expenses decreased from 54%for the quarter ended June 30, 2009 to 45% for the same period this year.

 

*Researchand Development*

 

Researchand development expenses consist of salaries and related costs of employeesengaged in ongoing research, design and development activities and costs forengineering materials and supplies. Research and development expenses were$1,826,118 for the three months ended June 30, 2010, compared to$1,189,517 for the same prior year period, an increase of $636,601 or 54%.  This increase was primarily attributable toan increase in payroll and related costs associated with hiring seventeenadditional engineers since June 30, 2009. Included in research and development expenses is share-basedcompensation expense of $135,238 and $111,096 for the three months endedJune 30, 2010 and 2009, respectively. We expect that research and development expenses will continue toincrease in 2010 as we plan to continue to add to our research and developmentteam in order to support our global licensees and continue to develop newleading audio technologies. As a percentage of total revenues, research anddevelopment expenses increased from 24% for the quarter ended June 30,2009 to 26% for the same period this year.

 

*Generaland Administrative*

 

Generaland administrative (“G&A”) expenses consist primarily of employee-relatedexpenses, attorneys’ fees, accounting fees, depreciation of the Company’sassets, patent amortization, and other professional fees. G&A expenses were$1,431,833 for the three months ended June 30, 2010, compared to$1,373,757 for the same prior year period, an increase of $58,076 or 4%. This increase was primarily related to higher legal and otherprofessional fees in the current period. Included in G&A expenses wasshare-based compensation expense of $241,927 and $238,766 for the three monthsended June 30, 2010 and 2009, respectively.  As a percentage of total revenues, G&Aexpenses decreased from 27% forthe quarter ended June 30, 2009 to 20%for the same period this year.

 

*OtherIncome, Net*

 

Other income, net consistsprimarily of interest income. Other income, net was $71,863 for the threemonths ended June 30, 2010, compared to $92,185 for the same prior yearperiod, a decrease of $20,322 or 22%. Our investment focus continues to be on asset protection of our cash,and as such we have invested our cash in low-risk, high liquidity investmentssuch as fully insured certificates of deposits and assets backed by the UnitedStates Treasury.  We continue to monitorour cash assets to maximize our interest income while maintaining an acceptablelevel of risk.  The Company did not realizeany losses on its investments in the current or prior year periods.

 

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*IncomeTaxes*

 

Incometax expense for the three months ended June 30, 2010 was $23,095, comparedto an income tax expense of $9,139 for the same prior year period.  The income tax provision consisted primarilyof taxes paid on licensing revenues in the current quarter that were sourcedfrom countries requiring foreign tax withholdings, principally Korea.  We reduced our tax provision and ourvaluation allowance on our deferred tax assets by $725,711 and $501,513 for thethree months ended June 30, 2010 and 2009, respectively, based on ourassessment of the future estimated realization of such assets.

 

***Six Months Ended June 30, 2010 Compared to Six Months Ended June 30,2009***

 

*Revenues*

 

Ourrevenues were $15,546,422 for the six months ended June 30, 2010, comparedto $10,759,538 for the six months ended June 30, 2009, an increase of$4,786,884 or 44%.  In our homeentertainment market, our total revenues increased by $2,455,951 in the sixmonths ended June 30, 2010.  Withinthis market, flat panel revenue increased by $2,291,000 mainly due to increasedrevenue from Samsung due to increased volume shipments.  Our revenues from the personal computermarket increased by $1,604,372, primarily due to revenue generated from newlicensees and increased revenues due to increased volume from our existing customers.  In the automotive market, revenues increasedby $523,196 primarily due to higher revenues from increased volume from ourJapanese customers who provide line install, dealer option and aftermarketautomotive audio systems to many of the significant Japanese automotivemanufacturers.  Additionally, we wereable to recover $180,653 in this market segment through our royalty complianceprogram in the six months ended June 30, 2010 compared to $51,360 in thesix months ended June 30, 2009.  Ourrevenues in the personal telecommunications market increased by $217,787 in thecurrent period due to increased revenues from new licensees such as TexasInstruments.

 

Thefollowing table presents our licensing revenues mix by market:

 
| ** **                                                | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                | ** ** | **2010**                                          | ** ** | **2009** | ** ** |
| Home entertainment (TV, set top box)                      |       | 63                                                | %          | 68 | % |
| PC (software, hardware)                                   |       | 16                                                |       | 9 |   |
| Personal telecommunications (mobile phone, PDA)           |       | 11                                                |       | 13 |   |
| Automotive                                                |       | 7                                                 |       | 5 |   |
| Portable media  devices (digital media player, headphone) |       | 3                                                 |       | 5 |   |

 

*Salesand Marketing*

 

Salesand marketing expenses were $6,641,687 for the six months ended June 30,2010, compared to $5,450,491 in the same prior year period, an increase of$1,191,196 or 22%.  This increase wasprimarily attributable to an increase in payroll and commissions and relatedcosts, such as payroll taxes, benefits and recruitment associated with theaddition of sales and marketing personnel since June 30, 2009.  We also increased participation and promotionat several trade shows, which resulted in an increase in such expenses ofapproximately $341,000 in the six months ended June 30, 2010.  Included in sales and marketing expenses isshare-based compensation expense of $345,788 and $246,917 for the six monthsended June 30, 2010 and 2009, respectively.  As a percentage of total revenues, sales andmarketing expenses decreased from 51% for the six months ended June 30,2009 to 43% for the same period this year.

 

*Researchand Development*

 

Researchand development expenses were $3,716,112 for the six months ended June 30,2010, compared to $2,364,183 for the same prior year period, an increase of$1,351,929 or 57%.  This increase wasprimarily attributable to an increase in payroll and related costs associatedwith hiring seventeen additional engineers since June 30, 2009.  Included in research and development expensesis share-based compensation expense of $284,746 and $218,819 for the six monthsended June 30, 2010 and 2009, respectively.  As a percentage of total revenues, researchand development expenses increased from 22% for the six months ended June 30,2009 to 24% for the same period this year.

 

*Generaland Administrative*

 

G&Aexpenses were $2,997,131 for the six months ended June 30, 2010, comparedto $2,805,884 for the same prior year period, an increase of $191,247 or 7%. The increase was primarilyattributable to an increase in accounting, legal and other professional fees.Included in G&A expenses is share-based compensation expense of $496,386and $481,627 for the six months ended June 30, 2010 and 2009,respectively.  As a percentage of totalrevenues, G&A expenses decreased from 26% for the six months ended June 30, 2009 to 19% for the same period this year.

 

*OtherIncome, Net*

 

Other income, net was$101,502 for the six months ended June 30, 2010, compared to $196,818 forthe same prior year period, a decrease of $95,316 or 94%. This decrease wasprimarily attributable to lower interest rates on the Company’s investments inthe current period.

 

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*IncomeTaxes*

 

Incometax expense was $31,463 and $14,075 for the six months ended June 30, 2010and 2009, respectively. The income tax provision consisted primarily of taxespaid on licensing revenues in the current quarter that were sourced fromcountries requiring foreign tax withholdings, principally Korea.  We reduced our tax provision and ourvaluation allowance on our deferred tax assets by $1,484,711 and $1,018,331 forthe six months ended June 30, 2010 and 2009, respectively, based on ourassessment of the future estimated realization of such assets.

 

**Liquidity and Capital Resources**

 

Our principal source of liquidity to fund ongoing operations atJune 30, 2010 consisted of cash, cash equivalents and short-and long-terminvestments of $42,324,996.  AtJune 30, 2010, we had cash and cash equivalents of $15,680,996, short-terminvestments of $12,383,000 and long-term investments of $14,261,000.  Cash and cash equivalents generally consistof cash, money market funds and treasury bills with original maturities ofthree months or less. The money market funds are primarily invested in U.S.government obligations.  Short-term investmentsconsist of certificates of deposit with original maturities ranging from 6 to12 months.  Long-term investments consistof certificates of deposit with maturities ranging from 18 to 24 months.  The cash and certificates of deposit are FDICinsured.  The Company has not experiencedany losses on its cash and cash equivalents or its short and long-terminvestments in the current period.

 

Netcash provided by operating activities was $1,072,953 and $213,133 for the sixmonths ended June 30, 2010 and 2009, respectively.  The increase in our cash flows from operatingactivities was primarily the result of net income of $2,097,176 during the sixmonths ended June 30, 2010, compared to net income of $187,550 during thesix months ended June 30, 2009. This was offset by changes in our operating assets and liabilitiesspecifically, an increase in our accounts receivable of $678,165 during the sixmonths ended June 30, 2010 compared to an increase of $75,766 during thesix months ended June 30, 2009.  Theincrease in accounts receivable during the six months ended June 30, 2010was primarily due to increased revenues in the current quarter from new andexisting licensees.

 

Netcash used in investing activities was $13,943,575and $5,104,415 during the three months ended June 30, 2010 and2009, respectively.  The increase in cashused by investing activities during the six months ended June 30, 2010 wasattributable primarily to the purchase of long-term investments in the currentperiod.  The Company expects to continueto invest in certificates of deposit with maturities ranging from 18 to 24months.

 

Webelieve our existing cash, cash equivalents, and 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 requirementswill depend on many factors, including our level of revenues, the timing andextent of spending to support product development efforts, the impact ofexisting adverse economic conditions, the expansion of sales and marketingactivities, the timing of introductions of new products, continuing marketacceptance of our products, and potential acquisitions of businesses ortechnologies.

 

**Item 3. Quantitative and Qualitative Disclosures about Market Risk**

 

Exceptas follows, there have been no material changes to the information called forby this Item 3 from the disclosures set forth in Part II, Item 7A inthe Company’s Annual Report on Form 10-K for the year endedDecember 31, 2009. As of June 30, 2010, the Company had $26.7 millionin short and long-term investments held in certificates of deposit (“CDs”), allof which are federally insured.  The CDshas stated interest rates when purchased, and we plan to hold the CDs tomaturity.  As of June 30, 2010, theCompany has $15.7 million in cash and cash equivalents, primarily held in moneymarket funds, which are invested in US government obligations, such as U.S.treasuries.  We have not realized anylosses on any of our investments. We believe that we have limited our exposureto interest rate risk as a result of investing in only federally insured CDsand U.S. government obligations.  Becauseof the conservative nature of these investments, interest rate fluctuations andexposure to interest rate risk has been minimum and immaterial.

 

**Item 4. Controls and Procedures**

 

*Evaluation of Disclosure Controls and Procedures.***Our Chief Executive Officer and President and our Chief FinancialOfficer have evaluated the effectiveness of our disclosure controls andprocedures (as defined in Rules 13a-15 (e) and 15d-15 (e) underthe Securities Exchange Act of 1934, as amended) as of the end of the periodcovered by this Quarterly Report on Form 10-Q and, based on thisevaluation, have concluded that our disclosure controls and procedures areeffective.

 

*Changes in Internal Controls.***There have beenno changes in our internal controls over financial reporting that occurredduring our second quarter ended June 30, 2010 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

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**PART II****—****OTHER INFORMATION**

 

**Item 1.  LegalProceedings**

 

The information set forthunder Note 4 of Notes to Unaudited Condensed Consolidated Financial Statements,included in Part I, Item 1 of this report, is incorporated herein byreference.  For an additional discussionof certain risks associated with legal proceedings, see Part II, Item1A. “Risk Factors.”

 

**Item 1A. Risk Factors**

 

You should carefully consider the risk factorsdescribed below, as well as the other information included in this QuarterlyReport on Form 10-Q, and in our other filings with the SEC, prior tomaking a decision to invest in our securities. The risks and uncertaintiesdescribed below are not the only ones facing our company. Additional risks anduncertainties not presently known or that we currently believe to be lesssignificant 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 continue for the foreseeablefuture. In addition, from time to time, certain of our OEM and semiconductormanufacturer customers may account for a significant portion of our revenues.For the six months ended June 30, 2010 and 2009, Samsung accounted forapproximately 40% and 42%, respectively, of our consolidated revenues. Ourtechnology license agreements with Samsung and most of our other manufacturersdo not obligate them to incorporate our technologies into any of their productsor to continue to do business with us. As a result, Samsung or the other manufacturers could develop their owntechnologies, use a competitor’s technologies or decide to exclude our audiorendering technology from their products altogether in an effort to reducecost, either of which could adversely impact our revenues andprofitability.  For example, during 2007,we were informed by Sony that they were no longer using our technology in themajority of their televisions.  The lossof any key customer in the future could have a material adverse affect on ourfinancial condition and results of operations.

 

***General economic conditions mayreduce our revenues and harm our business.***

 

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

 

***Our business is highly dependent onthe consumer electronics market, which is characterized by short product lifecycles, fluctuations in demand, seasonality and 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, we mayneed to develop new products or technologies to integrate with the new productsand technologies developed by our customers. If we are unable to develop thenecessary technologies to meet the changing needs of our customers or providesuch technologies at competitive prices, our customers may reduce their use ofour technologies and our revenues may decline. In addition, the dynamic natureof this market limits our ability and the ability of our customers toaccurately forecast quarterly and annual sales. If we, or our customers, areunable to adequately manage product transitions, our business and results ofoperations could be negatively affected.

 

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***We depend on the sale by ourlicensees of products that incorporate our technologies, and a reduction inthose sales would adversely affect our licensing revenue.***

 

We derive most of our revenue fromthe licensing of our technologies to consumer electronics productmanufacturers. We do not manufacture consumer electronics products ourselvesand our licensing revenue is dependent on sales by our licensees of productsthat incorporate our technologies. We cannot control these manufacturers’product development or commercialization efforts or predict their success. Inaddition, our license agreements, which typically require manufacturers ofconsumer electronics products and media software vendors to pay us a specifiedroyalty for every electronics product shipped that incorporates ourtechnologies, do not require these manufacturers to include our technologies inany specific number or percentage of units, and only a few of these agreementsguarantee us a minimum aggregate licensing fee. Accordingly, if our licenseessell fewer products incorporating our technologies, decline to actively marketproducts incorporating our technologies or otherwise face significant economicdifficulties, our revenue will decline. Changes in consumer tastes or trends,changes in industry standards or adverse changes in business and economicconditions may also adversely affect 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

 

Certain of our current and potential competitors enjoy notablecompetitive advantages, including:

 

·                  greater name recognition;

 

·                  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, strategicacquisitions, alliances, joint ventures, sales and marketing, and lobbyingindustry and government 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 royaltyreporting and unauthorized use of our intellectual property could materiallyadversely affect our operating results.***

 

Our licensing revenue is generatedprimarily from consumer electronics product manufacturers who license ourtechnologies and incorporate them in their products. Under a significantpercentage of our existing arrangements, these licensees typically pay us aspecified royalty for every product they ship that incorporates ourtechnologies. We rely on our licensees to accurately report the number of unitsshipped that incorporate our technologies. We calculate our license fees,prepare our financial reports, projections and budgets, and direct our salesand product development efforts based on these reports we receive from ourlicensees. However, it can be 

 

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difficult for us to independentlydetermine whether or not our licensees are reporting shipments accurately. Thisis especially true with respect to software incorporating our technologiesbecause software can be copied relatively easily and we often do not have easyways to determine how many copies have been made. Most of our licenseagreements permit us to audit our licensees’ records, but audits are generallyexpensive and time consuming and initiating audits could harm our customerrelationships. We expect that we will continue to be subject to understatementand non-reporting of royalty bearing revenues by licensees, which couldadversely affect our operating results. Conversely, to the extent that ourlicensees overstate the number of products incorporating our technologies,negative corrections could result in reductions of royalty revenue insubsequent periods. Some of our licensees may begin to more closely scrutinizetheir past licensing statements which may result in an increased receipt ofnegative corrective statements.

 

We also may experience problemswith non-licensee consumer electronics product manufacturers and media softwarevendors, particularly in emerging economies, incorporating our technologies orincorporating our technologies and trademarks into their products without ourauthorization and without paying us any licensing fees. This unauthorized useof our intellectual property could adversely 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.***

 

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

 

***Licenseeproducts that incorporate our technologies, from time to time, experiencequality problems that could damage our brand, decrease revenues and increaseoperating expenses.***

 

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

 

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

 

We conduct sales and customer support operations in a number of countriesthroughout the world that require refinement to adapt to the changing marketconditions on a regional basis. In addition, many of our significant customersare headquartered in Asia, particularly Korea and Japan. Approximately 72%, 88%and 90% of our revenues during the years ended December 31, 2009, 2008,and 2007, respectively, were derived from customers with headquarters locatedin Asia. We expect to continue to derive a significant portion of our revenuesfrom sales to customers in these regions for the foreseeable future. Also, asubstantial number of products incorporating our technologies are manufactured,assembled and tested by third parties in Asia. As a result, we are subject to anumber of risks of conducting business outside of the United States, any ofwhich could have a material adverse impact on our business and results ofoperations, 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;

 

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·                  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 management attentionon potential license agreements that are not consummated, or in which theconsumer 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 we willobtain any additional patents in the future, that the steps taken by us to protectour intellectual property will be adequate to prevent misappropriation of ourtechnology or that our competitors will not independently develop technologiesthat are substantially equivalent or superior to our technology. In addition,the laws of certain foreign countries may not protect our intellectual propertyrights to the same extent as do the laws of the U.S. It is possible that thirdparties may assert claims or initiate litigation against us or our customerswith respect to existing or future products. In addition, we may initiateclaims or litigation against third parties for infringement of our proprietaryrights or to determine the scope and validity of our proprietary 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 ourmanagement from our business. The outcome of any litigation is uncertain andcould require us to pay significant damages or could prevent us from licensing someor all of our technologies, which could significantly harm our business andresults of operations.

 

***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 

 

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stock.Even though our stock is listed on The NASDAQ Global Market, our stock has hadand may continue to have low trading volume and high volatility. Thehistorically low trading volume of our stock makes it more likely that a severefluctuation in volume, either up or down, will significantly impact the stockprice. Because of the relatively low trading volume of our stock, ourstockholders may have difficulty selling our common stock. In addition, thestock market in general, and The NASDAQ Global Market and the market fortechnology and small market cap companies in particular, has experienced extremeprice and volume fluctuations that have often been unrelated ordisproportionate to the operating performance of those companies. Further, themarket prices of securities of technology companies have been particularlyvolatile. These broad market and industry factors may materially harm themarket price of our common stock, regardless of our 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 5. Other Information**

 

One of our directors, Sam Yau, previously enteredinto a sales plan pursuant to Rule 10b5-1 (the “***10b5-1 Plan***”)promulgated under the Securities Exchange Act of 1934, as amended, pursuant towhich sales are expected to commence in August 2010.  The 10b5-1 Plancovers the sale over the next eight months of up to an aggregate of 30,000shares of the Company’s common stock issuable upon exercise of two stockoptions held by Mr. Yau, which expire in November 2010 and January 2011,respectively.  The shares covered by the 10b5-1 Plan will be sold if theprice per share of our common stock reaches the amounts designated in the10b5-1 Plan.

 

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**Item 6.  Exhibits**

 

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

 
| **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), 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. |
|                | 31.1       |            | Certification  of Chief Executive Officer of SRS Labs, Inc., pursuant to  Rule 13a-14 of the Securities Exchange Act. |
|                | 31.2       |            | Certification  of Chief Financial Officer of SRS Labs, Inc., pursuant to  Rule 13a-14 of the Securities Exchange Act. |
|                | 32.1       |            | Certification  of Chief Executive Officer of SRS Labs, Inc., pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |
|                | 32.2       |            | Certification  of Chief Financial Officer of SRS Labs, Inc., pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                                  | SRS  LABS, INC., a Delaware corporation       |
|---------------------------------------|----------------------------------------------------|
|                                  |                                               |   |
| Date:  August 5,  2010 | By:                                                | /S/  THOMAS C.K. YUEN |
|                                  | Thomas  C.K. Yuen                                  |
|                                  | Chairman  of the Board and Chief Executive Officer |
|                                  | (Principal  Executive Officer)                     |
| ** **                            | ** **                                         | ** ** |
| ** **                            | ** **                                         | ** ** |
| Date:  August 5,  2010 | By:                                                | /S/  ULRICH GOTTSCHLING |
|                                  | Ulrich  Gottschling                                |
|                                  | Chief  Financial Officer                           |
|                                  | (Principal  Financial and Accounting Officer)      |

 

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**EXHIBIT INDEX**

 

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

 
| **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), 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. |
|                | 31.1       |            | Certification  of Chief Executive Officer of SRS Labs, Inc., pursuant to  Rule 13a-14 of the Securities Exchange Act. |
|                | 31.2       |            | Certification  of Chief Financial Officer of SRS Labs, Inc., pursuant to  Rule 13a-14 of the Securities Exchange Act. |
|                | 32.1       |            | Certification  of Chief Executive Officer of SRS Labs, Inc., pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |
|                | 32.2       |            | Certification  of Chief Financial Officer of SRS Labs, Inc., pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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