Table of Contents

 

 

** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

**(Mark One)**

 
| **x**                                                                                                                                    | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                               | ** **                                                                                               |
| **For the  quarterly period ended March 31, 2010**                                                                                  |
| ** **                                                                                                                               | ** **                                                                                               |
| **OR**                                                                                                                                   |
| ** **                                                                                                                               | ** **                                                                                               |
| **o**                                                                                                                                    | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
| ** **                                                                                                                               | ** **                                                                                               |
| **For the  transition period          to         ** |

 

# **Commission File Number 0-21123**

#  

 

**SRS LABS, INC.**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

(Address of principal executive offices) (ZipCode)

 

**(949) 442-1070**

(Registrant’s telephone number, includingarea 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 markwhether the registrant has submitted electronically and posted on its corporatewebsite, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes o No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (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 in Rule 12b-2of the Exchange Act). Yes o   No x

 

As of April 30, 2010, 14,592,490 of the issuer’scommon stock, par value $.001 per share, were outstanding.

 

 

 

----

Table ofContents

 

**SRS LABS, INC.**

 

**QuarterlyReport on Form 10-Q**

**For theThree Months Ended March 31, 2010**

**Index**

 
| **PART I-FINANCIAL INFORMATION** | ** **                                                                                                                 |
|---------------------------------------|----------------------------------------------------------------------------------------------------------------------------|
| Item 1.                               | Financial Statements                                                                                                       | 4 |
|                                  | Condensed Consolidated Balance Sheets as of  March 31, 2010 (Unaudited) and December 31, 2009                    | 4 |
|                                  | Condensed Consolidated Statements of Operations for  the three months ended March 31, 2010 and 2009 (Unaudited)       | 5 |
|                                  | Condensed Consolidated Statements of Stockholders’  Equity for the three months ended March 31, 2010 (Unaudited) | 6 |
|                                  | Condensed Consolidated Statements of Cash Flows for  the three months ended March 31, 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                                                                | 14 |
| Item 4.                               | Controls and  Procedures                                                                                                   | 14 |
| **PART II-OTHER  INFORMATION**   | ** **                                                                                                                 |
| Item 1.                               | Legal Proceedings                                                                                                          | 14 |
| Item 1A.                              | Risk Factors                                                                                                               | 14 |
| Item 6.                               | Exhibits                                                                                                                   | 18 |
|                                  |                                                                                                                       |   |
| SIGNATURES                            | 19                                                                                                                         |

 

2

----

Table ofContents

 

**FORWARD-LOOKINGINFORMATION**

 

As used 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 Representative Officeof SRS Labs, 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 those relating to our futureoperating results, profitability, growth and capital requirements, ourinvestment and expansion plans, changes in our competitive position, theoutcome of certain disputes, changes in economic conditions or capital marketsand changes in customer usage patterns and preferences, are forward-lookingstatements. In some cases, you can identify forward-looking statements by termssuch as may, will, should, could, expect, plan, intend, forecast, anticipate,believe, estimate, predict, potential, likely or similar expressions orvariations of these terms. The forward-looking statements contained in thisQuarterly Report involve known and unknown risks, uncertainties and situationsthat may 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” ofthis 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-lookingstatement speaks only as of the date on which such statement is made, and,except as required by law, we undertake no obligation to update anyforward-looking statement to reflect events or circumstances after the date onwhich such statement is made or to reflect the occurrence of unanticipatedevents. New factors emerge from time to time, and it is not possible formanagement to predict all such factors.

 

3

----

Table ofContents

 

**PART I — FINANCIALINFORMATION**

 

**Item 1. Financial Statements**

 

**SRSLABS, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                   | ** ** | **March 31,  2010** | ** ** | **December 31,  2009** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                   | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                   |       |                     |       |                        |       |
| **Current Assets**                                                                                                                                                                           |       |                     |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                    |       | $                        | 21,430,207 |                        | $          | 27,988,164 |   |
| Accounts receivable, net                                                                                                                                                                     |       | 1,034,843                |       | 179,114                     |       |
| Prepaid expenses and other  current assets                                                                                                                                                   |       | 1,082,615                |       | 1,147,151                   |       |
| Short-term investments                                                                                                                                                                       |       | 12,284,000               |       | 12,963,000                  |       |
| **Total Current Assets**                                                                                                                                                                     |       | 35,831,665               |       | 42,277,429                  |       |
|                                                                                                                                                                                         |       |                     |       |                        |       |
| Long-term investments                                                                                                                                                                        |       | 8,044,000                |       | 538,000                     |       |
| Property and equipment,  net                                                                                                                                                                 |       | 585,387                  |       | 599,794                     |       |
| Intangible assets, net                                                                                                                                                                       |       | 2,750,368                |       | 2,702,160                   |       |
| Deferred income taxes, net                                                                                                                                                                   |       | 6,390,442                |       | 5,631,442                   |       |
| **Total Assets**                                                                                                                                                                             |       | $                        | 53,601,862 |                        | $          | 51,748,825 |   |
| ** **                                                                                                                                                                                   |       |                     |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                |       |                     |       |                        |       |
|                                                                                                                                                                                         |       |                     |       |                        |       |
| **Current Liabilities**                                                                                                                                                                      |       |                     |       |                        |       |
| Accounts payable                                                                                                                                                                             |       | $                        | 593,068    |                        | $          | 583,157 |   |
| Accrued liabilities                                                                                                                                                                          |       | 1,468,869                |       | 1,577,891                   |       |
| Deferred revenue                                                                                                                                                                             |       | 994,390                  |       | 1,193,454                   |       |
| **Total Current Liabilities**                                                                                                                                                                |       | $                        | 3,056,327  |                        | $          | 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; 14,592,490 and 14,563,715 shares issued  and outstanding at March 31, 2010 and December 31, 2009,  respectively |       | 14,593                   |       | 14,565                      |       |
| Additional paid-in capital                                                                                                                                                                   |       | 65,813,177               |       | 65,128,337                  |       |
| Accumulated deficit                                                                                                                                                                          |       | (15,282,235              | )          | (16,748,579                 | )          |
| **Total Stockholders’ Equity**                                                                                                                                                          |       | 50,545,535               |       | 48,394,323                  |       |
| **Total Liabilities and  Stockholders’ Equity**                                                                                                                                         |       | $                        | 53,601,862 |                        | $          | 51,748,825 |   |

 

See accompanying notes to the condensedconsolidated financial statements

 

4

----

Table of Contents

 

**SRS LABS, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                         | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
| Revenues                                                           |       | $                                                | 8,385,391  |   | $ | 5,704,010 |   |
| Cost of sales                                                      |       | 64,484                                           |       | 71,972 |   |
| Gross profit                                                       |       | 8,320,907                                        |       | 5,632,038 |   |
|                                                               |       |                                             |       |   |   |
| Operating expenses:                                                |       |                                             |       |   |   |
| Sales and marketing                                                |       | 3,420,544                                        |       | 2,664,992 |   |
| Research and development                                           |       | 1,889,993                                        |       | 1,248,814 |   |
| General and administrative                                         |       | 1,565,298                                        |       | 1,432,127 |   |
| Total operating expenses                                           |       | 6,875,835                                        |       | 5,345,933 |   |
|                                                               |       |                                             |       |   |   |
| Operating income                                                   |       | 1,445,072                                        |       | 286,105 |   |
| Other income, net                                                  |       | 29,639                                           |       | 104,633 |   |
| Income before income taxes                                         |       | 1,474,711                                        |       | 390,738 |   |
| Income taxes                                                       |       | 8,367                                            |       | 4,936 |   |
| Net income                                                         |       | $                                                | 1,466,344  |   | $ | 385,802 |   |
|                                                               |       |                                             |       |   |   |
| Net income per common  share:                                      |       |                                             |       |   |   |
| Basic                                                              |       | $                                                | 0.10       |   | $ | 0.03 |   |
| Diluted                                                            |       | $                                                | 0.10       |   | $ | 0.03 |   |
|                                                               |       |                                             |       |   |   |
| Weighted average shares  used in the per common share calculation: |       |                                             |       |   |   |
| Basic                                                              |       | 14,572,269                                       |       | 14,419,418 |   |
| Diluted                                                            |       | 15,320,917                                       |       | 14,648,122 |   |

 

 Seeaccompanying notes to the condensed consolidated financial statements

 

5

----

Table of Contents

 

**SRS LABS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATEDSTATEMENTS OF 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 |       | 28,775                |       | 28                      |       | 103,678         |       | —      |       | 103,706 |   |
| Share-based compensation                 |       | —                |       | —                  |       | 581,162         |       | —      |       | 581,162 |   |
| Net income                               |       | —                |       | —                  |       | —          |       | 1,466,344   |       | 1,466,344 |   |
|                                     |       |                  |       |                    |       |            |       |        |       |   |   |
| BALANCE, March 31,  2010            |       | 14,592,490            |       | $                       | 14,593     |            | $          | 65,813,177  |       | $ | (15,282,235 | ) | $ | 50,545,535 |   |

 

See accompanying notes to the condensedconsolidated financial statements

 

6

----

Table of Contents

 

**SRS LABS, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
| **Cash Flows from Operating  Activities:**                                                   |       |                                             |       |   |   |
| Net income                                                                                   |       | $                                                | 1,466,344  |   | $ | 385,802 |   |
| Adjustments to reconcile  net income to net cash provided by (used in) operating activities: |       |                                             |       |   |   |
| Depreciation and  amortization                                                               |       | 203,320                                          |       | 168,511 |   |
| Provision for doubtful  accounts                                                             |       | —                                           |       | 22,500 |   |
| Deferred taxes                                                                               |       | (759,000                                         | )          | (516,818 | ) |
| Share-based compensation                                                                     |       | 581,162                                          |       | 466,400 |   |
| Gain on disposition of  property and equipment                                               |       | —                                           |       | (10,875 | ) |
| Changes in operating  assets and liabilities:                                                |       |                                             |       |   |   |
| Accounts receivable                                                                          |       | (855,729                                         | )          | (325,371 | ) |
| Prepaid expenses and other  current assets                                                   |       | 64,536                                           |       | (162,553 | ) |
| Accounts payable                                                                             |       | 9,911                                            |       | 125,080 |   |
| Accrued liabilities                                                                          |       | (109,022                                         | )          | (35,609 | ) |
| Deferred revenue                                                                             |       | (199,064                                         | )          | (258,273 | ) |
| Net cash provided by (used  in) operating activities                                         |       | 402,458                                          |       | (141,206 | ) |
|                                                                                         |       |                                             |       |   |   |
| **Cash Flows from Investing  Activities:**                                                   |       |                                             |       |   |   |
| Purchase of short-term and  long-term investments                                            |       | (7,506,000                                       | )          | (3,669,000 | ) |
| Proceeds from sale of  short-term investments                                                |       | 679,000                                          |       | — |   |
| Expenditures related to  intangible assets                                                   |       | (186,143                                         | )          | (205,493 | ) |
| Purchase of property and  equipment                                                          |       | (50,978                                          | )          | (48,104 | ) |
| Proceeds from sale of  property and equipment                                                |       | —                                           |       | 17,600 |   |
| Net cash used in investing  activities                                                       |       | (7,064,121                                       | )          | (3,904,997 | ) |
|                                                                                         |       |                                             |       |   |   |
| **Cash Flows from Financing  Activities:**                                                   |       |                                             |       |   |   |
| Proceeds from exercise of  stock options                                                     |       | 103,706                                          |       | — |   |
| Net cash provided by  financing activities                                                   |       | 103,706                                          |       | — |   |
|                                                                                         |       |                                             |       |   |   |
| **Net Decrease in Cash and Cash  Equivalents**                                               |       | (6,557,957                                       | )          | (4,046,203 | ) |
| **Cash and Cash Equivalents,  Beginning of Period**                                          |       | 27,988,164                                       |       | 31,599,087 |   |
|                                                                                         |       |                                             |       |   |   |
| **Cash and Cash Equivalents, End  of Period**                                                |       | $                                                | 21,430,207 |   | $ | 27,552,884 |   |
|                                                                                         |       |                                             |       |   |   |
| **Supplemental Disclosure of Cash  Flow Information:**                                       |       |                                             |       |   |   |
| Cash paid during the  period for:                                                            |       |                                             |       |   |   |
| Income taxes                                                                                 |       | $                                                | 693,095    |   | $ | 534,314 |   |

 

See accompanying notes to the condensedconsolidated financial statements

 

7

----

Table ofContents

 

**SRS LABS,INC. AND SUBSIDIARIES****NOTES TO THE CONDENSED CONSOLIDATED FINANCIALSTATEMENTS (Unaudited)**

 

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

 

As used 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 the rules andregulations of the SEC for interim reporting. In the opinion of management, alladjustments (which include normal recurring adjustments) considered necessaryfor a fair presentation of our financial position and results of operationshave been included.

 

Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with GAAP havebeen condensed or omitted pursuant to SEC rules and regulations forpresentation of interim financial information. Therefore, the unauditedcondensed interim consolidated financial statements should be read inconjunction with the Company’s Annual Report on Form 10-K for the yearended December 31, 2009. Current and future financial statements may notbe directly comparable to the Company’s historical financial statements. Theresults of operations for the interim period are not necessarily indicative ofthe results to be expected for any other interim period or for the fullyear.  Amounts related to disclosure of December 31,2009 balances within these condensed consolidated financial statements werederived from the audited consolidated financial statements for the year ended December 31,2009.

 

**Estimates**

 

The preparation of financial statements inaccordance with GAAP requires management to make use of certain estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereported periods. We base our estimates on historical experience and on variousother assumptions that we believe are reasonable under the circumstances, theresults of which form the basis for making judgments about carrying values ofassets and liabilities that are not readily apparent from other sources.  By their nature, estimates are subject to aninherent degree of uncertainty.  Actualresults could differ materially from those estimates. See the auditedconsolidated financial statements and notes thereto included in our AnnualReport on Form 10-K for the year ended December 31, 2009 for anadditional discussion of the significant accounting policies and estimates usedin the preparation of our financial statements.

 

**Cash and Cash Equivalents**

 

Cash and cash equivalents include short-term, highlyliquid investments that are readily convertible to known amounts of cash andare so near maturity that they present insignificant risk of changes in valuebecause of interest rates. Cash and cash equivalents generally consist of cash,money market funds and instruments with original maturities of three months orless when purchased.  The Company placesits cash in banks and its cash and cash equivalents and money market funds atcertain financial institutions in excess of amounts insured by federalagencies.  The Company does not believethat it is subject to any unusual financial risk beyond the normal riskassociated with commercial banking relationships.  The Company performs periodic evaluations ofthe relative credit standing of these financial institutions.  The Company has not experienced any losses onits cash equivalents.

 

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

 

Short-term investments consist of certificates ofdeposit with original maturities ranging from six to twelve months.  Long-term investments consist of certificatesof deposit with original maturities ranging from eighteen to twenty-fourmonths.  All of the certificates ofdeposit are fully FDIC insured. The Company has not experienced any losses onits short and long-term investments.

 

**Customer Concentrations**

 

For the three monthsended March 31, 2010 and 2009, one customer, Samsung, accounted forapproximately 39% and 41%, respectively, of our revenues.

 

**Reclassifications**

 

Certain amounts in the financial statements havebeen reclassified to conform to the current presentation.

 

8

----

Table ofContents

 

**Income Taxes**

 

The Company currently hasnet operating loss carryforwards to offset income taxes. Consequently, nosignificant provision is reflected in the accompanying interim consolidatedfinancial statements.  Refer to ourAnnual Report on Form 10-K for the year ended December 31, 2009 foradditional disclosure in this regard.

 

**2.****            ****Intangible Assets**

 

Intangible assets consist of the following:

 
| ** **                                                  | ** ** | **March 31,  2010** | ** ** | **December 31,  2009** | ** ** |
|-------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Patents                                                     |       | $                        | 4,207,085  |                        | $          | 4,100,363 |   |
| Accumulated amortization                                    |       | (2,151,460               | )          | (2,072,763                  | )          |
| Patents, net                                                |       | 2,055,625                |       | 2,027,600                   |       |
| Other intangibles:                                          |       |                     |       |                        |       |
| License agreements  acquired in purchase of SRSWOWcast      |       | 640,071                  |       | 640,071                     |       |
| Capitalized software and  hardware for several technologies |       | 930,929                  |       | 851,508                     |       |
| Total of other intangibles                                  |       | 1,571,000                |       | 1,491,579                   |       |
| Accumulated amortization,  other intangibles                |       | (876,257                 | )          | (817,019                    | )          |
| Other intangibles, net                                      |       | 694,743                  |       | 674,560                     |       |
| Intangible assets, net                                      |       | $                        | 2,750,368  |                        | $          | 2,702,160 |   |

 

Amortization expense associated with our intangibleswas $137,946 and $115,959 in the first quarter of 2010 and 2009, respectively,and is included in general and administrative expenses in the accompanyingcondensed consolidated statements of operations.

 

**3.**             **Net IncomePer Common Share**

 

Basic net income per common share is computed bydividing net income or loss available to common stockholders by the weightedaverage number of common shares outstanding during each year. Diluted netincome per common share reflects the maximum dilution, based on the averageprice of the Company’s common stock during each period, and is computed similarto basic income or loss per share except that the denominator is increased toinclude the number of additional shares that would have been outstanding ifpotentially dilutive stock options and warrants had been exercised.

 

Basic and diluted net income per share are asfollows:

 
| ** **                                               | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **2010**                                                           | ** ** | **2009** | ** ** |
| BASIC EPS                                                | ** ** | ** **                                                         | ** ** | ** ** | ** ** |
| Net income                                               |       | $                                                                  | 1,466,344  |   | $ | 385,802 |   |
| Denominator: weighted  average common shares outstanding |       | 14,572,269                                                         |       | 14,419,418 |   |
| Basic net income per share                               |       | $                                                                  | 0.10       |   | $ | 0.03 |   |
|                                                     |       |                                                               |       |   |   |
| DILUTED EPS                                              |       |                                                               |       |   |   |
| Net income                                               |       | $                                                                  | 1,466,344  |   | $ | 385,802 |   |
| Denominator: weighted  average common shares outstanding |       | 14,572,269                                                         |       | 14,419,418 |   |
| Common equivalent shares  outstanding:                   |       |                                                               |       |   |   |
| Options                                                  |       | 748,648                                                            |       | 228,704 |   |
| Total diluted shares                                     |       | 15,320,917                                                         |       | 14,648,122 |   |
| Diluted net income per  share                            |       | $                                                                  | 0.10       |   | $ | 0.03 |   |

 

There were outstanding options to purchase anaggregate of 1,548,680 and 2,593,821 shares of the Company’s common stock as ofMarch 31, 2010 and 2009, respectively, that were not included in the tableabove because they would be anti-dilutive.

 

9

----

Table ofContents

 

**4.**             **Commitmentsand Contingencies**

 

On June 8, 2007, we sent a letter to SonyCorporation (“Sony”) relating to the possible infringement of several SRSpatents by Sony’s S-Force technology. Sony responded to the letter by filing aComplaint for Declaratory Relief in the U.S. District Court in the SouthernDistrict of New York on July 6, 2007. In November 2007, Sony and SRSentered into a standstill agreement for the purpose of conducting discussionstowards an amicable resolution of the dispute, and the Complaint forDeclaratory Relief was dismissed.  While the standstill agreement hasexpired, the parties continue to negotiate regarding this matter.  In October 2009,an independent third party hired to evaluate the Sony S-Force technologyinformed us that they had completed their evaluation based on the informationprovided by Sony.  Based on their study, they confirmed SRS’ positionthat the S-Force technology infringes our patents.  The basis forthis infringement 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.  SRS is unable to determineat this time the impact that this matter may have, if any, on its consolidatedfinancial position, results of operations or cash flows.

 

From time to time, we may be involved in otherlitigation matters and disputes arising in the normal course of business. Anysuch matters and disputes could be costly and time consuming, subject us todamages or equitable remedies, and divert our management and key personnel fromour business operations.

 

**5.****            ****SegmentInformation**

 

The Company operates inone reportable segment as disclosed in our Annual Report on Form 10-K forthe year ended December 31, 2009. The following schedule presents the Company’s revenue by geographicarea.  Licensing-related revenue issummarized based on the location of the licensee’s corporate headquarters.  For product and online sales, revenue isallocated to the Americas.  The Americasregion includes North, Central and South America.  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.

 
| ** **                     | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------|------------|--------------------------------------------------|------------|
| ** **                     | ** ** | **2010**                                         | ** ** | **%** | ** ** | **2009** | ** ** | **%** | ** ** |
| **Geographic Area  Revenues:** |       |                                             |       |   |   |   |   |   |   |
| Korea                          |       | $                                                | 3,645,082  |   | 43 | % | $ | 2,760,018 |   | 48 | % |
| Americas                       |       | 2,193,299                                        |       | 26 |   | 908,483 |   | 16 |   |
| Japan                          |       | 1,424,908                                        |       | 17 |   | 1,245,162 |   | 22 |   |
| China                          |       | 463,738                                          |       | 6 |   | 531,408 |   | 9 |   |
| Asia Pacific                   |       | 446,786                                          |       | 5 |   | 145,442 |   | 3 |   |
| Europe                         |       | 211,578                                          |       | 3 |   | 113,497 |   | 2 |   |
|                           |       |                                             |       |   |   |   |   |   |   |
| Total                          |       | $                                                | 8,385,391  |   | 100 | % | $ | 5,704,010 |   | 100 | % |

 

**6.****            ****Fair ValueMeasurements**

 

TheCompany measures the fair value of applicable financial and non-financialassets based on the following levels of 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.

 

10

----

Table of Contents

 

Thehierarchy noted above requires us to minimize the use of unobservable inputsand to use observable market data, if available, when determining fair value.There were no transfers between Level 1 and Level 2 and/or Level 3 during thethree months ended March 31, 2010. Financial assets carried at fair value as of March 31, 2010 areclassified below:

 
| ** **         | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|--------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Money market funds |       | $           | 21,430,207 |        | $          | —      |       | $         | —     |   | $ | 21,430,207 |   |
| Total              |       | $           | 21,430,207 |        | $          | —      |       | $         | —     |   | $ | 21,430,207 |   |

 

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

 

This information should be read in conjunction withthe audited consolidated financial statements and notes thereto and Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontained in our Annual Report on Form 10-K for the year ended December 31,2009, and the unaudited condensed interim consolidated financial statements andnotes thereto included in this Quarterly Report.

 

**Overview**

** **

We are the recognizedglobal leader in the practical application of psychoacoustics*,* the science behind how the human earoperates, and in the post processing segment of the market for audiodelivery.  Our award-winning audio enhancement technologies and solutionsdramatically restore audio and voice to its natural state, the way it wasoriginally recorded, in both dimension and clarity, thus providing a superiorconsumer experience for a wide variety of consumer electronic devices such astelevisions, personal computers and mobile phones.

 

Our operations areconducted through SRS Labs, Inc., the parent company, and its wholly-ownedsubsidiaries, SRSWOWcast.com, Inc., Shenzhen Representative Office of SRSLabs, Inc., Shanghai Representative Office of SRS Labs, Inc. and SRSLabs Japan, KK. Our business is focused on developing and licensing audio,voice and surround sound technology solutions to many of the world’s leadingoriginal equipment manufacturers, or OEMs, software providers and semiconductorcompanies, and limited sales and marketing of stand alone software and hardwareproducts through the Internet.

 

**Critical Accounting Policies**

 

#### Our critical accounting policies have beendisclosed in our Form 10-K for the year ended December 31, 2009.Our discussion and analysis of our resultsof operations and liquidity and capital resources are based on our unauditedconsolidated financial statements for the three months ended March 31,2010 and 2009, which have been prepared in accordance with GAAP.

####  

#### The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and disclosure of contingent assetsand liabilities. We base our estimates on historical and anticipated resultsand trends and on various other assumptions that we believe are reasonableunder the circumstances, including assumptions as to future events. Theseestimates form the basis for making judgments about the carrying value ofassets and liabilities that are not readily apparent from other sources. Bytheir nature, estimates are subject to an inherent degree of uncertainty.Actual results may materially differ from our estimates.

 

11

----

Table ofContents

 

**Results of Operations**

 

***Three Months Ended March 31, 2010Compared to Three Months Ended March 31, 2009***

 

*Revenues*

 

Our revenues consist primarily of royaltiesgenerated from the license of SRS Labs’ audio and voice technologies.  Our license agreements typically havemulti-year or automatic renewal terms, and either require: (a) per-unitroyalty payments for all products implementing our technologies and/orsolutions; (b) fixed annual or quarterly royalty payments; or (c) aminimum fixed annual or quarterly royalty payment, which allow the licensee toship up to a pre-determined number of units during the specified time period,with additional per-unit royalty payments thereafter.  The majority of our license agreements areper-unit royalty arrangements, which are generally reported by the licensee inthe quarter following shipment of the consumer electronics devices and aretherefore typically recognized by us following shipment of the devices by theOEM.  Revenues associated with fixedroyalty payments are recognized ratably over the term of the licenseagreement.  We also sell some of ourproducts and solutions via the Internet. Revenues associated with those sales are recognized upon shipment andwere not material in the three months ended March 31, 2010 or 2009.

 

Our revenues were $8,385,391 for the threemonths ended March 31, 2010, compared to $5,704,010 for the three monthsended March 31, 2009, an increase of $2,681,381 or 47%.  In our home entertainment market, our totalrevenues increased by $1,756,650 in the current quarter.  Within this market, revenues from televisionsincreased by $1,730,595 mainly due to increased royalties from existinglicensees such as Samsung.  Additionally,through our royalty compliance program, we were able to identify and collectapproximately $650,000 of previously under reported royalties in the currentfiscal quarter.  Ourrevenues from the personal computer market increased by $852,903 in the currentquarter, primarily due to revenues generated from new licensees and increasedrevenues from our existing customers including Dell, Hewlett Packard, andAsusTek.  Revenues in the personaltelecommunications market increased by $57,832 in the current quarter primarilydue to higher revenue from new and existing licensees, offset in part bydecreased revenue from one of our customers in Japan. In the automotive market,revenues increased by $45,726 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 Japanese automotivemanufacturers.  Revenues from portablemedia devices decreased by $31,729 in the current quarter primarily due todecreased revenues from MP3/MP4 players.

 

The following table presents our licensing revenuesmix by market:

 
| ** **                                               | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                               | ** ** | **2010**                                             | ** ** | **2009** | ** ** |
| Home entertainment (TV,  set top box)                    |       | 67                                                   | %          | 67 | % |
| PC (software, hardware)                                  |       | 15                                                   |       | 8 |   |
| Personal  telecommunications (mobile phone, PDA)         |       | 10                                                   |       | 13 |   |
| Automotive                                               |       | 5                                                    |       | 7 |   |
| Portable media devices (digital media player, headphone) |       | 3                                                    |       | 5 |   |

 

*Sales and Marketing*

 

Sales and marketing expenses consist primarily ofemployee salaries and benefits, sales consultants’ fees and related expenses,sales commissions, tradeshow costs and costs associated with brandingactivities. Sales and marketing expenses were $3,420,544 for the three monthsended March 31, 2010, compared to $2,664,992 for the same prior yearperiod, an increase of $755,552 or 28%. This increase was primarily attributable to an increase in payroll andrelated costs associated with hiring additional sales and marketing personnelsince March 31, 2009 and also due to increased commission and bonuses dueto increased revenue and net income in the current quarter.  In addition, the Company also increased itsparticipation and promotion at several trade shows, which resulted in anincrease in sales and marketing expense of approximately $199,000 in thecurrent quarter.  Share-basedcompensation also increased $61,379 in the current quarter due to the issuance ofoption grants to sales and marketing employees. Included in sales and marketing expenses is share-based compensationexpense of $177,195 and $115,816 for the three months ended March 31, 2010and 2009, respectively.  We expect thatsales and marketing expenses will continue to increase as we hire additionalsales personnel to penetrate target markets and key regions and as we continueto increase our marketing efforts to cultivate and elevate the SRS brandglobally.  As a percentage of totalrevenues, sales and marketing expenses decreased from 47% for the quarter ended March 31, 2009 to 41% for the same period this year.

 

12

----

Table of Contents

 

*Researchand Development*

 

Research anddevelopment expenses consist of salaries and related costs of employees engagedin ongoing research, design and development activities and costs forengineering materials and supplies. Research and development expenses were$1,889,993 for the three months ended March 31, 2010, compared to$1,248,814 for the same prior year period, an increase of $641,179 or 51%.  This increase was primarily attributable toan increase in payroll and related costs associated with hiring additionalengineers since March 31, 2009.  Inaddition, the Company invested in a new state-of-the-art Advanced Rendering Labin the current quarter.  Included inresearch and development expenses is share-based compensation expense of$149,508 and $107,723 for the three months ended March 31, 2010 and 2009,respectively.  We expect that researchand development expenses will continue to increase in 2010 as we continue addto our research and development team in order to support our global licenseesand to accelerate the implementation of our technology with a greater number ofcustomers and devices. As a percentage of total revenues, research anddevelopment expenses increased from 22% for the quarter ended March 31,2009 to 23% for the same period this year.

 

*Generaland Administrative*

 

General and administrative (“G&A”) expensesconsist primarily of employee-related expenses, attorneys’ fees, accountingfees, depreciation of the Company’s assets, patent amortization, and otherprofessional fees. G&A expenses were $1,565,298 for the three months ended March 31,2010, compared to $1,432,127 for the same prior year period, an increase of$133,171 or 9%. The increase wasprimarily due to an increase in bonus and profit sharing expense due toincreased net income, royalty audit costs and increased public companycosts.  Included in G&A expenses wasshare-based compensation expense of $254,459 and $242,861 for the three monthsended March 31, 2010 and 2009, respectively.  As a percentage of total revenues, G&Aexpenses decreased from 25% forthe quarter ended March 31, 2009 to 19% for the same period this year.

 

*OtherIncome, Net*

 

Otherincome, net consists primarily of interest income. Other income, net was $29,639for the three months ended March 31, 2010, compared to $104,633 for thesame prior year period, a decrease of $74,994 or 72%.  Our investment focus continues to be on assetprotection of our cash, and as such we have invested our cash in low-risk, highliquidity investments such as fully insured certificates of deposits and assetsbacked by the United States Treasury.  Wecontinue to monitor our cash assets to maximize our interest income whilemaintaining an acceptable level of risk. The Company did not realize any losses on its investments in the currentor prior year period.

 

*IncomeTaxes*

 

Income tax expense for the three months ended March 31, 2010 was $8,367, compared to an income taxexpense of $4,936 for the sameprior year period.  The income taxprovision consisted primarily of taxes paid on licensing revenues in the currentquarter that were sourced from countries requiring foreign tax withholdings,principally Korea.  We reduced our taxprovision and our valuation allowance on our deferred tax assets by $759,000and $516,818 for the three months ended March 31, 2010 and 2009,respectively, based on our assessment of the future estimated realization ofsuch assets.

 

**Liquidity and Capital Resources**

 

Our principal source ofliquidity to fund ongoing operations at March 31, 2010 consisted of cash,cash equivalents and short-and long-term investments of $41,758,207.  At March 31, 2010, we had cash and cashequivalents of $21,430,207, short-term investments of $12,284,000 and long-terminvestments of $8,044,000.  Cash and cashequivalents generally consist of cash, money market funds and other moneymarket instruments with original maturities of three months or less. The moneymarket funds are primarily invested in US government obligations.  Short-term investments consist ofcertificates of deposit with original maturities ranging from 6 to 12months.  Long-term investments consist ofcertificates of deposit with original maturities ranging from 18 to 24months.  The cash and certificates ofdeposit are FDIC insured.

 

Net cash provided by operating activities was $402,458 for the threemonths ended March 31, 2010, and net cash used in operating activities was$141,206 during the same period in the prior year.  The increase in our cash flows from operatingactivities was primarily the result of net income of $1,466,344 during the threemonths ended March 31, 2010, compared to net income of $385,802 during thethree months ended March 31, 2009. This was offset by changes in our operating assets and liabilitiesspecifically, an increase in our accounts receivable of $855,729 during thethree months ended March 31, 2010 compared to an increase of $325,371during the three months ended March 31, 2009.  The increase in accounts receivable duringthe three months ended March 31, 2010 was primarily due to increasedrevenues in the current quarter from new and existing licensees.

 

13

----

Table of Contents

 

Net cash used in investing activities was $7,064,121 and $3,904,997 during the three months ended March 31, 2010 and 2009, respectively.  The increase in cash used by investing activities during the three months ended March 31, 2010 was attributable primarily to the purchase of long-term investments.  The Company expects to continue to invest in certificates of deposit with maturities ranging from 18 to 24 months.

 

We believe our existing cash, cash equivalents, andshort and long-term investment balances together with cash generated fromoperating activities, will be sufficient to meet our anticipated cash needs forat least the next twelve months.  Ourfuture capital requirements will depend on many factors, including our level ofrevenues, the timing and extent of spending to support product developmentefforts, the impact of existing adverse economic conditions, the expansion ofsales and marketing activities, the timing of introductions of new products,continuing market acceptance of our products, and potential acquisitions ofbusinesses or technologies.

 

Our operations and financial results are subject tovarious risks and uncertainties that could adversely affect our business,financial condition, results of operations and trading price of our commonstock. Please refer to Item 1A, “Risk Factors” herein for information concerningthese and other uncertainties that could negatively impact us.

 

**Item 3.  Quantitative and Qualitative Disclosuresabout Market Risk**

 

There have been no material changes to theinformation called for by this Item 3 from the disclosures set forth in Part II,Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31,2009.

 

**Item 4.  Controls and Procedures**

 

*Evaluation of Disclosure Controls and Procedures.***Our Chief Executive Officer and Presidentand our Chief Financial Officer have evaluated the effectiveness of ourdisclosure controls and procedures (as defined in Rules 13a-15 (e) and15d-15 (e) under the Securities Exchange Act of 1934, as amended) as ofthe end of the period covered by this Quarterly Report on Form 10-Q and,based on this evaluation, have concluded that our disclosure controls andprocedures are effective.

 

*Changes in Internal Controls.***There have been no changes in ourinternal controls over financial reporting that occurred during our firstquarter ended March 31, 2010 that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

 

**PART II****—****OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

Theinformation set forth under Note 4 of Notes to Unaudited Condensed ConsolidatedFinancial Statements, included in Part I, Item 1 of this report, isincorporated herein by reference.  For anadditional discussion of certain risks associated with legal proceedings, seeItem 1A. Risk Factors.

 

**Item 1A. Risk Factors**

 

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

*** ***

***We are exposed to risks in our licensing business related to productand customer concentration.***

 

Currently, we generate amajority of our revenue in the home entertainment market, principally throughthe inclusion of SRS technology inside flat panel LCD and plasma televisions.We expect that the consumer home entertainment market will continue to accountfor a significant portion of our licensing revenues for the foreseeable future.Consumer spending on home entertainment products is subject to significantfluctuations, and there is significant price competition for such products. Retailprices for certain consumer electronics products that include our audiotechnology have decreased significantly, and we expect that this trend willcontinue for the foreseeable future. In addition, from time to time, certain ofour OEM and semiconductor manufacturer customers may account for a significantportion of our revenues. For the quarter ended March 31, 2010, Samsungaccounted for approximately 39% of our consolidated revenues. Thesemanufacturers could develop their own technologies or decide to exclude ouraudio rendering technology from their products altogether in an effort toreduce cost, 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 

 

14

----

Table of Contents

 

of their televisions.  The loss of any key customer in the futurecould have a material adverse affect on our financial condition and results ofoperations.

 

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

 

Our business is exposed to adverse changes in generaleconomic conditions because products that incorporate our technologies areentertainment-oriented and generally discretionary goods. The current slowdownor decline in U.S. and foreign economic growth has adversely affected consumerconfidence, disposable income and spending. As a result, sales by our licenseesof consumer electronics and other products incorporating our technologies maynot grow as rapidly as in prior periods or may even decrease, which couldadversely affect our licensing revenue.

 

***Our business is highly dependent on the consumer electronics market,which is characterized by short product life cycles, fluctuations in demand,seasonality and declining retail prices and is subject to risks related toproduct transitions.***

 

The consumer electronicsmarket is characterized by intense competition, rapidly evolving technology,and ever-changing consumer preferences. These factors result in the frequentintroduction of new products, short product life cycles and significant pricecompetition. As a result, we may need to develop new products or technologiesto integrate with the new products and technologies developed by our customers.If we are unable to develop the necessary technologies to meet the changingneeds of our customers or provide such technologies at competitive prices, ourcustomers may reduce their use of our technologies and our revenues maydecline. In addition, the dynamic nature of this market limits our ability andthe ability of our customers to accurately forecast quarterly and annual sales.If we, or our customers, are unable to adequately manage product transitions,our business and results of operations could be negatively affected.

 

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

 

We derive most of our revenue from the licensing of ourtechnologies to consumer electronics product manufacturers. We do notmanufacture consumer electronics products ourselves and our licensing revenueis dependent on sales by our licensees of products that incorporate ourtechnologies. We cannot control these manufacturers’ product development orcommercialization efforts or predict their success. In addition, our licenseagreements, which typically require manufacturers of consumer electronicsproducts and media software vendors to pay us a specified royalty for everyelectronics product shipped that incorporates our technologies, do not requirethese manufacturers to include our technologies in any specific number orpercentage of units, and only a few of these agreements guarantee us a minimumaggregate licensing fee. Accordingly, if our licensees sell fewer productsincorporating our technologies, decline to actively market productsincorporating 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 consumer electronics product manufacturers,who incorporate our technologies into their products, could limit the licensingfees we charge for our technologies, which could reduce our revenues.***

 

The markets for the consumerelectronics products in which our technologies are incorporated are intenselycompetitive and price sensitive. Retail prices for consumer electronicsproducts that include our technologies have decreased significantly, and weexpect prices to continue to decrease for the foreseeable future. In response,manufacturers have sought to reduce their product costs, which can result indownward pressure on the licensing fees we charge our customers who incorporateour technologies into their products. Alternatively, our customers may seek toeliminate our technologies in their products in favor of internally developedtechnologies. A decline in the licensing fees we charge could materially andadversely affect our operating results.

 

***We face intense competition from companies with greater brandrecognition and resources.***

 

The digital audio, consumerelectronics and entertainment markets are intensely competitive, subject torapid change, and significantly affected by new product introductions and othermarket activities of industry participants

 

Many of our current andpotential competitors enjoy notable competitive advantages, including:

 

·      greater name recognition;

 

·      a longer operating history;

 

15

----

Table ofContents

 

·                  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 currentand potential competitors may be able to respond more quickly and effectivelythan we can to new or changing opportunities, technologies, standards, orcustomer requirements.

 

***Inaccurate licensee royalty reporting and unauthorized use of ourintellectual property could materially adversely affect our operating results.***

 

Our licensing revenue is generated primarily from consumerelectronics product manufacturers who license our technologies and incorporatethem in their products. Under a significant percentage of our existingarrangements, these licensees typically pay us a specified royalty for everyproduct they ship that incorporates our technologies. We rely on our licenseesto accurately report the number of units shipped that incorporate ourtechnologies. We calculate our license fees, prepare our financial reports,projections and budgets, and direct our sales and product development effortsbased on these reports we receive from our licensees. However, it can bedifficult for us to independently determine whether or not our licensees arereporting shipments accurately. This is especially true with respect tosoftware incorporating our technologies because software can be copiedrelatively easily and we often do not have easy ways to determine how manycopies have been made. Most of our license agreements permit us to audit ourlicensees’ records, but audits are generally expensive and time consuming andinitiating audits could harm our customer relationships. We expect that we willcontinue to be subject to understatement and non-reporting of royalty bearingrevenues by licensees, which could adversely affect our operating results.Conversely, to the extent that our licensees overstate the number of productsincorporating our technologies, negative corrections could result in reductionsof royalty revenue in subsequent periods. Some of our licensees may begin tomore closely scrutinize their past licensing statements which may result in anincreased receipt of negative corrective statements.

 

We also may experience problems with non-licensee consumerelectronics product manufacturers and media software vendors, particularly inemerging economies, incorporating our technologies or incorporating our technologiesand trademarks into their products without our authorization and without payingus any licensing fees. This unauthorized use of our intellectual property couldadversely affect our operating results.

 

***Our business and future prospects depend upon the strength of ourbrand. Awareness of our brand depends to a significant extent upon decisions byour customers to display our trademarks on their products, and if our customersdo not display our trademarks on their products, our ability to increase ourbrand awareness may be harmed.***

 

Because we engage in relatively little direct brandadvertising, the promotion of our brand depends upon consumer electronicsindustry participants displaying our trademarks on their products thatincorporate our technologies.  Althoughwe do generally require our customers to place our brand on their products,some are not required to do so. Maintaining the SRS brand and our position asan industry standard is critical to maintaining and expanding our licensingrevenues 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 thatincorporate our technologies through the quality control evaluation processthat we require of our licensees, the strength of our brand could be adverselyaffected.

 

***Licensee products thatincorporate our technologies, from time to time, experience quality problemsthat could damage our brand, decrease revenues and increase operating expenses.***

 

Licensee products that incorporate our technologies often arecomplex and sometimes contain undetected software or hardware errors,particularly when first introduced or when new versions are released. Inaddition, those products are often combined with, or incorporated into, productsfrom other companies, sometimes making it difficult to identify the source of aproblem. Any negative 

 

16

----

Tableof Contents

 

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

 

***We are subject to risks associated with substantial internationaloperations.***

 

We conduct sales andcustomer support operations in a number of countries throughout the world thatrequire refinement to adapt to the changing market conditions on a regionalbasis. In addition, many of our significant customers are headquartered inAsia, particularly Korea and Japan. Approximately 72%, 88% and 90% of ourrevenues during the years ended December 31, 2009, 2008, and 2007,respectively, were derived from customers with headquarters located in Asia. Weexpect to continue to derive a significant portion of our revenues from salesto customers in these regions for the foreseeable future. Also, a substantialnumber of products incorporating our technologies are manufactured, assembledand tested by third parties in Asia. As a result, we are subject to a number ofrisks of conducting business outside of the United States, any of which couldhave a material adverse impact on our business and results of operations,including:

 

·                  global economic downturn;

 

·      political, social and economic instabilityand the risk of war, terrorist activities or other international incidents inAsia and elsewhere abroad;

 

·      currency fluctuations;

 

·                  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 and unpredictable sales cycle, which canresult in uncertainty and delays in generating additional revenues.***

 

Historically, because of thecomplexity of our technologies, it can take a significant amount of time andeffort to explain the benefits of our technologies to potential new customersand to negotiate a sale. For example, it typically takes six to nine monthsafter our first contact with a prospective customer before we start licensingour technology to that customer and another six to nine months to begingenerating revenues. In addition, purchases of our products are usually made inconnection with new design starts by our customers, the timing of which isoutside of our control. Accordingly, we may be unable to predict accurately thetiming of any significant future sales of our products. We may also spendsubstantial time and management attention on potential license agreements thatare not consummated, or in which the consumer electronic product ultimatelydoes not sell in large quantities, thereby foregoing other higher revenueopportunities.

 

***If our patents and other intellectual property rights do not adequatelyprotect our products, we may lose market share to our competitors and be unableto operate our business profitably.***

 

Our ability to compete maybe affected by our ability to protect our proprietary information. We havefiled numerous U.S. and foreign patent applications and to date have a numberof issued U.S. and foreign patents covering various aspects of ourtechnologies. We cannot guarantee that the steps taken by us to protect ourintellectual property will be adequate to prevent misappropriation of ourtechnology or that our competitors will not independently develop technologiesthat are substantially 

 

17

----

Table of Contents

 

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

 

***If we lose the services of our key personnel, or if we are unable toattract and retain other key personnel, we may not be able to manage ouroperations or meet our growth objectives.***

 

Our future success dependsto a large extent upon the continued service of key personnel, includingengineering, sales and administrative staff. We anticipate that any futuregrowth will require us to recruit and hire a number of new personnel inengineering, operations, finance, sales and marketing. Competition for suchpersonnel can be intense, and it is possible that we may not be able to recruitand retain necessary personnel to operate our business and support futuregrowth.

 

***The market price of our common stock is volatile and your investment inour common stock could suffer a decline in value.***

 

The trading price of ourcommon stock has been, and will likely continue to be, subject to widefluctuations in response to quarterly variations in our operating results,announcements of new products or technological innovations by us or ourcompetitors, strategic alliances between us and third parties, general marketfluctuations and other events and factors. Changes in earnings estimates made bybrokerage firms and industry analysts relating to the markets in which we dobusiness, or relating to us specifically, have in the past resulted in, andcould in the future result in, an immediate and adverse effect on the marketprice of the common stock. Even though our stock is listed on The NASDAQ GlobalMarket, our stock has had and may continue to have low trading volume and highvolatility. The historically low trading volume of our stock makes it morelikely that a severe fluctuation in volume, either up or down, willsignificantly impact the stock price. Because of the relatively low tradingvolume of our stock, our stockholders may have difficulty selling our commonstock. In addition,the stock market in general, and The NASDAQ Global Market and the market fortechnology and small market cap companies in particular, has experiencedextreme price 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 and bylaws as well as Delaware lawcontain provisions that could discourage transactions resulting in a change incontrol, which may negatively affect the market price of our common stock.***

 

Our certificate ofincorporation, our bylaws and Delaware law contain provisions that might enableour management to discourage, delay or prevent a change in control. Inaddition, these provisions could limit the price that investors would bewilling to pay in the future for shares of our common stock.

 

**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.                                                                                                                                                                                                                               |

 

18

----

Table of Contents

 

**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|                               | SRS  LABS, INC., a Delaware corporation       |
|------------------------------------|----------------------------------------------------|
|                               |                                               |   |
| Date:  May 6,  2010 | By:                                                |   /S/  THOMAS C.K. YUEN |
|                               | Thomas  C.K. Yuen                                  |
|                               | Chairman  of the Board and Chief Executive Officer |
|                               | (Principal  Executive Officer)                     |
| ** **                         | ** **                                         | ** ** |
| ** **                         | ** **                                         | ** ** |
| Date:  May 6,  2010 | By:                                                |   /S/  ULRICH GOTTSCHLING |
|                               | Ulrich  Gottschling                                |
|                               | Chief  Financial Officer                           |
|                               | (Principal  Financial and Accounting Officer)      |

 

19

----

Table of Contents

 

**EXHIBIT INDEX**

 

The exhibits listed below are hereby filed with theSEC 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.                                                                                                                                                                                                                               |

 

20

----