**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

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| **(Mark One)**                                                                                                                                                 |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **ý**                                                                                                                                                     | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT  OF 1934** |
| ** **                                                                                                                                                     | ** ** |
| **For the  quarterly period ended June 30, 2005**                                                                                                         |
| ** **                                                                                                                                                     | ** ** |
| **OR**                                                                                                                                                         |
| ** **                                                                                                                                                     | ** ** |
| **o**                                                                                                                                                          | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                     | ** ** |
| **For the  transition period from           to          ** |
| ** **                                                                                                                                                     | ** ** |
| **Commission  File Number 0-21123**                                                                                                                            |

 

**SRS LABS, INC.**

(Exact name 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)

 

**NotApplicable**

(Former name, former address and formerfiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes ý No o

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act). Yes o   No ý

 

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date: as of July 22,2005, 14,804,138 of the issuer’s common stock, par value $.001 per share, wereoutstanding.  In addition, as of July 22,2005, 674,098 shares of the issuer’s common stock were held as treasury shares.

 

 

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**SRSLABS, INC.**

 

**Form 10-Q**

**For thePeriod Ended June 30, 2005**

 

**Index**

 
| **PART I -  FINANCIAL INFORMATION** |
|------------------------------------------|
| Item 1.                                  | Financial Statements |
|                                     | Condensed Consolidated Balance Sheets as of  June 30, 2005 (Unaudited) and December 31, 2004 |
|                                     | Condensed Consolidated Statements of Operations for  the three and six months ended June 30, 2005 and 2004 (Unaudited) |
|                                     | Condensed  Consolidated Statements of Stockholders’ Equity and Comprehensive Income  (Loss) for the six months ended June 30, 2005 (Unaudited) |
|                                     | Condensed Consolidated Statements of Cash Flows for  the six months ended June 30, 2005 and 2004 (Unaudited) |
|                                     | Notes to the Condensed Consolidated Financial  Statements (Unaudited) |
| Item  2.                                 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
| Item  3.                                 | Quantitative  and Qualitative Disclosures About Market Risk |
| Item  4.                                 | Controls  and Procedures |
| **PART II - OTHER  INFORMATION**    |
| Item  2.                                 | Unregistered  Sales of Equity Securities and Use of Proceeds |
| Item  4.                                 | Submission  of Matters to a Vote of Security Holders |
| Item 6.                                  | Exhibits |
|                                     |   |
| SIGNATURES                               |

 

2

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**FORWARD-LOOKINGINFORMATION**

 

This Quarterly Report on Form 10-Q containsforward-looking statements reflecting management’s current expectations.Examples of such forward-looking statements include the expectations of theCompany with respect to its strategy. Although the Company believes that itsexpectations are based upon reasonable assumptions, there can be no assurancesthat the Company’s financial goals will be realized. Such forward-lookingstatements involve known and unknown risks, uncertainties and other factorsthat may cause the actual results, performance or achievements of the Company,or industry results, to be materially different from any future results,performance or achievements expressed or implied by such forward-lookingstatements. Numerous factors may affect the Company’s actual results and maycause results to differ materially from those expressed in forward-lookingstatements made by or on behalf of the Company. For this purpose, anystatements contained herein that are not statements of historical fact may bedeemed to be forward-looking statements. Without limiting the foregoing, thewords, “believes,” “anticipates,” “plans,” “expects” and similar expressions,are intended to identify forward-looking statements. The important factorsdiscussed in Part I, Item 2, “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Factors That May AffectFuture Results,” herein, among others, could cause actual results to differmaterially from those indicated by forward-looking statements made herein andpresented elsewhere by management. Such forward-looking statements representmanagement’s current expectations and are inherently uncertain. Investors arewarned that actual results may differ from management’s expectations. TheCompany assumes no obligation to update the forward-looking information toreflect actual results or changes in the factors affecting such forward-lookinginformation.

 

3

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**PART I — FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**SRSLABS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                  | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                                                                                                  | ** ** | **(unaudited)**        | ** ** | ** **                 | ** ** |
| **ASSETS**                                                                                                                                                                                                                  |       |                   |       |                       |       |
| **Current Assets**                                                                                                                                                                                                          |       |                   |       |                       |       |
| Cash and cash equivalents                                                                                                                                                                                                   |       | $                      | 6,834,871  |                       | $          | 7,011,912 |   |
| Accounts receivable, net                                                                                                                                                                                                    |       | 2,190,918              |       | 1,318,665                  |       |
| Inventories, net                                                                                                                                                                                                            |       | 518,355                |       | 571,280                    |       |
| Prepaid expenses and other current assets                                                                                                                                                                                   |       | 1,203,830              |       | 1,337,506                  |       |
| Deferred income taxes                                                                                                                                                                                                       |       | 23,406                 |       | 23,406                     |       |
|                                                                                                                                                                                                                        |       |                   |       |                       |       |
| **Total Current Assets**                                                                                                                                                                                                    |       | 10,771,380             |       | 10,262,769                 |       |
|                                                                                                                                                                                                                        |       |                   |       |                       |       |
| Investments available for sale                                                                                                                                                                                              |       | 17,221,340             |       | 17,261,267                 |       |
| Investment in LLC                                                                                                                                                                                                           |       | 2,739,591              |       | 2,596,090                  |       |
| Furniture, fixtures and equipment, net                                                                                                                                                                                 |       | 1,701,367              |       | 1,995,579                  |       |
| Intangible assets, net                                                                                                                                                                                                      |       | 2,604,429              |       | 2,660,955                  |       |
| Goodwill                                                                                                                                                                                                                    |       | 533,031                |       | 533,031                    |       |
| Deferred income taxes                                                                                                                                                                                                       |       | 229,160                |       | 192,750                    |       |
|                                                                                                                                                                                                                        |       |                   |       |                       |       |
| **Total Assets**                                                                                                                                                                                                            |       | $                      | 35,800,298 |                       | $          | 35,502,441 |   |
|                                                                                                                                                                                                                        |       |                   |       |                       |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                               |       |                   |       |                       |       |
| **Current Liabilities**                                                                                                                                                                                                     |       |                   |       |                       |       |
| Accounts payable                                                                                                                                                                                                            |       | $                      | 1,178,300  |                       | $          | 984,805 |   |
| Accrued liabilities                                                                                                                                                                                                         |       | 1,775,849              |       | 1,640,714                  |       |
| Deferred revenue                                                                                                                                                                                                            |       | 308,208                |       | 436,910                    |       |
| Income taxes payable                                                                                                                                                                                                        |       | 25,356                 |       | 8,628                      |       |
|                                                                                                                                                                                                                        |       |                   |       |                       |       |
| **Total Current Liabilities**                                                                                                                                                                                               |       | 3,287,713              |       | 3,071,057                  |       |
|                                                                                                                                                                                                                        |       |                   |       |                       |       |
| Commitments, contingencies and subsequent  event (Notes 8 and 12)                                                                                                                                                           |       |                   |       |                       |       |
|                                                                                                                                                                                                                        |       |                   |       |                       |       |
| **Stockholders’ Equity**                                                                                                                                                                                               |       |                   |       |                       |       |
| Preferred stock—$.001 par value; 2,000,000  shares authorized; no shares issued or outstanding                                                                                                                         |       | —                 |       | —                     |       |
| Common stock—$.001 par value; 56,000,000  shares authorized;14,799,138 and 14,671,416 shares issued; and 14,125,040 and  14,229,541 shares outstanding at June 30, 2005 and December 31,  2004, respectively |       | 14,800                 |       | 14,672                     |       |
| Additional paid-in capital                                                                                                                                                                                                  |       | 62,969,873             |       | 62,523,292                 |       |
| Accumulated other comprehensive loss                                                                                                                                                                                        |       | (350,834               | )          | (309,722                   | )          |
| Accumulated deficit                                                                                                                                                                                                         |       | (27,117,809            | )          | (27,853,003                | )          |
| Treasury stock at cost, 674,098 and 441,875  shares at June 30, 2005 and December 31, 2004, respectively                                                                                                          |       | (3,003,445             | )          | (1,943,855                 | )          |
|                                                                                                                                                                                                                        |       |                   |       |                       |       |
| **Total Stockholders’ Equity**                                                                                                                                                                                         |       | 32,512,585             |       | 32,431,384                 |       |
|                                                                                                                                                                                                                        |       |                   |       |                       |       |
| **Total Liabilities and Stockholders’ Equity**                                                                                                                                                                         |       | $                      | 35,800,298 |                       | $          | 35,502,441 |   |

 

See accompanying notes to the condensedconsolidated financial statements

 

4

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**SRSLABS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                       | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                                       | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                       | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues:                                                                        |       |                   |       |                 |       |   |   |   |   |
| Semiconductor                                                                    |       | $                      | 2,521,174  |                 | $          | 2,932,495 |   | $ | 4,505,737 |   | $ | 5,348,213 |   |
| Licensing                                                                        |       | 3,539,977              |       | 2,485,404            |       | 6,804,072 |   | 5,412,731 |   |
| Total revenues                                                                   |       | 6,061,151              |       | 5,417,899            |       | 11,309,809 |   | 10,760,944 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Cost of sales:                                                                   |       |                   |       |                 |       |   |   |   |   |
| Semiconductor                                                                    |       | 999,166                |       | 1,066,033            |       | 1,727,406 |   | 1,948,767 |   |
| Licensing                                                                        |       | 94,838                 |       | 20,407               |       | 151,183 |   | 46,544 |   |
| Total cost of sales                                                              |       | 1,094,004              |       | 1,086,440            |       | 1,878,589 |   | 1,995,311 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Gross Margin                                                                     |       | 4,967,147              |       | 4,331,459            |       | 9,431,220 |   | 8,765,633 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Operating expenses:                                                              |       |                   |       |                 |       |   |   |   |   |
| Sales and marketing                                                              |       | 1,678,500              |       | 1,260,067            |       | 3,370,878 |   | 2,955,435 |   |
| Research and development                                                         |       | 1,207,871              |       | 1,144,926            |       | 2,389,940 |   | 2,353,613 |   |
| General and administrative                                                       |       | 1,578,029              |       | 1,484,299            |       | 3,047,258 |   | 3,038,496 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Total operating expenses                                                         |       | 4,464,400              |       | 3,889,292            |       | 8,808,076 |   | 8,347,544 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Income from operations                                                           |       | 502,747                |       | 442,167              |       | 623,144 |   | 418,089 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Equity in income of investee                                                     |       | 13,764                 |       | —               |       | 91,096 |   | — |   |
| Other income, net                                                                |       | 166,293                |       | 98,774               |       | 314,226 |   | 336,224 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Income before income tax expense                                                 |       | 682,804                |       | 540,941              |       | 1,028,466 |   | 754,313 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Income tax expense                                                               |       | 169,070                |       | 311,239              |       | 293,272 |   | 549,142 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Net income                                                                       |       | $                      | 513,734    |                 | $          | 229,702 |   | $ | 735,194 |   | $ | 205,171 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Net income per common share:                                                     |       |                   |       |                 |       |   |   |   |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                            |       | $                      | 0.04       |                 | $          | 0.02 |   | $ | 0.05 |   | $ | 0.01 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Diluted                                                                          |       | $                      | 0.03       |                 | $          | 0.01 |   | $ | 0.05 |   | $ | 0.01 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Weighted average shares used in the  calculation of net income per common share: |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                            |       | 14,076,866             |       | 14,175,127           |       | 14,043,269 |   | 13,960,824 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Diluted                                                                          |       | 14,881,495             |       | 15,348,428           |       | 14,950,693 |   | 16,267,317 |   |

 

See accompanying notes to the condensedconsolidated financial statements

 

5

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**SRSLABS, INC.**

### **CONDENSEDCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY ANDCOMPREHENSIVE INCOME (LOSS) (Unaudited)**

 
| ** **                                                     | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Accumulated** | ** ** | **Treasury** | ** ** | ** ** | ** ** | **Comprehensive  Income (Loss)  for the Period** | ** ** |
|----------------------------------------------------------------|------------|-------------------|------------|-------------------------|------------|---------------------------------------|------------|-----------------|------------|--------------|------------|------------|------------|--------------------------------------------------|------------|
| ** **                                                     | ** ** | **Shares**        | ** ** | **Amount**              | ** ** | **Capital**                           | ** ** | **Loss**        | ** ** | **Deficit**  | ** ** | **Stock**  | ** ** | **Total**                                        | ** ** | **Ended** | ** ** |
|                                                           |       |              |       |                    |       |                                  |       |            |       |         |       |       |       |                                             |       |   |   |
| BALANCE, Dec. 31,  2004                                   |       | 14,229,541        |       | $                       | 14,672     |                                  | $          | 62,523,292      |       | $            | (309,722   | )          | $          | (27,853,003                                      | )          | $ | (1,943,855 | ) | $ | 32,431,384 |   |   |   |
| Proceeds from  exercise of stock options                       |       | 17,612            |       | 18                      |       | 66,269                                |       | —          |       | —       |       | —     |       | 66,287                                           |       |   |   |
| Deferred stock  option compensation                            |       | —            |       | —                  |       | 14,831                                |       | —          |       | —       |       | —     |       | 14,831                                           |       |   |   |
| Unrealized loss  on investments available for sale, net of tax |       | —            |       | —                  |       | —                                |       | (259,460        | )          | —       |       | —     |       | (259,460                                         | )          | (259,460 | ) |
| Net income                                                     |       | —            |       | —                  |       | —                                |       | —          |       | 221,460      |       | —     |       | 221,460                                          |       | 221,460 |   |
|                                                           |       |              |       |                    |       |                                  |       |            |       |         |       |       |       |                                             |       |   |   |
| BALANCE, March 31,  2005                                  |       | 14,247,153        |       | $                       | 14,690     |                                  | $          | 62,604,392      |       | $            | (569,182   | )          | $          | (27,631,543                                      | )          | $ | (1,943,855 | ) | $ | 32,474,502 |   | $ | (38,000 | ) |
| Proceeds from  exercise of stock options                       |       | 110,110           |       | 110                     |       | 355,742                               |       | —          |       | —       |       | —     |       | 355,852                                          |       |   |   |
| Deferred stock  option compensation                            |       | —            |       | —                  |       | 9,739                                 |       | —          |       | —       |       | —     |       | 9,739                                            |       |   |   |
| Purchase of  treasury stock                                    |       | (232,223          | )          | —                  |       | —                                |       | —          |       | —       |       | (1,059,590 | )          | (1,059,590                                       | )          |   |   |
|                                                           |       |              |       |                    |       |                                  |       |            |       |         |       |       |       |                                             |       |   |   |
| Unrealized gain  on investments available for sale, net of tax |       | —            |       | —                  |       | —                                |       | 218,348         |       | —       |       | —     |       | 218,348                                          |       | 218,348 |   |
|                                                           |       |              |       |                    |       |                                  |       |            |       |         |       |       |       |                                             |       |   |   |
| Net income                                                     |       | —            |       | —                  |       | —                                |       | —          |       | 513,734      |       | —     |       | 513,734                                          |       | 513,734 |   |
|                                                           |       |              |       |                    |       |                                  |       |            |       |         |       |       |       |                                             |       |   |   |
| BALANCE, June 30,  2005                                   |       | 14,125,040        |       | $                       | 14,800     |                                  | $          | 62,969,873      |       | $            | (350,834   | )          | $          | (27,117,809                                      | )          | $ | (3,003,445 | ) | $ | 32,512,585 |   | $ | 694,082 |   |

 

See accompanying notes to thecondensed consolidated financial statements

 

6

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**SRSLABS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | ** **                          | ** ** | ** ** | ** ** |
| **Cash Flows From Operating Activities:**                                          |       |                                |       |   |   |
| Net income                                                                         |       | $                                   | 735,194    |   | $ | 205,171 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                |       |   |   |
| Depreciation and amortization                                                      |       | 675,125                             |       | 622,288 |   |
| Provision for doubtful accounts                                                    |       | 32,258                              |       | 84,564 |   |
| Benefit for obsolete inventory                                                     |       | (16,782                             | )          | (57,451 | ) |
| Deferred taxes                                                                     |       | (36,410                             | )          | (20,128 | ) |
| (Accretion) amortization of (discount)  premium on investments available for sale  |       | (1,185                              | )          | 6,188 |   |
| Increase in deferred stock option  compensation                                    |       | 24,570                              |       | 40,201 |   |
| Loss on disposition of furniture, fixtures  and equipment                          |       | 2,267                               |       | 31 |   |
| Impairment on intangible assets                                                    |       | —                              |       | 3,431 |   |
| Equity in income of investee                                                       |       | (91,096                             | )          | — |   |
| Changes in operating assets and  liabilities:                                      |       |                                |       |   |   |
| Accounts receivable                                                                |       | (904,511                            | )          | (156,424 | ) |
| Inventories                                                                        |       | 69,707                              |       | 26,481 |   |
| Prepaid expenses and other current assets                                          |       | 133,676                             |       | (67,942 | ) |
| Accounts payable                                                                   |       | 193,495                             |       | (115,922 | ) |
| Accrued liabilities                                                                |       | 135,135                             |       | 25,656 |   |
| Deferred revenue                                                                   |       | (128,702                            | )          | 241,964 |   |
| Income taxes payable                                                               |       | 16,728                              |       | 257,181 |   |
|                                                                               |       |                                |       |   |   |
| Net cash provided by operating activities                                          |       | 839,469                             |       | 1,095,289 |   |
|                                                                               |       |                                |       |   |   |
| **Cash Flows From Investing Activities:**                                          |       |                                |       |   |   |
| Purchase of furniture, fixtures and  equipment                                     |       | (81,338                             | )          | (569,688 | ) |
| Proceeds from sale of investments available  for sale                              |       | —                              |       | 5,235,626 |   |
| Investment in LLC                                                                  |       | (52,405                             | )          | — |   |
| Expenditures related to patents and  intangible assets                             |       | (245,316                            | )          | (247,850 | ) |
|                                                                               |       |                                |       |   |   |
| Net cash (used in) provided by investing  activities                               |       | (379,059                            | )          | 4,418,088 |   |
|                                                                               |       |                                |       |   |   |
| **Cash Flows From Financing Activities:**                                          |       |                                |       |   |   |
| Proceeds from exercise of stock options                                            |       | 422,139                             |       | 2,988,171 |   |
| Purchase of Treasury Stock                                                         |       | (1,059,590                          | )          | — |   |
|                                                                               |       |                                |       |   |   |
| Net cash (used in) provided by financing  activities                               |       | (637,451                            | )          | 2,988,171 |   |
|                                                                               |       |                                |       |   |   |
| **Net (Decrease) Increase in Cash and Cash  Equivalents**                          |       | (177,041                            | )          | 8,501,548 |   |
| **Cash and Cash Equivalents, Beginning of  Period**                                |       | 7,011,912                           |       | 12,795,620 |   |
|                                                                               |       |                                |       |   |   |
| **Cash and Cash Equivalents, End of Period**                                       |       | $                                   | 6,834,871  |   | $ | 21,297,168 |   |
|                                                                               |       |                                |       |   |   |
| **Supplemental Disclosure of Cash Flow  Information:**                             |       |                                |       |   |   |
| Cash paid during the period for:                                                   |       |                                |       |   |   |
| Income taxes                                                                       |       | $                                   | 377,551    |   | $ | 360,741 |   |
| **Supplemental Disclosure of Non-Cash  Investing Activities:**                     |       |                                |       |   |   |
| Unrealized loss on investments, net                                                |       | $                                   | 41,112     |   | $ | 100,053 |   |

 

See accompanying notes to the condensedconsolidated financial statements

 

7

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**SRS LABS,INC.**

**NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

**1.****                                      Basisof Presentation and Summary of Significant Accounting Policies and Estimates**

 

As used herein, the “Company,” “SRS Labs,” “we,” “us,”or “our” means SRS Labs, Inc. and its wholly-owned subsidiaries, ValenceTech Limited (including its wholly-owned subsidiaries) and SRSWOWcast.com, Inc.(“SRSWOWcast”).  The accompanyingunaudited condensed consolidated financial statements have been prepared by theCompany in conformity with accounting principles generally accepted in theUnited States of America (“generally accepted accounting principles”) forinterim financial information and the rules and regulations of the U.S.Securities and Exchange Commission (“SEC”) for interim reporting. In theopinion of management, all adjustments (which include only normal recurringadjustments) considered necessary for a fair presentation of our financialposition and results of operations have been included. Certain amounts included in the accompanyingprior periods’ consolidated financial statements have been reclassified toconform to the current period presentation.

 

The condensed consolidated financial statementsinclude the accounts of SRS Labs, Inc. and its subsidiaries. Allinter-company accounts and transactions have been eliminated.

 

Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted pursuant to SEC rules andregulations for presentation of interim financial information. Therefore, thecondensed interim consolidated financial statements should be read inconjunction with the Company’s Annual Report on Form 10-K for the fiscalyear ended December 31, 2004. Current and future financial statements maynot be directly comparable to the Company’s historical financial statements.The results of operations for the interim period is not necessarily indicativeof the results to be expected for any other interim period or for the fullyear.

 

**Estimates**

 

The preparation of financial statements inaccordance with generally accepted accounting principles requires management tomake use of certain estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reported periods. We base our estimates on historical experienceand on various other assumptions that we believe are reasonable under thecircumstances, the results of which form the basis for making judgments aboutcarrying values of assets and liabilities that are not readily apparent fromother sources. Actual results could differ materially from those estimates. Seethe audited consolidated financial statements and notes thereto included in ourAnnual Report on Form 10-K for the year ended December 31, 2004 foran additional discussion of the significant accounting policies and estimatesused in the preparation of our financial statements.

 

**2.****                                     ****Stock-Based Compensation**

 

The Company accounts for stock-based awards toemployees under the recognition and measurement principles of AccountingPrinciples Board (“APB”) Opinion No. 25, “Accounting for Stock Issued toEmployees,” and related interpretations. The Company provides additional pro forma disclosures as required underStatement of Financial Accounting Standards (“SFAS”) No. 123, “Accountingfor Stock-Based Compensation” and SFAS No. 148, “Accounting forStock-Based Compensation — Transition and Disclosure — an Amendment of SFAS No. 123.” Accordingly, no stock-based employeecompensation cost is reflected in net income, as all options granted under theplan had an exercise price equal to the market value of the underlying commonstock on the date of grant. Had compensation expense been recorded under theprovisions of SFAS No. 123, the Company’s net income (loss) and earningsper share would have been the pro forma amounts indicated below:

 

8

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| ** **                                                                                         | ** ** | **For the three months ended** | ** ** | **For the six months ended** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **                                                                                         | ** ** | **June 30,**              | ** ** | **June 30****,**        | ** ** |
| ** **                                                                                         | ** ** | **2005**                       | ** ** | **2004**                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                               |       |                           |       |                         |       |   |   |   |   |
| Net income (attributable to common  shareholder) — as reported                                |       | $                              | 513,734    |                         | $          | 229,702 |   | $ | 735,194 |   | $ | 205,171 |   |
| Add: stock-based employee compensation  expense Included in reported net income, net of tax effect |       | 5,843                          |       | 15,715                       |       | 14,742 |   | 23,875 |   |
| Less fair value of stock-based employee  compensation expense                                      |       | (275,174                       | )          | (441,215                     | )          | (580,277 | ) | (834,883 | ) |
| Net income (loss) (attributable to common  shareholder) — pro forma                           |       | $                              | 244,403    |                         | $          | (195,798 | ) | $ | 169,659 |   | $ | (605,837 | ) |
| Net income (loss) per share:                                                                       |       |                           |       |                         |       |   |   |   |   |
| Basic, as reported                                                                                 |       | $                              | 0.04       |                         | $          | 0.02 |   | $ | 0.05 |   | $ | 0.01 |   |
| Basic, pro forma                                                                                   |       | $                              | 0.02       |                         | $          | (0.01 | ) | $ | 0.01 |   | $ | (0.04 | ) |
| Diluted, as reported                                                                               |       | $                              | 0.03       |                         | $          | 0.01 |   | $ | 0.05 |   | $ | 0.01 |   |
| Diluted, pro forma                                                                                 |       | $                              | 0.02       |                         | $          | (0.01 | ) | $ | 0.01 |   | $ | (0.04 | ) |

 

Thefair value of each option grant was estimated on the date of grant using theBlack-Scholes option-pricing model with the following weighted averageassumptions used for grants during the quarter ended June 30, 2005:

 

| Risk-free interest rate |   | 3.8        | %      |
|-------------------------|--------|------------|--------|
| Expected life           |   | 6.25 years |   |
| Expected volatility     |   | 59         | %      |

 

**3.             Capitalizationof Software Development Costs**

 

Costs incurred in the research, design anddevelopment of software for sale to others as a separate product or embedded ina product and sold as part of the product as a whole are charged to expenseuntil technological feasibility is established. Under SFAS No. 86, “Accountingfor the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,”the Company capitalizes software purchased from third parties if the relatedsoftware product under development has reached technological feasibility or ifthere are alternative future uses for the purchased software, provided thatcapitalized amounts will be realized over a period not exceeding five years.Costs incurred prior to the establishment of technological feasibility arecharged to research and development expense.

 

Capitalized software as of June 30, 2005and December 31, 2004 is as follows:

 

 
| ** **                 | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Capitalized  software      |       | $                       | 546,568    |                        | $          | 464,568 |   |
| Accumulated  amortization  |       | (250,126                | )          | (193,003                    | )          |
| Capitalized  software, net |       | $                       | 296,442    |                        | $          | 271,565 |   |

 

As of June 30, 2005, the weighted average useful life of theCompany’s capitalized software is approximately 2.2 years. The following tableshows the estimated amortization expense for those assets for the remaining sixmonths of the current fiscal year end and each of the four succeeding fiscalyears.

 
| **Year ending December 31,** | ** ** | **Estimated  Expense** | ** ** |
|-----------------------------------|------------|------------------------|------------|
| 2005                              |       | $                      | 61,856     |   |
| 2006                              |       | $                      | 125,300    |   |
| 2007                              |       | $                      | 73,023     |   |
| 2008                              |       | $                      | 32,105     |   |
| 2009                              |       | $                      | 4,158      |   |

 

9

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**4.             Goodwilland Intangible Assets**

 

OnJanuary 1, 2002, the Company adopted SFAS No. 142 “Goodwill and OtherIntangible Assets,” which, among other things, establishes new standards forgoodwill acquired in a business combination, eliminates the amortization ofgoodwill and requires the carrying value of goodwill and identifiableintangibles to be evaluated for impairment on an annual basis.

 

Inaccordance with SFAS No. 142, all of our intangible assets that have definitelives are being amortized on a straight-line basis over their estimated usefullives and goodwill is evaluated at least annually to determine if fair value ofthe asset has decreased below its carrying value. We performed our annualassessment of goodwill as of December 31, 2004, and determined that noadjustment to impair goodwill was necessary.

 

Goodwilland intangible assets consist of the following:

 
| ** **                                                                                                                                                                      | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Goodwill                                                                                                                                                                        |       | $                       | 533,031    |                        | $          | 533,031 |   |
|                                                                                                                                                                            |       |                    |       |                        |       |
| Patents                                                                                                                                                                         |       | $                       | 2,201,898  |                        | $          | 2,038,582 |   |
| Accumulated  amortization                                                                                                                                                       |       | (992,560                | )          | (891,178                    | )          |
| Patents, net                                                                                                                                                                    |       | 1,209,338               |       | 1,147,404                   |       |
| Other  Intangibles:                                                                                                                                                             |       |                    |       |                        |       |
| Assets  acquired in the purchase of our subsidiary Valence Technology in 1998:  Covenant not to compete, Developed Technology, ASP brand name, Cell Library,  and Customer List |       | 4,910,400               |       | 4,910,400                   |       |
| License  agreements acquired in purchase of our subsidiary SRSWOWcast in February 2003                                                                                     |       | 640,071                 |       | 640,071                     |       |
| Poly Planar  purchased technology for speaker products                                                                                                                          |       | 120,000                 |       | 120,000                     |       |
| Capitalized  software and hardware for several technologies                                                                                                                     |       | 476,841                 |       | 394,840                     |       |
| Total of  Other Intangibles                                                                                                                                                     |       | 6,147,312               |       | 6,065,311                   |       |
| Accumulated  amortization, other intangibles                                                                                                                                    |       | (4,752,221              | )          | (4,551,760                  | )          |
| Other  intangibles, net                                                                                                                                                         |       | 1,395,091               |       | 1,513,551                   |       |
| Intangible  assets, net                                                                                                                                                         |       | $                       | 2,604,429  |                        | $          | 2,660,955 |   |

 

Amortization periods range from three toeleven years depending on the estimated useful life of the asset. Amortizationexpense consists of the following:

 
| ** **                                                                                     | ** ** | **Three months ended  June 30,** | ** ** | **Six Months ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                     | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Patents                                                                                        |       | $                                     | 51,445     |                                | $          | 23,929 |   | $ | 101,382 |   | $ | 64,744 |   |
| Other intangibles:                                                                             |       |                                  |       |                                |       |   |   |   |   |
| Covenant not to compete, developed  technology, ASP brand name, cell library and customer list |       | 51,477                                |       | 51,477                              |       | 102,955 |   | 102,954 |   |
| License agreements acquired in purchase of  our subsidiary SRSWOWcast in February 2003    |       | 16,002                                |       | 16,002                              |       | 32,003 |   | 32,004 |   |
| Poly Planar purchased technology                                                               |       | —                                |       | 6,000                               |       | 4,000 |   | 12,000 |   |
| Capitalized software and hardware                                                              |       | 31,784                                |       | 21,665                              |       | 61,503 |   | 30,645 |   |
| Total intangible amortization expense                                                          |       | $                                     | 150,708    |                                | $          | 119,073 |   | $ | 301,843 |   | $ | 242,347 |   |

 

10

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As of June 30, 2005, the weightedaverage useful life of the Company’s patents and intangible assets isapproximately 3.3 years. The following table shows the estimatedamortization expense for those assets for the remaining six months of thecurrent fiscal year and each of the four succeeding fiscal years:

 
| **Year  ending  December 31,** | ** ** | **Estimated expense** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| 2005                                     |       | $                     | 315,288    |   |
| 2006                                     |       | $                     | 628,210    |   |
| 2007                                     |       | $                     | 546,529    |   |
| 2008                                     |       | $                     | 326,121    |   |
| 2009                                     |       | $                     | 176,931    |   |
| Thereafter                               |       | $                     | 611,350    |   |

 

**5.             InvestmentsAvailable for Sale**

 

The Company has classifiedits investments as available for sale in accordance with SFAS No. 115,“Accounting for Certain Investments in Debt and Equity Securities.” Thefollowing table summarizes the Company’s investment securities available forsale:

 
| ** **            | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------|------------|------------------------|------------|----------------------------|------------|
| Cost                  |       | $                      | 17,489,688 |                       | $          | 17,489,688 |   |
| Accretion of discount |       | 1,185                  |       | —                     |       |
| Unrealized loss       |       | (269,533               | )          | (228,421                   | )          |
| Estimated fair value  |       | $                      | 17,221,340 |                       | $          | 17,261,267 |   |

 

The contractual maturities of investments areshown below. Actual maturities may differ from contractual maturities.

 
| ** **                                      | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                      | ** ** | **Cost**               | ** ** | **Estimated  Fair Value**  | ** ** | **Cost** | ** ** | **Estimated  Fair Value** | ** ** |
| U.S. Government securities available for  sale: |       |                   |       |                       |       |   |   |   |   |
| Due in one to five years                        |       | $                      | 17,489,688 |                       | $          | 17,221,340 |   | $ | 17,489,688 |   | $ | 17,261,267 |   |
|                                                 |            |                        |            |                            |            |  |  |  |  |  |  |  |  |

 

The following table summarizes sales of availablefor sale securities for three months and six months ended June 30, 2005and 2004. Specific identification was used to determine costs in computingrealized gains or losses.

 
| ** **         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------|------------|------------------------|------------|----------------------|------------|
| ** **         | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **         | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Proceeds from sale |       | $                      | —     |                 | $          | — |   | $ | — |   | $ | 5,235,626 |   |
| Realized gains     |       | —                 |       | —               |       | — |   | 139,375 |   |
|                    |            |                        |            |                      |            |  |  |  |  |  |  |  |  |

 

**6.             Investmentin LLC**

 

On September 23, 2004, the Companyentered into a strategic alliance with Coming Home Studios LLC (“CHS”) toproduce and sell concert DVDs which include the Company’s Circle Surroundtechnology.   In connection with thestrategic alliance, the Company and CHS entered into four agreements:  aStrategic Alliance Agreement, the CHS/SRS LLC Operating Agreement, a WarrantAgreement and a Production Services Agreement.

 

In the Strategic Alliance Agreement, CHS andthe Company agree to work together to identify and implement co-promotionalopportunities, including trade shows, movie theatres, video streaming, concertDVDs, artist endorsements, bundling and premium deals, web-based promotionalclips and road shows.  The initial term of the agreement expires on July 9,2006 and is automatically renewable for successive one-year terms.

 

The Operating Agreement governs CHS/SRS, LLC,which is a joint venture between CHS and the Company formed to complete anddistribute concert videos featuring Duran Duran, Boz Scaggs, Godsmack and AllAccess.

 

11

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Pursuant to the Operating Agreement each ofCHS and the Company contributed capital with a value of $2,346,621.  CHS’capital contribution to CHS/SRS, LLC consists of the artist agreements andrelated contracts pursuant to which CHS/SRS, LLC will produce and distributethe above-referenced concert videos.

 

The Company’s capital contribution is anaggregate of $2,346,621, consisting of a $700,000 bridge loan that the Companyextended to CHS on July 9, 2004 in anticipation of the strategic alliance,which converted to equity on September 23, 2004, plus $1,100,621 in newcash and additional advances of $546,000. In addition, the Company capitalized $229,516 consisting of costsassociated with the formation of the LLC and co-promotional projects. CHS’capital contribution consisted of the artist agreements with Duran Duran, BozScaggs, Godsmack and All Access, pursuant to which the concert videos arefilmed, produced and distributed. CHS/SRS, LLC contracted with CHS to completeproduction of the concert videos pursuant to the Production Services Agreement.

 

Profits from the distribution of the concertvideos and related assets will be allocated and distributed in the followingmanner and order: (a) 100% to the Company until such time as the Companyhas received 130% of the cumulative additional advances that the Companyprovided to CHS/SRS, LLC; (b) equally until the Company and CHS have eachboth received 1.75 times their original capital contributions; and thereafter (c) 90%to CHS and 10% to the Company. The joint venture is accounted for using theequity method and profits are recognized following the guidance for equitymethod accounting. As of June 30, 2005, two of the concert videos, BozScaggs and Godsmack have been released. Profits of $13,764 and $91,096generated from these videos have been recognized and included in “Equity inIncome of Investee” in the Consolidated Statements of Operations for the threeand six months ended June 30, 2005, respectively.

 

Under the Warrant Agreement, the Company paidCHS $40,000 to acquire a warrant to purchase up to 122,000 units of Class Amembership interests in CHS, which represents approximately 10% of the equityof CHS, for an exercise price of $9.836 per unit, subject to adjustment basedon valuation of CHS at the time of an additional funding. The warrant is immediatelyvested and exercisable for up to two years. It is transferable and containscustomary anti-dilution and price protection provisions for warrants of thistype.

 

Under the Production Services Agreement,CHS/SRS, LLC contracted with CHS as an independent contractor to perform allproduction services and to provide all other services, personnel, materials andelements for the production, completion and delivery of the concert videos.CHS, as the independent contractor, shall receive an aggregate of $365,000 inproduction fees for all of its services under the Production ServicesAgreement. CHS is responsible for payment of all costs and expenses inconnection with the production and completion of the concert videos.

 

**7.             Net Income Per Common Share**

 

The Company applies SFAS No. 128,“Earnings per Share,” which requires the disclosure of basic and diluted netincome or loss per share for all current and prior periods. Basic net income orloss per common share is computed by dividing net income or loss available tocommon stockholders by the weighted average number of common shares outstandingduring each year. Diluted net income or loss per common share reflects themaximum dilution, based on the average price of the Company’s common stock eachperiod, and is computed similar to basic income or loss per share except thatthe denominator is increased to include the number of additional shares thatwould have been outstanding if potentially dilutive stock options and warrantshad been exercised.

 

Basic and diluted net income per sharecomputed in accordance with SFAS 128 for the three months and six monthsended June 30, are as follows:

 
|                                                    |   | **For the three months** |       | **For the six months**  |       |
|---------------------------------------------------------|--------|--------------------------|------------|-------------------------|------------|
|                                                    |   | **ended June 30,**  |       | **Ended June 30,** |       |
|                                                    |   | **2005**                 | ** ** | **2004**                | ** ** | **2005** | ** ** | **2004** |   |
| BASIC EPS                                               |   |                     |       |                    |       |   |   |   |   |
| Net income                                              |   | $                        | 513,734    |                    | $          | 229,702 |   | $ | 735,194 |   | $ | 205,171 |   |
| Denominator: weighted average common shares outstanding |   | 14,076,866               |       | 14,175,127              |       | 14,043,269 |   | 13,960,824 |   |
| Net income per share—basic                         |   | $                        | 0.04       |                    | $          | 0.02 |   | $ | 0.05 |   | $ | 0.01 |   |
| DILUTED EPS                                             |   |                     |       |                    |       |   |   |   |   |
| Net income                                              |   | $                        | 513,734    |                    | $          | 229,702 |   | $ | 735,194 |   | $ | 205,171 |   |
| Denominator: weighted average common shares outstanding |   | 14,076,866               |       | 14,175,127              |       | 14,043,269 |   | 13,960,824 |   |
| Common equivalent shares outstanding:                   |   |                     |       |                    |       |   |   |   |   |
|                                                    |   |                     |       |                    |       |   |   |   |   |
| Options                                                 |   | 804,629                  |       | 1,173,301               |       | 907,424 |   | 2,306,493 |   |
| Total diluted shares                                    |   | 14,881,495               |       | 15,348,428              |       | 14,950,693 |   | 16,267,317 |   |
| Net income per share—diluted                       |   | $                        | 0.03       |                    | $          | 0.01 |   | $ | 0.05 |   | $ | 0.01 |   |

 

12

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There were 1,979,479 and1,672,625 potentially dilutive options outstanding for the quarters endingJune 30, 2005 and 2004, respectively and there were 1,964,479 and 260,000potentially dilutive options outstanding for the six months endingJune 30, 2005 and 2004, respectively, that were not included in the tableabove because they would be anti-dilutive.

 

**8.             Commitmentsand Contingencies**

 

The Company is subject to legal proceedings andclaims that arise in the normal course of business. While the outcome of theseproceedings and claims cannot be predicted with certainty, management does notbelieve that the outcome of any of these matters will have a material adverseeffect on the Company’s consolidated financial position or results ofoperations.

 

**9.             Stockholders’Equity**

 

On June 30, 2004, the Company’s Board ofDirectors authorized the repurchase of up to $3,000,000 of its outstandingcommon stock for a period from July 1, 2004 to December 31, 2004 (the“2004 Repurchase Program”).  The Companyrepurchased 216,575 shares at a cost of $1,225,254 under the 2004 RepurchaseProgram.

 

On March 24, 2005, the Company’s Board ofDirectors authorized the repurchase of up to $3,000,000 of the outstandingshares of the Company’s common stock for a period from January 1, 2005 to December 31,2005 (the “2005 Repurchase Program”). As of June 30, 2005, 232,223 shareshad been repurchased under the 2005 Repurchase Program. Purchases may be madefrom time to time in the open market, block purchases or privately negotiatedtransactions, depending on market conditions, share price and otherfactors.  All repurchased shares arereflected as treasury stock in the accompanying consolidated balance sheets.The following table shows activity under the 2005 Repurchase Program for thesix months ending June 30, 2005:

 
| ** **                       | ** ** | **June 30,** | ** ** |
|----------------------------------|------------|-------------------|------------|
| ** **                       | ** ** | **2005**          | ** ** |
| Shares  repurchased              |       | 232,223           |       |
| Average  price per share         |       | $                 | 4.56       |   |
| Total  repurchase authorized     |       | $                 | 3,000,000  |   |
| Repurchases  under the plan      |       | $                 | (1,059,590 | ) |
| Authorized  repurchase remaining |       | $                 | 1,940,410  |   |

 

13

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**10.          SegmentInformation**

 

The Company operates two business segments —semiconductors and licensing.  TheCompany does not allocate corporate operating expenses or specific assets tothese segments. Therefore, the segment information that follows includes onlynet revenues, cost of sales and gross margins of the identified segments:

 
| ** **                                | ** ** | **Valence  Semiconductor** | ** ** | **SRS Labs  Licensing** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|----------------------------|------------|-------------------------|------------|-----------|------------|
| **Three Months Ended June 30, 2005** |       |                       |       |                    |       |      |       |
| Total revenues                            |       | $                          | 2,521,174  |                    | $          | 3,539,977 |       | $ | 6,061,151 |   |
| Cost of sales                             |       | 999,166                    |       | 94,838                  |       | 1,094,004 |       |
|                                      |       |                       |       |                    |       |      |       |
| Gross margin                              |       | $                          | 1,522,008  |                    | $          | 3,445,139 |       | $ | 4,967,147 |   |
|                                      |       |                       |       |                    |       |      |       |
| **Three Months Ended June 30, 2004** |       |                       |       |                    |       |      |       |
| Total revenues                            |       | $                          | 2,932,495  |                    | $          | 2,485,404 |       | $ | 5,417,899 |   |
| Cost of sales                             |       | 1,066,033                  |       | 20,407                  |       | 1,086,440 |       |
|                                      |       |                       |       |                    |       |      |       |
| Gross margin                              |       | $                          | 1,866,462  |                    | $          | 2,464,997 |       | $ | 4,331,459 |   |

 
| ** **                              | ** ** | **Valence  Semiconductor** | ** ** | **SRS Labs  Licensing** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|-------------------------|------------|-----------|------------|
| **Six Months Ended June 30, 2005** |       |                       |       |                    |       |      |       |
| Total revenues                          |       | $                          | 4,505,737  |                    | $          | 6,804,072 |       | $ | 11,309,809 |   |
| Cost of sales                           |       | 1,727,406                  |       | 151,183                 |       | 1,878,589 |       |
|                                    |       |                       |       |                    |       |      |       |
| Gross margin                            |       | $                          | 2,778,331  |                    | $          | 6,652,889 |       | $ | 9,431,220 |   |
|                                    |       |                       |       |                    |       |      |       |
| **Six Months Ended June 30, 2004** |       |                       |       |                    |       |      |       |
| Total revenues                          |       | $                          | 5,348,213  |                    | $          | 5,412,731 |       | $ | 10,760,944 |   |
| Cost of sales                           |       | 1,948,767                  |       | 46,544                  |       | 1,995,311 |       |
|                                    |       |                       |       |                    |       |      |       |
| Gross margin                            |       | $                          | 3,399,446  |                    | $          | 5,366,187 |       | $ | 8,765,633 |   |

 

For the three months ending June 30, 2005, onecustomer accounted for approximately 11% of consolidated revenues, or $669,084,in the semiconductor segment. For the same period in the prior year, twocustomers accounted for approximately 28% and 13% of consolidated revenues, or$1,523,144 and $687,831, in the semiconductor segment, respectively. There wasno significant customer in the licensing segment for the three months ended June 30,2005 and June 30, 2004.

 

For the six months ending June 30, 2005, onecustomer accounted for approximately 11% of consolidated revenues, or$1,231,510, in the semiconductor segment. For the same period in the prioryear, two customers accounted for approximately 23% and 10% of consolidatedrevenues, or $2,492,034 and $1,102,309, in the semiconductor segment,respectively. There was no significant customer in the licensing segment forthe six months ended June 30, 2005 and June 30, 2004.

 

The following schedule presents the Company’srevenue by geographic area. For product sales, revenue is allocated based onthe country to which the product was shipped. For licensing-related revenue,the allocation is based on the location of the licensee’s corporateheadquarters. The Americas region includes North, Central and South America.

 

14

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| ** **                    | ** ** | **Three Months Ended  June 30,** | ** ** | ** ** | ** ** | **Six Months Ended  June 30,** | ** ** | ** ** | ** ** |
|-------------------------------|------------|---------------------------------------|------------|------------|------------|-------------------------------------|------------|------------|------------|
| ** **                    | ** ** | **2005**                              | ** ** | **%**      | ** ** | **2004**                            | ** ** | **%**      | ** ** | **2005** | ** ** | **%** | ** ** | **2004** | ** ** | **%** | ** ** |
| **Geographic  Area Revenue:** |       |                                  |       |       |       |                                |       |       |       |   |   |   |   |   |   |   |   |
|                          |       |                                  |       |       |       |                                |       |       |       |   |   |   |   |   |   |   |   |
| Hong Kong                     |       | $                                     | 2,321,159  |       | 37         |                                | $          | 2,758,528  |       | 51 |   | $ | 4,055,350 |   | 35 |   | $ | 4,981,065 |   | 46 |   |
| Japan                         |       | 1,446,553                             |       | 24         |       | 1,299,523                           |       | 24         |       | 2,967,042 |   | 27 |   | 2,657,830 |   | 25 |   |
| Other Asia  Pacific           |       | 1,132,837                             |       | 19         |       | 266,895                             |       | 5          |       | 2,012,715 |   | 18 |   | 601,160 |   | 6 |   |
| Americas                      |       | 456,325                               |       | 8          |       | 526,358                             |       | 10         |       | 1,179,851 |   | 11 |   | 1,311,970 |   | 12 |   |
| China                         |       | 612,446                               |       | 10         |       | 513,660                             |       | 9          |       | 962,603 |   | 8 |   | 793,681 |   | 7 |   |
| Europe                        |       | 91,831                                |       | 2          |       | 52,935                              |       | 1          |       | 132,248 |   | 1 |   | 415,238 |   | 4 |   |
| Total                         |       | $                                     | 6,061,151  |       | 100        |                                | $          | 5,417,899  |       | 100 |   | $ | 11,309,809 |   | 100 |   | $ | 10,760,944 |   | 100 |   |

 

**11.****                              ****Recent AccountingPronouncements**

 

In May 2005, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards No. 154,“Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20and FASB Statement No. 3” (“SFAS 154”).  Opinion 20 previously required that most voluntary changes in accountingprinciple be recognized by including in net income of the period of the changethe cumulative effect of changing to the new accounting principle. ThisStatement requires retrospective application to prior periods’ financialstatements of changes in accounting principle, unless it is impracticable todetermine either the period-specific effects or the cumulative effect of thechange. When it is impracticable to determine the period-specific effects of anaccounting change on one or more individual prior periods presented, thisStatement requires that the new accounting principle be applied to the balancesof assets and liabilities as of the beginning of the earliest period for whichretrospective application is practicable and that a corresponding adjustment bemade to the opening balance of retained earnings for that period rather thanbeing reported in an income statement. This statement is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 31, 2005.  TheCompany does not expect the adoption of SFAS 154 to have an impact on itsconsolidated financial position, results of operations or cash flows.

 

 InDecember 2004, the FASB issued a revised Statement 123, which as amendedis effective for the Company’s first quarter of 2006. Statement 123(R) requirescompanies to expense in their consolidated statement of operations theestimated fair value of employee stock options and similar awards. SFAS 123(R)will be effective for quarterly periods beginning after December 31,2005.  The Company will adopt theprovisions of Statement 123(R) using a modified prospective application. Underthe modified prospective application, Statement 123(R), which provides certainchanges to the method for valuing stock-based compensation among other changes,will apply to new awards and to awards that are outstanding on the effectivedate and are subsequently modified or cancelled. Compensation expense foroutstanding awards for which the requisite service had not been rendered as ofthe effective date will be recognized over the remaining period using thecompensation cost calculated for pro forma disclosure purposes under Statement123. Depending on the model used to calculate stock-based compensation expensein the future, the implementation of certain other requirements of Statement123(R) and additional option grants expected to be made in the future, the proforma disclosure may not be indicative of the stock-based compensation expensethat will be recognized in the Company’s future financial statements. TheCompany is in the process of determining how the new method of valuingstock-based compensation as prescribed in Statement 123(R) will be applied tovaluing stock-based awards granted after the effective date and the impact therecognition of compensation expense related to such awards will have on itsfinancial statements.

 

**12.****                              ****SubsequentEvent**

 

On July 20, 2005, theCompany became the managing member of CHS/SRS, LLC.  Under the terms ofthe Operating Agreement, the Company is entitled to receive a five percentmanagement fee of all net revenues received, after all additional advances havebeen repaid. Subsequent to becoming the managing member, the Companycontributed additional advances totaling $355,000 to CHS/SRS, LLC. Under theterms of the Operating Agreement, all additional advances shall be repaid outof the profits of the CHS/SRS LLC at 130% of the cumulative additional advancescontributed. See Note 6 herein.

 

15

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**Item 2. Management’s Discussion and Analysis of Financial Condition and Resultsof 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 the Company’s Annual Report on Form 10-K for the year ended December 31,2004 (the “Form 10-K”), the audited consolidated financial statements andthe notes thereto included in the Form 10-K and the unaudited condensedinterim consolidated financial statements and notes thereto included in thisQuarterly Report.

 

**Overview**

 

SRSLabs is a leading developer and provider of application-specific integratedcircuits, or (“ASIC”), standard integrated circuits, or ICs, and audio andvoice technology solutions for the home entertainment, portable media device,personal telecommunications, personal computer, automotive and broadcastmarkets. We operate in the following two business segments:

 

*Semiconductors:  *Through SRSLabs, Inc.’s wholly-owned subsidiary, Valence Tech Limited, andValenceTech Limited’s wholly-owned subsidiaries (collectively “Valence”), weoperate a fabless semiconductor business which develops, designs and marketsstandard and custom analog ICs, digital signal processors, or DSPs, and mixedsignal integrated circuits primarily to original equipment manufacturers, orOEMs, and original design manufacturers, or ODMs, in the Asia Pacific region.

 

*Licensing:**  ***Through SRSLabs, the parent company, and its wholly-owned subsidiary, SRSWOWcast.com, Inc.,doing business as SRSWOWcast Technologies (“SRSWOWcast”), the licensing segmentdevelops and licenses audio, voice and surround sound technology solutions tomany of the world’s leading OEMs/ODMs, software providers and semiconductorcompanies, and licenses and markets hardware and software products for theInternet and professional audio markets.

 

Asused herein, the “Company,” “SRS Labs,” “we,” “us,” or “our” means SRS Labs, Inc.and its wholly owned subsidiaries, including Valence and SRSWOWcast.com Inc.

 

**Results of Operations**

 

**Three Months Ended June 30, 2005 Compared toThree Months Ended June 30, 2004**

 

*Revenues*

 

Semiconductor revenues consists of (a) designfees relating to, and sales of, ASIC for third parties by Valence to originalequipment manufacturers (“OEMs”); and  (b) salesof general purpose integrated circuits (“ICs”) designed by Valence under thebrand name ASP.  Licensing revenuesconsist primarily of royalties generated from the license of SRS Labs’ audioand voice technologies.  License androyalty agreements generally provide for the license of technologies for a feebased on the number of units distributed by the licensee.  However, we have in the past and may again inthe future, enter into a license agreement for a one-time fee. Also included inlicensing revenue are revenues generated from the sale of hardware and softwareapplications into the broadcast audio markets.

 

Total revenues for the threemonths ended June 30, 2005 were $6,061,151 compared to $5,417,899 for thethree months ended June 30, 2004, an increase of $643,252 or 11.9%. Semiconductorrevenues were $2,521,174 for the three months ended June 30, 2005 comparedto $2,932,495 for the three months ended June 30, 2004, a decrease of$411,321 or 14.0%. Within semiconductor revenue, ASIC accounted for $1,744,614or 69.2% for the three months ended June 30, 2005 compared to $2,012,938or 68.6% for the same period last year, a decrease of $268,324 or 13.3%. ASPchips accounted for $776,560 or 30.8% for the three months ended June 30,2005 compared to $919,557 or 31.4% for the same period last year, a decrease of$142,997 or 15.7%. Within ASP revenues, SRS chips accounted for 40.7% for the threemonths ended June 30, 2005 compared to 32.4% for the same period lastyear. The decrease in ASIC and ASP sales can be primarily attributed tocompetitive pressures within ASP standard products and decreased demand from amajor ASIC customer due a shift in market trend that resulted in the end of aproduct life cycle for two ASIC chips, which had contributed $241,000 inrevenue in Q2 2004.

 

16

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Licensing revenues were$3,539,977 for the three months ended June 30, 2005, compared to$2,485,404 for the three months ended June 30, 2004, an increase of$1,054,573 or 42.4%. The sales growth in licensing was attributable to ourcontinued diversification strategy, which expanded the use of our technologiesinto the portable devices, PC, mobile phone and automotive markets.  The following table presents the Company’slicensing revenues mix by market segment:

 
| ** **                                                | ** ** | **Three Months Ended June 30,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| Home  Entertainment (TV, Set Top Box, A/V Receiver, DVD)  |       | 44                                   | %          | 63 | % |
| Portable  Media Devices (Digital Media Player, Headphone) |       | 24                                   | %          | 9 | % |
| PC  (Software, Hardware)                                  |       | 12                                   | %          | 8 | % |
| Personal  Telecommunications (Mobile Phone, PDA)          |       | 16                                   | %          | 19 | % |
| Automotive                                                |       | 4                                    | %          | 1 | % |

 

*Gross Margin*

 

Cost of sales consists primarily offabrication costs, assembly and test costs, and the cost of materials andoverhead from operations. Gross margins are dependent on the mix of productssold, services provided and royalties earned. The decline in semiconductorgross margins can be attributable to the amortization of masking charges and anaggressive pricing strategy on ASP chips to increase marketpenetration. Thefollowing table presents the Company’s gross margin percentages for the threemonths ended June 30:

 
| ** **                                                    | ** ** | **Three Months Ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| **Semiconductor**                                             |       |                                 |       |   |   |
| ASIC revenue  as a percentage of total semiconductor revenue  |       | 69.2                                 | %          | 68.6 | % |
| ASIC gross  margin                                            |       | 63.4                                 | %          | 66.8 | % |
|                                                          |       |                                 |       |   |   |
| ASP revenue  as a percentage of total semiconductor revenue   |       | 30.8                                 | %          | 31.4 | % |
| ASP gross  margin                                             |       | 53.5                                 | %          | 56.7 | % |
|                                                          |       |                                 |       |   |   |
| Total  semiconductor revenue as a percentage of total revenue |       | 41.6                                 | %          | 54.1 | % |
| Total  semiconductor gross margin                             |       | 60.4                                 | %          | 63.6 | % |
|                                                          |       |                                 |       |   |   |
| **Licensing**                                                 |       |                                 |       |   |   |
| Licensing  revenue as a percentage of total revenue           |       | 58.4                                 | %          | 45.9 | % |
| Licensing  gross margin                                       |       | 97.3                                 | %          | 99.2 | % |
|                                                          |       |                                 |       |   |   |
| **Total  Gross Margin**                                       |       | 82.0                                 | %          | 79.9 | % |

 

*Sales and Marketing*

 

Sales and marketing expenses consistprimarily of employee salaries, sales consultants’ fees and related expenses,sales commissions and product promotion costs. Sales and marketing expenseswere $1,678,500 for the three months ended June 30, 2005 compared to$1,260,067 for the same prior year period, an increase of $418,433 or33.2%.  The increase is primarilyattributable to headcount and recruiting expenses related to increased salesand marketing personnel in our semiconductor segment and increased licensing salespersonnel in Korea and China to capitalize on the growing licensingopportunities in those geographies.  As apercentage of total revenues, sales and marketing expenses increased from 23.3%for the quarter ended June 30, 2004 to 27.7% for the same period thisyear.

 

*Researchand Development*

 

Research anddevelopment expenses consist of salaries and related costs of employees engagedin ongoing research, design and development activities. Research anddevelopment expenses were $1,207,871 for the three months ended June 30,2005 compared to $1,144,926 for the same prior year period, an increase of$62,945 or 5.5%.  The increase isprimarily attributable to increased costs associated with headcount andexpenses incurred in customer support. As a percentage of total revenues, research and development expenseswere 21.1% for the quarter ended June 30, 2004, and 19.9% for the sameperiod this year.

 

17

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*Generaland Administrative*

 

General and administrative (“G&A”)expenses consist primarily of employee-related expenses, legal costs associatedwith the administration of intellectual property and other professional fees.G&A expenses were $1,578,029 for the three months ended June 30, 2005compared to $1,484,299 for the same prior year period, an increase of $93,730or 6.3%. The increase is primarily attributable to professional fees associatedwith the restatement of our financial statements in Q2 2005 for fiscal2004.  As a percentage of total revenues,G&A expenses decreased from 27.4% for the quarter ended June 30, 2004,to 26.0% for the same period this year.

 

*Equityin Income of Investee*

* *

OnSeptember 23, 2004, we entered into a strategic alliance with Coming HomeStudios LLC (“CHS”) to produce and sell concert DVDs which incorporate ourCircle Surround technology.  Inconnection with that strategic alliance, we entered into a joint venture,CHS/SRS, LLC, formed to complete and distribute concert videos featuring DuranDuran, Boz Scaggs, Godsmack and All Access. Equity in income of investee represents the Company’s proportionateshare of profit from the joint venture. The joint venture is accounted for using the equity method and profitsare recognized following the guidance for equity method accounting.  CHS/SRS, LLC recognizes and accrues profitsas it gets sales and/or royalty reports. For the three months ended June 30,2005, the profit recognized under the joint venture operating agreement was$13,764.

 

*OtherIncome, Net*

 

Other income, net,consists primarily of interest income, gain on sale of securities and foreigncurrency transaction gains and losses. Other income, net, was $166,293 for thethree months ended June 30, 2005, compared to $98,774 for the same prioryear period, an increase of $67,519 or 68.4%. The increase is primarilyattributable to improved interest rates on investments.

 

*Provisionfor Income Taxes*

 

The income tax expense for the threemonths ended June 30, 2005 was $169,070, compared to tax expense of$311,239 for the same prior year period, a decrease of $142,169 or 45.7%. Theprovision consists primarily of taxes paid on licensing revenues sourced fromcountries requiring foreign tax withholdings and taxes paid on profits in HongKong at the rate of 17.5%.  The lowertax expense in fiscal 2005 resulted from decreased taxable income in ourforeign subsidiary.  In addition, webenefited from the U.S. Japan tax treaty, which eliminated source-countrywithholdings on royalties. That treaty became effective on July 1, 2004.

 

**Six Months Ended June 30, 2005 Compared to SixMonths Ended June 30, 2004**

 

Total revenues for the sixmonths ended June 30, 2005 were $11,309,809 compared to $10,760,944 forthe period ended June 30, 2004, an increase of $548,865 or 5.1%. Semiconductorrevenues were $4,505,737 for the six months ended June 30, 2005 comparedto $5,348,213 for the period ended June 30, 2004, a decrease of$842,476 or 15.8%. Within semiconductor revenue, ASIC accounted for $3,214,076or 71.3% for the six months ended June 30, 2005 compared to $3,662,069 or68.5% for the same period last year, a decrease of $447,993 or 12.2%. ASP chipsaccounted for $1,291,661 or 28.7% for the six months ended June 30, 2005compared to $1,686,144 or 31.5% for the same period last year, a decrease of$394,483 or 23.4%. Within ASP revenues, SRS chips accounted for 47.0% for thesix months ended June 30, 2005 compared to 34.7% for the same period lastyear. The decrease in ASIC and ASP sales can be primarily attributed tocompetitive pressures and the end of product life cycles for certain chips.

 

Licensing revenues were$6,804,072 for the three months ended June 30, 2005, compared to$5,412,731 for the six months ended June 30, 2004, an increase of$1,391,341 or 25.7%. The sales growth in licensing was attributable to ourcontinued diversification strategy, which expanded the use of our technologiesin the portable devices, PC, mobile phone and automotive markets. The followingtable presents the Company’s licensing revenues mix by market segment:

 
| ** **                                                | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Home  Entertainment (TV, Set Top Box, A/V Receiver, DVD)  |       | 53                                 | %          | 67 | % |
| Portable  Media Devices (Digital Media Player, Headphone) |       | 19                                 | %          | 9 | % |
| PC (Software,  Hardware)                                  |       | 12                                 | %          | 12 | % |
| Personal  Telecommunications (Mobile Phone, PDA)          |       | 13                                 | %          | 11 | % |
| Automotive                                                |       | 3                                  | %          | 1 | % |

 

18

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*Gross Margin*

 

Cost of sales consists primarily offabrication costs, assembly and test costs, and the cost of materials andoverhead from operations. Gross margins are dependent on the mix of productssold, services provided and royalties earned. The decline in semiconductorgross margins can be attributable to the amortization of masking charges and anaggressive pricing strategy on ASP chips to increase marketpenetration. Thefollowing table presents the Company’s gross margin percentages for the sixmonths ended June 30:

 
| ** **                                                    | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| **Semiconductor**                                             |       |                               |       |   |   |
| ASIC revenue  as a percentage of total semiconductor revenue  |       | 71.3                               | %          | 68.5 | % |
| ASIC gross  margin                                            |       | 64.8                               | %          | 67.1 | % |
|                                                          |       |                               |       |   |   |
| ASP revenue  as a percentage of total semiconductor revenue   |       | 28.7                               | %          | 31.5 | % |
| ASP gross  margin                                             |       | 53.8                               | %          | 55.9 | % |
|                                                          |       |                               |       |   |   |
| Total  semiconductor revenue as a percentage of total revenue |       | 39.8                               | %          | 49.7 | % |
| Total  semiconductor gross margin                             |       | 61.7                               | %          | 63.6 | % |
|                                                          |       |                               |       |   |   |
| **Licensing**                                                 |       |                               |       |   |   |
| Licensing  revenue as a percentage of total revenue           |       | 60.2                               | %          | 50.3 | % |
| Licensing  gross margin                                       |       | 97.8                               | %          | 99.1 | % |
|                                                          |       |                               |       |   |   |
| **Total  Gross Margin**                                       |       | 83.4                               | %          | 81.5 | % |

 

*Sales and Marketing*

 

Sales and marketing expenses consistprimarily of employee salaries, sales consultants’ fees and related expenses,sales commissions and product promotion costs. Sales and marketing expenseswere $3,370,878 for the six months ended June 30, 2005 compared to$2,955,435 for the same prior year period, an increase of $415,443 or 14.1%.The increase is primarily attributable to headcount and recruiting expensesrelated to increased sales and marketing personnel in our semiconductor segmentand increased licensing sales personnel in Korea and China to capitalize on thegrowing licensing opportunities in those geographies.  As a percentage of total revenues, sales andmarketing expenses increased from 27.5% for the six months ended June 30,2004 to 29.8% for the same period this year.

 

*Researchand Development*

 

Research anddevelopment expenses consist of salaries and related costs of employees engagedin ongoing research, design and development activities. Research and developmentexpenses were $2,389,940 for June 30, 2005 compared to $2,353,613 for thesame prior year period, an increase of $36,327 or 1.5%.  As a percentage of total revenues, researchand development expenses were 21.9% for the six months ended June 30, 2004,and 21.1% for the same period this year.

 

*Generaland Administrative*

 

General and administrative (“G&A”)expenses consist primarily of employee-related expenses, legal costs associatedwith the administration of intellectual property and other professional fees.G&A expenses were $3,047,258 for the six months ended June 30, 2005compared to $3,038,496 for the same prior year period, an increase of $8,762 or0.3%. As a percentage of total revenues, G&A expenses decreased from 28.2%for the six-month period ended June 30, 2004, to 26.9% for the same periodthis year.

 

*Equityin Income of Investee*

* *

Equityin income of investee represents the Company’s proportionate share of profitfrom the CHS/SRS, LLC joint venture that we entered into with CHS.  For the six months ended June 30, 2005,the profit recognized under the operating agreement for the joint venture was$91,096.

 

19

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*OtherIncome, Net*

 

Other income, net,consists primarily of interest income, gain on sale of securities and foreigncurrency transaction gains and losses. Other income, net, was $314,226 for thesix months ended June 30, 2005, compared to $336,224 for the same prioryear period, a decrease of $21,998 or 6.5%. The decrease is primarily attributableto decreased levels of cash due to the repurchase of treasury shares, offset byimproved interest rates on investments.

 

*Provisionfor Income Taxes*

 

The income tax expense for the six monthsended June 30, 2005 was $293,272, compared to tax expense of $549,142 forthe same prior year period, a decrease of $255,870 or 46.6%. The provisionconsists primarily of taxes paid on licensing revenues sourced from countriesrequiring foreign tax withholdings and taxes paid on profits in Hong Kong atthe rate of 17.5%.  The lowertax expense in fiscal 2005 resulted from decreased taxable income in ourforeign subsidiary.  In addition, webenefited from the U.S. Japan tax treaty, which eliminated source-countrywithholdings on royalties. That treaty became effective on July 1, 2004.

 

**Liquidity and Capital Resources**

 

The Company’s principal source of liquidityto fund ongoing operations at June 30, 2005 consisted of cash, cashequivalents and long-term investments of $24,056,211.  At June 30, 2005, the Company had cashand cash equivalents of $6,834,871 and long-term investments of $17,221,340.Cash and cash equivalents generally consist of cash, money market funds andother money market instruments with original maturities of three months orless. Investments consist of U.S. government securities rated AAA.

 

Net cash provided by operating activities was$839,469 and $1,095,289 during the six months ended June 30, 2005 and June 30,2004, respectively. The decrease in our operating cash flows is primarily theresult of an increase in accounts receivable associated with increasedlicensing activity.  Our accounts payableincreased $193,495 and decreased $115,922 during the six months ended June 30,2005 and 2004, respectively.  Our accruedliabilities increased $135,135 and $25,656 during the six months ended June 30,2005 and 2004, respectively.  The changesin liability accounts generally relate to increases in professional fees,commissions and bonus and the timing of payments to vendors and employees.

 

Our net cash used in and provided by investing activities was $379,059 and $4,418,088 during the six months ended June 30, 2005 and June 30, 2004, respectively. The shift from net cash provided by investing activities during the period ended June 30, 2004, as compared to net cash used in investing activities during the period ended June 30, 2005, was attributable primarily to a $5,235,626 decrease in proceeds from sales of investments available for sale, offset by $488,350 decrease in purchases of furniture, fixtures and equipment.

 

On September 23, 2004, we entered into astrategic alliance with Coming Home Studios LLC (“CHS”) to produce and sellconcert DVDs which incorporate our Circle Surround technology. In connectionwith that strategic alliance, we entered into a joint venture, CHS/SRS, LLC,formed to complete and distribute concert videos featuring Duran Duran, BozScaggs, Godamack and All Access.

 

Profits fromthe distribution of the concert videos and related assets will be allocated anddistributed in the following manner and order: (a) 100% to the Companyuntil such time as we have received 130% of the cumulative additional advancesthat we provided to CHS/SRS, LLC; (b) equally until we and CHS have eachreceived 1.75 times our respective original capital contributions; andthereafter (c) 90% to CHS and 10% to the Company.  The Company’s capital contribution is anaggregate of $2,346,621, consisting of a $700,000 bridge loan that the Companyextended to CHS on July 9, 2004 in anticipation of the strategic alliance,which converted to equity on September 23, 2004, plus $1,100,621 in newcash and additional advances of $546,000. CHS’ capital contribution consistedof the artist agreements with Duran Duran, Boz Scaggs, Godsmack and All Accesspursuant to which the concert videos are filmed, produced and distributed.Subsequent to June 30, 2005 and as of August 5, 2005, we havecontributed $355,000 in additional advances to the joint venture.

 

 

Based on current plans and businessconditions, the Company expects that its cash, cash equivalents and investmentstogether with any amounts generated from operations will be sufficient to meetthe Company’s cash requirements for the foreseeable future. However, there canbe no assurance that the Company will not be required to seek other financingsooner or that such financing, if required, will be available on termssatisfactory to the Company.

 

**Factors That May Affect Future Results**

 

***The concertDVDs for our joint venture with Coming Home Studios may not be completed.***

** **

We have invested a total of $2.7 million inCHS/SRS, LLC, our joint venture with CHS to produce a total of six concert DVDsby *Duran Duran, Godsmack, Boz Scaggs*and *All Access* featuring our Circle Surround technology.  Although two of the concert DVDs have been completedand are in distribution, the remaining four concert DVDs have been delayed pastthe originally scheduled completion date. We depend on the services of other parties beyond our control toproduce, complete and distribute the concert DVDs, including, withoutlimitation, the services of CHS pursuant to a production services agreementbetween CHS and CHS/SRS, LLC.  On July 20,2005 the Company replaced Coming Home Studios as the manager of CHS/SRS,LLC.  In this capacity, we areresponsible for the financial management of CHS/SRS, LLC, and CHS isresponsible for completion of the concert DVDs pursuant to the productionservices agreement.

 

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The production, completion and distributionof the concert DVDs is subject to a number of uncertainties, including delaysand increased expenditures due to creative problems, technical difficulties,talent availability, accidents, natural disasters and other events beyond ourcontrol.  Because of these uncertainties,the projected cost of the concert DVDs may increase, the completion dates maybe substantially delayed or the projects may be abandoned due to the exigenciesof production.  Delays in production mayalso result in concert DVDs not being ready for release at the intended timeand being postponed to a less favorable time, which could result in lowerrevenues.  In extreme cases, a concertDVD may be abandoned.  We cannot predictthe success of any of the concert DVDs even if they are completed because theireconomic success will depend on their acceptance by the public, which cannot beaccurately predicted.  The economicsuccess of a concert DVD may also depend on the public’s acceptance ofcompeting shows, the availability of alternative forms of entertainment andleisure time activities, general economic conditions, and other tangible andintangible factors, all of which can change and cannot be predicted withcertainty.  Although we are not requiredto expend additional funds related to our strategic alliance with CHS, we haveelected to make additional capital contributions subsequent to June 30,2005 in the aggregate amount of $355,000. There can be no assurance that the concert DVDs can be completed, or ifcompleted and distributed, that the concert DVDs will achieve economicsuccess.  If the concert DVDs are furtherdelayed, not completed or generate insufficient returns once completed, thereis a risk that our investment in CHS/SRS, LLC will be impaired or lost.

 

*Weare exposed to risks in our licensing business related to product and customerconcentration*

* *

Currently,our licensing revenue is concentrated in the home theater market with themajority of revenue generated from the inclusion of SRS technology insidetelevisions, DVD players and set-top boxes. We expect that the consumer homeentertainment market will continue to account for a significant portion of ourlicensing revenues for the foreseeable future. While consumer spending ingeneral on consumer electronic products has increased, retail prices forcertain consumer electronics products that include our audio technology, suchas DVD players, have decreased significantly. Indications are that this trendwill continue for the foreseeable future. From time to time, certain of ouroriginal equipment manufacturer and semiconductor manufacturer customers mayaccount for a significant portion of revenue from a particular productapplication, such as DVD players, set-top boxes or televisions. Consumerelectronics products manufacturers could decide to exclude our audioenhancement technology from their home theater products altogether in an effortto reduce cost. The loss of any such customer could have a material adverseaffect on our financial condition and results of operations.

 

*Ourbusiness is highly dependent on the consumer electronics market, which ischaracterized by short product life cycles, fluctuations in demand andseasonality, and subject to risks related to product transitions and supply ofother components*

* *

Theconsumer electronics market is characterized by intense competition, rapidlyevolving technology, and ever-changing consumer preferences. These factorsresult in the frequent introduction of new products, short product life cyclesand significant price competition. The dynamic nature of this market limitsour, as well as our customers’, ability to accurately forecast quarterly andannual sales. If we, or our customers, are unable to manage producttransitions, our business and results of operations could be negativelyaffected.

 

*Pricingpressures on the consumer electronics product manufacturers who incorporate ourtechnologies into their products could limit the licensing fees we charge forour technologies, which could adversely affect our revenues*

* *

Themarkets for the consumer electronics products in which our technologies areincorporated are intensely competitive and price sensitive. Retail prices forconsumer electronics products that include our technologies, such as DVDplayers and home theater systems, have decreased significantly, and we expectprices 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. A decline in the licensing fees we charge could materiallyand adversely affect our operating results.

 

*Ourbusiness and prospects depend on the strength of our brand, and if we do notmaintain and strengthen our brand, our business will be materially harmed*

* *

Maintainingand strengthening the “SRS” brand is critical to maintaining and expanding bothour products and services business and our technology licensing business, aswell as to our ability to enter new markets for our audio and other technologies.Our continued success is due, in part, to our reputation for providing highquality products, services and technologies across multiple consumerelectronics product segments. If we fail to effectively promote and maintainthe SRS brand, our business and prospects will suffer.

 

21

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*Ourquarterly results may fluctuate*

* *

Ouroperating results may fluctuate from those in prior quarters and will continueto be subject to quarterly and other fluctuations due to a variety of factors,including the extent to which our licensees incorporate our technologies intotheir products; the timing of orders from, and the shipments to, majorcustomers; the timing of new product introductions; the gain or loss of significantcustomers; competitive pressures on selling prices; the market acceptance ofnew or enhanced versions of our technologies; the rate that our semiconductorlicensees manufacture and distribute chips to product manufacturers; andfluctuations in general economic conditions, particularly those affecting theconsumer electronics market. Due to our dependence on the consumer electronicsmarket, the substantial seasonality of sales in the market could impact ourrevenues and net income. In particular, we believe that there is seasonalityrelating to the Christmas season generally and the Chinese New Year within theAsia region, which fall into the fourth and first quarters respectively. As aresult, we believe that period-to-period comparisons of our results ofoperations are not necessarily meaningful and should not be relied on asindications of future performance.

 

*Weare subject to the highly cyclical nature of the semiconductor industry*

* *

Thesemiconductor industry is highly cyclical. The industry has experiencedsignificant downturns, often in connection with, or in anticipation of,maturing product cycles (of both semiconductor companies’ and their customers’products) and declines in general economic conditions. These downturns havebeen characterized by production overcapacity, high inventory levels andaccelerated erosion of average selling prices. Any future downturns couldsignificantly harm our sales or reduce our profitability for a prolonged periodof time. From time to time, the semiconductor industry also has experiencedperiods of increased demand and production capacity constraints. We mayexperience substantial changes in future operating results due to generalsemiconductor industry conditions, general economic conditions and otherfactors.

 

*Werely on revenue contribution from our ASIC and standard IC business*

* *

Wederive a significant amount of our revenue from Valence’s ASIC business.Valence’s engineering team focuses on the design of custom ASICs to meetspecific customers’ requirements and out sources the production of the designto mask houses, foundries and packaging houses located primarily in Asia. Theoperations of Valence could be affected by a variety of factors, including thetiming of customer orders, the timing of development revenue, changes in themix of products distributed and the mix of distribution channels employed, theemergence of a new industry standard, product obsolescence and changes inpricing policies by us, our competitors or our suppliers.

 

Businessrevenue from ASICs is concentrated in a limited number of customers in theareas of consumer electronics, communications products, computers and computerperipherals. The business generated from any one customer may be for a fixedlength or quantity. As such, it is customary in our ASIC business to have acertain amount of customer turnover as new ASIC projects are obtained fordifferent customers. However, it is possible that the loss of any particularcustomer or any bad debt arising from such customer may have a materiallyadverse impact on our financial condition and results of operation.

 

Valenceadds significant diversity to our overall business structure and opportunities.We recognize that in the presence of such corporate diversity, and inparticular with regard to the semiconductor industry, there will always exist apotential for conflict among sales channels between us and our technologylicensees. Although the operations of our licensing business and those ofValence are generally complementary, there can be no assurances that saleschannel conflicts will not arise. If such potential conflicts do materialize,we may or may not be able to mitigate the effect of such perceived conflicts,which, if not resolved, may impact the results of operations.

 

*Potentialchannel conflict with existing semiconductor partners could cause us to losefuture business*

* *

Aswe bring out more and more Valence semiconductors with SRS audio technologiesembedded in them, our current semiconductor partners may perceive those newdevices as threats to their own products. The semiconductor partners mayrespond by reducing or eliminating the volumes of business they presently dowith us, which would have an adverse effect on our licensing revenue.

 

*Weare exposed to risks in our Valence business related to product fabricationoutsourcing to third parties*

* *

Valenceis a “fabless” semiconductor company meaning that Valence designs, develops andmarkets our selection of custom and standard integrated circuits but we rely onthird-party contractors to manufacture, assemble and test our products. Fromtime to time there can be foundry capacity issues due to global demands thataffect the semiconductor industry. Although we believe our relationships aregenerally good, we do not have long-term supply agreements with our third-party

 

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vendors and they are not obligated to perform services or supplyproducts to us for any particular period or in any particular quantities,except as provided in each separate purchase order accepted by them. Theincreased demand for our products coupled with the demand for foundry services,is, and will continue to be for the foreseeable future, a challenge for us. Intimes of high demand, there are significant risks associated with our relianceon third-party vendors including: reallocation of capacity to other foundrycustomers, potential price increases, delays and interruptions in orderdeliveries, reduced control over product quality and increased risk ofmisappropriation of intellectual property.

 

*Weconduct operations in a number of countries and are subject to risks ofinternational operations, particularly in the People’s Republic of China (“PRC”)and other parts of Asia*

* *

Wehave significant operations in the PRC and other parts of Asia that requirerefinement to adapt to the changing market conditions in those regions. Ouroperations in Asia, and international operations in general, are subject torisks of unexpected changes in, or impositions of, legislative or regulatoryrequirements.

 

Ourcustomers geographically located in the Asia Pacific markets accounted forapproximately 86%, 93% and 90% of total Company sales in 2004, 2003 and 2002,respectively and are expected to continue to account for a substantial percentageof sales in the future.

 

ThePRC economy has experienced significant growth in the past decade; but suchgrowth has been uneven across geographic and economic sectors. There can be noassurance that such growth will continue or that any potential currencydevaluation in the region will not have a negative effect on our business,including Valence. The PRC economy has also experienced deflation in the past,which may continue in the future. The current economic situation may adverselyaffect our profitability over time as expenditures for consumer electronicsproducts and information technology may decrease due to the results of slowingdomestic demand and deflation.

 

HongKong is a Special Administrative Region of the PRC with its own government andlegislature. Hong Kong enjoys a high degree of autonomy from the PRC under theprinciple of “one country, two systems.” We can give no assurance that HongKong will continue to enjoy autonomy from the PRC.

 

TheHong Kong dollar has remained relatively constant due to the U.S. dollar pegand currency board system that has been in effect in Hong Kong since 1983.Since mid-1997, interest rates in Hong Kong have fluctuated significantly andreal estate and retail sales have declined. We can give no assurance that theHong Kong economy will not worsen or that the historical currency peg of theHong Kong dollar to the U.S. dollar will be maintained. Continued decliningconsumer spending in Hong Kong, deflation or the discontinuation of thecurrency peg could adversely affect our business.

 

*Weare exposed to currency fluctuations and instability in the Asian markets*

* *

Weexpect that international sales will continue to represent a significantportion of our total revenues. To date, all of our licensing revenues have beendenominated in U.S. dollars and most costs have been incurred in U.S. dollars.It is our expectation that licensing revenues will continue to be denominatedin U.S. dollars for the foreseeable future. Because Valence’s business isprimarily focused in Asia and because of our anticipated expansion of businessin the PRC and other parts of Asia, our consolidated results of operations andfinancial position could be significantly affected by risks associated withinternational activities, including economic and labor conditions, politicalinstability, tax laws (including U.S. taxes on foreign subsidiaries) andchanges in the value of the U.S. dollar versus the local currency in which theproducts are sold. In addition, our valuation of assets recorded as a result ofthe Valence acquisition may also be adversely impacted by the currencyfluctuations relative to the U.S. dollar. We intend to actively monitor our****foreign exchange exposure and to implementstrategies to reduce our foreign exchange risk at such time that we determinethe benefits of such strategies outweigh the associated costs. However, thereis no guarantee that we will take steps to insure against such risks, andshould such risks occur, there is no guarantee that we will not besignificantly impacted.

 

*Ifthe sale of consumer electronics products incorporating our technologies doesnot grow in emerging markets, our ability to increase our licensing revenue maybe limited*

* *

Wealso expect that growth in our licensing revenue will depend, in part, upon thegrowth of sales of consumer electronics products incorporating our technologiesin other countries, including China and India, as consumers in these marketshave more disposable income and are increasingly purchasing entertainmentproducts with surround sound capabilities. However, if our licensing revenuefrom the use of our technologies in these new markets or geographic areas doesnot expand, our prospects could be adversely affected.

 

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*Weare subject to competitive pressures*

* *

Ourexisting and potential competitors include both large and emerging domestic andinternational companies that have substantially greater financial,manufacturing, technical, marketing, distribution and other resources. Presentor future competitors may be able to develop products and technologiescomparable or superior to ours, and to adapt more quickly than us to newtechnologies or evolving market needs. We believe that the competitive factorsaffecting the market for our products and technologies include productperformance, price and quality; product functionality and features; the ease ofintegration; and implementation of the products and technologies with otherhardware and software components in the OEM’s products. In addition, themarkets in which we compete are intensely competitive and are characterized byrapid technological changes, declining average sales prices and rapid productobsolescence. Accordingly, there can be no assurance that we will be able tocontinue to compete effectively in its respective markets, that competitionwill not intensify or that future competition will not have a material adverseeffect on our business, operating results, cash flows and financial condition.

 

*Wehave a long and unpredictable sales cycle, which can result in uncertainty anddelays in generating additional revenues*

* *

Historically,because of the complexity of our technologies, it can take a significant amountof time and effort to explain the benefits and to negotiate a sale. Forexample, it typically takes six to nine months after our first contact with aprospective customer before we start licensing our technology to that customer.In addition, purchase of our products is usually made in connection with newdesign starts, the timing of which is outside of our control. Accordingly, wemay be unable to predict accurately the timing of any significant future salesof our products. We may also spend substantial time and management attention onpotential license agreements that are not consummated, thereby foregoing otheropportunities.

 

*Westrongly rely on our intellectual property*

* *

Ourability to compete may be affected by our ability to protect our proprietaryinformation. We have filed numerous U.S. and foreign patent applications and todate have a number of issued U.S. and foreign patents covering various aspectsof our technologies. There can be no assurance that the steps taken by us toprotect our intellectual property will be adequate to prevent misappropriationof our technology or that our competitors will not independently developtechnologies that are substantially equivalent or superior to our technology.In addition, the laws of certain foreign countries may not protect ourintellectual property rights to the same extent, as do the laws of the U.S. Thesemiconductor industry is characterized by frequent claims and litigationregarding patent and other property rights. We are not currently a party to anyclaims of this nature. There can be no assurances that third parties will notassert claims or initiate litigation against us or our customers with respectto existing or future products. In addition, we may initiate claims orlitigation against third parties for infringement of our proprietary rights orto determine the scope and validity of our proprietary rights.

 

*Wedepend on our key personnel*

* *

Ourfuture success depends to a large extent upon the continued service of keypersonnel, including engineering, sales and marketing staff, and highly skilledsemiconductor design staff. We anticipate that any future growth will requireus to recruit and hire a number of new personnel in engineering, operations,finance, sales and marketing. Competition for such personnel can be intense,and there can be no assurance that we can recruit and retain necessarypersonnel to operate our business and support future growth.

 

*Themarket price of our common stock is volatile*

* *

Thetrading price of our common stock has been, and will likely continue to be,subject to wide fluctuations in response to quarterly variations in ouroperating results, announcements of new products or technological innovationsby us or our competitors, strategic alliances between us and third parties,general market fluctuations and other events and factors. Changes in earningsestimates made by brokerage firms and industry analysts relating to the marketsin which we do business, or relating to us specifically, have in the pastresulted in, and could in the future result in, an immediate and adverse effecton the market price of the common stock. Even though our stock is quoted on theNasdaq Stock Market, our stock has had and may continue to have low tradingvolume and high volatility. The historically low trading volume of our stockmakes it more likely that a severe fluctuation in volume, either up or down,will significantly impact the stock price. Since our shares are thinly traded,our shareholders may have difficulty selling our common stock.

 

*Ourcertificate of incorporation, bylaws, change in control agreements withofficers and key employees,  as well asDelaware law contain provisions that could discourage transactions resulting ina change in control, which may negatively affect the market price of our commonstock*

* *

Ourcertificate of incorporation, bylaws, change in control agreements withofficers and key employees and Delaware law contain provisions that mightenable our management to discourage, delay or prevent 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.

 

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**Item 3.  Quantitativeand Qualitative Disclosures about 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 31,2004.

 

**Item 4.  Controls andProcedures**

 

*Evaluationof Disclosure Controls and Procedures*

 

We conductedan evaluation of the effectiveness of the design and operation of ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) asof the end of the period covered by this Quarterly Report. The controlsevaluation was done under the supervision and with the participation ofmanagement, including our Chief Executive Officer and Chief Financial Officer.Based on their evaluation as of the end of the period covered by this QuarterlyReport, our Chief Executive Officer and Chief Financial Officer have concludedthat our disclosure controls and procedures are effective.

 

*Changes inInternal Controls*

 

On May 10, 2005, management of theCompany was advised by BDO Seidman, LLP, its independent registered publicaccounting firm (“BDO Seidman”), of the conclusion reached by it regarding theCompany’s interim accounting for sales and marketing expenses related to tradeshows.  This conclusion was reached inconnection with BDO Seidman’s financial statement review procedures relating tothe Company’s Quarterly Report on Form 10-Q for the first quarter of theyear ending December 31, 2005 (“fiscal 2005”).  Commencing in the first quarter of the fiscalyear ended December 31, 2004 (“fiscal 2004”), the Company began tocapitalize and amortize trade show expenses incurred in the fiscal year toreflect the future economic benefits received during such fiscal year.  Management discussed the issue with the AuditCommittee of the Company’s Board of Directors and BDO Seidman and was of theview that capitalization and amortization of trade show expenses wasallowable.  As part of the first quarterfiscal 2005 review, BDO Seidman noted that trade show costs previouslycapitalized and amortized should have been treated as period expenses in fiscal2004.  As a result, BDO Seidman expressedits view that (a) trade show costs previously capitalized and amortizedduring fiscal 2004 should have been treated as period expenses in fiscal 2004; (b) eachof the Company’s quarterly reports previously filed in fiscal 2004 should beamended; and (c) no reliance should be placed on the previously issuedfiscal 2004 quarterly financial statements. We restated our financial results for the quarters ended March 31, June 30,and September 30, 2004 to reflect adjustments to our previously reportedfinancial information.  In addition, theCompany’s annual report on Form 10-K for fiscal 2004 has been amended toreflect the restated quarterly results including the quarter ended December 31,2004.

 

In the course of BDO Seidman’s financialstatement review procedures relating to the Quarterly Report on Form 10-Qfor the first quarter of fiscal 2005, BDO Seidman advised the Company that theCompany’s improper interpretation of accounting literature with respect tointerim accounting for sales and marketing expenses related to trade showexpenses described above constituted a deficiency in the Company’s internalcontrols and advised the Audit Committee that this internal control deficiencyconstitutes a reportable condition and a material weakness as defined inStatement on Auditing Standards No. 60. As a result of this internal control deficiency, the Company hasimplemented in the quarterly period covered by this report more formalprocedures regarding changes in accounting treatment and related communicationswith the Company’s Audit Committee and the Company’s independent registeredpublic accounting firm.

 

The Company believes that these correctiveactions, taken as a whole, will remediate the control deficiency identifiedabove, but the Company will continue to monitor the effectiveness of theseactions and will make any other changes or take such other actions asmanagement determines to be appropriate.

 

Except for the controls described above, nochange in the Company’s internal controls over financial reporting (as definedin Rules 13a-15(f) and 15d-15(f) under the Exchange Act)occurred during the second quarter ended June 30, 2005, that hasmaterially affected, or is reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

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**PART II — OTHER INFORMATION**

 

**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds**

 

   On March 24, 2005, the Company’s Board ofDirectors authorized the repurchase of up to $3,000,000 of the outstandingshares of the Company’s common stock for a period from January 1, 2005 toDecember 31, 2005 (the “2005 Repurchase Program”). As of June 30, 2005, 232,223shares had been repurchased under the 2005 Repurchase Program. Purchases may bemade from time to time in the open market, block purchases or privatelynegotiated transactions, depending on market conditions, share price and otherfactors.  All repurchased shares arereflected as treasury stock in the accompanying consolidated balance sheets.The following table details our common stock repurchases for the three monthsended June 30, 2005:  

 

**Issuer Purchases of Equity Securities**

 
| ** **              | ** ** | **(a)**                                           | ** ** | **(b)**                                     | ** ** | **(c)**                                                                                              | ** ** | **(d)**                                                                                                                                 | ** ** |
|-------------------------|------------|---------------------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Period**              | ** ** | **Total Number of  Shares (or Units)  Purchased** | ** ** | **Average Price Paid  per Share (or Unit)** | ** ** | **Total Number of  Shares (or Units)  Purchased as Part  of Publicly  Announced Plans  or Programs** | ** ** | **Maximum Number  (or Approximate  Dollar Value) of  Shares (or Units)  that May Yet Be  Purchased Under  the Plans or  Programs** | ** ** |
| April  1-30,  2005 |       | 150,311                                           |       | $                                           | 3.97       |                                                                                                 | 150,311    | ** **                                                                                                                              | **$**      | 2,403,281 | ** ** |
| May  1-31, 2005    |       | 38,370                                            | ** ** | **$**                                       | 5.57       |                                                                                                 | 188,681    | ** **                                                                                                                              | **$**      | 2,189,739 | ** ** |
| June 1-30, 2005    |       | 43,542                                            | ** ** | **$**                                       | 5.73       |                                                                                                 | 232,223    | ** **                                                                                                                              | **$**      | 1,940,410 | ** ** |

 

**Item 4.    Submissionof Matters to a Vote of Security Holders**

 

The AnnualMeeting of Stockholders of SRS Labs, Inc. was held on June 22, 2005 for thepurpose of (a) electing two Class III directors to the Board of Directors and(b) voting on a proposal to ratify the appointment of BDO Seidman LLP asindependent auditors for the fiscal year ending December 31, 2005.

 

Sam Yau andThomas C.K. Yuen were elected to serve as a Class III Directors of the Companyfor a three-year term expiring at the 2008 Annual Meeting of Stockholders.  Carol Miltner and Winston Hickman continuedas Class I Directors and David R. Dukes continued in office as a Class IIDirector.  The tabulation of the votescast for the election of Messrs. Yau and Yuen was as follows:

 
| **Nominee**        | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|--------------------|------------|---------------|------------|--------------------|------------|
| Sam Yau            |       | 11,802,570    |       | 660,576            |       |
| Thomas C. K.  Yuen |       | 12,422,580    |       | 43,566             |       |

 

The proposalto ratify the appointment of BDO Seidman LLP as independent auditors for thefiscal year ending December 31, 2005 was approved.  The tabulation of votes was as follows:

 
| **Votes For** | ** ** | **Votes Against** | ** ** | **Abstentions** | ** ** | **Broker Non-Votes** | ** ** |
|---------------|------------|-------------------|------------|-----------------|------------|----------------------|------------|
| 12,139,455    |       | 324,771           |       | 1,920           |       | 0                    |       |

 

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**Item6.  Exhibits**

 

Theexhibits listed below are hereby filed with the U.S. Securities and Exchange Commissionas part of this Report.

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                 |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Certificate of Incorporation of  the Company, previously filed with the Commission 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 Commission 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 Commission as Exhibit 3.1 to the Company’s  Quarterly Report on Form 10-Q for the period ended September 30, 1999, filed  with the Commission on November 12, 1999, which is incorporated herein by  reference.                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.1                |       | SRS Labs, Inc. 2005  Change in Control Protection Plan, previously filed with the Commission as  Exhibit 10.1 to the Form 8-K filed with the Commission on  May 2, 2005, which is incorporated herein by reference.                                                                                                                         |
|                |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.2                |       | Form of Participation  Agreement under the SRS Labs, Inc. 2005 Change in Control Protection  Plan for Select Executive Officers (with schedule of parties attached),  previously filed with the Commission as Exhibit 10.2 to the  Form 8-K filed with the Commission on May 2, 2005, which is  incorporated herein by reference. |
|                |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.3                |       | Form of Participation  Agreement under the SRS Labs, Inc. 2005 Change in Control Protection  Plan for Select Employees (with schedule of parties attached),  previously filed with the Commission as Exhibit 10.3 to the  Form 8-K filed with the Commission on May 2, 2005, which is  incorporated herein by reference.          |
|                |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.4                |       | SRS  Labs, Inc. 2005 Profit Sharing and Bonus Plan, previously filed with the  Commission as Exhibit 10.4 to the Form 8-K filed with the  Commission on May 2, 2005, which is incorporated herein by reference.                                                                                                                             |
|                |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.5                |       | SRS Labs, Inc.  Amended and Restated 1996 Long-Term Incentive Plan, as amended, previously  filed with the Commission as Exhibit 10.5 to the Form 8-K filed  with the Commission on May 2, 2005, which is incorporated herein by  reference.                                                                                                |
|                |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.6                |       | Form of Nonqualified  Stock Option Agreement (with schedule of parties attached), previously  filed with the Commission as Exhibit 10.1 to the Form 8-K filed  with the Commission on April 4, 2005, which is incorporated herein by  reference.                                                                                       |
|                |       |                                                                                                                                                                                                                                                                                                                                                            |
| 31.1                |       | Certification of Chief  Executive Officer of SRS Labs, Inc., pursuant to Rule 13a-14 of the  Securities Exchange Act.                                                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                                                            |
| 31.2                |       | Certification of Chief  Financial Officer of SRS Labs, Inc., pursuant to Rule 13a-14 of the  Securities Exchange Act.                                                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                                                            |
| 32.1                |       | Certification of Chief  Executive Officer of SRS Labs, Inc., pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                            |
| 32.2                |       | Certification of Chief  Financial Officer of SRS Labs, Inc., pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                              |

 

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**SIGNATURES**

 

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:  August 11, 2005 | By:                                         | /s/ THOMAS C.K. YUEN |   |
|                                  |                                        | Thomas C.K. Yuen |
|                                  |                                        | Chairman of the Board and Chief Executive Officer |
|                                  |                                        | (Principal Executive Officer) |
| ** **                            | ** **                                  | ** ** |
| ** **                            | ** **                                  | ** ** |
| Date:  August 11, 2005 | By:                                         | /s/ JANET M. BISKI |   |
|                                  |                                        | Janet M. Biski |
|                                  |                                        | Chief Financial Officer |
|                                  |                                        | (Principal Financial and Accounting Officer) |

 

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