**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

----

 

| **(Mark One)**                                                                                                                                        |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|
| **ý**                                                                                                                                            | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                  |
| **For the quarterly period ended March 31, 2003**                                                                                                     |
|                                                                                                                                                  |
| **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 of registrant as specified in its charter)

 

----

 

| **Delaware**                                                                        |   | **33-0714264**                        |
|-------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                     |   | (I.R.S. Employer  Identification No.) |
|                                                                                |
| **2909 Daimler Street, Santa Ana, California 92705**                                |
| (Address of principal executive offices) (Zip Code)                                 |
|                                                                                |
| **(949) 442-1070**                                                             |
| (Registrant’s telephone number, including area code)                           |
|                                                                                |
| **Not Applicable**                                                                  |
| (Former name, former address and former fiscal year, if changed since  last report) |

 

----

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes ý No o

 

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

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date: as of May 9,2003, 13,213,498 of the issuer’s common stock, par value $.001 per share, wereoutstanding. In addition, as of May 9, 2003, 225,300 shares of the issuer’scommon stock were held as treasury shares.

 

 

----

 

**SRS LABS, INC.**

 

**Form 10-Q**

**For the Period Ended March 31, 2003**

 

**Index**

 
| **PART  I—FINANCIAL INFORMATION** |
|----------------------------------------|
| Item 1.                                | Financial Statements |
|                                   | Condensed  Consolidated Balance Sheets as of March 31, 2003 (Unaudited) and  December 31, 2002 (Audited) |
|                                   | Condensed  Consolidated Statements of Operations for the three months ended March 31,  2003 and 2002 (Unaudited) |
|                                   | Condensed  Consolidated Statements of Stockholders’ Equity and Comprehensive Income  (Loss) for the three months ended March 31, 2003 (Unaudited) |
|                                   | Condensed  Consolidated Statements of Cash Flows for the three months ended March 31,  2003 and 2002 (Unaudited) |
|                                   | Notes  to the Condensed Interim 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.                               | Changes  in Securities and Use of Proceeds |
| Item 6.                                | Exhibits and  Reports on Form 8-K |
| SIGNATURES                             |
| CERTIFICATIONS                         |

 

----

 

**FORWARD-LOOKING INFORMATION**

 

This Quarterly Report on Form 10-Q contains forward-lookingstatements within the meaning of Section 21E of the Securities ExchangeAct of 1934, as amended, and Section 27A of the Securities Act of 1933, asamended, reflecting management’s current expectations. Examples of suchforward-looking statements include the expectations of the Company with respectto its strategy. Although the Company believes that its expectations are basedupon reasonable assumptions, there can be no assurances that the Company’sfinancial goals will be realized. Such forward-looking statements involve knownand unknown risks, uncertainties and other factors that may cause the actualresults, performance or achievements of the Company, or industry results, to bematerially different from any future results, performance or achievementsexpressed or implied by such forward-looking statements. Numerous factors mayaffect the Company’s actual results and may cause results to differ materiallyfrom those expressed in forward-looking statements made by or on behalf of theCompany. For this purpose, any statements contained herein that are notstatements of historical fact may be deemed to be forward-looking statements.Without limiting the foregoing, the words, “believes,” “anticipates,” “plans,”“expects” and similar expressions, are intended to identify forward-looking statements.The important factors discussed in Part I, Item 2, “Management’sDiscussion and Analysis of Financial Condition and Results ofOperations—Factors That May Affect Future Results”, herein, among others, couldcause actual results to differ materially from those indicated byforward-looking statements made herein and presented elsewhere by management.Such forward-looking statements represent management’s current expectations andare inherently uncertain. Investors are warned that actual results may differfrom management’s expectations. The Company assumes no obligation to update theforward-looking information to reflect actual results or changes in the factorsaffecting such forward-looking information.

 

1

----

 

**PART I****— FINANCIAL INFORMATION**

 

**Item 1.Financial Statements****.**

 

**SRS LABS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

** **
|                                                                                                                                                                                                                     |   | **March 31, 2003** |       | **December 31, 2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|----------------------------|--------|
|                                                                                                                                                                                                                     |   | **(Unaudited)**    |       |                       |   |
| **ASSETS**                                                                                                                                                                                                               |   |               |       |                       |   |
| **Current Assets**                                                                                                                                                                                                       |   |               |       |                       |   |
| Cash and cash equivalents                                                                                                                                                                                                |   | $                  | 13,225,769 |                       | $      | 15,720,860 |   |
| Accounts receivable, net                                                                                                                                                                                                 |   | 920,282            |       | 1,074,421                  |   |
| Inventories, net                                                                                                                                                                                                         |   | 855,092            |       | 807,382                    |   |
| Prepaid expenses and other current assets                                                                                                                                                                                |   | 407,870            |       | 462,442                    |   |
| Deferred income taxes                                                                                                                                                                                                    |   | 36,147             |       | 36,147                     |   |
|                                                                                                                                                                                                                     |   |               |       |                       |   |
| **Total Current Assets**                                                                                                                                                                                                 |   | 15,445,160         |       | 18,101,252                 |   |
|                                                                                                                                                                                                                     |   |               |       |                       |   |
| Investments available for sale                                                                                                                                                                                           |   | 8,540,024          |       | 6,630,771                  |   |
| Furniture, fixtures & equipment,  net                                                                                                                                                                           |   | 1,870,616          |       | 1,935,424                  |   |
| Goodwill, net                                                                                                                                                                                                            |   | 1,173,102          |       | 533,031                    |   |
| Intangible assets, net                                                                                                                                                                                                   |   | 1,908,903          |       | 1,957,359                  |   |
| Deferred income taxes                                                                                                                                                                                                    |   | 147,190            |       | 149,498                    |   |
|                                                                                                                                                                                                                     |   |               |       |                       |   |
| **Total Assets**                                                                                                                                                                                                         |   | $                  | 29,084,995 |                       | $      | 29,307,335 |   |
|                                                                                                                                                                                                                     |   |               |       |                       |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                            |   |               |       |                       |   |
| **Current Liabilities**                                                                                                                                                                                                  |   |               |       |                       |   |
| Accounts payable                                                                                                                                                                                                         |   | $                  | 815,604    |                       | $      | 1,011,032 |   |
| Accrued liabilities                                                                                                                                                                                                      |   | 1,715,192          |       | 2,347,702                  |   |
| Income taxes payable                                                                                                                                                                                                     |   | 323,448            |       | 341,172                    |   |
|                                                                                                                                                                                                                     |   |               |       |                       |   |
| **Total Current Liabilities**                                                                                                                                                                                            |   | 2,854,244          |       | 3,699,906                  |   |
| Minority interest                                                                                                                                                                                                        |   | —             |       | 325,371                    |   |
| Commitments and contingencies                                                                                                                                                                                            |   |               |       |                       |   |
|                                                                                                                                                                                                                     |   |               |       |                       |   |
| **Stockholders’ Equity**                                                                                                                                                                                            |   |               |       |                       |   |
| Preferred stock—$.001 par value; 2,000,000  shares authorized; no shares issued and outstanding                                                                                                                     |   | —             |       | —                     |   |
| Common stock—$.001 par value; 56,000,000  shares authorized; 13,213,498 and 12,876,314 shares issued; and 12,988,198  and 12,651,014 shares outstanding at March 31, 2003 and December 31,  2002, respectively |   | 13,214             |       | 12,877                     |   |
| Additional paid in capital                                                                                                                                                                                               |   | 56,957,625         |       | 55,966,589                 |   |
| Cumulative other comprehensive loss                                                                                                                                                                                      |   | (173,778           | )          | (88,564                    | )      |
| Accumulated deficit                                                                                                                                                                                                      |   | (29,847,709        | )          | (29,890,243                | )      |
| Less treasury stock at cost, 225,300 shares  at March 31, 2003 and at December 31, 2002                                                                                                                                  |   | (718,601           | )          | (718,601                   | )      |
|                                                                                                                                                                                                                     |   |               |       |                       |   |
| Total Stockholders’ Equity                                                                                                                                                                                          |   | 26,230,751         |       | 25,282,058                 |   |
|                                                                                                                                                                                                                     |   |               |       |                       |   |
| Total Liabilities and Stockholders’ Equity                                                                                                                                                                          |   | $                  | 29,084,995 |                       | $      | 29,307,335 |   |

 

See accompanying notes to the condensed interim consolidated financialstatements

 

2

----

 

**SRS LABS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                                                    |   | **Three Months Ended  March 31,** |      |
|-----------------------------------------------------------------------------------------|--------|-----------------------------------|-----------|
|                                                                                    |   | **2003**                          |      | **2002** |   |
|                                                                                    |   |                              |      |   |   |
| Revenues:                                                                               |   |                              |      |   |   |
| Licensing                                                                               |   | $                                 | 2,628,311 |   | $ | 1,795,722 |   |
| Semiconductor                                                                           |   | 1,711,819                         |      | 1,471,142 |   |
| Other                                                                                   |   | 130,244                           |      | 288,516 |   |
| Total revenues                                                                          |   | 4,470,374                         |      | 3,555,380 |   |
|                                                                                    |   |                              |      |   |   |
| Cost of sales                                                                           |   | 669,568                           |      | 793,345 |   |
|                                                                                    |   |                              |      |   |   |
| Gross margin                                                                            |   | 3,800,806                         |      | 2,762,035 |   |
|                                                                                    |   |                              |      |   |   |
| Operating expenses:                                                                     |   |                              |      |   |   |
| Sales and marketing                                                                     |   | 1,352,490                         |      | 1,260,440 |   |
| Research and development                                                                |   | 1,081,215                         |      | 965,076 |   |
| General and administrative                                                              |   | 1,314,610                         |      | 1,233,525 |   |
|                                                                                    |   |                              |      |   |   |
| Total operating expenses                                                                |   | 3,748,315                         |      | 3,459,041 |   |
|                                                                                    |   |                              |      |   |   |
| Income (loss) from operations                                                           |   | 52,491                            |      | (697,006 | ) |
|                                                                                    |   |                              |      |   |   |
| Other income, net                                                                       |   | 164,126                           |      | 87,963 |   |
| Minority interest                                                                       |   | 5,430                             |      | 19,748 |   |
|                                                                                    |   |                              |      |   |   |
| Income (loss) before income tax expense                                                 |   | 222,047                           |      | (589,295 | ) |
|                                                                                    |   |                              |      |   |   |
| Income tax expense                                                                      |   | 179,513                           |      | 101,438 |   |
|                                                                                    |   |                              |      |   |   |
| Net income (loss)                                                                       |   | $                                 | 42,534    |   | $ | (690,733 | ) |
|                                                                                    |   |                              |      |   |   |
| Net income (loss) per common share:                                                     |   |                              |      |   |   |
| Basic                                                                                   |   | $                                 | 0.00      |   | $ | (0.05 | ) |
|                                                                                    |   |                              |      |   |   |
| Diluted                                                                                 |   | $                                 | 0.00      |   | $ | (0.05 | ) |
|                                                                                    |   |                              |      |   |   |
| Weighted average shares used in the  calculation of net income (loss) per common share: |   |                              |      |   |   |
| Basic                                                                                   |   | 12,798,238                        |      | 12,669,407 |   |
|                                                                                    |   |                              |      |   |   |
| Diluted                                                                                 |   | 12,983,526                        |      | 12,669,407 |   |

 

 See accompanying notes to thecondensed interim consolidated financial statements

 

3

----

 

**SRS LABS, INC.**

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

** **
|                                                           |             |       |       | **Additional  Paid-In  Capital** |   | **Accumulated  Other  Comprehensive********Income (Loss)** |   | **Accumulated****Deficit** |   | **Treasury  Stock** |     | **Total** |   | **Comprehensive********Income (Loss)********for the Periods  Ended** |   |
|----------------------------------------------------------------|------------------|------------|------------|----------------------------------|--------|------------------------------------------------------------|--------|----------------------------|--------|---------------------|----------|-----------|--------|----------------------------------------------------------------------|--------|
|                                                           |             |       |
|                                                           | **Common Stock** |       |
|                                                           | **Shares**       |       | **Amount** |                             |
|                                                           |             |       |       |                             |   |                                                       |   |                       |   |                |     |      |   |                                                                 |   |   |   |
| BALANCE, Dec 31, 2002                                          |             | 12,651,014 |       | $                                | 12,877 |                                                       | $      | 55,966,589                 |   | $                   | (88,564  | )         | $      | (29,890,243                                                          | )      | $ | (718,601 | ) | $ | 25,282,058 |   | $ | 791,843 |   |
| Proceeds from exercise of  stock options                       |             | 5,000      |       | 5                                |   | 13,120                                                     |   | —                     |   | —              |     | —    |   | 13,125                                                               |   |   |   |
| Deferred stock option  compensation                            |             | —     |       | —                           |   | 18,236                                                     |   | —                     |   | —              |     | —    |   | 18,236                                                               |   |   |   |
| Issuance of Common Stock                                       |             | 332,184    |       | 332                              |   | 959,680                                                    |   | —                     |   | —              |     | —    |   | 960,012                                                              |   |   |   |
| Unrealized loss on  investments available for sale, net of tax |             | —     |       | —                           |   | —                                                     |   | (85,214                    | )      | —              |     | —    |   | (85,214                                                              | )      | $ | (85,214 | ) |
| Net income                                                     |             | —     |       | —                           |   | —                                                     |   | —                     |   | 42,534              |     |      |   | 42,534                                                               |   | 42,534 |   |
|                                                           |             |       |       |                             |   |                                                       |   |                       |   |                |     |      |   |                                                                 |   |   |   |
| BALANCE, March 31, 2003                                        |             | 12,988,198 |       | $                                | 13,214 |                                                       | $      | 56,957,625                 |   | $                   | (173,778 | )         | $      | (29,847,709                                                          | )      | $ | (718,601 | ) | $ | 26,230,751 |   | $ | 749,163 |   |
|                                                                |                  |            |            |                                  |        |                                                            |        |                            |        |                     |          |           |        |                                                                      |        |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to the condensed interim consolidated financialstatements

 

4

----

 

**SRS LABS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

** **
|                                                                                       |   | **Three Months Ended  March 31,** |       |
|--------------------------------------------------------------------------------------------|--------|-----------------------------------|------------|
|                                                                                       |   | **2003**                          |       | **2002** |   |
|                                                                                       |   |                              |       |   |   |
| **Cash Flows From Operating  Activities:**                                                 |   |                              |       |   |   |
| Net income (loss)                                                                          |   | $                                 | 42,534     |   | $ | (690,733 | ) |
| Adjustments to reconcile net loss to net  cash (used in) provided by operating activities: |   |                              |       |   |   |
| Depreciation and amortization                                                              |   | 286,115                           |       | 352,407 |   |
| Minority interest                                                                          |   | (5,430                            | )          | (19,748 | ) |
| Provision for doubtful accounts                                                            |   | 8,804                             |       | 38,319 |   |
| Provision for obsolete inventory                                                           |   | (27,108                           | )          | 93,714 |   |
| Deferred Taxes                                                                             |   | 2,308                             |       | — |   |
| Amortization of premium on investments  available for sale                                 |   | —                            |       | 263 |   |
| Increase in deferred stock option  compensation                                            |   | 18,236                            |       | 13,703 |   |
| Changes in operating assets and  liabilities:                                              |   |                              |       |   |   |
| Accounts receivable                                                                        |   | 145,335                           |       | (356,106 | ) |
| Inventories                                                                                |   | (20,602                           | )          | 2,092 |   |
| Prepaid expenses and other current assets                                                  |   | 54,572                            |       | 242,633 |   |
| Accounts payable                                                                           |   | (195,428                          | )          | (20,354 | ) |
| Accrued liabilities                                                                        |   | (632,510                          | )          | 336,041 |   |
| Income taxes payable                                                                       |   | (17,724                           | )          | 9,148 |   |
|                                                                                       |   |                              |       |   |   |
| Net cash (used in) provided by operating  activities                                       |   | (340,898                          | )          | 1,379 |   |
|                                                                                       |   |                              |       |   |   |
| **Cash Flows From Investing  Activities:**                                                 |   |                              |       |   |   |
| Purchase of furniture, fixtures and  equipment                                             |   | (120,843                          | )          | (93,747 | ) |
| Purchase of investments available for sale                                                 |   | (1,994,467                        | )          | — |   |
| Expenditures related to patents and  intangible assets                                     |   | (52,008                           | )          | — |   |
|                                                                                       |   |                              |       |   |   |
| Net cash used in investing activities                                                      |   | (2,167,318                        | )          | (93,747 | ) |
|                                                                                       |   |                              |       |   |   |
| **Cash Flows From Financing  Activities:**                                                 |   |                              |       |   |   |
| Proceeds from exercise of stock options                                                    |   | 13,125                            |       | 28,381 |   |
|                                                                                       |   |                              |       |   |   |
| Net cash provided by financing activities                                                  |   | 13,125                            |       | 28,381 |   |
|                                                                                       |   |                              |       |   |   |
| **Net Decrease in Cash and  Cash Equivalents**                                             |   | (2,495,091                        | )          | (63,987 | ) |
| **Cash and Cash Equivalents,  Beginning of Period**                                        |   | 15,720,860                        |       | 19,011,167 |   |
|                                                                                       |   |                              |       |   |   |
| **Cash and Cash Equivalents,  End of Period**                                              |   | $                                 | 13,225,769 |   | $ | 18,947,180 |   |
|                                                                                       |   |                              |       |   |   |
| **Supplemental Disclosures  of Cash Flow Information:**                                    |   |                              |       |   |   |
| Cash paid during the period for:                                                           |   |                              |       |   |   |
| Income taxes                                                                               |   | $                                 | 209,491    |   | $ | 92,290 |   |
| **Supplemental Disclosure of  Non-Cash Investing and Financing Activities:**               |   |                              |       |   |   |
| Unrealized (loss) on investments, net                                                      |   | $                                 | (85,214    | ) | $ | (2,407 | ) |
| Issuance of Common stock for minority  interest                                            |   | $                                 | 960,012    |   | — |   |

 

See accompanying notes to the condensed interim consolidated financialstatements

 

5

----

 

**1.****                                     ****General/Basis ofPresentation**

 

SRS Labs is a leading developer and provider of application specificintegrated circuits (“ASICs”), standard integrated circuits (“ICs”) and audioand voice technology solutions for the home theater, portable audio, wireless,computer, game, automotive, broadcast, Internet and telecommunications markets.The Company operates its business through three operating units: SRS Labs, theparent company; its wholly-owned subsidiary, SRSWOWcast.com, Inc., doingbusiness as SRSWOWcast Technologies (“SRSWOWcast”); and its wholly-ownedsubsidiary, ValenceTech Limited, and ValenceTech Limited’s wholly-ownedsubsidiaries (collectively “Valence”). SRS Labs and its wholly-owned subsidiaries together are herebycollectively referred to as the “Company”.

 

The Company operates in three business units in the following fivebusiness segments:

 

***SRS Labs***

 

*Licensing**:***  TheCompany’s licensing segment develops and licenses audio and voice technologiesto many of the world’s leading original equipment manufacturers (“OEMs”),software providers and semiconductor manufacturers.

 

*Products**:***  Theproduct segment develops and sells consumer products that incorporateproprietary audio and speaker technologies.

 

***Valence***

 

*Semiconductor:*  Thesemiconductor segment develops and sells technology solutions in the form ofanalog and digital signal processor (“DSP”) ASIC semiconductors or otherimbedded custom semiconductor designs to OEMs around the world.

 

*Component Distribution:*  Thecomponent distribution segment is an authorized, non-exclusive distributor ofsemiconductor components, subassemblies and finished goods for selected OEMcustomers. The Company is no longer emphasizing this business due to itsdecision to focus on higher margin revenue. Although the Company expectsrevenues for this segment to decline further in the current year, it will continueto operate in this segment.

 

***SRSWOWcast***

 

*Internet and Broadcast:** ***The Company’s Internet and broadcast segmentdevelops and licenses software and hardware audio enhancement technologysolutions for the Internet and broadcast markets.

 

The accompanying condensed interim consolidated financial statementshave been prepared by the Company without audit in conformity with accountingprinciples generally accepted in the United States of America (“generallyaccepted accounting principles”) for interim financial information and with therules and regulations of the U.S. Securities and Exchange Commission (“SEC”).In the opinion of management, all adjustments (which include only normalrecurring adjustments) considered necessary for a fair presentation have beenincluded. Certain accounts have been reclassified from that previously reportedto conform to the current period presentation.

 

Certain information and footnote disclosures normally included infinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted pursuant to SEC rules and regulationsfor presentation of interim financial information. Therefore, the condensedinterim consolidated financial statements should be read in conjunction withthe Company’s Annual Report on Form 10-K for the fiscal year endedDecember 31, 2002. Current and future financial statements may not bedirectly comparable to the Company’s historical financial statements. Theresults of operations for the interim periods are not necessarily indicative ofthe results to be expected for the full year.

 

6

----

 

**2.****                                     ****Goodwill and IntangibleAssets**

 

On January 1, 2002 the Company adopted SFAS No. 142 “Goodwilland Other Intangible Assets”, which, among other things, establishes newstandards for goodwill acquired in a business combination, eliminates theamortization of goodwill and requires the carrying value of goodwill andidentifiable intangibles to be evaluated for impairment on an annual basis.Identifiable intangible assets with a determinable useful life are amortizedover that period.

 

In accordance with SFAS No. 142, all of our intangible assets thathave definite lives are being amortized on a straight-line basis over theirestimated useful lives and goodwill is evaluated to determine if fair value ofthe asset has decreased below its carrying value. At December 31, 2002, weevaluated goodwill and determined that no adjustment to impair goodwill wasnecessary.

 

Goodwill and intangible assets consist of the following:

 
|                                |   | **March 31, 2003** |      | **December 31, 2002** |   |
|-------------------------------------|--------|--------------------|-----------|-----------------------|--------|
|                                |   |               |      |                  |   |
| Goodwill & assembled workforce  |   | $                  | 1,173,102 |                  | $      | 533,031 |   |
| Patents                             |   | 1,399,134          |      | 1,398,565             |   |
| Accumulated amortization            |   | (573,939           | )         | (590,365              | )      |
| Patents, net                        |   | 825,195            |      | 808,200               |   |
| Other intangibles                   |   | 5,030,400          |      | 5,030,400             |   |
| Accumulated amortization            |   | (3,946,692         | )         | (3,881,241            | )      |
| Other intangibles, net              |   | 1,083,708          |      | 1,149,159             |   |
| Goodwill and intangible assets, net |   | $                  | 3,082,005 |                  | $      | 2,490,390 |   |

 

In February 2003, SRS Labs completed an exchange offer with theminority shareholders of SRSWOWcast, pursuant to which SRS Labs acquired all3,000,000 outstanding shares of Series A Convertible Preferred Stock inexchange for the issuance of 332,184 shares of SRS Labs common stock. As aresult of the exchange offer, goodwill in the amount of $640,071 was recorded.

 

Amortizationperiods range from three to eleven years depending on the estimated useful lifeof the asset. Amortization expense consists of the following:

 
|                       |   | **Three months ended  March 31,** |    |
|----------------------------|--------|-----------------------------------|---------|
|                       |   | **2003**                          |    | **2002** |   |
|                       |   |                              |    |   |   |
| Patents                    |   | $                                 | 35,013  |   | $ | 32,751 |   |
| Other intangibles          |   | 65,451                            |    | 146,497 |   |
| Total amortization expense |   | $                                 | 100,464 |   | $ | 179,248 |   |
|                            |        |                                   |         |  |  |  |  |  |  |

 

7

----

 

Our weighted average amortization period for patents and otherintangibles is approximately 10 years. The following table shows theestimated amortization expense for those assets for the current year and eachof the four succeeding fiscal years.

 

| **Year ending  December 31,** |   | **Estimated expense** |    |
|-------------------------------|--------|-----------------------|---------|
|                          |   |                  |    |
| 2003                          |   | $                     | 348,595 |   |
| 2004                          |   | $                     | 340,621 |   |
| 2005                          |   | $                     | 340,621 |   |
| 2006                          |   | $                     | 340,621 |   |
| 2007                          |   | $                     | 318,036 |   |

 

**3.****                                     ****Investments Available forSale**

 

The Company has classified its investments as available-for-sale inaccordance with SFAS No. 115, “Accounting for Certain Investments in Debtand Equity Securities.”

 

Thefollowing table summarizes the Company’s investment securities available forsale:

 
|                                           |   | **March 31,  2003** |      | **December 31, 2002** |   |
|------------------------------------------------|--------|---------------------|-----------|-----------------------|--------|
|                                           |   |                |      |                  |   |
| U.S. Government securities available for sale: |   |                |      |                  |   |
| Cost                                           |   | $                   | 8,632,500 |                  | $      | 6,638,033 |   |
| Unrealized (losses)                            |   | (92,476             | )         | (7,262                | )      |
| Estimated fair value                           |   | $                   | 8,540,024 |                  | $      | 6,630,771 |   |

 

The contractual maturities of investments are shown below. Actualmaturities may differ from contractual maturities.

 
|                                           |   | **March 31, 2003** |      | **December 31, 2002**     |   |
|------------------------------------------------|--------|--------------------|-----------|---------------------------|--------|
|                                           |   | **Cost**           |      | **Estimated  Fair Value** |   | **Cost** |   | **Estimated  Fair Value** |   |
|                                           |   |               |      |                      |   |   |   |   |   |
| U.S. Government securities available for sale: |   |               |      |                      |   |   |   |   |   |
| Due in one to five years                       |   | $                  | 8,632,500 |                      | $      | 8,540,024 |   | $ | 6,638,033 |   | $ | 6,630,771 |   |
|                                                |        |                    |           |                           |        |  |  |  |  |  |  |  |  |

 

**4.****                                     ****Inventories**

 

Inventories, which consist of finished goods, are stated at the lowerof cost or net realizable value. Cost is calculated using the weighted averagemethod and is comprised of material costs and, where applicable, subcontractingand overhead costs that have been incurred in bringing the inventories to theirpresent location and condition. Net realizable value represents the estimatedselling price less costs to be incurred in selling and distribution.

 

8

----

 

**5.****                                     ****Minority Interest**

 

Minority interest represents the minority stockholders’ proportionateshare of the equity in the consolidated subsidiary SRSWOWcast. AtMarch 31, 2002 and December 31, 2002, the Company owned approximately 87%of the outstanding capital stock of SRSWOWcast. In February 2003, SRS Labscompleted an exchange offer with the minority shareholders of SRSWOWcast,pursuant to which SRS Labs acquired all 3,000,000 outstanding shares ofSeries A Convertible Preferred Stock in exchange for the issuance of 332,184shares of SRS Labs common stock. As a result of the exchange offer, SRSWOWcastbecame a wholly-owned subsidiary of SRS Labs. The proforma effect as if this transaction had occurred at the beginningof this quarter and the beginning of last year would have been immaterial.

 

**6.****                                     ****Stock-Based Compensation**

 

The Company accounts for stock-based awards to employees under therecognition and measurement principles of APB No. 25, “Accounting forStock Issued to Employees,” and related interpretations. The Company has adoptedthe disclosure-only provisions of FAS No. 123. Accordingly, no stock-basedemployee compensation cost is reflected in net income (loss), as all optionsgranted under the plan had an exercise price equal to the market value of theunderlying common stock on the date of grant. Had compensation cost for theCompany’s stock option plan been determined based on the fair value at thegrant date for awards for the three months ended March 31, 2003 and 2002,consistent with the provisions of FAS No. 123, the Company’s net income(loss) and earnings (loss) per share would have been increased to the pro formaamounts indicated below:

 
|                                                                                      |   | **For the  Quarter endedMarch 31,** |   |
|-------------------------------------------------------------------------------------------|--------|-------------------------------------|--------|
|                                                                                      |   | **2003**                            |   | **2002** |   |
|                                                                                      |   |                                |   |   |   |
| Net income (loss) (attributable to common shareholder)  — as reported                |   | $                                   | 42,534 |   | $ | (690,733 | ) |
| Add: deferred compensation expense already recognized                                     |   | 18,236                              |   | 13,703 |   |
| Less fair value of stock-based employee compensation  expense, net of related tax effects |   | (514,866                            | )      | (456,549 | ) |
| Net (loss) (attributable to common shareholder)—pro  forma                           |   | (454,096                            | )      | (1,133,579 | ) |
| Net (loss) per share (basic and diluted)—as reported                                 |   | $                                   | 0.00   |   | $ | (0.05 | ) |
| Net income (loss) per share (basic and diluted)—pro  forma                           |   | $                                   | (0.04  | ) | $ | (0.09 | ) |

 

The fair value of each option grant was estimated on the date of grantusing the Black-Scholes option-pricing model with the following weightedaverage assumptions used for grants in 2002. There have been no grants during the quarter ended March 31, 2003.

 

| Risk free interest rate |   | 3.60    | %      |
|-------------------------|--------|---------|--------|
| Expected life           |   | 5 years |   |
| Expected volatility     |   | 87      | %      |

 

Because FAS No. 123 has not been applied to options granted priorto January 1, 1995, the resulting pro forma compensation cost may not berepresentative of that to be expected in the future years.

 

9

----

 

**7.****                                     ****Net Income (Loss) Per CommonShare**

 

The Company applies SFAS No. 128, “Earnings per Share,” whichrequires the disclosure of basic and diluted net income or loss per share forall current and prior periods. Basic net income or loss per common share iscomputed by dividing net income or loss available to common stockholders by theweighted average number of common shares outstanding during each year. Dilutednet income or loss per common share reflects the maximum dilution, based on theaverage price of our common stock each period and is computed similar to basicincome or loss per share except that the denominator is increased to includethe number of additional shares that would have been outstanding if potentiallydilutive stock options and warrants had been exercised.

 

Basic and diluted net income (loss) per share computed in accordancewith SFAS 128 for the three months ended March 31 are as follows:

 

|                                                    |   | **For the Quarter**

**ended March 31,** |   |
|---------------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                    |   | **2003**                                      |   | **2002** |   |
|                                                    |   |                                          |   |   |   |
| BASIC EPS                                               |   |                                          |   |   |   |
| Net income (loss)                                       |   | $                                             | 42,534 |   | $ | (690,733 | ) |
| Denominator: weighted average common shares outstanding |   | 12,798,238                                    |   | 12,699,407 |   |
| Net income (loss) per share—basic                  |   | $                                             | 0.00   |   | $ | (0.05 | ) |
|                                                    |   |                                          |   |   |   |
| DILUTED EPS                                             |   |                                          |   |   |   |
| Net income (loss)                                       |   | $                                             | 42,534 |   | $ | (690,733 | ) |
| Denominator: weighted average common shares outstanding |   | 12,798,238                                    |   | 12,699,407 |   |
| Common equivalent shares outstanding:                   |   |                                          |   |   |   |
| Options                                                 |   | 185,288                                       |   | — |   |
| Total shares                                            |   | 12,983,526                                    |   | 12,699,407 |   |
| Net income (loss) per share—diluted                |   | $                                             | 0.00   |   | $ | (0.05 | ) |

 

There were 4,237,038 and 5,479,921 potentially dilutive optionsoutstanding at March 31, 2003 and 2002, respectively, that were not includedabove because they would be anti-dilutive.

 

**8.****                                     ****Commitments andContingencies**

 

The Company is subject to legal proceedings and claims that arise inthe normal course of business. While the outcome of these proceedings andclaims cannot be predicted with certainty, management does not believe that theoutcome of any of these matters will have a material adverse effect on the Company’sconsolidated financial position or results of operations.

 

The Company has contractual obligations and commitments with regards tooperating lease arrangements. The following table quantifies the expectedcontractual obligations and commitments subsequent to December 31, 2002:

 
|                        |   | **Payments due in fiscal** |    |
|-----------------------------|--------|----------------------------|---------|
|                        |   | **2003**                   |    | **2004** |   | **2005** |   |
|                        |   |                       |    |   |   |   |   |
| Operating lease commitments |   | $                          | 421,894 |   | $ | 340,297 |   | $ | 114,770 |   |
|                             |        |                            |         |  |  |  |  |  |  |  |

 

10

----

 

**9.****                                     ****Stockholders’ Equity**

 

On May 9, 2002, the Company’s Board of Directors authorized therepurchase of up to 500,000 of the outstanding shares of the Company’s commonstock for a period from May 10, 2002 to November 10, 2002 (the “2002Repurchase Program”). As of March 31, 2003, 225,300 shares had beenrepurchased at a cost of $718,601 under the 2002 Repurchase Program. Allrepurchased shares under all the Repurchase Programs are reflected as treasurystock in the accompanying consolidated balance sheets.

 

**10.****                              ****Segment Information**

 

The Company operates its three operating units in the following fivebusiness segments: (i) SRS Labs: (a) the licensing of technologies developed by the Company toOEMs and semiconductor manufacturers, and (b) the sale of consumerproducts incorporating SRS proprietary technologies; (ii) Valence:  (a) the development and marketing oftechnology either in the form of ASICs or other imbedded custom semiconductordesigns, and (b) the component distribution business; and (iii) SRSWOWcast:  the sale of hardware and software solutionsto the Internet and broadcast audio markets. The Company does not allocatecorporate operating expenses or specific assets to these segments. Therefore,the segment information that follows includes only net revenues, cost of salesand gross margins of the identified segments:

 
|                                   |   | **Business Segments** |      |         |   |
|----------------------------------------|--------|-----------------------|-----------|--------------|--------|
|                                   |   | **SRS Labs**          |      | **Valence**  |   | **SRS WOWcast** |   |   |   |
|                                   |   | **Licensing**         |      | **Products** |   | **ASIC** |   | **Components** |   | **Product and  Internet Sales** |   | **Total** |   |
|                                   |   |                  |      |         |   |   |   |   |   |   |   |   |   |
| **Three Months  Ended March 31, 2003** |   |                  |      |         |   |   |   |   |   |   |   |   |   |
| Net revenues                           |   | $                     | 2,628,311 |         | $      | 1,248 |   | $ | 1,711,819 |   | $ | 52,261 |   | $ | 76,735 |   | $ | 4,470,374 |   |
| Cost of sales                          |   | 11,782                |      | 852          |   | 567,748 |   | 74,839 |   | 14,347 |   | 669,568 |   |
|                                   |   |                  |      |         |   |   |   |   |   |   |   |   |   |
| Gross margin                           |   | $                     | 2,616,529 |         | $      | 396 |   | $ | 1,144,071 |   | $ | (22,578 | ) | $ | 62,388 |   | $ | 3,800,806 |   |
|                                   |   |                  |      |         |   |   |   |   |   |   |   |   |   |
| **Three Months Ended  March 31, 2002** |   |                  |      |         |   |   |   |   |   |   |   |   |   |
| Net revenues                           |   | $                     | 1,795,722 |         | 24,919 |   | $ | 1,471,142 |   | $ | 234,931 |   | 28,666 |   | $ | 3,555,380 |   |
| Cost of sales                          |   | 26,272                |      | 17,967       |   | 514,821 |   | 234,217 |   | 68 |   | 793,345 |   |
|                                   |   |                  |      |         |   |   |   |   |   |   |   |   |   |
| Gross margin                           |   | $                     | 1,769,450 |         | $      | 6,952 |   | $ | 956,321 |   | $ | 714 |   | $ | 28,598 |   | $ | 2,762,035 |   |

 

The following schedule presents the Company’s revenue by geographicarea. For product sales, revenue is allocated based on the country to which theproduct was shipped. For licensing-related revenue, the allocation is based onthe location of the licensee’s corporate headquarters. The Americas regionincludes North, Central and South America.

 

|                         |   | **Three Months Ended  March 31,** |      |
|------------------------------|--------|-----------------------------------|-----------|
|                         |   | **2003**                          |      | **2002** |   |
| **Geographic Area Revenue:** |   |                              |      |   |   |
|                         |   |                              |      |   |   |
| Asia Pacific                 |   | $                                 | 4,020,933 |   | $ | 2,688,697 |   |
| Americas                     |   | 417,850                           |      | 456,738 |   |
| Europe                       |   | 31,591                            |      | 409,945 |   |
|                         |   |                              |      |   |   |
| Total                        |   | $                                 | 4,470,374 |   | $ | 3,555,380 |   |

 

11

----

 

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

 

In July 2002, the Financial Accounting Standards Board (“FASB”)issued SFAS 146, “Accounting for Costs Associated with Exit or DisposalActivities,” which addressed financial accounting and reporting for costsassociated with exit or disposal activities and supercedes Emerging Issues TaskForce (EITF) Issue 94-3, “Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (Including CertainCosts Incurred in a Restructuring).” SFAS 146 requires that a liabilityfor a cost associated with an exit or disposal activity be recognized at thedate of an entity’s commitment to an exit plan. SFAS 146 also establishesthat the liability should initially be measured and recorded at fair value. TheCompany has adopted the provisions of the SFAS 146 for exit or disposalactivities effective January 1, 2003. The adoption of SFAS No. 146 did nothave a material impact on the Company’s consolidated results of operations,financial position or cash flows.

 

In December 2002, the FASB issued SFAS No. 148, “Accountingfor Stock-Based Compensation—Transition and Disclosure—an Amendment to SFASNo. 123.” SFAS No. 148 provides alternative methods of transition fora voluntary change to the fair value based method on accounting for stock-basedemployee compensation. The Comany has not currently adopted SFAS No. 123 andaccordingly the implementation of SFAS No. 148 has not had a material effect onthe Company's consolidated financial position or results of operations.

 

In November 2002, the FASB issued interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees. Includingindirect Guarantees of Indebtedness of Others,” which disclosures are effectivefor financial statements for periods ending after December 15, 2002. Whilethe Company has various guarantees included in contracts in the normal courseof business, primarily in the form of indemnities, these guarantees would onlyresult in immaterial increases in future costs, but do not representsignificant commitments or contingent liabilities of the indebtedness ofothers.

 

In January 2003, the FASB issued interpretation No. 46,“Consolidation of Variable Interest Entities” (FIN 46) which requires theconsolidation of variable interest entities, as defined. FIN 46 is applicableto financial statements to be issued by the Company after 2002; however,disclosures are required currently if the Company expects to consolidate anyvariable interest entities. No material entities were consolidated as a resultof FIN 46.

 

12

----

 

**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations.**

 

Thisinformation should be read in conjunction with the unaudited condensed interimconsolidated financial statements and the notes thereto included in thisQuarterly Report, and the audited consolidated financial statements and notesthereto and Management’s Discussion and Analysis of Financial Condition andResults of Operations contained in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2002.

 

**Overview**

 

SRS Labs is a leading developer and provider of application specificintegrated circuits, (“ASICs”), standard integrated circuits (“ICs”) and audioand voice technology solutions for the home theater, portable audio, wireless,computer, game, automotive, broadcast, Internet and telecommunications markets.The Company operates its business through three operating units: SRS Labs, theparent company; its wholly-owned subsidiary, SRSWOWcast.com, Inc., doingbusiness as SRSWOWcast Technologies (“SRSWOWcast”); and its wholly-ownedsubsidiary, ValenceTech Limited, and ValenceTech Limited’s wholly-ownedsubsidiaries (collectively “Valence”).

 

The Company operates in three business units in the following five businesssegments:

 

***SRS**** **Labs***

 

*Licensing:*  The Company’s licensing segment develops and licenses audio andvoice technologies to many of the world’s leading original equipmentmanufacturers (“OEMs”), software providers and semiconductor manufacturers.

 

*Products:*  The *product* segment develops and sells consumer products thatincorporate proprietary audio and speaker technologies.

 

***Valence***

 

*Semiconductor**:***  Thesemiconductor segment develops and sells technology solutions in the form ofanalog and digital signal processor (“DSP”) ASIC semiconductors or otherimbedded custom semiconductor designs to OEMs around the world.

 

*Component Distribution:*  Thecomponent distribution segment is an authorized, non-exclusive distributor ofsemiconductor components, subassemblies and finished goods for selected OEMcustomers. The Company is no longer emphasizing this business due to itsdecision to focus on higher margin revenue. Although the Company expectsrevenues for this segment to decline further in the current year, it willcontinue to operate in this segment.

 

***SRSWOWcast***

 

*Internet and Broadcast:* TheCompany’s Internet and broadcast segment develops and licenses software andhardware audio enhancement technology solutions for the Internet and broadcastmarkets.

 

13

----

 

**Critical Accounting Policies**

 

The Company has prepared the accompanying condensed interim consolidatedfinancial statements without audit in conformity with accounting principlesgenerally accepted in the United States for interim financial information.

 

The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and disclosure of contingent assets and liabilities.We base our estimates on historical and anticipated results and trends and onvarious other assumptions that we believe are reasonable under thecircumstances, including assumptions as to future events. These estimates formthe basis for making judgments about the carrying value of assets andliabilities that are not readily apparent from other sources. By their nature,estimates are subject to an inherent degree of uncertainty. Actual results maydiffer from our estimates.

 

The following represents a summary of our critical accounting policies,defined as those policies that we believe are: (a) the most important tothe portrayal of our financial condition and results of operations, and(b) that require management’s most difficult, subjective or complexjudgments, often as a result of the need to make estimates about the mattersthat are inherently uncertain.

 

*Allowance for Doubtful Accounts*

 

We maintain allowances for doubtful accounts for estimated lossesresulting from the inability of our customers to make required payments. Weevaluate the ability to collect upon our accounts receivable based on specificcustomer circumstances, current economic trends, historical experience and theage of past due receivables. Unanticipated changes in the liquidity orfinancial position of our customers may require additional provisions fordoubtful accounts.

 

*Inventory Obsolescence Reserves*

 

Our inventories are stated at the lower of cost or net realizable value.We make provisions for estimated excess and obsolete inventory based on ourregular reviews of inventory quantities on hand and the latest forecasts ofproduct demand and production requirements from our customers. If actual marketconditions or our customer’s product demands are less favorable than thoseprojected, additional provisions may be required.

 

*Valuation of Intangible Assets*

 

In accordance with Statement of Financial Accounting Standards (“SFAS”)No. 142, “Goodwill and Other Intangible Assets”, we assess potentialimpairments to intangible assets when there is evidence that events or changesin circumstances indicate that the carrying amount of an asset may not berecovered. Our judgments regarding the existence of impairment indicators andfuture cash flows related to intangible assets are based on operationalperformance of our acquired businesses, market conditions, and other factors.If the carrying value of a reporting unit exceeds its fair value, goodwill isconsidered impaired and a second test is performed to measure the amount of impairmentloss, if any. For fiscal 2002, an independent valuation of goodwill and otherintangibles was performed. To date, we have not recognized any impairment ofour goodwill and other intangible assets in connection with our adoption ofSFAS 142. However, no assurances can be given that future evaluation ofgoodwill will not result in charges as a result of future impairment.

 

*Income Taxes*

 

In preparing our consolidated financial statements, we go through aprocess to estimate our income taxes in each of the countries in which weoperate. The process includes an assessment of the current tax expense, theresults from tax examinations and the effects of temporary differencesresulting from the different treatment of transactions for tax and financialaccounting purposes. These differences result in deferred tax assets andliabilities, which are included in the Consolidated Balance Sheet. Therealization of deferred tax assets as a result of future taxable income must beassessed and to the extent that the realization is doubtful, we establish avaluation allowance. Our income tax provision is based on calculations andassumptions that will be subject to examination by the taxing authorities inthe jurisdictions in which we operate. Should the actual results differ fromour estimates, we would have to adjust the income tax provision in the periodin which the facts and circumstances that give rise to the revision becomeknown. Tax law and rate changes are reflected in the income tax provision inthe period in which such changes are enacted.

 

14

----

 

**Results of Operations**

 

**Three Months Ended March 31, 2003 Compared to Three MonthsEnded March 31, 2002**

 

*Revenues*

 

The Company generates revenues in three operating business units infive business segments. Semiconductor revenues consists of (a) design feesrelating to, and sales of, application specific integrated circuits (“ASICs”)for third parties by Valence to original equipment manufacturers (“OEMs”); and(b) sales of general purpose integrated circuits (“ICs”) designed byValence under the brand name ASP. Licensing revenues are royalties generatedprimarily from the license of SRS Labs’ audio and voice technologies. Licenseand royalty agreements generally provide for the license of technologies for aspecified period of time for either a single fee or a fee based on the numberof units distributed by the licensee. Component distribution revenue consistsof (a) the manufacture and sale of Valence’s own branded product line ofVCD players, amplifiers and game products and (b) the distribution ofsemiconductor products, manufacturing components and sub-assemblies toOEMs for the Hong Kong and People’s Republic of China (“PRC”) markets.Product sales represent sales of consumer products incorporating one or more ofSRS Labs’ proprietary technologies. Internet and broadcast revenues consist ofthe sale of hardware and software applications involving the Internet andbroadcast audio markets.

 

Total revenues for the three months ended March 31, 2003 were$4,470,374 compared to $3,555,380 for the three months ended March 31, 2002, anincrease of $914,994 or 25.7%. Semiconductor revenues were $1,711,819 for thethree months ended March 31, 2003 compared to $1,471,142 for the three monthsended March 31, 2002, an increase of $240,677 or 16.4%. This increase wasattributable to expansion of Valence’s ASIC customer base, increased designwins and new chip offerings.  Licensingrevenues were $2,628,311 for the three months ended March 31, 2003, compared to$1,795,722 for the three months ended March 31, 2002, an increase of $832,589or 46.4%. This increase was attributable to the continuation of the salesgrowth of home entertainment products such as DVD players, TV’s and set topboxes, which incorporate SRS Labs’ technologies. Other revenues were $130,244for the three months ended March 31, 2003 compared to $288,516 for the threemonths ended March 31, 2002 a decrease of $158,272 or 54.9%.  Other revenues are comprised of thefollowing components for the quarters ended March 31, 2003 and 2002respectively:  component distribution —40% and 81%; product revenues — 1% and 9% ; internet and broadcast business —59% and 10%.  Component distributionrevenues were $52,261 for the three months ended March 31, 2003 compared to$234,931 for the three months ended March 31, 2002 a decrease of $182,670 or77.8%. This decrease was due to the Company’s decision to focus on highermargin ASIC and licensing revenues and de-emphasize certain lower margin distributionactivities. Product revenues were $1,248 for the three months ended March 31,2003 compared to $24,919 for the comparable period in 2002, a decrease of$23,671 or 95%. This decrease was due to the decrease of the on-linemerchandising of the WOW Thing processor box. Revenues generated by the Company’s Internet and broadcast basedbusiness were $76,735 for the three months ended March 31, 2003 compared to$28,666 for the three months ended March 31, 2002 an increase of $48,069 or167.7%. This increase was attributable to the sales of professional hardwareequipment to the broadcast market.

 

15

----

 

*Gross Margin*

 

Cost of sales consists primarily of fabrication costs, assembly andtest costs, and the cost of materials and overhead from operations. The grossmargin percentage for the three months ended March 31, 2003 increased to 85.0%as a percentage of total revenue as compared to 77.7% for the three monthsended March 31, 2002. The increase is attributable to continued efforts by theCompany to focus the revenue base towards higher margin semiconductor andlicensing revenues and away from lower margin component distribution.  Gross margins may fluctuate in futurequarters depending on the mix of products sold and services provided, royaltiesearned, competitive pricing, new product introduction costs and other factors.

 

*Sales and Marketing*

 

Sales and marketing expenses consist primarily of employee salaries,sales consultants’ fees and related expenses, sales commissions and productpromotion costs. Sales and marketing expenses were $1,352,490 for the threemonths ended March 31, 2003 compared to $1,260,440 for the same prior yearperiod, an increase of $92,050 or 7.3%. The net increase in sales and marketingexpenses for the three months ended March 31, 2003 is primarily attributable toincreased promotion costs associated with higher licensing revenue and costsassociated with the promotion of our technologies in new markets. As apercentage of total revenues, sales and marketing expenses decreased from 35.5%for the quarter ended March 31, 2002, to 30.3% for the same period this year.

 

*Research and Development*

 

Research and development expenses consist of salaries and related costsof employees engaged in ongoing research, design and development activities andcosts for engineering materials and supplies. Research and development expenseswere $1,081,215 for the three months ended March 31, 2003 compared to $965,076for the same prior year period, an increase of $116,139, or 12.0%. The increasein research and development costs is primarily due to the addition of researchand development personnel and increased costs associated with the increasedsemiconductor business activity.  As apercentage of total revenues, research and development expenses decreased from27.1% for the quarter ended March 31, 2002, to 24.2% for the same period thisyear.

 

*General and Administrative*

 

General and administrative (“G&A”) expenses consist primarily ofemployee-related expenses, legal costs associated with the administration ofintellectual property and other professional fees. G&A expenses were$1,314,610 for the three months ended March 31, 2003 compared to $1,233,525 forthe same prior year period, an increase of $81,085 or 6.6%. The increase wasprimarily attributable to increased professional fees and public companyexpenses.  As a percentage of totalrevenues, G&A expenses decreased from 34.7% for the quarter ended March 31,2002, to 29.4% for the same period this year.

 

*Income (Loss) From Operations*

 

Income from operations increased by $749,497 to $52,491 for the quarterended March 31, 2003, as compared to a loss from operations of $697,006 for thequarter ended March 31, 2002.  Theincrease in income from operations is due to an increase in gross profit of$1,038,771, partially offset by an increase in sales and marketing, researchand development and general and administrative expenses of $289,274.

 

*Other Income, Net*

 

Other income, net, consists primarily of interest income, gain or(loss) on sale of securities, interest expense and foreign currency transactiongains and losses. Other income, net, was $164,126 for the three months endedMarch 31, 2003, compared to $87,963 for the same prior year period, an increaseof $76,163 or 87.4%. The increase is primarily attributable to higher interestrates earned on investment balances.

 

16

----

 

*Minority Interest*

 

Minority interest represents the minority shareholders’ proportionateshare of losses in SRSWOWcast. Minority interest was $5,430 for the threemonths ended March 31, 2003, compared to $19,748 for the three months endedMarch 31, 2002, a decrease of $14,318 or 72.5%. The decrease is primarilyattributable to decreased losses and the difference in the reporting period of30 days. In February 2003, SRS Labs completed an exchange offer with theminority shareholders of SRSWOWcast, pursuant to which SRS Labs acquired all ofthe outstanding shares of Series A Convertible Preferred Stock in exchangefor the issuance of shares of SRS Labs common stock. As a result of theexchange offer, SRSWOWcast became a wholly-owned subsidiary of SRS Labs.

 

*Provision for Income Taxes*

 

The income tax expense for the three months ended March 31, 2003 was$179,513, compared to tax expense of $101,438 for the same prior year period,an increase of $78,075 or 77.0%. The increase results from the increase in theHong Kong tax rate from 16.5% to 17.5%, effective January 1, 2003, and thehigher levels of foreign tax on higher licensing revenues sourced fromcountries requiring foreign tax withholdings.

 

**Liquidity and Capital Resources**

 

The Company’s principal source of liquidity to fund ongoing operationsat March 31, 2003 consisted of cash, cash equivalents and long-term investmentsaggregating $21,765,793. At March 31, 2003, the Company had cash and cashequivalents of $13,225,769 and long-term investments of $8,540,024. Cash andcash equivalents generally consist of cash, money market funds and other moneymarket instruments with original maturities of three months or less.Investments consist of U.S. government securities rated AAA.

 

The Company’s operating activities used $340,898 in cash for the threemonths ended March 31, 2003.  The use ofcash by operations resulted from a net decrease in accounts receivable andprepaid expenses and other current assets, a net decrease in accounts payable,accrued liabilities and income taxes payable and increases in inventories, aswell as certain adjustments to reconcile net income to cash used in operatingactivities including depreciation and amortization.  The primary use of cash for the three months ended March 31, 2003resulted from the Company’s payment of accounts payable and accrued liabilitiesassociated with commissions and product promotion costs as well as professionalfees. Net cash used in investing activities for the three months ended March31, 2003 was $2,167,318, resulting primarily from the purchase of U.S.government securities, purchases of furniture, fixtures and equipment andexpenditures related to intangible assets. Net cash provided by financingactivities for the three months ended March 31, 2003 was $13,125, reflectingthe proceeds from sale of common stock pursuant to exercise of employee stockoptions.

 

Based on current plans and business conditions, the Company expectsthat its cash, cash equivalents and investments together with any amountsgenerated from operations will be sufficient to meet the Company’s cashrequirements for the foreseeable future. However, there can be no assurancethat the Company will not be required to seek other financing sooner or thatsuch financing, if required, will be available on terms satisfactory to theCompany.

 

**Newly Adopted and Recent Accounting Pronouncements**

 

In July 2002, the Financial Accounting Standards Board (“FASB”)issued SFAS 146, “Accounting for Costs Associated with Exit or DisposalActivities,” which addressed financial accounting and reporting for costsassociated with exit or disposal activities and supercedes Emerging Issues TaskForce (EITF) Issue 94-3, “Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (Including CertainCosts Incurred in a Restructuring).” SFAS 146 requires that a liabilityfor a cost associated with an exit or disposal activity be recognized at thedate of an entity’s commitment to an exit plan. SFAS 146 also establishesthat the liability should initially be measured and recorded at fair value. TheCompany has adopted the provisions of the SFAS 146 for exit or disposalactivities effective January 1, 2003. The adoption of SFAS No. 146 did nothave a material impact on the Company’s consolidated results of operations,financial position or cash flows.

 

In December 2002, the FASB issued SFAS No. 148, “Accountingfor Stock-Based Compensation—Transition and Disclosure—an Amendment to SFASNo. 123.” SFAS No. 148 provides alternative methods of transition fora voluntary change to the fair value based method on accounting for stock-basedemployee compensation. The Company

 

17

----

 

hasnot currently adopted SFAS No. 123 and accordingly the implementation ofSFAS No. 148 has not had a material effect on the Company’s consolidatedfinancial position or results of operations.

 

In November 2002, the FASB issued interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees. Includingindirect Guarantees of Indebtedness of Others,” which disclosures are effectivefor financial statements for periods ending after December 15, 2002. Whilethe Company has various guarantees included in contracts in the normal courseof business, primarily in the form of indemnities, these guarantees would onlyresult in immaterial increases in future costs, but do not representsignificant commitments or contingent liabilities of the indebtedness ofothers.

 

In January 2003, the FASB issued interpretation No. 46,“Consolidation of Variable Interest Entities” (FIN 46) which requires the consolidationof variable interest entities, as defined. FIN 46 is applicable to financialstatements to be issued by the Company after 2002; however, disclosures arerequired currently if the Company expects to consolidate any variable interestentities. No material entities were consolidated as a result of FIN 46.

 

**Factors That May Affect Future Results**

* *

*Our quarterly results may fluctuate*

 

Our operating results may fluctuate from those in prior quarters andwill continue to be subject to quarterly and other fluctuations due to avariety of factors, including the extent to which our licensees incorporate ourtechnologies into their products; the timing of orders from, and the shipmentsto, major customers; the timing of new product introductions; the gain or lossof significant customers; competitive pressures on selling prices; the marketacceptance of new or enhanced versions of our technologies; the rate that oursemiconductor licensees manufacture and distribute chips to productmanufacturers; and fluctuations in general economic conditions, particularlythose affecting the consumer electronics market. Due to our dependence on theconsumer electronics market, the substantial seasonality of sales in the marketcould impact our revenues and net income. In particular, we believe that thereis seasonality relating to the Christmas season generally and the Chinese NewYear within the Asia region, which fall into the fourth and first quartersrespectively. As a result, we believe that period-to-period comparisons of ourresults of operations are not necessarily meaningful and should not be reliedon as indications of future performance.

 

*We rely on revenue contribution from our ASIC and standardIC business*

 

We derive a significant amount of our revenue from Valence’s ASICbusiness. Valence’s engineering team focuses on the design of custom ASICs tomeet specific customers’ requirements and out sources the production of thedesign to mask houses, foundries and packaging houses located primarily inAsia. The operations of Valence could be affected by a variety of factors,including the timing of customer orders, the timing of development revenue,changes in the mix of products distributed and the mix of distribution channelsemployed, the emergence of a new industry standard, product obsolescence andchanges in pricing policies by the Company, its competitors or its suppliers.

 

Business revenue from ASICs is concentrated in a limited number ofcustomers in the areas of consumer electronics, communications products, computersand computer peripherals. The business generated from any one customer may befor a fixed length or quantity. As such, it is customary in our ASIC businessto have a certain amount of customer turnover as new ASIC projects are obtainedfor different customers. However, it is possible that the loss of anyparticular customer or any bad debt arising from such customer may have amaterial adverse impact on our financial condition and results of operation.Beginning in fiscal 1999, Valence began to exit from certain lower marginproduct offerings in the distribution side of the business and has placed moreemphasis on developing and distributing products that are related to orincorporate our proprietary technologies. As a result, the immediate loss inrevenue of the low margin distribution business will not be entirely offset bythe new proprietary technology based products, which will take time to developand be introduced into the marketplace. There can be no assurance that we willbe able to quickly introduce new products to offset the loss in revenue or thatthe new products developed will receive a favorable market acceptance.

 

Valence adds significant diversity to our overall business structure andopportunities. We recognize that in the presence of such corporate diversity,and in particular with regard to the semiconductor industry, there will alwaysexist a potential for a conflict among sales channels between the Company andour technology licensees. Although the operations of

 

18

----

 

ourlicensing business and those of Valence are generally complementary, there canbe no assurances that sales channel conflicts will not arise. If such potentialconflicts do materialize, we may or may not be able to mitigate the effect ofsuch perceived conflicts, which, if not resolved, may impact the results ofoperations.

 

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

 

Currently, our licensing revenue is concentrated in the home theatermarket with the majority of revenue generated from the inclusion of SRStechnology inside televisions, DVD players and set-top boxes. We expect thatthe consumer home entertainment market will continue to account for asignificant portion of our licensing revenues for the foreseeable future. Whileconsumer spending in general on consumer electronic products has increased,retail prices for certain consumer electronics products that include our audiotechnology, such as DVD players have decreased significantly and indicationsare that this trend will continue for the foreseeable future. Declining pricesof consumer electronic products could put pressure on our licensing fees thatare charged to the manufacturers.  Inaddition, consumer electronics products manufacturers could decide to excludeour audio enhancement technology from their home theater products altogether inan effort to reduce cost.  Also, given the current economic environment,consumer spending on DVD players and other home electronic products may notincrease as expected.  Such declines inconsumer spending, should they occur, and continued decreases in consumerproduct pricing for electronic goods may have a significant negative impact onour financial results.

 

*We are exposed to certain risks in producing professionaland consumer products*

 

We intend to continue to develop and offer high-end audio enhancementproducts, including professional and consumer hardware and software products.We have also developed a line of speakers that incorporate proprietary flatpanel designs, which have been marketed to OEMs and industry retailbuyers. There can be no assurance that our products will be accepted in themarket or that we will be able to develop an effective distribution channel andbuild acceptable brand recognition as a product manufacturer. As the businessincreases, it is anticipated that significant capital will be required tofinance product inventory and accounts receivable. As a result, we are subjectto risks of product obsolescence, bad debt and insufficient finance to grow thebusiness.

 

We also recognize that as we develop and market new consumer audioproducts, there will always exist a potential for conflict and competitionbetween SRS Labs and our technology licensees. Although our intended productsand those of our licensees do not generally overlap, there can be no assurancesthat our products will not compete with those of our licensees. If suchconflicts do materialize, it is uncertain whether we will be able to mitigate theeffect of such conflicts, which, if not resolved, may adversely impact ourbusiness and results of operations.

 

*We conduct operations in a number of countries and aresubject to risks of international operations, particularly in Asia and the PRC*

 

We havesignificant operations in Hong Kong, the PRC and other parts of Asia thatrequire refinement to adapt to the changing market conditions in that region.Our customers geographically located in the Asia Pacific markets accounted forapproximately 90%, and 76% of total Company sales in the quarters ended March31, 2003 and 2002, respectively and are expected to continue to account for asubstantial percentage of sales in the future. Because we rely on sales tocustomers in Asia for a substantial portion of our revenue, our business isvery likely to be adversely impacted by economic downturns and instability inthat region. In addition, international sales are subject to risks, including,but not limited to:

 

•                           fluctuations in foreign exchange rates;

•                           changes in legal and regulatory requirements;

•                           political and economic instability and acts ofterrorism;

•                           any public health crisis such as SARS;

•                           difficulties in staffing and managinginternational operations;

•                           foreign trade disputes; and

•                           potentially adverse tax consequences.

 

19

----

 

The PRC economy has experienced significant growth in the past decade;but such growth has been uneven across geographic and economic sectors. Therecan be no assurance that such growth will continue or that any potentialcurrency devaluation in the region will not have a negative effect on ourbusiness, including Valence.

 

Hong Kong is a Special Administrative Region of the PRC with its owngovernment and legislature. Hong Kong enjoys a high degree of autonomy from thePRC under the principle of “one country, two systems.” We can give no assurancethat Hong Kong will continue to enjoy autonomy from the PRC.

 

The Hong Kong dollar has remained relatively constant due to the U.S.dollar peg and currency board system that has been in effect in Hong Kong since1983. Since mid-1997, interest rates in Hong Kong have fluctuated significantlyand real estate and retail sales have declined. We can give no assurance thatthe Hong Kong economy will not worsen or that the historical currency peg ofthe Hong 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.

 

*Our results of operations may be adversely affected by theongoing slowdown in the global economy*

 

Over the pastyear, the global economy has been experiencing a slowdown due to many factors,including decreased consumer confidence, unemployment, the ongoing threat andcost of terrorism and reduced corporate profits and capital spending. Recentpolitical events, including the U.S. military action in the Middle East, haveput further pressure on economic conditions. The potential turmoil that mayresult from such events contributes to the uncertainty of the economic climate,further reducing predictability and our ability to develop and implementlong-term strategic plans. The impact of these or future similar events mayhave a material adverse impact on our operating results and financial position.

 

*We are subject to competitive pressures*

 

Our existing and potential competitors include both large and emergingdomestic and international 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 other hardwareand software components in the OEM’s products. In addition, the markets inwhich we compete are intensely competitive and are characterized by rapidtechnological 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.

 

*We strongly rely on our intellectual property*

 

Our ability to compete may be affected by our ability to protect ourproprietary information. We have filed numerous U.S. and foreign patentapplications and to date have a number of issued U.S. and foreign patentscovering various aspects of our technologies. There can be no assurance thatthe steps taken by SRS Labs to protect our intellectual property will beadequate to prevent misappropriation of our technology or that our competitorswill not independently develop technologies that are substantially equivalentor superior to our technology. In addition, the laws of certain foreigncountries may not protect our intellectual property rights to the same extent,as do the laws of the U.S. The semiconductor industry is characterized byfrequent claims and litigation regarding patent and other property rights. Weare not currently a party to any claims of this nature. There can be noassurances that third parties will not assert claims or initiate litigationagainst the Company or our customers with respect to existing or futureproducts. In addition, we may initiate claims or litigation against thirdparties for infringement of our proprietary rights or to determine the scopeand validity of our proprietary rights.

 

20

----

 

*We depend on our executive officers and other key personnel*

 

Our future success depends to a large extent upon the continued serviceof our executives, as well as key engineering, sales, and marketing staff,including highly skilled semiconductor design personnel. We anticipate that anyfuture growth will require us to recruit and hire a number of new personnel inengineering, operations, finance, sales and marketing. Competition for suchpersonnel during times of economic growth is intense, and there can be noassurance that we can recruit and retain necessary personnel to operate itsbusiness and support future growth.

 

*The market price of our common stock is volatile*

 

The trading price of our Common Stock has been, and will likely continueto be, subject to wide fluctuations in response to quarterly variations in ouroperating results, announcements of new products or technological innovationsby the Company or our competitors, strategic alliances between SRS Labs andthird parties, general market fluctuations and other events and factors.Changes in earnings estimates made by brokerage firms and industry analystsrelating to the markets in which we do business, or relating to the Companyspecifically, have in the past resulted in, and could in the future result in,an immediate and adverse effect on the market price of the Common Stock. Eventhough our stock is quoted on the NASDAQ Stock Market, our stock has had andmay continue to have low trading volume and high volatility. The historicallylow trading volume of our stock makes it more likely that a severe fluctuationin volume, either up or down, will significantly impact the stock price. Sinceour shares are thinly traded, our shareholders may have difficulty selling ourcommon stock.

 

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

 

There have been no material changes to information called for by thisItem 3 from the disclosures set forth in Part II, Item 7A in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2002.

 

**Item 4****.  Controls and Procedures.**

 

Withinthe 90 days prior to the date of this Report, the Company carried out anevaluation, under the supervision and with the participation of the Company’smanagement, including the Company’s President and Chief Executive Officer andthe Company’s Chief Financial Officer, of the effectiveness of the design andoperation of the Company’s disclosure controls and procedures, as defined inExchange Act Rule 15d-14(c). Based upon that evaluation, the Company’sPresident and Chief Executive Officer and the Company’s Chief Financial Officerconcluded that the Company’s disclosure controls and procedures are effectivein enabling the Company to record, process, summarize and report informationrequired to be included in the Company’s periodic filings with the U.S.Securities and Exchange Commission (the “Commission”) within the required timeperiod. There have been no significant changes in the Company’s internalcontrols or in other factors that could significantly affect internal controlssubsequent to the date the Company carried out its evaluation.

 

21

----

 

**PART II—OTHER INFORMATION**

 

**Item2.  Changes in Securities and Use ofProceeds.**

 

On January 10, 2003, the Company offered each holder of shares of SeriesA Preferred Stock (“Series A Preferred”) of SRSWOWcast.com, Inc. (“SRSWOWcast”)the right to exchange theirshares of Series A Preferred for shares of SRS Labs common stock (the“SRS Common Stock”) at thefollowing exchange ratio: each share of Series A Preferred would be convertedinto that number of whole shares of SRS Labs Common Stock determined bydividing $0.32 by the greater of $2.50 or the closing sale price of a shares ofSRS Labs Common Stock on February 14, 2003, or such later date to which theexchange offer was extended (the “Expiration Date”), as such closing sale price is reported by the Nasdaq StockMarket.  The exchange offer expired onFebruary 14, 2003.  At the time of theexchange offer, there were a total of eight holders of shares of Series APreferred.  All of the holders of SeriesA Preferred Stock accepted the exchange offer and exchanged an aggregate of3,000,000 shares of Series A Preferred Stock for 332,184  shares of SRS Common Stock. The Companyreceived no remuneration for this exchange.

 

There was no general solicitation in connection with the exchangeoffer.  The exchange offer was limitedto the eight holders of the Series A Preferred.  All of the holders of the Series A Preferred were sophisticatedinvestors with pre-existing relationships with the Company and its managementand were accredited investors as defined under Regulation D under theSecurities Act of 1933, as amended (the "Securities Act").  Based on these facts, the Issuer believesthat the issuance of the SRS Labs Common Stock was exempt from registrationunder the Securities Act pursuant to Section 4(2) of the Securities Act, as atransaction by an issuer not involving a public offering.

 

**Item6.  Exhibits and Reports on Form 8-K.**

 

(a)                                  *Exhibits*.

 

Theexhibit listed below is hereby filed with the Commission as part of thisReport.

 
| **Exhibit  Number** |   | **Description**                                                                                             |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                        |
| 99.1*               |   | Pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
| 99.2*               |   | Pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

----

*                                 Pursuant toCommission Release No. 33-8212, this certification will be treated as“accompanying” this Annual Report on Form 10-K and not “filed” as part of suchreport for purposes of Section 18 of the Exchange Act, or otherwise subject tothe liability of Section 18 of the Exchange Act and this certification will notbe deemed to be incorporated by reference into any filing under the SecuritiesAct of 1933, as amended, or the Exchange Act, except to the extent that theregistrant specifically incorporates it by reference.

 

(b)                         *Reports on Form 8-K.*

 

Noreport on Form 8-K was filed with the SEC during the three-month periodended March 31, 2003.

 

22

----

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|                | SRS  LABS, INC.,  a Delaware corporation |
|---------------------|-----------------------------------------------|
|                |                                          |
| Date:  May 15, 2003 | By:                                           | /s/ THOMAS C.K. YUEN |
|                |                                          | **Thomas  C.K. Yuen** |
|                |                                          | **Chairman  of the Board and Chief Executive Officer** |

 

23

----

 

**CERTIFICATIONS**

 

I,Thomas C.K. Yuen, certify that:

 

1.                                       I have reviewed this quarterly report onForm 10-Q of SRS Labs, Inc.;

 

2.                                       Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.                                       Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.                                       I am responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and I have:

 

a)                                      designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

b)                                     evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within90 days prior to the filing date of this quarterly report (the “EvaluationDate”); and

 

c)                                      presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.                                       I have disclosed, based on my most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                                      all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b)                                     any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.                                       I have indicated in this quarterly reportwhether or not there were significant changes in internal controls or in otherfactors that could significantly affect internal controls subsequent to thedate of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Date:  May 15, 2003 | /s/ THOMAS C.K. YUEN                                                              |
|---------------------|-----------------------------------------------------------------------------------|
|                | Thomas C.K. Yuen                                                                  |
|                | Chairman of the  Board and Chief Executive Officer  (Principal Executive Officer) |

 

24

----

 

I, Janet M. Biski, certify that:

 

1.                                       I have reviewed this quarterly report on Form10-Q of SRS Labs, Inc.;

 

2.                                       Based on my knowledge, this annual reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3.                                       Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

 

4.                                       The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and have:

 

a)                                      designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this annual report isbeing prepared;

 

b)                                     evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this annual report (the ‘‘Evaluation Date’’); and

 

c)                                      presented in this annual report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunctions):

 

a)                                      all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b)                                     any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this annualreport whether there were significant changes in internal controls or in otherfactors that could significantly affect internal controls subsequent to thedate of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Date:  May 15, 2003 | By:    | /s/ JANET M. BISKI                                      |
|---------------------|--------|---------------------------------------------------------|
|                |   | Janet M. Biski                                          |
|                |   | Chief Financial  Officer  (Principal Financial Officer) |

 

25

----