**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 June 30, 2006**                                                                              |
| ** **                                                                                                                          |
| **OR**                                                                                                                              |
| ** **                                                                                                                          | ** ** | ** **                                                                                               |
| **o**                                                                                                                               | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
| ** **                                                                                                                          | ** ** | ** **                                                                                               |
| **For the  transition period           to        ** |
| ** **                                                                                                                          |
| **Commission File Number 0-21123**                                                                                                  |

 

**SRS LABS, INC.**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

(Address of principal executive offices) (ZipCode)

 

**(949) 442-1070**

(Registrant’s telephone number, includingarea code)

 

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

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.(Check one):

 
| Large  accelerated filer  o |   | Accelerated  filer  o |   | Non-accelerated  filer  x |
|---------------------------------------|--------|---------------------------------|--------|-------------------------------------|

 

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

 

As of July 24, 2006, 15,584,819 of the issuer’scommon stock, par value $.001 per share, were outstanding; of this amount,674,098 shares of the common stock were held as treasury shares.

 

 

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**SRS LABS, INC.**

 

**Form 10-Q**

**For thePeriod Ended June 30, 2006**

**Index**

 
| **PART I-FINANCIAL  INFORMATION** | ** **                                                                                                                                                  |
|----------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Item 1.                                | Financial Statements                                                                                                                                        |   |
|                                   | Condensed  Consolidated Balance Sheets as of June 30, 2006 (Unaudited) and December 31,  2005                                                     |   |
|                                   | Condensed  Consolidated Statements of Operations for the three and six months ended June 30,  2006 and 2005 (Unaudited)                                |   |
|                                   | Condensed  Consolidated Statements of Stockholders’ Equity and Comprehensive Income for  the three and six months ended June 30, 2006 (Unaudited) |   |
|                                   | Condensed  Consolidated Statements of Cash Flows for the six months ended June 30,  2006 and 2005 (Unaudited)                                          |   |
|                                   | Notes to the  Condensed Consolidated Financial Statements (Unaudited)                                                                                       |   |
| Item 2.                                | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                 |   |
| Item 3.                                | Quantitative and  Qualitative Disclosures About Market Risk                                                                                                 |   |
| Item 4.                                | Controls and Procedures                                                                                                                                     |   |
| **PART II-OTHER  INFORMATION**    | ** **                                                                                                                                                  |
| Item 6.                                | Exhibits                                                                                                                                                    |   |
|                                   |                                                                                                                                                        |   |
| SIGNATURES                             |                                                                                                                                                        |

 

2

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**FORWARD-LOOKINGINFORMATION**

 

As usedherein, the “Company,” “SRS Labs,” “we,” “us,” or “our” means SRS Labs, Inc.and its wholly-owned subsidiaries, including ValenceTech Limited, ValenceTechnology Limited (including its direct and indirect wholly-ownedsubsidiaries, collectively “Valence”), SRSWOWcast.com, Inc. and the jointventure with Coming Home Studios LLC, CHS/SRS LLC.

 

Some of thestatements in this Quarterly Report on Form 10-Q contain forward—lookingstatements regarding our assumptions, projections, expectations, targets,intentions or beliefs about future events, which involve risks anduncertainties. All statements other than statements of historical factsincluded in this Quarterly Report relating to expectation of future financialperformance, continued growth, changes in economic conditions or capitalmarkets and changes in customer usage patterns and preferences, areforward-looking statements. In some cases, you can identify forward-lookingstatements by terms such as may, will, should, expect, plan, intend, forecast,anticipate, believe, estimate, predict, potential, continue or the negative ofthese terms or other comparable terminology. The forward-looking statementscontained in this Quarterly Report involve known and unknown risks,uncertainties and situations that may cause our or our industry’s actualresults, level of activity, performance or achievements to be materiallydifferent from any future results, levels of activity, performance orachievements expressed or implied by these statements. Factors that might causeactual events or results to differ materially from those indicated by theseforward-looking statements may include the matters listed under “RiskFactors” in Item 1A in our most recently filed Form 10-K and elsewhere inthis Form 10-Q, including, but not limited to, uncertainties related tothe sale of Valence; the general market conditions concerning the semiconductorbusiness; the acceptance of new SRS Labs products and technologies; the importof competitive products and pricing; the timely development and release oftechnologies by the Company; general business and economic conditions,especially in Asia; product and customer concentration in our business; ourhigh dependence on the consumer electronics market, which is characterized byshort product life cycles, fluctuations in demand and seasonality; the risk ofwidespread illness; our dependence on growth in emerging markets; the lengthand unpredictable nature of our sales cycle; our ability to protect ourproducts through patents and other intellectual property rights; our dependenceon key personnel; the volatility of the price of our common stock; provisionsthat could discourage transactions resulting in a change in control containedin our certificate of incorporation and bylaws as well as Delaware law;competition we face from companies with greater brand recognition andresources; pricing pressures on the consumer electronics product manufacturers;adverse state, federal or foreign legislation or regulation or adversedeterminations by regulators; and other factors identified from time to time inour filings with the Securities and Exchange Commission.

 

Anyforward-looking statement speaks only as of the date on which such statement ismade, and, except as required by law, we undertake no obligation to update anyforward-looking statement to reflect events or circumstances after the date onwhich such statement is made or to reflect the occurrence of unanticipatedevents. New factors emerge from time to time, and it is not possible formanagement to predict all such factors.

 

3

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**PART I— FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**SRS LABS, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                   | ** ** | **June 30, 2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                   | ** ** | **(unaudited)**        | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| **Current Assets**                                                                                                                                                                                                           |       |                   |       |                        |       |
| Cash and  cash equivalents                                                                                                                                                                                                   |       | 12,071,951             |       | $                           | 8,752,339  |   |
| Accounts  receivable, net                                                                                                                                                                                                    |       | 1,453,597              |       | 1,886,780                   |       |
| Inventories,  net                                                                                                                                                                                                            |       | 59,518                 |       | 80,421                      |       |
| Prepaid  expenses and other current assets                                                                                                                                                                                   |       | 452,158                |       | 522,426                     |       |
| Investments  available for sale                                                                                                                                                                                              |       | 11,968,615             |       | —                      |       |
| Assets held  for sale                                                                                                                                                                                                        |       | 2,264,847              |       | 1,859,127                   |       |
|                                                                                                                                                                                                                         |       |                   |       |                        |       |
| **Total  Current Assets**                                                                                                                                                                                                    |       | 28,270,686             |       | 13,101,093                  |       |
|                                                                                                                                                                                                                         |       |                   |       |                        |       |
| Investments  available for sale                                                                                                                                                                                              |       | 5,099,589              |       | 17,077,170                  |       |
| Furniture,  fixtures and equipment, net                                                                                                                                                                                 |       | 486,460                |       | 425,288                     |       |
| Intangible  assets, net                                                                                                                                                                                                      |       | 2,108,121              |       | 2,015,605                   |       |
| Deferred  income taxes                                                                                                                                                                                                       |       | 386,412                |       | 380,386                     |       |
| Long term  assets held for sale                                                                                                                                                                                              |       | 2,113,613              |       | 2,065,123                   |       |
|                                                                                                                                                                                                                         |       |                   |       |                        |       |
| **Total  Assets**                                                                                                                                                                                                            |       | $                      | 38,464,881 |                        | $          | 35,064,665 |   |
|                                                                                                                                                                                                                         |       |                   |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                               | ** ** | ** **             | ** ** | ** **                  | ** ** |
| **Current Liabilities**                                                                                                                                                                                                      |       |                   |       |                        |       |
| Accounts  payable                                                                                                                                                                                                            |       | $                      | 898,905    |                        | $          | 741,811 |   |
| Accrued  liabilities                                                                                                                                                                                                         |       | 852,956                |       | 801,898                     |       |
| Deferred  revenue                                                                                                                                                                                                            |       | 110,254                |       | 537,636                     |       |
| Liabilities  related to assets held for sale                                                                                                                                                                                 |       | 1,700,706              |       | 2,170,701                   |       |
|                                                                                                                                                                                                                         |       |                   |       |                        |       |
| **Total  Current Liabilities**                                                                                                                                                                                               |       | 3,562,821              |       | 4,252,046                   |       |
|                                                                                                                                                                                                                         |       |                   |       |                        |       |
| Commitments and contingencies and  subsequent events (Note 7 and 12)                                                                                                                                                         |       |                   |       |                        |       |
|                                                                                                                                                                                                                         |       |                   |       |                        |       |
| **Stockholders’ Equity**                                                                                                                                                                                                |       |                   |       |                        |       |
| Preferred  stock—$.001 par value; 2,000,000 shares authorized; no shares issued or  outstanding                                                                                                                         |       | —                 |       | —                      |       |
| Common  stock—$.001 par value; 56,000,000 shares authorized; 15,584,819 and  14,953,690 shares issued; and 14,910,721 and 14,279,592 shares outstanding at  June 30, 2006 and December 31, 2005, respectively |       | 15,586                 |       | 14,955                      |       |
| Additional  paid-in capital                                                                                                                                                                                                  |       | 66,581,360             |       | 63,574,518                  |       |
| Accumulated  other comprehensive loss                                                                                                                                                                                        |       | (506,046               | )          | (496,021                    | )          |
| Accumulated  deficit                                                                                                                                                                                                         |       | (28,185,395            | )          | (29,277,388                 | )          |
| Treasury  stock at cost, 674,098 shares at June 30, 2006 and December 31,  2005                                                                                                                                    |       | (3,003,445             | )          | (3,003,445                  | )          |
|                                                                                                                                                                                                                         |       |                   |       |                        |       |
| **Total  Stockholders’ Equity**                                                                                                                                                                                         |       | 34,902,060             |       | 30,812,619                  |       |
|                                                                                                                                                                                                                         |       |                   |       |                        |       |
| **Total  Liabilities and Stockholders’ Equity**                                                                                                                                                                         |       | $                      | 38,464,881 |                        | $          | 35,064,665 |   |

 

See accompanying notes to the condensedconsolidated financial statements

 

4

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**SRS LABS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                       | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                                       | ** ** | **2006**               | ** ** | **2005**             | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                       | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                                         |       | $                      | 4,259,839  |                 | $          | 3,539,977 |   | $ | 8,595,507 |   | $ | 6,804,072 |   |
| Cost of sales                                                                    |       | 35,293                 |       | 94,838               |       | 83,105 |   | 151,183 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Gross margin                                                                     |       | 4,224,546              |       | 3,445,139            |       | 8,512,402 |   | 6,652,889 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Operating expenses:                                                              |       |                   |       |                 |       |   |   |   |   |
| Sales and  marketing                                                             |       | 1,885,416              |       | 1,026,477            |       | 3,750,785 |   | 2,208,924 |   |
| Research and  development                                                        |       | 631,739                |       | 547,787              |       | 1,286,028 |   | 1,123,992 |   |
| General and  administrative                                                      |       | 1,357,789              |       | 1,427,501            |       | 2,994,997 |   | 2,700,352 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Total  operating expenses                                                        |       | 3,874,944              |       | 3,001,765            |       | 8,031,810 |   | 6,033,268 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Income from continuing operations                                                |       | 349,602                |       | 443,374              |       | 480,592 |   | 619,621 |   |
| Other income, net                                                                |       | 224,005                |       | 160,341              |       | 403,718 |   | 309,611 |   |
| Income from  continuing operations before income tax expense                     |       | 573,607                |       | 603,715              |       | 884,310 |   | 929,232 |   |
| Income tax expense                                                               |       | 167,745                |       | 168,506              |       | 327,168 |   | 287,530 |   |
| Income from continuing operations                                                |       | 405,862                |       | 435,209              |       | 557,142 |   | 641,702 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Discontinued operations (Note 9):                                                |       |                   |       |                 |       |   |   |   |   |
| Income from  discontinued operations before income tax expense                   |       | 151,876                |       | 79,088               |       | 194,252 |   | 99,233 |   |
| Gain on  disposal                                                                |       | 371,295                |       | —               |       | 371,295 |   | — |   |
| Income tax  (benefit) expense                                                    |       | (385                   | )          | 563                  |       | 30,696 |   | 5,741 |   |
| Income from discontinued operations                                              |       | 523,556                |       | 78,525               |       | 534,851 |   | 93,492 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Net income                                                                       |       | $                      | 929,418    |                 | $          | 513,734 |   | $ | 1,091,993 |   | $ | 735,194 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Income from continuing operations per  common share:                             |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                            |       | $                      | 0.03       |                 | $          | 0.03 |   | $ | 0.04 |   | $ | 0.05 |   |
| Diluted                                                                          |       | $                      | 0.02       |                 | $          | 0.03 |   | $ | 0.03 |   | $ | 0.04 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Income from discontinued operations per  common share:                           |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                            |       | $                      | 0.04       |                 | $          | 0.01 |   | $ | 0.04 |   | $ | 0.01 |   |
| Diluted                                                                          |       | $                      | 0.03       |                 | $          | 0.01 |   | $ | 0.03 |   | $ | 0.01 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Net income per common share:                                                     |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                            |       | $                      | 0.06       |                 | $          | 0.04 |   | $ | 0.08 |   | $ | 0.05 |   |
| Diluted                                                                          |       | $                      | 0.06       |                 | $          | 0.03 |   | $ | 0.07 |   | $ | 0.05 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Weighted  average shares used in the calculation of net income per common share: |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                            |       | 14,622,210             |       | 14,076,866           |       | 14,523,459 |   | 14,043,269 |   |
| Diluted                                                                          |       | 16,334,105             |       | 14,881,495           |       | 16,206,277 |   | 14,950,693 |   |

 

See accompanying notes to the condensedconsolidated financial statements

 

5

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**SRS LABS, INC.**

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

 
| ** **                                                     | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Accumulated**   | ** ** | **Treasury** | ** ** | ** ** | ** ** | **Comprehensive  Income  for the Period** | ** ** |
|----------------------------------------------------------------|------------|------------------|------------|-------------------------|------------|---------------------------------------|------------|-------------------|------------|--------------|------------|------------|------------|-------------------------------------------|------------|
| ** **                                                     | ** ** | **Shares**       | ** ** | **Amount**              | ** ** | **Capital**                           | ** ** | **(Loss) Income** | ** ** | **Deficit**  | ** ** | **Stock**  | ** ** | **Total**                                 | ** ** | **Ended** | ** ** |
| ** **                                                     | ** ** | ** **       | ** ** | ** **              | ** ** | ** **                            | ** ** | ** **        | ** ** | ** **   | ** ** | ** ** | ** ** | ** **                                | ** ** | ** ** | ** ** |
| BALANCE, Dec. 31, 2005                                    |       | 14,279,592       |       | $                       | 14,955     |                                  | $          | 63,574,518        |       | $            | (496,021   | )          | $          | (29,277,388                               | )          | $ | (3,003,445 | ) | $ | 30,812,619 |   |   |   |
| Proceeds from exercise of stock options                        |       | 230,370          |       | 230                     |       | 1,014,988                             |       | —            |       | —       |       | —     |       | 1,015,218                                 |       |   |   |
| Stock based compensation                                       |       | —           |       | —                  |       | 399,738                               |       | —            |       | —       |       | —     |       | 399,738                                   |       |   |   |
| Unrealized loss on investments available for sale,  net of tax |       | —           |       | —                  |       | —                                |       | (58,282           | )          | —       |       | —     |       | (58,282                                   | )          | (58,282 | ) |
| Net income                                                     |       | —           |       | —                  |       | —                                |       | —            |       | 162,575      |       | —     |       | 162,575                                   |       | 162,575 |   |
|                                                           |       |             |       |                    |       |                                  |       |              |       |         |       |       |       |                                      |       |   |   |
| BALANCE, March 31, 2006                                   |       | 14,509,962       |       | $                       | 15,185     |                                  | $          | 64,989,244        |       | $            | (554,303   | )          | $          | (29,114,813                               | )          | $ | (3,003,445 | ) | $ | 32,331,868 |   | $ | 104,293 |   |
| Proceeds from exercise of stock options                        |       | 400,759          |       | 401                     |       | 1,203,311                             |       | —            |       | —       |       | —     |       | 1,203,712                                 |       |   |   |
| Stock based compensation                                       |       | —           |       | —                  |       | 388,805                               |       | —            |       | —       |       | —     |       | 388,805                                   |       |   |   |
| Unrealized gain on investments available for sale,  net of tax |       | —           |       | —                  |       | —                                |       | 48,257            |       | —       |       | —     |       | 48,257                                    |       | 48,257 |   |
| Net income                                                     |       | —           |       | —                  |       | —                                |       | —            |       | 929,418      |       | —     |       | 929,418                                   |       | 929,418 |   |
|                                                           |       |             |       |                    |       |                                  |       |              |       |         |       |       |       |                                      |       |   |   |
| BALANCE, June 30, 2006                                    |       | 14,910,721       |       | $                       | 15,586     |                                  | $          | 66,581,360        |       | $            | (506,046   | )          | $          | (28,185,395                               | )          | $ | (3,003,445 | ) | $ | 34,902,060 |   | $ | 1,081,968 |   |

 

See accompanying notes to thecondensed consolidated financial statements

 

6

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**SRS LABS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                                                 | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2006**                                      | ** ** | **2005** | ** ** |
| **Cash  Flows From Operating Activities:**                                                                 |       |                                          |       |   |   |
| Income from  continuing operations                                                                         |       | $                                             | 557,142    |   | $ | 641,702 |   |
| Adjustments  to reconcile income from continuing operations to net cash provided by  operating activities: |       |                                          |       |   |   |
| Depreciation  and amortization                                                                             |       | 355,866                                       |       | 417,022 |   |
| Provision  for doubtful accounts                                                                           |       | (7,532                                        | )          | 8,425 |   |
| Deferred  taxes                                                                                            |       | (6,026                                        | )          | — |   |
| Accretion of  discount on investments available for sale                                                   |       | (1,059                                        | )          | (1,185 | ) |
| Stock-based  compensation expense                                                                          |       | 687,400                                       |       | 24,570 |   |
| Loss on  disposition of furniture, fixtures and equipment                                                  |       | 1,582                                         |       | 2,267 |   |
| Changes in  operating assets and liabilities:                                                              |       |                                          |       |   |   |
| Accounts  receivable                                                                                       |       | 440,715                                       |       | 287,557 |   |
| Inventories                                                                                                |       | 20,903                                        |       | (30,752 | ) |
| Prepaid  expenses and other current assets                                                                 |       | 70,268                                        |       | 163,264 |   |
| Accounts  payable                                                                                          |       | 157,094                                       |       | (88,470 | ) |
| Accrued  liabilities                                                                                       |       | 51,058                                        |       | 1,149,403 |   |
| Deferred  revenue                                                                                          |       | (427,382                                      | )          | (128,702 | ) |
| Income taxes  payable                                                                                      |       | —                                        |       | 103,111 |   |
|                                                                                                       |       |                                          |       |   |   |
| Net cash  provided by operating activities                                                                 |       | 1,900,029                                     |       | 2,548,212 |   |
|                                                                                                       |       |                                          |       |   |   |
| **Cash  Flows From Investing Activities:**                                                                 |       |                                          |       |   |   |
| Purchase of  furniture, fixtures and equipment                                                             |       | (183,330                                      | )          | (45,252 | ) |
| Expenditures  related to patents and intangible assets                                                     |       | (327,806                                      | )          | (245,316 | ) |
|                                                                                                       |       |                                          |       |   |   |
| Net cash  used in investing activities                                                                     |       | (511,136                                      | )          | (290,568 | ) |
|                                                                                                       |       |                                          |       |   |   |
| **Cash  Flows From Financing Activities:**                                                                 |       |                                          |       |   |   |
| Purchase of  treasury stock                                                                                |       | —                                        |       | (1,059,590 | ) |
| Proceeds  from exercise of stock options                                                                   |       | 1,923,257                                     |       | 407,740 |   |
|                                                                                                       |       |                                          |       |   |   |
| Net cash  provided by (used in) financing activities                                                       |       | 1,923,257                                     |       | (651,850 | ) |
|                                                                                                       |       |                                          |       |   |   |
| **Net  Increase in Cash from Continuing Operations**                                                       |       | 3,312,150                                     |       | 1,605,794 |   |
|                                                                                                       |       |                                          |       |   |   |
| **Cash  Flows From Discontinued Operations:**                                                              |       |                                          |       |   |   |
| Net cash  used in operating activities                                                                     |       | (128,298                                      | )          | (1,708,743 | ) |
| Net cash  used in investing activities                                                                     |       | (159,913                                      | )          | (88,491 | ) |
| Net cash  provided by financing activities                                                                 |       | 295,673                                       |       | 14,399 |   |
| **Net  Increase (Decrease) in Cash from Discontinued Operations**                                          |       | 7,462                                         |       | (1,782,835 | ) |
|                                                                                                       |       |                                          |       |   |   |
| **Net  Increase (Decrease) in Cash and Cash Equivalents**                                                  |       | 3,319,612                                     |       | (177,041 | ) |
| **Cash and  Cash Equivalents, Beginning of Period**                                                        |       | 8,752,339                                     |       | 7,011,912 |   |
| **Cash and  Cash Equivalents, End of Period**                                                              |       | $                                             | 12,071,951 |   | $ | 6,834,871 |   |
|                                                                                                       |       |                                          |       |   |   |
| **Supplemental  Disclosure of Cash Flow Information:**                                                     |       |                                          |       |   |   |
| Cash paid  during the period for:                                                                          |       |                                          |       |   |   |
| Income taxes                                                                                               |       | $                                             | 311,102    |   | $ | 377,551 |   |
| **Supplemental  Disclosure of Non-Cash Investing Activities:**                                             |       |                                          |       |   |   |
| Unrealized  loss on investments, net                                                                       |       | $                                             | (10,025    | ) | $ | (41,112 | ) |

 

See accompanying notes to the condensedconsolidated financial statements

 

7

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**SRS LABS, INC.**

**NOTES TOTHE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

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

 

As used herein, the “Company,”“SRS Labs,” “we,” “us,” or “our” means SRS Labs, Inc. and its wholly-ownedsubsidiaries, including ValenceTech Limited, Valence Technology Limited(including its direct and indirect wholly-owned subsidiaries, collectively “Valence”),SRSWOWcast.com, Inc. (“SRSWOWcast”) and the joint venture with Coming HomeStudios LLC, CHS/SRS LLC. The accompanying unaudited condensed consolidatedfinancial statements have been prepared by the Company in conformity withaccounting principles generally accepted in the United States of America (“generallyaccepted accounting principles”) for interim financial information and the rules andregulations of the U.S. Securities and Exchange Commission (“SEC”) for interimreporting. In the opinion of management, all adjustments (which include onlynormal recurring adjustments) considered necessary for a fair presentation ofour financial position and results of operations have been included. Certainamounts included in the accompanying prior periods’ consolidated financialstatements have been reclassified to conform to the current periodpresentation. All material inter-company accounts and transactions have beeneliminated.

 

Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted pursuant to SEC rules andregulations for presentation of interim financial information. Therefore, thecondensed interim consolidated financial statements should be read inconjunction with the Company’s Annual Report on Form 10-K for the fiscalyear ended December 31, 2005. Current and future financial statements may notbe directly comparable to the Company’s historical financial statements. Theresults of operations for the interim period are not necessarily indicative ofthe results to be expected for any other interim period or for the full year.

 

On February 23, 2006, the Board ofDirectors of the Company (the “Board of Directors” or the “Board”) approved aplan to sell Valence in order to focus increased management attention andfinancial resources on its licensing business. On July 14, 2006, the Company entered into a definitiveSale and Purchase Agreement to sell Valence to Noblehigh Enterprises Inc. (“Noblehigh”).See Note 12.

 

Additionally, on February 23, 2006, theBoard authorized management to take all reasonable steps to divest the Company’sentire equity interest in the CHS/SRS LLC joint venture (the “Joint Venture”)to produce and distribute six concert videos featuring our Circle SurroundTechnology. On June 30, 2006 the Company completedthe sale of its interest in the Joint Venture to Coming Home Studios, LLC (“CHS”)in exchange for $200,000, the rights to all cash assets of the Joint Venture,and a promissory note in the amount of $175,000. See Note 9.

 

Asa result of our decisions to sell Valence and our entire equity interest in thejoint venture, we have accounted for the semiconductor business segment and thejoint venture as discontinued operations in the accompanying condensedconsolidated financial statements. We have reclassified prior periods to conform tothe current period presentation.

 

**Estimates**

 

The preparation of financial statements inaccordance with generally accepted accounting principles requires management tomake use of certain estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reported periods. We base our estimates on historicalexperience and on various other assumptions that we believe are reasonableunder the circumstances, the results of which form the basis for makingjudgments about carrying values of assets and liabilities that are not readilyapparent from other sources. Actual results could differ materially from thoseestimates. See the audited consolidated financial statements and notes theretoincluded in our Annual Report on Form 10-K for the year ended December 31,2005 for an additional discussion of the significant accounting policies andestimates used in the preparation of our financial statements.

 

8

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

 

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 123 (revised 2004), “Share-Based Payment,” ** **(“SFAS 123R”). ThisStatement requires companies to expense the estimated fair value of stockoptions and similar equity instruments issued to employees over the requisiteservice period. SFAS 123R eliminates the alternative to use the intrinsicmethod of accounting provided for in Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees (“APB 25”), which generally resultedin an immaterial amount of compensation expense recorded in the financialstatements related to the grant of stock options to employees if certainconditions were met. The pro forma impact from recognition of the estimatedfair value of stock options granted to employees has been previously disclosedin our footnotes as required under previous accounting rules.

 

Effective for the first quarter of fiscal 2006, weadopted SFAS 123R using the modified prospective method, which requires us torecord compensation expense for all awards granted after the date of adoption,and for the unvested portion of previously granted awards that remainoutstanding at the date of adoption. Accordingly, prior period amounts presentedherein have not been restated to reflect the adoption of SFAS 123R.

 

The fair value concepts were not changedsignificantly in SFAS 123R; however, in adopting SFAS 123R, companies mustchoose among alternative valuation models and amortization assumptions. Afterassessing alternative valuation models and amortization assumptions, we arecontinuing to use both the Black-Scholes-Merton (“BSM”) option-pricing formulaand straight-line amortization of compensation expense over the requisiteservice period of the grant. We will reconsider use of this model if additionalinformation becomes available in the future that indicates another model wouldbe more appropriate for us, or if grants issued in future periods havecharacteristics that cannot be reasonably estimated using this model. UnderSFAS No. 123, “Accounting for Stock Based Compensation” (“SFAS 123”), wewere not required to estimate forfeitures in our expense calculation for thestock compensation pro forma footnote disclosure; however, SFAS 123R requiresan estimate of forfeitures and upon adoption we changed our methodology toinclude an estimate of forfeitures. The adoption of SFAS 123R had no effect oncash flows from financing activities.

 

The following table illustrates the effect on netincome and net income per share as if the Company had applied the fair valuerecognition provisions of SFAS 123 to options granted under the Company’s stockoption plans as of January 1, 2005. For purposes of this pro formadisclosure, the fair value of the options is estimated using a BSMoption-pricing formula and amortized on a straight-line basis to expense over theoptions’ vesting period:

 
| **** ****                                                                                                                 | **** **** | ****Three Months  Ended**** | **** **** | ****Six Months  Ended**** | **** **** |
|--------------------------------------------------------------------------------------------------------------------------------|----------------|----------------------------------|----------------|--------------------------------|----------------|
| **** ****                                                                                                                 | **** **** | ****June 30,****            | **** **** | ****June 30,****          | **** **** |
| **** ****                                                                                                                 | **** **** | ****2005****                     | **** **** | ****2005****                   | **** **** |
|                                                                                                                           |           |                             |           |                           |           |
| Net income -  as reported                                                                                                      |           | $                                | 513,734        |                           | $              | 735,194 |   |
| Add:  Share-based employee compensation expense included in net income, net of  related tax effects - as reported              |           | 5,843                            |           | 14,742                         |           |
| Deduct:  Share-based employee compensation expense determined under fair value method,  net of related tax effects - pro forma |           | (275,174                         | )              | (580,277                       | )              |
| Net income -  pro forma                                                                                                        |           | $                                | 244,403        |                           | $              | 169,659 |   |
| Basic - as  reported                                                                                                           |           | $                                | 0.04           |                           | $              | 0.05 |   |
| Basic - pro  forma                                                                                                             |           | $                                | 0.02           |                           | $              | 0.01 |   |
| Diluted - as  reported                                                                                                         |           | $                                | 0.03           |                           | $              | 0.05 |   |
| Diluted -  pro forma                                                                                                           |           | $                                | 0.02           |                           | $              | 0.01 |   |

 

**Share Option Plans**

 

The Company has in effect several share-based plansunder which non-qualified and incentive stock options have been granted toemployees, non-employees and board members. The following equity compensationplans have also been approved by our stockholders: the SRS Labs, Inc. 2006Stock Incentive Plan (the “2006 Plan”), the SRS Labs, Inc. Amended andRestated 1996 Long-Term Incentive Plan (the “1996 Plan”), and the SRS Labs, Inc.Amended and Restated 1996 Non-employee Directors’ Stock Option Plan (the “Non-employeeDirectors Plan”). The Board of Directors determines eligibility, vestingschedules and exercise prices for options granted under the plans. Weissue new shares to satisfy stock option exercises under our share-based plans.No income tax benefit was realized from activity in our share-based plansduring the three and six months ended fiscal 2006 and 2005.

 

9

----

 

A summary of the shares reserved for grant andoptions available for grant under each plan is as follows:

 
| **** ****               | **** **** | ****June 30, 2006**** | **** **** |
|------------------------------|----------------|---------------------------------|----------------|
| **** ****               | **** **** | ****Shares****                  | **** **** | ****Shares**** | **** **** |
| **** ****               | **** **** | ****Reserved****                | **** **** | ****Available**** | **** **** |
| **** ****               | **** **** | ****for Grant****          | **** **** | ****for Grant**** | **** **** |
| 2006 Plan                    |           | 1,500,000                       |           | 1,380,000 |   |
| 1996 Plan                    |           | 8,500,000                       |           | 0 |   |
| Non-employee  Directors Plan |           | 500,000                         |           | 340,000 |   |
| Total                        |           | 10,500,000                      |           | 1,720,000 |   |

 

Option awards are generally granted with an exerciseprice equal to the market price of the Company’s stock at the date of grant.Option awards generally have a term of 10 years and vest and become exercisableover a four-year service period.

 

The fair value of each share-based award isestimated on the grant date using the BSM option-pricing formula. Expectedvolatilities are based on the historical volatility of the Company’s stockprice. The expected term of options granted subsequent to the adoption of SFAS123R is derived using the simplified method as defined in the SEC’s StaffAccounting Bulletin 107, “Implementation of FASB 123R.” The risk-free rate forperiods within the contractual life of the option is based on the U.S. Treasuryinterest rates in effect at the time of grant. The fair value of optionsgranted was estimated using the following weighted-average assumptions:

 
| **** ****            | **** **** | ****Three Months Ended**** | **** **** | ****Six Months Ended**** | **** **** |
|---------------------------|----------------|--------------------------------------|----------------|------------------------------------|----------------|
| **** ****            | **** **** | ****June 30,****                | **** **** | ****June 30,****              | **** **** |
| **** ****            | **** **** | ****2006****                         | **** **** | ****2005****                       | **** **** | ****2006**** | **** **** | ****2005**** | **** **** |
| Expected  term (in years) |           | 6.25                                 |           | 6.25                               |           | 6.25 |   | 6.25 |   |
| Expected  volatility      |           | 56                                   | %              | 59                                 | %              | 57 | % | 62 | % |
| Risk-free  interest rate  |           | 5.0                                  | %              | 3.8                                | %              | 4.9 | % | 4.0 | % |
| Dividend  yield           |           | 0.00                                 | %              | 0.00                               | %              | 0.00 | % | 0.00 | % |

 

Total compensation cost recognized in the three andsix months ending June 30, 2006 is as follows:

 
| ** **                                                     | ** ** | **Three Months** | ** ** | **Six Months** | ** ** |
|----------------------------------------------------------------|------------|-----------------------|------------|---------------------|------------|
| Continuing  Operations:                                        |       |                  |       |                |       |
| Sales and  Marketing                                           |       | $                     | 136,459    |                | $          | 298,512 |   |
| Research and  Development                                      |       | 75,174                |       | 202,161             |       |
| General and  Administrative                                    |       | 132,387               |       | 186,727             |       |
| Total  compensation cost recognized in Continuing Operations   |       | $                     | 344,020    |                | $          | 687,400 |   |
|                                                           |       |                  |       |                |       |
| Total  compensation cost recognized in Discontinued Operations |       | $                     | 44,785     |                | $          | 101,143 |   |
| Total  compensation cost recognized                            |       | $                     | 388,805    |                | $          | 788,543 |   |

 

A summary of option activity under the stock optionplans and changes during the quarter then ended is presented below:

 
| **** ****                        | **** **** | ****June 30, 2006**** | **** **** |
|---------------------------------------|----------------|---------------------------------|----------------|
| **** ****                        | **** **** | **** ****                  | **** **** | ****Weighted-Average**** | **** **** | **** **** | **** **** |
| **** ****                        | **** **** | **** ****                  | **** **** | **** **** | **** **** | ****Remaining**** | **** **** | ****Aggregate**** | **** **** |
| **** ****                        | **** **** | **** ****                  | **** **** | ****Exercise**** | **** **** | ****Contractual**** | **** **** | ****Intrinsic**** | **** **** |
| **** ****                        | **** **** | ****Shares****                  | **** **** | ****Price**** | **** **** | ****Term**** | **** **** | ****Value**** | **** **** |
| Outstanding  at beginning of period   |           | 4,263,040                       |           | $ | 4.47 |   |   |   |   |   |
| Granted                               |           | 385,900                         |           | 5.70 |   |   |   |   |   |
| Cancelled/forfeited                   |           | (66,963                         | )              | 6.28 |   |   |   |   |   |
| Exercised                             |           | (400,759                        | )              | 3.00 |   |   |   |   |   |
| Outstanding  at end of period         |           | 4,181,218                       |           | $ | 4.69 |   | 5.4 |   | $ | 1,236,775 |   |
| Options  exercisable at end of period |           | 2,891,745                       |           | $ | 4.28 |   | 4.4 |   | $ | 2,060,012 |   |

 

A summary of the grant-date fair value and intrinsicvalue information is as follows:

 
| **** ****                                    | **** **** | ****Three Months Ended**** | **** **** | ****Six Months Ended**** | **** **** |
|---------------------------------------------------|----------------|--------------------------------------|----------------|------------------------------------|----------------|
| **** ****                                    | **** **** | ****June 30,****                | **** **** | ****June 30,****              | **** **** |
| **** ****                                    | **** **** | ****2006****                         | **** **** | ****2005****                       | **** **** | ****2006**** | **** **** | ****2005**** | **** **** |
| Weighted-average  grant-date fair value per share |           | $                                    | 3.37           |                               | $              | 3.36 |   | $ | 3.46 |   | $ | 2.98 |   |
| Intrinsic  value of options exercised             |           | $                                    | 972,818        |                               | $              | 172,957 |   | $ | 1,355,027 |   | $ | 202,841 |   |

 

10

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A summary of the activity of the Company’s non-vestedshares during the six months ended June 30, 2006 is presented below:

 
| **** ****                                | **** **** | **** **** | **** **** | ****Weighted-Average**** | **** **** | ****Remaining****    | **** **** |
|-----------------------------------------------|----------------|----------------|----------------|--------------------------|----------------|----------------------|----------------|
| **** ****                                | **** **** | **** **** | **** **** | **** ****           | **** **** | ****Remaining****    | **** **** | ****Unrecognized**** | **** **** |
| **** ****                                | **** **** | **** **** | **** **** | ****Grant-Date****       | **** **** | ****Years****        | **** **** | ****Compensation**** | **** **** |
| **** ****                                | **** **** | ****Shares**** | **** **** | ****Fair Value****  | **** **** | ****To Vest**** | **** **** | ****Cost**** | **** **** |
| Nonvested  outstanding at beginning of period |           | 1,195,964      |           | $                        | 3.21           |                 |           |   |   |   |
| Granted                                       |           | 495,900        |           | 3.46                     |           |                 |           |   |   |
| Vested                                        |           | (334,678       | )              | 3.02                     |           |                 |           |   |   |
| Forfeited                                     |           | (67,713        | )              | 2.69                     |           |                 |           |   |   |
| Nonvested  outstanding at end of period       |           | 1,289,473      |           | $                        | 3.58           |                 | 2.95           |   | $ | 2,636,148 |   |
|                                               |                |                |                |                          |                |                      |                |  |  |  |  |

 

**3.****                                     ****Capitalization of SoftwareDevelopment Costs**

 

Costs incurred in the research, design anddevelopment of software for sale to others as a separate product or embedded ina product and sold as part of the product as a whole are charged toexpense until technological feasibility is established. Under SFAS No. 86,“Accounting for the Costs of Computer Software to be Sold, Leased or OtherwiseMarketed,” the Company capitalizes software purchased from third parties if therelated software product under development has reached technologicalfeasibility or if there are alternative future uses for the purchased software,provided that capitalized amounts will be realized over a period not exceedingfive years. Costs incurred prior to the establishment of technologicalfeasibility are charged to research and development expense.

 

Capitalized software as of June 30, 2006 and December 31,2005 is as follows:

 
| ** **                 | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Capitalized  software      |       | $                       | 707,008    |                        | $          | 595,568 |   |
| Accumulated  amortization  |       | (386,819                | )          | (309,990                    | )          |
| Capitalized  software, net |       | $                       | 320,189    |                        | $          | 285,578 |   |

 

As of June 30, 2006, the weighted average useful life of theCompany’s capitalized software is approximately 1.8 years. The following tableshows the estimated amortization expense for those assets for the remaining sixmonths of the current fiscal year end and each of the four succeeding fiscalyears.

 
| **Year ending December 31,** | ** ** | **Estimated  Expense** | ** ** |
|---------------------------------------------|------------|------------------------|------------|
| 2006                                        |       | $                      | 73,817     |   |
| 2007                                        |       | 104,276                |       |
| 2008                                        |       | 54,997                 |       |
| 2009                                        |       | 10,270                 |       |
| 2010                                        |       | —                 |       |
|                                             |            |                        |            |  |

 

**4.****                                     ****Intangible Assets**

 

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

 

Inaccordance with SFAS No. 142, all of our intangible assets that havedefinite lives are being amortized on a straight-line basis over theirestimated useful lives and are evaluated at least annually to determine if fairvalue of the asset has decreased below its carrying value. At December 31,2005, we performed our annual assessment and determined that no impairmentexisted.

 

11

----

 

Intangibleassets consist of the following:

 
| ** **                                                                   | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                   | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Patents                                                                      |       | $                       | 2,555,908  |                        | $          | 2,339,543 |   |
| Accumulated  amortization                                                    |       | (1,211,447              | )          | (1,093,368                  | )          |
| Patents, net                                                                 |       | 1,344,461               |       | 1,246,175                   |       |
| Other  Intangibles:                                                          |       |                    |       |                        |       |
| License  agreements acquired in purchase of SRSWOWcast in February 2003 |       | 640,071                 |       | 640,071                     |       |
| Poly Planar  purchased technology for speaker products                       |       | 120,000                 |       | 120,000                     |       |
| Capitalized  software and hardware for several technologies                  |       | 637,281                 |       | 525,840                     |       |
| Total of  Other Intangibles                                                  |       | 1,397,352               |       | 1,285,911                   |       |
| Accumulated  amortization, other intangibles                                 |       | (633,692                | )          | (516,481                    | )          |
| Other  intangibles, net                                                      |       | 763,660                 |       | 769,430                     |       |
| Intangible  assets, net                                                      |       | $                       | 2,108,121  |                        | $          | 2,015,605 |   |

 

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

 
| ** **                                                                                  | ** ** | **Three months ended  June 30,** | ** ** | **Six Months ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                  | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Patents                                                                                     |       | $                                               | 60,411     |                                          | $          | 51,445 |   | $ | 118,079 |   | $ | 101,382 |   |
| Other  intangibles:                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| License agreements  acquired in purchase of our subsidiary SRSWOWcast in February 2003 |       | 16,002                                          |       | 16,002                                        |       | 32,003 |   | 32,003 |   |
| Poly Planar  purchased technology                                                           |       | —                                          |       | —                                        |       | — |   | 4,000 |   |
| Capitalized  software and hardware                                                          |       | 44,518                                          |       | 31,784                                        |       | 85,208 |   | 61,503 |   |
| Total  intangible amortization expense                                                      |       | $                                               | 120,931    |                                          | $          | 99,231 |   | $ | 235,290 |   | $ | 198,888 |   |

 

As of June 30, 2006, the weightedaverage useful life of the Company’s patents and intangible assets isapproximately 2.7 years. The following table shows the estimatedamortization expense for those assets for the remaining six months of thecurrent fiscal year and each of the four succeeding fiscal years:

 
| **Year ending  December 31,** | ** ** | **Estimated expense** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|
| 2006                                    |       | $                          | 171,872    |   |
| 2007                                    |       | $                          | 407,573    |   |
| 2008                                    |       | $                          | 291,292    |   |
| 2009                                    |       | $                          | 217,082    |   |
| 2010                                    |       | $                          | 206,196    |   |
| Thereafter                              |       | $                          | 578,816    |   |

 

12

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**5.**                                      **Investments Available forSale**

 

The Company has classified its investments asavailable for sale in accordance with SFAS No. 115, “Accounting forCertain Investments in Debt and Equity Securities.” The following tablesummarizes the Company’s investment securities available for sale:

 
| ** **             | ** ** | **June 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Cost                   |       | $                           | 17,489,688 |                            | $          | 17,489,688 |   |
| Accretion of  discount |       | 3,261                       |       | 2,202                           |       |
| Unrealized  loss       |       | (424,745                    | )          | (414,720                        | )          |
| Estimated  fair value  |       | $                           | 17,068,204 |                            | $          | 17,077,170 |   |

 

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

 
| ** **                                      | ** ** | **June 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | **Cost**                    | ** ** | **Estimated  Fair Value**  | ** ** | **Cost** | ** ** | **Estimated  Fair Value** | ** ** |
| U.S.  Government securities available for sale: |       |                        |       |                            |       |   |   |   |   |
| Due in one  year or less (a)                    |       | 11,992,949                  |       | 11,968,615                      |       | — |   | — |   |
| Due in one  to five years                       |       | 5,500,000                   |       | 5,099,589                       |       | 17,491,890 |   | 17,077,170 |   |
|                                            |       | $                           | 17,492,949 |                            | $          | 17,068,204 |   | $ | 17,491,890 |   | $ | 17,077,170 |   |
|                                                 |            |                             |            |                                 |            |  |  |  |  |  |  |  |  |

 

----

(a)             Availablefor sale securities due in one year or less are classified as short-term in thecondensed consolidated balance sheets, as the original contractual maturitiesare greater than 90 days.

 

**6.**                                      **Net Income Per Common Share**

 

The Company applies SFAS No. 128, “Earnings perShare,” which requires the disclosure of basic and diluted net income or lossper share for all current and prior periods. Basic net income or loss percommon share is computed by dividing net income or loss available to commonstockholders by the weighted average number of common shares outstanding duringeach year. Diluted net income or loss per common share reflects the maximumdilution, based on the average price of the Company’s common stock each period,and is computed similar to basic income or loss per share except that thedenominator is increased to include the number of additional shares that wouldhave been outstanding if potentially dilutive stock options and warrants had beenexercised.

 

13

----

 

Basic and diluted net income per share computed inaccordance with SFAS 128 for the three and six months ended June 30,are as follows:

 
| ** **                                               | ** ** | **For the three months** | ** ** | **For the six months** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                               | ** ** | **Ended June 30,**            | ** ** | **Ended June 30,**          | ** ** |
| ** **                                               | ** ** | **2006**                                | ** ** | **2005**                              | ** ** | **2006** | ** ** | **2005** | ** ** |
| BASIC EPS                                                |       |                                    |       |                                  |       |   |   |   |   |
| Income from  continuing operations                       |       | $                                       | 405,862    |                                  | $          | 435,209 |   | $ | 557,142 |   | $ | 641,702 |   |
| Income from  discontinued operations                     |       | 523,556                                 |       | 78,525                                |       | 534,851 |   | 93,492 |   |
| Net income                                               |       | $                                       | 929,418    |                                  | $          | 513,734 |   | $ | 1,091,993 |   | $ | 735,194 |   |
| Denominator:  weighted average common shares outstanding |       | 14,622,210                              |       | 14,076,866                            |       | 14,523,459 |   | 14,043,269 |   |
| Income from  continuing operations—basic            |       | $                                       | 0.03       |                                  | $          | 0.03 |   | $ | 0.04 |   | $ | 0.05 |   |
| Income from  discontinued operations—basic          |       | $                                       | 0.04       |                                  | $          | 0.01 |   | $ | 0.04 |   | $ | 0.01 |   |
| Net income  per share—basic                         |       | $                                       | 0.06       |                                  | $          | 0.04 |   | $ | 0.08 |   | $ | 0.05 |   |
|                                                     |       |                                    |       |                                  |       |   |   |   |   |
| DILUTED EPS                                              |       |                                    |       |                                  |       |   |   |   |   |
| Income from  continuing operations                       |       | $                                       | 405,862    |                                  | $          | 435,209 |   | $ | 557,142 |   | $ | 641,702 |   |
| Income from  discontinued operations                     |       | 523,556                                 |       | 78,525                                |       | 534,851 |   | 93,492 |   |
| Net income                                               |       | $                                       | 929,418    |                                  | $          | 513,734 |   | $ | 1,091,993 |   | $ | 735,194 |   |
| Denominator:  weighted average common shares outstanding |       | 14,622,210                              |       | 14,076,866                            |       | 14,523,459 |   | 14,043,269 |   |
| Common  equivalent shares outstanding:                   |       |                                    |       |                                  |       |   |   |   |   |
| Options                                                  |       | 1,711,895                               |       | 804,629                               |       | 1,682,818 |   | 907,424 |   |
| Total  diluted shares                                    |       | 16,334,105                              |       | 14,881,495                            |       | 16,206,277 |   | 14,950,693 |   |
| Income from  continuing operations—diluted          |       | $                                       | 0.02       |                                  | $          | 0.03 |   | $ | 0.03 |   | $ | 0.04 |   |
| Income from  discontinued operations—diluted        |       | $                                       | 0.03       |                                  | $          | 0.01 |   | $ | 0.03 |   | $ | 0.01 |   |
| Net income  per share—diluted                       |       | $                                       | 0.06       |                                  | $          | 0.03 |   | $ | 0.07 |   | $ | 0.05 |   |

 

There were 1,614,619 and 1,979,479 potentiallydilutive options outstanding for the three months ending June 30, 2006 and2005, respectively, and there were 1,614,619 and 1,964,479 potentially dilutiveoptions outstanding for the six months ending June 30, 2006 and 2005,respectively, that were not included in the table above because they would beanti-dilutive.

 

**7.**                                      **Commitments andContingencies**

 

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

 

**8.**                                      **Stockholders’ Equity**

 

OnMarch 24, 2005, the Company’s Board of Directors authorized the repurchaseof up to $3,000,000 of the outstanding shares of the Company’s common stock fora period from March 25, 2005 to March 24, 2006 (the “2005 RepurchaseProgram”). The Company repurchased 232,223 shares under this plan. There was noactivity under the 2005 Repurchase Program during the first fiscal quarter of2006, and the program expired on March 24, 2006.

 

On June 22, 2006, the Company’s Board ofDirectors adopted and the Company’s stockholders approved the 2006 StockIncentive Plan (the “2006 Plan”), a plan for which 1,500,000 shares of theCompany’s common stock may be issued pursuant to Awards under the Planprovided that the Company shall not make additional awards under the 1996 Plan.Either the Board of Directors or a committee appointed by the Board willadminister the 2006 Plan. Under the 2006 Plan, the Committee may grantoptions that are intended to qualify as incentive stock options (“ISOs”). Additionally,the Committee may also grant share appreciation rights, restricted shares,restricted share units, unrestricted shares, deferred share units, andperformance awards. The vesting period is dependent on the type of Awardgranted.

 

14

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**9.**                                      **Discontinued Operations**

 

OnFebruary 23, 2006, the Board approved a plan to sell Valence in order tofocus increased management attention and financial resources on its licensingbusiness. We have retained Kaufman Bros., L.P., a financial advisor based inNew York City, to assist us in facilitating the sale. On July 14, 2006,the Company entered into a definitive Sale and Purchase Agreement to sell  Valence to Noblehigh. See Note 12.

 

Additionally,on February 23, 2006, the Board authorized management to take allreasonable steps to divest the Company’s entire equity interest in the JointVenture. On June 30, 2006, the Company completed the sale of its interestin the Joint Venture to Coming Home Studios, LLC (“CHS”) in exchange for$200,000, the rights to all cash assets of the joint venture, and a promissorynote in the amount of $175,000. As of the close of business on June 30,2006, SRS had received $150,000 from CHS and had transferred the cash assets ofthe joint venture to SRS. The remaining $50,000 was received from CHS on July 5,2006. The Company has recorded a gain on disposal of its interest in the LLC of$371,295 in the accompanying condensed consolidated statement of operations forthe three month period ended June 30, 2006. Any amounts related to thepromissory note will be recorded at the time the cash is received by SRS.

 

Income from discontinuedoperations consists of direct revenues and direct expenses of Valence andCHS/SRS LLC. General corporate overhead costs have not been allocated todiscontinued operations. A summary of the operating results of Valence and theJoint Venture included in discontinued operations in the accompanying condensedconsolidated statements of operation is as follows:

 
| ** **                                     | ** ** | **For the three months  ended June 30,** | ** ** | **For the six months  ended June 30,** | ** ** |
|------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                                          | ** ** | **2005**                                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Semiconductors:**                            | ** ** | ** **                                                        | ** ** | ** **                                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues.                                      | ** ** | **$**                                                             | 2,228,826  | ** **                                                      | **$**      | 2,521,174 | ** ** | **$** | 4,370,534 | ** ** | **$** | 4,505,737 | ** ** |
| Cost of  sales                                 |       | 1,001,262                                                         |       | 999,166                                                         |       | 2,069,746 |   | 1,727,406 |   |
| Gross margin                                   |       | 1,227,564                                                         |       | 1,522,008                                                       |       | 2,300,788 |   | 2,778,331 |   |
| Total  operating expenses                      |       | 1,081,015                                                         |       | 1,462,636                                                       |       | 2,210,163 |   | 2,774,808 |   |
| Income from  operations                        |       | 146,549                                                           |       | 59,372                                                          |       | 90,625 |   | 3,523 |   |
| Other  income, net                             |       | 3,678                                                             |       | 5,952                                                           |       | 7,863 |   | 4,614 |   |
| Income  before income tax (benefit) expense    |       | 150,227                                                           |       | 65,324                                                          |       | 98,488 |   | 8,137 |   |
| Income tax  (benefit) expense                  |       | (385                                                              | )          | 563                                                             |       | 30,696 |   | 5,741 |   |
| **Net  income from semiconductors**            |       | 150,612                                                           |       | 64,761                                                          |       | 67,792 |   | 2,396 |   |
| **Net  income from CHS/SRS LLC**               |       | 1,649                                                             |       | 13,764                                                          |       | 95,764 |   | 91,096 |   |
| **Gain on  Sale of CHS/SRS LLC**               |       | 371,295                                                           |       | —                                                          |       | 371,295 |   | — |   |
| **Total  income from discontinued operations** |       | $                                                                 | 523,556    |                                                            | $          | 78,525 |   | $ | 534,851 |   | $ | 93,492 |   |

 

A summary of the assets andliabilities related to the discontinued operations of Valence and the JointVenture classified as held for sale in the accompanying condensed consolidatedbalance sheet is as follows:

 
| ** **                                        | ** ** | **June 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|---------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                                        | ** ** | **(unaudited)**             | ** ** | ** **                      | ** ** |
| **Current  assets held for sale:**                |       |                        |       |                            |       |
| Accounts  receivable, net                         |       | $                           | 950,081    |                            | $          | 902,771 |   |
| Inventories,  net                                 |       | 1,032,771                   |       | 534,226                         |       |
| Prepaid  expenses and other current assets        |       | 281,995                     |       | 422,130                         |       |
| Total                                             |       | 2,264,847                   |       | 1,859,127                       |       |
|                                              |       |                        |       |                            |       |
| **Long  term assets held for sale:**              |       |                        |       |                            |       |
| Furniture,  fixtures and equipment, net      |       | 1,143,439                   |       | 1,060,631                       |       |
| Goodwill                                          |       | 533,031                     |       | 533,031                         |       |
| Intangibles,  net                                 |       | 437,143                     |       | 471,461                         |       |
| Total                                             |       | 2,113,613                   |       | 2,065,123                       |       |
|                                              |       |                        |       |                            |       |
| **Liabilities  related to assets held for sale:** |       |                        |       |                            |       |
| Accounts  payable                                 |       | 858,256                     |       | 855,559                         |       |
| Accrued  liabilities                              |       | 842,450                     |       | 1,315,142                       |       |
| Total                                             |       | 1,700,706                   |       | 2,170,701                       |       |
|                                                   |            |                             |            |                                 |            |  |  |

 

15

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

 

TheCompany previously operated in two business segments — semiconductors andlicensing. However, as a result of the Board’s decision on February 23,2006 to sell the semiconductor business, the Company now has continuingoperations in only one business segment, licensing. Our revenue from continuingoperations is solely derived from licensing related revenue.

 

For the three and six months ending June 30,2006, there was no significant customer in the licensing segment. For the sameperiod in the prior year, two customers accounted for approximately 10% each inthe licensing segment. The following schedule presents the Company’srevenue from continuing operations by geographic area. Licensing-relatedrevenue is allocated based on the location of the licensee’s corporate headquarters.The Americas region includes North, Central and South America.

 
| ** **                    | ** ** | **Three Months Ended  June 30,** | ** ** | ** ** | ** ** | **Six Months Ended  June 30,** | ** ** | ** ** | ** ** |
|-------------------------------|------------|-------------------------------------------------|------------|------------|------------|-----------------------------------------------|------------|------------|------------|
| ** **                    | ** ** | **2006**                                        | ** ** | **%**      | ** ** | **2005**                                      | ** ** | **%**      | ** ** | **2006** | ** ** | **%** | ** ** | **2005** | ** ** | **%** | ** ** |
| **Geographic  Area Revenue:** |       |                                            |       |       |       |                                          |       |       |       |   |   |   |   |   |   |   |   |
|                          |       |                                            |       |       |       |                                          |       |       |       |   |   |   |   |   |   |   |   |
| Japan                         |       | $                                               | 1,883,315  |       | 44         |                                          | $          | 1,446,553  |       | 41 |   | $ | 3,911,095 |   | 45 |   | $ | 2,967,042 |   | 44 |   |
| Korea                         |       | 1,208,108                                       |       | 28         |       | 962,787                                       |       | 27         |       | 2,384,609 |   | 28 |   | 1,654,821 |   | 24 |   |
| Americas                      |       | 336,081                                         |       | 8          |       | 427,239                                       |       | 12         |       | 806,520 |   | 9 |   | 1,099,039 |   | 16 |   |
| China                         |       | 806,806                                         |       | 19         |       | 611,566                                       |       | 17         |       | 1,425,828 |   | 17 |   | 950,923 |   | 14 |   |
| Europe                        |       | 25,529                                          |       | 1          |       | 91,832                                        |       | 3          |       | 67,455 |   | 1 |   | 132,247 |   | 2 |   |
| Total                         |       | $                                               | 4,259,839  |       | 100        |                                          | $          | 3,539,977  |       | 100 |   | $ | 8,595,507 |   | 100 |   | $ | 6,804,072 |   | 100 |   |

 

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

 

InJuly 2006, the Financial Accounting Standards Board (FASB) issued FASBInterpretation No. (FIN) 48, **Accounting for Uncertainty in Income Taxes**.FIN 48 is an interpretation of FASB Statement No. 109, “Accounting forIncome Taxes,” and it seeks to reduce the diversity in practice associated withcertain aspects of measurement and recognition in accounting for income taxes.In addition, FIN 48 requires expanded disclosure with respect to theuncertainty in income taxes and is effective as of the beginning of our 2007fiscal year. We are currently evaluating the impact, if any, that FIN 48 willhave on our consolidated financial statements.

 

**12.**                               **Subsequent Events**

 

On July 14, 2006, the Company entered into adefinitive Sale and Purchase Agreement (“Purchase Agreement”) to sell Valenceto Noblehigh Enterprises Inc. (“Noblehigh”). Noblehigh is owned by Willas ArrayElectronics (Holding) Limited (“Willas-Array”) as well as certain members ofmanagement of Valence (collectively referred to herein as the “ManagementBuyers”).

 

The sale to Noblehigh will be effected through twosimultaneous transactions: (1) the repurchase by Valence of approximately74% of the outstanding shares of Valence from SRS and (2) the purchase byNoblehigh of the remaining outstanding shares of Valence from SRS for $4.3million. Valence will repurchase shares from SRS using its existing cash, cashequivalents and other current assets, all of which are reflected on SRS’sbalance sheet. The purchase price is subject to adjustment dependent uponValence’s net current assets as of June 30, 2006 subject to review by theparties’ auditors. The Company expects to recognize a gain from the sale ofValence.

 

In connection with the sale of Valence to Noblehigh,the majority of management personnel of Valence will execute Waiver of Change of Control agreements to confirm that theyare not entitled to any payments or other benefits as a result of the sale ofValence. Also, subject to the sale of Valence, SRS will repurchase fromManagement Buyers up to 550,000 shares of SRS common stock, which suchindividuals may obtain through the exercise of vested employee stockoptions. The repurchase price payable for such shares shall be equal to theaverage closing price of SRS common stock for the 10 trading days prior to theclosing date of the sale of Valence. The repurchase of any shares from theManagement Buyers will occur concurrently with the closing of the sale ofValence.

 

The Purchase Agreement contains customaryrepresentations, covenants, warranties indemnification and terminationprovisions. The closing of the sale of Valence is subject to a number ofconditions, including the approval of the transaction by the shareholders ofWillas-Array.

 

16

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**Item 2. Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

This information should be read in conjunction withthe audited consolidated financial statements and notes thereto and Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontained in the Company’s Annual Report on Form 10-K for the year ended December 31,2005, or the Form 10-K, the audited consolidated financial statements andthe notes thereto included in the Form 10-K and the unaudited condensedinterim consolidated financial statements and notes thereto included in thisQuarterly Report.

 

**Overview**

 

SRSLabs is a leading developer and provider of audio and voice technologysolutions for the home entertainment, portable media device, personaltelecommunications, personal computer, automotive, and broadcast markets, and adeveloper and provider of application specific integrated circuits, or ASICs,and standard integrated circuits, or ICs.

 

Historically,we have operated in the two business segments, licensing and semiconductors.

 

*Licensing:****  ***ThroughSRS Labs, the parent company, and its wholly-owned subsidiary, SRSWOWcast.com, Inc.,doing business as SRSWOWcast Technologies, or SRSWOWcast, we develop andlicense audio, voice and surround sound technology solutions to many of theworld’s leading OEMs, software providers and semiconductor companies, andlicense and market hardware and software products for the Internet andprofessional audio markets.

 

*DiscontinuedOperations:*

 

*Semiconductors:  *Through SRSLabs, Inc.’s wholly-owned subsidiary, ValenceTech Limited, and ValenceTechLimited’s wholly-owned subsidiaries (collectively “Valence”), we operate afabless semiconductor business which develops, designs and markets standard andcustom analog ICs, digital signal processors, and mixed signal integratedcircuits primarily to original equipment manufacturers and original designmanufacturers, in the Asia Pacific region. On February 23, 2006, the Boardapproved a plan to sell Valence in order to focus increased managementattention and financial resources on its licensing business.   On July 14, 2006, the Company enteredinto a definitive Sale and Purchase Agreement to sell  Valence to Noblehigh Enterprises Inc. As aresult of our decision to sell Valence, we have accounted for the semiconductorbusiness segment as discontinued operations in the accompanying condensedconsolidated financial statements.

 

*CHS/SRS LLC: *In September 2004, we entered into astrategic alliance with Coming Home Studios LLC, or CHS, to use and promote SRSLabs technologies, promote CHS productions and to promote each company’srespective brands. In connection with the strategic alliance, the Company andCHS established a joint venture, CHS/SRS, LLC, or the Joint Venture, to produceand distribute six concert videos featuring our Circle Surround technology, orthe Concert Videos. Initially, Coming Home Studios LLC was the manager of theCHS/SRS Joint Venture; however, the Company became manager of the Joint Venturein July, 2005. As a result of becoming the manager of, and providing financialsupport to the Joint Venture, the Company was required under FASBInterpretation No. 46, Consolidation of Variable Interest Entities (FIN46R), to consolidate the financial statements of the Joint Venture into ourfinancial statements commencing with the third quarter of fiscal 2005.Previously, we accounted for our 50% equity ownership in the Joint Venture asan investment using the equity method.

 

In February 2006, our Board ofDirectors, or the Board, authorized management to take all reasonable steps todivest our entire equity interest in the Joint Venture. As a result of ourdecision to sell our entire equity interest in the Joint Venture, we haveaccounted for the Joint Venture as a discontinued operation in the accompanyingcondensed consolidated financial statements. On June 30, 2006, the Company completed the sale of itsinterest in the Joint Venture to Coming Home Studios, LLC (“CHS”) in exchangefor $200,000, the rights to all cash assets of the joint venture, and apromissory note in the amount of $175,000. As of the close of business on June 30,2006, SRS had received $150,000 from CHS and had transferred the cash assets ofthe joint venture to SRS. The remaining $50,000 was received from CHS on July 5,2006. The Company has recorded a gain on disposal of its interest in the LLC ofapproximately $370,000. Any amounts related to the promissory note will berecorded as a gain at the time the cash is received by SRS.

 

As used herein, the “Company,”“SRS Labs,” “we,” “us,” or “our” means SRS Labs, Inc. and its direct andindirect wholly-owned subsidiaries, including ValenceTech Limited, Valence,SRSWOWcast.com, Inc. and the joint venture with Coming Home Studios LLC,CHS/SRS LLC.

 

17

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#### **Critical Accounting Policies**

 

Our discussion and analysis of our resultsof operations and liquidity and capital resources are based on our consolidatedfinancial statements which have been prepared in accordance with accounting principlesgenerally accepted in the United States of America.

 

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

 

*Stock Based Compensation*

 

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 123 (revised 2004), “Share-Based Payment,” ** **(“SFAS 123R”). ThisStatement requires companies to expense the estimated fair value of stockoptions and similar equity instruments issued to employees over the requisiteservice period. SFAS 123R eliminates the alternative to use the intrinsicmethod of accounting provided for in Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees (“APB 25”), which generally resultedin an immaterial amount of compensation expense recorded in the financialstatements related to the grant of stock options to employees if certain conditionswere met. The pro forma impact from recognition of the estimated fair value ofstock options granted to employees has been disclosed in our footnotes asrequired under previous accounting rules.

 

Effective for the first quarter of fiscal 2006, weadopted SFAS 123R using the modified prospective method, which requires us torecord compensation expense for all awards granted after the date of adoption,and for the unvested portion of previously granted awards that remainoutstanding at the date of adoption. Accordingly, prior period amountspresented herein have not been restated to reflect the adoption of SFAS 123R.

 

The fair value concepts were not changedsignificantly in SFAS 123R; however, in adopting this SFAS 123R, companies mustchoose among alternative valuation models and amortization assumptions. Afterassessing alternative valuation models and amortization assumptions, we arecontinuing to use both the Black-Scholes-Merton (“BSM”) option-pricing formulaand straight-line amortization of compensation expense over the requisiteservice period of the grant. We will reconsider use of this model if additionalinformation becomes available in the future that indicates another model wouldbe more appropriate for us, or if grants issued in future periods havecharacteristics that cannot be reasonably estimated using this model. UnderSFAS No. 123, “Accounting for Stock Based Compensation” (“SFAS 123”), wewere not required to estimate forfeitures in our expense calculation for thestock compensation pro forma footnote disclosure; however, SFAS 123R requiresan estimate of forfeitures and upon adoption we changed our methodology toinclude an estimate of forfeitures.

 

The following table illustrates the effect on netincome and income per share if we had applied the fair value recognitionprovisions of SFAS 123 to options granted under our stock option plans in thefirst fiscal quarter of 2005. For purposes of this pro forma disclosure, thefair value of the options is estimated using a BSM option-pricing formula andamortized on a straight-line basis to expense over the options’ vesting period:

 
| **** ****                                                                                                                 | **** **** | ****Three Months  Ended**** | **** **** | ****Six Months  Ended**** | **** **** |
|--------------------------------------------------------------------------------------------------------------------------------|----------------|----------------------------------|----------------|--------------------------------|----------------|
| **** ****                                                                                                                 | **** **** | ****June 30,****            | **** **** | ****June 30,****          | **** **** |
| **** ****                                                                                                                 | **** **** | ****2005****                     | **** **** | ****2005****                   | **** **** |
|                                                                                                                           |           |                             |           |                           |           |
| Net income -  as reported                                                                                                      |           | $                                | 513,734        |                           | $              | 735,194 |   |
| Add:  Share-based employee compensation expense included in net income, net of  related tax effects - as reported              |           | 5,843                            |           | 14,742                         |           |
| Deduct:  Share-based employee compensation expense determined under fair value method,  net of related tax effects - pro forma |           | (275,174                         | )              | (580,277                       | )              |
| Net income -  pro forma                                                                                                        |           | $                                | 244,403        |                           | $              | 169,659 |   |
| Basic - as  reported                                                                                                           |           | $                                | 0.04           |                           | $              | 0.05 |   |
| Basic - pro  forma                                                                                                             |           | $                                | 0.02           |                           | $              | 0.01 |   |
| Diluted - as  reported                                                                                                         |           | $                                | 0.03           |                           | $              | 0.05 |   |
| Diluted -  pro forma                                                                                                           |           | $                                | 0.02           |                           | $              | 0.01 |   |

 

18

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The fair value of each share-based award isestimated on the grant date using the BSM option-pricing formula. Expectedvolatilities are based on the historical volatility of the Company’s stockprice. The expected term of options granted subsequent to the adoption of SFAS123R is derived using the simplified method as defined in the SEC’s StaffAccounting Bulletin 107, “Implementation of FASB 123R.” The risk-free rate forperiods within the contractual life of the option is based on the U.S. Treasuryinterest rates in effect at the time of grant.

 

Total compensation cost recognized in the three andsix months ending June 30, 2006 is as follows:

 
| ** **                                                     | ** ** | **Three Months** | ** ** | **Six Months** | ** ** |
|----------------------------------------------------------------|------------|-----------------------|------------|---------------------|------------|
| Continuing  Operations:                                        |       |                  |       |                |       |
| Sales and  Marketing                                           |       | $                     | 136,459    |                | $          | 298,512 |   |
| Research and  Development                                      |       | 75,174                |       | 202,161             |       |
| General and  Administrative                                    |       | 132,387               |       | 186,727             |       |
| Total  compensation cost recognized in Continuing Operations   |       | $                     | 344,020    |                | $          | 687,400 |   |
|                                                           |       |                  |       |                |       |
| Total  compensation cost recognized in Discontinued Operations |       | $                     | 44,785     |                | $          | 101,143 |   |
| Total  compensation cost recognized                            |       | $                     | 388,805    |                | $          | 788,543 |   |

 

19

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**Results of Continuing Operations**

 

**Three Months Ended June 30, 2006 Compared toThree Months Ended June 30, 2005**

 

*Revenues*

 

Licensing revenues consist primarily of royaltiesgenerated from the license of SRS Labs’ audio and voice technologies. Licenseand royalty agreements generally provide for the license of technologies for afee based on the number of units distributed by the licensee. However, we havein the past and may again in the future, enter into a license agreementfor a one-time fee. Also included in licensing revenue are revenues generatedfrom the sale of hardware and software applications into the broadcast audiomarkets.

 

Licensing revenues were $4,259,839 for the threemonths ended June 30, 2006, compared to $3,539,977 for the three monthsended June 30, 2005, an increase of $719,862 or 20.3%. The sales growth inlicensing was primarily attributable to continued strong sales in the HomeEntertainment and Automotive segments. Within the Home Entertainment segment,revenue growth is due to increased licensing fees related to flat panelmonitors and televisions.  Thefollowing table presents the Company’s licensing revenues mix by marketsegment:

 
| ** **                                               | ** ** | **Three Months Ended June 30,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                               | ** ** | **2006**                                       | ** ** | **2005** | ** ** |
| Home  Entertainment (TV, Set Top Box, A/V Receiver, DVD) |       | 53                                             | %          | 47 | % |
| Portable Media Devices (Digital Media Player, Headphone) |       | 19                                             | %          | 24 | % |
| Personal Telecommunications (Mobile phone, PDA)          |       | 11                                             | %          | 16 | % |
| PC  (Software, Hardware)                                 |       | 10                                             | %          | 9 | % |
| Automotive                                               |       | 7                                              | %          | 4 | % |

 

*Sales and Marketing*

 

Sales and marketing expenses consistprimarily of employee salaries, sales consultants’ fees and related expenses,sales commissions and product promotion costs. Sales and marketing expenseswere $1,885,416 for the three months ended June 30, 2006, compared to$1,026,477 for the same prior year period, an increase of $858,939 or 83.7%. Thisincrease is primarily attributable to increased sales headcount in overseasmarkets and related expenses, increased commissions on higher revenues, andincreased marketing expenses, including headcount in the United States, relatedto efforts to enhance the Company’s brand.  In addition, the increase is attributable to $136,459in stock option expense that was recognized due to the adoption of FAS 123R inthe current fiscal year. As a percentage of total revenues, sales and marketingexpenses increased from 29.0% for the quarter ended June 30, 2005 to****44.3%for the same period this year.

 

*Researchand Development*

 

Researchand development expenses consist of salaries and related costs of employeesengaged in ongoing research, design and development activities and costs forengineering materials and supplies. Research and development expenses were $631,739for the three months ended June 30, 2006, compared to $547,787 for thesame prior year period, an increase of $83,952 or 15.3%. This increase is primarilyattributable to $75,174 in stock option expense that was recognized due to theadoption of FAS 123R in the current fiscal year.  As a percentage of total revenues, researchand development expenses were 15.5%for the quarter ended June 30, 2005, and 14.8% for the same period thisyear.

 

*Generaland Administrative*

 

General and administrative (“G&A”)expenses consist primarily of employee-related expenses, legal costs associatedwith the administration of intellectual property and other professional fees.G&A expenses were $1,357,789 for the three months ended June 30, 2006,compared to $1,427,501 for the same prior year period, a decrease of $69,712 or4.9%. The decrease is primarilyattributable to decreased accounting and legal fees and outside consultingcosts. In addition, the decrease was offset by the Company recognizing $132,387in stock option expense due to the adoption of FAS 123R in the current fiscalyear. As a percentage of total revenues, G&A expenses decreased from 40.3% for the quarter ended June 30,2005, to 31.9% for the sameperiod this year.

 

*OtherIncome, Net*

 

Otherincome, net, consists primarily of interest income. Other income, net, was $224,005for the three months ended June 30, 2006, compared to $160,341 for thesame prior year period, an increase of $63,664 or 39.7%. This increase isprimarily attributable to higher interest income on larger cash balancesinvested.

 

20

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*Provisionfor Income Taxes*

 

The income tax expense for the threemonths ended June 30, 2006 was $167,745,compared to tax expense of $168,506 for the same prior year period. Thisprovision consists primarily of taxes paid on licensing revenues sourced fromcountries requiring foreign tax withholdings, principally Korea.

 

*Discontinued Operations*

 

As a result ofour decision to sell Valence and our entire equity interest in the JointVenture, we have accounted for the semiconductor business segment and the JointVenture as discontinued operations. All prior periods have been reclassified toconform to the current period presentation.

 

Income from discontinuedoperations consists of direct revenues and direct expenses of Valence andCHS/SRS LLC. General corporate overhead costs have not been allocated todiscontinued operations. A summary of the operating results of Valence and theJoint Venture included in discontinued operations in the accompanying condensedconsolidated statements of operation is as follows:

 
| ** **                                     | ** ** | **For the three months  ended June 30,** | ** ** |
|------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                                          | ** ** | **2005** | ** ** |
| **Semiconductors:**                            | ** ** | ** **                                                        | ** ** | ** ** | ** ** |
| Revenues                                       | ** ** | **$**                                                             | 2,228,826  | ** ** | **$** | 2,521,174 | ** ** |
| Cost of  sales                                 |       | 1,001,262                                                         |       | 999,166 |   |
| Gross margin                                   |       | 1,227,564                                                         |       | 1,522,008 |   |
| Total  operating expenses                      |       | 1,081,015                                                         |       | 1,462,636 |   |
| Income from  operations                        |       | 146,549                                                           |       | 59,372 |   |
| Other  income, net                             |       | 3,678                                                             |       | 5,952 |   |
| Income  before income tax (benefit) expense    |       | 150,227                                                           |       | 65,324 |   |
| Income tax  (benefit) expense                  |       | (385                                                              | )          | 563 |   |
| **Net  income from semiconductors**            |       | 150,612                                                           |       | 64,761 |   |
| **Net  income from CHS/SRS LLC**               |       | 1,649                                                             |       | 13,764 |   |
| **Gain on  Sale of CHS/SRS LLC**               |       | 371,295                                                           |       | — |   |
| **Total  income from discontinued operations** |       | $                                                                 | 523,556    |   | $ | 78,525 |   |

 

Semiconductorrevenues were $2,228,826 in the three months ended June 30, 2006 comparedto $2,521,174 in the three months ended June 30, 2005, a decrease of $292,348or 11.6%. ASP revenues increased $141,925 due to the introduction of severalnew ASP chips. The increase in ASP revenues was offset by a decrease in ASICrevenues of $434,273, due to a decline in ASIC product demand. Gross margindecreased from 60% to 55% in the quarters ended June 30, 2005 and 2006,respectively, due to an increase in lower margin ASP sales. Operating expensesdecreased $381,621 primarily due to decreased head count and related expenses. Otherincome (expense), net and income tax expense were comparable with the priorperiod. Net income from CHS/SRS LLC was comparable to the prior period. TheCompany recognized a gain on the sale of its interest in CHS/SRS LLC of$371,295 on June 30, 2006.

 

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**Six Months Ended June 30, 2006 Compared to SixMonths Ended June 30, 2005**

 

*Revenues*

 

Licensing revenues were $8,595,507 for the sixmonths ended June 30, 2006, compared to $6,804,072 for the six monthsended June 30, 2005, an increase of $1,791,435 or 26.3%. The sales growthin licensing was attributable to our continued strong sales in all five of ourmarket segments with four of the five segments achieving year over year growth.The Home Entertainment segment continues to grow in total revenues due toincreases in Advanced Display revenues, partially offset by a decrease in SetTop Box and CRT revenues. The following table presents the Company’slicensing revenues mix by market segment:

 
| ** **                                               | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                               | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| Home  Entertainment (TV, Set Top Box, A/V Receiver, DVD) |       | 54                                                | %          | 55 | % |
| Portable Media Devices (Digital Media Player, Headphone) |       | 20                                                | %          | 19 | % |
| Personal Telecommunications (Mobile phone, PDA)          |       | 11                                                | %          | 13 | % |
| PC  (Software, Hardware)                                 |       | 9                                                 | %          | 10 | % |
| Automotive                                               |       | 6                                                 | %          | 3 | % |

 

*Sales and Marketing*

 

Sales and marketing expenses consistprimarily of employee salaries, sales consultants’ fees and related expenses,sales commissions and product promotion costs. Sales and marketing expenseswere $3,750,785 for the six months ended June 30, 2006, compared to$2,208,924 for the same prior year period, an increase of $1,541,861 or 69.8%. Thisincrease is primarily attributable to increased headcount and related expenses,increased commissions on higher revenues, and increased marketing activitiesrelated to efforts to enhance the Company’s brand.  In addition, the increase is primarily attributableto $298,512 in stock option expense that was recognized due to the adoption ofFAS 123R in the current fiscal year. As a percentage of total revenues, salesand marketing expenses increased from 32.5% for the six months ended June 30,2005 to****43.6% for the same period this year.

 

*Researchand Development*

 

Researchand development expenses consist of salaries and related costs of employeesengaged in ongoing research, design and development activities and costs forengineering materials and supplies. Research and development expenses were$1,286,028 for the six months ended June 30, 2006, compared to $1,123,992for the same prior year period, an increase of $162,036 or 14.4%. This increaseis primarily attributable to $202,161 in stock option expense that was recognizeddue to the adoption of FAS 123R in the current fiscal year, offset by decreasedhead count and related expenses.  As apercentage of total revenues, research and development expenses were 16.5% for the six months ended June 30,2005, and 15.0% for the same period this year.

 

*Generaland Administrative*

 

General and administrative (“G&A”)expenses consist primarily of employee-related expenses, legal costs associatedwith the administration of intellectual property and other professional fees.G&A expenses were $2,994,997 for the six months ended June 30, 2006,compared to $2,700,352 for the same prior year period, an increase of $294,645or 10.9%. This increase isprimarily attributable to increased professional fees, costs associated withthe Company’s separation from its former Chief Financial Officer and consultingagreements related to human resources activities. In addition, the increase isattributable to $186,727 in stock option expense that was recognized due to theadoption of FAS 123R in the current fiscal year. As a percentage of totalrevenues, G&A expenses decreased from 39.7% for the six months ended June 30, 2005, to 34.8% for the same period this year.

 

*OtherIncome, Net*

 

Otherincome, net, consists primarily of interest income. Other income, net, was$403,718 for the six months ended June 30, 2006, compared to $309,611 forthe same prior year period, an increase of $94,107 or 30.4%. This increase isprimarily attributable to higher interest income on larger cash balancesinvested.

 

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*Provisionfor Income Taxes*

 

The income tax expense for the six monthsended June 30, 2006 was $327,168,compared to tax expense of $287,530 for the same prior year period, an increaseof $39,638 or 13.8%. This provision consists primarily of taxes paid onlicensing revenues sourced from countries requiring foreign tax withholdings,principally Korea.

 

*Discontinued Operations*

 

Asa result of our decision to sell Valence and our entire equity interest in the JointVenture, we have accounted for the semiconductor business segment and the JointVenture as discontinued operations. All prior periods have been reclassified toconform to the current period presentation.

 

Income from discontinuedoperations consists of direct revenues and direct expenses of Valence andCHS/SRS LLC. General corporate overhead costs have not been allocated todiscontinued operations. A summary of the operating results of Valence and theJoint Venture included in discontinued operations in the accompanying condensedconsolidated statements of operation is as follows:

 
| ** **                                     | ** ** | **For the six months  ended June 30,** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                                        | ** ** | **2005** | ** ** |
| **Semiconductors:**                            | ** ** | ** **                                                      | ** ** | ** ** | ** ** |
| Revenues.                                      | ** ** | **$**                                                           | 4,370,534  | ** ** | **$** | 4,505,737 | ** ** |
| Cost of  sales                                 |       | 2,069,746                                                       |       | 1,727,406 |   |
| Gross margin                                   |       | 2,300,788                                                       |       | 2,778,331 |   |
| Total  operating expenses                      |       | 2,210,163                                                       |       | 2,774,808 |   |
| Income from  operations                        |       | 90,625                                                          |       | 3,523 |   |
| Other  income, net                             |       | 7,863                                                           |       | 4,614 |   |
| Income  before income tax (benefit) expense    |       | 98,488                                                          |       | 8,137 |   |
| Income tax  (benefit) expense                  |       | 30,696                                                          |       | 5,741 |   |
| **Net  income from semiconductors**            |       | 67,792                                                          |       | 2,396 |   |
| **Net  income from CHS/SRS LLC**               |       | 95,764                                                          |       | 91,096 |   |
| **Gain on  Sale of CHS/SRS LLC**               |       | 371,295                                                         |       | — |   |
| **Total  income from discontinued operations** |       | $                                                               | 534,851    |   | $ | 93,492 |   |

 

Semiconductorrevenues were $4,370,534 for the six months ended June 30, 2006 comparedto $4,505,737 for the six months ended June 30, 2005, a decrease of$135,203 or 3%. ASP revenues increased $654,740 due to the introduction ofseveral new ASP chips. The increase in ASP revenues was offset by a decrease inASIC revenues of $789,943, due to a decline in ASIC product demand. Gross margindecreased from 62% to 53% in the quarters ended June 30, 2005 and 2006,respectively, due to an increase in lower margin ASP sales. Operating expensesdecreased $564,645 or 20% primarily due to decreased head count and relatedexpenses. Other income, net and income tax expense were materially consistentwith the prior period. Net income from CHS/SRS LLC was comparable to the priorperiod. The Company recognized a gain on the sale of its interest in CHS/SRSLLC of $371,295 on June 30, 2006.

 

**Liquidity and Capital Resources**

 

The Company’s principal source of liquidityto fund ongoing operations at June 30, 2006 consisted of cash, cashequivalents and long-term investments of $29,140,155. At June 30, 2006,the Company had cash and cash equivalents and short term investments of $24,040,566 and long-term investmentsof $5,099,589. Cash and cashequivalents generally consist of cash, money market funds and other money marketinstruments with original maturities of three months or less. Investmentsconsist of U.S. government securities rated AAA.

 

Net cash provided by operating activitiesfrom continuing operations was $1,900,029 and $2,548,212 during the six monthsended June 30, 2006 and June 30, 2005, respectively. The decrease inour operating cash flows is primarily the result of our deferred revenuedecreasing $427,382 and $128,702 in the six months ended June 30, 2006 andJune 30, 2005, respectively, due to recognition of revenue on prepaidroyalties. Accrued liabilities increased $51,058 and $1,149,403 during the sixmonths ended June 30, 2006 and 2005, respectively. The changes inliability accounts generally relate to increases in professional fees, commissionsand bonus and the timing of payments to vendors and employees. Accountsreceivable decreased $440,715 and $287,557 during the six months ended June 30,2006 and 2005, respectively, due to timing of billing and cash receipts, whichpartially offset the decreases in operating cash flows.

 

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Our net cash used in investing activities from continuing operations was $511,136 and $290,568 during the six months ended June 30, 2006 and June 30, 2005, respectively. The increase in net cash used by investing activities was attributable primarily to a $82,490 increase in cash used in expenditures related to patents and intangible assets and a $138,078 increase to purchase of furniture, fixtures and equipment.

 

Our net cash provided by financing activities from continuing operations was $1,923,257 during the six months ended June 30, 2006 and our net cash used in financing activities from continuing operations was $651,850 during the six months ended June 30, 2005. The increase in net cash provided by financing activities was attributable to an increase in stock option exercises. Additionally, during the six months ended June 30, 2005, the Company repurchased treasury stock of $1,059,590 and did not purchase any treasury stock in the six months ended June 30, 2006.

 

Our net cash increase from discontinued operations was $7,462 during the six months ended June 30, 2006 and our net cash decrease from discontinued operations was $1,782,835 during the six months ended June 30, 2005. We are unable to estimate at this time the future cash expenditures that the Company will incur related to the disposition of the Company’s interest in Valence.

 

We expect expenditures related to patents andintangible assets to increase in the future consistent with the growth in ourlicensing business, as we continue to invest in the development of newtechnologies.

 

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

 

Our operations and financial results aresubject to various risks and uncertainties that could adversely affect ourbusiness, financial condition and results of operations and the trading priceof our common stock. Please refer to Item 1A, “Risk Factors” in our annualreport on Form 10-K for fiscal year 2005 for information concerning theseand other uncertainties that could negatively impact the Company.

 

**Item 3. Quantitative andQualitative Disclosures about Market Risk**

 

There have been no material changes to theinformation called for by this Item 3 from the disclosures set forth in Part II,Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31,2005.

 

**Item 4. Controls and Procedures**

 

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

 

*Changesin Internal Controls.**  *There havebeen no changes in our internal controls over financial reporting that occurredduring our second quarter ended June 30, 2006 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

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**PART II - OTHER INFORMATION**

 

**Item 6. Exhibits**

 

Theexhibits listed below are hereby filed with the U.S. Securities and ExchangeCommission (the “SEC”) as part of this Report.

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                 |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Certificate of Incorporation of the  Company, previously filed with the SEC as Exhibit 3.1 to the Company’s  Registration Statement on Form SB-2, specifically included in Amendment No. 1  to such Registration Statement filed with the SEC on July 3, 1996 (File No. 333-4974-LA),  which is incorporated herein by reference. |
| 3.2                 |       | Bylaws of the Company, previously filed  with the SEC as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q  for the period ended September 30, 1999, filed with the SEC on November 12,  1999, which is incorporated herein by reference.                                                                                     |
| 10.1                |       | Termination Agreement dated June 30,  2006 between SRS Labs, Inc. and Coming Home Studios, LLC, previously  filed as Exhibit 10.1 to the Company’s Form 8-K filed with the  Securities and Exchange Commission on July 7, 2006, which is incorporated  herein by reference.                                                       |
| 10.2                |       | Promissory Note dated June 30, 2006  between SRS Labs, Inc. and Coming Home Studios, LLC. previously filed as  Exhibit 10.2 to the Company’s Form 8-K filed with the Securities  and Exchange Commission on July 7, 2006, which is incorporated herein by  reference.                                                             |
| 10.3                |       | Security Agreement dated June 30, 2006  between SRS Labs, Inc. and Coming Home Studios, LLC, previously filed as  Exhibit 10.3 to the Company’s Form 8-K filed with the Securities  and Exchange Commission on July 7, 2006, which is incorporated herein by  reference.                                                          |
| 10.4                |       | Assignment dated June 30, 2006 between  SRS Labs, Inc. and Coming Home Studios, LLC, previously filed as Exhibit 10.4  to the Company’s Form 8-K filed with the Securities and Exchange  Commission on July 7, 2006, which is incorporated herein by reference.                                                                   |
| 10.5                |       | First Amendment to the Strategic Alliance  Agreement dated June 30, 2006 between SRS Labs, Inc. and Coming  Home Studios, LLC, previously filed as Exhibit 10.5 to the Company’s Form 8-K  filed with the Securities and Exchange Commission on July 7, 2006, which  is incorporated herein by reference.                         |
| 10.6                |       | SRS Labs, Inc. 2006 Stock Incentive  Plan, previously filed as Exhibit 10.1 to the Company’s Form 8-K  filed with the Securities and Exchange Commission on June 28, 2006,  which is incorporated herein by reference.                                                                                                                 |
| 10.7                |       | SRS Labs, Inc. Patent Reward Program,  previously filed as Exhibit 10.2 to the Company’s Form 8-K filed  with the Securities and Exchange Commission on June 28, 2006, which is  incorporated herein by reference.                                                                                                                     |
| 10.8                |       | SRS Labs, Inc. 2006 Profit Sharing and  Bonus Plan, previously filed as Exhibit 99.1 to the Company’s Form 8-K  filed with the Securities and Exchange Commission on April 18, 2006,  which is incorporated herein by reference.                                                                                                       |
| 31.1                |       | Certification of Chief Executive Officer of  SRS Labs, Inc., pursuant to Rule 13a-14 of the Securities Exchange  Act.                                                                                                                                                                                                                                 |
| 31.2                |       | Certification of Chief Financial Officer of  SRS Labs, Inc., pursuant to Rule 13a-14 of the Securities Exchange  Act.                                                                                                                                                                                                                                 |
| 32.1                |       | Certification of Chief Executive Officer of  SRS Labs, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act  of 2002.                                                                                                                                                                                                                              |
| 32.2                |       | Certification of Chief Financial Officer of  SRS Labs, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act  of 2002.                                                                                                                                                                                                                              |

 

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**SIGNATURES**

 

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

 
|                                 | SRS LABS, INC., a Delaware corporation |
|--------------------------------------|---------------------------------------------|
|                                 |                                        |   |
| Date:  August 8, 2006 | By:                                         | /S/ THOMAS C.K. YUEN |
|                                 |                                        | Thomas C.K. Yuen |
|                                 |                                        | Chairman of the Board and Chief Executive Officer |
|                                 |                                        | (Principal Executive Officer) |
| ** **                           | ** **                                  | ** ** |
| ** **                           | ** **                                  | ** ** |
| Date:  August 8, 2006      | By:                                         | /S/ ULRICH GOTTSCHLING |
|                                 |                                        | Ulrich Gottschling |
|                                 |                                        | Chief Financial Officer |
|                                 |                                        | (Principal Financial and Accounting Officer) |

 

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**EXHIBIT INDEX**

 

The exhibits listed below are hereby filedwith the SEC as part of this Report.

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

 

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