Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

| **(Mark  One)**                                                                                               |                                                                                                     |
|---------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
| **x**                                                                                                         | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
| ** **                                                                                                    | ** **                                                                                               |
| **For the  quarterly period ended September 30, 2008**                                                   |
| ** **                                                                                                    | ** **                                                                                               |
| **OR**                                                                                                        |
| ** **                                                                                                    | ** **                                                                                               |
| **o**                                                                                                         | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
| ** **                                                                                                    | ** **                                                                                               |
| **For the  transition period from      to      ** |
| ** **                                                                                                    | ** **                                                                                               |
| **Commission  File Number 0-21123**                                                                           |

 

**SRS LABS, INC.**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

(Address of principal executive offices) (ZipCode)

 

**(949) 442-1070**

(Registrant’s telephone number, includingarea code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x No o

 

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, a non-accelerated filer, ora smaller reporting company. See the definitions of “large accelerated filer,” “acceleratedfiler” and “smaller reporting company” in Rule 12b-2 of the ExchangeAct. (Check one):

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o   No x

 

Asof October 30, 2008, 15,782,577 shares of the issuer’s common stock, parvalue $.001 per share, were outstanding.

 

 

 

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**SRSLABS, INC.**

 

**QuarterlyReport on Form 10-Q**

**For theThree and Nine Months Ended September 30, 2008**

**Index**

 
| **PART I-FINANCIAL  INFORMATION** |                                                                                                                                                    |
|----------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
| Item 1.                                | Financial  Statements                                                                                                                                   |   |
|                                   | Condensed Consolidated Balance Sheets as of  September 30, 2008 (Unaudited) and December 31, 2007                                             |   |
|                                   | Condensed Consolidated Statements of Operations for  the three and nine months ended September 30, 2008 and 2007 (Unaudited)                       |   |
|                                   | Condensed Consolidated Statements of Stockholders’  Equity and Comprehensive Income for the nine months ended September 30,  2008 (Unaudited) |   |
|                                   | Condensed Consolidated Statements of Cash Flows for  the nine months ended September 30, 2008 and 2007 (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  1A.                              | Risk  Factors                                                                                                                                           |   |
| Item  6.                               | Exhibits                                                                                                                                                |   |
| SIGNATURES                             |                                                                                                                                                    |

 

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**FORWARD-LOOKINGINFORMATION**

 

As used herein, the “Company,” “SRS Labs,” “SRS,”“we,” “us,” or “our” means SRS Labs, Inc. and its wholly-owned subsidiarySRSWOWcast.com, Inc.

 

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, and ourpotential stock repurchases are forward-looking statements. In some cases, youcan identify forward-looking statements by terms such as may, will, should,expect, plan, intend, forecast, anticipate, believe, estimate, predict,potential, continue or the negative of these terms or other comparableterminology. The forward-looking statements contained in this Quarterly Reportinvolve known and unknown risks, uncertainties and situations that may causeour or our industry’s actual results, level of activity, performance orachievements to be materially different from any future results, levels ofactivity, performance or achievements expressed or implied by these statements.Factors that might cause actual events or results to differ materially fromthose indicated by these forward-looking statements may include thematters listed in our most recently filed Annual Report on Form 10-K andelsewhere in this Quarterly Report on Form 10-Q, including, but not limitedto, general business and economic conditions; our high dependence on theconsumer electronics market, which is characterized by short product lifecycles, fluctuations in demand and seasonality; the loss of any one significantcustomer; the acceptance of new SRS Labs products and technologies; the importof competitive products and pricing; the timely development and release oftechnologies by the Company; product and customer concentration in ourbusiness; our dependence on growth in emerging markets; the length andunpredictable nature of our sales cycle; our ability to protect our productsthrough patents and other intellectual property rights; our dependence on keypersonnel; the volatility of the price of our common stock; provisions thatcould discourage transactions resulting in a change in control contained in ourcertificate of incorporation and bylaws as well as Delaware law; competition weface from companies with greater brand recognition and resources; pricingpressures on the consumer electronics product manufacturers; and other factorsidentified from time to time in our filings with the Securities and ExchangeCommission.

 

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.

 

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**PART I— FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**SRSLABS, INC. AND SUBSIDIARY**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                        | ** ** | **September 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                                                                                        | ** ** | **(Unaudited)**                  | ** ** | ** **                      | ** ** |
| **ASSETS**                                                                                                                                                                                                                        |       |                             |       |                            |       |
| **Current Assets**                                                                                                                                                                                                                |       |                             |       |                            |       |
| Cash and cash equivalents                                                                                                                                                                                                         |       | $                                | 41,733,491 |                            | $          | 39,615,291 |   |
| Accounts receivable, net                                                                                                                                                                                                          |       | 569,503                          |       | 1,138,425                       |       |
| Prepaid expenses and other current assets                                                                                                                                                                                         |       | 833,100                          |       | 893,388                         |       |
| Short-term investments                                                                                                                                                                                                            |       | 4,984,000                        |       | —                          |       |
|                                                                                                                                                                                                                              |       |                             |       |                            |       |
| **Total Current Assets**                                                                                                                                                                                                          |       | 48,120,094                       |       | 41,647,104                      |       |
|                                                                                                                                                                                                                              |       |                             |       |                            |       |
| Investments available for sale                                                                                                                                                                                                    |       | —                           |       | 5,451,875                       |       |
| Property and equipment, net                                                                                                                                                                                                       |       | 360,561                          |       | 309,727                         |       |
| Intangible assets, net                                                                                                                                                                                                            |       | 2,321,642                        |       | 2,197,616                       |       |
| Deferred income taxes, net                                                                                                                                                                                                        |       | 2,986,421                        |       | 1,776,202                       |       |
|                                                                                                                                                                                                                              |       |                             |       |                            |       |
| **Total Assets**                                                                                                                                                                                                                  |       | $                                | 53,788,718 |                            | $          | 51,382,524 |   |
|                                                                                                                                                                                                                              |       |                             |       |                            |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                    |       |                             |       |                            |       |
| **Current Liabilities**                                                                                                                                                                                                           |       |                             |       |                            |       |
| Accounts payable                                                                                                                                                                                                                  |       | $                                | 546,912    |                            | $          | 529,063 |   |
| Accrued liabilities                                                                                                                                                                                                               |       | 959,748                          |       | 689,308                         |       |
| Deferred revenue                                                                                                                                                                                                                  |       | 1,802,999                        |       | 1,156,836                       |       |
|                                                                                                                                                                                                                              |       |                             |       |                            |       |
| **Total Current Liabilities**                                                                                                                                                                                                     |       | 3,309,659                        |       | 2,375,207                       |       |
|                                                                                                                                                                                                                              |       |                             |       |                            |       |
| **Commitments and Contingencies (Note 4)**                                                                                                                                                                                        |       |                             |       |                            |       |
|                                                                                                                                                                                                                              |       |                             |       |                            |       |
| **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; 15,796,777 and 16,946,377 shares issued; and 15,782,577  and 15,778,715 shares outstanding at September 30, 2008 and  December 31, 2007, respectively |       | 15,798                           |       | 16,947                          |       |
| Additional paid-in capital                                                                                                                                                                                                        |       | 69,582,396                       |       | 74,143,772                      |       |
| Accumulated other comprehensive loss                                                                                                                                                                                              |       | —                           |       | (48,125                         | )          |
| Accumulated deficit                                                                                                                                                                                                               |       | (19,021,531                      | )          | (19,155,096                     | )          |
| Treasury stock at cost, 14,200 and  1,167,662 shares at September 30, 2008 and December 31, 2007,  respectively                                                                                                         |       | (97,604                          | )          | (5,950,181                      | )          |
|                                                                                                                                                                                                                              |       |                             |       |                            |       |
| **Total Stockholders’ Equity**                                                                                                                                                                                               |       | 50,479,059                       |       | 49,007,317                      |       |
|                                                                                                                                                                                                                              |       |                             |       |                            |       |
| **Total Liabilities and Stockholders’ Equity**                                                                                                                                                                               |       | $                                | 53,788,718 |                            | $          | 51,382,524 |   |

 

See accompanying notes to the condensedconsolidated financial statements

 

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**SRSLABS, INC. AND SUBSIDIARY**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                   | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                   | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                   | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                     |       | $                                | 4,319,433  |                            | $          | 4,769,271 |   | $ | 13,438,565 |   | $ | 14,536,526 |   |
| Cost of sales                                                |       | 22,107                           |       | 36,850                          |       | 88,426 |   | 115,912 |   |
|                                                         |       |                             |       |                            |       |   |   |   |   |
| Gross profit                                                 |       | 4,297,326                        |       | 4,732,421                       |       | 13,350,139 |   | 14,420,614 |   |
|                                                         |       |                             |       |                            |       |   |   |   |   |
| Operating expenses:                                          |       |                             |       |                            |       |   |   |   |   |
| Sales and marketing                                          |       | 2,451,026                        |       | 1,460,185                       |       | 7,078,563 |   | 5,104,195 |   |
| Research and development                                     |       | 948,305                          |       | 689,901                         |       | 2,727,838 |   | 2,366,121 |   |
| General and administrative                                   |       | 1,524,529                        |       | 1,436,184                       |       | 4,490,484 |   | 4,105,792 |   |
|                                                         |       |                             |       |                            |       |   |   |   |   |
| Total operating expenses                                     |       | 4,923,860                        |       | 3,586,270                       |       | 14,296,885 |   | 11,576,108 |   |
|                                                         |       |                             |       |                            |       |   |   |   |   |
| Operating (loss) income                                      |       | (626,534                         | )          | 1,146,151                       |       | (946,746 | ) | 2,844,506 |   |
| Other income, net                                            |       | 310,219                          |       | 508,825                         |       | 1,093,543 |   | 1,511,585 |   |
| (Loss) income before income taxes                            |       | (316,315                         | )          | 1,654,976                       |       | 146,797 |   | 4,356,091 |   |
| Income taxes                                                 |       | —                           |       | (18,800                         | )          | 13,232 |   | (18,800 | ) |
| Net (loss) income                                            |       | $                                | (316,315   | )                               | $          | 1,673,776 |   | $ | 133,565 |   | $ | 4,374,891 |   |
|                                                         |       |                             |       |                            |       |   |   |   |   |
| Net (loss) income per common share:                          |       |                             |       |                            |       |   |   |   |   |
| Basic                                                        |       | $                                | (0.02      | )                               | $          | 0.10 |   | $ | 0.01 |   | $ | 0.27 |   |
| Diluted                                                      |       | $                                | (0.02      | )                               | $          | 0.10 |   | $ | 0.01 |   | $ | 0.26 |   |
|                                                         |       |                             |       |                            |       |   |   |   |   |
| Weighted average shares used in the per  share calculations: |       |                             |       |                            |       |   |   |   |   |
| Basic                                                        |       | 15,779,486                       |       | 16,268,524                      |       | 15,778,493 |   | 16,160,970 |   |
| Diluted                                                      |       | 15,779,486                       |       | 16,978,841                      |       | 16,249,158 |   | 17,100,334 |   |

 

See accompanying notes to the condensedconsolidated financial statements

 

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**SRSLABS, INC. AND SUBSIDIARY**

**CONDENSEDCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND**

**COMPREHENSIVEINCOME (Unaudited)**

**For TheNine Months Ended September 30, 2008**

 
| ** **                                                     | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Accumulated** | ** ** | **Treasury** | ** ** | ** ** | ** ** | **Comprehensive** | ** ** |
|----------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|---------------------------------------|------------|-----------------|------------|--------------|------------|------------|------------|-------------------|------------|
| ** **                                                     | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**                           | ** ** | **Loss**        | ** ** | **Deficit**  | ** ** | **Stock**  | ** ** | **Total**         | ** ** | **Income** | ** ** |
| BALANCE,  December 31, 2007                               |       | 15,778,715            |       | $                       | 16,947     |                                  | $          | 74,143,772      |       | $            | (48,125    | )          | $          | (19,155,096       | )          | $ | (5,950,181 | ) | $ | 49,007,317 |   |   |   |
| Proceeds from  exercise of stock options                       |       | 23,062                |       | 24                      |       | 69,648                                |       | —          |       | —       |       | —     |       | 69,672            |       |   |   |
| Purchase of  treasury stock                                    |       | (19,200               | )          | —                  |       | —                                |       | —          |       | —       |       | (122,053   | )          | (122,053          | )          |   |   |
| Cancellation of  treasury stock                                |       | —                |       | (1,173                  | )          | (5,973,457                            | )          | —          |       | —       |       | 5,974,630  |       | —            |       |   |   |
| Stock-based  compensation                                      |       | —                |       | —                  |       | 1,342,433                             |       | —          |       | —       |       | —     |       | 1,342,433         |       |   |   |
| Unrealized gain  on investments available for sale, net of tax |       | —                |       | —                  |       | —                                |       | 48,125          |       | —       |       | —     |       | 48,125            |       | 48,125 |   |
| Net income                                                     |       | —                |       | —                  |       | —                                |       | —          |       | 133,565      |       | —     |       | 133,565           |       | 133,565 |   |
|                                                           |       |                  |       |                    |       |                                  |       |            |       |         |       |       |       |              |       |   |   |
| BALANCE,  September 30, 2008                              |       | 15,782,577            |       | $                       | 15,798     |                                  | $          | 69,582,396      |       | $            | —     |       | $          | (19,021,531       | )          | $ | (97,604 | ) | $ | 50,479,059 |   | $ | 181,690 |   |
|                                                                |            |                       |            |                         |            |                                       |            |                 |            |              |            |            |            |                   |            |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to thecondensed consolidated financial statements

 

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**SRSLABS, INC. AND SUBSIDIARY**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Cash Flows from Operating Activities:**                                          |       |                                                |       |   |   |
| Net income                                                                         |       | $                                                   | 133,565    |   | $ | 4,374,891 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                                |       |   |   |
| Depreciation and amortization                                                      |       | 504,407                                             |       | 560,777 |   |
| Provision for doubtful accounts                                                    |       | 7,470                                               |       | 93,993 |   |
| Deferred income taxes                                                              |       | (1,210,219                                          | )          | (1,022,205 | ) |
| Stock-based compensation                                                           |       | 1,342,433                                           |       | 1,289,060 |   |
| Changes in operating assets and  liabilities:                                      |       |                                                |       |   |   |
| Accounts receivable                                                                |       | 561,452                                             |       | (846,007 | ) |
| Prepaid expenses and other current assets                                          |       | 60,288                                              |       | 153,422 |   |
| Accounts payable                                                                   |       | 17,849                                              |       | (249,444 | ) |
| Accrued liabilities                                                                |       | 270,440                                             |       | (489,159 | ) |
| Deferred revenue                                                                   |       | 646,163                                             |       | 57,441 |   |
| Net cash provided by operating activities                                          |       | 2,333,848                                           |       | 3,922,769 |   |
|                                                                               |       |                                                |       |   |   |
| **Cash Flows from Investing Activities:**                                          |       |                                                |       |   |   |
| Purchase of property and equipment                                                 |       | (191,921                                            | )          | (99,343 | ) |
| Purchase of investments                                                            |       | (4,984,000                                          | )          | — |   |
| Proceeds from sale of investments                                                  |       | 5,500,000                                           |       | — |   |
| Expenditures related to intangible assets                                          |       | (487,346                                            | )          | (602,263 | ) |
| Net cash used in investing activities                                              |       | (163,267                                            | )          | (701,606 | ) |
|                                                                               |       |                                                |       |   |   |
| **Cash Flows from Financing Activities:**                                          |       |                                                |       |   |   |
| Proceeds from exercise of stock options                                            |       | 69,672                                              |       | 1,842,964 |   |
| Purchase of treasury stock                                                         |       | (122,053                                            | )          | — |   |
| Net cash (used in) provided by financing  activities                               |       | (52,381                                             | )          | 1,842,964 |   |
|                                                                               |       |                                                |       |   |   |
| **Net Increase in Cash and Cash Equivalents**                                      |       | 2,118,200                                           |       | 5,064,127 |   |
| **Cash and Cash Equivalents, Beginning of  Period**                                |       | 39,615,291                                          |       | 35,011,425 |   |
| **Cash and Cash Equivalents, End of Period**                                       |       | $                                                   | 41,733,491 |   | $ | 40,075,552 |   |
|                                                                               |       |                                                |       |   |   |
| **Supplemental Disclosure of Cash Flow  Information:**                             |       |                                                |       |   |   |
| Cash paid during the period for:                                                   |       |                                                |       |   |   |
| Income taxes                                                                       |       | $                                                   | 772,530    |   | $ | 839,967 |   |
| **Supplemental Disclosure of Non-Cash  Investing/Financing Activities:**           |       |                                                |       |   |   |
| Unrealized gain on investments available  for sale                                 |       | $                                                   | 48,125     |   | $ | 127,215 |   |
| Retirement of Treasury Stock                                                       |       | $                                                   | 5,974,630  |   | — |   |

 

See accompanying notes to the condensedconsolidated financial statements

 

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**SRSLABS, INC. AND SUBSIDIARY**

**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,” “SRS,”“we,” “us,” or “our” means SRS Labs, Inc. and its wholly-owned subsidiarySRSWOWcast.com, Inc.  Theaccompanying unaudited condensed consolidated financial statements have beenprepared by the Company in conformity with accounting principles generallyaccepted in the United States of America (“generally accepted accountingprinciples” or “GAAP”) 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.

 

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 yearended December 31, 2007. Current and future financial statements may notbe directly comparable to the Company’s historical financial statements. Theresults of operations for the interim period are not necessarily indicative ofthe results to be expected for any other interim period or for the fullyear.  The condensed consolidated balancesheet as of December 31, 2007 and related disclosure amounts within thesecondensed consolidated financial statements were derived from the audited 2007consolidated financial statements.

 

**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.  By theirnature, estimates are subject to an inherent degree of uncertainty.  Actual results could differ materially fromthose estimates. See the audited consolidated financial statements and notesthereto included in our Annual Report on Form 10-K for the year ended December 31,2007 for an additional discussion of the significant accounting policies andestimates used in the preparation of our financial statements.

 

**Cash and Cash Equivalents and Short-term Investments**

 

Cash and cash equivalents are short-term,highly liquid investments that are readily convertible to cash and are so nearmaturity that they present insignificant risk of changes in value because ofinterest rates. Cash and cash equivalents generally consist of cash, moneymarket funds and instruments with original maturities of three months or lesswhen purchased.  Short-term investmentsconsist of certificates of deposits with original maturities of twelve monthsor less when purchased.  The Companyplaces its cash in banks and its cash and cash equivalents in commercial paperand money market funds at certain financial institutions in excess of amountsinsured by federal agencies.  The Companydoes not believe that it is subject to any unusual financial risk beyond thenormal risk associated with commercial banking relationships.  The Company performs periodic evaluations ofthe relative credit standing of these financial institutions.  The Company has not experienced anysignificant losses on its cash equivalents or investments.

 

**Customer Concentrations**

 

Ourrevenue is primarily derived from licensing. For the three months ended September 30, 2008, Samsung accountedfor approximately 40% of the licensing revenue. For the same period in the prior year, Samsung, LG and New Japan Radioaccounted for approximately 26%, 14% and 11%, respectively, of the licensingrevenue.  For the nine months ended September 30,2008, Samsung accounted for approximately 40% of the licensing revenue.  For the same period in the prior year,Samsung accounted for approximately 25% of the licensing revenue.

 

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**Income Taxes**

 

The Company has netoperating loss carryforwards to offset income taxes. Consequently, no provisionis reflected in the accompanying interim financial statements.  Refer to our Annual Report on Form 10-Kfor additional disclosure.

 

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

 

Intangible assets consist of the following:

 
| ** **                                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Patents                                                     |       | $                      | 3,632,136  |                  | $          | 3,315,343 |   |
| Accumulated amortization                                    |       | (1,830,608             | )          | (1,622,954            | )          |
| Patents, net                                                |       | 1,801,528              |       | 1,692,389             |       |
| Other intangibles:                                          |       |                   |       |                  |       |
| License agreements acquired in purchase of  SRSWOWcast      |       | 640,071                |       | 640,071               |       |
| Capitalized software and hardware for  several technologies |       | 620,752                |       | 663,310               |       |
| Total of other intangibles                                  |       | 1,260,823              |       | 1,303,381             |       |
| Accumulated amortization, other intangibles                 |       | (740,709               | )          | (798,154              | )          |
| Other intangibles, net                                      |       | 520,114                |       | 505,227               |       |
| Intangible assets, net                                      |       | $                      | 2,321,642  |                  | $          | 2,197,616 |   |

 

Amortization periods range from three to tenyears depending on the estimated useful life of the asset. Amortization expenseconsists of the following:

 
| ** **                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Patents                                                |       | $                                                    | 63,413     |                                                | $          | 76,952 |   | $ | 218,352 |   | $ | 216,460 |   |
| Other intangibles:                                     |       |                                                 |       |                                                |       |   |   |   |   |
| License agreements acquired in purchase of  SRSWOWcast |       | 16,002                                               |       | 16,002                                              |       | 48,005 |   | 48,005 |   |
| Capitalized software and hardware                      |       | 31,422                                               |       | 40,399                                              |       | 92,053 |   | 132,383 |   |
| Total intangible amortization expense                  |       | $                                                    | 110,837    |                                                | $          | 133,353 |   | $ | 358,410 |   | $ | 396,848 |   |

 

As of September 30, 2008, the weightedaverage useful life of the Company’s patents and intangible assets wasapproximately 6.62 years. The following table shows the estimatedamortization expense for those assets for the remaining months of the currentfiscal year and each of the four succeeding fiscal years and thereafter:

 

| **Years Ending December 31,** | ** ** | **Estimated Expense** | ** ** |
|----------------------------------------------|------------|----------------------------|------------|
| 2008                                         |       | $                          | 118,532    |   |
| 2009                                         |       | 407,563                    |       |
| 2010                                         |       | 378,733                    |       |
| 2011                                         |       | 344,437                    |       |
| 2012                                         |       | 301,790                    |       |
| Thereafter                                   |       | 770,587                    |       |
| Total                                        |       | $                          | 2,321,642  |   |

 

**3.**                                      **Net Income Per Common Share**

 

The Company applies Statement of FinancialAccounting Standards (“SFAS”) No. 128, *Earnings per Share*(“SFAS No. 128”), which requires the disclosure of basic and diluted netincome or loss per share for all current and prior periods. Basic net income orloss per common share is computed by dividing net income or loss available tocommon stockholders by the weighted average number of common shares outstandingduring each year. Diluted net income or loss per common share reflects themaximum dilution, based on the average price of the Company’s common stockduring each period, and is computed similar to basic income or loss per shareexcept that the denominator is increased to include the number of additionalshares that would have been outstanding if potentially dilutive stock optionsand warrants had been exercised.

 

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Basic and diluted net income per share computed inaccordance with SFAS No. 128 for the three and nine months ended September 30,2008 and 2007 are as follows:

 
| ** **                                               | ** ** | **Three Months**             | ** ** | **Nine Months**              | ** ** |
|----------------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **                                               | ** ** | **Ended September 30,** | ** ** | **Ended September 30,** | ** ** |
| ** **                                               | ** ** | **2008**                          | ** ** | **2007**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| BASIC EPS                                                |       |                              |       |                              |       |   |   |   |   |
| Net (loss) income                                        |       | $                                 | (316,315   | )                                 | $          | 1,673,776 |   | $ | 133,565 |   | $ | 4,374,891 |   |
| Denominator: weighted average common shares  outstanding |       | 15,779,486                        |       | 16,268,524                        |       | 15,778,493 |   | 16,160,970 |   |
| Net (loss) income per share—basic                   |       | $                                 | (0.02      | )                                 | $          | 0.10 |   | $ | 0.01 |   | $ | 0.27 |   |
|                                                     |       |                              |       |                              |       |   |   |   |   |
| DILUTED EPS                                              |       |                              |       |                              |       |   |   |   |   |
| Net (loss) income                                        |       | $                                 | (316,315   | )                                 | $          | 1,673,776 |   | $ | 133,565 |   | $ | 4,374,891 |   |
| Denominator: weighted average common shares  outstanding |       | 15,779,486                        |       | 16,268,524                        |       | 15,778,493 |   | 16,160,970 |   |
| Common equivalent shares outstanding:                    |       |                              |       |                              |       |   |   |   |   |
| Options                                                  |       | —                            |       | 710,317                           |       | 470,665 |   | 939,364 |   |
| Total diluted shares                                     |       | 15,779,486                        |       | 16,978,841                        |       | 16,249,158 |   | 17,100,334 |   |
| Net (loss) income per share—diluted                 |       | $                                 | (0.02      | )                                 | $          | 0.10 |   | $ | 0.01 |   | $ | 0.26 |   |

 

There were outstanding options to purchase anaggregate of 2,943,708 and 2,164,455 shares of the Company’s common stock forthe three months and nine months ended September 30, 2008, respectively,that were not included in the table above because they would be anti-dilutive. There were outstanding options to purchasean aggregate of 557,439 and 542,660 shares of the Company’s common stock forthe three and nine months ended September 30, 2007, respectively, thatwere not included in the table above because they would be anti-dilutive.

 

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

 

On June 8, 2007, we sent a letter toSony Corporation (“Sony”) relating to the possible infringement of several SRSpatents by Sony’s S-Force technology. Sony responded to the letter by filing aComplaint for Declaratory Relief in the U.S. District Court in the SouthernDistrict of New York on July 6, 2007. In November 2007, Sony and SRSentered into a standstill agreement for the purpose of conducting discussionstowards an amicable resolution of the dispute, and the Complaint forDeclaratory Relief was dismissed.  While the standstill agreement hasexpired, the parties continue to negotiate regarding this matter.  In October 2008,the outside patent counsel hired to evaluate the Sony S-Force technologyinformed us that they had completed their evaluation based on the informationprovided by Sony.  Based on their study, they confirmed SRS’ positionthat the S-Force technology infringes our patents.  The basis forthis infringement position has been provided to Sony for theirreview.  SRS cannot assure that it will prevail in this matter and isunable to determine at this time the impact that this matter may have, if any,on its consolidated financial position, results of operations or cash flows. From time to time, we may be involved in other litigation matters and disputesarising in the normal course of business. Any such matters and disputes couldbe costly and time consuming, subject us to damages or equitable remedies, anddivert our management and key personnel from our business operations.

 

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**5.****                                     ****Segment Information**

 

The Company operates inone reportable segment as disclosed in our Annual Report on Form 10-K.  The following schedule presents theCompany’s revenue by geographic area. Revenue is summarized based on thelocation of the licensee’s corporate headquarters. The Americas region includesNorth, Central and South Americas.

 
| ** **                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                    | ** ** | **2008**                                             | ** ** | **%**                                               | ** ** | **2007** | ** ** | **%** | ** ** | **2008** | ** ** | **%** | ** ** | **2007** | ** ** | **%** | ** ** |
| **Geographic  Area Revenue:** |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                          |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Korea                         |       | $                                                    | 2,210,538  |                                                | 51         | % | $ | 2,190,563 |   | 46 | % | $ | 6,870,299 |   | 51 | % | $ | 5,748,574 |   | 39 | % |
| Japan                         |       | 1,207,605                                            |       | 28                                                  |       | 1,631,214 |   | 34 |   | 4,227,037 |   | 32 |   | 5,970,028 |   | 41 |   |
| Americas                      |       | 466,563                                              |       | 11                                                  |       | 425,798 |   | 9 |   | 1,263,691 |   | 9 |   | 1,422,278 |   | 10 |   |
| China                         |       | 345,985                                              |       | 8                                                   |       | 426,540 |   | 9 |   | 844,398 |   | 6 |   | 1,276,869 |   | 9 |   |
| Europe                        |       | 88,742                                               |       | 2                                                   |       | 95,156 |   | 2 |   | 233,140 |   | 2 |   | 118,777 |   | 1 |   |
| Total                         |       | $                                                    | 4,319,433  |                                                | 100        | % | $ | 4,769,271 |   | 100 | % | $ | 13,438,565 |   | 100 | % | $ | 14,536,526 |   | 100 | % |

 

**6.**                                      **Recent AccountingPronouncements**

 

In May 2008,the Financial Accounting Standards Board (“FASB”) issued SFAS  No. 162, *Hierarchy ofGenerally Accepted Accounting Principles* (“SFAS No. 162”). Thisstatement is intended to improve financial reporting by identifying aconsistent framework, or hierarchy, for selecting accounting principles to beused in preparing financial statements of nongovernmental entities that arepresented in conformity with generally accepted accounting principles. Thisstatement will be effective 60 days following the SEC’s approval of the PublicCompany Accounting Oversight Board amendment to AU Section 411, *The Meaning of Present Fairly in Conformity with Generally AcceptedAccounting Principles*. The Company does not expect that the adoptionof SFAS No. 162 will have a material impact on its consolidated financialposition or results of operations.

 

In April 2008,the FASB issued FASB Staff Position (“FSP”) SFAS No. 142-3, *Determination of the Useful Life of Intangible Assets*(“FSP No. 142-3”).  This FSP amends the factors that should beconsidered in developing renewal or extension assumptions used to determine theuseful life of a recognized intangible asset under SFAS No. 142, *Goodwill and Other Intangible Assets*(“SFAS142”). The intent of FSP No. 142-3 is to improve the consistency betweenthe useful life of a recognized intangible asset under SFAS No. 142and the period of expected cash flows used to measure the fair value of theasset under SFAS No. 141R, and other GAAP. This FSP is effective forfinancial statements issued for fiscal years beginning after December 15,2008, and interim periods within those fiscal years. Early adoption isprohibited. The Company is currently evaluating the impact of FSP No. 142-3,but does not expect the adoption of this pronouncement will have a materialimpact on its consolidated financial position, results of operations or cashflows.

 

In December 2007,FASB issued SFAS No. 141 (revised 2007), *BusinessCombinations* (“SFAS No. 141(R)”), which replaces SFAS No. 141.SFAS No. 141(R) retains the purchase method of accounting foracquisitions, but requires a number of changes, including changes in the wayassets and liabilities are recognized in the purchase accounting. It alsochanges the recognition of assets acquired and liabilities assumed arising fromcontingencies, requires the capitalization of in-process research anddevelopment at fair value, and requires the expensing of acquisition-relatedcosts as incurred. SFAS No. 141(R) is effective for us beginning January 1,2009 and will apply prospectively to business combinations completed on or afterthat date. We do not expect the adoption of SFAS No. 141 (R) willhave a material effect on our consolidated financial position or results ofoperations.

 

In September 2006,the FASB issued SFAS No. 157, *FairValue Measurements* (“SFAS No. 157”). The purpose of SFAS No. 157is to define fair value, establish a framework for measuring fair value andenhance disclosures about fair value measurements. The measurement anddisclosure requirements became effective for us beginning January 1,2008.  The adoption of SFAS No. 157did not have a material effect on our consolidated financial position orresults of operations.

 

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**7.**                                      **Share Repurchase Program**

 

On May 19, 2008, the Company’s Board ofDirectors approved a stock repurchase program.  Under the stock repurchaseprogram, the Company was seeking to acquire up to $10.0 million of the Company’soutstanding common stock for a period from May 20, 2008 to November 19,2008.   In total, the Company repurchaseda total of 14,200 shares of the Company’s outstanding common stock under theprogram all in the second fiscal quarter. On August 29, 2008, the Company suspended this repurchase programand announced it would conduct a Dutch auction tender offer, pursuant to whichthe Company could purchase up to $10.0 million of shares of its common stock(the “Dutch Auction”). On September 30, 2008, the Dutch Auction wasterminated and withdrawn as a result of the Company’s receipt of an unsolicitedinbound offer to purchase all of the Company’s common stock for considerationwith a stated value per share in excess of the repurchase price set forth inthe Offer to Purchase for the Dutch Auction. As a result, SRS did not repurchase any shares under the Dutch Auction.After consultation with its financial and legal advisors, the Company’s Boardof Directors believes that proceeding with the inbound offer as submitted, wasnot in the best interest of the Company and its stockholders.

 

On November 3, 2008, the Company’s Board of Director’s approved a stock repurchase program, pursuant to which the Company is seeking to acquire up to $15.0 million of the Company’s outstanding common stock.  This repurchase program will not be conducted using a Dutch auction and and will commence on November 7, 2008 and will remain open for a period of up to six months.

 

**Item 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations**

 

This information should be read in conjunction withthe audited consolidated financial statements and notes thereto and Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontained in our Annual Report on Form 10-K for the year ended December 31,2007, and the unaudited condensed interim consolidated financial statements andnotes thereto included in this Quarterly Report.

 

**Overview**

 

We are a leading developer and provider ofaudio and voice technology solutions for the home entertainment, portable mediadevice, personal telecommunications, personal computer, automotive, andbroadcast markets.  Our operations areconducted through SRS Labs, Inc., the parent company, and its wholly-ownedsubsidiary, SRSWOWcast.com, Inc. Our business is focused on developing andlicensing audio, voice and surround sound technology solutions to many of theworld’s leading original equipment manufacturers, or OEMs, software providersand semiconductor companies, and licensing and marketing hardware and softwareproducts for thePC and broadcast audio markets.

 

#### **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 accountingprinciples generally 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. Actualresults may materially differ from our estimates.

 

Refer to the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2007 for a discussion of criticalaccounting policies which include revenue recognition, valuation of accountsreceivable, valuation of intangible assets and capitalization of software,recognition and measurement of current and deferred income tax assets andliabilities, and stock-based compensation. During the nine months ended September 30, 2008, there were nomaterial changes to these policies.

 

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**Results of Operations**

 

***Three Months Ended September 30, 2008Compared to Three Months Ended September 30, 2007***

 

*Revenues*

 

Licensing revenues consist primarily of royaltiesgenerated from the license of our audio and voice technologies.  License and royalty agreements generallyprovide for the license of technologies for a fee based on the number of unitsdistributed by the licensee or on an annual flat fee arrangement.  Certain of our licenses include minimumannual royalties. Also included in licensing revenue are revenues generatedfrom the sale of hardware and software applications into the PC and broadcastaudio markets.

 

The following table presents our licensing revenuesmix by market:

 
| ** **                                                | ** ** | **Three Months Ended September 30,** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| Home Entertainment (TV, Set Top Box, A/V  Receiver, DVD)  |       | 68                                                       | %          | 70 | % |
| Portable Media  Devices (Digital Media Player, Headphone) |       | 10                                                       | %          | 11 | % |
| Automotive                                                |       | 9                                                        | %          | 7 | % |
| Personal Telecommunications (Mobile Phone,  PDA)          |       | 8                                                        | %          | 6 | % |
| PC (Software, Hardware)                                   |       | 5                                                        | %          | 6 | % |

 

Ourrevenues were $4,319,433 forthe three months ended September 30, 2008, compared to $4,769,271 for thethree months ended September 30, 2007, a decrease of $449,838 or 9%.  Revenues in our Home Entertainment marketdecreased by $373,339 or 11% primarily due to decreased revenues associated with the previously disclosed lossof one major customer, offset by increased revenues from our largest licensee.Additionally, in the prior fiscal year, we changed the fee arrangement with onelicensee, from a per unit royalty to a flat fee royalty arrangement, whichresulted in a one-time increase in revenues of approximately $443,000 for thethree months ended September 30, 2007. Revenues in the portablemedia devices market decreased by $97,372 or 19% primarily due to decreasedrevenues from headphones and MP3 docking stations. Revenues in the automotivemarket increased $63,638 or 19% due to increased revenues from severalcustomers in Japan who provide line install, dealer option and after marketautomotive audio systems to many of the significant Japanese automobilemanufacturers.  Revenues in the PC market decreased by$56,694 or 20% due to fewersoftware downloads.

 

*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 $2,451,026 for the three months ended September 30, 2008, compared to$1,460,185 for the same prior year period, an increase of $990,841 or 68%.  This increase was primarily attributable toone-time recruitment and severance costs, totaling approximately $500,000, inthe third quarter of 2008 related to the Company’s ongoing investment instrengthening its sales and marketing departments.  In addition to increasing the marketing andsales personnel by three additional persons during the three months ended September 30,2008, the Company has also increased its branding efforts.  Included in sales and marketing expenses isstock-based compensation expense of $111,751 and $112,162 for the three monthsended September 30, 2008 and 2007, respectively.  We expect that sales and marketing expenseswill continue to increase as we hire additional sales personnel to penetratetarget markets and key regions and as we continue to increase our marketingefforts to cultivate and elevate the SRS brand globally.  As a percentage of total revenues, sales andmarketing expenses increased from 31% for the three months ended September 30,2007 to 57% for the same periodthis year.

 

*Researchand Development*

 

Research anddevelopment expenses consist of salaries and related costs of employees engagedin ongoing research, design and development activities and costs forengineering materials and supplies. Research and development expenses were$948,305 for the three months ended September 30, 2008, compared to $689,901for the same prior year period, an increase of $258,404 or 37%.  This increase is attributable to employingsix additional engineers in the three months ended  September 30, 2008 as compared to thesame period in the prior year, and increased travel to support our globallicensees.  Included in research anddevelopment expenses is stock-based compensation expense of $85,734 and$108,987 for the three months ended September 30, 2008 and 2007,respectively.  We expect that researchand development expenses will continue to increase as we seek to accelerate theimplementation of our technology with a greater number of customers anddevices.  As a percentage of totalrevenues, research and development expenses increased from 14% for the three months ended September 30,2007 to 22% for the same period this year.

 

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*Generaland Administrative*

 

General and administrative (“G&A”)expenses consist primarily of employee-related expenses, legal costs associatedwith the administration of intellectual property and other professional fees.G&A expenses were $1,524,529 for the three months ended September 30,2008, compared to $1,436,184 for the same prior year period, an increase of$88,345 or 6%. The increase isprimarily attributable to an increase in other professional fees ofapproximately $166,000 associated with the Company’s Dutch Auction repurchaseprogram in the three months ended September 30, 2008.  Included in general and administrativeexpenses is stock-based compensation expense of $227,706 and $216,901 for thethree months ended September 30, 2008 and 2007, respectively.  As a percentage of total revenues, G&Aexpenses increased from 30% forthe quarter ended September 30, 2007 to 35% for the same period this year.

 

*InterestIncome*

 

Interestincome was $310,219 for the three months ended September 30, 2008,compared to $508,825 for the same prior year period, a decrease of $198,606 or39%. This decrease was primarily attributable to lower interest rates earned oncash balances invested.

 

*Provisionfor Income Taxes*

 

The income taxexpense for the three months ended September 30, 2008 was $0, compared toa tax benefit of $18,800 for the same prior year period.  The prior year income tax benefit reflects atax refund due from the state of California. We reduced our current quarter tax provision and our valuation allowanceon our deferred tax assets by $385,290 and $450,290 for the three months ended September 30,2008 and 2007, respectively, based on our assessment of the future estimatedrealization of such assets.

 

**Nine Months Ended September 30, 2008 Compared toNine Months Ended September 30, 2007**

 

*Revenues*

 

The following table presents our licensingrevenues mix by market:

 
| ** **                                                | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| Home Entertainment (TV, Set Top Box, A/V  Receiver, DVD)  |       | 70                                                      | %          | 68 | % |
| Portable Media  Devices (Digital Media Player, Headphone) |       | 9                                                       | %          | 9 | % |
| Automotive                                                |       | 9                                                       | %          | 7 | % |
| Personal Telecommunications (Mobile Phone,  PDA)          |       | 7                                                       | %          | 7 | % |
| PC (Software, Hardware)                                   |       | 5                                                       | %          | 9 | % |

 

Licensing revenues were $13,438,565 for the ninemonths ended September 30, 2008, compared to $14,536,526 for the ninemonths ended September 30, 2007, a decrease of $1,097,961 or 8%.  The decrease in licensing revenues wasprimarily attributable to a decrease in PC revenue of $626,045 or 47% due tothe loss of our major customer in this market. This customer contributed$580,247 in revenue during the first nine months of 2007.  There were no significant amounts of revenuederived from this customer after the second fiscal quarter of 2007.   Revenue from the Home Entertainment marketdecreased $429,447 or 4% primarily due to the previously disclosed loss of one majorcustomer in this market, and another significant customer changing in fiscal2007 from a per unit royalty arrangement to a flat fee agreement.  These decreases were offset in part byincreased revenues from our largest licensee.

 

*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 $7,078,563 for the nine months ended September 30, 2008, compared to$5,104,195 for the same prior year period, an increase of $1,974,368 or39%.  This 

 

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increase was primarilyattributable to higher payroll and related costs, including recruitment costsof $449,000, associated with hiring an additional twelve sales and marketingpersonnel in the first nine months of 2008 including our Vice President ofSales and our Vice President of Marketing. In addition to increasing the marketing and sales personnel, the Companyhas also increased its branding efforts. Included in sales and marketing expenses is stock-based compensationexpense of $381,607 and $382,655 for the nine months ended September 30,2008 and 2007, respectively.  As apercentage of total revenues, sales and marketing expenses increased from 35%for the nine months ended September 30, 2007 to 53% for the same period this year.

 

*Researchand Development*

 

Research anddevelopment expenses consist of salaries and related costs of employees engagedin ongoing research, design and development activities and costs forengineering materials and supplies. Research and development expenses were$2,727,838 for the nine months ended September 30, 2008, compared to$2,366,121 for the same prior year period, an increase of $361,717 or 15%.  This increase was attributable to higherpayroll related costs associated with hiring six additional engineers in fiscal2008. Included in research and development expenses is stock-based compensationexpense of $294,684 and $325,173 for the nine months ended September 30,2008 and 2007, respectively.  As apercentage of total revenues, research and development expenses increased from 16% for the nine months ended September 30,2007 to 20% for the same period this year.

 

*Generaland Administrative*

 

G&A expenses consist primarily ofemployee-related expenses, legal costs associated with the administration ofintellectual property and other professional fees. G&A expenses were$4,490,484 for the nine months ended September 30, 2008, compared to$4,105,792 for the same prior year period, an increase of $384,692 or 9%. Theincrease was primarily attributable to an increase in professional fees andexpenses of $166,000, associated with the Company’s Dutch Auction repurchaseprogram, which was terminated in September 2008.  The Company also incurred increasedprofessional and legal fees associated with corporate matters, and an increasein stock-based compensation expense. Included in general and administrative expenses is stock-basedcompensation expense of $666,142 and $581,232 for the nine months ended September 30,2008 and 2007, respectively.  As apercentage of total revenues, G&A expenses increased from 28% for the nine months ended September 30,2007 to 33% for the same periodthis year.

 

*Interest Income*

 

Interestincome was $1,093,543 for the nine months ended September 30, 2008,compared to $1,511,585 for the same prior year period, a decrease of $418,042or 28%. This decrease was primarily attributable to lower interest rates earnedon cash balances invested.

 

*Provisionfor Income Taxes*

 

The income taxexpense for the nine months ended September 30, 2008 was $13,232, comparedto tax benefit of $18,800 for the same prior year period.  We reduced our current period tax provisionand our valuation allowance on our deferred tax assets by $1,210,219 and$1,022,205 for the nine months ended September 30, 2008 and 2007,respectively, based on our assessment of the future estimated realization ofsuch assets.

 

**Liquidity and Capital Resources**

 

Our principal source of liquidity to fundongoing operations at September 30, 2008 consisted of cash, cashequivalents and short-term investments of $46,717,491.  At September 30, 2008, we had cash andcash equivalents of $41,733,491 and short-term investments of $4,984,000. Cashand cash equivalents are short-term highly liquid investments that are readilyconvertible to known amounts of cash and are so near maturity that they presentinsignificant risk of changes in value because of interest rates.  Cash and cash equivalents generally consistof cash, money market funds and instruments with original maturities of threemonths or less. The money market funds are primarily invested in U.S.government obligations. Short-term investments consist of certificates ofdeposit with original maturities of six months.

 

Net cash provided byoperating activities was $2,333,848 and $3,922,769 during the nine months endedSeptember 30, 2008 and September 30, 2007, respectively.  The $1,588,921 decrease in net cash providedby operating activities for the nine months ended September 30, 2008,compared to the same period in the prior year, was primarily a 

 

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result of a decrease in net income from $4,374,891during the nine months ended September 30, 2007 to $133,565 for the ninemonths ended September 30, 2008. Offsetting the decrease in net income, accounts receivable decreased by$561,452 during the nine months ended September 30, 2008 compared to anincrease of $846,007 during the same period in the prior year, due to lowerrevenues and increased cash collections. Additionally, accounts payable and accrued liabilities increased $17,849and $270,440, respectively, during the nine months ended September 30,2008 as compared to decreasing $249,444 and $489,159, respectively, in the sameperiod in the prior year.  The changes inliability accounts generally related to the timing of payments to vendors andchanges in accrued commissions and amounts due to employees under our ProfitSharing and Bonus Plan.  Additionally,deferred revenue increased $646,163 for the nine months ended September 30,2008 compared to $57,441 during the nine months ended September 30,2007.   The increase in deferred revenueduring the nine months ended September 30, 2008 was primarily due to theCompany entering into a multi-year license agreement with LG Electronics in October 2007for the use of our existing technology for television and monitors through December 2010.  We received the final lump sum payment underthis agreement in the nine months ended September 30, 2008.

 

Our net cash used in investing activities was$163,267 and $701,606 during thenine months ended September 30, 2008 and 2007, respectively.  The net cash used in investing activities wasattributable primarily to the Company’s purchase of short-term investmentsduring the nine months ended September 30, 2008 totaling $4,984,000.  Offsetting this decrease, the Companyreceived $5,500,000 from the sale of investments during the nine months ended September 30,2008.

 

Our net cash used in financing activities was $52,381 during the nine months ended September 30, 2008, and net cash provided by financing activities was $1,842,964 during the nine months ended September 30, 2007. The decrease in net cash provided by financing activities was primarily attributable to a decrease in stock option exercises during the current period. The Company expects to continue to use a portion of its cash to conduct market repurchases under the stock repurchase program approved by the Board of Directors on November 3, 2008.  Under the new stock repurchase program, the Company is seeking to acquire up to $15.0 million of the Company’s outstanding common stock.  This repurchase program will not be conducted using a Dutch auction and will commence on November 7, 2008 and will remain open for a period of up to six months.

 

Based on current plans and businessconditions, we expect that our cash, cash equivalents and investments togetherwith any amounts generated from operations will be sufficient to meet our cashrequirements for the next twelve months. However, we cannot guarantee that wewill not be required to seek other financing sooner or that such financing, ifrequired, will be available on terms satisfactory to us.

 

Our operations and financial results aresubject to various risks and uncertainties that could adversely affect ourbusiness, financial condition, results of operations and trading price of ourcommon stock. Please refer to Item 1A, “Risk Factors” in this report forinformation concerning these and other uncertainties that could negativelyimpact us.

 

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

 

There have been no material changes to theinformation called for by this Item 3 from the disclosures set forth in Part II,Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31,2007.

 

**Item 4.  Controls and Procedures**

 

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

 

*Changes in Internal Controls.***There have been no changes in ourinternal controls over financial reporting that occurred during our thirdquarter ended September 30, 2008 that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

 

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**PART II:OTHER INFORMATION**

 

**Item 1A. Risk Factors**

 

*You shouldcarefully consider the risk factors described below, as well as the otherinformation included in this Report, prior to making a decision to invest inour securities. The risks and uncertainties described below are not the onlyones facing our company. Additional risks and uncertainties not presently knownor that we currently believe to be less significant may also adversely affectus.*

 

***General economic or market conditions may reduce our revenues and harmour business.***

 

Our business is particularlyexposed to adverse changes in general economic and market conditions, becauseproducts that incorporate our technologies are entertainment oriented and oftenluxury goods. A slowdown or decline in U.S. or foreign economic growth mayadversely affect consumer confidence, disposable income or retail spending ingeneral. As a result, sales by our licensees of consumer electronics and otherproducts incorporating our technologies may not grow as rapidly as in priorperiods or may even decrease if the current economic downturn continues orworsens, which could adversely affect our licensing revenue.

 

***Our business is highly dependent on the consumer electronics market,which is characterized by short product life cycles, fluctuations in demand andseasonality, and is subject to risks related to product transitions and supplyof other components.***

 

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

 

***Our business and future prospects depend on the strength of our brandand our continued recognition as an industry standard in our existing or futuremarkets.  If we do not maintain and strengthen our brand, our businesswill be materially harmed.***

 

Maintaining and strengtheningthe “SRS” brand and our position as an industry standard is critical to maintainingand expanding our licensing revenues and licensing relationships, as well as toour ability to enter into new markets for our technologies.  Our continuedsuccess depends, in part, on our reputation for providing high qualitytechnologies across a wide range of consumer products, including homeelectronics, personal computing devices, automotive entertainment systems, cellphones, PDAs and PCs.  If we fail to promote, maintain and expand the SRSbrand successfully, our business and future prospects will suffer. Maintaining and strengthening our brand will depend heavily on our ability tocontinue to develop innovative technologies for the entertainment industry andto continue to provide high quality technologies, which we may not dosuccessfully. Moreover, we believe that the likelihood that our technologieswill be adopted as industry standards in other markets and for variousapplications depends, in large part, upon the strength of our brand, becauseprofessional organizations and industry participants are more likely to accept,as an industry standard, technologies developed by a well-respected andwell-known brand.  If our technologies are not recognized as industrystandards in existing or future markets, our ability to enter into new licensingarrangements or expand our revenues will be adversely affected.

 

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

 

Currently, we generate amajority of our revenue in the home theater market, principally through theinclusion of SRS technology inside LCD and Plasma televisions, and set-topboxes. We expect that the consumer home entertainment market will continue toaccount for a significant portion of our licensing revenues for the foreseeablefuture. While consumer spending in general on consumer electronic products hasincreased, retail prices for certain consumer electronics products that includeour audio technology have decreased significantly. We expect that this trendwill continue for the foreseeable 

 

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future. In addition, from time to time, certain of our OEMand semiconductor manufacturer customers may account for a significant portionof our revenues. For example, for the year ended December 31, 2007,Samsung accounted for approximately 28% of our consolidated revenues. Thesemanufacturers could develop their own technologies or decide to exclude ouraudio rendering technology from their products altogether in an effort toreduce costs. The loss of any key customer could have a material adverse affecton our financial condition and results of operations.

 

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

 

We derive most of our revenuefrom the licensing of our technologies to manufacturers of consumer electronicsproducts. We do not manufacture consumer electronics products ourselves and ourlicensing revenue is dependent on sales by our licensees of products thatincorporate our technologies and the ability of such licensees to achieve broadmarket acceptance for such products. We cannot control these manufacturers’product development or commercialization efforts or predict their success. Inaddition, our license agreements, which typically require manufacturers ofconsumer electronics products to pay us a specified royalty for productsshipped that incorporate our technologies, do not require these manufacturersto include our technologies in any specific number or percentage of units.Accordingly, if our licensees sell fewer products incorporating ourtechnologies, decline to market products incorporating our technologies, orotherwise face significant economic difficulties, our revenue will decline.Lower sales of products incorporating our technologies could occur for a numberof reasons including, but not limited to, new product introductions andtechnological advancements, the existence of competing products, changes inconsumer tastes or trends, or changes in industry standards, as well asincreased market saturation for the products incorporating our technologies oralternate consumer entertainment options, any of which could adversely impactour business.

 

***Pricing pressures on the consumer electronics product manufacturers,who incorporate our technologies into their products, could limit the licensingfees we charge for our technologies, which could reduce our revenues.***

 

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

 

***We face intense competition from companies withgreater brand recognition and resources.***

 

The digital audio, consumer electronics andentertainment markets are intensely competitive, subject to rapid change, andsignificantly affected by new product introductions and other market activitiesof industry participants

 

Many of our current and potential competitors enjoysubstantial competitive advantages, including:

 

·                  greater namerecognition;

 

·                  a longeroperating history;

 

·                  more developeddistribution channels and deeper relationships with consumer electronicsproducts designers and manufacturers;

 

·                  a more extensivecustomer base;

 

·                  broader productand service offerings;

 

·                  greaterresources for competitive activities, such as research and development,strategic acquisitions, alliances, joint ventures, sales and marketing, andlobbying industry and government standards; and

 

·                  more techniciansand engineers.

 

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As a result, these current and potential competitorsmay be able to respond more quickly and effectively than we can to new orchanging opportunities, technologies, standards, or customer requirements.

 

***We are subject to risks associated with substantialinternational operations.***

 

We conduct sales and customer support operations in anumber of countries throughout the world that require refinement to adapt tothe changing market conditions on a regional basis. In addition, many of oursignificant customers are headquartered in the Asia Pacific region,particularly Japan and Korea. Approximately 90%, 91% and 84% of our revenueswere derived from customers with headquarters located in the Asia Pacificmarkets during the years ended December 31, 2007, 2006 and 2005,respectively. We expect to continue to derive a significant portion of ourrevenues from sales to customers in these markets for the foreseeable future.Also, a substantial number of products incorporating our technologies aremanufactured, assembled and tested by third parties in Asia. As a result, weare subject to a number of risks of conducting business outside of the UnitedStates, any of which could have a material adverse impact on our business andresults of operations, including:

 

·                  political,social and economic instability, and the risk of war, terrorist activities orother international incidents in Asia and elsewhere abroad;

 

·                  difficulties andcosts of staffing and managing foreign operations;

 

·                  unexpectedchanges in, or impositions of, government requirements;

 

·                  adverse changesin tariffs and other protectionist laws and business practices that favor localcompetitors;

 

·                  potentiallylonger payment cycles and greater difficulty in collecting receivables fromforeign entities;

 

·                  the burdens ofcomplying with a variety of non-U.S. laws and reduced protection of ourintellectual property in some countries;

 

·                  potentiallyadverse tax consequences and the complexities of foreign value added taxsystems; and

 

·                  other factors beyond our control,including natural disasters and major health concerns.

 

***If the sale of consumer electronics products incorporating ourtechnologies does not grow in emerging markets, our ability to increase ourlicensing revenue may be limited.***

 

We also expect that growth inour licensing revenue will depend, in part, upon the growth of sales ofconsumer electronics products incorporating our technologies in othercountries, including China and India, as consumers in these markets have moredisposable income and are increasingly purchasing entertainment products withsurround sound capabilities. These countries have rapidly expanding and growingeconomies that are less mature than economies of other regions in which wederive significant portions of our revenue. Because of this, changes toemployment patterns, currency fluctuations and political uncertainties couldimpact our ability to grow our licensing revenue in these regions

 

***We have a long and unpredictable sales cycle, which can result inuncertainty and delays in generating additional revenues.***

 

Historically, because of thecomplexity of our technologies, it can take a significant amount of time andeffort to explain the benefits of our technologies to potential new customersand to negotiate a sale. For example, it typically takes six to nine monthsafter our first contact with a prospective customer before we start licensingour technology to that customer. In addition, purchases of our products areusually made in connection with new design starts by our customers, the timingof which is outside of our control. Accordingly, we may be unable to predictaccurately the timing of any significant future sales of our products. We mayalso spend substantial time and management attention on potential licenseagreements that are not consummated, or in which the consumer electronicproduct ultimately does not sell in large quantities, thereby foregoing otherhigher revenue opportunities.

 

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

 

Our ability to compete may beaffected by our ability to protect our proprietary information. We have filednumerous U.S. and foreign patent applications and to date have a number ofissued U.S. and foreign patents covering various aspects of our technologies.We cannot guarantee that the steps taken by us to protect our intellectualproperty will be adequate to prevent misappropriation of our technology or thatour competitors will not independently develop technologies that aresubstantially equivalent or superior to our technology. In addition, the lawsof certain foreign countries may not protect our intellectual property rightsto the same extent as do the laws of the U.S. Litigation in the consumerelectronics markets is common. It is possible that third parties may assertclaims or initiate litigation against us or our customers with respect toexisting or future products. In addition, we may initiate claims or litigationagainst third parties for infringement of our proprietary rights or todetermine the scope and validity of our proprietary rights. Claims andlitigation brought against us or initiated by us could be costly and timeconsuming and could divert our management from our business. The outcome of anysuch pending or future litigation is uncertain, and could require us to paysignificant damages or could prevent us from licensing some or all of ourtechnologies, of which could significantly harm our business and results of operations.

 

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

 

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

 

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

 

The trading price of our commonstock has been, and will likely continue to be, subject to wide fluctuations inresponse to quarterly variations in our operating results, announcements of newproducts or technological innovations by us or our competitors, strategicalliances between us and third parties, general market fluctuations and otherevents and factors. Changes in earnings estimates made by brokerage firms andindustry analysts relating to the markets in which we do business, or relatingto us specifically, have in the past resulted in, and could in the futureresult in, an immediate and adverse effect on the market price of the commonstock. Even though our stock is quoted on the NASDAQ Global Market, our stock hashad and may continue to have low trading volume and high volatility. Thehistorically low trading volume of our stock makes it more likely that a severefluctuation in volume, either up or down, will significantly impact the stockprice. Because of the relatively low trading volume of our stock, ourstockholders may have difficulty selling our common stock.

 

***Our certificate of incorporation and bylaws as well as Delaware lawcontain provisions that could discourage transactions resulting in a change incontrol, which may negatively affect the market price of our common stock.***

 

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

 

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**Item 6. Exhibits**

 

The exhibits listed below are hereby filed with the SEC as part of thisReport.

 
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                 |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1             |       | Certificate of Incorporation of the Company,  previously filed with the SEC as Exhibit 3.1 to the Company’s  Registration Statement on Form SB-2, specifically included in Amendment  No. 1 to such Registration Statement filed with the SEC on July 3,  1996 (File No. 333-4974-LA), which is incorporated herein by reference. |
| 3.2             |       | Bylaws of the Company, previously filed with the SEC  as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for  the period ended September 30, 1999, filed with the SEC on  November 12, 1999, which is incorporated herein by reference.                                                                                     |
| 31.1            |       | Certification of Chief Executive Officer of SRS  Labs, Inc., pursuant to Rule 13a-14 of the Securities Exchange Act.                                                                                                                                                                                                                                  |
| 31.2            |       | Certification of Chief Financial Officer of SRS  Labs, Inc., pursuant to Rule 13a-14 of the Securities Exchange Act.                                                                                                                                                                                                                                  |
| 32.1            |       | Certification of Chief Executive Officer of SRS  Labs, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                              |
| 32.2            |       | Certification of Chief Financial Officer of SRS  Labs, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                              |

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
|                                        | SRS LABS, INC., a Delaware corporation       |
|----------------------------------------|---------------------------------------------------|
|                                   |                                              |
| Date:  November 4, 2008 | By:                                               | /S/ THOMAS C.K.  YUEN |
|                                   | Thomas C.K. Yuen                                  |
|                                   | Chairman of the Board and Chief Executive Officer |
|                                   | (Principal Executive Officer)                     |
| ** **                             | ** **                                        |
| ** **                             | ** **                                        |
| Date:  November 4, 2008 | By:                                               | /S/ ULRICH  GOTTSCHLING |
|                                   | Ulrich Gottschling                                |
|                                   | Chief Financial Officer                           |
|                                   | (Principal Financial and Accounting Officer)      |

 

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**EXHIBITINDEX**

 
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                 |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1             |       | Certificate of Incorporation of the Company,  previously filed with the SEC as Exhibit 3.1 to the Company’s  Registration Statement on Form SB-2, specifically included in Amendment  No. 1 to such Registration Statement filed with the SEC on July 3,  1996 (File No. 333-4974-LA), which is incorporated herein by reference. |
| 3.2             |       | Bylaws of the Company,  previously filed with the SEC as Exhibit 3.1 to the Company’s Quarterly  Report on Form 10-Q for the period ended September 30, 1999, filed with  the SEC on November 12, 1999, which is incorporated herein by reference.                                                                                          |
| 31.1            |       | Certification of Chief Executive Officer of SRS  Labs, Inc., pursuant to Rule 13a-14 of the Securities Exchange Act.                                                                                                                                                                                                                                  |
| 31.2            |       | Certification of Chief Financial Officer of SRS  Labs, Inc., pursuant to Rule 13a-14 of the Securities Exchange Act.                                                                                                                                                                                                                                  |
| 32.1            |       | Certification of Chief Executive Officer of SRS  Labs, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                              |
| 32.2            |       | Certification of Chief Financial Officer of SRS  Labs, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                              |

 

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