<PAGE>   1
================================================================================

                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

                                 --------------

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE 
     SECURITIES EXCHANGE ACT OF 1934

     For the quarterly period ended September 30, 1998

                                       or

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE 
     SECURITIES EXCHANGE ACT OF 1934

     For the transition period from ____________ to _____________ 


                        Commission File Number 0-21123

                                 SRS LABS, INC.
             (Exact name of registrant as specified in its charter)

                                 --------------

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

                2909 Daimler Street, Santa Ana, California 92705
               (Address of principal executive offices) (Zip Code)

                                 (949) 442-1070
              (Registrant's telephone number, including area code)

                                 Not applicable
              (Former name, former address and former fiscal year,
                         if changes since last report)

                                 --------------

    Indicate by check mark whether the registrant (1) has filed all reports 
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.   Yes  X   No
                                                ---     ---
                      APPLICABLE ONLY TO CORPORATE ISSUERS

    Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: as of October 31, 1998,
11,646,223 shares of the issuer's common stock, par value $.001 per share, were
outstanding.

================================================================================

<PAGE>   2



                                 SRS LABS, INC.

                                    FORM 10-Q

                     FOR THE PERIOD ENDED SEPTEMBER 30, 1998

                                      INDEX




<TABLE>
<CAPTION>
                                                                                Page
                                                                                ----
<S>                                                                              <C>
Part I - Financial Information                                                      
                                                                                    
  Item 1. Financial Statements.                                                     
                                                                                    
          Consolidated Balance Sheets as of September 30, 1998 (Unaudited)          
          and December 31, 1997                                                   3 
                                                                                    
          Consolidated Statements of Operations for the three months and            
          nine months ended September 30, 1998 and 1997 (Unaudited)               4 
                                                                                    
          Consolidated Statements of Cash Flows for the nine months ended           
          September 30, 1998 and 1997 (Unaudited)                                 5 
                                                                                    
          Notes to the Interim Consolidated Financial Statements (Unaudited)      7 
                                                                                    
  Item 2. Management's Discussion and Analysis of Financial Condition and           
          Results of Operations.                                                 11 
                                                                                    
  Item 3. Quantitative and Qualitative Disclosures About Market Risk.            18 
                                                                                    
                                                                                    
Part II - Other Information                                                         
                                                                                    
  Item 2. Changes in Securities and Use of Proceeds.                             19 
                                                                                    
  Item 6. Exhibits and Reports on Form 8-K.                                      19 
                                                                                    
                                                                                    
Signatures                                                                       20 
</TABLE>


<PAGE>   3


                         PART I - FINANCIAL INFORMATION


ITEM 1.  FINANCIAL STATEMENTS.

                                 SRS LABS, INC.

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                        September 30,    December 31,
                                                            1998             1997
                                                        -------------    ------------
                                                         (Unaudited)
                                      ASSETS
<S>                                                      <C>              <C>        
Current Assets
   Cash and cash equivalents                             $ 7,856,201      $ 4,446,753
   Investments available for sale                          1,150,039        2,010,775
   Accounts receivable                                     5,701,729        3,989,927
   Inventories                                             6,939,484               --
   Prepaid expenses and other current assets               1,469,444          578,957
   Deferred income taxes                                     505,674          170,674
                                                         -----------      -----------
        Total current assets                              23,622,571       11,197,086

  Investments available for sale                          12,113,705       19,556,262
  Furniture, fixtures & equipment, net                     1,283,509          245,779
  Intangible assets, net                                   6,167,535          313,673
  Deferred income taxes                                      229,223          229,223
                                                         -----------      -----------
        Total Assets                                     $43,416,543      $31,542,023
                                                         ===========      ===========

                          LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities
   Accounts Payable                                      $ 7,004,059      $   202,352
   Accrued liabilities                                     1,521,792          826,242
   Line of credit                                          8,000,000               --
   Income taxes payable                                      717,345        1,011,426
   Current portion of consideration 
     due on asset purchase                                        --           81,804
                                                         -----------      -----------
        Total Current Liabilities                         17,243,196        2,121,824


Stockholders' Equity
   Preferred stock - $.001 par value 
     2,000,000 shares authorized;
     no shares issued and outstanding
   Common stock - $.001 par value 
     56,000,000 shares authorized; 11,622,423 
     (at September 30, 1998) and 9,609,867
     (at December 31, 1997) shares issued 
     and outstanding                                          11,623            9,610
   Additional paid-in capital                             39,013,504       25,022,437
   Deferred stock option compensation                        306,493          231,087
   Unrealized gain on investments available for sale         147,264          163,600
   Retained earnings (deficit)                           (13,305,537)       3,993,465
                                                         -----------      -----------
        Total Stockholders' Equity                        26,173,347       29,420,199
                                                         -----------      -----------
        Total Liabilities and Stockholders' Equity       $43,416,543      $31,542,023
                                                         ===========      ===========
</TABLE>


                 See accompanying notes to financial statements


                                       3

<PAGE>   4


                                 SRS LABS, INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)

<TABLE>
<CAPTION>
                                          Three Months Ended            Nine Months Ended
                                             September 30,                September 30,
                                      --------------------------  --------------------------
                                         1998           1997          1998           1997
                                      -----------    -----------  ------------    ----------
<S>                                   <C>            <C>          <C>             <C>       
Revenues
Chip and licensing revenue            $ 3,935,479    $ 2,505,656  $ 11,341,907    $6,833,555
Product and component sales             7,382,323             --    18,658,661            --
                                      -----------    -----------  ------------    ----------
  Total revenues                       11,317,802      2,505,656    30,000,568     6,833,555
Cost of sales                           7,810,345         71,161    19,596,284       186,240
                                      -----------    -----------  ------------    ----------
Gross margin                            3,507,457      2,434,495    10,404,284     6,647,315

Sales and marketing                     1,176,466        400,284     3,876,993     1,190,178
Research and development                  577,816        116,137     1,576,526       414,516
General and administrative              1,536,407        636,739     4,157,535     1,842,272
                                      -----------    -----------  ------------    ----------
Operating income before write-off 
  of acquired in-process research 
  and development                         216,768      1,281,335       793,230     3,200,349
Write-off of acquired in-process 
  research and development                     --             --    18,510,378            --
                                      -----------    -----------  ------------    ----------
  Income (loss) from operations           216,768      1,281,335   (17,717,148)    3,200,349


Other income                                   --             --        77,438            --
Interest income, net                       11,728        276,471       316,688       806,712
                                      -----------    -----------  ------------    ----------
                                           11,728        276,471       394,126       806,712
Income (loss) before income tax
  expense (benefit)                       228,496      1,557,806   (17,323,022)    4,007,061
Income tax expense (benefit)               36,986        475,131       (24,020)    1,381,356
                                      -----------    -----------  ------------    ----------
Net income (loss)                     $   191,510    $ 1,082,675  $(17,299,002)   $2,625,705
                                      ===========    ===========  ============    ==========
Net Income (Loss) per Common Share
  Basic                               $      0.02    $      0.11  $      (1.53)   $     0.28
                                      ===========    ===========  ============    ==========
  Diluted                             $        --    $      0.11  $         --    $     0.25
                                      ===========    ===========  ============    ==========

Weighted Average Shares Used in the
  Calculation of Net Income (Loss) 
  per Common Share
  Basic                                11,619,090      9,580,867    11,339,653     9,542,287
                                      ===========    ===========  ============    ==========
  Diluted                                     N/A     10,244,385           N/A    10,620,668
                                      ===========    ===========  ============    ==========
</TABLE>


                 See accompanying notes to financial statements


                                       4
<PAGE>   5

                                 SRS LABS, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                          Nine Months Ended
                                                                             September 30,
                                                                    ------------------------------
                                                                        1998              1997
                                                                    ------------       -----------
<S>                                                                 <C>                <C>        
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)                                                   $(17,299,002)      $ 2,625,705
Adjustments to reconcile net income (loss) to net cash provided
  by operating activities:
    Depreciation and amortization                                      1,300,758           251,604
    Deferred income taxes                                               (335,000)               --
    Write-off of acquired in-process research and development         18,510,378                --
    Realized gain on sales of investments available for sale             (77,438)               --
    Amortization of premium on investments available for sale             39,464            81,903
    Accretion of consideration due on asset purchase                       8,196            17,882
    Increase in deferred compensation                                     75,406            60,909
    Increase (decrease) in cash resulting from changes in 
      operating accounts, net of acquisitions:
        Accounts receivable                                            1,560,735        (2,067,923)
        Inventories                                                     (307,698)               --
        Prepaid expenses and other current assets                       (437,722)         (125,077)
        Accounts payable                                              (1,750,143)         (152,936)
        Other accrued liabilities                                        695,550          (215,572)
        Income taxes payable                                            (467,447)          881,124
                                                                    ------------       -----------
    Net cash provided by operations                                    1,516,037         1,357,619

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture, fixtures and equipment                           (166,042)          (35,080)
Proceeds from sales of investments available for sale                  8,317,572
Purchases of investments available for sale                                               (580,256)
Cash paid for acquisitions, less cash acquired                        (6,911,216)               --
Expenditures related to patents                                         (576,830)          (51,439)
                                                                    ------------       -----------
    Net cash provided (used) in investing activities                     663,484          (666,775)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from line of credit                                           8,000,000                --
Payments on subsidiary debt                                           (6,846,737)               --
Payment of consideration due on asset purchase                           (91,707)         (140,394)
Exercise of stock options                                                168,371           140,543
                                                                    ------------       -----------
    Net cash provided by financing activities                          1,229,927               149
                                                                    ------------       -----------

NET INCREASE IN CASH AND CASH EQUIVALENTS                              3,409,448           690,993
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                         4,446,753         3,455,997
                                                                    ------------       -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD                            $  7,856,201       $ 4,146,990
                                                                    ============       ===========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Cash paid during the period for:
    Interest                                                        $    239,716       $         0
    Income taxes                                                    $    640,000       $         0

SUPPLEMENTAL DISCLOSURES ON NON-CASH TRANSACTIONS:
  Additional consideration accrued for asset purchase               $      8,196       $    41,794
  Unrealized gain (loss) on investments, net                        $    (16,336)      $    55,742
</TABLE>


                 See accompanying notes to financial statements


                                       5

<PAGE>   6

                                 SRS LABS, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)


SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITY:

During the nine months ended September 30, 1998, the Company issued 1,680,611
shares of common stock in payment of $12,105,778 of the acquisition price of
Valence Technology, Inc.
(Note 2)

During the nine months ended September 30, 1998, the Company issued 125,000
shares of common stock in consideration for certain non-competition agreements
with the key employees of Valence. The shares have an ascribed fair value of
$900,400. (Note 2)

During the nine months ended September 30, 1998, the Company issued 25,000
shares of common stock in conjunction with the acquisition of VIP. The shares
have an ascribed fair value of $176,575. (Note 2)

During the nine months ended September 30, 1998, the Company issued warrants to
purchase 100,000 shares of common stock in conjunction with the acquisition of
VIP. The warrants have an ascribed value of $341,957. (Note 2)

The Company acquired the stock of Valence Technology, Inc. during the nine
months ended September 30, 1998. (Note 2)

In conjunction with the acquisition, certain liabilities were assumed as
follows:

    Fair value of assets acquired                               $ 14,076,279
    Acquired in-process research and development costs            17,471,668
    Acquired intangible assets                                     5,910,400
                                                                ------------
      Total consideration                                        (21,879,033)
                                                                ------------  
    Liabilities assumed                                         $ 15,579,314
                                                                ============

During the nine months ended September 30, 1998, the Company issued 35,294
shares of common stock in conjunction with the acquisition of certain rights
associated with the Circle Surround technology. The shares have an ascribed fair
value of $300,000. (Note 2)



                 See accompanying notes to financial statements


                                       6
<PAGE>   7
                                 SRS LABS, INC.

             NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


1.  GENERAL/BASIS OF PRESENTATION

    SRS Labs, Inc. (the "Company") is known as a leading provider of audio and
voice enhancement technology solutions. The Company's business consists of
licensing audio and voice enhancement technologies to manufacturers of consumer
electronics, computer, gaming and telecommunications equipment; the design of
custom ASICs (application-specific integrated circuits) for consumer
electronics, game, telecommunications and personal computer manufacturers; the
distribution of components, chips and assembly systems for the China and Hong
Kong markets; and the manufacturing and marketing of home theater and game
products for the Asian consumer marketplace.

    The accompanying interim consolidated financial statements have been
prepared by the Company without audit (except for the balance sheet information
as of December 31, 1997) in conformity with generally accepted accounting
principles for interim financial information and with the rules and regulations
of the U.S. Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such regulations. In the opinion of management, all adjustments
(which include only normal recurring adjustments) considered necessary for a
fair presentation have been included.

    The interim financial statements should be read in conjunction with the
Company's Annual Report on Form 10-KSB for the fiscal year ended December 31,
1997, the Current Report on Form 8-K dated March 12, 1998 and the Current Report
on Form 8-K/A dated May 18, 1998. Current and future financial statements may
not be directly comparable to the Company's historical financial statements. The
results of operations for the interim periods are not necessarily indicative of
the results to be expected for the full year.

2.  ACQUISITIONS

    On March 2, 1998, the Company acquired (the "Acquisition") all of the
outstanding shares of capital stock of Valence Technology Inc., a British Virgin
Islands holding company with its principal business operations in Hong Kong and
China ("Valence"). Valence, which conducts its business through its subsidiaries
based in Hong Kong and China, is engaged in three primary areas of business,
namely, the design and sale of application-specific integrated circuits (ASICs)
and other semiconductor products; the design, manufacture and sale of consumer
electronics products; and the distribution of components and products within
mainland China and throughout Asia. The aggregate purchase price of $19,500,000
consisted of approximately $7,400,000 in cash and 1,680,611 shares of the
Company's common stock. The acquisition was accounted for as a purchase having
an effective date of February 1, 1998. In connection with such acquisition,
three of the four management shareholders and their respective sole
shareholders, each of whom was a key employee of Valence or one of its
subsidiaries, entered into non-competition agreements with the Company. In
consideration for these agreements and for a nominal cash payment equal to the
par value of the shares, the Company issued 125,000 additional shares of its
common stock in aggregate to such three shareholders.

    The following summarizes the consideration granted for the acquisition of
Valence and non-compete agreements, the allocation of the purchase price and
other purchase accounting adjustments:

    Cash                                                  $ 7,394,222
    Common stock                                           13,006,178
                                                          -----------
    Total purchase price                                   20,400,400
    Deficiency in net assets acquired                       1,503,035
    Acquisition costs                                       1,478,633
                                                          -----------
    Excess of purchase price over net assets              $23,382,068
                                                          ===========
    Allocation to:
      In-process research and development                 $17,471,668
      Intangible assets                                     5,910,400
                                                          -----------
                                                          $23,382,068
                                                          ===========

                                       7
<PAGE>   8
                                SRS LABS, INC.

             NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

    The resulting intangible assets are being amortized on a straight-line basis
over periods ranging from three to eleven years.

    Unaudited proforma combined results of operations for the nine months ended
September 30, 1998 would have been as follows had the Acquisition occurred on
January 1, 1998:

    Revenues                                              $32,338,561
    Proforma Net Loss                                     $  (328,554)
    Proforma Net Loss Per Share                           $     (0.03)
    Weighted Average Shares Outstanding                    11,819,713

    On February 28, 1998, the Company acquired certain rights to a proprietary
technology, Voice Intelligibility Processor, ("VIP") from a third party. The
aggregate consideration, including acquisition costs, was $1,138,710 and was
comprised of $620,178 in cash, 25,000 shares of the Company's common stock with
a fair value of $176,575 and warrants to purchase 100,000 shares of the
Company's common stock at $9.47 per share with a fair value of $341,957. The
purchase price allocated to in-process research and development was charged to
the Company's operations, resulting in a charge of $1,038,710. The remainder of
the purchase price was allocated to an intangible asset and is being amortized
over eight years.

    On May 21, 1998, the Company acquired certain rights to a proprietary
technology, Circle Surround, from a third party. The aggregate consideration,
including acquisition costs, was $834,985 and was comprised of $534,985 in cash
and 35,294 shares of the Company's common stock with a fair value of $300,000.
The purchase price was allocated to an intangible asset and is being amortized
over ten years.

3.  INVESTMENTS AVAILABLE FOR SALE

    The Company has classified its investments as available-for-sale in
accordance with SFAS No. 115. As of September 30, 1998, the Company's
available-for-sale investments had a cost of $13,014,145 and an estimated fair
value of $13,263,744, based on quoted market prices. The unrealized gains on
these investments of $249,600, net of income taxes of $102,336, have been
reported in the Company's Consolidated Balance Sheet as an increase in
stockholders' equity.


                                       8
<PAGE>   9
                                SRS LABS, INC.

             NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

4.   CHANGE IN ACCOUNTING PRINCIPLES

    Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS 130). FAS
130 requires that all items recognized under accounting standards as components
of comprehensive earnings be reported in an annual financial statement that is
displayed with the same prominence as other annual financial statements. It also
requires that an entity classify items of other comprehensive earnings by their
nature in an annual financial statement. For example, other comprehensive
earnings may include foreign currency translation adjustments and unrealized
gains and losses on marketable securities classified as available-for-sale.
Annual financial statements for prior periods will be reclassified, as required.
The Company's total comprehensive income (loss) is as follows:

<TABLE>
<CAPTION>
                                               For Three Months Ended     For Nine Months Ended   
                                                 September  30,                September 30,      
                                               ----------------------   ------------------------- 
                                                  1998        1997          1998          1997    
                                               ---------   ----------   ------------   ---------- 
<S>                                             <C>        <C>          <C>            <C>        
    Net income (loss)                           $191,510   $1,082,675   $(17,299,002)  $2,625,705 
    Unrealized gain (loss) on investments                                                         
      available for sale, net of tax              41,423       60,331        (16,336)      55,742 
                                                --------   ----------   ------------   ---------- 
        Total comprehensive income (loss)       $232,933   $1,143,006   $(17,315,338)  $2,681,447 
                                                ========   ==========   ============   ==========
</TABLE>

5.  NET INCOME (LOSS) PER COMMON SHARE

    In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" (FAS 128) which
is effective for financial statements for both interim and annual periods ending
after December 15, 1997. FAS 128 requires the Company to disclose a basic and
diluted earnings per share (EPS). The Company adopted the provisions of FAS 128
in the fiscal year ended December 31, 1997. The following is an illustration of
the reconciliation of the numerators and the denominators of the basic and
diluted net income (loss) per common share computations:


<TABLE>
<CAPTION>
                                         For Three Months                     For Three Months
                                     Ended September 30, 1998             Ended September 30, 1997
                               -----------------------------------  ------------------------------------
                                 Income       Shares     Per Share    Income       Shares      Per Share
                               (Numerator) (Denominator)   Amount   (Numerator) (Denominator)    Amount
                               ----------- ------------- ---------  ----------- -------------  ---------
<S>                             <C>          <C>           <C>      <C>           <C>            <C>   
BASIC:
Income available to
  common stockholders           $  191,510   11,619,090    $ 0.02   $ 1,082,675   9,580,867      $ 0.11

DILUTED:
Effect of Dilutive Securities:
Stock options                                                                       663,518        0.00
                                ----------   ----------    ------   -----------  ----------      ------
Income available to common
  stockholders                      N/A          N/A         N/A    $ 1,082,675  10,244,385      $ 0.11
                                ==========   ==========    ======   ===========  ==========      ======
</TABLE>


                                       9

<PAGE>   10
                                SRS LABS, INC.

             NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


<TABLE>
<CAPTION>
                                          For Nine Months                      For Nine Months
                                     Ended September 30, 1998              Ended September 30, 1997
                               ------------------------------------  ------------------------------------
                                  Income       Shares     Per Share    Income       Shares      Per Share
                                (Numerator) (Denominator)   Amount   (Numerator) (Denominator)    Amount
                               ------------ ------------- ---------  ----------- -------------  ---------
<S>                             <C>          <C>           <C>      <C>           <C>            <C>   
BASIC:
Income (loss) available to
  common stockholders          $(17,299,002)  11,339,653   $ (1.53)  $ 2,625,705   9,542,287     $ 0.28

DILUTED:
Effect of Dilutive Securities:
Stock options                                                                      1,078,381      (0.03)
                               ------------   ----------   -------   -----------  ----------     ------
Income available to common 
  stockholders                      N/A          N/A           N/A   $ 2,625,705  10,620,668     $ 0.25
                               ============   ==========   =======   ===========  ==========     ======
</TABLE>


                                       10

<PAGE>   11

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
         RESULTS OF OPERATIONS

OVERVIEW

    SRS Labs, Inc. (the "Company") is known as a leading provider of audio and
voice enhancement technology solutions. The Company's business consists of
licensing audio and voice enhancement technologies to manufacturers of consumer
electronics, computer, gaming and telecommunications equipment; the design of
custom ASICs (application-specific integrated circuits) for consumer
electronics, game, telecommunications and personal computer manufacturers; the
distribution of components, chips and assembly systems for the China and Hong
Kong markets; and the manufacturing and marketing of home theater and game
products for the Asian consumer marketplace.

    From the Company's inception in 1993 through February of 1998, the Company
derived substantially all of its revenue from royalties received from technology
licenses. On March 2, 1998, the Company acquired all of the outstanding capital
stock of Valence Technology, Inc., a British Virgin Islands holding company with
its principal business operations in Hong Kong and China ("Valence") for an
aggregate purchase price, excluding non-compete agreements and acquisition
costs, of $19,500,000 consisting of approximately $7,400,000 in cash and
approximately 1,680,611 shares of the Company's common stock, $.001 par value
per share (the "Common Stock"). The acquisition was accounted for as a purchase
with an effective date of February 1, 1998. The acquisition of Valence has had,
and will continue to have, a material impact on the Company's financial
statements for the reporting period ending September 30, 1998 and for the
reporting periods thereafter; accordingly, current and future financial
statements may not be directly comparable to the Company's historical financial
statements.

    During the first quarter of the fiscal year ending December 31, 1998
("Fiscal 1998"), the Company acquired certain rights to Voice Intelligibility
Processor ("VIP"), which is a patented voice processing technology that improves
the intelligibility of the spoken voice, especially in high ambient noise
environments. Aggregate consideration, including acquisition costs, was
$1,138,710 and was comprised of $620,178 in cash, 25,000 shares of Common Stock
and warrants to purchase 100,000 shares of Common Stock at $9.47 per share.

    During the second quarter of Fiscal 1998, the Company acquired certain
rights to Circle Surround, which is a patented audio delivery system that allows
multi-channel surround sound to be encoded into a two-channel stereo format and
allows an encoded two-channel audio source or a traditional stereo audio source
to be decoded into a multi-channel surround format. The aggregate purchase
price, including acquisition costs, was $834,985 and was comprised of $534,985
in cash and 35,294 shares of Common Stock.

RESULTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED 
SEPTEMBER 30, 1997

Revenues

    Total revenues for the three months ended September 30, 1998 were
$11,317,802 including revenues generated by Valence. This contrasts with the
third quarter of 1997 when the revenues of $2,505,656 were generated entirely
from the Company's licensing activities. Chip and licensing revenue of
$3,935,479 increased 57.1% compared to the same period last year. Licensing
revenue decreased from the same period last year primarily as a result of
declining per unit royalty due to aggressive pricing from certain of the
Company's competitors, the weakness in the semiconductor industry as experienced
by our chip partners, the erosion of revenue in the PC market, where certain
royalties paid to the company are a percentage of average selling price and the
absence of technology transfer fees due to overall economic conditions. Should
these conditions continue, they may result in declining licensing revenue in the
future. The decrease was offset by the custom ASIC chip design and chip sales
related to Valence's activities. Revenue generated from product and component
sales is primarily attributable to Valence; and therefore, is not comparable to
last year.


                                       11
<PAGE>   12

Gross Margin

    Gross margin for the three month period ended September 30, 1998 decreased
to 31.0% from 97.2% for the same period in 1997. This decline in margin
percentage results from the decrease in licensing revenues for the current
quarter and the shift in the Company's revenue base towards product and
electronic component sales which have significantly lower margins as compared
with the Company's historic technology licensing revenue base. The decline in
margin percentage is also due to competitive price reductions of the Company's
electronic products, specifically VideoCD players sold primarily in China. The
Company's gross margins in the future will depend on the revenue mix between
product and electronic component sales and revenues from licensing and chip
activities, as well as competitive pricing pressure on existing products.

Sales and Marketing

    Sales and marketing expenses for the third quarter were $1,176,466 compared
to $400,284 for the same quarter last year, an increase of 193.9% which is
primarily due to sales and marketing activities attributed to Valence. Sales and
marketing expenses as a percentage of total revenue for the three months ended
September 30, 1998 decreased to 10.4% from 16.0% for the three months ended
September 30, 1997 due to the leveraging of these expenses over a larger revenue
base.

Research and Development

    Research and development expenses for the third quarter were $577,816
compared to $116,137 for the same quarter last year, an increase of 397.5% which
is primarily due to research and development activities attributed to Valence.
For the three months ended September 30, 1998, Valence incurred research and
development expenses aggregating $421,677. Research and development expenses as
a percentage of total revenue for the three months ended September 30, 1998
increased slightly to 5.1% from 4.6% for the three months ended September 30,
1997.

General and Administrative

    General and administrative expenses for the third quarter were $1,536,407
compared to $636,739 for the same quarter last year, an increase of 141.3% which
is attributable to Valence's operations and the amortization of certain
intangible assets associated with the Valence acquisition. Amortization of these
intangibles total $326,497 for the three months ended September 30, 1998.
General and administrative expenses as a percentage of total revenue for the
three months ended September 30, 1998 decreased to 13.6% from 25.4% for the
three months ended September 30, 1997, as general and administrative expenses
are leveraged over a larger revenue base.

Other Income/Interest Income, net

    Net interest and other income for the third quarter was $11,728 compared to
$276,471 for the same quarter of 1997. Other income and interest income, net
reflects interest earned on average cash and investment balances less interest
paid on the outstanding borrowings under the Company's line of credit. The
decrease is primarily due to lower average cash and investment balances as
compared to the prior year and current interest expense charged on the
outstanding borrowings under the Company's line of credit.

Income Tax Expense

    Income tax expense for the third quarter was $36,986 compared to $475,131
for the same quarter last year, a decrease of 92.2%. The effective tax rate for
the three months ended September 30, 1998, which is based on current estimates
of the annual effective income tax rate, was 16.2% compared to 30.5% for the
three months ended September 30, 1997. Lower statutory tax rates in the Asian
countries where Valence has its principal business operations, and where
substantially all of the earnings for the quarter arose, resulted in a lower
consolidated tax rate for the Company.


                                       12


<PAGE>   13

NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED 
SEPTEMBER 30, 1997

Revenues

    Total revenues for the nine months ended September 30, 1998 were $30,000,568
including revenues generated by Valence since February 1, 1998. This contrasts
with the nine month period ended September 30, 1997 when the revenues of
$6,833,555 were all generated from the Company's licensing activities. Chip and
licensing revenue of $11,341,907 increased 66.0% compared to the same period
last year. Licensing revenue decreased from the same period last year, but the
decrease was offset by the custom ASIC chip design and chip sales related to
Valence's activities. Revenue from licensing has decreased over the past year
due to declining per unit royalty due to aggressive pricing from certain of the
Company's competitors, the weakness in the semiconductor industry as experienced
by our chip partners, the erosion of revenue in the PC market, where certain
royalties paid to the company are a percentage of average selling price and the
absence of technology transfer fees due to overall economic conditions. Should
these conditions continue, they may result in declining licensing revenue in the
future. Revenue generated from product and component sales is primarily
attributable to Valence; and therefore, is not comparable to last year.

Gross Margin

    Gross margin for the nine month period ended September 30, 1998 decreased to
34.7% from 97.3% for the same period in 1997. This decrease results from the
shift in the Company's revenue base towards product and electronic component
sales that have significantly lower margins compared with the Company's historic
technology licensing revenue base. The Company's gross margins in the future
will depend on the revenue mix between product and electronic component sales
and revenues from licensing and chip activities. However, the Company expects
product and electronic component sales to contribute a significant portion of
revenues in the near term, resulting in lower anticipated margins compared to
its historical margins.

Sales and Marketing

    Sales and marketing expenses for the first nine months of 1998 were
$3,876,993 compared to $1,190,178 for the same prior year period, an increase of
225.8% which is primarily due to sales and marketing activities attributed to
Valence. Sales and marketing expenses as a percentage of total revenue for the
nine months ended September 30, 1998 decreased to 12.9% from 17.4% for the nine
months ended September 30, 1997 due to the leveraging of these expenses over a
larger revenue base.

Research and Development

    Research and development expenses for the nine months ended September 30,
1998 were $1,576,526 compared to $414,516 for the same period last year, an
increase of 280.3% which is primarily due to research and development activities
attributed to Valence. For the nine months ended September 30, 1998, Valence
incurred research and development expenses aggregating $1,160,903. Research and
development expenses as a percentage of total revenue for the nine months ended
September 30, 1998 decreased to 5.3% from 6.1% for the nine months ended
September 30, 1997.

General and Administrative

    General and administrative expenses for the first nine months of 1998 were
$4,157,535 compared to $1,842,272 for the comparable prior year period, an
increase of 125.7% which is attributable to Valence's operations and the
amortization of certain intangible assets associated with the Valence
acquisition. Amortization of these intangibles total $853,992 for the nine
months ended September 30, 1998. General and administrative expenses as a
percentage of total revenue for the nine months ended September 30, 1998
decreased to 13.9% from 27.0% for the nine months ended September 30, 1997, as
general and administrative expenses are leveraged over a larger revenue base.


                                       13
<PAGE>   14

Acquired In-Process Research and Development

    Acquired in-process research and development costs of $18,510,378 during the
nine month period ended September 30, 1998 represented an allocation of a
portion of the purchase price for certain assets associated with the VIP
technology and for the acquisition of the outstanding shares of Valence
Technology, Inc. to in-process research and development costs, which, based on
management assumptions, had no future alternative use. (See Note 2 to the
Interim Consolidated Financial Statements.)

Other Income/Interest Income, net

    Net interest and other income for the first nine months of 1998 was
$394,126, a decrease from the net interest income amount of $806,712 for the
same prior year period. The decrease is primarily due to lower average cash and
investment balances during the fiscal year to date as compared to the prior year
due to cash paid in conjunction with the acquisition of Valence and for the
acquisition of new technologies.

Income Tax Expense (Benefit)

    The income tax benefit for the nine months ended September 30, 1998 was
$24,020 compared to an expense of $1,381,356 for the same period last year.
Lower statutory tax rates in the Asian countries where Valence has its principal
business operations contributed to a lower consolidated tax rate.

LIQUIDITY AND CAPITAL RESOURCES

    The Company's principal source of liquidity at September 30, 1998 consisted
of cash, cash equivalents and investments aggregating $21.1 million, as well as
borrowings available under its credit facility. The Company's cash, cash
equivalents and investments serve as collateral for borrowings under the
Company's credit facility. At September 30, 1997, the Company had cash, cash
equivalents and long term investments of approximately $25.7 million.

    The Company has primarily financed its operations through the cash provided
by its operations and proceeds from its initial public offering of Common Stock
in August 1996. The Company's operating activities provided $1,516,037 in cash
for the nine months ended September 30, 1998 and $1,357,619 for the nine months
ended September 30, 1997. The $158,418 increase in cash provided by operations
was primarily due to the decrease in accounts receivable.

    As described above, the Company acquired Valence and additional technologies
during the first nine months of Fiscal 1998. (See Note 2 to the Interim
Consolidated Financial Statements.)

    On March 4, 1998, the Company obtained a revolving line of credit with a
bank which expires on June 1, 2000 and is secured by certain of the Company's
investments. The total availability under the line of credit is the lesser of
$10 million or a percentage of the fair market value of the collateral. The line
of credit bears interest at the bank's prime rate or LIBOR plus 0.75%. The
Company had $8.0 million outstanding under the line of credit as of September
30, 1998. As a result of the acquisition of Valence, the Company provided
Valence $8.0 million to pay off its short-term debt and other obligations. These
funds were provided by borrowings on the above-referenced line of credit.

    The Company anticipates that its primary uses of working capital in future
periods will be to acquire new technologies, to provide Valence with additional
working capital and to fund increased costs for additional sales headcount and
marketing activities associated with the introduction of new technologies and
products into the market. The Company also anticipates making additional capital
expenditures for the improvement of its operating system infrastructure and
management reporting systems in the United States and Hong Kong. Management
currently estimates these capital expenditures could aggregate $1,000,000
through 1999.

    Based on current plans and business conditions, the Company believes that
its cash, cash equivalents, investments and/or available borrowings under its
line of credit, together with any amounts generated from operations, will be
sufficient to meet the Company's operating and capital requirements for the
foreseeable 


                                       14

<PAGE>   15

future. However, there can be no assurance that the Company will not be required
to seek other financing sooner or that such financing, if required, will be
available on terms satisfactory to the Company.

Year 2000 Readiness Disclosure

    The Company is currently in the process of addressing a problem that is
facing all users of automated information systems. The"Year 2000 issue" arises
out of the fact that many of the world's computer systems currently record years
in a two-digit format. Such computer systems will be unable to properly
interpret dates beyond the year 1999, which could lead to business disruptions
in the U.S. and internationally.

    The Company and its subsidiaries have identified the following areas, which
could be impacted by the Year 2000 issue. They are: Company products; internally
used systems and software; products or services provided by key third parties;
and the inability of chip partners or licensees to process business transactions
relating to licensing revenue.

    During Fiscal 1998, the Company and its subsidiaries began a review of its
internal systems including those which support manufacturing process control and
financial and general business operations. The review consisted of an evaluation
of significant internal hardware systems and major software application programs
for their ability to accurately recognize and process dates properly in the Year
2000 and beyond. As a result of this evaluation, the Company has identified
certain systems which require upgrades to be Year 2000 ready, including certain
business software applications. The Company is in the process of replacing,
converting or eliminating systems which it has determined are not Year 2000
compliant. The Company anticipates that it will complete its review of its
internal systems and expects that all necessary upgrades to ensure Year 2000
compliance will be completed by the second quarter of 1999.

    In addition, the Company and its subsidiaries are in the process of
assessing the compliance of their major customers, suppliers and vendors.
Management believes that third-party relationships upon which the Company
relies represent the greatest risk with respect to the Year 2000 issue, because
the Company cannot guarantee that third parties will be able to adequately
assess and address their Year 2000 compliance issues in a timely manner. As a
consequence, the Company can give no assurances that issues related to Year 2000
would not have a material adverse effect on future results of operations or
financial condition.

    Total costs relating to the Company's compliance efforts, based on
management's best estimates, could range as high as $1,000,000. The Company is
expensing as incurred, all costs related to the assessment of Year 2000
compliance issues. Equipment purchases required for Year 2000 compliance will be
capitalized and charged to expense over the useful lives of those assets in
accordance with the Company's existing policy. These cost estimates are based on
currently available information and may be subject to change.

    While the Company continues to focus on solutions for Year 2000 issues and
expects its internal operations to be Year 2000 compliant in a timely manner,
the difficulty in determining whether third-parties have resolved their Year
2000 issues necessitates the need for the development of a contingency plan.
Such a plan will set forth the Company's responses should the Company or
third parties which are materially significant to the Company fail to achieve 
Year 2000 compliance in a timely manner. The Company expects to finalize its 
contingency plan by mid-year 1999.

    The information set forth above under this caption "Year 2000 Readiness
Disclosure" relates to the Company's efforts to address the Year 2000 concerns
regarding the Company's (a) operations; (b) products and technologies licensed
or sold to third parties and (c) major suppliers and customers. Such statements
are intended as Year 2000 Statements and Year 2000 Readiness Disclosures and are
subject to the Year 2000 Information Readiness Act."


                                       15
<PAGE>   16

FORWARD-LOOKING STATEMENTS AND FACTORS WHICH MAY AFFECT FUTURE RESULTS

    Included in this Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations are a number of forward-looking statements
that are subject to certain risks and uncertainties that could cause the
Company's actual results and financial position to be affected negatively as
events unfold in the markets for the Company's products. These events include,
but are not limited to, the risks involved in the expansion of the Company's
business through acquisitions of new companies like Valence or new technologies
like VIP and Circle Surround, as well as the risks discussed below. The Company
assumes no obligation to update the forward-looking information in this Report
or the factors listed below to reflect actual results or changes in the factors
affecting such forward-looking information. 

Quarterly Fluctuations

    The Company's operating results may fluctuate from those in prior quarters
and will continue to be subject to quarterly and other fluctuations due to a
variety of factors, including the extent to which the Company's licensees
incorporate SRS or the Company's other technologies into their products, the
gain or loss of significant customers, competitive pressures on selling prices,
the acceptance of new or enhanced versions of the Company's technologies, the
rate that the Company's semiconductor licensees manufacture and distribute chips
to original equipment manufacturers ("OEMs"), the ability of the Company to
secure one-time license fees for its technologies from new and existing
licensees and general business conditions, particularly those affecting the
consumer electronics market. Due to the Company's dependence on the consumer
electronics market, the substantial seasonality of sales in the market could
impact the Company's revenues and net income. In particular, the Company
believes that there is seasonality relating to the Christmas season as well as
the Chinese New Year within the Asia-Pacific region which fall into the fourth
and first quarters, respectively.

Changes to the Business Model/Integration of Valence/Refinement of Asian
Strategy

    From the Company's inception in 1993 to 1997, the Company derived
substantially all of its revenues from licensing activities. As a result of the
acquisition of Valence, the Company has added business operations engaged in the
design and sale of ASICs and other semiconductor products; the design,
manufacture and sale of consumer electronics products; and the distribution of
components and products within mainland China and throughout Asia. These
operations differ substantially from the Company's previous business model, and
future operating results could be affected by a variety of factors, including
the timing of customer orders, the timing of development revenue, changes in the
mix of products distributed and the mix of distribution channels employed, the
emergence of new industry standards, product obsolescence and changes in pricing
policies by the Company, its competitors or its suppliers.

    The Company's future success will depend in large part on its ability to
successfully create business synergies upon integrating the operations of
Valence with those of the Company. The degree to which the Company can
successfully derive synergistic value will depend on a number of factors,
including the Company's ability to expand the scope of its operations beyond
technology licensing into the new business of manufacturing electronic and
semiconductor products and the Company's ability to increase its market
penetration in China. The integration of certain operations following the
acquisition has required and will continue to require the dedication of
management and other personnel resources which may temporarily distract from the
day-to-day business of the combined company. The geographic separation of these
operations is likely to place additional strain on the Company's resources. In
addition, the Company's significant operations in China and Asia have required
refinement to adapt to the changing market conditions in that region. This
refinement may impact certain of the Company's current business directions,
including Valence, as the Company attempts to position itself to maximize
penetration of selected growth segments in that region. The Company's
operations in Asia, and internationally in general, also are subject to risks of
unexpected changes in, or impositions of, legislative or regulatory
requirements.

    The acquisition of Valence has added significant diversity to the Company's
overall business structure and the Company's opportunities. The Company
recognizes that in the presence of such corporate diversity, and in particular
with regard to the semiconductor industry, there will always exist a potential
for a conflict among sales channels between the Company and certain of the
Company's technology licensees. Although the operations of the Company's
licensing business and those of Valence are generally complementary, there can
be no assurances 


                                       16
<PAGE>   17

that sales channel conflicts will not arise. If such potential conflicts do
materialize, the Company may or may not be able to mitigate the effect of such
perceived conflicts which, if not resolved, may impact the results of
operations.

Currency Risk/Stability of Asian Markets

        The Company expects that international sales will continue to represent
a significant portion of total revenues. To date, all of the Company's revenues
have been denominated in U.S. dollars and most costs have been incurred in U.S.
dollars. It is the Company's expectation that licensing revenues will continue
to be denominated in U.S. dollars for the foreseeable future. With its
acquisition of Valence and the Company's anticipated expansion of its business
in China and other parts of Asia, the Company's consolidated operations and
financial results could be significantly affected by risks associated with
international activities, including economic and labor conditions, political
instability, tax laws (including U.S. taxes on foreign subsidiaries) and changes
in the value of the U.S. dollar versus the local currency in which the products
are sold. In addition, the Company's valuation of assets recorded as a result of
the Valence acquisition may also be adversely impacted by the currency
fluctuations relative to the U.S. dollar. The Company intends to actively
monitor its foreign exchange exposure and to implement strategies to reduce its
foreign exchange risk at such time that the Company determines the benefits of
such strategies outweigh the associated costs. However, there is no guarantee
that the Company will take steps to insure against such risks, and should such
risks occur, there is no guarantee that the Company will not be significantly
impacted. Countries in the Asia Pacific region have recently experienced
weakness in their currency, banking and equity markets. These weaknesses could
adversely affect consumer demand for Valence's products, the U.S. dollar value
of the Company's and its subsidiaries' foreign currency denominated sales, the
availability and supply of product components to Valence and ultimately, the
Company's consolidated results of operations.

Competitive Pressures

    The Company's existing and potential competitors include both large and
emerging domestic and international companies that have substantially greater
financial, manufacturing, technical, marketing, distribution and other
resources. Competitors of the Company may also include a number of smaller
companies that may have greater flexibility to address specific market needs. In
addition, the markets in which the Company competes are intensely competitive
and are characterized by rapid technological changes, declining average sales
prices and rapid product obsolescence.

Importance of Intellectual Property

    The Company's ability to compete may be affected by its ability to protect
its proprietary information. The Company has filed several U.S. and foreign
patent applications and to date has a number of issued U.S. and foreign patents
covering various aspects of its technologies. There can be no assurance that the
steps taken by the Company to protect its intellectual property will be adequate
to prevent misappropriation of its technology or that the Company's competitors
will not independently develop technologies that are substantially equivalent or
superior to the Company's technology. In addition, the laws of certain foreign
countries may not protect the Company's intellectual property rights to the same
extent as do the laws of the U.S. The semiconductor industry is characterized by
frequent claims and litigation regarding patent and other property rights. The
Company is not currently a party to any claims of this nature. There can be no
assurances that third parties will not assert additional claims or initiate
litigation against the Company or its customers with respect to existing or
future products. In addition, the Company may initiate claims or litigation
against third parties for infringement of the Company's proprietary rights or to
determine the scope and validity of the proprietary rights of the Company or
others.

Management of Growth; Dependence on Key Personnel

    The Company has recently experienced rapid growth and expansion with the
acquisition of Valence. This acquisition has placed, and will continue to place,
a significant strain on its administrative, operational and financial resources,
and has increased, and will continue to increase, the level of responsibility
for both existing and new management personnel. The Company's future success
depends in part on the continued service of its 


                                       17
<PAGE>   18

key engineering, sales, marketing and executive personnel, including highly
skilled semiconductor design personnel. The Company anticipates that any future
growth will require it to recruit and hire a number of new personnel in
engineering, operations, finance, sales and marketing. Competition for such
personnel is intense, and there can be no assurance that the Company can retain
and recruit necessary personnel to operate its business and support future
growth. The Company's ability to manage its growth successfully also will
require the Company to continue to expand and improve its administrative,
operational, management and financial systems and controls.

Volatility of Stock Price

    The trading price of the Common Stock has been, and will likely continue to
be, subject to wide fluctuations in response to quarterly variations in the
Company's operating results, announcements of new products or technological
innovations by the Company or its competitors, general market fluctuations and
other events and factors. Changes in earnings estimates made by brokerage firms
and industry analysts relating to the markets in which the Company does
business, or relating to the Company specifically, have in the past resulted in,
and could in the future result in, an immediate and adverse effect on the market
price of the Common Stock.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

    Not Applicable.


                                       18
<PAGE>   19



                          PART II - OTHER INFORMATION


ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

USE OF PROCEEDS

    The effective date of the Company's initial public offering of its Common
    Stock was August 8, 1996 (SEC Registration No. 333-4974-LA). Since the
    Company's last periodic report filed pursuant to Section 13(a) of the
    Securities Exchange Act of 1934, as amended (i.e., its Quarterly Report on
    Form 10-Q for the Quarterly Period Ended June 30, 1998), there has been no
    change in the Company's use of its aggregate net offering proceeds of
    $22,052,955. As noted in such prior Report, the Company utilized an
    aggregate of $8,394,222 in connection with three acquisitions (see Note 2 to
    the Interim Consolidated Financial Statements herein) with the remaining
    funds being temporarily invested in cash and municipal bonds pending
    application.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K.

      (a) Exhibits. The exhibits listed below are hereby filed with the U.S.
Securities and Exchange Commission (the "Commission") as part of this Report.

            Exhibit
              No.                           Description
            -------                         -----------
             10.1       Employment Agreement, dated July 1, 1998 by and between 
                        the Company and John AuYeung.

             27         Financial Data Schedule.


      (b)  Reports on Form 8-K

      No reports on Form 8-K were filed with the Commission during the three 
month period ended September 30, 1998.


                                       19

<PAGE>   20

                                   SIGNATURES


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

                                   SRS LABS, INC.,
                                   a Delaware Corporation

Date:  November 13, 1998           By:   /s/ JANET M. BISKI
                                         ---------------------------------------
                                         Janet M. Biski
                                         Vice President, Chief Financial Officer
                                         and Secretary (Principal Financial and
                                         Accounting Officer)



                                       20


<PAGE>   21


                                  EXHIBIT INDEX


        Exhibit
          No.                        Description
        -------                      -----------

         10.1       Employment Agreement dated July 1, 1998 by and between the 
                    Company and John AuYeung

         27         Financial Data Schedule