| ” Reference also is made to “Item 1A Risk Factors” for a discussion relating to certain business risks relating to our business |
| SRS Labs was incorporated in the State of California on June 23, 1993 and reincorporated in the State of Delaware on June 28, 1996 |
| Our executive offices are located at 2909 Daimler Street, Santa Ana, California 92705 |
| Our Products and Technologies Licensing Our licensing business develops and markets audio rendering, voice and surround sound technologies to OEMs, ODMs, semiconductor manufacturers, and software providers in the home entertainment, portable media device, personal telecommunications, automotive and personal computer markets |
| Our portfolio of licensable technologies includes a wide range of techniques for the processing and delivery of audio, voice and surround sound, including the following: · Surround Sound—Our surround sound technology, Circle Surround®, is a complete encoding and decoding format |
| Circle Surround encoding enables the distribution of up to 6dtta1 channels of audio over existing two-channel carriers such as digital media files, standard definition and high-definition 5 ______________________________________________________________________ television, FM radio, and CDs |
| Circle Surround decoding decodes Circle Surround encoded material for multi-channel playback or creates up to 6dtta1 channels of audio from older formats of material, including mono, stereo, 4-channel surround or other matrix surround formats |
| Circle Surround decoding is available in three solutions: Circle Surround, Circle Surround II™ and Circle Surround Automotive™ |
| · Audio Rendering—Our audio rendering technologies optimize device audio output and enable the presentation of 3D and multichannel audio content over two speakers |
| These technologies include the ability to render 5dtta1multichannel content over two speakers, to create a wider sound stage for more natural audio, to improve the perceived bass response in small speakers, and to dynamically position audio sources in a virtual 3D space using headphones, and to reposition the audio image for non-optimally placed speakers |
| Our audio technologies include: SRS Xspace 3D™, SRS WOW™, SRS WOW XT™, SRS WOW HD™, SRS TruBass®, SRS FOCUS®, SRS Headphone™, SRS DialogClarity™, SRS TruSurround® XT, SRS 3D® Sound and SRS Auto™ |
| · Voice Processing—Our VIP™ and Noise Reduction™ technologies, dramatically reduce noise to produce much clearer and crisper dialog over wireless communication devices and improve the intelligibility of the human voice in a variety of listening situations, including high ambient background environments |
| The SRS Labs portfolio of technologies can address a broad spectrum of product applications within the vertical markets that we have targeted |
| Our technologies may be implemented in a variety of methods, including discrete analog components, chip modules, analog semiconductors, DSPs and software |
| These various implementation options offer customers flexibility when incorporating our technologies into products |
| Semiconductors Our fabless semiconductor business designs, develops and markets custom and proprietary analog, digital and mixed signal integrated circuits |
| These products address a wide range of applications in the consumer electronics, home entertainment, telecommunications and personal computer markets |
| We market our semiconductor products in two categories: (a) custom ASICs for specific OEM customers primarily in the Asia Pacific region, and (b) standard integrated circuits marketed under the brand name, ASP Microelectronics, or ASP, many of which include our audio, voice and surround sound technologies |
| As of the end of 2005, approximately 39 engineers supported our IC design capabilities |
| We outsource the manufacturing of these ASICs to a network of fabrication partners throughout Asia Pacific, including Chartered Semiconductor, Samsung and Tower Semiconductor Limited in Israel |
| In addition to performing contract design work, we also design, develop and market standard ICs for the Asia Pacific manufacturing market under the ASP brand name |
| The products created are based upon management’s analysis of trends in the market, knowledge gained from long standing relationships with customers and overall business experience |
| The general purpose integrated circuits offered include micro-controllers for DVD Players, set-top box receivers and audio/video equipment; ICs for telecommunication and game equipment; small signal transistors and ICs used mainly in the manufacture of consumer products such as television sets, radios, telephones, computer mother boards, add-on boards and audio hi-fi systems |
| Many of these products are developed by utilizing our custom design libraries, advanced mixed signal design technologies, system level expertise, software knowledge and understanding of customer requirements |
| Many of these chips include SRS audio technologies and by the end of 2005, 38prca of the ASP product line included SRS audio chips |
| 6 ______________________________________________________________________ Our Customers and Markets We license our technologies and sell our semiconductors throughout the Western Hemisphere, the Asia Pacific region and in Europe |
| The following table presents our revenue by geographic area |
| For product sales, revenue is allocated based on the country to which product was shipped |
| For licensing-related revenue, the allocation is based on the location of the licensee’s corporate headquarters |
| The Americas region includes North, Central and South America |
| Years ended December 31, 2005 % 2004 % 2003 % Geographic Area Revenue: Hong Kong $ 7cmam672cmam588 33 % $ 9cmam975cmam904 46 % $ 9cmam235cmam976 47 % Japan 5cmam644cmam518 24 % 4cmam906cmam343 23 % 5cmam402cmam565 27 % Korea 4cmam217cmam780 18 % 1cmam456cmam063 7 % 381cmam416 2 % China 2cmam734cmam596 12 % 2cmam028cmam224 9 % 2cmam193cmam863 11 % Americas 2cmam300cmam263 10 % 2cmam354cmam668 11 % 875cmam461 5 % Other Asia Pacific 383cmam420 2 % 205cmam817 1 % 845cmam529 4 % Europe 275cmam094 1 % 675cmam369 3 % 878cmam971 4 % Total $ 23cmam228cmam259 100 % $ 21cmam602cmam388 100 % $ 19cmam813cmam781 100 % Licensing Through our licensing business segment, we market our portfolio of technologies to the following vertical markets: home entertainment; personal telecommunications; portable media; personal computers and automotive |
| Our license agreements typically have multi-year or automatic renewal terms, and either require per-unit royalty payments for all products implementing our technologies or provide for a fixed annual or quarterly royalty payment |
| License agreements also specify the use of our trademarks and logos on the product, within the packaging and in the user’s manual |
| Agreements also require our product review and approval to guarantee the quality of the technology implementation and the correct usage of our logos and trademarks |
| We believe these terms ensure the quality and consistency of the technology and elevate the awareness of the SRS brand in the marketplace |
| Most agreements do not have volume requirements and may be terminated by the licensees or us without substantial financial penalty |
| Commencing in 2003, we embarked on a strategy to further diversify our concentration across markets |
| The following chart shows the percentage of our licensing revenue we received in 2005 and 2004 from each of these markets |
| GRAPHIC GRAPHIC 7 ______________________________________________________________________ Home Entertainment Home entertainment products represent the largest current market for our technologies and have historically been the largest revenue contributor to our licensing business |
| Manufacturers in this market utilize our technologies to differentiate their products from their competitors while improving functionality and product performance |
| In many instances, manufacturers license multiple technologies from us for multiple product lines and divisions |
| Product categories within this market include HD televisions (such as LCD and Plasma televisions), set-top boxes, DVD players, audio/video receivers, and complete home-theater-in-a-box systems |
| Our audio technologies are widely used by television manufacturers as a differentiating feature and as a solution to audio challenges that manufacturers encounter |
| As television makers continue to migrate from bulky tube models to thinner digital displays, manufacturers are finding that they have less room for speakers, which may compromise the overall audio quality of the television |
| We provide manufacturers with patented solutions for accurately presenting surround sound, improving bass response, increasing dialog clarity, and creating a more natural sound stage |
| These solutions improve the audio quality of the set without the expense of additional equipment or larger speakers |
| In 2005, our technologies continued to grow in popularity for use in flat panel TVs from LG, Samsung, and Sony |
| Although they present surround sound content, DVD players and set-top-boxes are typically connected to two-channel televisions |
| Our SRS TruSurround XT technology creates a surround sound experience over any existing two-speaker system, including the internal speakers of a television |
| This technology also creates a virtual surround experience from stereo material |
| The audio/visual receiver is the central hub for a typical home theater system |
| Many homes are now being equipped with “home-theater-in-a-box” systems that come complete with a DVD player, VCR, CD player, set-top box, and 5dtta1 speakers |
| Our portfolio of technologies addresses the needs of this market by improving audio performance and by providing surround sound rendering |
| Personal Telecommunications SRS Labs provides the personal telecommunications market with both voice and audio rendering technologies |
| Mobile phones are adding multimedia at a rapid pace |
| New services include digital music downloads, ring-tones and true-tones, streaming video, gaming, and television viewing |
| In 2004 and 2005, KDDI, SK Telecom, Sprint, and Verizon joined NTT DoCoMo and others with new multimedia services |
| SRS Labs’ strong presence in the home entertainment market, our suite of voice technologies, and our existing start into the mobile market with customers like NEC present a growth opportunity for SRS Labs |
| SRS solutions address specific needs in the mobile market |
| For example, our technologies address needs like voice intelligibility in noisy environments, clarity of dialog in video content, poor bass-response of small speakers, hampered stereo imaging in narrow-set speakers, and 3D audio for interactive gaming |
| Portable Media MP3 players and other portable media players enable consumers to enjoy audio and video content while on the go |
| As volume for these devices increases, consumer pricing pressure leads to wider use of cost-effective components by manufacturers to keep production costs low |
| Our solutions enable vendors of portable media devices to increase the quality of their audio output without increasing hardware component costs |
| In 2005, customers using SRS technologies in their portable media player products included LG, Reigncom (iRiver), and Samsung |
| 8 ______________________________________________________________________ Personal Computers Personal computers (PCs) in the home are often used as media hubs |
| Through PCs, users enjoy and manage collections of music, and movies along with downloaded and recorded television programming |
| This content is now being distributed through the home using networked media adapter products |
| Throughout these systems, there is a need for optimizing playback on the computer speakers, presenting a home theater experience on a laptop, transmitting surround sound around the home, and enjoying content on headphones |
| Technology solutions from SRS are well positioned to fill these needs |
| In 2005, Toshiba and Fujitsu were among the customers using SRS technologies in their personal computer and related products |
| Automotive SRS Labs has invested in research to create solutions specific to the needs of the automotive market |
| Within vehicles, audio and video content is played from multiple sources and then presented on both speakers and headphones |
| Stereo content from sources like CDs, MP3 players, and HD Radio® needs to be presented on all speakers in the car, some of which may not be optimally placed and may not have strong bass response |
| Surround sound content from DVDs, radio, and downloaded music needs to be rendered on both car speakers with a maximum sweet spot and on rear-seat headphones |
| Our automotive solutions like SRS CS Auto, SRS Circle Surround II, and SRS TruSurround XT meet these needs and provide manufacturers in this segment with a fully tunable solution |
| In 2005, customers using our automotive technology included Fujitsu-Ten, Kenwood, and Philips |
| Semiconductors Our custom ASIC customers include the Asia-based manufacturing facilities for consumer electronics, telecommunications and personal computer manufacturers headquartered in North America, Europe and Asia Pacific |
| We believe our expertise in design work allows us to offer our customers a shorter development cycle, smaller die size and faster turnaround time for final production, which strengthens our relationships with our customers and helps us retain our competitive advantage in the Asia Pacific region |
| Our target customers for ICs are the original design manufacturers, or ODMs and OEMs of a variety of television applications, including LCD, projection, CRT and plasma televisions, as well as personal telecommunications, automotive, portable audio and personal computer equipment |
| Customer Concentration For fiscal year 2005, there was no customer that accounted for more than 10prca of consolidated revenues |
| For fiscal year 2004, one customer in the semiconductor segment accounted for approximately 10prca or dlra2cmam180cmam065 of consolidated revenues |
| For fiscal year 2003, one customer in the semiconductor segment accounted for approximately 11prca or dlra2cmam107cmam790 of consolidated revenues |
| Given the significant amount of revenues derived from these customers, the loss of any such customer or the uncollectibility of related receivables could have a material adverse effect on our financial condition and results of operations |
| Our Strategy As explained above, we are pursuing the divestiture of our semiconductor business in order to focus on our licensing business |
| Consequently, the following discussion addresses the key elements of the strategy for our licensing business |
| Our sales strategy is to identify high-growth markets, develop needed technology solutions and features and work with software and semiconductor platform partners to make these technologies widely 9 ______________________________________________________________________ available and easy-to-implement by OEMs and ODMs |
| We believe that we will continue to strengthen our market position as a world leader in audio and voice technology by employing the strategy of providing a continuous stream of patented audio and voice technologies, penetrating new licensing accounts, expanding relationships with existing licensees, creating a broad platform of software and semiconductor partners and developing strong brand awareness of the SRS logo |
| The mission of our licensing platform efforts is to achieve comprehensive and strategic coverage for our technology solutions within all of our targeted vertical product markets in order to expand sales and licensing opportunities |
| By developing strong relationships with the leading software and semiconductor companies, our audio technologies can be delivered to customers worldwide across high growth and high volume product applications |
| We work together with our platform partners (leading semiconductor manufacturers and middleware or firmware software providers) to provide our mutual customers with the technology, which best fits their needs |
| Many times, a platform partner will become enabled with our technology due to a customer request |
| Other platforms become enabled with our technology due to their identification as a key component to enter a new market |
| As a technology licensing company, one of our greatest assets is the strength of our brand |
| Since brand recognition drives licensing sales, we have invested in strategies that increase consumer awareness of SRS Labs with the ultimate goal of establishing our brand with both product manufacturers and consumers around the world as the symbol for high-quality audio |
| The three primary vehicles that we use to further the proliferation of our brand are: (a) placement of the SRS logo by OEMS on products and in co-marketing programs; (b) online branding programs; and (c) use, and recognition of use, of SRS technology by content and broadcast professionals |
| In the majority of products which use SRS technologies, our logo is either prominently displayed on the product itself or, in the case of software products and mobile phones, featured in the graphical user interface |
| This consistent logo exposure is considered a key tool in reaching consumers worldwide |
| In addition, we work with our OEM customers as they launch new products that feature SRS technologies |
| We supply complete SRS corporate and technology tool kits with a wide array of material, including SRS logos, illustrations, technology explanations and suggested demonstration material |
| In 2005, for example, we worked with Dell to place SRS Circle Surround encoded high-definition video and our logo into their sales kiosks |
| Online Branding |
| Online exposure has also been an important part of our branding strategy |
| A beneficial component of our relationship with Microsoft is that the SRS logo displayed in the audio control panel of Microsoft’s Windows® Media Player links to an SRS technology page |
| As a result, SRS has received significant traffic and opportunities to create brand awareness with consumers and to educate consumers on the benefits of SRS technology |
| Our online efforts also include the direct sale of plug-ins for Windows Media Player |
| Revenue from the sale of these products is not significant, but gives us a valuable demonstration platform to showcase our audio technologies |
| Use of SRS Technology by Content and Broadcast Professionals |
| We develop, license and sell professional hardware and software products to enable content companies, broadcasters and music publishers to encode their material using our SRS Circle Surround technology |
| When SRS Circle Surround is professionally used, the logo is often displayed within the content itself, on the packaging material, or in the case of radio an announcement that the broadcast is being delivered in SRS Circle Surround |
| We have concentrated on three key market segments in the professional audio space: television, radio and music, and have developed a line of hardware and software products to address these markets |
| These products are sold directly to professional customers and are also available from selected dealers and distributors servicing the professional audio and broadcast communities |
| We did not generate significant revenue from the sale of 10 ______________________________________________________________________ professional hardware equipment in 2005 |
| The primary purpose of this business is to enable our other businesses and to increase awareness for SRS Labs within the content community |
| Sales and Marketing We have two types of revenue collection systems with our licensees—bundled or non-bundled |
| Under a bundled agreement, royalty revenue may be collected by our platform partner at the time the solution is sold to an OEM or ODM Most often, however, we collect revenue directly from our licensees |
| These licensing arrangements with OEMs or ODMs authorize them to design, build and sell products containing our technology |
| Under this licensing method, OEM product licensees are free to choose a semiconductor solution from the platform partner that best suits their technical and cost-of-goods-sold requirements |
| We receive royalties directly from the licensed OEM or ODM for the use of our technologies in licensed products manufactured and shipped by the OEM or ODM Many major OEMs have licenses or purchase products manufactured by a licensed ODM for the use of one or more of our technologies and for the use and display of our trademarks |
| In the case of the platform partner who bundles our technology within their solution, the cost of the solution includes our royalty at the time it is sold |
| The platform partner remits that royalty directly back to us on behalf of the licensee, thus streamlining the royalty collection process of royalty reporting |
| Our process for selecting particular platform partners for distributing our technology is based on several criteria including: (a) segment leadership—we target chip partners that hold preeminent positions in market segments characterized by high growth, volume and/or margins; (b) volume—platforms which will maximize exposure of our technologies to a large number of potential OEMs; (c) synergy—platforms which serve to position our technologies along with compatible and additive technologies for integrated delivery; and (d) convergence potential—which enable us to establish a presence on platforms that intersect merging functional features |
| An example of this would be the platforms for new personal multifunctional devices that include mobile phone, personal digital assistant, or PDA, and MP3 capabilities |
| To implement our licensing sales strategy within our identified vertical markets, we have established a direct sales force and a worldwide network of independent sales agents |
| In North America, we employ a direct sales force to market our portfolio of audio and voice technologies to the OEM community |
| Internationally, we maintain offices in Japan, Hong Kong and Korea to support our multi-national OEM customers |
| We actively promote the use of our trademarks and logos and direct customers to prominently display the appropriate SRS technology logo on products, packaging and in advertising |
| We work closely with our licensees to enhance their success in selling finished products and semiconductor products that incorporate our technologies through a variety of licensee support programs |
| These programs include engineering support, sales training, tradeshow support, publicity and media relations programs, customized marketing materials, advertising, speaking engagements and industry conferences |
| Where possible, we use the Internet to provide technology demonstrations |
| We conduct in-person technology demonstrations or presentations for the press and other companies to promote our technologies and products |
| We also regularly participate in tradeshows and conferences to increase awareness of our technologies and to market our technologies and products |
| We work closely with our licensees and Platform Partners to actively explore additional opportunities to place our technologies in new products and/or markets |
| Backlog Backlog is applicable only to our semiconductor business |
| Sales of semiconductors are primarily made pursuant to standard purchase orders for the delivery of ASIC and IC products |
| Order quantities and delivery schedules are frequently changed to reflect product availability, scheduling at our fabrication partner facilities or changes in our customers’ needs |
| Customer orders can be canceled or rescheduled without significant penalty to the customer |
| Accordingly, our backlog at any particular date is not 11 ______________________________________________________________________ representative of actual sales for any succeeding period |
| For this reason, we believe that backlog is not generally a good indicator of future revenue |
| As of December 2005 and 2004, the backlog of orders for ASIC and IC products to non-affiliated parties was dlra961cmam194 and dlra1cmam539cmam567, respectively |
| We expect that all or substantially the entire current backlog of orders for 2005 will be completed in 2006 |
| Research and Development Our customers compete in markets that are characterized by rapidly changing technology and continuous improvement in products and services |
| Our research and development expenditures in 2005, 2004, and 2003 were approximately 26dtta1prca, 30dtta0prca and 28dtta9prca of total operating expenses respectively |
| These expenses consist of salaries and related costs of employees and consultants engaged in ongoing research, design and development activities and costs for engineering materials and supplies |
| As of December 31, 2005, we had 51 employees in our R&D group representing 45prca of our total human resources |
| Our software, hardware and application engineers focus on developing intellectual property, technology solutions and consumer products |
| Twelve engineers are based in the US and support of our licensing business with the remaining 39 engineers based in Hong Kong and support of our semiconductor business |
| Competition We compete in each of our business segments with a number of different companies, which produce a variety of technologies, processes and products |
| Licensing Competition in the audio, voice and surround sound technology licensing business includes other licensing companies who offer competing technologies as well as the internal engineering department of our licensees, who may develop audio technologies for use in their own products |
| In the field of audio improvement, we compete directly with other audio providers, including Audistry by Dolby, BBE Sound, and Qsound |
| Our 3D positional audio technology directly competes with technologies from QSound and Synoptic |
| We believe that our bass technology, TruBass, competes directly with several technologies, including MaxxBass from Waves, Ltd, Vi |
| BE from Spatializer, and non-proprietary bass systems, such as Bass Boost, that are included on a variety of electronics products, including televisions, portable stereos and speaker products |
| Because our audio technologies work with any existing recorded material, whether mono, stereo or surround sound, most of our audio technologies, including SRS 3D, SRS FOCUS, SRS TruBass and SRS Dialog Clarity, can be used either as an alternative or as a complement to almost any competing audio technology |
| Our surround sound rendering technologies compete primarily with Dolby Virtual Speaker and our surround sound format competes directly with the Dolby ProLogic family |
| However, our surround sound decoders and renderers are compatible with third party content formats, creating an opportunity for cooperation |
| Specifically, our surround sound decoders compete primarily with Dolby ProLogic II and DTS NEO 6 |
| Many companies in the wireless and telecommunications industry are investigating methods to increase the quality of a voice signal; but we believe that their development work focuses on techniques to reduce noise and provide echo cancellation |
| We are not aware of any direct competing technologies to our voice technology, VIP, which processes the actual voice signal to improve intelligibility leveraging the nature of the human speech pattern |
| VIP is compatible to these other noise cancellation techniques |
| Many of the companies referenced above have, or may have, substantially greater resources than us to devote to advance their existing technologies and develop new products |
| We believe that we compete based primarily on the quality and performance of our proprietary technologies, brand name awareness, 12 ______________________________________________________________________ the ease and cost of implementing our technologies, the ability to meet OEMs’ needs to differentiate their products, and the strength of our licensee relationships |
| However, there can be no assurance that based on these factors, we will continue to be competitive with existing or future products or technologies of our competitors |
| In the broadcast and professional audio markets, our Circle Surround technology competes directly with surround sound formats from Dolby Laboratories and DTS, Inc, which market professional products for the encoding and creation of multichannel content |
| Both of these companies have more established reputations, greater technical, sales, marketing and distribution capabilities and stronger brand presence in the movie/cinema, television broadcast and music recording segments of professional audio |
| These competitors also have established or may establish strategic relationships with potential customers of our Circle Surround technology that may affect our customers’ decisions to purchase products or license technology from us |
| Semiconductors The Asia Pacific semiconductor industry is dominated by several major suppliers, such as Motorola, National Semiconductor and Texas Instruments |
| These established semiconductor companies usually do not offer custom design services to manufacturers and will only do so if the number of semiconductors required by such manufacturers is very large |
| We occasionally compete with smaller design houses in Japan, Taiwan or Korea, such as Sunplus, but most of these design houses are focused on standard semiconductor chip categories, such as random access memory, micro-controller and other non-proprietary functional processes |
| We believe that our ASIC team is more flexible in its strategy of designing new products, as well as more responsive in the service provided to clients |
| With 19 years of experience in the Asia Pacific semiconductor market, our large accumulated design IP library can be reused for different designs and can support a shorter chip development cycle and a lower chip cost |
| Using our proprietary software, many of our designs can be re-targeted for different foundries and processes, which allows us to reduce risk and cost |
| We have strong in-house testing capabilities, using state-of-the-art software and hardware development tools |
| We also believe that our expertise in local business practices and a strong franchise of relationships with clients gives us a competitive advantage over newcomers to the industry and large multi-national firms |
| Our ability to develop standard ICs that incorporate our audio technologies has opened up new chip sales opportunities, but could in the future cause channel conflict with our network of SRS technology semiconductor partners |
| Our objective has been to minimize this conflict by concentrating our design and sales efforts on chip products for markets and product applications that are underserved by our existing semiconductor partners |
| The markets in which we sell our products are also subject to significant price competition |
| Accordingly, we expect to continue to experience declines in the selling prices of our products over the life cycle of each product |
| In order to offset declines in the selling prices of our products, we have been required to reduce the costs of products through product design changes, manufacturing process changes, volume discounts and other savings negotiated with our manufacturing subcontractors |
| Since we do not operate our own manufacturing facilities, we may not be able to reduce costs as rapidly as competitors who perform their own manufacturing |
| Our gross margins are affected by our ability to design and introduce, in a timely manner, lower-cost versions of existing products or higher gross margin new products, and our ability to successfully manage our manufacturing subcontractor relationships |
| 13 ______________________________________________________________________ Intellectual Property Rights and Proprietary Information We operate in industries where innovation, investment in new ideas and protection of intellectual property rights are important for success |
| We rely on a variety of intellectual property protections for our products and services, including patent, copyright, trademark and trade secret laws and contractual obligations |
| We pursue a policy of enforcing such rights |
| There can be no assurance, however, that our intellectual property rights will be adequate to ensure our competitive position, or that competitors will not be able to produce a non-infringing competitive product or service |
| There can be no assurance that third parties will not assert infringement claims against us, or that if required to obtain any third party licenses as a result of an infringement dispute, we will be able to obtain such licenses |
| Although we believe that our patents and trademarks are important to each of our business segments, such patents and trademarks are especially important to the licensing business segments |
| In order to protect the underlying technology concepts, we have filed and/or obtained patents for all of our marketed technologies including technologies marketed under the trademarks SRS, TruSurround, TruSurround XT, FOCUS, Circle Surround, Circle Surround II, WOW, VIP and TruBass |
| In addition, we have numerous issued patents and patents pending for speaker and other acoustic reproduction technologies |
| We pursue a general practice of filing patent applications for our technologies in the United States and various foreign countries where our licensees manufacture, distribute or sell licensed products |
| We continually update and add new applications to our patent portfolio to address changing worldwide market conditions and our new technological innovations |
| The range of expiration dates for our patents extend between the years 2006 to 2015 |
| We have multiple patents covering unique aspects and improvements for many of our technologies |
| Accordingly, the expiration of any single patent is not likely to significantly affect our intellectual property position or the ability to generate licensing revenue |
| Our strategy for protection of our trademarks identifying the various SRS technology solutions is commensurate with our strategy for obtaining patent protection |
| Specifically, we routinely file US federal and foreign trademark applications for the various word names and logos used to market our technology solutions to licensees and the general public |
| The duration of the US and foreign registered trademarks can typically be maintained indefinitely, provided proper maintenance fees are paid and trademarks are continually used or licensed by us |
| Seasonality Due to the dependence of both our licensing and semiconductor businesses on the consumer electronics market, we experience seasonal fluctuation in sales and earnings |
| In particular, we believe that the licensing business experiences seasonality relating to the Christmas season in the fourth quarter, and the semiconductor business located in the Asia Pacific region experiences seasonality related to the Chinese New Year in the first quarter |
| We have moved toward diversifying our key market segments in the consumer electronics industry in an effort to even out our seasonal fluctuation |
| Employees As of December 31, 2005, we employed 113 persons, 23 in finance and administration; 51 in research and development, engineering and product development; and 39 in sales and marketing |
| Of the 113 employees, we employ 74 individuals in our semiconductor business; 12 in finance and administration; 39 in research and development, engineering and product development; and 23 in sales and marketing |
| All of the semiconductor employees are located overseas |
| None of our employees are covered by a collective bargaining agreement or are presently represented by a labor union |
| We have not experienced any labor problems or a work stoppage and believe we have good relations with our employees |
| There we make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after we electronically file such material with or furnish it to the SEC Our SEC reports can be accessed through the investor relations section of our website |
| The information found on our website is not part of this or any other report we file with or furnish to the SEC Item 1A Risk Factors We are exposed to risks in our licensing business related to product and customer concentration |
| Currently, our licensing revenue is concentrated in the home theater market with the majority of revenue generated from the inclusion of SRS technology inside televisions, DVD players and set-top boxes |
| We expect that the consumer home entertainment market will continue to account for a significant portion of our licensing revenues for the foreseeable future |
| While consumer spending in general on consumer electronic products has increased, retail prices for certain consumer electronics products that include our audio technology, such as DVD players, have decreased significantly |
| Indications are that this trend will continue for the foreseeable future |
| From time to time, certain of our OEM and semiconductor manufacturer customers may account for a significant portion of revenue from a particular product application, such as DVD players, set-top boxes or televisions |
| Consumer electronics products manufacturers could decide to exclude our audio rendering technology from their home theater products altogether in an effort to reduce cost |
| The loss of any such customer could have a material adverse affect on our financial condition and results of operations |
| Our business is highly dependent on the consumer electronics market, which is characterized by short product life cycles, fluctuations in demand and seasonality, and is subject to risks related to product transitions and supply of other components |
| The consumer electronics market is characterized by intense competition, rapidly evolving technology, and ever-changing consumer preferences |
| These factors result in the frequent introduction of new products, short product life cycles and significant price competition |
| The dynamic nature of this market limits our, as well as our customers’ ability to accurately forecast quarterly and annual sales |
| If we, or our customers, are unable to manage product transitions, our business and results of operations could be negatively affected |
| Pricing pressures on the consumer electronics product manufacturers, who incorporate our technologies into their products, could limit the licensing fees we charge for our technologies, which could adversely affect our revenues |
| The markets for the consumer electronics products in which our technologies are incorporated are intensely competitive and price sensitive |
| Retail prices for consumer electronics products that include our technologies, such as DVD players and home theater systems, have decreased significantly, and we expect prices to continue to decrease for the foreseeable future |
| In response, manufacturers have sought to reduce their product costs, which can result in downward pressure on the licensing fees we charge our customers who incorporate our technologies |
| A decline in the licensing fees we charge could materially and adversely affect our operating results |
| We conduct operations in a number of countries and are subject to risks of international operations, particularly in Asia and the People’s Republic of China |
| We have significant operations in Hong Kong, the People’s Republic of China (PRC) and other parts of Asia that require refinement to adapt to the changing market conditions in those regions |
| Our 15 ______________________________________________________________________ operations in Asia, and international operations in general, are subject to risks of unexpected changes in, or impositions of, legislative or regulatory requirements |
| Our customers geographically located in the Asia Pacific markets accounted for approximately 89prca, 86prca, and 91prca of total Company sales in 2005, 2004 and 2003, respectively and are expected to continue to account for a substantial percentage of sales in the future |
| The economic climate in Asia continues to be impacted by increases in unemployment, declines in consumer spending, currency devaluation and bank failures |
| Any of these factors, should they continue, could significantly reduce the demand for the end user goods in which our products and technologies are used |
| The PRC economy has experienced significant growth in the past decade; but such growth has been uneven across geographic and economic sectors |
| There can be no assurance that such growth will continue or that any potential currency devaluation in the region will not have a negative effect on our business, including Valence |
| The PRC economy has also experienced deflation in the past, which may continue in the future |
| The current economic situation may adversely affect our profitability over time as expenditures for consumer electronics products and information technology may decrease due to the results of slowing domestic demand and deflation |
| Hong Kong is a Special Administrative Region of the PRC with its own government and legislature |
| Hong Kong enjoys a high degree of autonomy from the PRC under the principle of “one country, two systems |
| ” It is possible that Hong Kong may not continue to enjoy autonomy from the PRC The Hong Kong dollar has remained relatively constant due to the US dollar peg and currency board system that has been in effect in Hong Kong since 1983 |
| Since mid-1997, interest rates in Hong Kong have fluctuated significantly and real estate and retail sales have declined |
| It is possible that the Hong Kong economy may deteriorate or that the historical currency peg of the Hong Kong dollar to the US dollar may not be maintained |
| Continued declining consumer spending in Hong Kong, deflation or the discontinuation of the currency peg could adversely affect our business |
| Our ability to generate revenues and meet with customers may be effected by widespread illness Widespread illnesses such as the SARS illness and the Avian Influenza, or Asia Bird Flu, could impact our operations or our consumer electronics licensee’s operations |
| For example, our ability to visit our customers, our ability to conduct sales meetings or presentations, and sell through rates of electronics products to end consumers may be dramatically effected by either widespread or perceived potential illnesses |
| We are uncertain of the total costs associated with the planned divestiture of Valence |
| In order for us to focus on our licensing business, our Board approved on February 23, 2006 the sale of our semiconductor business |
| In connection with such sale, the Company may incur cash and non-cash accounting charges, which at the present cannot be reasonably estimated |
| The timing and amount of the net charges may have a negative impact to the statement of operations |
| If the sale of consumer electronics products incorporating our technologies does not grow in emerging markets, our ability to increase our licensing revenue may be limited |
| We also expect that growth in our licensing revenue will depend, in part, upon the growth of sales of consumer electronics products incorporating our technologies in other countries, including China and India, as consumers in these markets have more disposable income and are increasingly purchasing entertainment products with surround sound capabilities |
| However, if our licensing revenue from the use of our technologies in these new markets or geographic areas does not expand, our prospects could be adversely affected |
| 16 ______________________________________________________________________ We have a long and unpredictable sales cycle, which can result in uncertainty and delays in generating additional revenues |
| Historically, because of the complexity of our technologies, it can take a significant amount of time and effort to explain the benefits of our technologies and to negotiate a sale |
| For example, it typically takes six to nine months after our first contact with a prospective customer before we start licensing our technology to that customer |
| In addition, purchases of our products are usually made in connection with new design starts, the timing of which is outside of our control |
| Accordingly, we may be unable to predict accurately the timing of any significant future sales of our products |
| We may also spend substantial time and management attention on potential license agreements that are not consummated, thereby foregoing other opportunities |
| If our patents and other intellectual property rights do not adequately protect our products, we may lose market share to our competitors and be unable to operate our business profitably |
| Our ability to compete may be affected by our ability to protect our proprietary information |
| We have filed numerous US and foreign patent applications and to date have a number of issued US and foreign patents covering various aspects of our technologies |
| There can be no assurance that the steps taken by us to protect our intellectual property will be adequate to prevent misappropriation of our technology or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology |
| In addition, the laws of certain foreign countries may not protect our intellectual property rights to the same extent, as do the laws of the US It is possible that third parties may assert claims or initiate litigation against us or our customers with respect to existing or future products |
| In addition, we may initiate claims or litigation against third parties for infringement of our proprietary rights or to determine the scope and validity of our proprietary rights |
| If we lose the services of our key personnel, or if we are unable to attract and retain other key personnel, we may not be able to manage our operations or meet our growth objectives |
| Our future success depends to a large extent upon the continued service of key personnel, including engineering, sales and marketing staff, and highly skilled semiconductor design staff |
| We anticipate that any future growth will require us to recruit and hire a number of new personnel in engineering, operations, finance, sales and marketing |
| Competition for such personnel can be intense, and it is possible that we may not be able to recruit and retain necessary personnel to operate our business and support future growth |
| The market price of our common stock is volatile and your investment in our common stock could suffer a decline in value |
| The trading price of our common stock has been, and will likely continue to be, subject to wide fluctuations in response to quarterly variations in our operating results, announcements of new products or technological innovations by us or our competitors, strategic alliances between us and third parties, 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 we do business, or relating to us 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 |
| Even though our stock is quoted on the Nasdaq Stock Market, our stock has had and may continue to have low trading volume and high volatility |
| The historically low trading volume of our stock makes it more likely that a severe fluctuation in volume, either up or down, will significantly impact the stock price |
| Since our shares are thinly traded, our shareholders may have difficulty selling our common stock |
| 17 ______________________________________________________________________ Our certificate of incorporation and bylaws as well as Delaware law contain provisions that could discourage transactions resulting in a change in control, which may negatively affect the market price of our common stock |
| Our certificate of incorporation, our bylaws and Delaware law contain provisions that might enable our management to discourage, delay or prevent change in control |
| In addition, these provisions could limit the price that investors would be willing to pay in the future for shares of our common stock |
| We face intense competition from companies with greater brand recognition and resources |
| The digital audio, consumer electronics, and entertainment markets are intensely competitive, subject to rapid change, and significantly affected by new product introductions and other market activities of industry participants Many of our current and potential competitors enjoy substantial competitive advantages, including: · greater name recognition; · a longer operating history; · more developed distribution channels and deeper relationships with semiconductor and consumer electronics products manufacturers; · a more extensive customer base; · broader product and service offerings; · greater resources for competitive activities, such as research and development, strategic acquisitions, alliances, joint ventures, sales and marketing, and lobbying industry and government standards; and · more technicians and engineers |
| As a result, these current and potential competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards, or customer requirements |