into
a multi-year license agreement with LG for the usage of our existing technology
for televisions and monitors for the next four years. Beginning in the third
fiscal quarter of 2007, the Company recognized revenue from LG for televisions
and monitors under the new multi-year license agreement. During the third
fiscal quarter of 2007, the Company also recognized the final trailing revenue
reported by LG for televisions and monitors under the previous license
agreement. For the same period in the prior year, one customer, Samsung,
accounted for approximately 22% of the revenue. For the nine months ended September 30,
2007, one customer, Samsung, accounted for approximately 25% of the licensing
revenue. For the same period in the prior year, two customers, Samsung and
Sony, accounted for approximately 17% and 12%, respectively, of the licensing
revenue.
2.
Stock-Based Compensation
We
account for stock-based compensation under the provisions of Statement of
Financial Accounting Standards (“SFAS”) No. 123(R),
Share-Based
Payment
(“SFAS 123R”). SFAS 123R requires measurement of all
employee stock-based awards using a fair-value method and recording of related
compensation expense in the consolidated financial statements over the
requisite service period. Further, as required under SFAS 123R, we estimate
forfeitures for share based awards that are not expected to vest. For the three
months ended September 30, 2007, we recorded stock-based compensation
expense of $438,050 under the fair-value provisions of SFAS 123R, compared to
$383,404 in the same period in the prior year. For the nine months ended September 30,
2007, we recorded stock-based compensation expense of $1,289,060 under the
fair-value provisions of SFAS 123R, compared to $1,070,804 for the same period
in the prior year.
Option
awards are granted with an exercise price equal to the market price of the
Company’s stock at the date of grant. Option awards generally have a term of 10
years and vest and become exercisable over a four-year service period.
The
fair value of each share-based award is estimated on the grant date using the
Black-Scholes-Merton (“BSM”) option-pricing formula and straight-line
amortization of compensation expense over the requisite service period of the
grant. Expected volatilities are based on the historical volatility of the
Company’s stock price. The risk-free rate for periods within the contractual
life of the option is based on the U.S. Treasury interest rates in effect at
the time of grant. The fair value of options granted was estimated using the
following weighted-average assumptions:
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
|
2007
|
|
2006*
|
|
2007
|
|
2006
|
|
|
Expected term (in years)
|
|
6.25
|
|
—
|
|
6.25
|
|
6.25
|
|
|
Expected volatility
|
|
56
|
%
|
—
|
%
|
56
|
%
|
57
|
%
|
|
Risk-free interest rate
|
|
4.4
|
%
|
—
|
%
|
4.8
|
%
|
4.9
|
%
|
|
Dividend yield
|
|
0.00
|
%
|
—
|
%
|
0.00
|
%
|
0.00
|
%
|
*Note: There were no
options granted in the three months ended September 30, 2006
Total
compensation cost recognized is as follows:
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Continuing Operations:
|
|
|
|
|
|
|
|
|
|
|
Sales and marketing
|
|
$
|
112,162
|
|
$
|
140,228
|
|
$
|
382,655
|
|
$
|
438,740
|
|
|
Research and development
|
|
108,987
|
|
67,383
|
|
325,173
|
|
269,544
|
|
|
General and administrative
|
|
216,901
|
|
175,793
|
|
581,232
|
|
362,520
|
|
|
Total compensation cost recognized in continuing
operations
|
|
438,050
|
|
383,404
|
|
1,289,060
|
|
1,070,804
|
|
|
Total compensation cost recognized in discontinued
operations
|
|
—
|
|
—
|
|
—
|
|
101,143
|
|
|
Total compensation cost recognized
|
|
$
|
438,050
|
|
$
|
383,404
|
|
$
|
1,289,060
|
|
$
|
1,171,947
|
|
9
any
of these matters will have a material adverse effect on the Company’s
consolidated financial position or results of operations.
7.
Discontinued Operations
On February 23,
2006, the Board approved a plan to sell Valence in order to focus increased
management attention and financial resources on its licensing business. On July 14,
2006, we entered into a definitive Sale and Purchase Agreement to sell Valence
to Noblehigh Enterprises Inc. (“Noblehigh”). Noblehigh is owned by Willas Array
Electronics (Holding) Limited as well as certain members of management of
Valence. The sale transaction was completed on September 29, 2006.
The sale to Noblehigh was
effected through two simultaneous transactions: (1) the repurchase by
Valence of approximately 74% of the outstanding shares of Valence from SRS
using its existing cash and (2) the purchase by Noblehigh of the remaining
outstanding shares of Valence from SRS for $4.3 million. The sale resulted in a
gain on the disposal of discontinued operations of $260,763 in the Company’s
third fiscal quarter of 2006.
Additionally, on February 23,
2006, the Board authorized management to take all reasonable steps to divest
the Company’s entire equity interest in the Joint Venture. On June 30,
2006, we completed the sale of our interest in the Joint Venture to Coming Home
Studios LLC in exchange for $200,000, the rights to all cash assets of the
Joint Venture, and a promissory note in the amount of $175,000. The sale of our
interest in the Joint Venture resulted in a gain on the sale of $371,295 in the
Company’s second fiscal quarter of 2006. As of September 30, 2007, the
outstanding principal balance due on the note is $159,724 plus accrued interest.
Any amounts related to the promissory note and accrued interest thereon will be
recorded at the time the cash is received by us.
As a result of our
decision to sell Valence and our entire equity interest in the Joint Venture in
February 2006, we accounted for Valence and the Joint Venture as
discontinued operations beginning in the first fiscal quarter of 2006.
Income from discontinued
operations for the three and nine months ended September 30, 2006
consisted of direct revenues and direct expenses of Valence and CHS/SRS LLC.
General corporate overhead costs have not been allocated to discontinued
operations. A summary of the operating results of Valence and the Joint Venture
included in discontinued operations in the accompanying condensed consolidated
statements of operations is as follows:
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
|
September 30, 2006
|
|
September 30, 2006
|
|
|
Valence:
|
|
|
|
|
|
|
Revenues.
|
|
$
|
3,312,397
|
|
$
|
7,682,931
|
|
|
Cost of sales
|
|
1,493,004
|
|
3,562,750
|
|
|
Gross margin
|
|
1,819,393
|
|
4,120,181
|
|
|
Total operating expenses
|
|
983,356
|
|
3,193,519
|
|
|
Income from operations
|
|
836,037
|
|
926,662
|
|
|
Other income, net
|
|
23,806
|
|
31,669
|
|
|
Income before income tax expense
|
|
859,843
|
|
958,331
|
|
|
Income tax expense
|
|
2,936
|
|
33,632
|
|
|
Net income from Valence
|
|
856,907
|
|
924,699
|
|
|
Net (loss) income from CHS/SRS LLC
|
|
(3,384
|
)
|
92,380
|
|
|
Subtotal
|
|
853,523
|
|
1,017,079
|
|
|
Gain on sale of Valence
|
|
260,763
|
|
260,763
|
|
|
Gain on sale of CHS/SRS LLC
|
|
—
|
|
371,295
|
|
|
Total income from discontinued operations
|
|
$
|
1,114,286
|
|
$
|
1,649,137
|
|
8.
Segment Information
The Company previously
operated in two business segments — semiconductors and licensing. However, as a
result of the Board’s decision on February 23, 2006 to sell Valence, the
semiconductor business, the Company now has continuing operations in only one
business segment, licensing. Our revenue from continuing operations is solely
derived from licensing related revenue.
12
Item 2. Management’s
Discussion and Analysis of Financial Condition and Results of Operations
This information should be read in conjunction with
the audited consolidated financial statements and notes thereto and Management’s
Discussion and Analysis of Financial Condition and Results of Operations
contained in the Company’s Annual Report on Form 10-K for the year ended December 31,
2006, and the unaudited condensed interim consolidated financial statements and
notes thereto included in this Quarterly Report.
Overview
SRS Labs is a leading
developer and provider of audio and voice technology solutions for the home
entertainment, portable media device, personal telecommunications, personal
computer, automotive, and broadcast markets. Prior to September 29, 2006,
the Company was also a developer and provider of application specific
integrated circuits and standard integrated circuits through its formerly
wholly-owned subsidiary, Valence Tech Limited.
Licensing
Our operations are conducted through SRS Labs, Inc.,
the parent company, and its wholly-owned subsidiary, SRSWOWcast.com, Inc.
Our business is focused on developing and licensing audio, voice and surround
sound technology solutions to many of the world’s leading original equipment
manufacturers, or OEMs, software providers and semiconductor companies, and
licensing and marketing hardware and software products for the Internet and
professional audio markets.
A focus of the Company at this time is protection of
its patents and enforcement of its royalty program. We believe that the
proactive enforcement and administration of these programs will help us to
identify improper or unauthorized usage of our intellectual properties, as well
as to ensure the accurate and timely royalty reporting by our licensees. While
there could be a short-term negative impact in terms of increased expenses or
decreased revenue, we believe that this strategy will have positive long-term
results and will lead to even stronger relationships with our customers.
Discontinued
Operations
Valence:
Through our formerly wholly-owned
subsidiary, ValenceTech Limited, we operated a fabless semiconductor business
which developed, designed and marketed standard and custom analog integrated
circuits, digital signal processors, and mixed signal integrated circuits
primarily to OEMs and original design manufacturers in the Asia Pacific region.
On February 23,
2006, our Board approved a plan to sell Valence in order to focus management’s
attention and financial resources on our licensing business. On July 14,
2006, we entered into a definitive Sale and Purchase Agreement to sell Valence
to Noblehigh Enterprises Inc. Noblehigh is owned by Willas Array Electronics
(Holding) Limited as well as certain members of management of Valence. The sale
transaction was completed on September 29, 2006 and accordingly the
results of the operations of Valence are included as discontinued operations in
the accompanying condensed consolidated statement of operations beginning in
the first quarter of 2006.
CHS/SRS LLC:
In September 2004,
we entered into a strategic alliance with Coming Home Studios LLC, or CHS, to
use and promote SRS Labs’ technologies, to promote CHS productions and to
promote each company’s respective brands. In connection with the strategic
alliance, SRS and CHS established a Joint Venture, CHS/SRS LLC, to produce and
distribute nine concert videos featuring our Circle Surround technology. On February 23,
2006, our Board authorized management to take all reasonable steps to divest
our entire equity interest in the Joint Venture. On June 30, 2006, we
completed the sale of our interest in the Joint Venture to CHS. Accordingly,
the results of operations of CHS/SRS LLC are included as discontinued
operations in the accompanying condensed consolidated statement of operations
beginning in the first quarter of 2006.
Critical Accounting Policies
Our
discussion and analysis of our results
of operations and liquidity and capital resources are based on our consolidated
financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States of America.
The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported
14
amounts of assets,
liabilities, revenues and expenses, and disclosure of contingent assets and
liabilities. We base our estimates on historical and anticipated results and
trends and on various other assumptions that we believe are reasonable under
the circumstances, including assumptions as to future events. These estimates form the
basis for making judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources. By their nature, estimates
are subject to an inherent degree of uncertainty. Actual results may materially
differ from our estimates.
Results
of Continuing Operations
Three Months Ended September 30, 2007 Compared to
Three Months Ended September 30, 2006
Revenues
Revenues consist primarily of royalties generated
from the license of SRS Labs’ audio and voice technologies. License and royalty
agreements generally provide for the license of technologies for a fee based on
the number of units distributed by the licensee. However, we have entered into
in the past, and may again enter into in the future, a license agreement
for a one-time fee or an annual fixed fee amount. Also included in licensing
revenue are revenues generated from the sale of hardware and software
applications into the personal computer (“PC”) and broadcast audio markets.
Revenues were $4,769,271 for the three months ended September 30,
2007, compared to $4,910,203 for the three months ended September 30,
2006, a decrease of $140,932, or 3%. The decrease in revenues was primarily
attributable to the declining use of our technology by two of our customers. As
indicated in our Quarterly Report for the quarter ended March 31, 2007,
filed with the SEC in May 2007, during April 2007, we were informed
by Sony, one of our largest licensees, it has begun to distribute televisions
that include internally developed audio technology, rather than technology
licensed from us. Additionally, as indicated in our Quarterly Report for the
quarter ended March 31, 2007, filed with the SEC in May 2007, during April 2007,
we were informed by Toshiba that they had elected not to utilize our technology
in their personal computers during 2007. These two events negatively impacted
our revenues in the third quarter of 2007, and we anticipate these two events
to continue to negatively affect our revenues in future periods. Included in
our third quarter 2006 revenues was approximately $250,000 from Samsung
received as a result of royalty compliance activities. There were no material
revenues from such compliance activities during the third quarter of 2007. Offsetting
a portion of these noted decreases, we continued to increase flat panel
television revenues from our largest customer, Samsung Electronics.
During 2007, the Company entered into a multi-year,
license agreement with LG Electronics for the usage of our existing technology
for televisions and monitors through December 2010. Beginning in the third
fiscal quarter of 2007, the Company recognized revenues from LG for televisions
and monitors under the new multi-year license agreement, as well as recognized
the final trailing revenue reported by LG for televisions and monitors under
the previous license agreement. The Company also closed all open compliance
issues with LG, which did not result in a material impact to our financial
results of the third quarter of 2007.
Earlier this year, we elected to modify our sales
approach in our Greater China Region, in that we are no longer requiring
certain of our customers to obtain our technology through bundled arrangements
with our integrated circuit (“IC”) partners, but instead are allowing them to
license our technology directly from us. We believe that this change will
strengthen our relationship with these customers. During the third quarter of
2007, our largest China based television licensee transitioned to this new
approach and signed a new contract with the Company. Accordingly, we noted a
decrease in revenues of approximately $140,000 from this customer for the third
quarter of 2007 as a result of the customer placing into production ICs that
had previously been purchased from the IC partner under the prior method. Additionally,
we entered into a new agreement with another large China based television
manufacturer under a direct relationship and anticipate that this will begin to
generate revenues for us during 2008.
Revenues in our Portable Media Devices decreased
$195,233, or 27%, for the three months ended September 30, 2007, compared
to the same period in the prior year, primarily due to the loss of two MP3
customers in the third and fourth quarters of 2006. Additionally, during the
third quarter of 2007, we recognized no revenue from our largest China based
customer in this segment as their contract with us expired the prior quarter. We
have entered into a new contact with this customer and will begin to recognize
revenues under the terms of the new agreement during the fourth quarter of this
year.
We continue to recognize increasing revenues from
our automotive segment and anticipate that revenues will continue to grow in
future periods. Our technology usage is being expanded, particularly by Japan
based automotive suppliers and we are continuing to obtain design wins that
will generate revenues for us through 2010.
15
The
following table presents our revenues by market:
|
|
|
Three Months Ended
September 30,
|
|
|
|
|
2007
|
|
2006
|
|
|
Home Entertainment (TV, Set Top Box, A/V Receiver,
DVD)
|
|
70
|
%
|
66
|
%
|
|
Portable Media Devices (Digital Media Player,
Headphone)
|
|
11
|
%
|
15
|
%
|
|
Automotive
|
|
7
|
%
|
5
|
%
|
|
PC (Software, Hardware)
|
|
6
|
%
|
9
|
%
|
|
Personal Telecommunications (Mobile Phone, PDA)
|
|
6
|
%
|
5
|
%
|
Sales and
Marketing
Sales
and marketing expenses consist primarily of employee salaries, sales
consultants’ fees and related expenses, sales commissions and product promotion
costs. Sales and marketing expenses were $1,460,185 for the three months ended September 30,
2007, compared to $1,743,660 for the same prior year period, a decrease of
$283,475, or 16%. This decrease is primarily attributable to decreased
marketing management head count and related expenses. Included in sales and
marketing expenses is stock based compensation expense of $112,162 and $140,228
for the three months ended September 30, 2007 and 2006, respectively. As a
percentage of total revenues, sales and marketing expenses decreased from 36%
for the three months ended September 30, 2006 to 31% for the same period this year.
Research
and Development
Research and
development expenses consist of salaries and related costs of employees engaged
in ongoing research, design and development activities and costs for
engineering materials and supplies. Research and development expenses were
$689,901 for the three months ended September 30, 2007, compared to
$628,227 for the same prior year period, an increase of $61,674, or 10%. This
increase is attributable to an increase in head count and payroll related costs
and an increase in stock based compensation expense due to current year stock
option grants. Included in research and development expenses is stock based
compensation expense of $108,987 and $67,383 for the three months ended September 30,
2007 and 2006, respectively. As a percentage of total revenues, research and
development expenses increased from 13%
for the three months ended September 30, 2006 to 14% for the same period
this year.
General
and Administrative
General
and administrative (“G&A”) expenses consist primarily of employee-related
expenses, legal costs associated with the administration of intellectual
property and other professional fees. G&A expenses were $1,436,184 for the
three months ended September 30, 2007, compared to $1,277,601 for the same
prior year period, an increase of $158,583, or 12%. The increase is primarily attributable to increased legal and
accounting fees associated with the protection of SRS’s patents and enforcement
of its royalty compliance program. The increase is also attributed to increased
costs associated with Sarbanes-Oxley compliance and increased stock based
compensation expense due to 2007 stock option grants. Partially offsetting the
increases is lower bonus expense. Included in general and administrative
expenses is stock based compensation expense of $216,901 and $175,793 for the
three months ended September 30, 2007 and 2006, respectively. As a
percentage of total revenues, G&A expenses increased from 26% for the quarter ended September 30,
2006 to 30% for the same period
this year.
Other
Income, Net
Other
income, net, consists principally of interest income. Other income, net, was
$508,825 for the three months ended September 30, 2007, compared to $291,236
for the same prior year period, an increase of $217,589, or 75%. This increase
is primarily attributable to higher interest rates earned on larger cash
balances invested.
Provision
for Income Taxes
The
income tax benefit for the three months ended September 30, 2007 was
$18,800
, compared to tax expense of $231,620 for the
same prior year period. The prior year provision consists primarily of taxes
paid on licensing revenues sourced from countries requiring foreign tax
withholdings, principally Korea. We reduced our current quarter tax provision
16
and
our valuation allowance on our deferred tax assets by $450,290 based on our
assessment of the future realizability of certain deferred tax assets. The
current period income tax benefit reflects a tax refund due from the state of
California.
Discontinued
Operations
As a result of our February 2006
decisions to sell Valence and our entire equity interest in CHS/SRS LLC, we
have accounted for the semiconductor business segment and CHS/SRS LLC as
discontinued operations in the accompanying condensed consolidated financial
statements beginning in the first fiscal quarter of 2006. The Company sold
Valence in September 2006 and its entire equity interest in CHS/SRS LLC in
June 2006.
Income from discontinued
operations consists of direct revenues and direct expenses of Valence and
CHS/SRS LLC. General corporate overhead costs have not been allocated to
discontinued operations. A summary of the operating results of Valence and the
Joint Venture included in discontinued operations in the accompanying condensed
consolidated statements of operation for the three months ended September 30,
2006 is as follows:
|
Valence:
|
|
|
|
|
Revenues.
|
|
$
|
3,312,397
|
|
|
Cost of sales
|
|
1,493,004
|
|
|
Gross margin
|
|
1,819,393
|
|
|
Total operating expenses
|
|
983,356
|
|
|
Income from operations
|
|
836,037
|
|
|
Other income, net
|
|
23,806
|
|
|
Income before income benefit
|
|
859,843
|
|
|
Income tax expense
|
|
2,936
|
|
|
Net income from Valence
|
|
856,907
|
|
|
Net loss from CHS/SRS LLC
|
|
(3,384
|
)
|
|
Net income from discontinued operations
|
|
853,523
|
|
|
Gain on sale of Valence
|
|
260,763
|
|
|
Total income from discontinued operations
|
|
$
|
1,114,286
|
|
Nine Months Ended September 30, 2007 Compared to
Nine Months Ended September 30, 2006
Revenues
Revenues consist primarily of royalties generated
from the license of our audio and voice technologies. License and royalty
agreements generally provide for the license of technologies for a fee based on
the number of units distributed by the licensee. However, we have entered into
in the past, and may again enter into in the future, a license agreement
for a one-time fee or an annual fixed fee amount. Also included in licensing
revenue are revenues generated from the sale of hardware and software
applications into the PC and broadcast audio markets.
Revenues were $14,536,526 for the nine months ended September 30,
2007, compared to $13,505,710 for the nine months ended September 30,
2006, an increase of $1,030,816, or 8%. The increase in revenues was primarily
attributable to our strong sales in flat panel televisions and monitors in our
Home Entertainment market, which grew by $2,694,834, or 44%. Partially
offsetting the increases in Home Entertainment was a decrease in revenue from
Sony, which began selling products using its own internally developed
technology, as well as decreases in the CRT television business. Additionally,
we experienced an increase in royalties in the Automotive market of $235,597,
or 31%. Offsetting revenue increases in the Home Entertainment and Automotive
market was a decrease in revenue in our Portable Media Devices of $1,053,621,
or 44%, due to decreased MP3 sales and the loss of two MP3 customers in the
third and fourth quarters of 2006.
17
The
following table presents our licensing revenues mix by market:
|
|
|
Nine Months Ended
September 30,
|
|
|
|
|
2007
|
|
2006
|
|
|
Home Entertainment (TV, Set Top Box, A/V Receiver,
DVD)
|
|
68
|
%
|
59
|
%
|
|
PC (Software, Hardware)
|
|
9
|
%
|
10
|
%
|
|
Portable Media Devices (Digital Media Player,
Headphone)
|
|
9
|
%
|
18
|
%
|
|
Personal Telecommunications (Mobile Phone, PDA)
|
|
7
|
%
|
8
|
%
|
|
Automotive
|
|
7
|
%
|
5
|
%
|
Sales and
Marketing
Sales
and marketing expenses consist primarily of employee salaries, sales
consultants’ fees and related expenses, sales commissions and product promotion
costs. Sales and marketing expenses were $5,104,195 for the nine months ended September 30,
2007, compared to $5,494,445 for the same prior year period, a decrease of
$390,250, or 7%. This decrease is primarily attributable to decreased marketing
management head count and related expenses and decreased bonus expense,
partially offset by increased headcount in sales. Included in sales and
marketing expenses is stock based compensation expense of $382,655 and $438,740
for the nine months ended September 30, 2007 and 2006, respectively. As a
percentage of total revenues, sales and marketing expenses decreased from 41%
for the nine months ended September 30, 2006 to 35% for the same period this year.
Research
and Development
Research and
development expenses consist of salaries and related costs of employees engaged
in ongoing research, design and development activities and costs for
engineering materials and supplies. Research and development expenses were
$2,366,121 for the nine months ended September 30, 2007, compared to
$1,914,255 for the same prior year period, an increase of $451,866, or 24%. This
increase is attributable to an increase in head count and payroll related costs
and an increase in stock based compensation expense due to current year stock
option grants. Included in research and development expenses is stock based
compensation expense of $325,173 and $269,544 for the nine months ended September 30,
2007 and 2006, respectively. As a percentage of total revenues, research and
development expenses increased from 14%
for the nine months ended September 30, 2006 to 16% for the same period
this year.
General
and Administrative
General
and administrative (“G&A”) expenses consist primarily of employee-related
expenses, legal costs associated with the administration of intellectual
property and other professional fees. G&A expenses were $4,105,792 for the
nine months ended September 30, 2007, compared to $4,272,598 for the same
prior year period, a decrease of $166,806, or 4%. The decrease is primarily attributable a decrease in
consultants fees and costs associated with the Company’s separation from its
former Chief Financial Officer in the first quarter of 2006, partially offset
by an increase in stock based compensation expense. Included in general and
administrative expenses is stock based compensation expense of $581,232 and
$362,520 for the nine months ended September 30, 2007 and 2006,
respectively. As a percentage of total revenues, G&A expenses decreased
from 32% for the nine months
ended September 30, 2006 to 28%
for the same period this year.
Other
Income, Net
Other
income, net, consists principally of interest income. Other income, net, was
$1,511,585 for the nine months ended September 30, 2007, compared to
$694,954 for the same prior year period, an increase of $816,631, or 118%. This
increase is primarily attributable to higher interest rates earned on larger
cash balances invested.
Provision
for Income Taxes
The
income tax benefit for the nine months ended September 30, 2007 was
$18,800
, compared to tax expense of $558,788 for the
same prior year period. The prior year provision consists primarily of taxes
paid on licensing revenues sourced from countries requiring foreign tax
withholdings, principally Korea. We reduced our current quarter tax provision
and our valuation allowance on our deferred tax assets by $1,022,205 based on
our assessment of the future realizability of certain deferred tax assets. The
current period income tax benefit reflects a tax refund due from the state of
California.
18
Discontinued
Operations
As a result of our February 2006
decisions to sell Valence and our entire equity interest in CHS/SRS LLC, we
have accounted for the semiconductor business segment and CHS/SRS LLC as
discontinued operations in the accompanying condensed consolidated financial
statements beginning in the first fiscal quarter of 2006. The Company sold
Valence in September 2006 and its entire equity interest in CHS/SRS LLC in
June 2006.
Income from discontinued
operations consists of direct revenues and direct expenses of Valence and
CHS/SRS LLC. General corporate overhead costs have not been allocated to
discontinued operations. A summary of the operating results of Valence and the
Joint Venture included in discontinued operations in the accompanying condensed
consolidated statements of operation for the nine months ended September 30,
2006 is as follows:
|
Valence:
|
|
|
|
|
Revenues.
|
|
$
|
7,682,931
|
|
|
Cost of sales
|
|
3,562,750
|
|
|
Gross margin
|
|
4,120,181
|
|
|
Total operating expenses
|
|
3,193,519
|
|
|
Income from operations
|
|
926,662
|
|
|
Other income, net
|
|
31,669
|
|
|
Income before income tax expense
|
|
958,331
|
|
|
Income tax expense
|
|
33,632
|
|
|
Net income from Valence
|
|
924,699
|
|
|
Net income from CHS/SRS LLC
|
|
92,380
|
|
|
Net income from discontinued operations
|
|
1,017,079
|
|
|
Gain on sale of Valence
|
|
260,763
|
|
|
Gain on sale of CHS/SRS LLC
|
|
371,295
|
|
|
Total income from discontinued operations
|
|
$
|
1,649,137
|
|
Liquidity and Capital Resources
Our principal source of liquidity to fund
ongoing operations at September 30, 2007 consisted of cash, cash
equivalents and long-term investments of $45,429,472. At September 30,
2007, we had cash and cash equivalents of $40,075,552 and long-term investments
of $5,353,920. Cash and cash equivalents are short-term highly liquid
investments that are readily convertible to known amounts of cash and are so near
maturity that they present insignificant risk of changes in value because of
interest rates. Cash and cash equivalents generally consist of cash, money
market funds and instruments with original maturities of three months or less. Investments
consist of U.S. government securities rated AAA.
Net cash provided by
operating activities was $3,922,769 and $2,044,316 during the nine months ended
September 30, 2007 and September 30, 2006, respectively. The
$1,878,453 increase in net cash provided by operating activities for the nine
months ended September 30, 2007, compared to the same period in the prior
year, was primarily a result of the Company not having any cash outflow related
to discontinued operations during the nine months ended September 30, 2007
as the discontinued operations were sold in the second and third fiscal
quarters of 2006. Partially offsetting the increase, accounts receivable rose
by $846,007 during the nine months ended September 30, 2007 compared to
$401,462 in the same period in the prior year, primarily due to a significant
customer reporting royalties later than in prior periods. Additionally,
accounts payable and accrued liabilities decreased $249,444 and $489,159,
respectively, during the nine months ended September 30, 2007 as compared
to increasing $156,478 and $312,031, respectively, during the same period in
the prior year. The changes in liability accounts generally relate to the
timing of payments to vendors and changes in accrued commissions and amounts
due to employees under the 2007 Bonus and Profit Sharing Plan.
Net cash used in investing activities was $701,606 during the nine months ended September 30,
2007, and net cash provided by investing activities during the same period in
the prior year was $13,836,919. The decrease in cash from investing activities
is primarily due to the Company selling its available-for-sale investments for
$9,993,748 in September 2006 and re-investing the proceeds into cash
equivalents. In the prior period, the Company also received $4,300,000 and
$371,295 for the sale of Valence and its equity interest in CCH/SRS LLC,
respectively. There were no cash inflows or outflows from the discontinued
operations in the current period.
19
Our net cash provided by financing activities from continuing operations was $
1,842,964 and $1,493,341 during the nine months ended September 30, 2007 and September 30, 2006, respectively. The increase in net cash provided by financing activities was attributable to the Company not repurchasing any of its common stock in 2007 offset by a decrease in stock option exercises.
We expect expenditures related to patents and intangible assets to increase in the future consistent with the growth in our licensing business, as we continue to invest in the development of new technologies.
Based
on current plans and business conditions, we expect that our cash, cash
equivalents and investments together with any amounts generated from operations
will be sufficient to meet our cash requirements for the next twelve months.
However, there can be no assurance that we will not be required to seek other
financing sooner or that such financing, if required, will be available on
terms satisfactory to us.
Our
operations and financial results are subject to various risks and uncertainties
that could adversely affect our business, financial condition, results of
operations and trading price of our common stock. Please refer to Item 1A, “Risk
Factors” in our annual report on Form 10-K for fiscal year 2006 for
information concerning these and other uncertainties that could negatively
impact us.
Item 3. Quantitative and
Qualitative Disclosures about Market Risk
There
have been no material changes to the information called for by this Item 3 from
the disclosures set forth in Part II, Item 7A in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2006.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures.
Our Chief Executive Officer and
President and our Chief Financial Officer have evaluated the effectiveness of
our disclosure controls and procedures (as defined in Rules 13a-15 (e) and
15d-15 (e) under the Securities Exchange Act of 1934, as amended) as of
the end of the period covered by this Quarterly Report on Form
10-Q and, based on this evaluation, have concluded that our disclosure controls
and procedures are effective.
Changes in Internal Controls.
There have been no changes in our
internal controls over financial reporting that occurred during our third
quarter ended September 30, 2007 that have materially affected, or are
reasonably likely to materially affect, our internal controls over financial
reporting.
20