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 our Annual Report on Form 10-K for the year ended December 31, 2008, and the unaudited condensed interim consolidated financial statements and notes thereto included in this Quarterly Report.

Overview

We are the recognized global leader in the practical application of psychoacoustics,the science behind how the human ear operates, and in the post processing segment of the market for audio delivery. Our award-winning audio enhancement technologies and solutions dramatically restore audio and voice to its natural state, the way it was originally recorded, in both dimension and clarity, thus providing a superior consumer experience for a wide variety of consumer electronic devices such as televisions, personal computers and mobile phones.

Our operations are conducted through SRS Labs, Inc., and its wholly-owned subsidiaries, SRSWOWcast.com, Inc. and Shenzhen Representative Office of SRS Labs, 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 limited sales and marketing of stand alone software and hardware products through the Internet.

Critical Accounting Policies

Our discussion and analysis of our results of operations and liquidity and capital resources are based on our unaudited consolidated financial statements for the three months ended March 31, 2009 and 2008, which have been prepared in accordance with GAAP.

The preparation of these financial statements requires us to make estimates and judgments that affect the reported 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 Operations

Three Months Ended March 31, 2009 Compared to Three Months Ended March 31, 2008

Revenues

Our revenues consist primarily of royalties generated from the license of SRS Labs' audio and voice technologies. Our license agreements typically have multi-year or automatic renewal terms, and either require: (a) per-unit royalty payments for all products implementing our technologies and/or solutions;
(b) fixed annual or quarterly royalty payments; or (c) a minimum fixed annual or quarterly royalty payment, which allow the licensee to ship up to a pre-determined number of units during the specified time period, with additional per-unit royalty payments thereafter. The majority of our license agreements are per-unit royalty arrangements, which are generally reported by the licensee in the quarter following shipment of the consumer electronics device and are therefore are typically recognized by us following shipment by the OEM. Revenues associated with fixed royalty payments are recognized ratably over the term of the license agreement. We also sell some of our products and solutions via the Internet. Revenues associated with those sales are recognized upon shipment and were not material in the three months ended March 31, 2009 or 2008.

Our revenues were $5,704,010 for the three months ended March 31, 2009, compared to $4,940,988 for the three months ended March 31, 2008, an increase of $763,022 or 15%. Our revenues in the personal telecommunications market increased by $493,213 in the current quarter primarily due to increased revenues from Samsung Mobile and NEC. Our revenues from the personal computer market increased by $224,896, primarily due to revenue generated from several new licensees, including Hewlett Packard and BenQ. In our home entertainment market, our total revenues increased by $91,560 in the current quarter. Within this market, revenues from set-top boxes increased $71,228 in the current quarter, while revenues from flat panel televisions and monitors in the current quarter were relatively comparable to the prior year period. Although flat panel revenue increased from new licensees such as Vizio and other China based TV OEMs, such increase was offset by decreased revenue in the current quarter from Japanese TV OEMs such as Toshiba, Sony and Panasonic. In the automotive market, revenues increased by $54,449 primarily due to increased revenues from two customers in Japan who provide line install, dealer option and after market automotive audio systems to many of the significant Japanese automotive manufactures. Revenues in the portable media devices decreased by $101,097 primarily due to decreased revenues from MP3 players and docking stations.

The following table presents our licensing revenues mix by market:

                                                              Three Months Ended March 31,
                                                                2009               2008
Home entertainment (TV, set top box)                                   67 %               76 %
Personal telecommunications (mobile phone, PDA)                        13                  6
PC (software, hardware)                                                 8                  4
Automotive                                                              7                  7
Portable media devices (digital media player, headphone)                5                  7

Sales and Marketing

Sales and marketing expenses consist primarily of employee salaries, sales consultants' fees and related expenses, sales commissions and costs associated with branding activities. Sales and marketing expenses were $2,739,140 for the three months ended March 31, 2009, compared to $2,143,622 for the same prior year period, an increase of $595,518 or 28%. This increase was primarily attributable to an increase in payroll and related costs associated with the addition of 13 sales and marketing personnel since March 31, 2008. In addition, the Company has also increased its advertising and branding efforts, which resulted in an increase in expense of approximately $219,000 in the current quarter. Included in sales and marketing expenses is share-based compensation expense of $115,816 and $141,894 for the three months ended March 31, 2009 and 2008, respectively. We expect that sales and marketing expenses will continue to increase as we hire additional sales personnel to penetrate target markets and key regions and as we continue to increase our marketing efforts to cultivate and elevate the SRS brand globally. As a percentage of total revenues, sales and marketing expenses increased from 43% for the quarter ended March 31, 2008 to 48% 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 $1,174,666 for the three months ended March 31, 2009, compared to $926,762 for the same prior year period, an increase of $247,904 or 27%. This increase was primarily attributable to an increase in payroll and related costs associated with hiring an additional seven engineers since March 31, 2008. Included in research and development expenses is share-based compensation expense of $107,723 and $123,626 for the three months ended March 31, 2009 and 2008, respectively. We expect that research and development expenses will continue to increase in 2009 as we continue add to our research and development team in order to support our global licensees and to accelerate the implementation of our technology with a greater number of customers and devices. As a percentage of total revenues, research and development expenses increased from 19% for the quarter ended March 31, 2008 to 21% for the same period this year.

General and Administrative

General and administrative ("G&A") expenses consist primarily of employee-related expenses, attorneys' fees, accounting fees and other professional fees. G&A expenses were $1,432,127 for the three months ended March 31, 2009, compared to $1,438,358 for the same prior year period, a decrease of $6,231 or 1%. Included in G&A expenses is share-based compensation expense of $242,861 and $237,624 for the three months ended March 31, 2009 and 2008, respectively. As a percentage of total revenues, G&A expenses decreased from 29% for the quarter ended March 31, 2008 to 25% for the same period this year.

Other Income, Net

Other income, net consists primarily of interest income. Other income, net was $104,633 for the three months ended March 31, 2009, compared to $449,961 for the same prior year period, a decrease of $345,328 or 77%. This decrease was primarily attributable to lower interest rates earned on lower cash balances.

Income Taxes

Income tax expense for the three months ended March 31, 2009 was $4,936, compared to an income tax benefit of $2,094 for the same prior year period. The income tax provision consisted primarily of taxes paid on licensing revenues in the current quarter that were sourced from countries requiring foreign tax withholdings, principally Korea. We reduced our tax provision and our valuation allowance on our deferred tax assets by $516,818 and $463,074 for the three months ended March 31, 2009 and 2008, respectively, based on our assessment of the future estimated realization of such assets.

Liquidity and Capital Resources

Our principal source of liquidity to fund ongoing operations at March 31, 2009 consisted of cash, cash equivalents and short-term investments of $39,057,884. At March 31, 2009, we had cash and cash equivalents of $27,552,884 and short-term investments of $11,505,000. Cash and cash equivalents generally consist of cash, money market funds and other money market instruments with original maturities of three months or less. The money market funds are primarily invested in US government obligations. The cash and certificates of deposit are FDIC insured. Short-term investments consist of certificates of deposit with original maturities ranging from 6 to 12 months.

Net cash used in operating activities was $141,206 during the three months ended March 31, 2009, and net cash provided by operating activities was $2,897,301 during the same period in the prior year. The decrease in our cash flows from operating activities was primarily the result of changes in our operating assets and liabilities specifically, a decrease in our deferred revenue of $258,273 during the three months ended March 31, 2009 compared to an increase of $1,155,214 during the three months ended March 31, 2008. The decrease in deferred revenue during the three months ended March 31, 2009 was due to the Company recognizing revenue from customers who prepaid us royalties. During the three months ended March 31, 2008, the Company received the final lump sum payment under the multi-year license agreement with LG Electronics, which caused deferred revenue to increase. Additionally, accounts receivable increased $325,371 during the three months ended March 31, 2009 as compared to decreasing $753,940 during the three months ended March 31, 2008. The increase in accounts receivable as of March 31, 2009 was due to increased revenues recorded in the current quarter. Furthermore, cash flow from operating activities decreased due to a decrease in net income of $472,550 from $858,352 during the three months ended March 31, 2008 to $385,802 during the three months ended March 31, 2009.

Net cash used in investing activities was $3,904,997 during the three months ended March 31, 2009 and net cash provided by investing activities was $5,199,846 during the same period in the prior year. Net cash used by investing activities during the three months ended March 31, 2009 was attributable primarily to the purchase of short-term investments.

We believe our existing cash, cash equivalents and short-term investment balances together with cash generated from operating activities, will be sufficient to meet our anticipated cash needs for at least the next twelve months. Our future capital requirements will depend on many factors, including our level of revenues, the timing and extent of spending to support product development efforts, the impact of existing adverse economic conditions, the expansion of sales and marketing activities, the timing of introductions of new products and the continuing market acceptance of our products.

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" herein for information concerning these and other uncertainties that could negatively impact us.