Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the Quarterly Period Ended December 28, 2007

OR

 

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

For the Transition Period From              To             

Commission File Number: 001-32431

DOLBY LABORATORIES, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   90-0199783
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

100 Potrero Avenue

San Francisco, CA

  94103-4813
(Address of principal executive offices)   (Zip Code)

(415) 558-0200

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer  x            Accelerated Filer  ¨            Non-Accelerated Filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

On January 17, 2008 the registrant had 50,187,528 shares of Class A common stock, par value $0.001 per share, and 60,858,768 shares of Class B common stock, par value $0.001 per share, outstanding.

 

 

 


Table of Contents

DOLBY LABORATORIES, INC.

FORM 10-Q

TABLE OF CONTENTS

 

     PART I – FINANCIAL INFORMATION     

Item 1.

   Condensed Consolidated Financial Statements   
   Condensed Consolidated Balance Sheets as of September 28, 2007 and December 28, 2007    2
   Condensed Consolidated Statements of Operations for the Fiscal Quarters Ended December 29, 2006 and December 28, 2007    3
   Condensed Consolidated Statements of Cash Flows for the Fiscal Quarters Ended December 29, 2006 and December 28, 2007    4
   Notes to Condensed Consolidated Financial Statements    5

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    16

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    27

Item 4.

   Controls and Procedures    28
   PART II – OTHER INFORMATION   

Item 1.

   Legal Proceedings    29

Item 1A.

   Risk Factors    29

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    48

Item 6.

   Exhibits    48
Signatures    49

 

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Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1 – CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

DOLBY LABORATORIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

     September 28,
2007
   December 28,
2007
     (unaudited)

ASSETS

     

Current assets:

     

Cash and cash equivalents

   $ 368,467    $ 280,246

Short-term investments

     231,217      200,727

Accounts receivable, net of allowance

     28,165      37,955

Inventories

     14,883      14,585

Deferred income taxes

     73,686      76,086

Prepaid expenses and other current assets

     17,000      19,585
             

Total current assets

     733,418      629,184

Property, plant and equipment, net

     85,552      85,079

Intangible assets, net

     35,389      93,672

Goodwill

     39,364      258,967

Long-term investments

     73,224      29,301

Non-current deferred income taxes

     12,393      17,887

Other non-current assets

     12,357      12,541
             

Total assets

   $ 991,697    $ 1,126,631
             

LIABILITIES AND STOCKHOLDERS’ EQUITY

     

Current liabilities:

     

Accounts payable and accrued liabilities

   $ 119,068    $ 138,488

Income taxes payable

     9,051      15,155

Current portion of debt

     1,563      1,571

Deferred revenue

     13,522      18,358
             

Total current liabilities

     143,204      173,572

Long-term debt

     9,691      9,209

Long-term deferred revenue

     5,073      4,932

Deferred income tax liability

     —        17,694

Other non-current liabilities

     14,294      32,015
             

Total liabilities

     172,262      237,422

Controlling interest

     22,279      22,031

Stockholders’ equity:

     

Class A common stock

     49      50

Class B common stock

     61      61

Additional paid-in capital

     375,830      392,999

Retained earnings

     409,749      457,710

Accumulated other comprehensive income

     11,467      16,358
             

Total stockholders’ equity

     797,156      867,178
             

Total liabilities and stockholders’ equity

   $ 991,697    $ 1,126,631
             

See accompanying notes to unaudited condensed consolidated financial statements

 

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DOLBY LABORATORIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

     Fiscal Quarter Ended  
     December 29,
2006
    December 28,
2007
 
     (unaudited)  

Revenue:

    

Licensing

   $ 82,375     $ 122,430  

Product sales

     15,210       20,010  

Services

     6,857       7,787  
                

Total revenue

     104,442       150,227  
                

Cost of revenue:

    

Cost of licensing

     7,660       3,263  

Cost of product sales (1)

     8,686       11,648  

Cost of services (1)

     2,683       3,055  
                

Total cost of revenue

     19,029       17,966  
                

Gross margin

     85,413       132,261  
                

Operating expenses:

    

Selling, general and administrative (1)

     37,311       50,986  

Research and development (1)

     8,836       13,907  
                

Total operating expenses

     46,147       64,893  
                

Operating income

     39,266       67,368  

Interest income

     6,086       5,821  

Interest expense

     (453 )     (363 )

Other (expense), net

     (206 )     (254 )
                

Income before provision for income taxes and controlling interest

     44,693       72,572  

Provision for income taxes

     14,452       24,607  
                

Income before controlling interest

     30,241       47,965  

Controlling interest in net income, net of tax

     (348 )     (292 )
                

Net income

   $ 29,893     $ 47,673  
                

Earnings per share (basic)

   $ 0.28     $ 0.43  

Earnings per share (diluted)

   $ 0.27     $ 0.42  

Weighted-average shares outstanding (basic)

     107,947       110,592  

Weighted-average shares outstanding (diluted)

     112,767       114,700  

Expense for rent payable to related party included in selling, general and administrative expenses

     337       340  

(1)    Stock-based compensation included above was classified as follows:

    

Cost of product sales

     218       241  

Cost of services

     37       40  

Selling, general and administrative

     3,859       4,295  

Research and development

     747       890  

See accompanying notes to unaudited condensed consolidated financial statements

 

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DOLBY LABORATORIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     Fiscal Quarter Ended  
     December 29,
2006
    December 28,
2007
 
     (unaudited)  

Operating activities:

    

Net income

   $ 29,893     $ 47,673  

Adjustments to reconcile net income to net cash flows from operating activities:

    

Depreciation and amortization

     3,331       5,246  

Stock-based compensation expense

     4,861       5,466  

Accretion of discounts on debt securities

     (107 )     (115 )

Tax benefit from exercise of stock options

     9,131       6,412  

Excess tax benefit from exercise of stock options

     (8,567 )     (6,309 )

Provision for doubtful accounts

     54       192  

Deferred income taxes

     675       (7,035 )

Other non-cash items affecting net income

     532       229  

Changes in operating assets and liabilities:

    

Accounts receivable

     6,860       (8,123 )

Inventories

     (265 )     (462 )

Prepaid expenses and other assets

     (2,035 )     (300 )

Accounts payable and accrued liabilities

     1,411       10,425  

Income taxes, net

     415       17,664  

Deferred revenue

     1,040       4,678  

Other non-current liabilities

     (64 )     625  
                

Cash flows from operating activities

     47,165       76,266  
                

Investing activities:

    

Purchases of available-for-sale securities

     (123,790 )     (66,255 )

Proceeds from sale of available-for-sale securities

     61,112       140,610  

Purchases of property, plant and equipment

     (1,798 )     (1,477 )

Acquisitions, net of cash acquired

     —         (248,715 )

Other investing activities

     54       7  
                

Cash flows from investing activities

     (64,422 )     (175,830 )
                

Financing activities:

    

Payments on debt

     (359 )     (379 )

Proceeds from the exercise of stock options

     3,743       5,134  

Issuance of Class A common stock (ESPP)

     479       505  

Excess tax benefit from exercise of stock options

     8,567       6,309  
                

Cash flows from financing activities

     12,430       11,569  
                

Effect of foreign exchange rate changes on cash and cash equivalents

     2,095       (226 )
                

Net decrease in cash and cash equivalents

     (2,732 )     (88,221 )

Cash and cash equivalents at beginning of period

     363,537       368,467  
                

Cash and cash equivalents at end of period

   $ 360,805     $ 280,246  
                

Supplemental disclosure:

    

Cash paid for income taxes

   $ 4,232     $ 7,063  

Cash paid for interest

     295       209  

See accompanying notes to unaudited condensed consolidated financial statements

 

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DOLBY LABORATORIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1. Summary of Business and Significant Accounting Policies

Dolby Laboratories develops and delivers innovative products and technologies that improve the entertainment experience. Since Ray Dolby founded Dolby Laboratories in 1965, we have been at the forefront of delivering sound technologies that are employed throughout the entertainment creation, distribution and playback process to enhance the entertainment experience. Today, Dolby technologies are standard in a wide range of entertainment platforms. Our technologies are used in virtually all DVD players and personal computer DVD playback software, increasingly in digital televisions and portable electronic devices, and also in a wide array of consumer electronic products such as gaming systems, audio/video receivers and mobile devices. Dolby cinema products are used in movie theatres around the world. Dolby broadcast products distribute high-quality audio around the world.

Our objective is to be an essential element in the best entertainment technologies by delivering innovative and enduring technologies that enrich the entertainment experience. We believe that our well-recognized brand and established history of successful innovation put us in a position to expand the use of our technologies in existing and new markets and to capitalize on key trends in digital entertainment, such as the transition to high-definition television, digital cinema, space-efficient home theatre systems, portable media and an increasing number of media delivery channels.

We deliver technologies, products, and services at each critical stage of the entertainment chain—content creation, content distribution and content playback. We work closely with content creators, including filmmakers, television producers, music producers, and video-game designers to incorporate Dolby technologies in entertainment content. As a result, we believe we are well positioned to work with entertainment distributors to deliver that content with our technologies, whether through 35 millimeter film or digital content for theatres, DVDs, broadcasts or the internet. By working successfully to encode and distribute content with Dolby technologies, we are able to license our decoding technologies to consumer electronics manufacturers and independent software vendors for consumer playback and sell our cinema equipment for large-scale public playback in movie theatres. Our involvement across the entertainment chain has resulted in a globally recognized brand and enables us to introduce technologies and services into new areas.

Unaudited Interim Financial Statements

The accompanying interim condensed consolidated balance sheets as of September 28, 2007 and December 28, 2007 and the condensed consolidated statements of operations and cash flows for the fiscal quarters ended December 29, 2006 and December 28, 2007 are unaudited. These interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). In our opinion, the interim consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements for the year ended September 28, 2007 and include all adjustments necessary for fair presentation. The results for the fiscal quarter ended December 28, 2007 are not necessarily indicative of the results to be expected for any subsequent quarterly or annual financial period, including the fiscal year ending September 26, 2008.

The accompanying interim financial statements are prepared in accordance with Securities and Exchange Commission rules and regulations, which allow certain information and footnote disclosures that are normally included in annual financial statements to be condensed or omitted. As a result, the accompanying interim financial statements should be read in conjunction with our consolidated financial statements for the year ended September 28, 2007 that are included in our Annual Report on Form 10-K and filed with the Securities and Exchange Commission. Certain prior period amounts have been reclassified to conform to current year presentation.

Use of Estimates

The preparation of the consolidated financial statements in accordance with U.S. GAAP requires management to make certain estimates and assumptions that affect the amounts reported and disclosed in our consolidated financial statements and accompanying notes. Significant items subject to such estimates and assumptions include valuation allowances for receivables, carrying values of inventories, goodwill, intangible assets, stock-based compensation, liabilities for unrecognized tax benefits and deferred income tax assets. Actual results could differ from our estimates.

 

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Per Share Data

Basic earnings per share is computed by dividing net income by the weighted-average number of shares of Class A common stock and Class B common stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the sum of the weighted-average number of shares of Class A common stock and Class B common stock outstanding and the potential number of shares of dilutive Class A common stock and Class B common stock outstanding during the period. The potential common shares are comprised entirely of options to purchase shares of Class A common stock and Class B common stock.

The following table sets forth the computation of basic and diluted earnings per share:

 

     Fiscal Quarter Ended
     December 29,
2006
   December 28,
2007
     (in thousands, except per share amounts)

Numerator:

     

Net income

   $ 29,893    $ 47,673
             

Denominator:

     

Weighted-average shares outstanding (basic)

     107,947      110,592

Potential common shares from options to purchase Class A common stock and Class B common stock

     4,820      4,108
             

Weighted-average shares outstanding (diluted)

     112,767      114,700
             

Earnings per share (basic)

   $ 0.28    $ 0.43

Earnings per share (diluted)

   $ 0.27    $ 0.42

A total of 948,353 and 525,538 options were excluded from the calculation of potential common shares for the first quarter of fiscal 2007 and the first quarter of fiscal 2008, respectively, because their inclusion would have been anti-dilutive.

Cash and Cash Equivalents

We consider all short-term highly liquid investments that have original maturities of 90 days or less from the date of purchase, to be cash equivalents. Cash and cash equivalents consist of funds held in general checking accounts, money market accounts and United States government agency securities.

Investments

We have investments in United States government agency securities, variable rate demand notes (VRDNs), auction rate certificates and municipal debt securities. We account for these instruments under the provisions of Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. Investments that have original maturities between 91 days and one year from the date of purchase are classified as short-term investments and investments that have maturities of more than one year from the date of purchase are classified as long-term investments. VRDNs and auction rate certificates which have original maturities greater than one year are classified as short-term investments based on our ability and intent to sell these instruments within one year from the date of purchase. All of our investments, except for an equity investment and investments held in our supplemental retirement plan for key executives, are classified as available-for-sale and are recorded at fair market value on the consolidated balance sheet. Unrealized gains or losses on our available-for-sale securities are reported as a component of other comprehensive income and realized gains or losses are reported as a component of net income. Investments held in our supplemental retirement plan for key executives are classified as trading securities and are included in other non-current assets on the consolidated balance sheet. Unrealized gains or losses on trading securities are reported as a component of net income.

In accordance with FASB Emerging Issues Task Force No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, we review our investment portfolio in order to assess whether our investments with unrealized loss positions are other-than-temporarily impaired. We had no material gross realized or unrealized holding losses from our investments for the first quarter of fiscal 2007 or the first quarter of fiscal 2008.

 

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Stock-Based Compensation

We account for stock-based compensation under the provisions of Statement of Financial Accounting Standards 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, net of estimated forfeitures, in the consolidated financial statements over the requisite service period. Stock-based compensation expense was $4.9 million and $5.5 million in the first quarter of fiscal 2007 and the first quarter of fiscal 2008, respectively. See Note 4 “Stockholders’ Equity and Stock-Based Compensation” for further discussion.

Income Taxes

We recognize our quarterly provision for income taxes based on our estimated full year projected effective tax rate. We estimate our effective tax rate based on projections of our income before income taxes for the full fiscal year. In the period that we file our annual tax returns, we true up our provision for income taxes to reflect any difference between our estimated provision and our filed tax return.

In the first quarter of fiscal 2008 we adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 addresses the accounting for and disclosure of uncertainty in income tax positions by prescribing a minimum recognition threshold that a tax position is required to satisfy before being recognized in the financial statements.

Goodwill and Intangible Assets

We account for goodwill in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142). As required by SFAS 142, we perform an impairment test on recorded goodwill by comparing the estimated fair value of each of our reporting units to the carrying value of the assets and liabilities of each unit, including goodwill. The fair value of each of our reporting units is determined by using a discounted cash-flow model which considers a number of factors, including estimated future cash-flows, risks facing us and our current market capitalization. If the carrying value of the assets and liabilities of the reporting units, including goodwill, were to exceed our estimate of the fair value of the reporting units, we would record an impairment charge in an amount equal to the excess of the carrying value of goodwill over the implied fair value of the goodwill. Our fiscal 2008 impairment test of goodwill will be performed in our third fiscal quarter.

The following table outlines changes to the carrying amount of goodwill:

 

     Total
     (in thousands)

Balance at September 28, 2007

   $ 39,364

Goodwill acquired – Coding Technologies AB (see Note 5)

     215,322

Translation adjustments

     4,281
      

Balance at December 28, 2007

   $ 258,967
      

Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), requires that long-lived assets, including intangible assets, with definite lives be amortized over their estimated useful lives and reviewed for impairment whenever events or changes in circumstances indicate an asset’s carrying value may not be recoverable. Recoverability of an asset is measured by comparison of its carrying amount to the expected future undiscounted cash flows that the asset is expected to generate. If it is determined that an asset is not recoverable, an impairment loss is recorded in the amount by which the carrying amount of the asset exceeds its fair value. Our intangible assets principally consist of acquired technology, patents and trademarks and are amortized on a straight-line basis over their useful lives ranging from five to 15 years. No intangible or long-lived assets were impaired as of December 28, 2007.

 

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Comprehensive Income

Comprehensive income includes net income, foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities which are reflected as a component of stockholders’ equity. The components of comprehensive income were as follows:

 

     Fiscal Quarter Ended  
     December 29,
2006
    December 28,
2007
 
     (in thousands)  

Net income

   $ 29,893     $ 47,673  

Other comprehensive income (loss):

    

Foreign currency translation adjustment

     3,967       4,987  

Unrealized gains (losses) on available-for-sale securities, net of tax

     (107 )     (96 )
                

Comprehensive income

   $ 33,753     $ 52,564  
                

Withholding Taxes

Licensing revenue is recognized gross of withholding taxes that are remitted by our licensees directly to their local tax authorities. Withholding taxes were $3.1 million and $4.0 million in the first quarter of fiscal 2007 and the first quarter of fiscal 2008, respectively.

 

2. Composition of Certain Financial Statement Captions

Cash, Cash Equivalents, and Investments

Cash, cash equivalents, and investments as of September 28, 2007 and December 28, 2007 consisted of the following:

 

     September 28,
2007
   December 28,
2007
     (in thousands)

Cash and cash equivalents:

     

Cash

   $ 128,061    $ 93,731

Cash equivalents:

     

Money market funds (tax exempt)

     239,198      186,515

U.S. government agency securities

     1,208      —  
             

Total cash and cash equivalents

     368,467      280,246
             

Investments:

     

U.S. government agency securities

     113,967      6,186

Auction rate certificates (tax exempt)

     103,950      122,750

Variable rate demand notes (tax exempt)

     54,900      54,800

Municipal debt securities (tax exempt)

     30,830      45,498

Equity investment

     794      794
             

Total investments

     304,441      230,028
             

Total cash, cash equivalents and investments

   $ 672,908    $ 510,274
             

 

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Our investment portfolio which is recorded as cash equivalents, short-term investments, and long-term investments as of September 28, 2007 was as follows:

 

     Cost    Unrealized
Gain
   Unrealized
Loss
    Estimated
Fair Value
     (in thousands)

Money market funds

   $ 239,198    $ —      $ —       $ 239,198

U.S. government agency securities

     115,026      149      —         115,175

Auction rate certificates

     103,950      —        —         103,950

Variable rate demand notes

     54,900      —        —         54,900

Municipal debt securities

     30,799      34      (3 )     30,830

Equity investment

     794      —        —         794
                            

Cash equivalents and investments

   $ 544,667    $ 183    $ (3 )   $ 544,847
                            

Our investment portfolio which is recorded as cash equivalents, short-term investments, and long-term investments as of December 28, 2007 was as follows:

 

     Cost    Unrealized
Gain
   Unrealized
Loss
    Estimated
Fair Value
     (in thousands)

Money market funds

   $ 186,515    $ —      $ —       $ 186,515

U.S. government agency securities

     6,148      38      —         6,186

Auction rate certificates

     122,750      —        —         122,750

Variable rate demand notes

     54,800      —        —         54,800

Municipal debt securities

     45,452      87      (41 )     45,498

Equity investment

     794      —        —         794
                            

Cash equivalents and investments

   $ 416,459    $ 125    $ (41 )   $ 416,543
                            

All of our investments in the tables above are classified as available-for-sale and, except for the equity investment, are recorded at fair market value on the consolidated balance sheet. The equity investment represents equity securities that we have accounted for under the cost method and classified as long-term investments based on our ability and intent to hold the investment for more than one year.

The following table shows the gross unrealized losses and fair value for those investments that were in an unrealized loss position as of December 28, 2007:

 

     Less than 12 months     12 months or greater    Total  
     Fair Value    Gross
Unrealized
Losses
    Fair Value    Gross
Unrealized
Losses
   Fair Value    Gross
Unrealized
Losses
 
     (in thousands)  

Municipal debt securities

   $ 15,622    $ (41 )   $ —      $ —      $ 15,622    $ (41 )

The unrealized losses on our investments in municipal debt securities were caused primarily by changes in interest rates. We have the ability to hold these securities until we recover any unrealized losses. As a result, we do not consider any investment in an unrealized loss position at December 28, 2007 to be other-than-temporarily impaired.

 

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Accounts Receivable

Accounts receivable consists of the following:

 

     September 28,
2007
    December 28,
2007
 
     (in thousands)  

Trade accounts receivable

   $ 25,245     $ 21,400  

Amounts receivable related to patent administration program

     2,634       14,934  

Other accounts receivable

     1,189       2,698  
                
     29,068       39,032  

Less: Allowance for doubtful accounts

     (903 )     (1,077 )
                

Accounts receivable, net of allowance

   $ 28,165     $ 37,955  
                

Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market and consist of the following:

 

     September 28,
2007
   December 28,
2007
     (in thousands)

Raw materials

   $ 4,799    $ 3,614

Work in process

     2,723      3,324

Finished goods

     7,361      7,647
             

Inventories

   $ 14,883    $ 14,585
             

Goodwill and Intangible Assets

Following is a summary of goodwill and intangible assets:

 

     September 28,
2007
    December 28,
2007
 
     (in thousands)  

Amortized intangible assets:

    

Acquired patents and technology

   $ 30,986     $ 58,967  

Customer relationships

     70       29,788  

Other intangibles

     12,278       15,155  
                
     43,334       103,910  

Less: Accumulated amortization

     (7,945 )     (10,238 )
                

Intangible assets, net

   $ 35,389     $ 93,672  
                

Non-amortized intangible assets:

    

Goodwill

   $ 39,364     $ 258,967  
                

Amortization expense associated with our intangible assets was $0.5 million and $2.3 million in the first quarter of fiscal 2007 and the first quarter of fiscal 2008, respectively, and is included in cost of licensing, cost of product sales and selling, general and administrative expenses in the accompanying consolidated statements of operations. The increase in intangible assets from September 28, 2007 to December 28, 2007 was due primarily to the acquisition of Coding Technologies AB (Coding Technologies) in November 2007. See Note 5, “Business Combinations” for further discussion regarding the acquisition of Coding Technologies.

 

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Accounts Payable and Accrued Liabilities

Accounts payable and accrued liabilities consist of the following:

 

     September 28,
2007
   December 28,
2007
     (in thousands)

Accounts payable

   $ 9,281    $ 11,154

Accrued royalties

     31,051      32,407

Amounts payable to joint licensing program partners

     25,781      33,528

Accrued compensation and benefits

     30,347      38,911

Accrued professional fees

     3,593      3,708

Current portion of litigation settlement (see Note 6)

     2,592      2,728

Other accrued liabilities

     16,423      16,052
             

Accounts payable and accrued liabilities

   $ 119,068    $ 138,488
             

Accrued royalties include amounts related to an ongoing dispute regarding the terms of a license agreement with an unrelated patent licensor. From the third quarter of fiscal 2006 through the third quarter of fiscal 2007 we had been accruing royalties related to this matter. We have informed the patent licensor that we may have overpaid them under the terms of the licensing agreement. The patent licensor has claimed that we have underpaid them under the terms of the licensing agreement. In the fourth quarter of fiscal 2007, we determined that it was appropriate to cease accruing additional royalties related to this dispute. We continue to try to resolve this matter with the patent licensor. We believe the amounts accrued as of December 28, 2007 are sufficient to cover any potential exposure we may have related to this dispute.

Accumulated Other Comprehensive Income

Accumulated foreign currency translation gains were $11.4 million and $16.3 million at September 28, 2007 and December 28, 2007, respectively. Accumulated unrealized gains on investments, net, were $0.1 million and less than $0.1 million at September 28, 2007 and December 28, 2007, respectively.

 

3. Income Tax Uncertainties

In the first quarter of fiscal 2008 we adopted the provisions of FIN 48. FIN 48 addresses the accounting for and disclosure of uncertainties in income tax positions by prescribing a minimum recognition threshold that a tax position is required to satisfy before being recognized in the financial statements.

The cumulative effect of adopting FIN 48 was a decrease in tax reserves of $0.3 million, resulting in an increase of $0.3 million in our beginning retained earnings balance. Upon adoption of FIN 48 we recorded $11.2 million to non-current liabilities, which represented a gross liability for unrecognized tax benefits of $7.9 million, interest of $1.2 million and penalties of $2.1 million. Additionally, we recorded $5.3 million to non-current deferred income tax assets for the effects of potential foreign tax credits, federal deduction of state income taxes and deductibility of interest expense. The net liability of $5.9 million, if recognized, would unfavorably affect our effective tax rate. We do not anticipate a significant change in our unrecognized tax benefits in the next twelve months.

Our policy to include interest and penalties related to gross unrecognized tax benefits within our provision for income taxes did not change upon the adoption of FIN 48. To the extent accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced in the period that such determination is made and reflected as a reduction in the overall income tax provision, to the extent that the interest expense had been provided through the tax provision, or as a reduction in goodwill to the extent it had been recognized through purchase accounting.

 

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In the first quarter of fiscal 2008 we recorded additional non-current liabilities related to FIN 48 tax uncertainties of $3.2 million, which consisted of $2.4 million for tax uncertainties from the acquisition of Coding Technologies and $0.8 million related to additional unrecognized tax benefits, including interest and penalties. The amounts associated with Coding Technologies were recorded to goodwill and the remaining amounts are reflected in the provision for income taxes. It is reasonably possible that our liability for unrecognized tax benefits related to Coding Technologies could change within the next twelve months as a result of our finalization of the purchase price allocation. At December 28, 2007, our total FIN 48 liabilities were approximately $14.4 million, which includes interest of $1.4 million and penalties of $2.3 million, and are included in non-current liabilities on our consolidated balance sheet.

We file income tax returns in the United States (U.S.) on a federal basis and in several U.S. state and foreign jurisdictions. Our two most significant tax jurisdictions are the U.S. and the United Kingdom. Our tax filings remain subject to examination by applicable tax authorities for a certain length of time following the tax year to which those filings relate. Our tax filings are no longer subject to examinations by the Internal Revenue Service or the appropriate governmental agencies for the United Kingdom through the tax year 2004. Our California filings are no longer subject to examination through tax year 1999 by the appropriate California agency. Other significant jurisdictions include Sweden, Australia, and Canada. As of September 28, 2007, our tax filings are under examination by New York State for tax years from 2002 to 2005 and New York City for tax years 2001 and 2004. We do not believe that the outcome of any examinations will have a material impact on our financial statements.

 

4. Stockholders’ Equity and Stock-Based Compensation

Stock-Based Compensation

We utilize stock-based awards as a form of compensation for employees, officers, directors and non-employee consultants. We account for stock-based awards under the provisions of SFAS 123R and related interpretations. Stock-based compensation expense was $4.9 million and $5.5 million in the first quarter of fiscal 2007 and the first quarter of fiscal 2008, respectively.

Stock Options. We have granted stock options to our employees, officers and directors under our 2005 Stock Plan and our 2000 Stock Incentive Plan. We utilize a Black-Scholes option pricing model to determine the fair value of employee stock options at the date of grant. The fair value of our stock-based awards was estimated using the following weighted-average assumptions:

 

     Fiscal Quarter Ended  
     December 29,
2006
    December 28,
2007
 

Expected term (in years)

   5.87     5.09  

Expected stock price volatility

   44.3 %   40.9 %

Risk-free interest rate

   4.6 %   3.7 %

Dividend yield

   —       —    

Stock-based compensation expense is recorded net of estimated forfeitures. In the first quarter of fiscal 2008 we utilized an estimated forfeiture rate of 5.4%, compared to 2.1% in the first quarter of fiscal 2007.

The following table summarizes information about stock options issued to officers, directors, employees and non-employee consultants under our 2000 Stock Incentive Plan and 2005 Stock Plan:

 

     Shares     Weighted
Average
Exercise Price
   Weighted Average
Remaining
Contractual Life
   Aggregate
Intrinsic Value
     (in thousands)          (in years)    (in thousands)

Options outstanding at September 28, 2007

   7,609     $ 12.73      

Grants

   273       45.99      

Exercises

   (642 )     8.00      

Forfeitures and expirations

   (27 )     27.19      
              

Options outstanding at December 28, 2007

   7,213       14.36    6.98    $ 260,017
              

Options vested at December 28, 2007 and expected to vest

   6,646       13.82    6.89    $ 243,074
              

Options exercisable at December 28, 2007

   3,224       6.76    5.73    $ 140,702
              

 

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Aggregate intrinsic value is based on the closing price of our common stock on December 28, 2007 of $50.40 and excludes the impact of options that were not in-the-money. The weighted-average fair value of stock options on the date of grant was $12.97 and $19.10 for the first quarter of fiscal 2007 and 2008, respectively.

 

5. Business Combinations

In the first quarter of fiscal 2008 we acquired all of the outstanding equity interests of Coding Technologies, a privately held provider of audio compression technologies for the mobile, digital broadcast and internet markets. The aggregate cost of the acquisition was approximately $253 million, net of acquired cash, including approximately $6 million in transaction costs. We believe the acquisition of Coding Technologies will increase our presence in the mobile, broadcast, digital radio and digital music download markets. The results of Coding Technologies’ operations from November 9, 2007, the date of acquisition, to December 28, 2007 are included in our results for the first quarter of fiscal 2008.

The allocation of the purchase price is preliminary and is therefore subject to change. We expect to complete the allocation by the end of the fiscal year. The aggregate cost of the acquisition, net of acquired cash, was allocated as follows:

 

     Total Purchase
Price Allocation
    Estimated Useful
Lives
     (in thousands)     (in years)

Goodwill

   $ 215,322     n/a

Developed technology

     27,400     8

Backlog

     2,800     4

Customer relationships

     29,100     9

Acquired liabilities, net

     (21,708 )   n/a
          

Total purchase price

   $ 252,914    
          

The following pro forma financial results for the first quarter of fiscal 2007 illustrate our estimates of what the combined results of Dolby and Coding Technologies would have been had the acquisition taken place at the beginning of the first quarter of fiscal 2007. As noted above, the results of Coding Technologies’ operations from the date of acquisition to December 28, 2007 are included in our results for the first quarter of fiscal 2008. The pro forma results assuming the acquisition had occurred at the beginning of the first quarter of fiscal 2008 would not have been materially different than our actual results for the first quarter of fiscal 2008.

 

     Fiscal Quarter
Ended
December 29,
2006
     (in thousands, except
per share amounts)

Revenue

   $ 108,545

Operating income

     37,979

Net income

     27,170

Earnings per share (basic)

   $ 0.25

Earnings per share (diluted)

   $ 0.24

Weighted-average shares outstanding (basic)

     107,947

Weighted-average shares outstanding (diluted)

     112,767

 

6. Legal Proceedings

In March 1997, an unrelated third party filed a lawsuit against us alleging breach of a written agreement. In April 2002, we settled the dispute and agreed to pay a total of $30.0 million, without interest, in ten equal annual installments of $3.0 million per year beginning in June 2002. We recorded this liability at its present value of $24.2 million on the consolidated balance sheet using a discount rate of 5.125%, which approximated our incremental cost of borrowing rate. Interest related to this liability is recorded quarterly and is included in other income, net on the accompanying condensed consolidated statements of operations. Other than such payments, neither party has any material obligations as a result of the settlement. As of December 28, 2007, we had $12.0 million remaining to be paid under this settlement.

 

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In addition, we are involved in various legal proceedings from time to time arising from the normal course of business activities, including claims of alleged infringement of intellectual property rights, commercial, employment and other matters. In our opinion, resolution of these proceedings is not expected to have a material adverse effect on our operating results or financial condition. However, it is possible that an unfavorable resolution of one or more such proceedings could materially affect our future operating results or financial condition in a particular period.

 

7. Geographic Data

Revenue by geographic region, which was determined based on the location of our licensees for licensing revenue, the location of our direct customers or distributors for product sales, and the location where services were performed for service revenue, was as follows:

 

     Fiscal Quarter Ended
     December 29,
2006
   December 28,
2007
     (in thousands)

International

   $ 80,381    $ 104,031

United States

     24,061      46,196
             

Total revenue

   $ 104,442    $ 150,227
             

The concentration of our revenue from individual countries or geographic regions was as follows:

 

     Fiscal Quarter Ended  
     December 29,
2006
    December 28,
2007
 

United States

   23 %   31 %

Japan

   21 %   21 %

Europe

   20 %   19 %

Taiwan

   11 %   11 %

China

   14 %   10 %

Other

   11 %   8 %

In the first quarter of fiscal 2008, revenue from our largest customer represented $16.5 million, or 11%, of total revenue for the quarter. In the first quarter of fiscal 2007, revenue from our largest customer represented $10.7 million, or 10%, of total revenue for the quarter.

Long-lived tangible assets, net of accumulated depreciation, by geographic region were as follows:

 

     Long-Lived Tangible Assets by
Geographic Region
     September 28,
2007
   December 28,
2007
     (in thousands)

United States

   $ 60,237    $ 59,310

International

     25,315      25,769
             

Total long-lived tangible assets, net of accumulated depreciation

   $ 85,552    $ 85,079
             

Long-lived tangible assets, which consist of property, plant and equipment net of accumulated depreciation, held in the United Kingdom were $22.1 million and $21.4 million at September 28, 2007 and December 28, 2007, respectively.

 

8. Recently Issued Accounting Standards

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes. FIN 48 clarifies the accounting for uncertainties in income taxes recognized in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. The Interpretation defines the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. We adopted FIN 48 in the first quarter of fiscal 2008. The adoption of FIN 48 did not have a material impact on our consolidated financial statements. Upon adoption, we recognized a $0.3 million decrease in a liability for unrecognized tax benefits which, as required, was accounted for as an increase to our beginning retained earnings balance.

 

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In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157). The purpose of SFAS 157 is to define fair value, establish a framework for measuring fair value and enhance disclosures about fair value measurements. The measurement and disclosure requirements are effective for fiscal years beginning after November 15, 2007. We do not expect the adoption of SFAS 157 will have a material effect on our consolidated financial statements.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The provisions of SFAS 159 become effective as of the beginning of our 2009 fiscal year. We are currently evaluating the impact that SFAS 159 will have on our consolidated financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141R, Business Combinations (SFAS 141R). SFAS 141R requires most identifiable assets, liabilities, noncontrolling interests, and goodwill acquired in a business combination to be recorded at “full fair value.” SFAS 141R applies to all business combinations, including combinations among mutual entities and combinations by contract alone. Under Statement 141R, all business combinations will be accounted for by applying the acquisition method. Statement 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We are currently evaluating the impact that SFAS 141R will have on our consolidated financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Non-controlling Interests in Consolidated Financial Statements (SFAS 160). SFAS 160 requires the ownership interests in subsidiaries held by parties other than the parent to be treated as a separate component of equity and be clearly identified, labeled, and presented in the consolidated financial statements. SFAS 160 is effective for periods beginning on or after December 15, 2008. Earlier adoption is prohibited. We are currently evaluating the impact that SFAS 160 will have on our consolidated financial statements.

 

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ITEM 2—MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and the related notes that appear elsewhere in this Form 10-Q. These discussions contain forward-looking statements reflecting our current expectations that involve risks and uncertainties. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue” or the negative of these terms or other comparable terminology. Forward-looking statements include, but are not limited to: demand for and future revenues from the sale of consumer electronics products incorporating our technologies, including traditional and next–generation DVD players; growth opportunities in the consumer electronics market; opportunities to incorporate our technologies in markets outside the traditional consumer electronics market or to deliver technology solutions in areas beyond sound; the impact of inclusion of certain of our technologies in audio standards; the rate of adoption of and sales of next–generation DVD players; diversification of sources of licensing revenue; demand for and future revenues from incorporation of our technologies in personal computers; increase in sales of our products and demand for consumer electronics products containing our technologies in emerging economies; concentration of manufacturing of consumer electronic products containing our technologies in emerging economies and the associated challenges in royalty collection and intellectual property enforcement; our ability to scale our organization and effectively apply our strategy across our markets; pricing strategies for our digital cinema product and competitive pricing pressures for our cinema products; the pace of the movie industry’s transition to digital cinema and our expected revenue associated with the transition; the expected timing of revenue and cost recognition for a number of digital cinema systems; our expected licensing, product sales and product services gross margins; our expected selling, general and administrative expenses and research and development expenses for the remaining quarter of fiscal 2007; our expected effective tax rate for the remaining quarter of fiscal 2007; our critical accounting policies, including those regarding revenue recognition, allowance for doubtful accounts, accounting for goodwill, accounting for income taxes, personal holding company matters and stock-based compensation; calculations of royalties due to our licensors; statements regarding the sufficiency of our cash reserves; and our expected rate of return on investments. Actual results may differ materially from those discussed in these forward-looking statements due to a number of factors, including: the rate of growth of the markets for consumer electronics that include our technologies; whether PC manufacturers will continue to include DVD software applications on personal computers that include Windows Vista Home Premium Edition or Ultimate Edition; whether sales of personal computers with the Home Premium Edition or the Ultimate Edition will be strong; whether our technologies are selected for and remain part of audio standards; the rate of deployment and adoption of next–generation DVD players; the extent to which our expectations regarding new licensing markets are realized; the extent to which consumer electronics manufacturers concentrate their production in emerging economies that present royalty collection and intellectual property enforcement challenges; the extent to which consumers in emerging economies elect to purchase products containing our technologies; the effectiveness of our transition to a functional organizational model; the extent to which professionals using our equipment continue to demand innovative technology solutions developed by us; the pace of the movie industry’s transition to digital cinema; our ability to tailor our traditional model of selling to respond to market trends; whether our competitors are able to develop and sell alternative digital cinema technologies to our customers; the accuracy of our identification of critical accounting policies and the accuracy of the assumptions we make in implementing such policies; the accuracy of our estimates regarding our taxable income and cash needs for the next twelve months; the accuracy of our calculations of royalties due to our licensors; fluctuations in interest rates; and risks set forth in the section entitled “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q and elsewhere in this filing. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these forward-looking statements. We are under no duty to update any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q to conform our prior statements to actual results. The periods presented herein consist of our first quarters of fiscal 2007 and 2008. Our fiscal quarter periods ended December 29, 2006 and December 28, 2007, both consisted of 13 weeks. Our 2008 fiscal year consists of 52 weeks and ends on September 26, 2008. The results for the fiscal quarter ended December 28, 2007 are not necessarily indicative of the results to be expected for any subsequent quarterly or annual financial period, including the fiscal year ending September 26, 2008.

 

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Overview

Dolby Laboratories develops and delivers innovative products and technologies that improve the entertainment experience. Since Ray Dolby founded Dolby Laboratories in 1965, we have been at the forefront of delivering sound technologies that are employed throughout the entertainment creation, distribution and playback process to enhance the entertainment experience. Today, Dolby technologies are standard in a wide range of entertainment platforms. Our technologies are used in virtually all DVD players and personal computer DVD playback software, increasingly in digital televisions and portable electronic devices, and also in a wide array of consumer electronic products such as gaming systems, audio/video receivers and mobile devices. Dolby cinema products are used in movie theatres around the world. Dolby broadcast products distribute high-quality audio around the world.

Our objective is to be an essential element in the best entertainment technologies by delivering innovative and enduring technologies that enrich the entertainment experience. We believe that our well-recognized brand and established history of successful innovation put us in a position to expand the use of our technologies in existing and new markets and to capitalize on key trends in digital entertainment, such as the transition to high-definition television, digital cinema, space-efficient home theatre systems, portable media and an increasing number of media delivery channels.

We deliver technologies, products, and services at each critical stage of the entertainment chain—content creation, content distribution and content playback. We work closely with content creators, including filmmakers, television producers, music producers, and video-game designers to incorporate Dolby technologies in entertainment content. As a result, we believe we are well positioned to work with entertainment distributors to deliver that content with our technologies, whether through 35 millimeter film or digital content for theatres, DVDs, broadcasts or the internet. By working successfully to encode and distribute content with Dolby technologies, we are able to license our decoding technologies to consumer electronics manufacturers and independent software vendors for consumer playback and sell our cinema equipment for large-scale public playback in movie theatres. Our involvement across the entertainment chain has resulted in a globally recognized brand and enables us to introduce technologies and services into new areas.

We are a global organization. We operate as a single reportable segment on an enterprise-wide basis. We generate revenue by licensing our technologies to manufacturers of consumer electronics products and independent software vendors, and selling our professional products and related services to entertainment content creators, producers, and distributors. We have licensed our technologies to manufacturers in approximately 35 countries and our licensees distribute products incorporating our technologies throughout the world. We sell our products and services in over 50 countries. In fiscal 2006, fiscal 2007 and the first quarter of fiscal 2008 revenue from outside the United States was 74%, 70% and 69% of our total revenue, respectively.

Opportunities, Challenges and Risks

Licensing revenue constitutes the majority of our total revenue, representing 77%, 80% and 82% of total revenue in fiscal 2006, fiscal 2007 and the first quarter of fiscal 2008, respectively. We categorize our licensing revenue into the following markets:

 

   

Consumer electronics (CE) market – primarily comprised of DVD players, DVD recorders, audio/video receivers and home-theatres-in-a-box.

 

   

Personal computer (PC) market – primarily comprised of software DVD players and DVD authoring applications.

 

   

Broadcast market – primarily comprised of televisions and television set-top boxes.

 

   

Gaming market – primarily comprised of video-game consoles.

 

   

Mobile – primarily comprised of mobile phones.

 

   

Automotive market – comprised of in-car entertainment products.

 

   

Licensing services – revenue from the administration of joint licensing programs.

 

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Historically, the consumer electronics market, which is driven primarily by revenue attributable to sales of DVD players, has been our largest market, generating just over 50% of our licensing revenue in fiscal 2005, approximately 45% in fiscal 2006, and just under 40% in fiscal 2007. The decrease in the consumer electronics market as a percentage of total licensing revenue has been due to faster revenue growth in our other markets, primarily the PC and broadcast markets. We expect next-generation DVD players for high-definition content to be a growth opportunity in the consumer electronics market. Dolby Digital has been selected as a mandatory audio standard and Dolby Digital Plus and Dolby TrueHD have been selected as optional audio standards in the Blu-ray Disc format. Our Dolby Digital, Dolby Digital Plus and Dolby TrueHD technologies have been selected as mandatory audio standards in the High-Definition Digital Versatile Disc (HD-DVD) format. The release and consumer adoption of next-generation DVD players has been slower than expected due, in part, to the competing HD-DVD and Blu-ray Disc formats. Consequently, our ability to generate significant royalties from the incorporation of our technology in next-generation DVD players has been delayed. Even assuming resolution of the competing disc format conflict, the rate of consumer adoption of next-generation DVD players is uncertain and may be slower than past growth rates of traditional DVD players.

We are continuing to diversify our sources of licensing revenue by actively promoting the incorporation of our technologies for use in growing markets outside of our consumer electronics market, such as PC, broadcast, gaming, mobile and automotive. As a result, while revenue from our consumer electronics market increased in fiscal 2007, it decreased as a percentage of our licensing revenue compared to fiscal 2006 and we expect this trend to continue in fiscal 2008. Any future growth in the PC, broadcast, gaming, mobile and automotive markets may not fully offset a potential decline in the growth of revenue generated from our consumer electronics market.

The personal computing market, which represented over 25% of our licensing revenue in fiscal 2005, just over 30% in fiscal 2006, and approximately 35% in fiscal 2007, has been primarily driven by sales of software DVD players and to a lesser extent, DVD authoring applications. Historically, PC manufacturers have frequently included DVD playback functionality as part of the software applications included in their products. In fiscal 2007, Microsoft introduced its Windows Vista operating system. Two of the six editions of this operating system, the Windows Vista Home Premium Edition and the Windows Vista Ultimate Edition, include Dolby technologies which help enable DVD playback functionality and DVD authoring capabilities. Since shipments of Windows Vista began in February 2007, sales of personal computers for the consumer market offered with the Home Premium Edition have been strong. In addition, many major PC manufacturers continue to include additional branded software applications with DVD playback capabilities and other features which were not provided in the Microsoft operating systems. This contributed to an increase in licensing revenue from our PC market in fiscal 2007 and the first quarter of fiscal 2008. In the future, PC manufacturers may elect to exclude additional DVD software applications on personal computers that include the Windows Vista Home Premium Edition or Windows Vista Ultimate Edition. Additionally, it is unclear at what pace business customers will migrate from their current operating systems to the Windows Vista operating systems and how such adoption will impact sales of software DVD players for business PCs. Additionally, through our PC Entertainment Experience, we are licensing a greater number of our technologies into entertainment-oriented PCs.

The broadcast market, which is primarily driven by demand for Dolby Digital in televisions and set-top boxes, represented approximately 10% of our licensing revenue in fiscal 2005, just over 10% in fiscal 2006 and just over 15% in fiscal 2007. The broadcast market has benefited from the transition from analog televisions to digital televisions, including high-definition televisions (HDTV). We expect this trend to continue, and as a result, we expect revenue from our broadcast market to increase as a percentage of licensing revenue in fiscal 2008.

Revenue generated from the gaming and automotive market has primarily been driven by sales of video-game consoles and in-car entertainment systems with Dolby Digital and ATRAC technology. Revenue generated by our licensing services market has primarily been driven by demand for MPEG 4 audio and MPEG 2 audio technologies used in portable music devices.

We have also introduced new technologies, including Dolby Volume, and high-dynamic range image technologies, Dolby Contrast and Dolby Vision. Our Dolby Volume technology controls the loudness of audio playback to provide a constant volume level, while maintaining the integrity of the signal. Dolby Contrast provides enhanced contrast, while Dolby Vision combines enhanced contrast with extended brightness and dynamic range for LCD televisions with LED backlighting technology. We do not anticipate generating significant revenue from these technologies in fiscal 2008.

 

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In the first quarter of fiscal 2008 we acquired all of the outstanding equity interests of Coding Technologies, a privately held provider of audio compression technologies for the mobile, digital broadcast and internet markets. We believe the acquisition of Coding Technologies will increase our presence in the mobile, broadcast, digital radio, and digital music download markets, though there is no guarantee that this will have a significant impact in fiscal 2008. Our ability to capitalize on the acquisition is subject to risks and uncertainties including the possibility that anticipated benefits may not be realized, integration risks, shifts in customer demand, and technology risks.

Our technologies are incorporated in consumer electronics and digital entertainment products throughout the world. We expect that sales of products incorporating our technologies in emerging economies, such as China and India, will increase in the future as consumers in these geographical markets have more disposable income available to purchase entertainment products, although there can be no assurance that this will occur. We also expect that manufacturers from lower-cost manufacturing countries, including China, will increase production of consumer electronics and digital entertainment products in the future to satisfy increased demand. Associated with opportunities of doing business in these emerging economies, such as China, are unique risks that have and will continue to affect our operating results, such as manufacturers failing to report or underreporting product shipments. In an effort to better serve our licensees and address these risks we have expanded our presence in Asia, with additional offices in Taiwan, Shenzhen and Seoul and a product testing center in the Shanghai Waigaoqiao Free Trade Zone.

Product sales consists of revenue from the sale of equipment to cinema operators, broadcasters and concert venues, representing 17%, 14% and 13% of total revenue in fiscal 2006, fiscal 2007 and the first quarter of fiscal 2008, respectively.

Our cinema products, which represented approximately 79% of product sales in fiscal 2005, 75% of product sales in fiscal 2006, and 71% of product sales in fiscal 2007, are primarily used to read and decode film soundtracks, calibrate cinema sound systems and to adapt analog cinema audio systems into digital audio formats. In addition, our digital cinema products load, store, decrypt and decode digital film files for presentation on a digital projector, as well as provide 3D capabilities. Sales of our cinema products and services tend to fluctuate based on the underlying trends in the motion picture industry. A significant trend in the cinema industry is the adoption of digital cinema. Digital cinema offers the motion picture industry possible means to achieve substantial cost savings in printing and distributing movies, to combat piracy, and to enable movies to be played repeatedly without degradation in image and audio quality. In fiscal 2005, we introduced our Dolby Digital Cinema system, which allows for the storage and playback of digital content and in fiscal 2007 we introduced Dolby 3D Digital Cinema technology, which delivers a 3D experience when combined with an exhibitor’s existing digital cinema system. Although the cinema industry is still in the early stages of adoption of digital cinema, the number of exhibitors adopting digital cinema for new theatre construction or existing theatre upgrades continues to grow. We expect that exhibitors constructing new theatres or upgrading existing theatres will generally choose digital cinema over traditional film cinema. We have made significant investments in our digital cinema initiative, and if our digital cinema systems are not widely deployed, our future prospects in digital cinema will be limited and our business could be materially and adversely affected. A number of competitors offer competing products for digital cinema, some of which are priced lower than our products. At least one competitor has a significantly greater installed base of its competing digital cinema products than we do, which could limit our eventual share of the digital cinema product market. As the market for digital cinema has grown we have faced more competitive pricing pressures than we have traditionally experienced for cinema products. As a result, we have had to implement pricing strategies which will have an adverse impact on our product sales gross margins in the future. In addition, digital cinema is based on open standards, which unlike traditional cinema, does not include our proprietary audio formats. As the film industry continues to adopt digital cinema, if we do not adapt our traditional cinema products and services to meet the demands of the digital cinema market, the demand for them will decline.

Our broadcast products, which represented approximately 17% of product sales in fiscal 2005, 21% of product sales in fiscal 2006, and 23% of product sales in fiscal 2007, are used to encode, transmit, and decode multiple channels of high-quality audio for DTV and HDTV program production and broadcast distribution and to measure the subjective loudness of audio content within broadcast programming. In recent years, growth in consumer demand for high-quality television content has increased the demand from broadcasters to deliver more content in Dolby Digital 5.1 surround sound, which has positively affected sales of our professional broadcast products.

Our services revenue, which represented 6%, 6% and 5% of total revenue in fiscal 2006, fiscal 2007 and the first quarter of fiscal 2008, respectively, is primarily tied to the motion picture production industry and, in particular, to the number of films being made by studios and independent filmmakers. The number of films that are produced

 

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can be affected by a number of factors, including strikes and work-stoppages within the motion picture industry as well as by the tax incentive arrangements that many foreign governments provide filmmakers to promote local filmmaking.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. The preparation of these financial statements in accordance with U.S. GAAP requires us to utilize accounting policies and make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies as of the date of the financial statements and the reported amounts of revenue and expenses during a fiscal period. The SEC considers an accounting policy to be critical if it is both important to a company’s financial condition and results of operations and it requires significant judgment and estimates on the part of management in its application. We have discussed the selection and development of the critical accounting policies with the audit committee of our board of directors, and the audit committee has reviewed our related disclosures in this Quarterly Report on Form 10-Q. Although we believe that our judgments and estimates are appropriate and correct, actual results may differ from those estimates.

The following are our critical accounting policies because we believe they are both important to the portrayal of our financial condition and results of operations and require critical management judgments and estimates about matters that are uncertain. If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operation for future periods could be materially affected. See “Risk Factors” for certain matters bearing risks on our future results of operations.

Revenue Recognition

We evaluate revenue recognition for transactions to license technologies, trademarks and know how, and to sell products and services using the criteria set forth by the SEC in Staff Accounting Bulletin 104, Revenue Recognition (SAB 104). For revenue transactions that involve software or software-related products, such as fees we earn from integrated software vendors (ISVs), certain product sales with software elements and certain other transactions, we recognize revenue under the guidance established by Statement of Position No. 97-2, Software Revenue Recognition (SOP 97-2). Both SAB 104 and SOP 97-2 state that revenue is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price to the buyer is fixed or determinable, and collectibility is probable. Judgment is required to assess whether collectibility is probable. We determine collectibility based on an evaluation of our customer’s recent payment history, the existence of a standby letter-of-credit between the customer’s financial institution and our financial institution, or an alternative credit evaluation.

The application of SOP 97–2 requires judgment, including whether the software element included with a hardware product is more-than-incidental to the hardware, whether a software arrangement includes multiple elements, and if so, whether vendor–specific objective evidence (VSOE) of fair value exists for those elements. For some of our arrangements, customers receive certain elements of the arrangement over a period of time or after delivery of the initial product. These elements may include support and maintenance and/or the right to receive product upgrades. The fair value of these elements is recognized over the estimated period for which these elements will be delivered, which is sometimes the estimated life of the product. If we do not have VSOE of fair value of any undelivered element included in a multiple-element arrangement containing software, we defer revenue until all elements are delivered and/or services have been performed, or until we have VSOE of fair value of all remaining undelivered elements. When the undelivered element is support, if we do not have fair value for the support element, revenue for the entire arrangement is bundled and recognized ratably over the support period.

 

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Goodwill

We account for goodwill in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142). As required by SFAS 142, we perform an impairment test on recorded goodwill by comparing the estimated fair value of each of our reporting units to the carrying value of the assets and liabilities of each unit, including goodwill. The fair value of each of our reporting units is determined by using a discounted cash-flow model which considers a number of factors, including estimated future cash-flows, risks facing us and our current market capitalization. If the carrying value of the assets and liabilities of the reporting units, including goodwill, were to exceed our estimation of the fair value of the reporting units, we would record an impairment charge in an amount equal to the excess of the carrying value of goodwill over the implied fair value of the goodwill. We use judgment in determining the estimated fair value of our reporting units, which include making assumptions of our future cash flows for each reporting unit. Our fiscal 2008 impairment test of goodwill will be performed in the third quarter of fiscal 2008. Fluctuations in our fair value, which may result from changes in economic conditions, our results of operations and other factors, relative to the carrying value, could result in impairment charges in future periods. We are currently evaluating whether the acquisition of Coding Technologies will result in an additional reporting unit or will be aggregated with any of our existing reporting units.

Accounting for Income Taxes

In preparing our consolidated financial statements, we are required to make estimates and judgments that affect our accounting for income taxes. This process includes estimating actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences, including differences in the timing of recognition of stock-based compensation expense, result in deferred tax assets and liabilities, which are included in our consolidated balance sheets. We also assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent that we believe that recovery is not likely, we have established a valuation allowance.

In the first quarter of fiscal 2008 we adopted the provisions of FIN 48. FIN 48 addresses the accounting for and disclosure of uncertainties in income tax positions by prescribing a minimum recognition threshold that a tax position is required to satisfy before being recognized in the financial statements. Our policy to include interest and penalties related to gross unrecognized tax benefits within our provision for income taxes did not change upon the adoption of FIN 48.

Significant judgment is required in determining the provision for income taxes, deferred tax assets and liabilities, the valuation allowance against our deferred tax assets and uncertainties in income tax positions. Our financial position and results of operations may be materially impacted if actual results significantly differ from these estimates or the estimates are adjusted in future periods.

Personal Holding Company Tax Matters. For United States federal income tax purposes, a corporation is generally considered to be a “personal holding company” under the United States Internal Revenue Code if (i) at any time during the last half of its taxable year more than 50% of its stock by value is owned, directly or indirectly, by virtue of the application of certain stock ownership attribution rules set forth in the Internal Revenue Code for purposes of applying the personal holding company rules, by five or fewer individuals and (ii) at least 60% of its adjusted ordinary gross income, as defined for United States federal income tax purposes, is “personal holding company income.” Personal holding company income is generally passive income, including royalty income, subject to certain exceptions such as qualifying software royalties. A personal holding company is subject to an additional tax on its undistributed after-tax income, calculated at the statutory tax rate, which is currently 15%. Since the personal holding company tax is imposed only on undistributed income, a personal holding company can avoid or mitigate liability for the tax, but not interest or penalties, by paying a dividend to its stockholders.

During the first quarter of fiscal 2008, more than 50% of the value of our stock was held by Ray Dolby and stockholders considered affiliated with him pursuant to the stock ownership attribution rules applicable to personal holding companies. We expect this will continue to be the case in the foreseeable future. In addition, a significant portion of our income is from licensing fees, which may constitute personal holding company income. We are reviewing the characterization of our licensing fees to determine if we may meet the exception to the personal holding company test due to royalties from computer software. Currently, however, we believe less than 60% of Dolby Laboratories’ adjusted ordinary gross income is personal holding company income. Given our current sources of revenue, we believe that neither we nor any of our subsidiaries is currently liable for personal holding company tax.

 

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Stock-Based Compensation

We account for stock-based compensation under the provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (SFAS 123R). SFAS 123R requires measurement of all employee stock-based compensation awards using a fair-value method and recording of such expense in the consolidated financial statements over the requisite service period. We utilize a Black-Scholes option pricing model to determine the fair value of employee stock options at the date of grant. To determine the fair value of a stock-based award using the Black-Scholes option pricing model requires that we make certain assumptions regarding the expected term of the award, the expected future volatility of our stock price over the expected term of the award and the risk-free interest rate over the expected term. We develop our assumptions for the Black-Scholes pricing model in accordance with guidelines set forth by the SEC in Staff Accounting Bulleting No. 107, Share-Based Payment (SAB 107). We estimate the expected term of stock-based awards by evaluating historical exercise patterns of our employees and applying an assumption of future exercise patterns. We utilize the historical volatility of our common stock as an estimate of the expected volatility of our stock price over the expected term of the awards. We use an average interest rate based on U.S. Treasury instruments with terms consistent with the expected term of our awards to estimate the risk-free interest rate. The amount of stock-based compensation expense is reduced for estimated forfeitures based on historical experience as well as future expectations. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Results of Operations

Revenue

 

     Fiscal Quarter Ended     Change  
     December 29,
2006
    December 28,
2007
    $    %  
     ($ in thousands)  

Licensing

   $ 82,375     $ 122,430     $ 40,055    49 %

Percentage of total revenue

     79 %     82 %     

Product sales

     15,210       20,010       4,800    32 %

Percentage of total revenue

     14 %     13 %     

Services

     6,857       7,787       930    14 %

Percentage of total revenue

     7 %     5 %     
                             

Total revenue

   $ 104,442     $ 150,227     $ 45,785    44 %
                             

Licensing. The 49% increase in licensing revenue from the first quarter of fiscal 2007 to the first quarter of fiscal 2008 was due to increased revenue in all of our markets, most significantly from our personal computer and broadcast market. The increase in revenue from our PC market was primarily driven by continued growth in shipments of notebook computers and shipments of Microsoft Vista, in particular, the Microsoft Vista Home Premium and Ultimate Editions which contain Dolby technologies, as well as the continued inclusion of additional software DVD player applications by PC manufacturers. In fiscal 2007 Microsoft Vista did not contribute to our licensing revenue until our third fiscal quarter. In addition, growth in entertainment-oriented PCs contributed to increased revenue from our PC Entertainment Experience offering. The increase in revenue from our broadcast market has been driven by growth in sales of cable and satellite set-top boxes and digital televisions that incorporate our technologies. In the future, PC manufacturers may elect to exclude additional DVD software applications on PCs that include the Windows Vista Home Premium Edition or Windows Vista Ultimate Edition and sales growth of set-top boxes and digital televisions with our technologies may decline.

Product Sales. The 32% increase in our product sales revenue from the first quarter of fiscal 2007 to the first quarter of fiscal 2008 was primarily attributable to sales of our 3D cinema products which were introduced in late fiscal 2007. Sales of our broadcast products and traditional cinema products also increased from the first quarter of fiscal 2007 to the first quarter of fiscal 2008.

Services. The 14% increase in service revenue from the first quarter of fiscal 2007 to the first quarter of fiscal 2008 was primarily attributable to an increase in film services on original films.

 

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Gross Margin

 

     Fiscal Quarter Ended  
     December 29,
2006
    December 28,
2007
 

Licensing gross margin percentage

   91 %   97 %

Product sales margin percentage

   43 %   42 %

Production services gross margin percentage

   61 %   61 %
            

Total gross margin percentage

   82 %   88 %
            

Licensing Gross Margin. We license intellectual property to our customers that may be internally developed, acquired by us or licensed from other parties. Our cost of licensing consists principally of royalty obligations to third parties for the licensing of intellectual property rights that we sublicense as part of our licensing arrangements with our customers. Our cost of licensing also includes amortization expenses associated with purchased intangible assets.

In the fourth quarter of fiscal 2007, we determined that it was appropriate to cease accruing royalty expense related to an ongoing dispute with an unrelated patent licensor. As a result, our licensing gross margin was higher in the first quarter of fiscal 2008 than the first quarter of fiscal 2007. For further detail, see the discussion regarding accrued liabilities in Note 2 in the notes to our financial statements. The increase in licensing gross margin was partially offset by approximately 1% due to amortization of intangible assets that were acquired as part of the acquisition of Coding Technologies in the first quarter of fiscal 2008. We expect our licensing gross margin to be approximately 96% for fiscal 2008.

Product Sales Gross Margin. Cost of product sales primarily consists of material costs related to the products sold, applied labor and manufacturing overhead and, to a lesser extent, amortization of certain intangible assets. The decrease in product sales gross margin from the first quarter of fiscal 2007 to the first quarter of fiscal 2008 was primarily due to the increase in sales of our 3D cinema products, specifically 3D glasses, which have lower margins than our other products.

Upon satisfying certain obligations, we expect to recognize revenue and associated costs related to a number of digital cinema systems that are currently deferred. We currently expect to recognize these transactions in the second half of fiscal 2008, and we expect that upon the eventual recognition, our product sales gross margins will be adversely impacted because these products were sold at a significantly lower margin than our other products.

Services Gross Margin. Cost of services primarily consists of the payroll and benefits costs of employees performing our professional services, the cost of outside consultants and reimbursable expenses incurred on behalf of customers. Services gross margin was relatively consistent from the first quarter of fiscal 2007 to the first quarter of fiscal 2008.

Operating Expenses

 

     Fiscal Quarter Ended     Change  
     December 29,
2006
    December 28,
2007
    $    %  
     ($ in thousands)  

Selling, general and administrative

   $ 37,311     $ 50,986     $ 13,675    37 %

Percentage of total revenue

     36 %     34 %     

Research and development

     8,836       13,907       5,071    57 %

Percentage of total revenue

     8 %     9 %     
                             

Total operating expenses

   $ 46,147     $ 64,893     $ 18,746    41 %
                             

Selling, General and Administrative. Selling, general and administrative expense consists primarily of personnel and personnel-related expenses, professional service fees and facility costs for our sales, marketing and administrative functions. The 37% increase in selling, general and administrative expenses from the first quarter of

 

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fiscal 2007 to the first quarter of fiscal 2008 was primarily due to an increase in personnel expenses and related occupancy and travel expenses. These increases were primarily driven by increases in headcount, bonus expense and annual pay increases for existing employees. Selling, general and administrative expenses also increased due to increases in depreciation and amortization and professional consulting fees. Amortization expense increased due to increased intangible assets acquired from Brightside Technologies, Inc. (Brightside) in April 2007 and Coding Technologies in November 2007. Professional consulting fees increased primarily due to increases in tax advisory services and legal services.

Research and Development. Research and development expense consists primarily of compensation and benefits related costs for personnel responsible for the research and development of new technologies and products. The 57% increase in research and development expense from the first quarter of fiscal 2007 to the first quarter of fiscal 2008 was primarily driven by an increase in personnel expenses due to an increase in headcount, largely attributable to the acquisitions of Brightside and Coding Technologies, as well as increases in bonus expense and annual pay increases for existing employees.

Other Income, Net

 

     Fiscal Quarter Ended     Change  
     December 29,
2006
    December 28,
2007
    $     %  
     ($ in thousands)  

Interest income

   $ 6,086     $ 5,821     $ (265 )   (4 )%

Interest expense

     (453 )     (363 )     90     20 %

Other income (expense), net

     (206 )     (254 )     (48 )   (23 )%
                              

Other income, net

   $ 5,427     $ 5,204     $ (223 )   (4 )%
                              

Other income, net, primarily consists of interest income earned on cash, cash equivalent and investment balances, offset by interest expense on outstanding balances on our facility debt obligations. Also included are gains and losses on foreign currency transactions. The decrease in other income, net, of 4% from the first quarter of fiscal 2007 to the first quarter of fiscal 2008 was primarily due to a decrease in interest income driven by lower investment balances as a result of the use of approximately $249 million in cash to acquire Coding Technologies in November 2007.

Income Taxes

 

     Fiscal Quarter Ended  
     December 29,
2006
    December 28,
2007
 

Income taxes:

    

Provision for income taxes

   $ 14,452     $ 24,607  

Effective tax rate

     32 %     34 %

Our effective tax rate is based upon a projection of annual fiscal year results. Our effective tax rate in the first quarter of fiscal 2007 was 32%, compared to 34% for the first quarter of fiscal 2008. In fiscal 2007, a change in tax law reinstated research and development tax credits for periods prior to fiscal 2007. As a result, we recognized an increase in research and development tax credits in the first quarter of fiscal 2007 thereby lowering our effective tax rate. We did not recognize a similar benefit in the first quarter of fiscal 2008.

Liquidity and Capital Resources

The following table presents selected financial information for the fiscal quarters ended on the dates indicated:

 

     September 28,
2007
   December 28,
2007
     (in thousands)

Cash and cash equivalents

   $ 368,467    $ 280,246

Short-term investments

     231,217      200,727

Long-term investments

     73,224      29,301

Accounts receivable, net of allowance

     28,165      37,955

Accounts payable and accrued liabilities

     119,068      138,488

Working capital (a)

     590,214      455,612

 

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     December 29,
2006
    December 28,
2007
 
     (in thousands)  

Cash flows from operating activities (fiscal year-to-date)

   $ 47,165     $ 76,266  

Capital expenditures (fiscal year-to-date) (b)

     (1,798 )     (1,477 )

Acquisitions, net of acquired cash

     —         (248,715 )

Cash flows from investing activities (fiscal year-to-date)

     (64,422 )     (175,830 )

Cash flows from financing activities (fiscal year-to-date)

     12,430       11,569  

 

(a) Working capital consists of total current assets less total current liabilities.

 

(b) Capital expenditures primarily consist of purchases of office equipment, building fixtures, computer hardware and software, leasehold improvements and production and test equipment.

As of December 28, 2007, we had cash and cash equivalents of $280.2 million, compared to $368.5 million at September 28, 2007. In addition, at December 28, 2007 we had short-term and long-term investments of $230.0 million, compared to $304.4 million at September 28, 2007. We believe that our cash, cash equivalents and potential cash flows from operations will be sufficient to satisfy our currently anticipated cash requirements through at least the next 12 months

Cash flows from operating activities were $76.3 million in the first quarter of fiscal 2008, compared to $47.2 million in the first quarter of fiscal 2007. Cash flows from operating activities consisted of net income adjusted for certain non-cash items, including stock-based compensation, depreciation and amortization, and the effect of changes in working capital and other operating activities. Cash flows from operating activities for the first quarter of fiscal 2008 were primarily driven by net income of $47.7 million. Adjustments for non-cash items included stock-based compensation expense of $5.5 million and depreciation and amortization expense of $5.2 million, partially offset by an increase in deferred taxes of $7.0 million. Changes in working capital were primarily driven by increases of $17.7 million in income taxes, net, $10.4 million in accounts payable and accrued liabilities and $4.7 million in deferred revenue, partially offset by increases in assets of $8.9 million.

Cash flows from investing activities for the first quarter of fiscal 2008 were primarily driven by the acquisition of Coding Technologies for approximately $248.7 million, net of acquired cash, partially offset by sales of available-for-sale securities of $74.4 million, net of purchases. Capital expenditures were $1.5 million in the first quarter of fiscal 2008.

Cash flows from financing activities were $11.6 million in the first quarter of fiscal 2008. Cash flows from financing activities were primarily driven by proceeds and excess tax benefits from the exercise of stock options.

A significant portion of our investment portfolio is comprised of tax-exempt securities, such as money market funds, auction rate certificates, variable rate demand notes, and municipal debt securities. Our securities have limited or no direct exposure to the sub-prime credit markets which have experienced recent losses. We did not recognize any losses on impairment of our investment securities in the first quarter of fiscal 2008.

Contractual Obligations and Commitments

The following table presents a summary of our contractual obligations and commitments as of December 28, 2007:

 

     Payments Due by Period
     Remainder of
Fiscal 2008
   Fiscal 2009
to 2010
   Fiscal 2011
to 2012
   After Fiscal
2012
   Total
     (in thousands)

Long-term debt (1)

   $ 1,171    $ 3,346    $ 3,729    $ 2,534    $ 10,780

Operating leases (2)

     3,974      9,936      9,677      10,457      34,044

Payments on litigation settlement (3)

     3,000      6,000      3,000      —        12,000
                                  

Total

   $ 8,145    $ 19,282    $ 16,406    $ 12,991    $ 56,824
                                  

 

(1) We maintain three term loans through our consolidated affiliates Dolby Properties, LLC, Dolby Properties Burbank, LLC and Dolby Properties United Kingdom, LLC, for financing commercial and real property at various locations in which we are the primary tenant.

 

(2) Operating lease payments include future minimum rental commitments, including those payable to our principal stockholder, for non-cancelable operating leases of office space as of December 28, 2007.

 

(3) In April 2002, we settled a dispute with an unrelated third party and agreed to pay a total of $30.0 million in ten equal annual installments of $3.0 million per year beginning in June 2002. See Note 6 “Legal Proceedings” for further discussion.

 

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Other Cash Obligations. Under the terms of the agreement to acquire all outstanding shares of our subsidiary, Cinea in September 2003, we have future payment obligations that equal approximately 5% to 8% of the revenue generated from products incorporating certain technologies we acquired in the transaction though 2022. As of December 28, 2007, no additional purchase consideration had been paid and no liability is reflected on our balance sheet.

As of December 28, 2007, we were unable to make a reasonably reliable estimate of when cash settlement with a taxing authority may occur in relation to the unrecognized tax benefits.

 

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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Sensitivity

Cash, Cash Equivalents and Investments. As of December 28, 2007, we had cash and cash equivalents of $280.2 million, which consisted of cash and highly-liquid money market funds. In addition, we had short-term and long-term investments of $230.0 million, which consisted primarily of auction rate certificates, United States government agency securities, variable rate demand notes, and municipal debt with original maturities greater than 90 days. Many of these investments are subject to fluctuations in interest rates, which could impact our results. At December 28, 2007 the average investment maturity of our investment portfolio was less than six months. Based on our investment portfolio balance as of December 28, 2007, a hypothetical change in interest rates of 1% would have approximately a $0.7 million impact, and a change of 0.5% would have approximately a $0.3 million impact on the carrying value of our portfolio. Furthermore, a hypothetical change in interest rates of 1% would have approximately a $3.8 million impact, and a change of 0.5% would have approximately a $1.9 million impact on interest income over a one-year period.

We do not utilize financial instruments for trading or other speculative purposes, nor do we utilize leveraged financial instruments.

Foreign Currency Exchange Risk

We maintain sales, marketing and business operations in foreign countries, most significantly in the United Kingdom, as well as Germany and Sweden as a result of our acquisition of Coding Technologies. Consequently, we have exposure to adverse changes in exchange rates associated with our foreign business operations. While the majority of our revenue is derived from transactions denominated in United States dollars, nearly all of our costs from our foreign operations are derived from transactions denominated in the functional currency of that foreign location. As a result, our operating income is subject to exposure from changes in exchange rates. The average exchange rate in fiscal 2006 was approximately 1.8 United States dollars for one British pound sterling, compared to 2.0 United States dollars for one British pound sterling in fiscal 2007. The average exchange rate in fiscal 2006 was approximately 0.75 United States dollars for one Australian dollar, compared to 0.81 United States dollars for one Australian dollar in fiscal 2007. We estimate that the decrease in the value of the United States dollar during fiscal 2007, primarily relative to the British pound sterling and the Australian dollar, decreased our operating income by approximately $2.7 million. In addition, we are in the process of expanding our foreign operations, which could increase our exposure to changes in foreign currency exchange rates. As a result of our acquisition of Coding Technologies, we have additional exposure to foreign currency risk, as a large portion of Coding Technologies’ transactions are denominated in Euros.

 

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ITEM 4 – CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We maintain “disclosure controls and procedures,” as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Subject to the limitations noted above, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the fiscal period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective to meet the objective for which they were designed and operate at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the fiscal quarter ended December 28, 2007, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are involved in various legal proceedings from time to time arising from the normal course of business activities, including claims of alleged infringement of intellectual property rights, commercial, employment and other matters. In our opinion, resolution of these proceedings is not expected to have a material adverse effect on our operating results or financial condition. However, it is possible that an unfavorable resolution of one or more such proceedings could materially affect our future operating results or financial condition in a particular period.

ITEM 1A. RISK FACTORS

A restated description of the risk factors associated with our business is set forth below. This description includes any material changes to and supersedes the description of the risk factors associated with our business previously disclosed in Part I, Item 1A of our Annual Report on Form 10–K for our fiscal year ended September 28, 2007. The following risk factors and other information included in this Quarterly Report on Form 10-Q should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we presently deem less significant may also impair our business operations. If any of the following risks actually occur, our business, operating results and financial condition could be materially adversely affected.

Our business and prospects depend on the strength of our brand, and if we do not maintain and strengthen our brand, our business will be materially harmed.

Maintaining and strengthening the “Dolby” brand is critical to maintaining and expanding our licensing, products and services, as well as to our ability to enter new markets for our sound and other technologies. Our continued success depends, in part, on our reputation for providing high quality products, services and technologies across a wide range of entertainment industries, including the consumer electronics products industry. If we fail to promote and maintain the Dolby brand successfully in licensing, products or services, our business and prospects will suffer. Moreover, we believe that the likelihood that our technologies will be adopted as industry standards in various markets and for various applications depends, in part, upon the strength of our brand, because professional organizations and industry participants are more likely to accept, as an industry standard, technologies developed by a well-respected and well-known brand. Maintaining and strengthening our brand will depend heavily on our ability to continue to develop innovative technologies for the entertainment industry and to continue to provide high quality products and services, which we may not do successfully.

We do not expect sales of traditional consumer DVD players to sustain their past growth rates. To the extent that sales of DVD players and home theatre systems level off or decline, or alternative technologies in which we do not participate replace DVDs as a dominant medium for consumer video entertainment, our licensing revenue will be adversely affected.

Growth in our revenue over the past several years has been the result, in large part, of the rapid growth in sales of DVD players and home theatre systems incorporating our technologies. However, as the markets for DVD players mature, we do not expect sales of traditional consumer DVD players to sustain their past growth rates. To the extent that sales of DVD players and home theatre systems level off or decline, our licensing revenue will be adversely affected. Additionally, the release and consumer adoption of next-generation DVD players has been delayed. There are currently two incompatible next-generation high-definition disc formats, which has resulted in delayed consumer adoption of next-generation DVD players. The delay in the release and consumer adoption of a dominant next-generation disc format, as well as the inability of traditional DVD players to sustain their past growth rates, could adversely affect our licensing revenue. Even assuming resolution of the competing disc format conflict, the rate of consumer adoption of next-generation DVD players is uncertain and may be slower than past growth rates of traditional DVD players. In addition, if new technologies are developed for use with DVDs or new technologies are developed that substantially compete with or replace DVDs as a dominant medium for consumer video entertainment, and if we are unable to develop and successfully market technologies that are incorporated into or compatible with those new technologies, our business, operating results and prospects will be adversely affected.

 

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

We derive most of our revenue from the licensing of our technologies to consumer electronics product manufacturers. Licensing revenue represented 75%, 77% and 80% of our total revenue in fiscal 2005, 2006 and 2007, respectively. We do not manufacture consumer electronics products ourselves and our licensing revenue is dependent on sales by our licensees of products that incorporate our technologies. We cannot control these manufacturers’ product development or commercialization efforts or predict their success. In addition, our license agreements, which typically require manufacturers of consumer electronics products and independent software vendors to pay us a specified royalty for every electronics product shipped that incorporates our technologies, do not require these manufacturers to include our technologies in any specific number or percentage of units, and only a few of these agreements guarantee us a minimum aggregate licensing fee. Accordingly, if our licensees sell fewer products incorporating our technologies, or otherwise face significant economic difficulties, our revenue will decline. Moreover, we have a widespread presence in markets for electronics products, such as the consumer electronics product market, which includes DVD players, audio/video receivers and other home theatre consumer electronics products, and, as a result, there is little room for us to further penetrate such markets. Lower sales of products incorporating our technologies could occur for a number of reasons. Changes in consumer tastes or trends, or changes in industry standards, may adversely affect our licensing revenue. Increasing market saturation, durability of products in the marketplace, competing products and alternate consumer entertainment options could adversely affect demand for new products incorporating our technologies. An economic recession would adversely affect demand for products incorporating our technologies and likely adversely affect our licensing revenue. In addition, our licensees, for whatever reason, may not choose to or may not be able to incorporate our technologies into their products in the future.

To the extent that sales of personal computers with Dolby technologies level off or decline, our licensing revenue will be adversely affected.

Historically, PC manufacturers have frequently included DVD playback functionality as part of the software applications included in their products. Microsoft introduced its Windows Vista operating system in 2007. Two of the six editions of this operating system, the Windows Vista Home Premium Edition and the Windows Vista Ultimate Edition, include Dolby technologies which help enable DVD playback functionality and DVD authoring capabilities. To date, sales of personal computers for the consumer market shipped with the Home Premium Edition have been strong. In addition, many major PC manufacturers continue to include additional DVD software applications which offer added DVD functionality not included in the Microsoft operating systems. Also, shipments of notebooks with Dolby technologies, for which we have a better rate of royalty collection, have continued to increase. All of these factors have contributed to an increase in licensing revenue from our PC market. In the future, PC manufacturers may elect to exclude additional DVD software application on personal computers that include the Windows Vista Home Premium Edition. Additionally, it is unclear at what pace business customers will migrate from their current operating systems to the Windows Vista operating systems, what the adoption rate of the Ultimate Edition will be, and how such adoption will impact sales of software DVD players for business PCs. Future shipments of notebooks with Dolby technologies could decline. If any of the foregoing occur, our licensing revenue will be adversely affected.

Our future success depends, in part, upon the growth of new and existing markets for our technologies and our ability to develop and adapt our technologies for those markets. If those markets do not grow or we are not able to develop successful products for them, our business prospects could be limited.

We expect that the future growth of our licensing revenue will depend, in part, upon the growth of, and our successful participation in, new opportunities for our technologies, including:

 

   

Digital television and radio broadcasting;

 

   

HDTV;

 

   

Personal computer technology;

 

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Next-generation DVD;

 

   

Video-game consoles and video-games;

 

   

Imaging

 

   

Home DVD recording;

 

   

Personal audio and video players, including internet music applications;

 

   

Broadband internet;

 

   

Mobile devices; and

 

   

In-car entertainment systems.

Our ability to penetrate these markets depends on increased consumer demand for products that contain our technologies, which may not occur. Any failure of such markets to develop or consumer demand to grow would have a material adverse effect on our business and prospects. For example, in the PC market, equipment manufacturers are experiencing pricing pressure and, as a result, may elect to exclude optional DVD playback functionality from their products, thereby requiring an additional cost to add this capability, which may affect demand for our technologies. Whether our revenue from digital broadcast networks and broadband internet services increases depends upon the expansion of digital broadcast technologies and broadband internet as a medium of entertainment, which may not occur. In addition, even when our technologies are adopted as industry standards for a particular market, such market may not fully develop. In such case, our success depends not only on whether our technologies are adopted as industry standards for such market, but also on the development of that market, which may not occur. Demand for our technologies in any of these developing markets may not continue to grow, and a sufficiently broad base of consumers and professionals may not adopt or continue to use these technologies. In addition, our ability to generate revenue from these markets may be limited to the extent that service providers in these markets choose to provide select technologies and entertainment for little or no cost, such as many of the services provided in connection with broadband internet services. Moreover, some of these markets are ones in which we have not previously participated and, because of our limited experience, we may not be able to adequately adapt our business and our technologies to the needs of customers in these fields.

If we fail to deliver innovative technologies in response to changes in the entertainment industry, our business could decline.

The markets for our products and the markets for consumer electronics products using our licensed technologies are characterized by rapid change and technological evolution. We will need to expend considerable resources on research and development, or acquisitions, in the future in order to continue to design and deliver enduring, innovative entertainment products and technologies. Despite our efforts, we may not be able to develop, or acquire, and effectively market new products, technologies and services that adequately or competitively address the needs of the changing marketplace. For example, we cannot assure that Dolby Volume, Dolby’s new volume leveling solution designed to address the annoyances of inconsistent loudness, or Dolby 3D Digital Cinema, Dolby’s new 3D digital cinema solution, will address the needs of the marketplace, be effectively marketed or be successful technologies. In addition, we may not correctly identify new or changing market trends at an early enough stage to capitalize on market opportunities. At times such changes can be dramatic, such as the shift from VHS tapes to DVDs for consumer playback of movies in homes and elsewhere. Our future success depends to a great extent on our ability to develop, or acquire, and deliver innovative technologies that are widely adopted in response to changes in the entertainment industry and that are compatible with the technologies or products introduced by other entertainment industry participants.

If we are unable to expand our business into non-sound technologies, our future growth could be limited.

Our future growth will depend, in part, upon our expansion into areas beyond sound technologies. For example, in addition to our digital cinema initiative, we are exploring other areas that facilitate delivery of digital

 

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entertainment, such as technologies for processing digital moving images and content protection. We will need to spend considerable resources on research and development or acquisitions in the future in order to deliver innovative non-sound technologies. Our April 2007 acquisition of Brightside Technologies Inc., a development-stage technology company focused on enabling the capture, distribution, and display of more vibrant video on LED backlit LCD televisions, is an example of our efforts to expand into areas beyond sound technologies. However, we have limited experience in non-sound technology markets and, despite our efforts, we cannot predict whether we will be successful in developing, or acquiring and marketing non-sound products, technologies and services. We will face significant risks in successfully integrating businesses that we acquire, such as Brightside, into our business.

In addition, many of the non-sound technology markets are relatively new and may not develop as we currently anticipate. Moreover, although we believe that many of the technological advances we may develop or acquire for digital cinema may have applicability in other areas, such as broadcasting or consumer electronics products, we may not ever be able to achieve these anticipated benefits in these other markets. A number of competitors and potential competitors may develop non-sound technologies similar to those that we develop, or acquire, some of which may provide advantages over our products, technologies and services. Some of these competitors have much greater experience and expertise in the non-sound fields we may enter. The non-sound products, technologies and services we expect to market may not achieve or sustain market acceptance, may not meet industry needs, and may not be accepted as industry standards. If we are unsuccessful in selling non-sound products, technologies and services, the future growth of our business may be limited. In addition, our efforts to enter or strengthen our positions in non-sound markets may be tied to the success of specific programs.

General economic conditions may reduce our revenues and harm our business.

Our business is particularly exposed to adverse changes in general economic conditions, because products that incorporate our technologies are entertainment oriented and generally luxury goods. A slowdown or decline in U.S. or foreign economic growth may adversely affect consumer confidence, disposable income or spending. As a result, sales by our licensees of consumer electronics and other products incorporating our technologies may not grow as rapidly as in prior periods or may even decrease, which could adversely affect our licensing revenue. In addition, any slowdown in consumer spending may negatively impact the motion picture industry and cinema owners, which could result in decreased growth, or potentially a decrease, in product sales and services, which could adversely affect our revenue.

Our operating results may fluctuate depending upon the timing of when we receive royalty reports from our licensees and of the satisfaction of our revenue recognition criteria.

Our quarterly operating results may fluctuate depending upon the timing of when we receive royalty reports from our licensees and of the satisfaction of our revenue recognition criteria. We recognize license revenue only after we receive royalty reports from our licensees regarding the shipment of their products that incorporate our technologies. As a result, the timing of our revenue depends upon the timing of our receipt of those reports. In addition, it is not uncommon for royalty reports to include positive or negative corrective or retroactive royalties that cover extended periods of time. Furthermore, there have been times in the past when we have recognized an unusually large amount of licensing revenue from a licensee in a given quarter because not all of our revenue recognition criteria were met in prior periods. This can result in a large amount of licensing revenue from a licensee being recorded in a given quarter that is not necessarily indicative of the amounts of licensing revenue to be received from that licensee in future quarters, thus causing fluctuations in our operating results. For example, in the fourth quarter of fiscal 2006 and second quarter of fiscal 2007 we recognized approximately $6.7 million and $7.7 million, respectively, in licensing revenue from two separate licensees related to royalties on shipments in prior periods.

If our products and technologies fail to be adopted as industry standards, our business prospects could be limited and our operating results could be adversely affected.

The entertainment industry depends upon industry standards to ensure the compatibility of its content across a wide variety of entertainment systems and products. Accordingly, we make significant efforts to design our products and technologies to address capabilities, quality and cost considerations so that they either meet, or, more importantly, are adopted as, industry standards across the broad range of entertainment industry markets in which we participate, as well as the markets in which we hope to compete in the future, including digital cinema. To have our products and technologies adopted as industry standards, we must convince a broad spectrum of professional organizations throughout the world, as well as our major customers and licensees who are members of such organizations, to adopt them as such and to ensure that other industry standards are consistent with our products and

 

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technologies. If our technologies are not adopted or do not remain as industry standards, our business, operating results and prospects could be materially and adversely affected. We expect that meeting, maintaining and establishing industry standard technologies will continue to be critical to our business in the future. In addition, the market for broadcast technologies has traditionally been heavily based upon industry standards, often set by governments or other regulatory bodies, and we expect this to continue to be the case in the future. If our technologies are not chosen as industry standards for broadcasting in particular geographic areas, this could adversely affect our ability to compete in these markets.

It may be more difficult for us, in the future, to have our technologies adopted as individual industry standards to the extent that entertainment industry participants collaborate on the development of industry standard technologies.

Increasingly, standards-setting organizations are adopting or establishing technology standards for use in a wide range of consumer electronics products. As a result, it is more difficult for individual companies to have their technologies adopted wholesale as an informal industry standard. We call this type of standard a “de facto” industry standard, meaning that the standard is not explicitly mandated by any industry standards-setting body but is nonetheless widely adopted. In addition, increasingly there are a large number of companies, including ones that typically compete against one another, involved in the development of new technologies for use in consumer entertainment products. As a result, these companies often license their collective intellectual property rights as a group, making it more difficult for any single company to have its technologies adopted widely as a de facto industry standard or to have its technologies adopted as an exclusive, explicit industry standard for consumer electronics products.

Even if our technologies are adopted as an industry standard for a particular market, market participants may not widely adopt our technologies.

Even when a standards-setting body mandates our technologies for a particular market, which we call an “explicit” industry standard, our technologies may not be the sole technologies adopted for that market as an industry standard. Accordingly, our operating results depend upon participants in that market choosing to adopt our technologies instead of competitive technologies that also may be acceptable under such standard. For example, the continued growth of our revenue from the broadcast market will depend upon both the continued adoption of digital television generally and the choice to use our technologies where it is an optional industry standard.

Our licensing of industry standard technologies can be subject to limitations that could adversely affect our business and prospects.

When a standards-setting body mandates our technologies as explicit industry standards, we generally must agree to license such technologies on a fair, reasonable and non-discriminatory basis, which could limit our control over the use of these technologies. In these situations, we must often limit the royalty rates we charge for these technologies, which could adversely affect our gross margins. Furthermore, we may be unable to limit to whom we license such technologies, and may be unable to restrict many terms of the license. From time to time we may be subject to claims that our licenses of our industry standard technologies may not conform to the requirements of the standards-setting body. Private parties have raised this type of issue with us in the past. Allegations such as these could be asserted in private actions seeking monetary damages and injunctive relief, or in regulatory actions. Claimants in such cases could seek to restrict or change our licensing practices or our ability to license our technologies in ways that could injure our reputation and otherwise materially and adversely affect our business, operating results and prospects.

Third parties from whom we license technologies may challenge our calculation of the royalties we owe them for inclusion of their technologies in our products and licensed technologies, which could adversely affect our operating results, business and prospects.

In some cases, primarily in connection with the licensing of our Dolby Digital technologies, the products we sell and the technologies we license to our customers include intellectual property that we have licensed from third parties. Our agreements with these third parties generally require us to pay them royalties for that use, and give the third parties the right to audit our calculation of those royalties. A third party may disagree with our interpretation of the terms of a license agreement or, as a result of an audit, a third party could challenge the accuracy of our calculation. We are currently involved in a license agreement dispute with a third party patent licensor.

 

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A successful challenge by a third party could increase the amount of royalties we have to pay to the third party, decrease our gross margin and adversely affect our operating results. Such a challenge could result in the termination of the license agreement which would impair our ability to continue to use and re-license intellectual property from that third party which, in turn, could adversely affect our business and prospects.

Inaccurate licensee royalty reporting and unauthorized use of our intellectual property could materially adversely affect our operating results.

Our licensing revenue is generated primarily from consumer electronics product manufacturers and independent software vendors who license our technologies and incorporate them in their products. Under our existing arrangements, these licensees typically pay us a specified royalty for every product they ship that incorporates our technologies. We rely on our licensees to accurately report the number of units shipped that incorporate our technologies. We calculate our license fees, prepare our financial reports, projections and budgets, and direct our sales and product development efforts based on these reports we receive from our licensees. However, it is often difficult for us to independently determine whether or not our licensees are reporting shipments accurately. This is especially true with respect to software incorporating our technologies because software can be copied relatively easily and we often do not have easy ways to determine how many copies have been made. Most of our license agreements permit us to audit our licensees’ records, but audits are generally expensive and time consuming and initiating audits could harm our customer relationships. In the past, licensees, particularly in emerging economies, such as China, have understated or failed to report the number of products incorporating our technologies that they shipped, and we have not been able to collect and recognize revenue to which we were entitled. We expect that we will continue to experience understated and non-reporting by licensees, which could adversely affect our operating results. Conversely, to the extent that our licensees overstate the number of products incorporating our technologies, or report the products under the wrong categories, negative corrections could result in reductions of royalty revenue in subsequent periods. In addition, some of our licensees may begin to more closely scrutinize their past or future licensing statements which may result in an increased receipt of negative corrective statements.

We also have often experienced, and expect to continue to experience, problems with non-licensee consumer electronics product manufacturers and independent software vendors, particularly in emerging economies, such as China, incorporating our technologies or incorporating our technologies and trademarks into their products without our authorization and without paying us any licensing fees. This unauthorized use of our intellectual property could adversely affect our operating results.

We face risks in conducting business in emerging economies, such as China, particularly due to the limited recognition and enforcement of intellectual property and contractual rights in these countries.

We believe that various trends will continue to increase our exposure to the risks of conducting business in emerging economies. For example, we expect consumer electronics product manufacturing in emerging economies, such as China, to continue to increase due to the availability of lower manufacturing costs as compared to in other industrial countries and an industry shift by discount retailers towards lower-end DVD player offerings. We also believe that our sales of products and services in emerging economies will expand in the future to the extent that the use of digital surround sound technologies increases in these countries, including in movies and broadcast television. We further expect that the sale of products incorporating our technologies will increase in emerging economies to the extent that consumers there become more affluent. We face many risks associated with operating in these emerging economies, in large part, due to limited recognition and enforcement of contractual and intellectual property rights. As a result, we may experience difficulties in enforcing our intellectual property rights in these emerging economies, where intellectual property rights are not as respected as they are in the United States, Japan and Europe. We believe that it is critical that we strengthen existing relationships and develop new relationships with entertainment industry participants world-wide to increase our ability to enforce our intellectual property and contractual rights without relying solely on the legal systems in the countries in which we operate. If we are unable to develop, maintain and strengthen these relationships, our revenue from these countries could be adversely affected.

Our licensing revenue depends in large part upon semiconductor manufacturers incorporating our technologies into integrated circuits, or ICs, for sale to our electronics product licensees and if, for any reason, our technologies are not incorporated in these ICs or fewer ICs are sold that incorporate our technologies, our operating results would be adversely affected.

 

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Our licensing revenue from consumer electronics product manufacturers depends in large part upon the availability of integrated circuits, or ICs, that implement our technologies. IC manufacturers incorporate our technologies into these ICs, which are then incorporated in consumer electronics products. We do not manufacture these ICs, but rather depend on IC manufacturers to develop, produce and then sell them to licensed consumer electronics product manufacturers. We do not control the IC manufacturers’ decisions whether or not to incorporate our technologies into their ICs, and we do not control their product development or commercialization efforts nor predict their success. As a result, if these IC manufacturers are unable or unwilling, for any reason, to implement our technologies into their ICs, or if, for any reason, they sell fewer ICs incorporating our technologies, our operating results will be adversely affected. For example, we are not able to control the extent and timing of the incorporation of Dolby Volume into ICs by IC manufacturers.

Our inability to deploy our digital cinema products in significant numbers in the early stages of the transition to digital cinema, coupled with the price of our products, could limit our future prospects in the digital cinema market and could materially and adversely affect our business.

The cinema industry is still in the early stages of the adoption of digital cinema for the distribution and exhibition of movies. A number of competitors offer competing products for digital cinema, some of which are priced lower than our products. At least one competitor has a significantly greater installed base of its competing digital cinema products than we do, which could limit our eventual share of the digital cinema product market and materially and adversely affect our operating results. As the market for digital cinema has grown we have faced more competitive pricing pressures than we have traditionally experienced for cinema products. As a result, we may have to implement pricing strategies which will have an adverse impact on our product sales gross margins in the future.

If the market for digital cinema develops more slowly than expected, our future prospects could be limited and our business could be materially and adversely affected.

If the industry cannot agree on one or more business models for digital cinema, the broad adoption of digital cinema will be delayed further. The conversion of movie theatres from film to digital cinema will require significant expenditures, and we cannot predict how quickly digital cinema will become widely adopted. At present only a limited number of movie theatres have been converted to digital cinema, and we expect the conversion of theatres to digital cinema technologies, if it occurs, to be a long-term process due to both technological and financial obstacles. If the market for digital cinema develops more slowly than expected, or if there is significant and sustained resistance by the motion picture industry or cinema operators to this technology or the cost of implementation, we may not realize significant returns on our investments in digital cinema technology, which could materially and adversely affect our operating results.

If we do not identify opportunities and successfully execute our initiatives to participate in the emerging digital cinema market, our future prospects could be limited and our business could be adversely affected.

The cinema industry is in the early stages of the adoption of digital cinema for the distribution and exhibition of movies. Industry participants continue to discuss business models to facilitate adoption of digital cinema by allocating the costs among industry participants, and the business models that ultimately emerge may vary from country to country. Participating in some of the models under discussion may require us to depart from our traditional model of selling our cinema products pursuant to one-time contracts, and could expose us to various risks we have not faced in the past. For example, we have participated in one model by deploying, at our expense, fully integrated digital cinema systems and seeking payment from motion picture distributors for films presented on the systems. In fiscal 2007, we introduced Dolby 3D Digital Cinema technology, providing us with an additional opportunity to participate in digital cinema. However, there is a risk that recent renewed interest in 3D cinema could be a fad and may not be long-lasting. If we do not identify, and successfully execute on opportunities to generate revenues from our digital cinema products and services, our future prospects in this market will be limited and our business could be materially and adversely affected.

If our digital cinema initiatives do not perform to expectations, our reputation may suffer and demand for our digital cinema products and services may not develop.

As we participate in digital cinema initiatives, if we or our equipment do not perform to expectations, our relationships with cinema industry participants may be adversely affected and our reputation may suffer, affecting the demand for our digital cinema products and services. Any negative publicity or significant problems with our digital cinema initiatives could materially and adversely affect our relationships in the cinema industry or the perception of our brand.

 

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Acquisition activities could result in operating difficulties, dilution to our stockholders and other harmful consequences.

We have evaluated, and expect to continue to evaluate, a wide array of possible strategic transactions, including acquisitions. For example, in November 2007 we acquired Coding Technologies, a privately held provider of audio compression technologies for the mobile, digital broadcast and internet markets and in April 2007 we acquired Brightside, a development-stage company focused on enabling the capture, distribution, and display of more vibrant video on LED backlit LCD televisions. Although we cannot predict whether or not we will complete any such acquisition or other transactions in the future, any of these transactions could be material in relation to our market capitalization, financial condition or results of operations. The process of integrating an acquired company, business or technology may create unforeseen difficulties and expenditures. The areas where we may face risks in integrating acquired businesses, including in connection with our acquisitions of Coding Technologies and Brightside, include:

 

   

Diversion of management time and focus from operating our business to acquisition integration challenges;

 

   

Cultural challenges associated with integrating employees from acquired businesses into our organization, including cultural and logistical challenges;

 

   

Retaining employees from businesses we acquire;

 

   

The need to implement or improve internal controls, procedures and policies appropriate for a public company at businesses that prior to the acquisition lacked effective controls, procedures and policies;

 

   

Possible write-offs or impairment charges resulting from acquisitions;

 

   

Unanticipated or unknown liabilities relating to acquired businesses; and

 

   

The need to integrate acquired businesses’ accounting, management information, manufacturing, human resources and other administrative systems to permit effective management.

Foreign acquisitions involve unique risks in addition to those mentioned above, including those related to integration of operations across different geographies, cultures and languages, currency risks and risks associated with the particular economic, political and regulatory environment in specific countries. Also, the anticipated benefit of our acquisitions may not materialize. Future acquisitions could result in potentially dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities or amortization expenses, or write-offs of goodwill, any of which could harm our operating results or financial condition. Future acquisitions may also require us to obtain additional equity or debt financing, which may not be available on favorable terms or at all. Moreover, acquisitions may have an adverse impact on our financial condition and results of operations, including a potential adverse impact on our gross margins.

Pricing pressures on the 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 sound technology, such as DVD players and home theatre 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 into the consumer electronics products that they sell. A decline in the licensing fees we charge could materially and adversely affect our operating results.

 

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If sales of consumer electronics products incorporating our technologies do 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 emerging economies, 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.

We face significant competition in various markets, and if we are unable to compete successfully, our business will suffer.

The markets for entertainment industry technologies are highly competitive, and we face competitive threats and pricing pressure in our markets. Competitors for our licensed technologies include: DivX, DTS, Fraunhofer Institute for Integrated Circuits, Microsoft, Philips, RealNetworks, Sony, SRS Labs and Thomson. In addition, other companies may become competitors in the future. Competitors for our products include: Avica, DTS, Doremi, EVS, GDC, Kodak, NEC, Panastereo, Qube, QuVis, REAL D, Sony and UltraStereo. Competitors for our services include DTS and Sony. In addition, other companies may become competitors in the future. Some people may perceive the quality of sound produced by some of our competitors’ technologies to be equivalent or superior to that produced by ours. In addition, some of our current and/or future competitors may have significantly greater financial, technical, marketing and other resources than we do, or may have more experience or advantages in the markets in which they compete. For example, Microsoft and RealNetworks may have an advantage over us in the market for internet technologies because of their greater experience and presence in that market. In addition, some of our current or potential competitors, such as Microsoft and RealNetworks, may be able to offer integrated system solutions in markets for sound or non-sound entertainment technologies, including audio, video and rights management technologies related to personal computers or the internet, which could make competing technologies that we develop unnecessary. By offering an integrated system solution, these potential competitors also may be able to offer competing technologies at lower prices than our technologies, which could adversely affect our operating results. Further, many of the consumer electronics products that include our sound technologies also include sound technologies developed by our competitors. As a result, we must continue to invest significant resources in research and development in order to enhance our technologies and our existing products and services and introduce new high-quality technologies, products and services to meet the wide variety of such competitive pressures. Our business will suffer if we fail to do so successfully.

Our relationships with entertainment industry participants are particularly important to our products, services and technology licensing, and if we fail to maintain such relationships our business could be materially harmed.

If we fail to maintain and expand our relationships with a broad range of participants throughout the entertainment chain, including motion picture studios, broadcasters, video-game designers, music producers and manufacturers of consumer electronics products, our business and prospects could be materially harmed. Relationships have historically played an important role in the entertainment industries that we serve. For example, sales of our products and services are particularly dependent upon our relationships with the major motion picture studios and broadcasters, and licensing of our technology is particularly dependent upon our relationships with consumer electronics product manufacturers, independent software vendors and integrated circuit, or IC, manufacturers. If we fail to maintain and strengthen these relationships, these entertainment industry participants may be more likely not to purchase and use our products, services and technologies, or create content incorporating our technologies, which could materially harm our business and prospects. In addition to directly providing substantially all of our revenue, these relationships are also critical to our ability to have our technologies adopted as industry standards. In addition, if major industry participants form strategic relationships that exclude us, whether in products, services or licensing, our business and prospects could be materially adversely affected.

We have limited or no patent protection for our technologies in particular countries, including China and India, which could limit our ability to grow our business in these markets.

We have a relatively limited number of issued patents in particular countries, including China and India. For example, in China we have only limited patent protection, especially with respect to our Dolby Digital technologies. In India, we have no issued patents. Consequently, growing our licensing revenue in these emerging countries will depend on our ability to obtain patent rights in these counties for existing and new technologies, which is uncertain. Moreover, because of the limitations of the legal systems in many of these countries, the effectiveness of patents obtained or that may in the future be obtained, if any, is likewise uncertain.

 

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We face diverse risks in our international business, which could adversely affect our operating results.

We are dependent on international sales for a substantial amount of our total revenue. For fiscal 2006, 2007 and the first quarter of 2008, revenue from outside the United States was 74%, 70% and 69% of our total revenue, respectively. We expect that international and export sales will continue to represent a substantial portion of our revenue for the foreseeable future. This future revenue will depend to a large extent on the continued use and expansion of our technologies in entertainment industries worldwide. Increased worldwide use of our technologies is also an important factor in our future growth.

Due to our reliance on sales to customers outside the United States, we are subject to the risks of conducting business internationally, including:

 

   

Our ability to enforce our contractual and intellectual property rights, especially in those foreign countries that do not respect and protect intellectual property rights to the same extent as do the United States, Japan and European countries, which increases the risk of unauthorized, and uncompensated, use of our technology;

 

   

United States and foreign government trade restrictions, including those which may impose restrictions on importation of programming, technology or components to or from the United States;

 

   

Foreign government taxes, regulations and permit requirements, including foreign taxes that we may not be able to offset against taxes imposed upon us in the United States, and foreign tax and other laws limiting our ability to repatriate funds to the United States;

 

   

Foreign labor laws, regulations and restrictions;

 

   

Changes in diplomatic and trade relationships;

 

   

Difficulty in staffing and managing foreign operations;

 

   

Fluctuations in foreign currency exchange rates and interest rates, including risks related to any interest rate swap or other hedging activities we undertake;

 

   

Political instability, natural disasters, war or events of terrorism; and

 

   

The strength of international economies.

The licensing of patents constitutes a significant source of our revenue. If we are unable to replace expiring patents with new patents or proprietary technologies, our revenue could decline.

We hold patents covering much of the technology that we license to consumer electronics product manufacturers, and our licensing revenue is tied in large part to the life of those patents. Our right to receive royalties related to our patents terminates with the expiration of the last patent covering the relevant technologies. However, many of our licensees choose to continue to pay royalties for continued use of our trademarks and know-how even after the licensed patents have expired, although at a reduced royalty rate. Accordingly, to the extent that we do not continue to replace licensing revenue from technologies covered by expiring patents with licensing revenue based on new patents and proprietary technologies, our revenue could decline.

As of December 28, 2007, we had 1,034 individual issued patents and nearly 1,550 pending patent applications in nearly 35 jurisdictions throughout the world. Our issued patents are scheduled to expire at various times through July 2027. Of these, 5 patents are scheduled to expire in the remainder of calendar year 2008, 5 patents are scheduled to expire in calendar year 2009 and 116 patents are scheduled to expire in calendar year 2010. We derive our licensing revenue principally from our Dolby Digital technologies. Patents relating to our Dolby Digital technologies generally expire between 2009 and 2017, and patents relating to our Dolby Digital Plus technologies, an extension of Dolby Digital, expire between 2019 and 2025. In addition, the remaining patents relating to Dolby

 

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Digital Live technologies, an extension of Dolby Digital, are scheduled to expire in 2021. The foregoing information excludes approximately 300 patents and 300 pending patent applications in approximately 25 countries, which acquired as the result of our acquisition of Coding Technologies.

We are, and may in the future be, subject to intellectual property rights claims, which are costly to defend, could require us to pay damages and could limit our ability to use particular technologies in the future.

Companies in the technology and entertainment industries own large numbers of patents, copyrights, trademarks and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. We have faced such claims in the past and we expect to face similar claims in the future.

Any intellectual property claims, with or without merit, could be time-consuming, expensive to litigate or settle and could divert management resources and attention. In the past we have settled claims relating to infringement allegations and agreed to make payments in connection with such settlements. We expect that similar claims will be asserted against us in the future in the ordinary course of our business. An adverse determination in any intellectual property claim could require that we pay damages or stop using technologies found to be in violation of a third party’s rights and could prevent us from offering our products and services to others. In order to avoid these restrictions, we may have to seek a license for the technology. This license may not be available on reasonable terms, could require us to pay significant royalties and may significantly increase our operating expenses. The technologies also may not be available for license to us at all. As a result, we may be required to develop alternative non-infringing technologies, which could require significant effort and expense. If we cannot license or develop technologies for any infringing aspects of our business, we may be forced to limit our product and service offerings and may be unable to compete effectively. In addition, at times in the past, we have chosen to defend our licensees from third-party intellectual property infringement claims even where such defense was not contractually required, and we may choose to take on such defense in the future. Any of these results could harm our brand, our operating results and our financial condition. In addition, from time to time we are engaged in disputes regarding the licensing of our intellectual property rights, including matters related to our royalty rates and other terms of our licensing arrangements. These types of disputes can be asserted by our customers or prospective customers or by other third parties as part of negotiations with us or in private actions seeking monetary damages or injunctive relief, or in regulatory actions. In the past, licensees have threatened to initiate litigation against us regarding our licensing royalty rate practices, including potential antitrust claims. Damages and requests for injunctive relief asserted in claims like these could be material, and could have a significant impact on our business. Any disputes with our customers or potential customers or other third parties could adversely affect our business, results of operations and prospects.

Our ability to develop proprietary technology in markets in which “open standards” are adopted may be limited, which could adversely affect our ability to generate revenue.

Standards-setting bodies, such as those for digital cinema technologies, may require the use of so-called “open standards,” meaning that the technologies necessary to meet those standards are publicly available. The use of open standards may reduce our opportunity to generate revenue, as open standards technologies are based upon non-proprietary technology platforms in which no one company maintains ownership over the dominant technologies.

Events and conditions in the motion picture and broadcast industries may affect sales of our cinema products and services.

Sales of our cinema products and services tend to fluctuate based on the underlying trends in the motion picture industry. For example, when box office receipts for the motion picture industry increase, we have typically seen sales of our cinema products increase as well, as cinema owners are more likely to build new theatres and upgrade existing theatres with our more advanced cinema products when they are doing well financially. Conversely, when box office receipts are down cinema owners tend to scale back on plans to upgrade their systems or build new theatres. Our cinema product sales are also subject to fluctuations based on events and conditions in the theatre industry generally that may or may not be tied to box office receipts in particular periods. For example, the growth in piracy of motion pictures adversely affects the construction of new screens, the renovation of existing theatres and the continued production of new motion pictures. Technological advances and the conversion of motion pictures into digital formats have made it easier to create, transmit and “share” high-quality unauthorized copies of motion pictures, including on pirated DVDs and on the internet. The launch of new digital services by broadcasters also influences the sale of our cinema products. On the other hand, our services revenue, both in the United States and internationally, is tied to the number of films being made by studios and independent filmmakers. A number of

 

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factors can affect the number of films that are produced, including strikes and work stoppages within the motion picture industry, as well as by the tax incentive arrangements that many foreign governments provide filmmakers to promote local filmmaking.

We may be unable to significantly expand our current product sales in the cinema industry because our products are already used by the vast majority of major cinema operators and major motion picture studios in the United States and much of the rest of the world. If the cinema industry does not expand, or if it contracts, the demand for our cinema products will be adversely affected.

Our ability to further penetrate the market for motion picture sound technologies is limited because of the widespread use of our current cinema products by major motion picture content creators, distributors and cinema operators. As a result, our future revenue from our products for the cinema industry will depend, in part, upon events and conditions in that industry—specifically, the continued production and distribution of motion pictures, and the construction of new theatres and the renovation of existing theatres, using our products and services. For example, in the late 1990s cinema operators in the United States built a large number of new cinema megaplexes. This initially resulted in increased sales of our cinema processors, but also resulted in an oversupply of screens in some markets. This oversupply led to significant declines in new theatre construction in the United States in the early 2000s, resulting in a corresponding decline in sales of our cinema processors. As a result, future growth in sales of our existing cinema products may be limited, and may decrease in the future, as the number of new cinemas being built and the number of existing cinemas without our products continues to decline.

The demand for our cinema products and services could decline as the film industry adopts digital cinema.

Although the cinema industry is still in the early stages of adoption of digital cinema for the distribution and exhibition of movies, the number of exhibitors adopting digital cinema for new theatre construction or existing theatre upgrades continues to grow. We expect that exhibitors constructing new theatres or upgrading existing theatres will generally choose digital cinema over traditional film cinema. While our film sound formats are de facto standards and our film soundtrack cinema processors are widely used around the world, digital cinema, which is based on open standards, does not include our proprietary audio formats. As the film industry continues to adopt digital cinema, if we do not adapt our traditional cinema products and services to meet the demands of the digital cinema market, the demand for them will decline. Furthermore, exhibitors adopting digital cinema can choose from multiple digital cinema servers other than ours, none of which contain our technologies. A decrease in the demand for our traditional film cinema products and services that is not accompanied by a meaningful increase in revenue from digital cinema would adversely affect our revenue stream.

In addition, a decrease in the demand for our products and services could adversely affect licensing of our technology, because the strength of our brand and our ability to use professional product developments to introduce new technologies, which can later be licensed, would be impaired. If, in such circumstances, we are unable to adapt our products and services or introduce new products for the market for digital cinema successfully, our business could be materially adversely affected.

Fluctuations in our quarterly and annual operating results may significantly affect the value of our stock.

A number of factors, many of which are outside our control, may cause or contribute to significant fluctuations in our quarterly and annual revenue and operating results. These fluctuations may make financial planning and forecasting more difficult. In addition, these fluctuations may result in unanticipated decreases in our available cash, which could negatively impact our business and prospects. As discussed more fully below, these fluctuations also could increase the volatility of our stock price. Factors that may cause or contribute to fluctuations in our operating results and revenue include:

 

   

Fluctuations in demand for our products and for the consumer electronics products of our licensees;

 

   

Fluctuations in the timing of royalty reports we receive from our licensees, including late, sporadic or inaccurate reports;

 

   

Sporadic payments we may be able to recover from companies utilizing our technologies without licenses;

 

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Corrections to licensees’ reports received in periods subsequent to those in which the original revenue was reported;

 

   

Introduction or enhancement of products, services and technologies by us, our licensees and our competitors, and market acceptance of these new or enhanced products, services and technologies;

 

   

Rapid, wholesale changes in technology in the entertainment industries in which we compete;

 

   

Events and conditions in the motion picture industry, including box office receipts that affect the number of theatres constructed, the number of movies produced and exhibited, the general popularity of motion pictures and strikes by motion picture industry participants;

 

   

The financial resources of cinema operators available to buy our products or to equip their theatres to accommodate upgraded or new technologies;

 

   

Consolidation by participants in the markets in which we compete, which could result among other things in pricing pressure;

 

   

The amount and timing of our operating costs and capital expenditures, including those related to the expansion of our business, operations and infrastructure;

 

   

Variations in the time-to-market of our technologies in the entertainment industries in which we operate;

 

   

Seasonal electronics product shipment patterns by our consumer electronics product licensees, particularly in the first quarter, which generally result in revenue in the second quarter;

 

   

The impact of, and our ability to react to, interruptions in the entertainment distribution chain, including as a result of work stoppages at our facilities, our customers’ facilities and other points throughout the entertainment distribution chain;

 

   

Changes in business cycles that affect the markets in which we sell our products and services or the markets for consumer electronics products incorporating our technologies;

 

   

Adverse outcomes of litigation or governmental proceedings, including any foreign, federal, state or local tax assessments or audits;

 

   

Costs of litigation and intellectual property protection; and

 

   

Seasonal demand for services in the motion picture industry, which could result in reduced revenue.

One or more of the foregoing or other factors may cause our operating expenses to be disproportionately higher or lower or may cause our revenue and operating results to fluctuate significantly in any particular quarterly or annual period. Results from prior periods are thus not necessarily indicative of the results of future periods.

Some of our customers are also our current or potential competitors, and if those customers were to choose to use their competing technologies rather than ours, our business and operating results would be adversely affected.

We face competitive risks in situations where our customers are also current or potential competitors. For example, Sony and Microsoft are significant licensee customers and Sony is a significant purchaser of our broadcast products and services, but Sony and Microsoft are also competitors with respect to some of our broadcast and consumer technologies. To the extent that our customers choose to utilize competing technologies they have developed or in which they have an interest, rather than use our technologies, our business and operating results could be adversely affected.

 

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Surround sound technologies could be treated as a commodity in the future, which could adversely affect our business, operating results and prospects.

We believe that the success we have had licensing our surround sound technologies to consumer electronics product manufacturers is due, in part, to the strength of our brand and the perception that our technologies provide a high-quality solution for surround sound. However, as applications that incorporate surround sound technologies become increasingly prevalent, we expect more competitors to enter this field with other solutions. Furthermore, to the extent that competitors’ solutions are perceived, accurately or not, to provide the same advantages as our technologies, at a lower or comparable price, there is a risk that sound encoding technologies such as ours will be treated as commodities, resulting in loss of status of our technologies, decline in their use, and significant pricing pressure. To the extent that our audio technologies become a commodity, rather than a premium solution, our business, operating results and prospects could be adversely affected.

Licensing some of our technologies in joint licensing programs, or “patent pools,” is a different business model for us, and we may face many challenges in conducting this business.

In fiscal 2002, we began licensing some of our patents through our wholly-owned subsidiary Via Licensing Corporation in joint licensing programs, or “patent pools,” with other companies in an effort to ensure that our technologies are compatible with other technologies in the entertainment industry and to promote our technologies as industry standards. These patent pools allow product manufacturers streamlined access to selected foundational technologies and are comprised of a group of patents held by a number of companies, including us in some cases, and administered by Via Licensing. If we do not identify new or changing market trends and technologies at an early enough stage to capitalize on market opportunities for joint licensing programs, we may not continue to be successful with this business model. Also, to the extent that Dolby technologies are included in patent pools, we have less control over the licensing of those technologies through the patent pools compared to licensing through our traditional business model in which we license our patents as bundles of technologies and interact directly with our customers. In addition, we may have less control over the application and quality control of our technologies included in these pools.

The loss of or interruption in operations of one or more of our key suppliers could materially delay or stop the production of our products and impair our ability to generate revenue.

Our reliance on outside suppliers for some of the key materials and components we use in manufacturing our products involves risks, including limited control over the price, timely delivery and quality of such components. We have no agreements with our suppliers to ensure continued supply of materials and components. Although we have identified alternate suppliers for most of our key materials and components, any required changes in our suppliers could cause material delays in our production operations and increase our production costs. In addition, our suppliers may not be able to meet our future production demands as to volume, quality or timeliness. Moreover, we rely on sole source suppliers for some of the components that we use to manufacture our products, including specific charged coupled devices, light emitting diodes and digital signal processors. These sole source suppliers may become unable or unwilling to deliver these components to us at an acceptable cost or at all, which could force us to redesign those specific products. Our inability to obtain timely delivery of key components of acceptable quality, any significant increases in the prices of components, or the redesign of our products could result in material production delays, increased costs and reductions in shipments of our products, any of which could increase our operating costs, harm our customer relationships or materially and adversely affect our business and operating results.

Revenue from our products may suffer if our production processes encounter problems or if we are not able to match our production capacity to fluctuating levels of demand.

Our products are highly complex, and production difficulties or inefficiencies can interrupt production, resulting in our inability to deliver products on time in a cost effective manner, which could harm our competitive position. If production is interrupted at one of our two manufacturing facilities, we may not be able to shift production to the other facility on a timely basis, and customers may purchase products from our competitors. A shortage of manufacturing capacity for our products could adversely affect our operating results and damage our customer relationships. We generally cannot quickly adapt our manufacturing capacity to rapidly changing market conditions. Likewise, we may be unable to respond to fluctuations in customer demand. At times we underutilize our manufacturing facilities as a result of reduced demand for some of our products. Any inability to respond to fluctuations in customer demand for our products may adversely affect our gross margins.

 

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Our products, from time to time, experience quality problems that can result in decreased sales and higher operating expenses.

Our products are complex and sometimes contain undetected software or hardware errors, particularly when first introduced or when new versions are released. In addition, our products are sometimes combined with or incorporated into products from other vendors, sometimes making it difficult to identify the source of a problem. These errors could result in a loss of or delay in market acceptance of our products or cause delays in delivering them and meeting customer demands, any of which could reduce our revenue and raise significant customer relations issues. In addition, if our products contain errors we could be required to replace or reengineer them, which would increase our costs. Moreover, if any such errors cause unintended consequences, we could face claims for product liability. Although we generally attempt to contractually limit liability for defective products to the cost of repairing or replacing these products, if these contract provisions are not enforced, or are unenforceable for any reason, or if liabilities arise that are not effectively limited, we could incur substantial costs in defending and settling product liability claims.

Awareness of our brand depends to a significant extent upon decisions by our customers to display our trademarks on their products, and if our customers do not display our trademarks on their products, our ability to increase our brand awareness may be harmed.

Because we engage in relatively little direct brand advertising, the promotion of our brand depends upon entertainment industry participants displaying our trademarks on their products that incorporate our technologies, such as film prints and consumer electronics products. Although we do not require our customers to place our brand on their products, we actively encourage them to do so. For example, we rely on consumer electronics product manufacturers that license our technologies to display our trademarks on their products in order to promote our brand. If our customers choose for any reason not to display our trademarks on their products, our ability to maintain or increase our brand awareness may be harmed, which would have an adverse effect on our business and prospects. In addition, if we fail to maintain high quality standards for our products, or if we fail to maintain high quality standards for the products that incorporate our technologies through the quality-control evaluation process that we require of our licensees, the strength of our brand could be adversely affected.

Licensee products that incorporate our technologies, from time to time, experience quality problems that could damage our brand, decrease revenues and increase operating expenses.

Licensee products that incorporate our technologies often are complex and sometimes contain undetected software or hardware errors, particularly when first introduced or when new versions are released. In addition, those products are often combined with, or incorporated into, products from other companies, sometimes making it difficult to identify the source of a problem. Any negative publicity or negative impact relating to these product problems could adversely affect the perception of our brand. In addition, these errors could result in loss of, or delay in, market acceptance of those products or Dolby technologies, or cause delays in delivering them and meeting customer demands, any of which could reduce our revenue and raise significant customer relations issues. Although we generally attempt to contractually limit our liability for our licensees’ defective products, we may elect to help reengineer those products, which could adversely affect our operating results.

A loss of one or more of our key customers or licensees in any of our markets could adversely affect our operating results.

From time to time, one or a small number of our customers or licensees may represent a significant percentage of our products, services or licensing revenue. Although we have agreements with many of these customers, these agreements typically do not require any minimum purchases or minimum royalty fees and do not prohibit customers from purchasing products and services from competitors. A decision by any of our major customers or licensees not to use our technologies, or their failure or inability to pay amounts owed to us in a timely manner, or at all, whether due to strategic redirections or adverse changes in their businesses or for other reasons, could have a significant effect on our operating results.

 

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We are subject to various environmental laws and regulations that could impose substantial costs upon us and may adversely affect our business, operating results and financial condition.

Some of our operations use substances regulated under various federal, state, local and international laws governing the environment, including those governing the discharge of pollutants into the air and water, the management, disposal and labeling of hazardous substances and wastes and the cleanup of contaminated sites. We could incur costs, fines and civil or criminal sanctions, third-party property damage or personal injury claims, or could be required to incur substantial investigation or remediation costs, if we were to violate or become liable under environmental laws. Liability under environmental laws can be joint and several and without regard to comparative fault. The ultimate costs under environmental laws and the timing of these costs are difficult to predict.

We also face increasing complexity in our product design as we adjust to new and future requirements relating to the materials composition of our products. For example, we redesigned our products so we could continue to offer them for sale within the European Union, when restrictions on lead and other hazardous substances that apply to specified electronic products put on the market in the European Union became effective as of July 1, 2006. Similar requirements related to marking of electronic products became effective in China as of March 1, 2007. For some products, substituting particular components containing regulated hazardous substances is more difficult or costly, and additional redesign efforts could result in production delays. Selected electronic products that we maintain in inventory may be rendered obsolete if not in compliance with the new environmental laws, which could negatively impact our ability to generate revenue from those products.

We also expect that our operations, whether manufacturing or licensing, will be affected by other new environmental laws and regulations on an ongoing basis. Although we cannot predict the ultimate impact of any such new laws and regulations, they will likely result in additional costs or decreased revenue, and could require that we redesign or change how we manufacture our products, any of which could have a material adverse effect on our business.

Any inability to protect our intellectual property rights could reduce the value of our products, services and brand.

Our business is dependent upon our patents, trademarks, trade secrets, copyrights and other intellectual property rights. Licensing revenue represented 75%, 77% and 80% of our total revenue in the fiscal years 2005, 2006 and 2007, respectively. Effective intellectual property rights protection, however, may not be available under the laws of every country in which our products and services and those of our licensees are distributed. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Any significant impairment of our intellectual property rights could harm our business or our ability to compete. In addition, protecting our intellectual property rights is costly and time consuming. We have taken steps in the past to enforce our intellectual property rights and expect to continue to do so in the future. However, it may not be practicable or cost effective for us to enforce our intellectual property rights fully, particularly in particular countries or where the initiation of a claim might harm our business relationships. For example, we have many times experienced, and expect to continue to experience, problems with consumer electronics product manufacturers incorporating our technologies into their products without our authorization. If we are unable to successfully identify and stop unauthorized use of our intellectual property, we could experience increased operational and enforcement costs, which could adversely affect our financial condition and results of operations. We generally seek patent protection for our innovations. It is possible, however, that some of these innovations may not be protectable. In addition, given the costs of obtaining patent protection, we may choose not to protect particular innovations that later turn out to be important. Moreover, we have limited or no patent protection in particular foreign jurisdictions. For example, in China we have only limited patent protection, especially with respect to our Dolby Digital technologies, and in India we have no issued patents. Furthermore, there is always the possibility, despite our efforts, that the scope of the protection gained will be insufficient or that an issued patent may later be found to be invalid or unenforceable. Moreover, we seek to maintain select intellectual property as trade secrets. These trade secrets could be compromised by third parties, or intentionally or accidentally by our employees, which would cause us to lose the competitive advantage resulting from them.

It is possible that we may be treated as a personal holding company, which could adversely affect our operating results and financial condition.

The Internal Revenue Service may assert that we or any of our subsidiaries are currently, or previously have been, liable for personal holding company tax, plus interest and penalties, if applicable. In addition, we and our subsidiaries may be liable for personal holding company tax in the future. For United States federal income tax purposes, a corporation is generally considered to be a “personal holding company” under the United States Internal

 

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Revenue Code if (i) at any time during the last half of its taxable year more than 50% of its stock by value is owned, directly or indirectly, by virtue of the application of certain stock ownership attribution rules set forth in the Internal Revenue Code for purposes of applying the personal holding company rules, by five or fewer individuals and (ii) at least 60% of its adjusted ordinary gross income, as defined for United States federal income tax purposes, is “personal holding company income.” Personal holding company income is generally passive income, including royalty income, subject to particular exceptions such as qualifying software royalties. A personal holding company is subject to an additional tax on its undistributed after-tax income, calculated at the statutory tax rate, which is currently 15%. Since the personal holding company tax is imposed only on undistributed income, a personal holding company can avoid or mitigate liability for the tax, but not interest or penalties, by paying a dividend to its stockholders.

More than 50% of the value of our stock is held by Ray Dolby and stockholders considered affiliated with him pursuant to the stock ownership attribution rules applicable to personal holding companies. We expect this will continue to be the case in the foreseeable future. In addition, a significant portion of our income is from licensing fees, which may constitute personal holding company income. Currently, however, we believe less than 60% of Dolby Laboratories’ adjusted ordinary gross income is personal holding company income.

However, the Internal Revenue Service may assert that we or one of our subsidiaries are currently, or previously have been, liable for personal holding company tax, plus interest and penalties, if applicable. In addition, we or our subsidiaries may be liable for personal holding company tax in the future. The treatment of select items of our income and the income of our subsidiaries, for purposes of the personal holding company tax, may be subject to challenge. In the event that we or any of our subsidiaries is determined to be a personal holding company, or for prior taxable years, to have been a personal holding company, we or our subsidiary could be liable for additional taxes, and possibly interest and penalties, based on the undistributed income and the tax rate in effect at that time, but only if we or our subsidiary, as the case may be, decides not to fully abate the tax by the payment of a dividend, although such a dividend will not eliminate interest and penalties. In addition, we believe that there exists a meaningful risk that in the relatively near future the mix of our revenue will change so that more of our adjusted ordinary gross income may be classified as personal holding company income. In such event, it is possible that we or one of our subsidiaries could become liable for the personal holding company tax, assuming the ownership test continues to be met. In that case, we or our subsidiary, as the case may be, may be required to pay additional tax in the event we or the subsidiary decides not to fully abate the tax by the payment of a dividend. Because no claim or assessment has been made against us with respect to personal holding company taxes, we are unable to quantify the amount of any additional taxes, and possibly interest and penalties, for which we may be liable in the future for past periods or the amount of the dividend that we may pay to abate the tax. Furthermore, we are unable to quantify the amount of personal holding company tax that we may be liable for or the dividend that we may elect to pay for future periods as such amounts, if any, would be based upon the application of the rules discussed above to the results of our future operations. We have explored options to reduce our exposure and the exposure of our subsidiaries to the personal holding company tax in the future, as well as continue to actively monitor our current exposure.

If we or any of our subsidiaries were to pay personal holding company tax (and possibly interest and penalties), this could significantly increase our consolidated tax expense and adversely affect our operating results. In addition, if the statutory tax rate increases in the future, the amount of any personal holding company tax we or any of our subsidiaries may have to pay could increase significantly, further impairing our operating results. In that regard, the statutory tax rate, which is currently 15%, is scheduled to return to ordinary income tax rate levels for tax years beginning on or after January 1, 2011. If we are deemed to be a personal holding company and, instead of paying the personal holding company tax, we elect to pay a dividend to our stockholders in an amount equal to all or a significant part of our undistributed personal holding company income, we may consume a significant amount of cash resources and be unable to retain or generate working capital. This would adversely affect our financial condition. As a result, if we pay such a dividend, we may decide to seek additional financing, although that financing may not be available to us when and as required on commercially reasonable terms, if at all.

Failure to comply with applicable current and future government regulations could have a negative effect on our business.

Our operations and business practices are subject to federal, state and local government laws and regulations, as well as international laws and regulations, including those relating to consumer and other safety-related compliance for electronic equipment, as well as compulsory license requirements as a prerequisite to being included as part of the industry standards, such as the United States HDTV standard. Any failure by us to comply with the laws and

 

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regulations applicable to us or our products could result in our inability to sell those products, additional costs to redesign products to meet such laws and regulations, fines or other administrative actions by the agencies charged with enforcing compliance and, possibly, damages awarded to persons claiming injury as the result of our non-compliance. Changes in or enactment of new statutes, rules or regulations applicable to us could have a material adverse effect on our business.

The loss of members of our management team could substantially disrupt our business operations.

Our success depends to a significant degree upon the continued individual and collective contributions of our management team. A limited number of individuals have primary responsibility for managing our business, including our relationships with key customers and licensees. We have key executives and senior technical people who have been with us for a number of years. These individuals, as well as the rest of our management team and key employees, are at-will employees, and we do not maintain any key-person life insurance policies. Losing the services of any key member of our team, whether from retirement, competing offers or other causes, could prevent us from executing our business strategy, cause us to lose key customer or licensee relationships, or otherwise materially affect our operations.

We rely on highly skilled personnel, and if we are unable to retain or motivate key personnel or hire qualified personnel, we may not be able to maintain our operations or grow effectively.

Our performance is largely dependent on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization. In this regard, we currently plan to hire a number of employees throughout fiscal 2008 in response to our growth and our current initiatives. We have maintained a rigorous, highly selective and time-consuming hiring process, which we believe has significantly contributed to our success to date, but has made it more difficult for us to hire a sufficient number of qualified employees. As we grow, our hiring process may prevent us from hiring the personnel we need in a timely manner. In addition, we are aware that some of our competitors have directly targeted our employees. If we are unable to hire and train a sufficient number of qualified employees or retain and motivate existing employees, our existing operations may suffer and we may be unable to grow effectively.

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements could be impaired, which could adversely affect our operating results, our ability to operate our business and our investors’ views of us.

We have a complex business organization that is international in scope. Ensuring that we have adequate internal financial and accounting controls and procedures in place to help ensure that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. On an ongoing basis, we document, review and, if appropriate, improve our internal controls and procedures in connection with Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors addressing these assessments. Both we and our independent auditors periodically test our internal controls in connection with the Section 404 requirements and could, as part of that documentation and testing, identify areas for further attention or improvement. Implementing any appropriate changes to our internal controls may require specific compliance training of our directors, officers and employees, entail substantial costs in order to modify our existing accounting systems, and take a significant period of time to complete. Such changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In addition, investors’ perceptions that our internal controls are inadequate or that we are unable to produce accurate financial statements may seriously affect our stock price.

For the foreseeable future, Ray Dolby or his affiliates will be able to control the selection of all members of our board of directors, as well as virtually every other matter that requires stockholder approval, which will severely limit the ability of other stockholders to influence corporate matters.

At December 28, 2007, Ray Dolby and his affiliates owned 100 shares of our Class A common stock and 60,000,000 shares of our Class B common stock. As of December 28, 2007, Ray Dolby and his affiliates, including his family members, had voting power over approximately 99% of our outstanding Class B common stock, which in the aggregate represented approximately 91% of the combined voting power of our outstanding Class A and Class B

 

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common stock. Under our certificate of incorporation, holders of Class B common stock are entitled to ten votes per share while holders of Class A common stock are entitled to one vote per share. Generally, shares of Class B common stock automatically convert into shares of Class A common stock upon transfer of such Class B common stock, other than transfers to certain specified persons and entities, including the spouse and descendents of Ray Dolby and the spouses and domestic partners of such descendents. Because of this dual class structure, Ray Dolby, his affiliates, and his family members and descendents will, for the foreseeable future, have significant influence over our management and affairs, and will be able to control virtually all matters requiring stockholder approval, including the election of directors and significant corporate transactions such as mergers or other sales of our company or assets, even if they come to own considerably less than 50% of the total number of outstanding shares of our Class A and Class B common stock. Ray Dolby, his affiliates, his family members and descendents will maintain this control even if in the future they come to own considerably less than 50% of the total number of outstanding shares of our Class A and Class B common stock. Moreover, these persons may take actions in their own interests that you or our other stockholders do not view as beneficial. Absent a transfer of Class B common stock that would trigger an automatic conversion as described above, there is no threshold or time deadline at which the shares of Class B common stock will automatically convert into shares of Class A common stock. Assuming conversion of all shares of Class B common stock held by persons not affiliated with Ray Dolby into shares of Class A common stock, so long as Ray Dolby and his affiliates, his family members and descendents continue to hold shares of Class B common stock representing approximately 10% or more of the total number of outstanding shares of our Class A and Class B common stock, they will hold a majority of the combined voting power of the Class A and Class B common stock.

Future sales of shares by insiders could cause our stock price to decline.

If our founder, officers, directors or employees sell, or indicate an intention to sell, substantial amounts of our Class A common stock in the public market, including shares of Class A common stock issuable upon conversion of shares of Class B common stock, the trading price of our Class A common stock could decline. As of December 28, 2007, we had a total of 110,903,748 shares of Class A and Class B common stock outstanding. Of these shares, 31,625,000 shares of Class A common stock were sold in our initial public offering by us and the selling stockholders, and an additional 8,000,000 shares of Class A common stock were sold in a secondary offering in May 2007 by our principal stockholder.

As of December 28, 2007, our directors and executive officers beneficially held 60,467,797 shares of Class B common stock, 6,730 shares of Class A common stock, vested options to purchase 459,534 shares of Class B common stock and vested options to purchase 222,248 shares of Class A common stock. We expect that any sale of our Class A common stock by our directors and executive officers would be subject to compliance with Rule 144 under the Securities Act

 

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Table of Contents

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Sales of Unregistered Securities

In the fiscal quarter ended December 28, 2007, we issued an aggregate of 474,741 shares of our Class B common stock to certain employees, officers and directors upon the exercise of options awarded under our 2000 Stock Incentive Plan and since December 29, 2007 through January 17, 2008, we issued an aggregate of 129,477 shares of our Class B common stock to certain employees and officers upon the exercise of options awarded under our 2000 Stock Incentive Plan. We received aggregate proceeds of $1.2 million in the fiscal quarter ended December 28, 2007, and $0.3 million in the period since December 29, 2007 through January 17, 2008 as a result of the exercise of these options. We believe these transactions were exempt from the registration requirements of the Securities Act in reliance on Rule 701 thereunder as transactions pursuant to compensatory benefit plans and contracts relating to compensation as provided under Rule 701. As of January 17, 2008 options to purchase an aggregate of 3,605,986 shares of our Class B common stock remain outstanding. All issuances of shares of our Class B common stock pursuant to the exercise of these options will be made in reliance on Rule 701. All option grants made under the 2000 Stock Incentive Plan were made prior to the effectiveness of our initial public offering. No further option grants will be made under our 2000 Stock Incentive Plan.

None of the foregoing transactions involved any underwriters, underwriting discounts or commissions, or any public offering.

Each share of our Class B common stock is convertible into one share of our Class A common stock at any time at the option of the holder or upon the affirmative vote of the holders of a majority of the shares of Class B common stock. In addition, each share of Class B common stock shall convert automatically into one share of Class A common stock upon any transfer, except for certain transfers described in our amended and restated certificate of incorporation.

ITEM 6. EXHIBITS

 

         

Incorporated by Reference Herein

Exhibit
Number

  

Description

  

Form

  

Date

2.1

   Share Transfer Agreement by and among the Dolby Laboratories, Inc., a California corporation, Dolby Sweden Holding AB, the Sellers set forth on Schedule A, CIMON Investment Managers AB, as Shareholder Representative, and U.S. Bank National Association, as Escrow Agent, dated as of November 8, 2007    Current Report on Form 8–K    November 13, 2007

10.1*

   2008 Dolby Executive Annual Incentive Plan    Current Report on Form 8–K    November 20, 2007

10.2*

   2008 Dolby Annual Incentive Plan    Current Report on Form 8–K    November 20, 2007

10.3*

   Form of Restricted Stock Unit Agreement — U.S. under the 2005 Stock Plan    Current Report on Form 8–K    November 20, 2007

10.4*

   Form of Restricted Stock Unit Agreement — U.K. under the 2005 Stock Plan    Current Report on Form 8–K    November 20, 2007

10.5*

   Senior Executive Supplemental Retirement Plan, as amended and restated      

31.1

   Certification by the Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.      

31.2

   Certification by the Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.      

32.1 ‡

   Certification by the Chief Executive Officer and the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.      

 

* Denotes a management contract or compensatory plan or arrangement

 

Furnished herewith

 

48


Table of Contents

SIGNATURES

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

Date: January 31, 2008

 

DOLBY LABORATORIES, INC.
By:   /s/ Kevin J. Yeaman
 

Kevin J. Yeaman

Chief Financial Officer

(Principal Financial and Accounting

Officer and Duly Authorized Officer)

 

49


Table of Contents

INDEX TO EXHIBITS

 

         

Incorporated by Reference Herein

Exhibit
Number

  

Description

  

Form

  

Date

2.1

   Share Transfer Agreement by and among the Dolby Laboratories, Inc., a California corporation, Dolby Sweden Holding AB, the Sellers set forth on Schedule A, CIMON Investment Managers AB, as Shareholder Representative, and U.S. Bank National Association, as Escrow Agent, dated as of November 8, 2007    Current Report on Form 8–K    November 13, 2007

10.1*

   2008 Dolby Executive Annual Incentive Plan    Current Report on Form 8–K    November 20, 2007

10.2*

   2008 Dolby Annual Incentive Plan    Current Report on Form 8–K    November 20, 2007

10.3*

   Form of Restricted Stock Unit Agreement — U.S. under the 2005 Stock Plan    Current Report on Form 8–K    November 20, 2007

10.4*

   Form of Restricted Stock Unit Agreement — U.K. under the 2005 Stock Plan    Current Report on Form 8–K    November 20, 2007

10.5*

   Senior Executive Supplemental Retirement Plan, as amended and restated      

31.1

   Certification by the Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.      

31.2

   Certification by the Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.      

32.1 ‡

   Certification by the Chief Executive Officer and the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.      

 

* Denotes a management contract or compensatory plan or arrangement

 

Furnished herewith

 

50

Senior Executive Supplemental Retirement Plan, as amended and restated

Exhibit 10.5

DOLBY LABORATORIES, INC.

SENIOR EXECUTIVE

SUPPLEMENTAL RETIREMENT PLAN

Effective Date: October 1, 1994

Amended and Restated Effective January 1, 2005

Terminated Effective August 2, 2005

Amended and Restated Effective January 1, 2008


TABLE OF CONTENTS

 

Section 1.

  

Purpose of the Plan

   1

Section 2.

  

Definitions

   1

2.1

  

“Account”

   1

2.2

  

“Beneficiary”

   1

2.3

  

“Board”

   1

2.4

  

“Change of Control”

   1

2.5

  

“Code”

   2

2.6

  

“Committee”

   2

2.7

  

“Company”

   2

2.8

  

“Compensation”

   2

2.9

  

“Disability”

   2

2.10

  

“Effective Date”

   2

2.11

  

“Employer”

   2

2.12

  

“ERISA”

   3

2.13

  

“Insolvency”

   3

2.14

  

“Investment Fund”

   3

2.15

  

“Participant”

   3

2.16

  

“Payment Date”

   3

2.17

  

“Plan”

   3

2.18

  

“Plan Year”

   3

2.19

  

“Projected Average Monthly Compensation”

   3

2.20

  

“Senior Executive”

   4

2.21

  

“Separation from Service”

   4

2.22

  

“Termination Date”

   4

2.23

  

“Trust”

   4

2.24

  

“Trustee”

   4

2.25

  

“Valuation Date”

   4

2.26

  

“Year of Benefit Service”

   4

2.27

  

“Year of Service”

   4

Section 3.

  

Administration of the Plan

   5

3.1

  

Generally

   5

Section 4.

  

Eligibility

   5

4.1

  

Participation

   5

4.2

  

Cessation of Participation

   5

Section 5.

  

Contributions

   5

5.1

  

Target Benefit

   5

5.2

  

Crediting of Contributions

   7

5.3

  

Time for Making Contributions

   8

Section 6.

  

Investment of Accounts

   8

6.1

  

Investment Direction

   8


6.2

  

Allocation of Income

   8

Section 7.

  

Distribution

   9

7.1

  

Termination

   9

7.2

  

Death Benefit

   9

7.3

  

Methods of Distribution

   9

7.4

  

Installment Payments

   9

7.5

  

Default Method of Distribution

   10

7.6

  

Special Distribution Election

   10

7.7

  

Acceleration of Distributions

   10

Section 8.

  

Beneficiary

   10

8.1

  

Designation of Beneficiary

   10

8.2

  

Automatic Designation

   10

Section 9.

  

Participant’s Rights Held in “Rabbi” Trust

   11

Section 10.

  

Time of Allocation

   11

Section 11.

  

Vesting of Plan Benefits

   11

Section 12.

  

Miscellaneous Provisions

   11

12.1

  

Nonassignability

   11

12.2

  

No Enlargement of Employment Rights

   11

12.3

  

Applicable Law

   11

12.4

  

Gender and Number

   11

Section 13.

  

Amendments and Termination

   12

13.1

  

Generally

   12

13.2

  

Distribution upon Termination

   12

Section 14.

  

Expenses

   12

Section 15.

  

Claims Procedures

   12

15.1

  

Applications for Benefits and Inquiries

   12

15.2

  

Denial of Claims

   12

15.3

  

Request for a Review

   13

15.4

  

Decision on Review

   14

15.5

  

Rules and Procedures

   14

15.6

  

Exhaustion of Remedies

   15

Section 16.

  

Execution

   15

 

ii


DOLBY LABORATORIES, INC.

SENIOR EXECUTIVE

SUPPLEMENTAL RETIREMENT PLAN

Section 1. Purpose of the Plan.

Dolby Laboratories, Inc. (“Company”) wishes to provide to certain executives of Dolby a vehicle by which selected senior executives may fulfill their pension expectations. The purpose of this Plan is to provide a select group of management and highly compensated employees (as defined in Section 201(2) of ERISA) employed by the Company in the United States with the opportunity to receive a retirement income benefit in addition to any benefits provided under other Company sponsored plans. The Plan is intended to comply with Code Section 409A in order to avoid compensation deferred under the Plan from being included in the gross income of Participants under Code Section 409A.

Section 2. Definitions.

Except as otherwise indicated, all definitions in this Plan shall have the meaning as indicated below:

2.1 “Account” means the account maintained for a Participant to record his interest under the Plan. An Account may not be encumbered or assigned by a Participant or any Beneficiary.

2.2 “Beneficiary” means any person or entity determined as such under Section 8 who is entitled to receive payments under the Plan because of the death of a Participant.

2.3 “Board” means the Board of Directors of the Company.

2.4 “Change of Control” means the purchase or other acquisition by any person, entity or group of persons, within the meaning of section 13(d) or 14(d) of the Securities Exchange Act of 1934 (“Act”), or any comparable successor provisions, or beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Act) of 30 percent or more of either the outstanding shares of common stock or the combined voting power of Company’s then outstanding voting securities entitled to vote generally, or the approval by the stockholders of

 

1


Company of a reorganization, merger, or consolidation, in each case, with respect to which persons who were stockholders of Company immediately prior to such reorganization, merger or consolidation do not immediately thereafter, own more than 50 percent of the combined voting power entitled to vote generally in the election of directors of the reorganized, merged or consolidated Company’s then outstanding securities, or a liquidation or dissolution of Company or of the sale of all or substantially all of Company’s assets.

2.5 “Code” means the Internal Revenue Code of 1986, as amended.

2.6 “Committee” means the administrative Committee of three (3) persons (or such other number as the Board may designate) who shall be appointed by, and who shall serve at the pleasure of, the Board as outlined in Section 3.

2.7 “Company” means Dolby Laboratories, Inc.

2.8 “Compensation” means with respect to any Participant the total base compensation paid to a Participant by the Company for a Plan Year.

2.9 “Disability” means a medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than twelve months, as a result of which the Participant is receiving income replacement benefits for a period of not less than three months under an accident and health plan covering employees of the Company and its wholly owned subsidiaries.

2.10 “Effective Date” means October 1, 1994.

2.11 “Employer” means the Company or the entity for whom services are performed and with respect to whom the legally binding right to compensation arises, and all entities with whom the Company would be considered a single employer under Code Section 414(b); provided that in applying Code Section 1563(a)(1), (2), and (3) for purposes of determining a controlled group of corporations under Section 414(b) of the Code, the language “at least 50 percent” is used instead of “at least 80 percent” each place it appears in Code Section 1563(a)(1), (2), and (3), and in applying Treasury Regulation § 1.414(c)-2 for purposes of determining trades or businesses (whether or not incorporated) that are under common control for purposes of Code Section 414(c) “at least 50 percent” is used instead of “at least 80 percent” each place it appears in Treasury Regulation § 1.414(c)-2; provided, however, “at least 20 percent” shall replace “at least 50 percent” in the preceding clause if there is a legitimate business criteria for using such lower percentage.

 

2


2.12 “ERISA” means the Employee Retirement Income Security Act of 1974, as amended.

2.13 “Insolvency” means either if (i) Company is unable to pay its debts as they become due, or (ii) Company is subject to a pending proceeding as a debtor under the United States Bankruptcy Code.

2.14 “Investment Fund” means such investment funds or vehicles as may be selected by the Committee for the investment of Account balances under the Plan.

2.15 “Participant” means any Senior Executive or former Senior Executive who is participating in the Plan.

2.16 “Payment Date” means as soon as administratively practicable, but not later than 90 days, after six months following a Participant’s Separation from Service, or the Participant’s Termination Date, as applicable.

2.17 “Plan” means the Dolby Laboratories, Inc. Senior Executive Supplemental Retirement Plan as set forth in this document.

2.18 “Plan Year” means the twelve month period beginning October 1 and ending September 30. The first Plan Year is the year beginning October 1, 1994.

2.19 “Projected Average Monthly Compensation” means a Participant’s monthly Compensation averaged over the thirty-six (36) consecutive months of service in the final three Plan Years preceding his attainment of age 65. For purposes of this Plan, Projected Average Monthly Compensation shall be based on the Participant’s annualized rate of Compensation as of

 

  (a) June 1, 1995, increased by 5% per annum for each future Plan Year after September 30, 1995, for individuals who became Participants on the Plan’s Effective Date; or

 

  (b) September 30 of the Plan Year in which the individual becomes a Participant, increased by 5% per annum for each future Plan Year after such September 30 for individuals who become Participants after the Plan’s Effective Date.

 

3


2.20 “Senior Executive” means an employee of the Company that has been designated eligible to participate in this Plan.

2.21 “Separation from Service” means a termination of employment with an Employer, other than by reason of death. A Participant shall not be deemed to have Separated from Service if the Participant continues to provide services to an Employer at an annual rate that is fifty percent or more of the services rendered, on average, during the immediately preceding three full years of employment with an Employer (or if employed by an Employer less than three years, such lesser period); provided, however, that a Separation from Service will be deemed to have occurred if a Participant’s service with an Employer is reduced to an annual rate that is less than twenty percent of the services rendered, on average, during the immediately preceding three years of employment with an Employer (or if employed by an Employer less than three years, such lesser period).

2.22 “Termination Date” means the date a Participant is no longer treated as employed by an Employer on account of his death.

2.23 “Trust” means the nonqualified “Rabbi” trust created by the Trustee and Company under the terms of the Plan.

2.24 “Trustee” means the person or persons named under the Trust as trustees.

2.25 “Valuation Date” means the last day of the Plan Year or the last day of each calendar quarter or month, as the Plan Committee may determine.

2.26 “Year of Benefit Service” means a Plan Year in which a Participant is credited with 1,000 hours of service as an employee with the Company. Participant will also be credited with 1/12 of a Year of Benefit Service to the nearest full calendar month of employment with the Company during the Plan Year in which such Participant dies or suffers a Disability provided that such Plan Year precedes the Plan Year containing the Participant’s 65th birthday.

2.27 “Year of Service” means a Plan Year in which an employee is credited with at least 1,000 hours of service by the Company.

 

4


Section 3. Administration of the Plan.

3.1 Generally. The Plan shall be administered by the Plan Committee comprised of three (3) persons (or such other number as designated by the board of directors of the Company) who shall be appointed by the Board of Directors of the Company. All decisions required to be made involving the interpretation, application and administration of the Plan shall be resolved by majority vote either at a meeting or in writing without a meeting.

3.2 Recordkeeping Responsibility. The Plan Committee shall have the primary responsibility for record keeping with respect to Plan benefits and for filing such written notices and/or reports as may be required by the Department of Labor.

Section 4. Eligibility.

4.1 Participation. Participation in this Plan shall be limited to Senior Executives or former Senior Executives who are designated by the Board as executives eligible to participate in the Plan. Notwithstanding any other provision of the Plan to the contrary, no new Participants shall be designated by the Board after October 1, 2004.

4.2 Cessation of Participation. A Participant’s status as such will cease as of his Separation from Service, Termination Date, or the date he otherwise ceases to be a Participant as determined by the Board; provided, however, the term “Participant” will include any former Participant who has not received all payments to which he is entitled under the Plan under Section 7.

Section 5. Contributions.

5.1 Target Benefit. The Company will contribute amounts on behalf of each Participant which are projected to fund an assumed monthly target benefit payable to each Participant beginning at age 65, payable in the form of a joint and 50% survivor annuity, equal to the product of (i) and (ii):

 

  (i) 2.00% of the Participant’s Projected Average Monthly Compensation, multiplied by

 

5


  (ii) a Participant’s total expected Years of Benefit Service up to 30 years, computed to the nearest full calendar month of completed service.

For this purpose, expected Years of Benefit Service includes all Years of Benefit Service rendered prior to October 1, 1994, and all Years of Benefit Service expected to be rendered after September 30, 1994 on the assumption the Participant renders at least 1,000 hours of service as a Participant in each year.

The contributions will be determined by using an 8% per annum interest rate, post-retirement mortality based on the 1983 Group Annuity Mortality Table, and an assumption that each Participant is male with a spouse three years younger. Notwithstanding anything to the contrary, a Participant’s target benefit is not guaranteed, and the Participant’s Account balance will vary according to the investment performance of the Trust. A Participant’s Account will be comprised of two components:

 

  (1) Past Service Component:

 

  (a) With respect to individuals who became Plan Participants on the Effective Date, the actuarial present value of the target benefit based on Years of Benefit Service and monthly rate of Compensation as of June 1, 1995. This past service component shall be contributed to the Trust by the Company on or after October 1, 1994. To the extent contributions are made after October 1, 1994, they shall be adjusted (increased) with interest at 8% per annum.

 

  (b) With respect to individuals who become Plan Participants after the Effective Date, the actuarial present value of the target benefit based on Years of Benefit Service and monthly rate of Compensation as of September 30 of the Plan Year in which the individual becomes a Participant. This past service component shall be contributed to the Trust by the Company on or after such September 30. To the extent contributions are made after such September 30, they shall be adjusted (increased) with interest at 8% per annum.

 

6


  (2) Future Service Component:

 

  (a) With respect to individuals who became Plan Participants on the Effective Date, a level annual Company contribution amount to be contributed to the Trust at the end of each Plan Year ending prior to the Participant’s attainment of age 65. The present value of the annual future service contributions for each Participant shall be equal to the difference between the present value of the Participant’s projected target benefit at age 65, and the past service component, both determined as of October 1, 1994.

 

  (b) With respect to individuals who become Plan Participants after the Effective Date, a level annual Company contribution amount to be contributed to the Trust at the end of each Plan Year (commencing with the first Plan Year after the initial year of Plan participation) and ending with the Plan Year prior to the Participant’s attainment of age 65. The present value of the annual future service contributions for each Participant shall be equal to the difference between the present value of the Participant’s projected target benefit at age 65, and the past service component, both determined as of September 30 of the Plan Year in which the individual becomes a Participant.

5.2 Crediting of Contributions. The Plan Committee shall establish and maintain an Account for each Participant. As of the last day of each Plan Year, for each Participant who is employed by the Company on such date, the Trustee shall allocate the contribution determined under Section 5.1. No contribution shall be allocated to an Account of a Participant who is not employed on the last day of the Plan Year, except that a Participant is entitled to receive a pro-rata contribution for such Plan Year where a partial Year of Benefit Service is credited under Section 2.26. Notwithstanding any other provision of the Plan to the contrary, no contribution shall be made for any Plan Year beginning on or after October 1, 2004.

 

7


5.3 Time for Making Contributions. The Company will make annual contributions to the Trust for each Plan Year, with such payments to be allocated among Participants’ Accounts by the Plan Committee as of the last day of the Plan Year. The Company’s annual contribution to the Trust may be made in one or more installments, payable as of the end of the Plan Year, and adjusted for interest attributable to the timing of the installment in relation to the end of the Plan Year.

Section 6. Investment of Accounts.

6.1 Investment Direction.

 

  (a) Unless the Board elects otherwise, the Trustee may invest the Trust solely in Investment Funds selected by the Participants. The Plan Committee or the Board shall have the right to determine, from time to time, the options that shall be offered with respect to the investment of such Accounts, including percentage increments in which such Accounts may be divided among Investment Funds, the maximum number of Investment Funds in which they may invest their Accounts at one time, the times and effective dates of elections to change investment of such Accounts, the Investment Fund(s) in which such Accounts will be held in the event an investment election is not made, the administrative costs to be charged to individuals for processing of investment election changes and any other elements affecting the investment of Accounts.

 

  (b) If the Participant has not directed the Trustee or Plan Committee to invest his Accounts in selected Investment Funds, when he or she first becomes a Plan Participant, then the Trustee may invest such Participant’s Account in a money market type Investment Fund until such direction from the Participant is obtained.

6.2 Allocation of Income. If a Participant so designates the investment of his Accounts in Investment Funds to the Trustee or the Plan Committee, his Account will be credited with investment earnings or losses based upon the performance of each Participant’s investment elections, until the Account has been fully distributed to a Participant or to the Beneficiary or Beneficiaries designated by the Participant in writing delivered to the Company. Pending complete distribution to a Participant, assets in Accounts will be Company assets and income derived thereon will be income to the Company.

 

8


Section 7. Distribution.

7.1 Termination. Upon termination of the services or employment of a Participant with an Employer for any reason other than death, the Participant will be entitled to the value of his Account balance determined as of the Valuation Date immediately preceding his Payment Date. Earnings or losses of the Investment Fund(s) will continue to be allocated to a Participant’s Account as long as he has an Account balance as of any Valuation Date following his Termination Date or Separation from Service. Distributions shall be made, or begin to be made, on the Payment Date.

7.2 Death Benefit. Upon termination of a Participant’s service or employment with an Employer by reason of his death, the Participant’s designated Beneficiary will be entitled to receive all amounts credited to the Account of the Participant as of the date of his death that have not yet been distributed. Said amounts shall be payable in a single lump sum on the Payment Date. Upon the death of a former Participant prior to complete distribution to him of the entire balance of his Account (and after his Termination Date or Separation from Service), the balance of his Account on the date of his death shall be paid to the Participant’s designated Beneficiary in a lump sum on the Payment Date.

7.3 Methods of Distribution. The Company shall direct distribution of the amounts credited to a Participant’s Account, including investment income (and losses) credited thereon pursuant to Section 6, to a Participant or his Beneficiary pursuant to the preceding Sections 7.1 or 7.2, in a lump sum. Effective January 1, 2005, a Participant may elect pursuant to Section 7.6 to receive distribution of amounts credited to his Account in a lump sum or in up to ten annual installments. A Participant’s distribution election is irrevocable on December 31, 2005 or such earlier time as the Company prescribes.

7.4 Installment Payments. Installment payments shall be calculated by dividing the Participant’s total Account by the number of installment payments remaining. For example, if a Participant elects to receive distribution of his or her Account in ten annual installments, at the time of the first installment payment the Account is divided by ten and one-tenth of the Account

 

9


is distributed. At the time of the second installment payment the Account is divided by nine and one-ninth of the Account is distributed. At the time of the tenth installment payment the entire Account is distributed. Pursuant to Section 7.1, the Participant’s Account will continue to be credited with earnings or losses based on the Investment Fund(s) selected by the Participant until the final installment payment has been made.

7.5 Default Method of Distribution. If no distribution election is made, a Participant shall receive distribution of amounts credited to his Account in a lump sum on the Payment Date.

7.6 Special Distribution Election. The Committee may permit a Participant to make a special distribution election with respect to amounts already credited to the Participant’s account and amounts that are credited to his account following such special distribution election; provided that such special distribution election is made prior to December 31, 2005 and otherwise in accordance with Notice 2005-1 or such other guidance as is promulgated under Code Section 409A. A Participant’s special distribution election is irrevocable on December 31, 2005 or such earlier time as the Company prescribes.

7.7 Acceleration of Distributions. Notwithstanding any other provision of the Plan to the contrary, the acceleration of the time or schedule of any payment under the Plan shall not be permitted except as permitted under Code Section 409A.

Section 8. Beneficiary.

8.1 Designation of Beneficiary. Each Participant may designate, by filing a form provided by the Plan Committee, a Beneficiary or Beneficiaries to receive any payment in the event of the Participant’s death. A Participant who has filed a designation of Beneficiary may revoke or change it at any time by filing a new form with the Plan Committee.

8.2 Automatic Designation. Unless otherwise designated, the Beneficiary of a married Participant will automatically be his spouse, and the Beneficiary of an unmarried Participant will be his estate.

 

10


Section 9. Participant’s Rights Held in “Rabbi” Trust.

The Company shall establish and maintain a “Rabbi” Trust which shall be an irrevocable trust in which the Company shall deposit deferred compensation payable to a Participant as determined in Section 5 of this Plan. Any “Rabbi” Trust assets are subject to the claims of the Company’s creditors in the event of the Company’s Insolvency, until paid to Participants and their Beneficiaries. The “Rabbi” Trust shall constitute an unfunded arrangement providing deferred compensation for a select group of senior management executives for purposes of Title I of ERISA.

Section 10. Time of Allocation.

This Plan shall be administered and individual Participant Accounts shall be updated at least annually. All allocations under this Plan shall be allocated as of each Valuation Date.

Section 11. Vesting of Plan Benefits.

The Account balance of a Participant or Beneficiary under the Plan shall be 100% vested.

Section 12. Miscellaneous Provisions.

12.1 Nonassignability. An Employee’s rights and interests under this Plan may not be assigned or transferred. In the event of a Participant’s death, payment of his Account balance shall be made to the Beneficiaries which he has designated under this Plan pursuant to the written designation filed with the Plan Committee in accordance with Section 8.1, or in the absence of such designation, to his estate, in accordance with Section 8.2.

12.2 No Enlargement of Employment Rights. Nothing contained in the Plan shall be construed as a contract of employment between the Company and any person, nor shall the Plan be deemed to give any person the right to be retained in the employ of the Company or to limit the right of the Company to employ or discharge any person with or without cause, or to discipline any Employee.

12.3 Applicable Law. Except as provided by federal law, including Code Section 409A, all questions pertaining to the validity, construction and administration of the Plan shall be determined under the laws of California.

12.4 Gender and Number. Except as otherwise required by the context, any masculine terminology in this document shall include the feminine, and any singular terminology shall include the plural.

 

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Section 13. Amendments and Termination.

13.1 Generally. The Board of Directors may at any time amend or terminate this Plan in whole or in part without the consent of the Participant or his Beneficiary. No amendment however, shall divest any Participant or Beneficiary of the credits to his Account, or of any rights to which he would have been entitled if the Plan had been terminated immediately prior to the effective date of the amendment.

13.2 Distribution upon Termination. Upon termination of the Plan, distributions of the credits to a Participant’s Account shall be made in the manner and at the time heretofore prescribed; provided that no additional credits shall be made to the Account of a Participant following termination of the Plan other than investment income (and losses) credited pursuant to Section 6.

Section 14. Expenses.

Costs of administration of the Plan will be paid by the Company as may be determined by the Board, with the exception of investment direction expenses charged to Participants in accordance with Section 6.1(a).

Section 15. Claims Procedures.

15.1 Applications for Benefits and Inquiries. Any application for benefits, inquiries about the Plan or inquiries about present or future rights under the Plan must be submitted to the Plan Administrator in writing by an applicant (or his or her authorized representative). The Plan Administrator is:

Dolby Laboratories, Inc.

100 Potrero Avenue

San Francisco, CA 94103-4813

15.2 Denial of Claims. In the event that any application for benefits is denied in whole or in part, the Plan Administrator must provide the applicant with written or electronic notice of the denial of the application, and of the applicant’s right to review the denial. Any electronic notice will comply with the regulations of the U.S. Department of Labor. The notice of denial will be set forth in a manner designed to be understood by the applicant and will include the following:

 

  (a) the specific reason or reasons for the denial;

 

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  (b) references to the specific Plan provisions upon which the denial is based;

 

  (c) a description of any additional information or material that the Plan Administrator needs to complete the review and an explanation of why such information or material is necessary; and

 

  (d) an explanation of the Plan’s review procedures and the time limits applicable to such procedures, including a statement of the applicant’s right to bring a civil action under Section 502(a) of ERISA following a denial on review of the claim, as described in Section 15.4 below.

This notice of denial will be given to the applicant within ninety (90) days after the Plan Administrator receives the application, unless special circumstances require an extension of time, in which case, the Plan Administrator has up to an additional ninety (90) days for processing the application. If an extension of time for processing is required, written notice of the extension will be furnished to the applicant before the end of the initial ninety (90) day period.

This notice of extension will describe the special circumstances necessitating the additional time and the date by which the Plan Administrator is to render its decision on the application.

15.3 Request for a Review. Any person (or that person’s authorized representative) for whom an application for benefits is denied, in whole or in part, may appeal the denial by submitting a request for a review to the Plan Administrator within sixty (60) days after the application is denied. A request for a review shall be in writing and shall be addressed to:

Dolby Laboratories, Inc.

100 Potrero Avenue

San Francisco, CA 94103-4813

A request for review must set forth all of the grounds on which it is based, all facts in support of the request and any other matters that the applicant feels are pertinent. The applicant (or his or her representative) shall have the opportunity to submit (or the Plan Administrator may

 

13


require the applicant to submit) written comments, documents, records, and other information relating to his or her claim. The applicant (or his or her representative) shall be provided, upon request and free of charge, reasonable access to, and copies of, all documents, records and other information relevant to his or her claim. The review shall take into account all comments, documents, records and other information submitted by the applicant (or his or her representative) relating to the claim, without regard to whether such information was submitted or considered in the initial benefit determination.

15.4 Decision on Review. The Plan Administrator will act on each request for review within sixty (60) days after receipt of the request, unless special circumstances require an extension of time (not to exceed an additional sixty (60) days), for processing the request for a review. If an extension for review is required, written notice of the extension will be furnished to the applicant within the initial sixty (60) day period. This notice of extension will describe the special circumstances necessitating the additional time and the date by which the Plan Administrator is to render its decision on the review. The Plan Administrator will give prompt, written or electronic notice of its decision to the applicant. Any electronic notice will comply with the regulations of the U.S. Department of Labor. In the event that the Plan Administrator confirms the denial of the application for benefits in whole or in part, the notice will set forth, in a manner calculated to be understood by the applicant, the following:

 

  (a) the specific reason or reasons for the denial;

 

  (b) references to the specific Plan provisions upon which the denial is based;

 

  (c) a statement that the applicant is entitled to receive, upon request and free of charge, reasonable access to, and copies of, all documents, records and other information relevant to his or her claim; and

 

  (d) a statement of the applicant’s right to bring a civil action under Section 502(a) of ERISA.

15.5 Rules and Procedures. The Plan Administrator will establish rules and procedures, consistent with the Plan and with ERISA, as necessary and appropriate in carrying out its responsibilities in reviewing benefit claims. The Plan Administrator may require an applicant who wishes to submit additional information in connection with an appeal from the denial of benefits to do so at the applicant’s own expense.

 

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15.6 Exhaustion of Remedies. No legal action for benefits under the Plan may be brought until the claimant (i) has submitted a written application for benefits in accordance with the procedures described by Section 15.1 above, (ii) has been notified by the Plan Administrator that the application is denied, (iii) has filed a written request for a review of the application in accordance with the appeal procedure described in Section 15.3 above, and (iv) has been notified that the Plan Administrator has denied the appeal. Notwithstanding the foregoing, if the Plan Administrator does not respond to a Participant’s claim or appeal within the relevant time limits specified in this Section 15, the Participant may bring legal action for benefits under the Plan pursuant to Section 502(a) of ERISA.

Section 16. Execution.

To record the amendment and restatement of this Plan, the Company has caused its appropriate officers to affix its corporate name and seal hereto this          day of                     , 2007.

 

 
By    
  President
By    
  Secretary

 

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Section 302 CEO Certification

Exhibit 31.1

CERTIFICATION

I, N. W. Jasper, Jr., certify that:

 

  1. I have reviewed this Quarterly Report on Form 10-Q of Dolby Laboratories, Inc.;

 

  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

  3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

  4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the registrant and have:

 

  (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

  5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: January 31, 2008

 

/s/ N.W. Jasper, Jr.

N. W. Jasper, Jr.

Principal Executive Officer

Section 302 CFO Certification

Exhibit 31.2

CERTIFICATION

I, Kevin J. Yeaman, certify that:

 

  1. I have reviewed this Quarterly Report on Form 10-Q of Dolby Laboratories, Inc.;

 

  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

  3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

  4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the registrant and have:

 

  (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

  5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: January 31, 2008

 

/s/ Kevin J. Yeaman

Kevin J. Yeaman

Principal Financial Officer

Section 906 CEO and CFO Certification

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Dolby Laboratories, Inc. (the “Company”) on Form 10-Q for the fiscal quarter ended December 28, 2007, as filed with the Securities and Exchange Commission (the “Report”), N.W. Jasper, Jr., President and Chief Executive Officer of the Company, and Kevin J. Yeaman, Chief Financial Officer of the Company, respectively, do each hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

 

   

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

   

The information in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

Date: January 31, 2008
/s/ N.W. Jasper, Jr.

N.W. Jasper, Jr.

President and Chief Executive Officer

 

/s/ Kevin J. Yeaman

Kevin J. Yeaman

Chief Financial Officer