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 25, 2009

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 has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

  Large accelerated filer    x   Accelerated filer   ¨
  Non-accelerated filer    ¨  (Do not check if a smaller reporting company)   Smaller reporting company   ¨

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 20, 2010 the registrant had 53,666,373 shares of Class A common stock, par value $0.001 per share, and 60,374,140 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    2
   Condensed Consolidated Balance Sheets as of September 25, 2009 and December 25, 2009    2
   Condensed Consolidated Statements of Operations for the Fiscal Quarters Ended December 26, 2008 and December 25, 2009    3
   Condensed Consolidated Statements of Cash Flows for the Fiscal Quarters Ended December 26, 2008 and December 25, 2009    4
   Notes to Condensed Consolidated Financial Statements    5
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    18
Item 3.    Quantitative and Qualitative Disclosures About Market Risk    30
Item 4.    Controls and Procedures    31
PART II – OTHER INFORMATION   
Item 1.    Legal Proceedings    32
Item 1A.    Risk Factors    32
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds    52
Item 6.    Exhibits    53
Signatures    54

 

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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 25,
2009
   December 25,
2009
     (unaudited)

ASSETS

     

Current assets:

     

Cash and cash equivalents

   $ 451,678    $ 406,238

Short-term investments

     283,808      372,767

Accounts receivable, net

     22,981      43,507

Inventories

     12,975      9,493

Deferred taxes

     83,438      87,767

Prepaid expenses and other current assets

     45,958      34,569
             

Total current assets

     900,838      954,341

Long-term investments

     205,938      246,022

Property, plant, and equipment, net

     92,178      98,292

Intangible assets, net

     82,035      77,595

Goodwill

     261,121      258,868

Deferred taxes

     23,755      26,149

Other non-current assets

     15,450      15,176
             

Total assets

   $ 1,581,315    $ 1,676,443
             

LIABILITIES AND STOCKHOLDERS’ EQUITY

     

Current liabilities:

     

Accounts payable

   $ 12,921    $ 10,396

Accrued liabilities

     100,901      111,694

Income taxes payable

     3,934      29,879

Current portion of long-term debt

     1,624      1,648

Deferred revenue

     37,204      28,294
             

Total current liabilities

     156,584      181,911

Long-term debt, net of current portion

     5,825      5,407

Long-term deferred revenue

     10,759      10,456

Deferred taxes

     13,573      13,263

Other non-current liabilities

     31,469      32,069
             

Total liabilities

     218,210      243,106

Stockholders’ equity:

     

Class A common stock

     53      54

Class B common stock

     60      60

Additional paid-in capital

     478,979      482,505

Retained earnings

     852,475      921,561

Accumulated other comprehensive income

     9,541      6,858
             

Total stockholders’ equity – Dolby Laboratories, Inc.

     1,341,108      1,411,038

Controlling interest

     21,997      22,299
             

Total stockholders’ equity

     1,363,105      1,433,337
             

Total liabilities and stockholders’ equity

   $ 1,581,315    $ 1,676,443
             

See accompanying notes to unaudited condensed consolidated financial statements

 

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Table of Contents

DOLBY LABORATORIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

      Fiscal Quarter Ended  
      December 26,
2008
    December 25,
2009
 
     (unaudited)  

Revenue:

    

Licensing

   $ 154,056      $ 165,775   

Product sales

     17,946        47,657   

Services

     8,256        7,784   
                

Total revenue

     180,258        221,216   
                

Cost of revenue:

    

Cost of licensing

     3,248        4,026   

Cost of product sales (1)

     9,359        28,084   

Cost of services (1)

     3,206        3,683   

Gain from amended patent licensing agreement

     (20,041     —     
                

Total cost of revenue

     (4,228     35,793   
                

Gross margin

     184,486        185,423   
                

Operating expenses:

    

Research and development (1)

     18,658        22,800   

Sales and marketing (1)

     24,487        30,384   

General and administrative (1)

     26,000        27,882   

Restructuring charges, net

     868        185   
                

Total operating expenses

     70,013        81,251   
                

Operating income

     114,473        104,172   

Interest income

     4,132        1,832   

Interest expense

     (263     (85

Other income/(expense), net

     (1,382     460   
                

Income before provision for income taxes

     116,960        106,379   

Provision for income taxes

     (38,623     (36,886
                

Net income before controlling interest

     78,337        69,493   

Less: net income attributable to controlling interest

     (242     (407
                

Net income attributable to Dolby Laboratories, Inc.

   $ 78,095      $ 69,086   
                

Earnings per share attributable to Dolby Laboratories, Inc. (basic)

   $ 0.69      $ 0.61   

Earnings per share attributable to Dolby Laboratories, Inc. (diluted)

   $ 0.68      $ 0.59   

Weighted average shares outstanding (basic)

     112,608        114,085   

Weighted average shares outstanding (diluted)

     114,870        116,138   

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

   $ 340      $ 343   

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

    

Cost of product sales

   $ 156      $ 78   

Cost of services

     27        25   

Research and development

     1,173        1,196   

Sales and marketing

     1,252        1,732   

General and administrative

     1,972        2,678   

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 26,
2008
    December 25,
2009
 
     (unaudited)  

Operating activities:

    

Net income before controlling interest

   $ 78,337      $ 69,493   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     6,519        7,806   

Stock-based compensation expense

     4,531        5,327   

Amortization of premium on investments

     974        1,868   

Excess tax benefit from exercise of stock options

     (792     (4,653

Provision for doubtful accounts

     851        (111

Deferred taxes

     6,918        (5,629

Unrealized losses/(gains) on Put Rights

     (6,606     1,299   

Unrealized losses/(gains) on auction rate certificates

     8,022        (1,307

Gain from amended patent licensing agreement

     (20,041     —     

Other non-cash items affecting net income

     (826     588   

Changes in operating assets and liabilities:

    

Accounts receivable

     1,225        (20,400

Inventories

     (2,388     3,490   

Prepaid expenses and other assets

     (2,059     6,927   

Accounts payable and accrued liabilities

     (6,456     8,459   

Income taxes, net

     24,135        34,791   

Deferred revenue

     6,202        (9,496

Other liabilities

     (1,122     12   
                

Net cash provided by operating activities

     97,424        98,464   
                

Investing activities:

    

Purchases of available-for-sale securities

     (96,801     (264,913

Proceeds from sale of available-for-sale securities

     17,050        134,784   

Purchases of property, plant, and equipment

     (996     (10,619

Purchase of intangible assets

     (8,321     (125
                

Net cash used in investing activities

     (89,068     (140,873
                

Financing activities:

    

Payments on debt

     (368     (398

Proceeds from the exercise of stock options

     1,335        7,337   

Issuance of Class A common stock (Employee Stock Purchase Plan)

     1,635        1,921   

Repurchase of common stock

     —          (15,661

Excess tax benefit from the exercise of stock options

     792        4,653   
                

Net cash provided by/(used in) financing activities

     3,394        (2,148
                

Effect of foreign exchange rate changes on cash and cash equivalents

     (4,077     (883
                

Net increase/(decrease) in cash and cash equivalents

     7,673        (45,440

Cash and cash equivalents at beginning of period

     394,761        451,678   
                

Cash and cash equivalents at end of period

   $ 402,434      $ 406,238   
                

Supplemental disclosure:

    

Cash paid for income taxes

   $ 7,663      $ 7,701   

Cash paid for interest

     119        95   

See accompanying notes to unaudited condensed consolidated financial statements

 

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DOLBY LABORATORIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Basis of Presentation

Unaudited Interim Financial Statements

The accompanying interim condensed consolidated balance sheets as of September 25, 2009 and December 25, 2009, and the condensed consolidated statements of operations and cash flows for the fiscal quarters ended December 26, 2008 and December 25, 2009 are unaudited. The September 25, 2009 condensed consolidated balance sheet was derived from our audited financial statements. These interim condensed 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 condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements for the fiscal year ended September 25, 2009 and include all adjustments necessary for fair presentation.

The results for the fiscal quarter ended December 25, 2009 are not necessarily indicative of the results to be expected for any subsequent quarterly or annual financial period, including the fiscal year ending September 24, 2010.

The accompanying interim condensed consolidated financial statements are prepared in accordance with Securities and Exchange Commission (SEC) 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 condensed consolidated financial statements should be read in conjunction with our consolidated financial statements for the fiscal year ended September 25, 2009 that are included in our Annual Report on Form 10-K and filed with the SEC. We have evaluated the impact of subsequent events up to the filing date, February 3, 2010, of these interim condensed consolidated financial statements.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of Dolby Laboratories and our wholly-owned subsidiaries. In addition, we have consolidated the financial results of jointly-owned affiliated companies for which our principal stockholder is the controlling interest. We report these controlling interests as a separate line in our condensed consolidated statements of operations as net income attributable to controlling interest and in our condensed consolidated balance sheets as controlling interest. We have eliminated all intercompany accounts and transactions upon consolidation.

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 estimated selling prices for elements sold in multiple-element revenue arrangements, valuation allowances for receivables, carrying values of inventories, goodwill, intangible assets, stock-based compensation, fair values of investments, put rights, accrued expenses, including liabilities for unrecognized tax benefits and deferred income tax assets. Actual results could differ from our estimates.

Reclassifications

We reclassified certain prior period amounts to conform to current period presentation. We have reclassified certain prior period research and development-related facilities and other expenses that were included within the selling, general, and administrative category within operating expenses to the research and development category within operating expenses. Additionally, in our consolidated statement of operations, we have changed the presentation of our operating expenses categories to provide additional detail by separating the selling, general, and administrative category in prior periods into sales and marketing and general and administrative categories.

 

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2. Summary of Significant Accounting Policies

There have been no material changes in our significant accounting policies, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended September 25, 2009, except for changes in the accounting policies listed below.

Recently Adopted Accounting Pronouncements

Business Combinations

The Financial Accounting Standards Board (FASB) amended the accounting standards for business combinations. The amendments require an entity to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. Subsequent changes to the estimated fair value of contingent consideration will be reflected in earnings until the contingency is settled. Acquisition-related costs and restructuring costs will be expensed as incurred rather than treated as part of the purchase price. The adoption of this accounting guidance will change our accounting treatment prospectively for business combinations initiated after September 25, 2009. The adoption of this accounting guidance did not have an impact on our condensed consolidated financial statements because we did not initiate any business combinations in the first quarter of fiscal 2010.

Controlling Interests

The FASB amended the accounting standards for the consolidation of controlling interests, which changed the accounting and presentation of controlling interests. Our adoption of this accounting guidance did not change our accounting for controlling interests. The presentation requirements of the guidance resulted in the reclassification of our controlling interest from the mezzanine to the equity section of our consolidated balance sheet.

Revenue Recognition

In October 2009, the FASB amended the accounting standards for revenue recognition to exclude software contained within a tangible product from the scope of the software revenue recognition guidance if the software is essential to the tangible product's functionality. Also in October 2009, the FASB amended the accounting standards for multiple-element revenue arrangements to:

 

   

provide updated guidance on whether multiple deliverables exist, how the elements in an arrangement should be separated, and how the consideration should be allocated;

 

   

require an entity to allocate revenue in an arrangement using estimated selling prices (ESP) of each element if a vendor does not have vendor-specific objective evidence of selling price (VSOE) or third-party evidence of selling price (TPE); and

 

   

eliminate the use of the residual method and require a vendor to allocate revenue using the relative selling price method.

In the first quarter of fiscal 2010, we early-adopted this accounting guidance on a prospective basis for applicable arrangements entered into or materially modified after September 25, 2009. In accordance with this guidance, we no longer account for revenue from product sales containing software elements under the software revenue recognition guidance.

We evaluate each element in a multiple-element arrangement to determine whether it represents a separate unit of accounting. An element constitutes a separate unit of accounting when the delivered element has standalone value and delivery of the undelivered element is probable and within our control. When these criteria are not met, the delivered elements are combined with the undelivered elements and the arrangement consideration is allocated to a combined, single unit. The amended guidance changed our units of accounting for our revenue transactions by allowing us to use ESP to establish the standalone selling price of the delivered and undelivered elements in an arrangement.

If the separation criteria are met, we account for each element within a multiple-element arrangement, such as hardware, software, maintenance, and other services, separately and we allocate arrangement consideration based on the relative selling price of each element. 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

 

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maintenance and/or the right to receive product upgrades. Revenue allocated to the undelivered element is recognized over the estimated service period of the respective element or when the product upgrade is delivered. We do not recognize revenue for delivered elements that is contingent on the future delivery of products or services or future performance obligations until we have completed these obligations.

Prior to our adoption of the amended guidance for revenue recognition, we were not able to establish VSOE of the standalone selling price for the undelivered support and maintenance elements for a majority of our multiple-element arrangements. VSOE was required to recognize revenue for an individual element independent of other elements in the arrangement. As a result, we typically allocated revenue from the entire arrangement to the undelivered element and recognized this revenue ratably over the estimated support period.

We now allocate revenue to each element in an arrangement based on a selling price hierarchy. The selling price for a deliverable is based on its VSOE, if available, TPE, if VSOE is not available, or estimated selling price, if neither VSOE nor TPE is available. We determine a best estimate of selling price using the same methods used to determine the selling price of an element sold on a standalone basis. We establish the best estimate of selling price for each element primarily by considering actual sales prices, as we typically sell each element on a standalone basis, and internal factors such as pricing practices, margin objectives, and customer demands. Consideration is also given to market conditions such as competitor pricing strategies and industry technology lifecycles.

For multiple-element product sales arrangements entered into or materially modified after September 25, 2009, we recognized $20.5 million in revenue in the first quarter of fiscal 2010. At December 25, 2009, the deferred revenue balance from these transactions was $0.2 million, representing the estimated selling price of our support and maintenance obligation bundled with our hardware sales. We are not able to reasonably estimate the effect of adopting this guidance on future periods, as the impact will vary based on the nature and volume of new or materially modified arrangements in any given future period.

Our adoption of the amended guidance did not change the accounting for arrangements entered into prior to September 25, 2009 and we continue to recognize revenue for such arrangements ratably over the estimated support period. For product sales arrangements entered into on or before September 25, 2009, we recognized $14.0 million in previously deferred revenue in the first quarter of fiscal 2010. At December 25, 2009, the remaining deferred revenue balance from these transactions was $20.7 million. We expect to recognize the majority of this deferred revenue in fiscal 2010, however circumstances may change such that this may not occur.

The following is a summary of our product sales revenue for the first quarter of fiscal 2010 and the associated deferred revenue balances as of December 25, 2009:

 

     Revenue    Deferred Revenue
     (in thousands)

Product sales entered into in the first quarter of fiscal 2010:

     

Multiple-element arrangements (1)

   $ 20,550    $ 241

Standalone arrangements (2)

     13,094      98

Product sales from prior periods for which revenue was deferred (3)

     14,013      20,741
             

Total

   $ 47,657    $ 21,080
             

 

(1) Of this revenue, we would have recognized $2.9 million in the first quarter of fiscal 2010 had we not adopted the changes in accounting standards. As such, we recognized an incremental $17.6 million as a result of our adoption of the new revenue recognition accounting standards in the first quarter of fiscal 2010.
(2) These arrangements were not affected by the changes in accounting standards.
(3) Represents revenue attributable to multiple-element arrangements entered into on or before September 25, 2009.

 

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3. Composition of Certain Financial Statement Captions

Cash, Cash Equivalents, and Investments

Cash, cash equivalents, and investments as of September 25, 2009 and December 25, 2009 consisted of the following:

 

     September 25,
2009
   December 25,
2009
     (in thousands)

Cash and cash equivalents:

     

Cash

   $ 132,772    $ 151,403

Cash equivalents:

     

Commercial paper

     —        29,989

Money market funds

     318,906      205,510

Municipal debt securities

     —        9,330

U.S. agency securities

     —        10,006
             

Total cash and cash equivalents

     451,678      406,238
             

Short-term investments:

     

Auction rate certificates

     57,254      58,111

Municipal debt securities

     105,963      121,267

U.S. agency securities

     20,367      60,301

U.S. government bonds

     19,995      39,943

Variable rate demand notes

     80,229      93,145
             

Total short-term investments

     283,808      372,767
             

Long-term investments (1):

     

Corporate bonds

     22,655      22,655

Municipal debt securities

     130,006      165,553

U.S. agency securities

     22,628      24,974

U.S. government bonds

     30,649      32,840
             

Total long-term investments

     205,938      246,022
             

Total cash, cash equivalents and investments

   $ 941,424    $ 1,025,027
             

 

(1) Our long-term investments have maturities that range from one to three years.

At December 25, 2009, we held tax-exempt auction rate certificates with a par value of $67.6 million. While we have had a number of successful redemptions, auctions for these investments have failed and there is no assurance that future auctions will succeed. As a result, we may not be able to liquidate our investments and fully recover the par value. We do not believe that the underlying issuers of our auction rate certificates are currently at risk of default. We continue to receive interest payments on the auction rate certificates in accordance with their terms.

In November 2008, we elected to accept a rights offering from UBS AG, which we refer to, along with its wholly owned subsidiaries UBS Financial Services, Inc. and UBS Securities LLC, as UBS. The rights offering provides us with an option (the “Put Rights”) to sell to UBS, at par value, our auction rate certificates purchased through UBS at any time during a two-year sale period beginning June 30, 2010. We elected to measure the Put Rights at fair value with gains and losses recognized as a component of net income. Simultaneous with the acceptance of the rights offering, we reclassified our auction rate certificates from the available-for-sale to the trading securities category within long-term investments in our consolidated balance sheet.

Our Put Rights are classified as financial assets within prepaid and other current assets because we plan to exercise these Put Rights in fiscal 2010. Due to our planned exercise of the Put Rights, we believe the recovery period for our auction rate certificates is likely to be less than one year, thus they are classified as short-term investments.

 

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In the first quarter of fiscal 2010, we recognized $1.3 million in net gains related to our auction rate certificates, which was primarily due to a decline in market volatility in the current period. The net gains from our auction rate certificates were offset by losses of $1.3 million related to our Put Rights.

Our investment portfolio, which we recorded as cash equivalents, short-term investments, and long-term investments, as of September 25, 2009 and December 25, 2009 was as follows:

 

     September 25, 2009
     Cost    Unrealized Gain    Unrealized Loss     Estimated Fair
Value
     (in thousands)

Auction rate certificates

   $ 57,254    $ —      $ —        $ 57,254

Corporate bonds

     22,403      252      —          22,655

Money market funds

     318,906      —        —          318,906

Municipal debt securities

     233,320      2,667      (18     235,969

U.S. agency securities

     42,515      480      —          42,995

U.S. government bonds

     50,431      213      —          50,644

Variable rate demand notes

     80,229      —        —          80,229
                            

Cash equivalents and investments

   $ 805,058    $ 3,612    $ (18   $ 808,652
                            
     December 25, 2009
     Cost    Unrealized Gain    Unrealized Loss     Estimated Fair
Value
     (in thousands)

Auction rate certificates

   $ 58,111    $ —      $ —        $ 58,111

Commercial paper

     29,989      —        —          29,989

Corporate bonds

     22,358      297      —          22,655

Money market funds

     205,510      —        —          205,510

Municipal debt securities

     293,548      2,639      (37     296,150

U.S. agency securities

     94,974      411      (104     95,281

U.S. government bonds

     72,937      3      (157     72,783

Variable rate demand notes

     93,145      —        —          93,145
                            

Cash equivalents and investments

   $ 870,572    $ 3,350    $ (298   $ 873,624
                            

We have classified all of our investments listed in the tables above, with the exception of our auction rate certificates, as available-for-sale securities recorded at fair market value on the condensed consolidated balance sheets, with unrealized gains and losses reported as a component of accumulated other comprehensive income. We have classified our auction rate certificates as trading securities recorded at fair market value on the condensed consolidated balance sheets, with unrealized gains and losses reported as a component of net income.

The following tables show the gross unrealized losses and the fair value for those available-for-sale securities that were in an unrealized loss position as of September 25, 2009 and December 25, 2009:

 

     September 25, 2009  
     Less than 12 months     12 months or greater    Total  
     Fair Value    Gross
Unrealized
Losses
    Fair Values    Gross
Unrealized
Losses
   Fair Value    Gross
Unrealized
Losses
 
     (in thousands)  

Municipal debt securities

   $ 8,405    $ (18   $ —      $ —      $ 8,405    $ (18
                                            

Total

   $ 8,405    $ (18   $ —      $ —      $ 8,405    $ (18
                                            

 

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Table of Contents
     December 25, 2009  
     Less than 12 months     12 months or greater    Total  
     Fair Value    Gross
Unrealized
Losses
    Fair Values    Gross
Unrealized
Losses
   Fair Value    Gross
Unrealized
Losses
 
                (in thousands)            

Municipal debt securities

   $ 24,952    $ (37   $ —      $ —      $ 24,952    $ (37

U.S. agency securities

     39,936      (104     —        —        39,936      (104

U.S. government bonds

     52,843      (157     —        —        52,843      (157
                                            

Total

   $ 117,731    $ (298   $ —      $ —      $ 117,731    $ (298
                                            

The unrealized losses on our available-for-sale securities were primarily a result of unfavorable changes in interest rates subsequent to the initial purchase of these securities. We do not intend to sell, and we will not need to sell, these securities before we recover any unrealized losses and we expect to recover the full carrying value of these securities. As a result, we do not consider any portion of the unrealized losses at September 25, 2009 and December 25, 2009 to be other-than-temporary impairment, nor do we consider any of the unrealized losses to be credit losses.

Accounts Receivable

Accounts receivable consists of the following:

 

     September 25,
2009
    December 25,
2009
 
     (in thousands)  

Trade accounts receivable

   $ 21,991      $ 40,848   

Amounts receivable related to patent administration program

     3,212        4,714   
                
     25,203        45,562   

Less: Allowance for doubtful accounts

     (2,222     (2,055
                

Accounts receivable, net

   $ 22,981      $ 43,507   
                

The increase in accounts receivable from September 25, 2009 to December 25, 2009 was due to the timing of our receipt of licensee statements.

Inventories

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

 

     September 25,
2009
   December 25,
2009
     (in thousands)

Raw materials

   $ 3,670    $ 3,096

Work in process

     1,207      499

Finished goods

     8,098      5,898
             

Inventories

   $ 12,975    $ 9,493
             

 

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Table of Contents

Goodwill and Intangible Assets

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

 

     Total  
     (in thousands)  

Balance at September 25, 2009

   $ 261,121   

Translation adjustments and other

     (2,253
        

Balance at December 25, 2009

   $ 258,868   
        

Intangible assets consist of the following:

 

     September 25,
2009
    December 25,
2009
 
     (in thousands)  

Amortized intangible assets:

    

Acquired patents and technology

   $ 59,964      $ 59,501   

Customer relationships

     30,851        30,281   

Customer contracts

     6,073        5,973   

Other intangibles

     20,184        20,307   
                
     117,072        116,062   

Less: Accumulated amortization

     (35,037     (38,467
                

Intangible assets, net

   $ 82,035      $ 77,595   
                

Amortization expense for our intangible assets was $3.3 million and $3.8 million in the first quarter of fiscal 2009 and 2010, respectively, and is included in cost of licensing, cost of product sales, and sales and marketing expenses in the accompanying condensed consolidated statements of operations. The decrease in gross intangible assets from September 25, 2009 to December 25, 2009 is primarily due to foreign currency translation.

Accrued Liabilities

Accrued liabilities consist of the following:

 

     September 25,
2009
   December 25,
2009
     (in thousands)

Accrued royalties

   $ 2,070    $ 3,643

Amounts payable to joint licensing program partners

     28,906      28,931

Accrued compensation and benefits

     40,952      49,227

Accrued professional fees

     4,392      3,993

Current portion of litigation settlement (see Note 7)

     2,785      2,857

Other accrued liabilities

     21,796      23,043
             

Accrued liabilities

   $ 100,901    $ 111,694
             

Accumulated Other Comprehensive Income

Accumulated foreign currency translation gains, net of tax, were $7.3 million at September 25, 2009, compared to $5.0 million at December 25, 2009. Accumulated unrealized gains on investments, net, were $2.2 million at September 25, 2009, compared to $1.9 million at December 25, 2009.

 

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Per Share Data

We compute basic earnings per share by dividing net income attributable to Dolby Laboratories, Inc. by the weighted average number of shares of Class A and Class B common stock outstanding during the period. For diluted earnings per share, we divide net income attributable to Dolby Laboratories, Inc. by the sum of the weighted average number of shares of Class A and Class B common stock outstanding and the potential number of shares of dilutive Class A and Class B common stock outstanding during the period.

The following table sets forth the computation of basic and diluted earnings per share attributable to Dolby Laboratories, Inc.:

 

     Fiscal Quarter Ended
     December 26,
2008
   December 25,
2009
     (in thousands, except per share
amounts)

Numerator:

     

Net income attributable to Dolby Laboratories, Inc.

   $ 78,095    $ 69,086
             

Denominator:

     

Weighted average shares outstanding (basic)

     112,608      114,085

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

     2,258      1,882

Potential common shares from restricted stock units

     4      171
             

Weighted average shares outstanding (diluted)

   $ 114,870    $ 116,138
             

Earnings per share attributable to Dolby Laboratories, Inc. (basic)

   $ 0.69    $ 0.61

Earnings per share attributable to Dolby Laboratories, Inc. (diluted)

   $ 0.68    $ 0.59

We excluded 3,255,835 and 1,568,319 options from the calculation of potential common shares for the first quarter of fiscal 2009 and 2010, respectively, because their inclusion would have been anti-dilutive. We excluded 229,058 and 20,442 restricted stock units from the calculation of potential common shares for the first quarter of fiscal 2009 and 2010, respectively, because their inclusion would have been anti-dilutive.

Withholding and Sales Tax

We recognize licensing revenue gross of withholding taxes, which our licensees remit directly to their local tax authorities. Withholding tax remittances were $6.2 million and $7.6 million in the first quarter of fiscal 2009 and 2010, respectively. We account for sales tax on a net basis by excluding sales tax from our revenue.

4. Fair Value Measurements

Fair value is the exchange price that would be received for an asset or would be paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. We minimize the use of unobservable inputs and use observable market data, if available, when determining fair value. We classify our inputs to measure fair value with the following three-level hierarchy:

 

Level 1:    Quoted prices in active markets that are accessible by us at the measurement date for identical assets and liabilities.
Level 2:    Prices not directly accessible by us. Such prices may be based upon quoted prices in active markets or inputs not quoted on active markets but are corroborated by market data.
Level 3:    Unobservable inputs are used when little or no market data is available and reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability.

 

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Financial assets carried at fair value as of December 25, 2009 are classified below:

 

      Level 1    Level 2    Level 3    Total
     (in thousands)

Investments held in supplemental retirement plan

   $ 2,268    $ —      $ —      $ 2,268

Money market funds

     205,510      —        —        205,510

Commercial paper

     —        29,989      —        29,989

Corporate Bonds

     —        22,655      —        22,655

Municipal debt securities

     —        296,150      —        296,150

U.S. agency securities

     —        95,281      —        95,281

U.S. government bonds

     —        72,783      —        72,783

Variable rate demand notes

     —        93,145      —        93,145

Auction rate certificates

     —        —        58,111      58,111

Put Rights

     —        —        8,209      8,209
                           

Total

   $ 207,778    $ 610,003    $ 66,320    $ 884,101
                           

Financial liabilities carried at fair value as of December 25, 2009 are classified below:

 

     Level 1    Level 2    Level 3    Total
     (in thousands)

Investments held in supplemental retirement plan

   $ 2,268    $ —      $ —      $ 2,268

Forward currency contract

     —        9      —        9

Interest rate derivative

     —        267      —        267
                           

Total

   $ 2,268    $ 276    $ —      $ 2,544
                           

We base the fair value of our Level 1 financial instruments on active quoted market prices for identical instruments. Our Level 1 financial instruments include money market funds and mutual fund investments held in our supplemental retirement plan. We obtain the fair value of our Level 2 financial instruments from professional pricing sources for identical or comparable instruments, rather than direct observations of quoted prices in active markets. Our Level 2 financial instruments include commercial paper, corporate bonds, municipal debt securities, U.S. agency securities, U.S. government bonds, variable rate demand notes, a forward currency contract, and an interest rate derivative. We classify our auction rate certificates and Put Rights as Level 3 financial assets because quoted prices are unobservable or no market data is available.

The following table provides a reconciliation between the beginning and ending balances of items measured at fair value on a recurring basis using significant unobservable inputs (Level 3):

 

      Auction rate certificates
and Put Rights
 
     (in thousands)  

Balances at September 25, 2009

   $ 66,762   

Gains or losses included in earnings:

  

Unrealized gains from auction rate certificates

     1,307   

Realized gain on redemptions at par of auction rate certificates

     8   

Unrealized losses from Put Rights

     (1,307

Redemptions at par of auction rate certificates

     (450
        

Balances at December 25, 2009

   $ 66,320   
        

Observable market information is insufficient to determine fair value of our auction rate certificates and Put Rights. We estimated fair value of our auction rate certificates by using a discounted cash flow model, which incorporates assumptions that market participants would use in their estimates of fair value. Some of the assumptions used to determine fair value of our auction rate certificates include the interest yield of the securities, market volatility, the expected liquidity of the securities, the collateral underlying the securities, the creditworthiness of the counterparty, the timing of expected future cash flows, the likelihood of a successful future auction, and the

 

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final stated maturities of the securities. We estimated the fair value of our Put Rights as the difference between par value and fair value of the underlying auction rate certificates, discounted for counterparty credit risk. Some of the assumptions used to determine fair value of our Put Rights include the value of the underlying auction rate certificates and the credit risk associated with the Put Rights issuer, UBS.

Unrealized gains/losses from auction rate certificates, realized gains on redemptions, and unrealized gains/losses from our Put Rights are included in the other expense, net line item in our consolidated statements of operations for the quarters ended December 26, 2008 and December 25, 2009.

5. Stock-Based Compensation

We have adopted stock compensation plans that provide for grants of stock-based awards as a form of compensation to employees, officers, and directors. We have issued stock-based awards in the form of stock options, restricted stock units, stock appreciation rights, and shares issued under our employee stock purchase plan. Stock-based compensation expense was $4.6 million and $5.7 million for the first quarter of fiscal 2009 and 2010, respectively.

Our stock-based compensation expense for the first quarter of fiscal 2009 was primarily comprised of $3.7 million for stock options and $0.8 million for restricted stock units. Our stock-based compensation expense for the first quarter of fiscal 2010 was primarily comprised of $3.7 million for stock options, $1.6 million for restricted stock units, and $0.2 million for stock appreciation rights.

During the first quarter of fiscal 2009, we granted 78,320 stock options at a weighted average exercise price of $28.00 per share and 27,695 restricted stock units at a weighted average grant price of $28.01 per share. During the first quarter of fiscal 2010, we granted 73,120 stock options at a weighted average exercise price of $42.73 per share and 14,165 restricted stock units at a weighted average grant price of $42.72 per share.

6. Restructuring

In fiscal 2009, we undertook a restructuring project to reallocate our global manufacturing resources. As part of this restructuring project, we consolidated our Wootton Bassett, U.K. manufacturing operations into our Brisbane, California facility in the second quarter of fiscal 2009, which resulted in a reduced manufacturing workforce. In addition, we reduced our workforce in our Brisbane, California manufacturing facility. These activities resulted in severance and other charges attributable to the termination of employees.

Also in fiscal 2009, we integrated our former Cinea reporting unit into our Dolby Entertainment Technology reporting unit, ceased using the associated leased facilities, and terminated employees. This activity resulted in facilities charges relating to non-cancelable lease costs and severance and other charges attributable to the termination of employees.

Changes in our restructuring accruals included within accrued liabilities on our consolidated balance sheets were as follows:

 

     Severance     Facilities and
contract
termination costs
    Fixed assets
write-off
    Other
associated costs
    Total  
     (in thousands)  

Balance at September 25, 2009

   $ 1,103      $ 88      $ —        $ 20      $ 1,211   

Restructuring charges

     50        —          9        126        185   

Cash payments

     (508     (26     —          (146     (680

Non-cash charges

     —          —          (9     —          (9
                                        

Balance at December 25, 2009

   $ 645      $ 62      $ —        $ —        $ 707   
                                        

We expect to satisfy all restructuring-related liabilities accrued as of the fiscal quarter ended December 25, 2009 in our fiscal year ended September 24, 2010.

 

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Table of Contents

7. 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. Interest related to this liability is recorded quarterly and is included in interest expense on the accompanying consolidated statements of operations. Other than such payments, neither party has any material obligations as a result of the settlement. As of December 25, 2009, we had $6.0 million remaining to be paid under this settlement.

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.

8. 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 we perform our services for services revenue, was as follows:

 

     Revenue by Geographic Region
     Fiscal Quarter Ended
     December 26,
2008
   December 25,
2009
     (in thousands)

International

   $ 125,355    $ 156,001

United States

     54,903      65,215
             

Total revenue

   $ 180,258    $ 221,216
             

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

 

     Fiscal Quarter Ended  
     December 26,
2008
    December 25,
2009
 

United States

   30   30

Japan

   22   20

Europe

   16   19

South Korea

   11   13

Taiwan

   11   9

China

   8   6

Other

   2   3

In the first quarter of fiscal 2009, revenue from one customer represented $18.7 million, or 10%, of the total revenue for the quarter. In the first quarter of fiscal 2010, revenue from one customer represented $19.5 million, or 9%, of the 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 25,
2009
   December 25,
2009
     (in thousands)

United States

   $ 71,703    $ 77,517

International

     20,475      20,775
             

Total long-lived tangible assets, net of accumulated depreciation

   $ 92,178    $ 98,292
             

 

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Long-lived tangible assets, which consist of property, plant, and equipment, net of accumulated depreciation, held in the United Kingdom were $15.4 million and $15.8 million at September 25, 2009 and December 25, 2009, respectively.

9. Contingencies

We are party to certain contractual agreements under which we have agreed to provide indemnifications of varying scope and duration to the other party relating to our licensed intellectual property. Historically, we have made no payments for these indemnification obligations and no amounts have been accrued in our consolidated financial statements with respect to these indemnification obligations. Due to the varying indemnification obligations, we are unable to make a reasonable estimate of the maximum potential amount we could be required to pay.

Under the terms of the September 2003 agreement to acquire all outstanding shares of our subsidiary, Cinea, we have future payment obligations that equal approximately 5% to 8% of the revenue generated through 2022 from products incorporating certain technologies that we acquired. As of December 25, 2009, no additional purchase consideration had been paid and no liability is reflected on our balance sheet. We have not met, and we do not expect to meet, the revenue threshold that would trigger a payment obligation.

10. Common Stock Repurchase Program

In November 2009, we announced a stock repurchase program, whereby we may repurchase up to $250 million of our Class A common stock. Stock repurchases under this program may be made through open market transactions, negotiated purchases, or otherwise, at times and in such amounts as we consider appropriate. The timing of repurchases and the number of shares repurchased will depend on a variety of factors including price, regulatory requirements, and other market conditions. We may limit, suspend, or terminate the stock repurchase program at any time without prior notice. Shares repurchased under the program will be returned to the status of authorized but unissued shares of Class A common stock.

The following table provides a summary of the quarterly repurchase activity during our first quarter of fiscal 2010 under the stock repurchase program:

 

Period

   Total Number of
Shares Purchased
   Cost
(in thousands)
   Average Price
Paid per Share

Q1 2010

   345,400    $ 15,661    $ 45.33
                  

Total

   345,400    $ 15,661    $ 45.33
                  

11. Comprehensive Income and Supplemental Equity Information

Comprehensive Income

The components of comprehensive income were as follows:

 

     Fiscal Quarter Ended  
     December 26,
2008
    December 25,
2009
 
     (in thousands)  

Net income before controlling interest

   $ 78,337      $ 69,493   

Other comprehensive income (loss):

    

Foreign currency translation adjustment losses, net of tax

     (14,324     (2,348

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

     2,081        (335

Reversal of unrealized losses on auction rate certificates, net of tax

     3,726        —     

Less: comprehensive income attributable to controlling interest

     (242     (407
                

Comprehensive income attributable to Dolby Laboratories, Inc.

   $ 69,578      $ 66,403   
                

In the first quarter of fiscal 2009, we reclassified our auction rate certificates from the available-for-sale category to the trading securities category. As a result of this reclassification, we reversed the unrealized losses on our auction rate certificates within other comprehensive income and recognized the losses as a component of net income.

 

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Table of Contents

Supplemental Equity Information

The following tables present our consolidated statements of changes in stockholders’ equity for the three months ended December 26, 2008, and December 25, 2009, respectively (shares in millions):

 

     Dolby Laboratories, Inc.              
     Shares of
Class A
common
stock
   Class A
common
stock
   Shares of
Class B
common

stock
    Class B
common
stock
   Additional
paid-in capital
   Retained
earnings
    Accumulated
other
comprehensive
income
    Total Dolby
Laboratories,
Inc.
    Controlling
Interest
    Total  
     (in thousands)  

Balance at September 26, 2008

   51,992    $ 52    60,482      $ 60    $  434,907    $  609,495      $ 4,739      $  1,049,253      $  22,098      $  1,071,351   

Net income

   —        —      —          —        —        78,095        —          78,095        242        78,337   

Retirement of treasury stock

   —        —      —          —        11      (11     —          —          —          —     

Adjustment to controlling interest

   —        —      —          —        —        —          —          —          575        575   

Translation adjustments, net of taxes of $6,884

   —        —      —          —        —        —          (14,324     (14,324     (2,707     (17,031

Unrealized losses on available-for-sale securities, net of taxes of $(2,268)

   —        —      —          —        —        —          5,807        5,807        —          5,807   

Distributions to controlling interest

   —        —      —          —        —        —          —          —          (120     (120

Stock-based compensation expense

   —        —      —          —        4,496      —          —          4,496        —          4,496   

Tax benefit from the exercise of Class A, Class B stock options and release of restricted stock units

   —        —      —          —        815      —          —          815        —          815   

Class A common stock issued under employee stock plans, net of stock withheld for taxes

   114      —      —          —        2,697      —          —          2,697        —          2,697   

Transfer of Class B common stock to Class A common stock

   125      —      (125     —        —        —          —          —          —          —     

Exercise of Class B stock options

   —        —      109        —        309      —          —          309        —          309   
                                                                        

Balance at December 26, 2008

   52,231    $ 52    60,466      $ 60    $ 443,235    $ 687,579      $ (3,778   $ 1,127,148      $ 20,088      $ 1,147,236   
                                                                        

 

     Dolby Laboratories, Inc.              
     Shares of
Class A
common
stock
    Class A
common
stock
   Shares of
Class B
common stock
    Class B
common
stock
   Additional
paid-in capital
    Retained
earnings
   Accumulated
other
comprehensive
income
    Total Dolby
Laboratories,
Inc.
    Controlling
Interest
    Total  
     (in thousands)  

Balance at September 25, 2009

   53,412      $ 53    60,437      $ 60    $  478,979      $  852,475    $ 9,541      $  1,341,108      $  21,997      $  1,363,105   

Net income

   —          —      —          —        —          69,086      —          69,086        407        69,493   

Translation adjustments, net of taxes of $1,730

   —          —      —          —        —          —        (2,348     (2,348     23        (2,325

Unrealized losses on available-for-sale securities, net of taxes of $206

   —          —      —          —        —          —        (335     (335     —          (335

Distributions to controlling interest

   —          —      —          —        —          —        —          —          (128     (128

Stock-based compensation expense

   —          —      —          —        5,327        —        —          5,327        —          5,327   

Repurchase of commons stock

   (345     —      —          —        (15,661     —        —          (15,661     —          (15,661

Tax benefit from the exercise of Class A, Class B stock options and release of restricted stock units

   —          —      —          —        4,603        —        —          4,603        —          4,603   

Class A common stock issued under employee stock plans, net of stock withheld for taxes

   300        1    —          —        8,488        —        —          8,489        —          8,489   

Transfer of Class B common stock to Class A common stock

   401        —      (401     —        —          —        —          —          —          —     

Exercise of Class B stock options

   —          —      347        —        769        —        —          769        —          769   
                                                                         

Balance at December 25, 2009

   53,768      $ 54    60,383      $ 60    $ 482,505      $ 921,561    $ 6,858      $ 1,411,038      $ 22,299      $ 1,433,337   
                                                                         

 

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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 interim 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: statements regarding the extent and timing of future licensing, products and services revenue levels and mix, expenses, margins, net income per diluted share, income taxes, tax benefits, acquisition costs and related amortization, and other measures of results of operations; our expectations regarding demand and acceptance for our technologies; growth opportunities and trends in the market in which we operate; our plans, strategies and expected opportunities; the deployment of and demand for our products and products incorporating our technologies; and future competition. Actual results may differ materially from those discussed in these forward-looking statements due to a number of factors, including the 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.

Overview

Since Ray Dolby founded Dolby Laboratories in 1965, we have been at the forefront of delivering audio technologies used throughout the entertainment creation, distribution, and playback process to enhance the entertainment experience. We have introduced a number of innovative audio technologies, including noise reduction for the recording and cinema industries and surround sound for the cinema and the home, and as a result, we believe professionals and consumers view the Dolby brand as a symbol of a superior entertainment experience.

We generate revenue by licensing our technologies to manufacturers of consumer electronics products and media software vendors and by selling our professional products and related services to entertainment content creators and distributors. We have licensed our technologies to consumer electronics manufacturers in approximately 25 countries and our licensees distribute their products incorporating our technologies throughout the world. We sell our products and services in over 85 countries. In fiscal 2007, 2008, and 2009, revenue from outside of the United States was 70%, 66%, and 65% of our total revenue, respectively. We base geographical data for our licensing, products, and services revenue on the location of our licensees’ headquarters, the end location where we ship our products, or the location where we perform our services, respectively.

We generate the majority of our revenue by selling products and licensing technologies that allow for the efficient distribution of high-quality audio content to cinemas and to a broad range of consumer entertainment devices. We provide products and services to creators and distributors of audio content that enable them to encode this content using our technologies. Customers of these products and services include film studios, television broadcasters, cable television operators, and satellite television operators. We then license our technologies, such as Dolby Digital, Dolby Digital Plus and Dolby Pulse, to consumer electronics manufacturers and software providers. These technologies enable consumer electronics products to decode and playback audio content previously encoded using the same technologies. Today, our technologies are standard in a wide range of consumer entertainment devices, including virtually all DVD players, audio/video receivers, and personal computer software DVD players. In addition, the majority of cinemas around the world use our products to playback audio content.

We believe that our well-recognized brand and our well-established history of introducing successful innovative technologies enable us to capitalize on important trends in digital entertainment and to expand in existing and new markets. The transition to digital television, high-definition home theater systems, portable media devices, and downloadable content services has resulted in increased consumer expectations for the quality and convenience of entertainment content. As a result, our technologies are increasingly included in digital televisions, set-top boxes, mobile handsets, and other portable media devices. We also offer products, software, and services for digital cinema video presentation as the cinema industry transitions from film to digital content. This includes our 3D cinema solution, which is now used in over 2,000 cinemas around the world.

 

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We also believe that our brand, our customer relationships, and our expertise will enable us to introduce technologies that improve the quality of audio and video entertainment. We have introduced audio enhancement technologies, such as Dolby Volume, that improve the audio quality of consumer electronics devices, regardless of whether the audio content was encoded using our technologies. We are developing and marketing video technologies that we believe can improve the quality of video presentation in consumer devices. Further, we are developing and marketing voice technologies for use in online gaming and Bluetooth headsets. We view the video and voice markets as early-stage opportunities.

Opportunities, Challenges, and Risks

While our revenue increased 23% from the first quarter of fiscal 2009 to the first quarter fiscal 2010 and we are optimistic about the prospects of our business, we continue to be cautious regarding future macroeconomic conditions and their potential negative impacts on consumer demand in the markets in which we license our technologies and sell our products. Our business is exposed to adverse changes in general economic conditions because our technologies are incorporated into entertainment-oriented products, which are generally discretionary goods, such as DVD players, Blu-ray Disc players, DVD recorders, personal computers, digital televisions, mobile devices, video game consoles, set top boxes, home-theaters-in-a-box, camcorders, portable media devices, audio/video receivers, and in-car entertainment systems. Our licensing revenue in the first quarter of fiscal 2010 grew when compared to the first quarter of fiscal 2009 primarily due to an increase in the number of digital televisions incorporating our technologies sold worldwide and an increase in revenue from our mobile market.

Licensing revenue constitutes the majority of our total revenue, representing 84%, 83%, and 75% of total revenue in fiscal 2008, 2009 and the first quarter of fiscal 2010, respectively. We categorize our licensing revenue into the following markets:

 

   

Personal computer (PC) market – primarily comprised of software DVD players, Microsoft Windows operating systems, and PC Entertainment Experience.

 

   

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

 

   

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

 

   

Gaming market – primarily comprised of video game consoles.

 

   

Mobile market – primarily comprised of cell phones and other mobile devices.

 

   

Automotive market – primarily comprised of in-car DVD players.

 

   

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

Our personal computer market, which represented approximately 40% of our licensing revenue in fiscal 2008, approximately 35% in fiscal 2009, and approximately 33% in the first quarter of fiscal 2010, was driven primarily by the inclusion of our technologies in media applications or operating systems that are often included in personal computer shipments. These media applications and operating systems include DVD playback and/or DVD authoring functionality that uses our technologies. Our PC market also includes revenue from our “PC Entertainment Experience” (PCEE) program, a suite of technologies for entertainment-oriented PCs that enhance the audio quality of media.

Microsoft includes our technologies in two editions of its Vista operating system, Vista Home Premium and Vista Ultimate, primarily for the consumer market. In addition, Microsoft’s newest operating system, Windows 7, includes Dolby technologies in four of the six available editions. Our technologies, including Dolby Digital Plus, are included in the Windows 7 Home Premium and Ultimate editions as well as the Windows 7 Professional and Enterprise editions. Almost half of the world's personal computer shipments are to the business market, and therefore the adoption of our technologies in the Professional and Enterprise editions increases the potential for us to receive royalties on a greater percentage of personal computer shipments.

There are several uncertainties associated with the Windows 7 opportunity. The inclusion of our technologies in Windows 7 Professional and Enterprise editions could result in our technologies residing in a greater percentage of PCs shipped than in the past when our technologies were only included in consumer editions of Microsoft operating systems and in third party DVD software applications. However, the benefit from this potential significant increase in reported units will be partially offset by substantial discounts, thereby reducing the average per unit

 

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royalty we would receive from Microsoft over time. We currently receive royalties for PCs that ship with third party DVD software applications containing our technologies. As Windows 7 provides enhanced DVD playback and incorporates some of the functionality found in these third party software applications, we expect that some PC manufacturers may exclude these applications from their offerings. Business customers may take several years to upgrade to Windows 7 given the longer adoption cycles associated with enterprise customers and the effects the current economy may have on information technology budgets. Consumers are increasingly purchasing low cost PCs, particularly netbooks. We expect these PCs to be sold with Windows 7 Starter or Home Basic editions, which do not contain our technologies.

Our broadcast market, driven by demand for our technologies in televisions and set top boxes, represented approximately 20% of our licensing revenue in fiscal 2008, approximately 25% in fiscal 2009, and approximately 28% in the first quarter of fiscal 2010. Our broadcast market has benefited from increased global shipments of digital televisions containing our technologies. We view the broadcast market as an area for continued growth, primarily driven by broadcast markets outside of the United States. We also view broadcast services, such as terrestrial broadcast or IPTV services, which operate under particular bandwidth constraints, as an area of opportunity for us to offer Dolby Digital Plus, HE-AAC, and Dolby Pulse, which enable the delivery of high-quality audio at reduced bit rates. Notwithstanding our success in the broadcast market to date, we may not be able to capitalize on these opportunities and actual results may differ from our expectations.

Our consumer electronics market, driven primarily by revenue attributable to sales of DVD and Blu-ray Disc players, represented approximately 25% of licensing revenue in fiscal 2008 and fiscal 2009 and approximately 24% in the first quarter of fiscal 2010. Within our consumer electronics market in the first quarter of fiscal 2010, we experienced a decrease in revenue from standard definition DVD players when compared to prior fiscal periods, which was partially offset by an increase in revenue from sales of Blu-ray Disc players containing our technologies. Blu-ray Disc represents a potential growth opportunity within our consumer electronics market, as Blu-ray Disc players are required to support Dolby Digital for primary audio content, Dolby Digital Plus for secondary audio content, and Dolby TrueHD is an optional audio standard. However, depending upon the success of the Blu-ray Disc, revenue from Blu-ray Disc players may not offset future declines in revenue from standard definition DVD players.

Revenue generated from the gaming and automotive markets was primarily driven by sales of video game consoles, portable gaming devices, and in-car entertainment systems with Dolby Digital, Dolby Digital Plus, ATRAC, and Dolby TrueHD technologies. Revenue from our licensing services market was primarily driven by demand for MPEG 4 and MPEG 2 audio compression technologies used in portable media devices. Revenue from our mobile market is primarily driven by demand for the AAC, HE-AAC, and Dolby Pulse audio compression technologies incorporated into mobile devices and to a lesser extent by Dolby Mobile, our suite of post-processing technologies optimized for mobile devices. We view the mobile market as an area of opportunity to increase revenue, however actual results may differ from our expectations.

We have introduced new technologies that we view as opportunities to expand into new areas in the broadcast, consumer electronics, and gaming markets, including Dolby Volume, dynamic range image technologies, and Dolby Axon. Dolby Volume is a sound leveling technology that performs measurement and analysis of signals according to a model based on the characteristics of human hearing, in order to provide consistent volume and quality across various programs. Our dynamic range imaging technologies include Dolby Contrast and Dolby Vision. Dolby Contrast provides enhanced contrast and Dolby Vision combines enhanced contrast with extended brightness and dynamic range, each for LCD televisions with LED backlit technology. Dolby Axon is a voice technology that enables online gamers to perceive other players’ locations, making the online gaming experience more real and immersive. We do not anticipate generating significant revenue from these technologies in fiscal 2010.

Consumer electronics and digital entertainment products throughout the world incorporate our technologies. We expect that sales of products incorporating our technologies in emerging economies, such as Brazil, China, India, and Russia, 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 this increased demand. There are risks associated with the opportunities of doing business in emerging economies that have affected, and will continue to affect, our operating results, such as manufacturers failing to report or underreporting product shipments containing our technologies.

 

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Product sales revenue consists primarily of sales of equipment to cinema operators and broadcasters representing 11%, 13%, and 21% of our total revenue in fiscal 2008, 2009, and the first quarter of fiscal 2010, respectively.

Our cinema products represented approximately 68% of product sales in fiscal 2008, 82% of product sales in fiscal 2009, and 91% of product sales in the first quarter of fiscal 2010. The increase in cinema product revenue as a percentage of total product revenue in the first quarter of fiscal 2010 was primarily due to a change in revenue recognition accounting standards, coupled with increased sales of digital cinema and related 3D products. See Note 2 “Summary of Significant Accounting Policies” for additional details on the changes in revenue recognition accounting standards.

Our traditional cinema products are primarily used to read and decode a film’s soundtrack, to calibrate cinema sound systems, and to adapt analog cinema audio systems to digital audio formats. Our digital cinema servers load, store, decrypt, and decode encrypted digital film files for presentation on a digital projector and our digital 3D products provide 3D image capabilities. There is a trend in the cinema industry to transition to digital cinema but macroeconomic conditions have somewhat limited the availability of funding for system integrators and exhibitors to finance digital cinema rollouts from which we could potentially benefit. Digital cinema offers the motion picture industry a possible means to achieve cost savings in printing and distributing movies, to combat piracy, and to enable repeated movie playback without degradation in image and audio quality. We offer our Dolby Digital Cinema server, which allows for the storage and playback of digital content, as well as our Dolby 3D Digital Cinema technology, which delivers a 3D experience when combined with an exhibitor’s existing digital cinema projector and server. We expect most exhibitors that are either constructing new theatres or upgrading existing theatres to choose digital cinema over traditional film cinema. Digital cinema is based on open standards, which, unlike traditional cinema standards, do not include our proprietary audio technologies. We are facing more pricing and other competitive pressures in the digital cinema products market than we have historically experienced in our traditional cinema products market.

A competitor has introduced a digital cinema solution into the market that supports the presentation of movies with higher resolution “4K” digital cinema projectors. Certain major U.S. exhibitors have announced their intention to outfit their theatres exclusively with 4K digital cinema equipment. Other exhibitors may feel that they need to outfit some or all of their theatres with 4K digital cinema equipment to compete in the same markets where competitors are promoting 4K solutions. Dolby currently does not offer a 4K digital cinema solution. If we do not offer a solution that supports 4K presentation, our future prospects in digital cinema may be limited and our business could be adversely affected. In addition, as the film industry is transitioning to digital cinema, the demand for our traditional cinema products and services is declining, and we anticipate that the demand for film-based products will continue to decline in future periods.

Our broadcast products represented approximately 24% of product sales in fiscal 2008, 13% of product sales in fiscal 2009, and 8% of product sales in the first quarter of fiscal 2010. Our broadcast products 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 the first quarter of fiscal 2010, the decrease in broadcast product revenue as a percentage of total product revenue was primarily due to the increase in digital cinema product revenue noted above.

Our services revenue, which represented approximately 5%, 4%, and 4% of total revenue in fiscal 2008, 2009, and the first quarter of fiscal 2010, 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. Several factors influence the number of films produced in a given fiscal period, including strikes and work stoppages within the motion picture industry as well as tax incentive arrangements that many governments provide filmmakers to promote local filmmaking.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based on our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP, and pursuant to rules and regulations of the SEC. The preparation of these financial statements in accordance with U.S. GAAP and SEC rules and regulations 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

 

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revenue and expenses during a fiscal period. The SEC considers an accounting policy and estimate to be critical if it is both important to a company’s financial condition and results of operations and it requires significant judgment on the part of management in its application. On a regular basis, we evaluate our assumptions, judgment, and estimates. We have discussed the selection and development of the critical accounting policies and estimates with the audit committee of our board of directors. 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 and estimates because we believe they are both important to the portrayal of our financial condition and results of operations and they require critical management judgments 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 our “Risk Factors” for certain matters bearing risks on our future results of operations.

Revenue Recognition

We enter into transactions to license technologies, trademarks, and know-how and to sell products and services. Revenue recognition standards 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 and other factors.

In October 2009, the FASB amended the accounting standards for revenue recognition to exclude software contained within a tangible product from the scope of the software revenue recognition guidance if the software is essential to the tangible product’s functionality. Also in October 2009, the FASB amended the accounting standards for multiple-element revenue arrangements to:

 

   

provide updated guidance on whether multiple deliverables exist, how the elements in an arrangement should be separated, and how the consideration should be allocated;

 

   

require an entity to allocate revenue in an arrangement using estimated selling prices (ESP) of each element if a vendor does not have vendor-specific objective evidence of selling price (VSOE) or third-party evidence of selling price (TPE); and

 

   

eliminate the use of the residual method and require a vendor to allocate revenue using the relative selling price method.

In the first quarter of fiscal 2010, we early-adopted this accounting guidance on a prospective basis for applicable arrangements entered into or materially modified after September 25, 2009. In accordance with this guidance, we no longer account for revenue from product sales containing software elements under the software revenue recognition guidance.

We evaluate each element in a multiple-element arrangement to determine whether it represents a separate unit of accounting. An element constitutes a separate unit of accounting when the delivered element has standalone value and delivery of the undelivered element is probable and within our control. When these criteria are not met, the delivered elements are combined with the undelivered elements and the arrangement consideration is allocated to a combined, single unit. The amended guidance changed our units of accounting for our revenue transactions by allowing us to use ESP to establish the standalone selling price of the delivered and undelivered elements in an arrangement.

If the separation criteria are met, we account for each element within a multiple-element arrangement, such as hardware, software, maintenance, and other services, separately and we allocate arrangement consideration based on the relative selling price of each element. 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. Revenue allocated to the undelivered element is recognized over the estimated service period of the respective element or when the product upgrade is delivered. We

 

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do not recognize revenue for delivered elements that is contingent on the future delivery of products or services or future performance obligations until we have completed these obligations.

Prior to our adoption of the amended guidance for revenue recognition, we were not able to establish VSOE of the standalone selling price for the undelivered support and maintenance elements for a majority of our multiple-element arrangements. VSOE was required to recognize revenue for an individual element independent of other elements in the arrangement. As a result, we typically allocated revenue from the entire arrangement to the undelivered element and recognized this revenue ratably over the estimated support period.

We now allocate revenue to each element in an arrangement based on a selling price hierarchy. The selling price for a deliverable is based on its VSOE if available, TPE, if VSOE is not available, or ESP, if neither VSOE nor TPE is available. We determine a best estimate of selling price using the same methods used to determine the selling price of an element sold on a standalone basis. We establish the best estimate of selling price for each element primarily by considering actual sales prices, as we typically sell each element on a standalone basis, and internal factors such as pricing practices, margin objectives, and customer demands. Consideration is also given to market conditions such as competitor pricing strategies and industry technology lifecycles. We apply management judgment to establish margin objectives, pricing strategies, and technology lifecycles, which are all used to determine our best estimate of selling price.

Goodwill, Intangible Assets and Impairment of Long-lived Assets

We evaluate and test our goodwill for impairment at a reporting unit level. A reporting unit is an operating segment or one level below an operating segment. The goodwill impairment test is a two-step process. In the first step, the carrying value of the net assets of a reporting unit, including goodwill, is compared to the fair value of the reporting unit. If the fair value of the reporting unit is determined to be less than the carrying value, a second step is performed in order to determine the implied fair value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, we would record an impairment loss equal to the difference. We test goodwill for impairment annually during our third fiscal quarter and when an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value.

We use the income approach to determine the fair value of our reporting units based on the present value of estimated future cash flows for each reporting unit. During our last annual goodwill impairment test performed in the third quarter of fiscal 2009, we had two reporting units – Via which had no assigned goodwill and Dolby Entertainment Technology with goodwill of $250.6 million. The cash flow model was based on our best estimate of future revenue and operating costs. Future revenue was estimated over the period we expect to earn such cash flows, at growth rates consistent with our internal forecasts. The revenue and cost estimates were based on several sources including our historical information, third party industry data, and review of our internal operations. The cash flow forecasts were adjusted by a discount rate of approximately 13% based on our weighted average cost of capital derived through a capital asset pricing model. The primary components of this model included our considerations of the relative weighting of our total asset structure between our equity and debt, the risk-free rate of return given by the rate of return on U.S. Treasury bonds, an average market risk premium based on a range of historical returns and forward looking estimates, and our beta. Our model utilized an effective tax rate of approximately 35%. Further, we evaluated the reasonableness of the fair value of our reporting units by comparing the aggregate fair value of our reporting units, determined under the income approach, to our market capitalization.

Our market capitalization at the end of our third quarter of fiscal 2009, the period of our annual impairment test, was approximately equal to the aggregate fair value of our reporting units determined under the income approach. Our market capitalization and the aggregate fair value of our reporting units under the income approach each approximated $4.2 billion, which exceeded the aggregate carrying value of our reporting units by approximately 220%. As of June 26, 2009, the fair values of our two reporting units exceeded their carrying values and therefore no impairment charge was required. Since our last annual impairment test, there have been no events or circumstances that would more likely than not trigger a reduction in the fair value of our reporting units below their carrying value.

Intangible assets with definite lives are amortized over their estimated useful lives. Our intangible assets principally consist of acquired technology, patents, trademarks, customer relationships and contracts, and are amortized on a straight-line basis over their useful lives ranging from two to 15 years.

 

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We review long-lived assets, including intangible assets, 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.

Accounting for Income Taxes

We make estimates and judgments that affect our accounting for income taxes, including estimating actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences, including the timing of recognition of stock-based compensation expense, result in deferred tax assets and liabilities, which are included in our condensed 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.

Our policy is to recognize a tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the tax authorities. We include interest and penalties related to gross unrecognized tax benefits within our provision for income taxes. To the extent accrued interest and penalties do not ultimately become payable, amounts accrued are reduced in the period that such determination is made and are reflected as a reduction of the overall income tax provision.

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 uncertainty in income tax positions. Our financial position and results of operations may be materially affected if actual results significantly differ from these estimates or the estimates are adjusted in future periods.

Stock-Based Compensation

We measure all employee stock-based compensation awards by using a fair-value method and we record such expense in the condensed consolidated financial statements over the requisite service period. We utilize the Black-Scholes option pricing model to determine the fair value of employee stock options at the date of grant. Determining 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 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 a blend of our historical volatility of our common stock and implied volatility based on traded options with similar terms 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. We are required to estimate forfeitures at the time of grant and revise our estimate, if necessary, in subsequent periods if actual forfeitures differ from our estimate.

Investments

Investments that have original maturities of 91 days or more at the date of purchase and with a current maturity of less than one year are classified as short-term investments. Investments that have maturities of more than one year are classified as long-term investments. All of our investments, except for auction rate certificates, are classified as available-for-sale securities. Our investments are recorded at fair value in the consolidated balance sheets. Unrealized gains and losses on our available-for-sale securities, except for credit losses, are reported as a component of accumulated other comprehensive income, while realized gains and losses as well as credit losses are reported as a component of net income. Our auction rate certificates are classified as trading securities. Unrealized gains or losses on trading securities are reported as a component of net income.

Our investments in auction rate certificates, with the exception of redemptions, have been illiquid since February 2008 due to failed auctions. The observable market information to determine the fair value of our auction rate certificates continues to be insufficient. Therefore, we continue to estimate the fair value by incorporating assumptions that market participants would use in their estimates of fair value. These assumptions include the interest yield of the securities, market volatility, the expected liquidity of the securities, the collateral underlying the

 

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securities, the creditworthiness of the counterparty, the timing of expected future cash flows, the likelihood of a successful future auction, and the final stated maturities of the securities.

Results of Operations

Revenue

 

     Fiscal Quarter Ended     Change  
     December 26,
2008
    December 25,
2009
    $     %  
     (in thousands)  

Licensing

   $ 154,056      $ 165,775      $ 11,719      8

Percentage of total revenue

     85 %      75 %     

Product sales

     17,946        47,657        29,711      166

Percentage of total revenue

     10 %      21 %     

Services

     8,256        7,784        (472   (6 )% 

Percentage of total revenue

     5 %      4 %     
                              

Total revenue

   $ 180,258      $ 221,216      $ 40,958      23 % 
                              

Licensing. The 8% increase in licensing revenue from the first quarter of fiscal 2009 to the first quarter of fiscal 2010 was primarily driven by an increase in revenue from our broadcast and mobile markets, offset by a decline in our gaming market. The increase in revenue from our broadcast market was attributable to an increase in worldwide sales of digital televisions and set-top boxes incorporating our technologies, partially offset by decreased revenue from National Telecommunications and Information Administration (“NTIA”) converter boxes. The increase in revenue from our mobile market was primarily driven by an increase in revenue from HE-AAC in the first quarter of fiscal 2010 when compared to the first quarter of fiscal 2009. These increases in licensing revenue were partially offset by a decrease in revenue from our gaming market in the first quarter of fiscal 2010 when compared to the first quarter of fiscal 2009.

Product Sales. The 166% increase in product sales revenue from the first quarter of fiscal 2009 to the first quarter of fiscal 2010 was due to our adoption of new revenue recognition accounting standards in the first quarter of fiscal 2010 that allowed us to recognize the majority of the revenue from our product sales in the period of sale. This was coupled with an increase in digital cinema and 3D units sold, primarily due to a promotion that offered price discounts for a bundled set of digital cinema and 3D products. Contributing to the increase in revenue in the first quarter of fiscal 2010 when compared to the first quarter of fiscal 2009, was the fact that we had not yet achieved compliance with the Digital Cinema Initiative (“DCI”) specifications and, as a result, the majority of our first quarter of fiscal 2009 digital cinema and related product sales revenue was deferred. We achieved compliance with the DCI specifications in the second quarter of fiscal 2009.

The FASB amended revenue recognition accounting standards that enabled us to recognize the majority of the revenue from our multiple-element product sales arrangements in the period of sale. We elected to adopt these standards prospectively for multiple-element arrangements entered into or materially modified after September 25, 2009. See Note 2 “Summary of Significant Accounting Policies” for additional details. For multiple-element product sales arrangements entered into after September 25, 2009, we recognized $20.5 million in revenue in the first quarter of fiscal 2010. As of December 25, 2009, the deferred revenue balance from these arrangements was $0.2 million, representing the estimated selling price of our support and maintenance obligation for such arrangements.

For the majority of our multiple-element product sales arrangements entered into on or prior to September 25, 2009, we accounted for the product and the associated support and maintenance elements as a combined unit, which typically resulted in the revenue being deferred and recognized ratably over the estimated support period. For these arrangements, we did not change our accounting treatment and we recognized $14.0 million in previously deferred revenue in the first quarter of fiscal 2010. As of December 25, 2009, the remaining deferred revenue balance from these arrangements was $20.7 million. We expect to recognize the majority of this deferred revenue in fiscal 2010, however circumstances may change such that this may not occur.

 

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The following is a summary of our product sales revenue for the first quarter of fiscal 2010 and the associated deferred revenue balances as of December 25, 2009:

 

     Revenue    Deferred Revenue
     (in thousands)

Product sales entered into in the first quarter of fiscal 2010:

     

Multiple-element arrangements (1)

   $ 20,550    $ 241

Standalone arrangements (2)

     13,094      98

Product sales from prior periods for which revenue was deferred (3)

     14,013      20,741
             

Total

   $ 47,657    $ 21,080
             

 

(1) Of this revenue, we would have recognized $2.9 million in the first quarter of fiscal 2010 had we not adopted the changes in accounting standards. As such, we recognized an incremental $17.6 million as a result of our adoption of the new revenue recognition accounting standards in the first quarter of fiscal 2010.
(2) These arrangements were not affected by the changes in accounting standards.
(3) Represents revenue attributable to multiple-element arrangements entered into on or prior to September 25, 2009.

Services. The 6% decrease in services revenue from the first quarter of fiscal 2009 to the first quarter of fiscal 2010 was primarily attributable to a decrease in services performed on original films.

Gross Margin

 

     Fiscal Quarter Ended  
     December 26,
2008
    December 25,
2009
 

Licensing gross margin percentage

   111   98

Licensing gross margin percentage excluding gain from

amended patent licensing agreement

   98   98

Product sales gross margin percentage

   48   41

Services gross margin percentage

   61   53
            

Total gross margin percentage

   102 %    84 % 
            

Licensing Gross Margin. We license intellectual property to our customers that may be internally developed, acquired by us or licensed from third parties. Our cost of licensing consists principally of amortization expenses associated with purchased intangible assets and intangible assets acquired in business combinations. Our cost of licensing also includes third-party royalty obligations paid to license intellectual property that we then sublicense to our customers. Licensing gross margin decreased thirteen points from the first quarter of 2009 to the first quarter of fiscal 2010, due primarily to a gain from an amended patent licensing agreement that we recorded within cost of revenue in our consolidated statement of operations in the first quarter of fiscal 2009. Excluding the gain from the amended patent licensing agreement, our licensing gross margin did not change from the first quarter of fiscal 2009 to the first quarter of fiscal 2010.

Product Sales Gross Margin. Cost of product sales primarily consists of the costs of materials related to the products sold, applied labor and manufacturing overhead and, to a lesser extent, amortization of certain intangible assets. Product sales gross margin decreased seven points from the first quarter of fiscal 2009 to the first quarter of fiscal 2010, due to an increase in revenue recognized, and associated costs, related to digital cinema and 3D product sales, which had lower margins than our traditional cinema and broadcast products. The increase in digital cinema sales in the first quarter of fiscal 2010 was primarily due to a promotion that offered price discounts for a bundled set of digital cinema and 3D products in the period. In the first quarter of fiscal 2009, we had not recognized revenue, and the related costs, for sales of our lower margin digital cinema products, as we had not yet achieved compliance with the DCI specifications. We achieved compliance with the DCI specifications in the second quarter of fiscal 2009.

 

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Services Gross Margin. Cost of services primarily consists of payroll and benefits costs for employees performing our professional services, the cost of outside consultants, and reimbursable expenses incurred on behalf of customers. Services gross margin decreased eight points from fiscal 2009 to fiscal 2010 due to lower services revenue and personnel costs that remained relatively unchanged.

Operating Expenses

 

     Fiscal Quarter Ended     Change  
     December 26,
2008
    December 25,
2009
    $     %  
     (in thousands)  

Research and development

   $ 18,658      $ 22,800      $ 4,142      22

Percentage of total revenue

     10     10    

Sales and Marketing

     24,487        30,384        5,897      24

Percentage of total revenue

     14 %      14 %     

General and Administrative

     26,000        27,882        1,882      7

Percentage of total revenue

     14 %      13 %     

Restructuring Charges, net

     868        185        (683   (79 )% 
                              

Total operating expenses

   $ 70,013      $ 81,251      $ 11,238      16
                              

Research and Development. Research and development expenses consist primarily of personnel and personnel-related costs, facility costs, and project development costs related to new technologies and products. The 22% increase in research and development expenses from the first quarter of fiscal 2009 to the first quarter of fiscal 2010 was primarily driven by increases in personnel and personnel-related expenses due to increases in headcount, primarily from an acquisition completed in fiscal 2009. The increase was further driven by an increase in prototype expenses related to development-stage technologies.

Sales and Marketing. Sales and marketing expenses consist primarily of personnel and personnel-related expenses, professional service fees, travel-related expenses, and facility costs for our sales and marketing functions. The 24% increase in sales and marketing expenses from the first quarter of fiscal 2009 to the first quarter of fiscal 2010 was primarily due to an increase in personnel and personnel-related expenses due to increases in headcount and increases in advertising expenditures driven by an ongoing brand awareness campaign.

General and Administrative. General and administrative expenses consist primarily of personnel and personnel-related expenses, professional service fees, travel-related expenses, and facility costs for our administrative functions. The 7% increase in general and administrative expenses from the first quarter of fiscal 2009 to the first quarter of fiscal 2010 was primarily due to an increase in personnel and personnel-related expenses, partially offset by reductions in professional service fees.

Restructuring Charges, net. Restructuring charges for the first quarter of fiscal 2010 include severance and other charges attributable to the consolidation of our Wootton Bassett, U.K. manufacturing operations into our Brisbane, California facility in fiscal 2009. Restructuring charges for the first quarter of fiscal 2009 include severance and other charges resulting from integrating our wholly owned subsidiary, Cinea, into our Dolby Entertainment Technology reporting unit.

Other Income, Net

 

     Fiscal Quarter Ended     Change  
     December 26,
2008
    December 25,
2009
    $     %  
     (in thousands)  

Interest income

   $ 4,132      $ 1,832      (2,300   (56 )% 

Interest expense

     (263     (85   178      68

Other income/(expense), net

     (1,382     460      1,842      133
                            

Total other income, net

   $ 2,487      $ 2,207      (280   (11 )% 
                            

 

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Other income, net, primarily consists of interest income earned on cash, cash equivalents, and investments, offset by interest expense principally attributable to the outstanding balances on our facility debt obligations. Also included are net gains/losses from foreign currency transactions, net gains from sales of available for sale securities, net gains/losses from trading securities, offset by net gains/losses from derivative instruments. The decrease in other income, net from the first quarter of fiscal 2009 to the first quarter of fiscal 2010 was primarily due to lower prevailing interest rates, resulting in lower interest income from our cash, cash equivalent, and investment balances. This was partially offset by higher interest bearing cash, cash equivalent, and investment balances, gains from sales of available for sale securities, and lower interest expense in the first quarter of fiscal 2010. In addition, in the first quarter of fiscal 2009 we recognized a net loss of approximately $1.4 million related to the valuation of our auction rate certificates and related Put Rights.

Income Taxes

 

     Fiscal Quarter Ended  
     December 26,
2008
    December 25,
2009
 
     (in thousands)  

Provision for income taxes

   $ 38,623      $ 36,886   

Effective tax rate

     33     35

Our effective tax rate is based upon a projection of our annual fiscal year results. Our effective tax rate for the first quarter of fiscal 2009 was 33% compared to 35% for the first quarter of fiscal 2010. In fiscal 2009, a change in tax law reinstated research and development tax credits for fiscal 2009 and for periods prior to fiscal 2009. As a result, we recognized an increase in research and development tax credits in the first quarter of fiscal 2009, thereby lowering our effective tax rate. Our effective tax rate for the first quarter of fiscal 2010 does not include a full-year benefit from research and development tax credits due to the expiration of these credits on December 31, 2009.

Liquidity, Capital Resources, and Financial Condition

 

     September 25,
2009
    December 25,
2009
 
     (in thousands)  

Cash and cash equivalents

   $ 451,678      $ 406,238   

Short-term investments

     283,808        372,767   

Long-term investments

     205,938        246,022   

Accounts receivable, net

     22,981        43,507   

Accounts payable and accrued liabilities

     113,822        122,090   

Working capital(a)

     744,254        772,430   
     December 26,
2008
    December 25,
2009
 

Net cash provided by operating activities

     97,424        98,464   

Capital expenditures (b)

     (996     (10,619

Net cash used in investing activities

     (89,068     (140,873

Net cash provided by (used in) financing activities

     3,394        (2,148

 

(a)

Working capital consists of total current assets less total current liabilities.

(b)

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

As of December 25, 2009, we had cash and cash equivalents of $406.2 million, compared to $451.7 million at September 25, 2009. In addition, at December 25, 2009, we had short-term and long-term investments of $618.8 million, compared to $489.7 million at September 25, 2009. Our principal sources of liquidity are our cash, cash equivalents, and investments, as well as cash flows from our operations. 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 provided by operating activities were $98.5 million in the first quarter of fiscal 2010, compared to $97.4 million in the first quarter of fiscal 2009. 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 2010 were primarily driven by net income before controlling interest of $69.5 million. Adjustments for non-cash items included stock-

 

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based compensation expense of $5.3 million, depreciation and amortization expense of $7.8 million, offset by the deferred taxes of $5.6 million. Changes in working capital were primarily driven by increases in assets of $10.0 million and decreases in deferred revenue of $9.5 million, offset by increases in income taxes payable of $34.8 million and accounts payable and accrued liabilities of $8.5 million.

Cash used in investing activities for the first quarter of fiscal 2010 were primarily driven by net purchases of available-for-sale securities of $130.1 million. Capital expenditures were $10.6 million for the first quarter of fiscal 2010, an increase of $9.6 million from the first quarter of fiscal 2009.

Cash used in financing activities were $2.1 million in the first quarter of fiscal 2010, compared to cash provided by financing activities of $3.4 million in the first quarter of fiscal 2009. Cash outflows from financing activities were primarily driven by our stock repurchase program of $15.7 million, offset by the exercise of employee stock options of $7.3 million, excess tax benefit from the exercise of stock options of $4.7 million, and proceeds from the issuance of stock under our employee stock purchase plan of $1.9 million.

Off-Balance-Sheet and Contractual Obligations

Our liquidity is not dependent on the use of off-balance sheet financing arrangements other than in connection with our operating leases.

There has been no material change in our contractual obligations other than in the ordinary course of business since our fiscal year ended September 25, 2009. See our Annual Report on Form 10-K for the fiscal year ended September 25, 2009, for additional information regarding our contractual obligations.

 

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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Sensitivity

Cash, Cash Equivalents and Investments.

As of December 25, 2009, we had cash and cash equivalents of $406.2 million, which consisted of cash and highly-liquid money market funds, commercial paper, municipal bonds, and U.S. agency securities with maturities of less than 90 days at the date of purchase. In addition, we had short-term and long-term investments of $618.8 million, which consisted primarily of auction rate certificates, corporate bonds, municipal debt securities, variable rate demand notes, U.S. agency securities, and U.S. government bonds 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 25, 2009 the weighted-average effective maturity of our investment portfolio was less than one year. Based on our investment portfolio balance as of December 25, 2009, a hypothetical change in interest rates of 1% would have approximately a $5.0 million impact, and a change of 0.5% would have approximately a $2.5 million impact on the carrying value of our portfolio. Furthermore, a hypothetical change in interest rates of 1% would have approximately a $5.7 million impact and a change of 0.5% would have approximately a $2.8 million impact on interest income over a one-year period.

At December 25, 2009, we held tax-exempt auction rate certificates with a par value of $67.6 million. While we have had a number of successful redemptions, auctions for these investments have failed and there is no assurance that future auctions will succeed. As a result, we may not be able to liquidate our investment and fully recover the par value. In November 2008, we accepted an offer from UBS AG, which we refer to, along with its wholly owned subsidiaries UBS Financial Services, Inc. and UBS Securities LLC, as UBS, to liquidate our auction rate certificates held in our UBS accounts on February 13, 2008. The UBS offer entitles us to sell our auction rate certificates for a price equal to the par value of the auction rate certificates plus accrued but unpaid interest, if any, at any time during a two-year period from June 30, 2010 through July 2, 2012. There is a risk that UBS will not perform its obligations in accordance with their offer. Furthermore, there is no assurance that we will be able to recoup our investments in the auction rate certificates.

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. We also conduct a growing portion of our business outside of the United States through subsidiaries with functional currencies other than the U.S. dollar (primarily Euros and British Pounds). As a result, we face exposure to adverse movements in currency exchange rates as the financial results of our international operations are translated from local currency into U.S. dollars upon consolidation. Most of our revenue from international markets is denominated in U.S. dollars, while the operating expenses of our international subsidiaries are predominantly denominated in local currency. Therefore, if the U.S. dollar weakens against the local currency, we would have increased operating expenses, which would only be partially offset by net revenue. Conversely, if the U.S. dollar strengthens against the local currency, operating expenses will decrease, which would only be partially offset by net revenue. Additionally, foreign exchange rate fluctuations on transactions denominated in currencies other than the functional currency result in gains or losses that are reflected in our condensed consolidated statement of operations. Our international operations are subject to risks typical of international business, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility.

 

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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 25, 2009, 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

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.

Macroeconomic conditions may reduce our revenue and harm our business.

We continue to be cautious regarding future macroeconomic conditions and their potential negative impact on consumer demand in the markets in which we license our technologies and sell our products. Our business is particularly exposed to adverse changes in macroeconomic conditions, because our technologies are incorporated into entertainment-oriented products, which are generally discretionary goods, such as DVD players, Blu-ray Disc players, personal computers, digital televisions, mobile devices, set top boxes, home-theaters-in-a-box, camcorders, portable media devices, gaming systems, audio/video receivers, and in-car entertainment systems. The global recession has adversely affected consumer confidence, disposable income, and spending. While we cannot predict future macroeconomic conditions, these conditions may persist or worsen. In addition, consumer spending slowdowns have affected, and likely will continue to negatively affect, the motion picture industry and cinema owners, which in recent times have resulted in decreased product sales and services. Consequently, we do not expect to sustain our prior levels of revenue growth in fiscal 2010. Furthermore, deteriorating economic conditions result in a greater likelihood that more of our licensees and customers will become delinquent on their obligations to us or be unable to pay, which in turn, could result in a higher level of write-offs, all of which would adversely affect our earnings. Moreover, deteriorating economic conditions and other factors may result in increased underreporting and non-reporting of royalty bearing revenue by our licensees as well as increased unauthorized use of our technologies, which would adversely affect our earnings.

To the extent that sales of personal computers with Dolby technologies 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. Two of six editions of Microsoft’s Windows Vista operating system, the Vista Home Premium Edition, and the Vista Ultimate Edition, include Dolby technologies, which help enable DVD playback functionality and DVD authoring capabilities. 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. Microsoft’s newest operating system, Windows 7, became generally available in October 2009. Windows 7 includes Dolby technologies, including Dolby’s next generation audio codec, Dolby Digital Plus, in the four Windows 7 editions that include DVD software applications. There are risks and uncertainties associated with this opportunity. Due in part to Windows 7 DVD playback enhancements and pricing pressure, we expect some PC manufacturers in the future will exclude additional DVD software applications on personal computers that include Windows 7 Home Premium, Professional, Enterprise, and Ultimate editions. Additionally, it is uncertain at what pace consumer and business customers will migrate from their current operating systems to the Windows 7 operating system and what the adoption rate of the editions with Dolby technologies will be. In addition, a growing number of lower priced PCs, particularly netbooks, are being sold or are anticipated to be sold which do not have Dolby technologies. Consumers may elect to purchase these lower priced PCs instead of computers with DVD

 

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playback functionality and Dolby technologies. Revenue from our PC market decreased from fiscal 2008 to fiscal 2009 and may decline in the future. Future shipments of PCs with Dolby technologies could also decline. If any of the foregoing occur, our licensing revenue will be adversely affected.

Sales of component DVD players have declined significantly and we expect them to decline further. To the extent that sales of component DVD players continue to decline or alternative technologies in which we do not participate replace DVDs or Blu-ray Disc as a dominant medium for consumer video entertainment, our licensing revenue will be adversely affected.

Until a few years ago, growth in our revenue had been the result, in large part, of the rapid growth in sales of component DVD players incorporating our technologies. However, as the markets for DVD players have matured, sales of component DVD players have declined significantly and we expect future sales of component consumer DVD players to continue to decline. Future revenue from Blu-ray Disc player may not offset future declines in revenue from standard definition DVD players, which would adversely affect our licensing revenue. In addition, if new technologies or distribution channels are developed that compete with or replace DVD and Blu-ray Disc players as dominant media for consumer video entertainment, we may not be able to develop complementary technologies for and generate revenue from those new technologies or distribution channels. Furthermore, new technologies or distribution channels may be less profitable for us than DVD and Blu-ray Disc players. Any of the foregoing could adversely affect our business and operating results.

If we do not increase our revenue and keep our expenses consistent with revenue we will not maintain profitability at recent levels.

Although we endeavor to effectively control our operating expenses, we expect to incur increased operating expenses in fiscal 2010 as we have large fixed expenses and plan to increase sales and marketing and research and development activities in an effort to promote both short and long term growth. Due to our expected operating expenses and the challenges of increasing revenue in the current environment, our income from operations and cash flows from operating and investing activities in fiscal 2010 could be lower than in fiscal 2009. As a result, we may not be able to maintain our 2009 levels of profitability in fiscal 2010 or on a quarterly or annual basis thereafter.

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 80%, 84%, and 83% of our total revenue in fiscal 2007, 2008, and 2009, 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 media 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 theater 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, changes in industry standards or adverse changes in business and economic conditions, 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.

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.

 

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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. Our ability to maintain and strengthen our brand will depend heavily on our ability to develop innovative technologies for the entertainment industry, to successfully enter into new markets, and to provide high quality products and services, which we may not do successfully. Establishing brand recognition is particularly challenging in newer markets in which we have limited experience.

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 media 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 made more difficult because in the past we have experienced problems with implementation licensees selling ICs with our technologies to third parties that are not system licensees and not reporting these sales. 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, time consuming, and potentially detrimental to our ongoing business relationships with our licensees. 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 understatement and non-reporting of royalty bearing revenue 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 media 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.

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 broadcasting;

 

   

HDTV;

 

   

Personal computer technologies;

 

   

Blu-ray Disc;

 

   

Mobile devices;

 

   

Personal audio and video players, including internet music applications;

 

   

Video game consoles and video games;

 

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Imaging; and

 

   

Broadband internet.

Our ability to penetrate these markets depends on increased consumer demand for products that contain our technologies, which may not occur. If these markets do not develop or consumer demand does not grow, it would have a material adverse effect on our business and prospects. For example, the extent to which 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. 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. 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 do not develop and deliver innovative technologies in response to industry and technology changes, 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 that can render our technologies and products obsolete or unmarketable. The process of developing new technologies is complex and uncertain. We will need to expend considerable resources on research and development, or acquisitions, in the future in order to design and deliver 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 in a timely manner that competitively address the needs of the changing marketplace. For example, we cannot ensure that Dolby Axon, Dolby Mobile, Dolby Volume, Dolby Contrast or Dolby Vision 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 in a timely manner 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 do not 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 entertainment, such as technologies for processing digital moving images. We will need to spend considerable resources on research and development or acquisitions in the future in order to deliver innovative non-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 integrating non-sound businesses that we acquire into our business.

In addition, many of the non-sound technology markets which we are targeting 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 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 than we do 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

 

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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.

If our products and technologies are not 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 capability, 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. 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 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 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 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.

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. Competitors for our products include: Avica, Audyssey Laboratories, Beaufort International Group, Doremi, EVS, GDC, Kodak, Linear Acoustic, NEC, Panastereo, Qube, QuVis, REAL D, Sony, Texas Instruments, and USL. 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, some of our current or potential competitors 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 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. Another competitor has introduced a digital cinema solution which supports the presentation of movies with higher resolution “4K” digital cinema projectors. Dolby currently does not offer a 4K digital cinema solution. As a result, we must invest significant resources in research and development in order to enhance our

 

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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 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 and after all other revenue recognition criteria are met. As a result, the timing of our revenue depends upon the timing of our receipt of those reports and when we cannot determine the creditworthiness of our customers, the receipt of cash. 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 third quarter of fiscal 2009 we recognized a total of approximately $21.6 million in licensing revenue from three licensees related to royalties on shipments in prior periods. Moreover, there have been times in the past when we have not recognized large amounts of products and services revenue in a given quarter, or over several quarters, because not all of our revenue recognition criteria were met in prior periods. For example, in fiscal 2009, we recognized approximately $38.6 million of previously deferred digital cinema product revenue, including $25.1 million relating to products sold in years prior to fiscal 2009.

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 global 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 revenue. 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.

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 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 increase due to the availability of lower manufacturing costs as compared to those of other industrial countries and the continued 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.

 

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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 worldwide 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 system 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.

Our licensing revenue from system licensees 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 system licensees. 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. Furthermore, we rely on IC manufacturers to report to us the number of ICs sold that incorporate our technologies so that we can track the accuracy of system licensee reporting. We have experienced problems in the past with IC manufacturers selling ICs with our technologies to third parties that are not system licensees, which has resulted in lost revenue.

Pricing pressures on the system licensees who incorporate our technologies into their products could limit the licensing fees we charge for our technologies, which could adversely affect our revenue.

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 technologies, such as DVD players and home theater systems, have decreased significantly, and we expect prices 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. Further, while we have contractual rights with many of our licensees for cost of living adjustments to our royalty rights, we may not be able to negotiate those terms in future contracts with existing and new licensees. Moreover, downward cost of living adjustments would result in declines in the licensing fees that we charge. A decline in, or the loss of the contractual right to increase, the licensing fees we charge could materially and adversely affect our operating results.

We have in the past, 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

 

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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 some instances, we have contractually agreed to provide indemnifications to licensees relating to our intellectual property. 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 our adherence to licensing on fair, reasonable, and non-discriminatory terms and 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 inability to deploy our digital cinema servers in significant numbers in 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.

A small percentage of theatres have adopted digital cinema for the distribution and exhibition of movies. A number of companies offer competing products for digital cinema, some of which are priced lower than our products or offer features, such as support for 4K presentation, that exhibitors may perceive to be potentially advantageous to our products. At least one competitor has a significantly greater installed base of its competing digital cinema playback servers than we do and another competitor has a significantly greater installed base of its competing 3D products than we do, either of which could limit our eventual share of the digital cinema market and materially and adversely affect our operating results. As the market for digital cinema has grown, we have faced more pricing and other competitive pressures than we have traditionally experienced for our traditional cinema products. As a result, we have implemented and may have to continue 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 major motion picture studios and the cinema exhibition industry cannot agree on one or more business models for digital cinema equipment financing or if funding is not available on favorable terms or at all, the broad adoption of digital cinema will be delayed further. The conversion of movie theatres from film to digital cinema will require significant capital investment and recent events in the lending market have resulted in system integrator difficulty in obtaining funding delaying broader adoption of digital cinema. We cannot predict how quickly digital cinema will become widely adopted. At present only a small percentage of movie theatres have been converted to digital cinema, and we expect the broad conversion of theatres to digital cinema technologies, if it occurs, to be a multi year process due to both technological and financial obstacles. If the demand for digital cinema equipment develops more slowly than expected, or if there is significant and sustained resistance by the motion picture studios or cinema exhibitors to this technology or the cost of implementation, or if funding is not available on favorable terms or at all, the broad adoption of digital cinema will continue to be delayed which could adversely affect our revenue.

If we do not identify opportunities, respond to challenges 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.

A small percentage of theatres have adopted 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 has required and 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. Further, as digital cinema has grown the digital cinema initiative specifications as well as exhibitor and

 

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studio expectations have evolved. For example, a competitor has introduced a digital cinema solution which supports the presentation of movies with higher resolution “4K” digital cinema projectors. Certain major U.S. exhibitors have announced their intention to outfit their theatres exclusively with 4K digital cinema equipment. Other exhibitors may feel that they need to outfit some or all of their theatres with 4K digital cinema equipment to compete in the same markets where competitors are promoting 4K solutions. We currently do not offer a digital cinema 4K solution. In fiscal 2007, we introduced Dolby 3D Digital Cinema technology, providing us with an additional opportunity to participate in digital cinema. However, there are risks that recent renewed interest in 3D cinema could be a fad and may not be long lasting and that our business model, which relies on reusable glasses for 3D viewing, will not succeed. If we do not identify and successfully execute on opportunities and respond to challenges to generate revenue 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.

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. We consider these types of transactions in connection with our efforts to expand our business beyond sound technologies to other technologies related to the delivery of digital entertainment. 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 include:

 

   

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

 

   

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

 

   

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 may have 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.

Planned changes to our enterprise resource planning and other key software applications could cause unexpected problems to occur and disrupt the management of our business.

We are replacing our enterprise resource planning (ERP) system as well as other key software applications used in our global operations. Our ERP system and related applications are integral to our ability to accurately and

 

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efficiently maintain our books and records, manage royalty and product revenue streams, record our transactions, provide critical information to our management, and prepare our financial statements. These replacement efforts, and any related unexpected difficulties, will cause us to incur additional costs and require management attention, placing burdens on our internal resources that may affect our operating results. If we fail to manage these changes effectively, it could adversely affect our operating results and the accuracy and timely reporting of those results.

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, 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 have in the past been, and may in the future be, involved in disputes with third party technology licensors regarding license terms.

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.

Our relationships with entertainment industry participants are particularly important to our products, services, and technology licensing, and if we do not 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 industry, including motion picture studios, broadcasters, video game designers, music producers, mobile content 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 technologies is particularly dependent upon our relationships with system licensees, media 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 some of our technologies in particular countries, including China, Taiwan, 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, Taiwan, and India. For example, in China and Taiwan we have only limited patent protection, especially with respect to our Dolby Digital technologies. In India, we have no issued patents for Dolby Digital technologies. Consequently, maintaining or growing our licensing revenue in these emerging countries will depend on our ability to obtain patent rights in these countries for existing and new technologies, which is uncertain. Moreover, because of the limitations of the legal systems in many countries, the effectiveness of patents obtained or that may in the future be obtained, if any, is likewise uncertain.

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 2007, 2008, and 2009, revenue from outside the United States was 70%, 66%, and 65% of our total revenue, respectively. We expect that international and export sales will represent a substantial portion of our revenue for the foreseeable future. This

 

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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 technologies;

 

   

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 other laws limiting our ability to repatriate funds to the United States;

 

   

Burdens of complying with a variety of foreign laws;

 

   

Changes in diplomatic and trade relationships;

 

   

Difficulty in staffing and managing foreign operations;

 

   

Adverse 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.

In addition, a significant number of our employees are located outside the United States. This means we have exposure to changes in foreign laws governing our relationships with our employees, which could have a direct impact on our operating costs. Expansion into international markets has required, and will require, significant management attention and resources. Moreover, local laws and customs in many countries differ significantly from those in the United States. We incur additional legal compliance costs associated with our international operations and could become subject to legal penalties in foreign countries if we do not comply with local laws and regulations, which may be substantially different from those in the United States. In many foreign countries, particularly in those with developing economies, it is common to engage in business practices that are prohibited by United States regulations applicable to us such as the Foreign Corrupt Practices Act and U.S. export controls. Although we implement policies and procedures designed to ensure compliance with the Foreign Corrupt Practices Act and U.S. export controls, there can be no assurance that all of our employees, distributors, dealers, and agents will not take actions in violation of our policies. Any such violation, even if prohibited by our policies, could have an adverse effect on our business.

The licensing of patents constitutes a significant source of our revenue. If we do not replace expiring patents with new patents or proprietary technologies, our revenue could decline.

We hold patents covering much of the technologies that we license to system licensees, 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 in a particular country. Accordingly, to the extent that we do not 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 25, 2009, we had nearly 1,800 individual issued patents and approximately 2,000 pending patent applications in nearly 45 jurisdictions throughout the world. Our issued patents are scheduled to expire at various times through January 2028. Of these, 110 patents are scheduled to expire in the remainder of calendar year 2010, 34 patents are scheduled to expire in calendar year 2011, and 51 patents are scheduled to expire in calendar year 2012. We derive our licensing revenue principally from our Dolby Digital technologies. Patents relating to our

 

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Dolby Digital technologies generally expire between 2010 and 2017, and patents relating to our Dolby Digital Plus technologies, an extension of Dolby Digital, expire between 2019 and 2026. In addition, the remaining patents relating to Dolby Digital Live technologies, an extension of Dolby Digital, are scheduled to expire in 2021.

Revisions to patent laws and regulations in the U.S. and abroad may adversely impact our ability to obtain, license and enforce our patent rights.

Our licensing business depends in part on the uniform and consistent treatment of patent rights in the U.S. and abroad. Changes to the patent laws and regulations in the U.S. and abroad may limit our ability to obtain, license, and enforce our rights. For example, in recent years the U.S. Congress has considered a number of changes to the patent laws including changes to the calculation of damages for patent infringement. In addition, court and administrative rulings may interpret existing patent laws and regulations in ways that adversely affect our ability to obtain, license, and enforce our patents. For example, in recent years the U.S. Supreme Court has issued rulings on the standard for determining whether an invention is obvious, which is a key issue when assessing patentability, the ability of a patent holder to obtain injunctive relief against infringers, and the ability of patent licensees to challenge the patents under which they are licensed. The ruling concerning injunctions may make it more difficult, under some circumstances, for us to obtain injunctive relief against a party that has been found to infringe one or more of our patents, and the ruling regarding patent challenges by licensees could potentially make it easier for our licensees to challenge our patents even though they have already agreed to take a license.

Our ability to develop proprietary technologies 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 products when they are doing well financially. Conversely, when box office receipts are down cinema owners tend to scale back on plans to expand or upgrade their systems. Our cinema product sales are also subject to fluctuations based on events and conditions in the cinema exhibition industry generally that may or may not be tied to box office receipts in particular time 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 from film to digital 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 HD digital services by broadcasters may also influence the sale of our cinema products if consumers decide to watch content at home rather than going to the cinema to watch motion pictures. On the other hand, our services revenue, both in the United States and internationally, is tied to the number of films being made by major studios and independent filmmakers. A number of 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.

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

Although only a small percentage of theatres have adopted digital cinema technologies for the distribution and exhibition of motion pictures, the number of cinema exhibitors adopting digital cinema for new theatre construction or existing theatre upgrades continues to grow. As exhibitors have constructed new theatres or upgraded existing theatres they have generally chosen digital cinema over traditional film cinema and we expect this trend to continue. Digital cinema, which is based on open standards, does not include our proprietary audio technologies. As the film industry continues to adopt digital cinema, the demand for our traditional cinema products and services has declined significantly and we anticipate that the demand for film based products will decline in future periods. Furthermore, exhibitors adopting digital cinema can choose from multiple digital cinema playback servers other than ours, none of

 

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which contain our technologies. A continued 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 products and services would adversely affect our revenue stream from the cinema industry.

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

Our stock repurchase program may be suspended or terminated at any time, which may result in a decrease in our stock price.

In November 2009, we announced a share repurchase program, whereby we may repurchase up to $250 million shares of our Class A common stock. This repurchase program may reduce the public float of shares available for trading on a daily basis. Depending on market conditions and other factors, such purchases may be limited, suspended or terminated at any time without prior notice. There can be no assurance that we will buy additional shares of our Class A common stock under our share repurchase program or that any future repurchases will have a positive impact on our stock price or earnings per share. Important factors that could cause us to discontinue our share repurchases include, among others, unfavorable market conditions, the market price of our Class A common stock, the nature of other investment opportunities presented to us from time to time, our ability to make appropriate, timely, and beneficial decisions as to when, how, and whether to purchase shares under the stock repurchase program, and the availability of funds necessary to continue purchasing stock. If we curtail our repurchase program, our stock price may be negatively affected.

Fluctuations in our operating results and other factors may contribute to the volatility of the market price 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 described 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 or the volatility of the market price of our stock include:

 

   

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

 

   

Adverse developments in general macroeconomic conditions;

 

   

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

 

   

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;

 

   

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

 

   

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

 

   

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

 

   

The announcement, 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;

 

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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;

 

   

Seasonal electronics product shipment patterns by our system 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;

 

   

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

 

   

Repurchases we make of our common stock;

 

   

Costs of litigation and intellectual property protection;

 

   

Variations between our operating results and published analysts’ expectations; and

 

   

Announcements by our competitors or significant customers.

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. Such fluctuations in our operating expenses or financial performance could contribute to the volatility of the market price of our stock. Results from prior periods are thus not necessarily indicative of the results of future periods.

If securities or industry analysts publish inaccurate or unfavorable research about our business or if our operating results do not meet or exceed their projections, our stock price could decline.

The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who cover us or our industry downgrade our stock or the stock of other companies in our industry, or publish inaccurate or unfavorable research about our business or industry, or if our operating results do not meet or exceed their projections, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline.

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 consumer, broadcast, and cinema technologies. To the extent that our customers choose to utilize competing technologies they have

 

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developed or in which they have an interest, rather than use our technologies, our business and operating results could be adversely affected.

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 system licensees 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.

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. During fiscal 2009 we consolidated our manufacturing operations into a single location and engaged contract manufacturers to begin producing some of our higher volume product lines as needed. Our reliance on contract manufacturers for the manufacture of our higher volume products involves risks, including limited control over timely delivery and quality of such products. If production of our products is interrupted as a result of the consolidation, our use of contract manufacturers or otherwise, we may not be able to manufacture products 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 and a contract manufacturer may encounter difficulties as well. 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.

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, to the extent that we engage contract manufacturers we do not have as much control over manufacturing which could result in quality problems. Furthermore, 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

 

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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.

Licensee products that incorporate our technologies, from time to time, experience quality problems that could damage our brand, decrease revenue, 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. For example, revenue from our largest customer represented approximately 10% of total revenue for fiscal 2009. 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 adverse effect on our operating results.

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 in 2006. Similar requirements related to marking of electronic products became effective in China in 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.

 

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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 80%, 84%, and 83% of our total revenue in the fiscal years 2007, 2008, and 2009, 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 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 some 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 and with implementation licensees selling ICs with our technologies to unlicensed consumer electronics product manufacturers that are not system licensees. 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. However, it is possible 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 and Taiwan we have only limited patent protection, especially with respect to our Dolby Digital technologies, and in India we have no issued patents. Even where we do have patent protection, the scope of such protection may be insufficient to prevent third parties from designing around our particular patent claims. Furthermore, there is always the possibility 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.

Continued global credit market weakness could negatively impact the value and liquidity of our investment portfolio.

We maintain an investment portfolio of various holdings, types, and maturities, including money market funds, U.S. agency securities, variable rate demand notes, auction rate certificates, and municipal debt securities. Although we follow an established investment policy and seek to minimize the credit risk associated with investments, these investments are subject to general credit, liquidity, market, and interest rate risks.

Our long-term investments include auction rate certificates at fair value. Auctions for these instruments began failing during the second quarter of fiscal 2008 and continued to fail through the end of our first quarter of fiscal 2010, resulting in our inability to liquidate these securities. Moreover, a liquid secondary market has not developed for these instruments. In November 2008, we accepted a rights offering from UBS AG, which we refer to, along with its wholly owned subsidiaries UBS Financial Services, Inc. and UBS Securities LLC, as UBS, to liquidate our auction rate certificates held in UBS accounts on February 13, 2008. The rights offering provides us with rights (the “Put Rights”) to sell our auction rate certificates for a price equal to the liquidation preference of the auction rate certificates plus accrued but unpaid dividends or interest, if any, at any time during a two year period from June 30, 2010 through July 2, 2012. There is a risk that UBS will not perform its obligations in accordance with their offer and consequently we may have to write down the value of the Put Rights. Furthermore, there is no assurance that we will be able to recoup our investments in the auction rate certificates.

If the global credit market continues to deteriorate, other components of our investment portfolio may be adversely impacted. While as of the date of this filing, we are not aware of any other downgrades, losses, failed auctions or other significant deterioration in the fair value of our cash, cash equivalents or investments, no assurance can be given that any further deterioration of the global credit and financial markets will not negatively impact our investments or our ability to meet our investment objectives. Such negative impact, should it arise, could require an impairment charge, which would adversely impact our financial results.

We face risks associated with international trade and currency exchange.

 

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We maintain sales, marketing, and business operations in foreign countries, most significantly in the United Kingdom. Consequently, we are exposed to fluctuations in exchange rates associated with the local currencies of our foreign business operations. While nearly all of our revenue is derived from transactions denominated in U.S. dollars, nearly all of our costs from our foreign operations are denominated in the currency of that foreign location. Consequently, exchange rate fluctuations between the U.S. dollar and other currencies could have a material impact on our profitability.

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 industry standards, such as the United States HDTV standard. Any failure by us to comply with the laws and 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.

We rely on distributors that we do not control.

We rely significantly on a global network of independent, regional distributors to market and distribute our cinema and broadcast products. Our distributor arrangements are non–exclusive and our distributors are not obligated to buy our products and can represent competing products. If we lose a major distributor for any reason or if our distributors are unable or unwilling to dedicate the resources necessary to promote our portfolio of products, our revenue will be adversely affected. Difficulties in ongoing relationships with distributors, such as failures to adhere to our policies also could adversely affect us. For example, while we have implement policies designed to promote compliance with the Foreign Corrupt Practices Act, export controls, and local laws, we do not have direct control over the business and risk management policies adopted by our distributors, and they could act contrary to our policies.

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. 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.

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

 

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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.

Changes in, or interpretations of, accounting principles could result in unfavorable accounting charges.

We prepare our consolidated financial statements in accordance U.S. GAAP. These principles are subject to interpretation by the SEC and various bodies formed to interpret and create appropriate accounting principles. A change in these principles can have a significant effect on our reported results and may even retroactively affect previously reported transactions. Our accounting principles that recently have been or may be affected by changes in the accounting principles are as follows:

 

   

revenue recognition;

 

   

accounting for stock-based compensation;

 

   

accounting for income taxes; and

 

   

accounting for business combinations and related goodwill.

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 25, 2009, 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 25, 2009, Ray Dolby and his affiliates, including his family members, had voting power of 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 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 descendants of Ray Dolby and the spouses and domestic partners of such descendants. Because of this dual class structure, Ray Dolby, his affiliates, and his family members and descendants 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 descendants 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 descendants 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 25, 2009, we had a total of 114,151,099 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.

 

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As of December 25, 2009, our directors and executive officers beneficially held 60,130,000 shares of Class B common stock, 11,482 shares of Class A common stock, vested options to purchase 398,076 shares of Class B common stock and vested options to purchase 373,583 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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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Sales of Unregistered Securities

In the fiscal quarter ended December 25, 2009, we issued an aggregate of 347,263 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 26, 2009 through January 20, 2010, we issued an aggregate of 91,600 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 approximately $0.7 million in the fiscal quarter ended December 25, 2009, and approximately $0.3 million in the period since December 26, 2009 through January 20, 2010 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 20, 2010 options to purchase an aggregate of 1,320,054 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.

The following table provides information regarding the Company's purchases of its Class A Common stock, $0.001 par value per share, during the first quarter of fiscal 2010:

 

Period

   Total Number of
Shares Purchased
   Average Price
Paid per Share
   Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs (1)
   Maximum Number (or
Approximate Dollar Value) of
Shares that May Yet Be
Purchased Under the Plans or
Programs(2)

September 26, 2009-October 23, 2009

   —      $ —      —      $  250.0 million

October 24, 2009-November 20, 2009

   —      $ —      —      $ 250.0 million

November 21, 2009-December 25, 2009

   345,400    $ 45.33    345,400    $ 234.3 million

Total

   345,400    $ 45.33    345,400    $  234.3 million

 

(1) Shares of Class A common stock were purchased under a $250.0 million stock repurchase program announced by the Company on November 3, 2009. The stock repurchase program does not have an expiration date. Stock repurchases under this program may be made through open market transactions, negotiated purchases, or otherwise, at times and in such amounts as the Company considers appropriate.
(2) Amounts shown in this column reflect amounts remaining under the stock repurchase program.

 

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ITEM 6. EXHIBITS

 

         

Incorporated by Reference Herein

Exhibit
Number

  

Description

  

Form

  

Date

  10.1*    2010 Dolby Executive Annual Incentive Plan    Current Report on Form 8-K   

November 2,

2009

  10.2*    Form of Restricted Stock Unit Agreement—Non-U.S. under the 2005 Stock Plan      
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 arrangement
Furnished herewith

 

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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: February 3, 2010

 

DOLBY LABORATORIES, INC.

By:

 

/s/    MURRAY J. DEMO        

  Murray J. Demo
  Executive Vice President and Chief Financial Officer
 

(Principal Financial and Accounting

Officer and Duly Authorized Officer)

 

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INDEX TO EXHIBITS

 

         

Incorporated by Reference Herein

Exhibit
Number

  

Description

  

Form

  

Date

  10.1*    2010 Dolby Executive Annual Incentive Plan    Current Report on Form 8-K    November 2, 2009
  10.2*    Form of Restricted Stock Unit Agreement—Non-U.S. under the 2005 Stock Plan      
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 arrangement
Furnished herewith

 

55

Form of Restricted Stock Unit Agreement

Exhibit 10.2

DOLBY LABORATORIES, INC.

2005 STOCK PLAN

NOTICE OF GRANT OF RESTRICTED STOCK UNITS

FOR NON-U.S. PARTICIPANTS

Unless otherwise defined herein, the terms defined in the Dolby Laboratories, Inc. 2005 Stock Plan, as amended from time to time (the “Plan”) shall have the same defined meanings in this Notice of Grant of Restricted Stock Units for Non-U.S. Participants (the “Notice of Grant”) and the Restricted Stock Unit Agreement for Non-U.S. Participants, including country-specific terms and conditions contained in the Appendix to the Restricted Stock Unit Agreement, attached hereto as Exhibit A (collectively, the “Restricted Stock Unit Agreement” or the “Agreement”).

Participant:                     

You have been granted              Restricted Stock Units (the “Award”). Each such Restricted Stock Unit is equivalent to one share of the Company’s Class A Common Stock for purposes of determining the number of shares subject to this award. None of the Restricted Stock Units will be issued (nor will you have the rights of a stockholder with respect to the underlying shares) until the vesting conditions described below are satisfied. Additional terms of this grant are as follows:

Date of Grant:                     ,             

Vesting Schedule: See attached Vesting Appendix

You acknowledge and agree that this Agreement and the vesting schedule set forth herein do not constitute an express or implied promise of continued engagement as a Service Provider for the vesting period, for any period, or at all, and shall not interfere with your right or the right of the Company or its Subsidiary or affiliate to terminate your relationship as a Service Provider at any time, with or without cause.

You hereby agree to accept as binding, conclusive, and final all decisions or interpretations of the Administrator upon any questions relating to the Plan and this Award.

[For the electronic version (employees other than executive officers and outside directors) use this language and omit signature block] By Participant’s electronic signature and the electronic signature of the Company’s representative, Participant and the Company agree that this Award is granted under and governed by the terms and conditions of the Plan and this Agreement. Participant has reviewed the Plan and this Agreement in their entirety, has had an opportunity to obtain the advice of counsel prior to executing this Agreement and fully understands all provisions of the Plan and Agreement. Participant hereby agrees to accept as

 

1


binding, conclusive and final all decisions or interpretations of the Administrator upon any questions relating to the Plan and Agreement.]

[For the paper version for executive officers and outside directors: By Participant’s signature and the signature of the Company’s representative below, Participant and the Company agree that this Award is granted under and governed by the terms and conditions of the Plan and this Agreement, Participant has reviewed the Plan and this Agreement in their entirety, has had an opportunity to obtain the advice of counsel prior to executing this Agreement and fully understands all provisions of the Plan and Agreement. Participant hereby agrees to accept as binding, conclusive and final all decisions or interpretations of the Administrator upon any questions relating to the Plan and Agreement.]

 

PARTICIPANT       DOLBY LABORATORIES, INC.

 

   

 

Signature     By

 

   

 

Print Name     [Title]

 

2


Vesting Appendix

The Restricted Stock Units will vest as provided below, and once vested, shall be settled by the Company’s issuance of shares of Stock reflecting that number of vested Restricted Stock Units.

The Restricted Stock Units will vest after the satisfaction of the following conditions:

 

Date of Vesting

Vested

  Total Number of Shares Vested   Percentage

 

3


EXHIBIT A

DOLBY LABORATORIES, INC.

2005 STOCK PLAN

RESTRICTED STOCK UNIT AGREEMENT

FOR NON-U.S. PARTICIPANTS

1. Grant. Dolby Laboratories, Inc. (the “Company”) hereby grants to the individual set forth in the Notice of Grant of Restricted Stock Units for Non-U.S. Participants (the “Participant”) an award of Restricted Stock Units (“RSUs”) pursuant to Section 8 of the Dolby Laboratories, Inc. 2005 Stock Plan, as set forth in the Notice of Grant of Restricted Stock Units for Non-U.S. Participants (the “Notice of Grant”) and subject to the terms and conditions in this Restricted Stock Unit Agreement for Non-U.S. Participants, including country-specific terms and conditions contained in the attached Appendix (collectively, the “Agreement”) and the Dolby Laboratories, Inc. 2005 Stock Plan as may be amended from time to time (the “Plan”). Unless otherwise defined herein, the terms defined in the Plan shall have the same defined meanings in this Agreement.

2. Company’s Obligation. Each RSU represents the right to receive a Share after satisfying the applicable vesting conditions set forth in the Notice of Grant. Unless and until the RSUs vest, the Participant will have no right to receive Shares under such RSUs. Prior to actual distribution of any Shares pursuant to the vesting of any RSUs, such RSUs will represent an unsecured obligation of the Company, payable (if at all) only from the general assets of the Company.

3. Vesting Schedule. Subject to paragraph 4, and to relevant Plan provisions, the RSUs awarded by this Agreement will vest in the Participant according to the vesting schedule specified in the Notice of Grant.

4. Forfeiture upon Termination of Service. Notwithstanding any contrary provision of this Agreement or the Notice of Grant, if the Participant terminates service as a Service Provider, for any or no reason prior to vesting, the unvested RSUs awarded by this Agreement will thereupon be forfeited at no cost to the Company.

5. Payment after Vesting. Any RSUs that vest in accordance with this Agreement will be paid to the Participant (or in the event of the Participant’s death, to his or her estate) in Shares. Payment upon vesting will be subject to the Participant (or his or her estate) satisfying the applicable Tax-Related Items (defined below) withholding obligations set forth in paragraph 11.

6. Payments after Death. Any distribution or delivery to be made to the Participant under this Agreement will, if the Participant is then deceased, be made to the administrator or executor of the Participant’s estate. Any such administrator or executor must furnish the

 

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Company with (a) written notice of his or her status as transferee, and (b) evidence satisfactory to the Company to establish the validity of the transfer and compliance with any laws or regulations pertaining to said transfer.

7. Rights as Stockholder. Neither the Participant nor any person claiming under or through the Participant will have any of the rights or privileges of a stockholder of the Company in respect of any Shares deliverable hereunder unless and until Shares (in certificated or uncertificated form in the Company’s sole discretion) have been issued, recorded on the records of the Company or its transfer agents or registrars, and delivered to the Participant or Participant’s broker.

8. No Guarantee of Continued Service. THE PARTICIPANT ACKNOWLEDGES AND AGREES THAT THE VESTING OF RSUS PURSUANT TO THE VESTING SCHEDULE HEREOF IS EARNED ONLY BY CONTINUING AS AN ACTIVE SERVICE PROVIDER AT THE WILL OF THE COMPANY (OR THE PARENT OR SUBSIDIARY OR AFFILIATE EMPLOYING OR RETAINING THE PARTICIPANT) AND NOT THROUGH THE ACT OF BEING HIRED, BEING GRANTED THIS AWARD OR ACQUIRING SHARES HEREUNDER. THE PARTICIPANT FURTHER ACKNOWLEDGES AND AGREES THAT THIS AGREEMENT, THE TRANSACTIONS CONTEMPLATED HEREUNDER AND THE VESTING SCHEDULE SET FORTH HEREIN DO NOT CONSTITUTE AN EXPRESS OR IMPLIED PROMISE OF CONTINUED ENGAGEMENT AS A SERVICE PROVIDER FOR THE VESTING PERIOD, FOR ANY PERIOD, OR AT ALL, AND WILL NOT INTERFERE IN ANY WAY WITH THE PARTICIPANT’S RIGHT OR THE RIGHT OF THE COMPANY (OR THE PARENT OR SUBSIDIARY OR AFFILIATE EMPLOYING OR RETAINING THE PARTICIPANT) TO TERMINATE THE PARTICIPANT’S RELATIONSHIP AS A SERVICE PROVIDER AT ANY TIME, WITH OR WITHOUT CAUSE.

9. Address for Notices. Any notice to be given to the Company under the terms of this Agreement will be addressed to the Company at 100 Potrero Avenue, San Francisco, CA 94103, U.S.A., Attn: Stock Administration, or at such other address as the Company may hereafter designate in writing or electronically.

10. Code Section 409A. Notwithstanding anything in this Agreement to the contrary, if any Participant would be considered a “specified employee” within the meaning of Section 409A of the Code and the regulations thereunder at the time of such Participant’s termination as a Service Provider, the RSUs (and/or at the election of the Participant the cash received from the sale of the Shares underlying the vested RSUs) will not be paid to the Participant until the date that is six (6) months and one (1) day following the date of the Participant’s termination as a Service Provider.

11. Withholding of Taxes.

(a) Regardless of any action the Company and/or the Subsidiary or affiliate employing the Participant (the “Employer”) take with respect to any or all income tax, social insurance, payroll tax, payment on account or other tax-related items related to the Participant’s participation in the Plan and legally applicable to the Participant (“Tax-Related Items”), the

 

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Participant acknowledges that the ultimate liability for all Tax-Related Items is and remains the Participant’s responsibility and may exceed the amount actually withheld by the Company or the Employer. The Participant further acknowledges that the Company and/or the Employer (i) make no representations or undertakings regarding the treatment of any Tax-Related Items in connection with any aspect of the RSUs, including, but not limited to, the grant, vesting or settlement of the RSUs, the issuance of Shares in settlement of the RSUs, the subsequent sale of Shares acquired at vesting and the receipt of any dividends and/or any dividend equivalents; and (ii) do not commit to and are under no obligation to structure the terms of the Award or any aspect of the RSUs to reduce or eliminate the Participant’s liability for Tax-Related Items or achieve any particular tax result. Further, if the Participant has become subject to tax in more than one jurisdiction between the date of grant and the date of any relevant taxable event, the Participant acknowledges that the Company and/or the Employer (or former employer, as applicable) may be required to withhold or account for Tax-Related Items in more than one jurisdiction.

(b) Prior to the relevant taxable or tax withholding event, as applicable, the Participant shall pay or make adequate arrangements satisfactory to the Company and/or the Employer to satisfy all Tax-Related Items. In this regard, the Participant hereby authorizes the Company and/or the Employer, or their respective agents, at their discretion and without any notice or authorization by Participant, to satisfy the obligations with regard to all Tax-Related Items by one of a combination of the following:

 

  (i) withholding from the Participant’s wages or other cash compensation paid to the Participant by the Company and/or the Employer; or

 

  (ii) withholding from proceeds of the sale of Shares acquired upon vesting/settlement of the RSUs either through a voluntary sale or through a mandatory sale arranged by the Company (on the Participant’s behalf pursuant to this authorization); or

 

  (iii) withholding in Shares to be issued upon vesting/settlement of the RSUs.

To avoid negative accounting treatment, the Company may withhold or account for Tax-Related Items by considering applicable minimum statutory withholding amounts or other applicable withholding rates. If the obligation for Tax-Related Items is satisfied by withholding in Shares, for tax purposes, the Participant is deemed to have been issued the full number of Shares subject to the vested RSUs, notwithstanding that a number of the Shares is held back solely for the purpose of paying the Tax-Related Items due as a result of any aspect of the Participant’s participation in the Plan. No fractional Shares will be withheld or issued pursuant to the grant of RSUs and the issuance of Shares thereunder.

Finally, the Participant shall pay to the Company or the Employer any amount of Tax-Related Items that the Company or the Employer may be required to withhold or account for as a result of the Participant’s participation in the Plan that cannot be satisfied by the means previously described. The Company may refuse to issue or deliver the Shares or the proceeds of the sale of Shares, if the Participant fails to comply with the Participant’s obligations in connection with the Tax-Related Items. The Participant shall have no further rights with respect to any Shares that are

 

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retained by the Company pursuant to this provision, and under no circumstances will the Company be required to issue any fractional Shares.

12. Nature of Grant. In accepting the RSUs, the Participant acknowledges, understands and agrees that:

(a) the Participant acknowledges receipt of a copy of the Plan (including any applicable appendixes or sub-plans thereunder) and represents that he or she is familiar with the terms and provisions thereof, and hereby accepts this RSU subject to all of the terms and provisions thereof. The Participant has reviewed the Plan (including any applicable appendixes or sub-plans thereunder) and this Agreement in their entirety, has had an opportunity to obtain the advice of counsel prior to executing this Agreement and fully understands all provisions of the RSU. The Participant hereby agrees to accept as binding, conclusive and final all decisions or interpretations of the Administrator upon any questions arising under the Plan or this RSU. Participant further agrees to notify the Company upon any change in the residence address in the Notice of Grant;

(b) the Company (and not the Employer) is granting the RSU. The Company will administer the Plan from outside Participant’s country of residence;

(c) the Plan is established voluntarily by the Company, it is discretionary in nature and it may be modified, amended, suspended or terminated by the Company at any time;

(d) the grant of the RSUs is voluntary and occasional and does not create any contractual or other right to receive future grants of RSUs, or benefits in lieu of RSUs, even if RSUs have been granted repeatedly in the past;

(e) all decisions with respect to future awards of RSUs, if any, will be at the sole discretion of the Company;

(f) the Participant is voluntarily participating in the Plan;

(g) the RSUs and the Shares subject to the RSUs are extraordinary items that do not constitute compensation of any kind for services of any kind rendered to the Company or the Employer, and which are outside the scope of the Participant’s employment contract, if any;

(h) the RSUs and the Shares subject to the RSUs are not intended to replace any pension rights or compensation;

(i) the RSUs and the Shares subject to the RSUs are not part of normal or expected compensation or salary for any purposes, including, but not limited to, calculating any severance, resignation, termination, redundancy, dismissal, end of service payments, bonuses, long-service awards, pension or retirement or welfare benefits or similar payments and in no event should be considered as compensation for, or relating in any way to, past services for the Company, the Employer or any Subsidiary or affiliate of the Company;

 

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(j) the RSU grant and the Participant’s participation in the Plan will not be interpreted to form an employment contract or relationship with the Company or any Subsidiary or affiliate of the Company and the Company will not incur any liability of any kind to Participant as a result of any change or amendment, or any cancellation, of the Plan at any time;

(k) the future value of the underlying Shares is unknown and cannot be predicted with certainty;

(l) no claim or entitlement to compensation or damages shall arise from forfeiture of the RSUs resulting from termination of the Participant’s status as a Service Provider by the Company or the Employer (for any reason whatsoever and whether or not in breach of local labor laws), and in consideration of the grant of the RSUs to which the Participant is otherwise not entitled, the Participant irrevocably agrees never to institute any claim against the Company or the Employer, waives his or her ability, if any, to bring any such claim, and releases the Company and the Employer from any such claim; if, notwithstanding the foregoing, any such claim is allowed by a court of competent jurisdiction, then, by participating in the Plan, the Participant shall be deemed irrevocably to have agreed not to pursue such claim and agrees to execute any and all documents necessary to request dismissal or withdrawal of such claims;

(m) in the event of termination of the Participant’s status as a Service Provider (whether or not in breach of local labor laws), the Participant’s right to vest in the RSUs under the Plan, if any, will terminate effective as of the date that the Participant is no longer actively employed and will not be extended by any notice period mandated under local law (e.g., active employment would not include a period of “garden leave” or similar period pursuant to local law); the Administrator shall have the exclusive discretion to determine when the Participant is no longer actively employed for purposes of the Award; and

(n) the RSUs and the benefits under the Plan, if any, will not automatically transfer to another company in the case of a merger or a Change in Control.

13. No Advice Regarding Grant. The Company is not providing any tax, legal or financial advice, nor is the Company making any recommendations regarding the Participant’s participation in the Plan, or the Participant’s acquisition or sale of the underlying Shares. The Participant is hereby advised to consult with his or her own personal tax, legal and financial advisors regarding his or her participation in the Plan before taking any action related to the Plan

14. Data Privacy. The Participant hereby explicitly and unambiguously consents to the collection, use and transfer, in electronic or other form, of the Participant’s personal data as described in this Agreement and any other RSU materials by and among, as applicable, the Employer, the Company, and any Subsidiary or affiliate for the exclusive purpose of implementing, administering and managing the Participant’s participation in the Plan.

The Participant understands that the Company and the Employer may hold certain personal information about the Participant, including, but not limited to, the Participant’s name, home address and telephone number, e-mail address, date of birth,

 

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social insurance number or other identification number, salary, nationality, job title, any shares of stock or directorships held in the Company or any Subsidiary or affiliate, details of all RSUs or any other entitlement to Shares awarded, canceled, exercised, vested, unvested or outstanding in the Participant’s favor, for the exclusive purpose of implementing, administering and managing the Plan (“Data”).

The Participant understands that Data may be transferred to the designated Plan broker, or such other stock plan service provider as may be selected by the Company in the future, which is assisting the Company in the implementation, administration and management of the Plan. The Participant understands that the recipients may be located in the United States, or elsewhere, and that the recipient’s country (e.g., the United States) may have different data privacy laws and protections than the Participant’s country. The Participant understands that he or she may request a list with the names and addresses of any potential recipients of the Data by contacting the Participant’s local human resources representative. The Participant authorizes the Company, the plan broker and any other possible recipients which may assist the Company (presently or in the future) with implementing, administering and managing the Plan to receive, possess, use, retain and transfer the Data, in electronic or other form, for the sole purpose of implementing, administering and managing the Participant’s participation in the Plan. The Participant understands that Data will be held only as long as is necessary to implement, administer and manage the Participant’s participation in the Plan. The Participant understands that he or she may, at any time, view Data, request additional information about the storage and processing of Data, require any necessary amendments to Data or refuse or withdraw the consents herein, in any case, without cost, by contacting in writing the Participant’s local human resources representative. The Participant understands, however, that refusal or withdrawal of consent may affect the Participant’s ability to participate in the Plan. For more information on the consequences of the Participant’s refusal to consent or withdrawal of consent, the Participant understands that he or she may contact his or her local human resources representative.

15. Grant is Not Transferable. Except to the limited extent provided in paragraph 6, this grant and the rights and privileges conferred hereby will not be transferred, assigned, pledged, or hypothecated in any way (whether by operation of law or otherwise) and will not be subject to sale under execution, attachment, or similar process. Upon any attempt to transfer, assign, pledge, hypothecate, or otherwise dispose of this grant, or any right or privilege conferred hereby, or upon any attempted sale under any execution, attachment, or similar process, this grant and the rights and privileges conferred hereby immediately will become null and void.

16. Binding Agreement. Subject to the limitation on the transferability of this grant contained herein, this Agreement will be binding upon and inure to the benefit of the heirs, legatees, legal representatives, successors, and assigns of the parties hereto.

17. Additional Conditions to Issuance of Stock. If at any time the Company will determine, in its discretion, that the listing, registration, or qualification of the Shares upon any securities exchange or under any state or federal law, or the consent or approval of any governmental regulatory authority is necessary or desirable as a condition to the issuance of

 

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Shares to the Participant (or his or her estate), such issuance will not occur unless and until such listing, registration, qualification, consent, or approval will have been effected or obtained free of any conditions not acceptable to the Company. The Company will make all reasonable efforts to meet the requirements of any such state or federal law or securities exchange and to obtain any such consent or approval of any such governmental authority.

18. Plan Governs. This Agreement and the Notice of Grant are subject to all terms and provisions of the Plan. In the event of a conflict between one or more provisions of this Agreement or the Notice of Grant and one or more provisions of the Plan, the provisions of the Plan will govern.

19. Governing Law and Venue. This Award will be governed by, and construed in accordance with, the laws of the State of California, U.S.A. without regard to principles of conflict of laws. For purposes of litigating any dispute that arises directly or indirectly from the relationship of the parties evidenced by the Award or this Agreement, the parties hereby submit to and consent to the exclusive jurisdiction of the State of California and agree that such litigation shall be conducted only in the courts of San Francisco County, California, or the federal courts for the United States for the Northern District of California, and no other courts, where this Award is made and/or to be performed.

20. Language. Participant has received the terms and conditions of this Agreement and any other related communications in English, and Participant consents to having received these documents in English. If the Participant has received this Agreement or any other document related to the Plan translated into a language other than English and if the meaning of the translated version is different than the English version, the English version will control.

21. Electronic Delivery. The Company may, in its sole discretion, decide to deliver any documents related to current or future participation in the Plan by electronic means. The Participant hereby consents to receive such documents by electronic delivery and agrees to participate in the Plan through an on-line or electronic system established and maintained by the Company or any third party designated by the Company. By Participant’s electronic signature and the electronic signature of the Company’s representative, Participant and the Company agree that this RSU is granted under and governed by the terms and conditions of the Plan and this Agreement.

22. Administrator Authority. The Administrator will have the power to interpret the Plan and this Agreement and to adopt such rules for the administration, interpretation, and application of the Plan as are consistent therewith and to interpret or revoke any such rules (including, but not limited to, the determination of whether or not any RSUs have vested and whether the Participant is actively employed). All actions taken and all interpretations and determinations made by the Administrator in good faith will be final and binding upon the Participant, the Company, and all other interested persons. No member of the Administrator will be personally liable for any action, determination, or interpretation made in good faith with respect to the Plan or this Agreement.

 

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23. Severability. The provisions of this Agreement are severable and if any one or more provisions are determined to be illegal or otherwise unenforceable, in whole or in part, the remaining provisions shall nevertheless be binding and enforceable.

24. Appendix. Notwithstanding any provisions in this Agreement, the Award shall be subject to any special terms and conditions set forth in any Appendix to this Agreement for the Participant’s country. Moreover, if the Participant relocates to one of the countries included in the Appendix, the special terms and conditions for such country will apply to the Participant, to the extent the Company determines that the application of such terms and conditions is necessary or advisable in order to comply with local law or facilitate the administration of the Plan. The Appendix constitutes part of this Agreement.

25. Imposition of Other Requirements. The Company reserves the right to impose other requirements on the Participant’s participation in the Plan, on the Award and on any Shares acquired under the Plan, to the extent the Company determines it is necessary or advisable in order to comply with local law or facilitate the administration of the Plan, and to require the Participant to sign any additional agreements or undertakings that may be necessary to accomplish the foregoing.

 

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DOLBY LABORATORIES, INC.

2005 STOCK PLAN

RESTRICTED STOCK UNIT AGREEMENT

FOR NON-U.S. PARTICIPANTS

Special Terms and Conditions for Participants Outside the U.S.

This Appendix includes additional country-specific terms and conditions that apply to Participants resident in countries listed below. This Appendix is part of the Agreement and contains terms and conditions material to participation in the Plan. Unless otherwise provided below, capitalized terms used but not defined herein shall have the same meanings assigned to them in the Plan and the Agreement.

Australia

Form of Settlement.

RSUs granted to employees resident in Australia shall be paid in Shares only.

Securities Law Notice.

If the Participant acquires Shares under the Plan and offers such Shares for sale to a person or entity resident in Australia, the offer may be subject to disclosure requirements under Australian law. The Participant should obtain legal advice on disclosure obligations prior to making any such offer.

Australian Addendum.

The Participant understands and agrees that the RSUs are offered subject to and in accordance with the terms of the Plan and the Australian Addendum to the Plan. The Participant further agrees to be bound by the terms of the Plan as supplemented for implementation in Australia by the Australian Addendum and the terms of the Award as set forth in the Agreement.

Canada

Form of Settlement.

RSUs granted to employees resident in Canada shall be paid in Shares only.

Consent to Receive Information in English for Quebec Employees.

The Participant acknowledges that it is the express wish of the parties that this Agreement, as well as all documents, notices and legal proceedings entered into, given or instituted pursuant

 

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hereto or relating directly or indirectly hereto, be written in English.

Le participant reconnaît que c’est son souhait exprès d’avoir exigé la rédaction en anglais de cette convention, ainsi que de tous documents exécutés, avis donnés et procédures judiciaries intentées, directement ou indirectement, relativement à ou suite à la présente convention.

Authorization to Release and Transfer Necessary Personal Information.

The following provision supplements paragraph 14 of the Agreement:

The Participant hereby authorizes the Company and the Company’s representatives to discuss with and obtain all relevant information from all personnel, professional or not, involved in the administration and operation of the Plan. The Participant further authorizes the Company, any Parent, Subsidiary or affiliate and the Administrator of the Plan to disclose and discuss the Plan with their advisors. The Participant further authorizes the Company and any Parent, Subsidiary or affiliate to record such information and to keep such information in the Participant’s employee file.

France

Consent to Receive Information in English.

By accepting the grant of the RSUs, the Participant confirms having read and understood the Plan and the Agreement, which were provided in English language. The Participant accepts the terms of those documents accordingly.

En acceptant cette attribution gratuite d’actions, le Participant confirme avoir lu et compris le Plan et ce Contrat, incluant tous leurs termes et conditions, qui ont été transmis en langue anglaise. Le Participant accepte les dispositions de ces documents en connaissance de cause.

Germany

No special provisions.

Hong Kong

Form of Settlement.

RSUs granted to employees resident in Hong Kong shall be paid in Shares only.

Securities Law Notice.

Warning: The RSUs and Shares issued at vesting do not constitute a public offering of securities under Hong Kong law and are available only to employees of the Company, its Subsidiaries or affiliates. The Agreement, including this Appendix, the Plan and other incidental

 

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communication materials have not been prepared in accordance with and are not intended to constitute a “prospectus” for a public offering of securities under the applicable securities legislation in Hong Kong. Nor have the documents been reviewed by any regulatory authority in Hong Kong. The RSUs are intended only for the personal use of each eligible employee of the Employer, the Company or any Subsidiary or affiliate and may not be distributed to any other person. If the Participant is in any doubt about any of the contents of the Agreement, including this Appendix, or the Plan, the Participant should obtain independent professional advice.

The Participant agrees, and the Participant’s heirs and assigns agree, not to sell any Shares within six months of the date of grant.

Occupational Retirement Schemes Ordinance Alert.

The Company specifically intends that neither the Award nor the Plan will be an occupational retirement scheme for purposes of the Occupational Retirement Schemes Ordinance (“ORSO”).

Japan

No special provisions.

Korea

No special provisions.

Netherlands

Consent to Comply with Dutch Securities Law.

The Participant has been granted RSUs under the Plan, pursuant to which the Participant may acquire Shares. Participants who are residents of the Netherlands should be aware of the Dutch insider trading rules, which may impact the sale of such Shares. In particular, the Participant may be prohibited from effecting certain share transactions if the Participant has insider information regarding the Company.

Below is a discussion of the applicable restrictions. The Participant is advised to read the discussion carefully to determine whether the insider rules apply to the Participant. If it is uncertain whether the insider rules apply, the Company recommends that the Participant consult with his or her personal legal advisor. Please note that the Company cannot be held liable if the Participant violates the Dutch insider rules. The Participant is responsible for ensuring compliance with these rules.

By entering into the Agreement and participating in the Plan, the Participant acknowledges having read and understood the notification below and acknowledges that it is his or her own responsibility to comply with the Dutch insider trading rules, as discussed herein.

 

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Prohibition Against Insider Trading.

Dutch securities laws prohibit insider trading. Under Article 46 of the Act on the Supervision of the Securities Trade 1995, anyone who has “inside information” related to the Company is prohibited from effectuating a transaction in securities in or from the Netherlands. “Inside information” is knowledge of a detail concerning the issuer to which the securities relate that is not public and which, if published, would reasonably be expected to affect the Share price, regardless of the actual effect on the price. The insider could be any employee of the Company or its Dutch Subsidiary or affiliate who has inside information as described above.

Given the broad scope of the definition of inside information, certain employees of the Company working at its Dutch Subsidiary or affiliate may have inside information and thus, would be prohibited from effectuating a transaction in securities in the Netherlands at a time when he or she had such inside information.

Singapore

Securities Law Notice.

The RSUs are being granted pursuant to the “Qualifying Person” exemption under section 273(1)(f) of the Singapore Securities and Futures Act (Chapter 289, 2006 Ed.) (“SFA”). The Plan has not been lodged or registered as a prospectus with the Monetary Authority of Singapore. The Participant should note that such RSU grant is subject to section 257 of the SFA and the Participant will not be able to make any subsequent sale in Singapore, or any offer of such subsequent sale of the Class A common stock in Singapore, or any offer of the Class A common stock underlying the RSUs unless such sale or offer in Singapore is made pursuant to the exemptions under Part XIII Division (1) Subdivision (4) (other than section 280) of the SFA (Chapter 289, 2006 Ed.).

Director Reporting Notice.

If the Participant is a director, associate director or shadow director of a Singapore Subsidiary or affiliate of the Company, as the terms are used in the Singapore Companies Act (the “SCA”), the Participant agrees to comply with notification requirements under the SCA. Among these requirements is an obligation to notify the Singapore Subsidiary or affiliate in writing when the Participant receives an interest (e.g., Awards, Shares) in the Company or any related companies (including when Participant sells Shares acquired through an Award). In addition, the Participant must notify the Singapore Subsidiary or affiliate when the Participant sells or receives Shares of the Company or any related company (including when the Participant sells or receives Shares acquired under the Plan). These notifications must be made within two days of acquiring or disposing of any interest in the Company or any related company. In addition, a notification must be made of the Participant’s interests in the Company or any related company within two days of becoming a director. The Participant should consult with his or her personal legal advisor regarding his or her notification obligations under the SCA.

 

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Sweden

No special provisions.

Taiwan

No special provisions.

United Kingdom

Terms and conditions are set forth in the Company’s 2005 Stock Plan Restricted Stock Unit Agreement for U.K. Participants.

 

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Section 302 CEO Certification

Exhibit 31.1

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: February 3, 2010

 

/s/ Kevin J. Yeaman

Kevin J. Yeaman
President and Chief Executive Officer
Section 302 CFO Certification

Exhibit 31.2

CERTIFICATION

I, Murray J. Demo, 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: February 3, 2010

 

/s/ Murray J. Demo

Murray J. Demo
Executive Vice President and Chief 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 25, 2009, as filed with the Securities and Exchange Commission (the “Report”), Kevin J. Yeaman, President and Chief Executive Officer of the Company and Murray J. Demo, Executive Vice President and 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: February 3, 2010

 

/s/ Kevin J. Yeaman.

Kevin J. Yeaman
President and Chief Executive Officer

/s/ Murray J. Demo

Murray J. Demo
Executive Vice President and Chief Financial Officer