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 31, 2010

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 x 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, 2011 the registrant had 53,117,827 shares of Class A common stock, par value $0.001 per share, and 58,931,538 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

     3   
  

Condensed Consolidated Balance Sheets as of September 24, 2010 and December 31, 2010

     3   
  

Condensed Consolidated Statements of Operations for the Fiscal Quarters Ended December  25, 2009 and December 31, 2010

     4   
  

Condensed Consolidated Statements of Cash Flows for the Fiscal Quarters Ended December 25, 2009 and December 31, 2010

     5   
  

Notes to Condensed Consolidated Financial Statements

     6   

Item 2.

  

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

     20   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     31   

Item 4.

  

Controls and Procedures

     32   
PART II – OTHER INFORMATION   

Item 1.

  

Legal Proceedings

     33   

Item 1A.

  

Risk Factors

     33   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     51   

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 24,      
2010
           December 31,      
2010
 
     (unaudited)  
ASSETS       

Current assets:

     

Cash and cash equivalents

         $ 545,861             $ 433,638   

Short-term investments

     302,269         270,593   

Accounts receivable, net

     54,257         68,638   

Inventories

     28,338         27,799   

Deferred taxes

     102,758         97,914   

Prepaid expenses and other current assets

     26,930         25,475   
                 

Total current assets

     1,060,413         924,057   

Long-term investments

     190,837         367,727   

Property, plant and equipment, net

     94,097         99,109   

Intangible assets, net

     67,019         67,340   

Goodwill

     264,580         266,236   

Deferred taxes

     19,948         20,593   

Other non-current assets

     14,878         15,069   
                 

Total assets

         $ 1,711,772             $ 1,760,131   
                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

     

Current liabilities:

     

Accounts payable

         $ 3,606             $ 11,183   

Accrued liabilities

     144,608         110,928   

Income taxes payable

     7,895         14,154   

Deferred revenue

     9,647         8,065   
                 

Total current liabilities

     165,756         144,330   

Long-term deferred revenue

     12,775         13,523   

Deferred taxes

     11,547         559   

Other non-current liabilities

     27,015         29,867   
                 

Total liabilities

     217,093         188,279   

Stockholders’ equity:

     

Class A common stock

     53         53   

Class B common stock

     59         59   

Additional paid-in capital

     329,902         320,245   

Retained earnings

     1,135,922         1,222,309   

Accumulated other comprehensive income

     7,801         8,032   
                 

Total stockholders’ equity – Dolby Laboratories, Inc.

     1,473,737         1,550,698   

Controlling interest

     20,942         21,154   
                 

Total stockholders’ equity

     1,494,679         1,571,852   
                 

Total liabilities and stockholders’ equity

         $ 1,711,772             $ 1,760,131   
                 

See accompanying notes to unaudited condensed consolidated financial statements

 

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DOLBY LABORATORIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

     Fiscal Quarter Ended  
           December 25,      
2009
       December 31,      
2010
 
     (unaudited)  

Revenue:

  

Licensing

       $ 165,775           $ 188,176   

Products

     47,657         46,027   

Services

     7,784         8,509   
                 

Total revenue

     221,216         242,712   
                 

Cost of revenue:

     

Cost of licensing

     4,026         3,961   

Cost of products (1)

     28,084         22,198   

Cost of services (1)

     3,683         2,980   
                 

Total cost of revenue

     35,793         29,139   
                 

Gross margin

     185,423         213,573   
                 

Operating expenses:

  

Research and development (1)

     22,800         28,327   

Sales and marketing (1)

     30,384         38,217   

General and administrative (1)

     27,882         37,042   

Restructuring charges, net

     185         785   
                 

Total operating expenses

     81,251         104,371   
                 

Operating income

     104,172         109,202   

Interest income

     1,832         1,614   

Interest expense

     (85)         (283)   

Other income, net

     460         533   
                 

Income before provision for income taxes

     106,379         111,066   

Provision for income taxes

     (36,886)         (24,301)   
                 

Net income including controlling interest

     69,493         86,765   

Less: net income attributable to controlling interest

     (407)         (378)   
                 

Net income attributable to Dolby Laboratories, Inc.

       $ 69,086           $ 86,387   
                 

Earnings per share attributable to Dolby Laboratories, Inc.:

     

Basic

       $ 0.61           $ 0.77   

Diluted

       $ 0.59           $ 0.76   

Weighted-average shares outstanding:

     

Basic

     114,085         112,035   

Diluted

     116,138         113,713   

Related party rent expense included in general and administrative expenses

       $ 343           $ 343   

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

     

Cost of products

       $ 78           $ 146   

Cost of services

     25         38   

Research and development

     1,196         2,323   

Sales and marketing

     1,732         2,996   

General and administrative

     2,678         5,757   

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 25,      
2009
          December 31,      
2010
 
     (unaudited)  

Operating activities:

  

Net income including controlling interest

       $ 69,493          $ 86,765   

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

    

Depreciation and amortization

     7,806        9,539   

Stock-based compensation

     5,327        10,984   

Amortization of premium on investments

     1,868        3,235   

Excess tax benefit from exercise of stock options

     (4,653     (9,386

Provision for doubtful accounts

     (111     333   

Losses on Put Rights

     1,299        -   

Gains on auction rate certificates

     (1,307     -   

Deferred income taxes

     (5,629     (6,640

Cash distributions to controlling interest

     (128     -   

Other non-cash items affecting net income

     716        (476

Changes in operating assets and liabilities:

    

Accounts receivable

     (20,400     (14,789

Inventories

     3,490        536   

Prepaid expenses and other assets

     6,927        (1,450

Accounts payable and accrued liabilities

     8,459        (27,539

Income taxes, net

     34,791        20,510   

Deferred revenues

     (9,496     (843

Other non-current liabilities

     12        (127
                

Net cash provided by operating activities

     98,464        70,652   
                

Investing activities:

  

Purchases of available-for-sale securities

     (264,913)        (309,660)   

Proceeds from sales of available-for-sale securities

     134,784        159,825   

Purchases of property, plant and equipment

     (10,619)        (9,646)   

Acquisitions, net of cash acquired

     -        (3,350)   

Purchases of intangible assets

     (125)        -   

Proceeds from sales of property, plant and equipment and assets held for sale

     -        621   
                

Net cash used in investing activities

     (140,873     (162,210
                

Financing activities:

  

Repayment of long-term debt

     (398)        -   

Proceeds from issuance of Class A common stock (Employee Stock Purchase Plan)

     1,921        2,536   

Net proceeds from exercise of stock options

     7,337        13,213   

Repurchase of common stock

     (15,661)        (45,966)   

Excess tax benefit from exercise of stock options

     4,653        9,386   
    

Net cash used in financing activities

     (2,148     (20,831
                

Effect of foreign exchange rate changes on cash

     (883)        166   
                

Net decrease in cash and cash equivalents

     (45,440)        (112,223)   

Cash and cash equivalents at beginning of period

     451,678        545,861   
                

Cash and cash equivalents at end of period

       $ 406,238          $ 433,638   
                

Supplemental disclosure:

    

Cash paid for income taxes

       $ 7,701          $ 10,431   

Cash paid for interest

     95        204   

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

We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the U.S. (U.S. GAAP), and with Securities and Exchange Commission (SEC) rules and regulations, which allow for certain information and footnote disclosures that are normally included in annual financial statements prepared in accordance with U.S. GAAP to be condensed or omitted. In our opinion, these condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements for the fiscal year ended September 24, 2010 and include all adjustments necessary for fair presentation. The accompanying condensed consolidated financial statements should be read in conjunction with our consolidated financial statements for the fiscal year ended September 24, 2010, which are included in our Annual Report on Form 10-K filed with the SEC.

The results for the fiscal quarter ended December 31, 2010 are not necessarily indicative of the results to be expected for any subsequent quarterly or annual financial period, including the fiscal year ending September 30, 2011.

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 in which our principal stockholder has a 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 accounts receivable, carrying values of inventories and certain property, plant and equipment, products provided under operating leases, goodwill, intangible assets, stock-based compensation, fair values of investments, accrued expenses, including liabilities for unrecognized tax benefits, and deferred income tax assets. Actual results could differ from our estimates.

Fiscal Year

Our fiscal year is a 52 or 53 week period ending on the last Friday in September. The fiscal periods presented herein include the 13 week period ended December 25, 2009, and the 14 week period ended December 31, 2010. Our fiscal year ended September 24, 2010 (fiscal 2010) consisted of 52 weeks, while our fiscal year ending September 30, 2011 (fiscal 2011) consists of 53 weeks.

 

2. Summary of Significant Accounting Policies

There have been no material changes to our significant accounting policies as compared to those described in our Annual Report on Form 10-K for the fiscal year ended September 24, 2010.

 

3. Composition of Certain Financial Statement Captions

 

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Cash, Cash Equivalents, and Investments

Cash, cash equivalents, and investments as of September 24, 2010 and December 31, 2010 consist of the following:

 

     September 24,
2010
     December 31,
2010
 
        
     (in thousands)  

Cash and cash equivalents:

     

Cash

       $ 156,440           $ 195,437   

Cash equivalents:

     

Money market funds

     354,428         238,201   

U.S. agency securities

     10,000         -   

Commercial paper

     19,993         -   

Municipal debt securities

     5,000         -   
        

Total cash and cash equivalents

     545,861         433,638   
        

Short-term investments:

     

Corporate bonds

     3,788         22,244   

Commercial paper

     9,990         19,988   

Municipal debt securities

     188,123         195,894   

U.S. agency securities

     70,376         28,297   

U.S. and foreign government bonds

     29,992         4,170   
        

Total short-term investments

     302,269         270,593   
        

Long-term investments:

     

Corporate bonds

     25,870         51,372   

Municipal debt securities

     127,458         259,518   

U.S. agency securities

     27,522         49,419   

U.S. government bonds

     9,987         7,418   
        

Total long-term investments

     190,837         367,727   
        

Total cash, cash equivalents and investments

       $ 1,038,967           $ 1,071,958   
        

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

 

     September 24,
2010
 
        
             Amortized Cost      Unrealized
Gains
     Unrealized
Losses
    Estimated Fair
Value
 
        
     (in thousands)  

Commercial paper

               $ 29,983       $ -       $ -      $ 29,983   

Corporate bonds

     29,238         420         -        29,658   

Money market funds

     354,428         -         -        354,428   

Municipal debt securities

     318,825         1,781         (25     320,581   

U.S. agency securities

     107,512         390         (4     107,898   

U.S. government bonds

     39,949         30         -        39,979   
        

Cash equivalents and investments

               $ 879,935       $ 2,621       $ (29   $ 882,527   
        

 

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     December 31,
2010
 
        
             Amortized Cost      Unrealized
Gains
     Unrealized
Losses
    Estimated Fair
Value
 
        
     (in thousands)  

Commercial paper

               $ 19,987       $ 1       $ -      $ 19,988   

Corporate bonds

     73,276         358         (18     73,616   

Money market funds

     238,201         -         -        238,201   

Municipal debt securities

     454,875         1,032         (495     455,412   

U.S. agency securities

     77,434         286         (4     77,716   

U.S. and foreign government bonds

     11,580         8         -        11,588   
        

Cash equivalents and investments

               $ 875,353       $ 1,685       $ (517   $ 876,521   
        

We have classified all of our investments listed in the tables above 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. When we sell securities, we reclassify amounts of gains and losses into earnings based on specific identification of the securities sold.

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:

 

           September 24, 2010         
        
     Less than 12 months     12 months or greater      Total  
        
                 Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
 
        
     (in thousands)  

Municipal debt securities

       $ 62,494       $ (25   $ -       $ -       $ 62,494       $ (25

U.S. agency securities

     30,112         (4     -         -         30,112         (4
        

Total

       $ 92,606       $ (29   $ -       $ -       $ 92,606       $ (29
        
     December 31, 2010  
        
     Less than 12 months     12 months or greater      Total  
        
             Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
 
        
     (in thousands)  

Corporate bonds

       $ 11,367       $ (18   $ -       $ -       $ 11,367       $ (18

Municipal debt securities

     180,031         (495     -         -         180,031         (495

U.S. agency securities

     20,040         (4     -         -         20,040         (4
        

Total

       $ 211,438       $ (517   $ -       $ -       $ 211,438       $ (517
        

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. As of December 31, 2010, we owned 63 securities that were in an unrealized loss position. We do not intend to sell, nor do we believe we will need to sell, these

 

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securities before we recover the associated unrealized losses. 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 24, 2010 or December 31, 2010 to be an other-than-temporary impairment, nor do we consider any of the unrealized losses to be credit losses.

The following table summarizes the amortized cost and estimated fair value of short-term and long-term available-for-sale investments based on stated maturities as of December 31, 2010:

 

     December 31,
2010
 
                     Amortized Cost      Fair Value  
        
     (in thousands)  

Due within 1 year

                       $ 269,639       $ 270,593   

Due in 1 to 2 years

     305,959         306,238   

Due in 2 to 3 years

     61,554         61,489   
        

Total

                       $ 637,152       $ 638,320   
        

Accounts Receivable

Accounts receivable consists of the following:

 

             September 24,         
2010
             December 31,         
         2010
 
     (in thousands)  

Trade accounts receivable

           $ 45,651               $ 55,950   

Accounts receivable related to patent administration program

     10,646         15,033   
                 

Accounts receivable, gross

     56,297         70,983   

Less: allowance for doubtful accounts

     (2,040)         (2,345)   
                 

Accounts receivable, net

           $ 54,257               $ 68,638   
                 

Inventories

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

 

             September 24,         
2010
             December 31,         
2010
 
     (in thousands)  

Raw materials

           $ 10,314               $ 13,098   

Work in process

     3,109         1,552   

Finished goods

     14,915         13,149   
                 

Inventories

           $ 28,338               $ 27,799   
                 

 

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Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consist of the following:

 

             September 24,         
2010
             December 31,         
2010
 
     (in thousands)  

Prepaid assets

           $ 16,191               $ 15,622   

Other current assets

     1,650         3,512   

Income tax receivable

     3,497         1,086   

Assets held for sale

     5,592         5,255   
                 

Prepaid expenses and other current assets

           $ 26,930               $ 25,475   
                 

Assets held for sale represent digital cinema equipment that we leased to exhibitors beginning in fiscal 2005 in an effort to encourage the cinema industry to transition to digital cinema. In fiscal 2010, management committed to a plan to sell some of this leased equipment, which required us to classify these assets as held for sale as of September 24, 2010. We expect to sell these assets during fiscal 2011, and as such, we have classified the equipment within current assets in our condensed consolidated balance sheets as of September 24, 2010 and December 31, 2010. We believe that the current carrying value of these products is recoverable. Products under operating leases with a carrying value of approximately $1.2 million have not yet met the criteria to be classified as held for sale. As a result, these assets are classified as held for use and remain within property, plant and equipment.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost and consist of the following:

 

             September 24,         
2010
             December 31,         
2010
 
     (in thousands)  

Land

       $ 12,835           $ 12,755   

Buildings

     27,029         26,598   

Leasehold improvements

     33,264         33,799   

Machinery and equipment

     16,080         17,257   

Computer systems and software

     43,611         51,817   

Furniture and fixtures

     9,440         10,030   

Products provided under operating leases

     1,209         1,209   
                 
     143,468         153,465   

Less: accumulated depreciation

     (49,371)         (54,356)   
                 

Property, plant and equipment, net

       $ 94,097           $ 99,109   
                 

Depreciation expense for our property, plant and equipment is included in cost of products, cost of services, research and development expenses, sales and marketing expenses, and general and administrative expenses in the accompanying condensed consolidated statements of operations.

Goodwill and Intangible Assets

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

 

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                 Total               
     (in thousands)  

Balance at September 24, 2010

       $ 264,580   

Acquired goodwill

     182   

Translation adjustments

     1,474   
        

Balance at December 31, 2010

       $ 266,236   
        

Intangible assets consist of the following:

 

       September 24,
2010
       December 31,
2010
 
          
       Cost        Accumulated
Amortization
    Net        Cost        Accumulated
Amortization
       Net  
Intangible assets subject to amortization:      (in thousands)  
Acquired patents and technology        $        61,767         $ (24,986     $    36,781           $      65,629         $     (28,059)           $    37,570   
Customer relationships        30,790           (10,095     20,695           31,199           (10,095)           21,104   
Customer contracts        5,973           (4,483     1,490           6,063           (4,483)           1,580   
Other intangibles        20,307           (12,254     8,053           20,308           (13,222)           7,086   
          
Total        $    118,837         $      (51,818)      $    67,019           $    123,199         $     (55,859)           $    67,340   
          

Amortization expense for our intangible assets is included in cost of licensing, cost of products, and sales and marketing expenses in the accompanying condensed consolidated statements of operations.

During the fiscal quarter ended December 31, 2010, we acquired a company for a total purchase price of $4.5 million. Based on an allocation of the purchase price, goodwill and intangible assets resulting from this acquisition amounted to approximately $0.2 million and $4.3 million, respectively. Of the total purchase price, $1.2 million was withheld by us to resolve certain contingent liabilities which may arise after the acquisition date. The acquired intangible asset is included within acquired patents and technology in the table above. The remaining fluctuation in the recorded cost of intangible assets from September 24, 2010 to December 31, 2010 was due to foreign currency translation.

As of December 31, 2010, we expect amortization expense in future periods to be as follows:

 

Fiscal Year                                                     

  

Amortization Expense

     (in thousands)

Remainder of 2011

   $            13,688

2012

   13,556

2013

   12,863

2014

   10,715

2015

   7,833

Thereafter

   8,685
    

Total

   $            67,340
    

Accrued Liabilities

Accrued liabilities consist of the following:

 

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       September 24,
2010
       December 31,
2010
 
          
       (in thousands)              

Accrued royalties

             $ 4,140         $ 5,028   

Amounts payable to joint licensing program partners

       42,837           35,043   

Accrued compensation and benefits

       62,044           29,668   

Accrued professional fees

       8,078           7,682   

Current portion of litigation settlement

       2,890           2,927   

Accrued customer refunds

       4,120           7,342   

Other accrued liabilities

       20,499           23,238   
          

Accrued liabilities

             $         144,608         $ 110,928   
          

Other Non-Current Liabilities

Other non-current liabilities consist of the following:

 

     September 24,
2010
     December 31,
2010
 
        
     (in thousands)  

Supplemental retirement plan obligations

               $ 2,118           $ 2,051   

Non-current tax liabilities

     20,036         22,406   

Other liabilities

     4,861         5,410   
        

Other non-current liabilities

               $             27,015           $         29,867   
        

Accumulated Other Comprehensive Income

Accumulated other comprehensive income consists of the following:

 

     September 24,
2010
     December 31,
2010
 
        
     (in thousands)         

Accumulated foreign currency translation gains, net of tax of ($2,655) and ($3,067)

               $ 6,195         7,302   

Accumulated unrealized gains on available-for-sale securities, net of tax of ($986) and ($443)

     1,606         730   
        

Total accumulated other comprehensive income

               $             7,801           $         8,032   
        

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 dilutive shares of Class A and Class B common stock outstanding during the period.

 

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

 

     Fiscal Quarter Ended  
     December 25,
2009
    December 31,
2010
 
     (in thousands, except per share
amounts)
 

Numerator:

    

Net income attributable to Dolby Laboratories, Inc.

                       $ 69,086          $ 86,387   
                

Denominator:

    

Weighted-average shares outstanding - basic

     114,085        112,035   

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

     1,882        1,388   

Potential common shares from restricted stock units

     171        290   
                

Weighted-average shares outstanding – diluted

     116,138        113,713   
                

Net income per share attributable to Dolby Laboratories, Inc. - basic

                       $ 0.61          $ 0.77   

Net income per share attributable to Dolby Laboratories, Inc. - diluted

                       $ 0.59          $ 0.76   

Anti-dilutive options excluded from calculation

         1,568            2,671   

Anti-dilutive restricted stock units excluded from calculation

     20        331   

The increase in the number of anti-dilutive stock options and restricted stock units from first quarter of fiscal 2010 to the first quarter of fiscal 2011 is primarily due to the timing of grants. We made broad-based grants during the first quarter of fiscal 2011 due to a shift in timing of our annual performance and compensation review cycle. In prior years, we typically made broad-based grants during the second quarter of the fiscal year. See Footnote 5 Stock-Based Compensation for information on current quarter grants.

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 $7.6 million and $8.2 million in the fiscal periods ended December 25, 2009 and December 31, 2010, respectively. We account for sales tax on a net basis by excluding sales tax from our revenue.

Income Taxes

Our effective tax rate is based upon a projection of our annual fiscal year results. Our effective tax rate was 35% and 22% for the first quarter of fiscal 2010 and the first quarter of fiscal 2011, respectively. In the first quarter of fiscal 2011, we completed the restructuring of our international operations, which resulted in the release of a deferred tax liability of $11.0 million related to the amortization of an intangible asset from a prior year acquisition. We also made an election to indefinitely reinvest a portion of our undistributed earnings in a foreign subsidiary, which resulted in a reduction to the fiscal year 2011 tax rate.

Additionally, in the first quarter of fiscal 2011, a change in the tax law retroactively reinstated the federal research and development tax credits for a portion of fiscal 2010. As a result, we recognized an increase in federal research and development tax credits for fiscal 2010 in fiscal 2011, thereby further lowering our effective tax rate.

 

4. Fair Value Measurements

Fair value is the exchange price that would be received for an asset or that 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 using 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 and liabilities carried at fair value as of September 24, 2010 are classified below:

 

     Level 1      Level 2      Level 3      Total  
     (in thousands)  

Assets:

           

Investments held in supplemental retirement plan (1)

       $ 2,200       $ -           $             -       $ 2,200   

Money market funds (2)

     354,428         -         -         354,428   

Commercial paper (2)

     -         29,983         -         29,983   

Corporate bonds (2)

     -         29,658         -         29,658   

Municipal debt securities (2)

     -         320,581         -         320,581   

U.S. agency securities (2)

     -         107,898         -         107,898   

U.S. government bonds (2)

     -         39,979         -         39,979   
                                   

Total

       $     356,628           $     528,099           $ -           $     884,727   
                                   

(1)     These assets are included within prepaid expenses and other current assets and other non-current assets.

(2)     These assets are included within cash and cash equivalents, short-term investments, and long-term investments.

 

       Level 1        Level 2        Level 3      Total  
       (in thousands)  

Liabilities:

                 

Investments held in supplemental retirement plan (1)

         $     2,200             $             -             $             -           $         2,200   
                                         

Total

         $ 2,200             $ -             $ -           $ 2,200   
                                         

(1)     These liabilities are included within accrued liabilities and other non-current liabilities.

Financial assets and liabilities carried at fair value as of December 31, 2010 are classified below:

 

     Level 1      Level 2      Level 3      Total  
     (in thousands)  

Assets:

           

Investments held in supplemental retirement plan (1)

       $ 2,242           $ -           $ -           $ 2,242   

Money market funds (2)

     238,201         -         -         238,201   

Commercial paper (2)

     -         19,988         -         19,988   

Corporate bonds (2)

     -         73,616         -         73,616   

Municipal debt securities (2)

     -         455,412         -         455,412   

U.S. agency securities (2)

     -         77,716         -         77,716   

U.S. and foreign government bonds (2)

     -         11,588         -         11,588   
                                   

Total

       $     240,443           $     638,320           $             -           $     878,763   
                                   

(1)     These assets are included within prepaid expenses and other current assets and other non-current assets.

(2)     These assets are included within cash and cash equivalents, short-term investments, and long-term investments.

 

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     Level 1      Level 2      Level 3      Total  
     (in thousands)  

Liabilities:

           

Investments held in supplemental retirement plan (1)

       $ 2,242           $                 -           $             -           $         2,242   
                                   

Total

       $         2,242           $ -           $ -           $ 2,242   
                                   

(1) These liabilities are included within accrued liabilities and other non-current liabilities.

We base the fair value of our Level 1 financial instruments on active quoted market prices for identical instruments. 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. We did not own any Level 3 financial assets or liabilities as of September 24, 2010 or December 31, 2010.

 

5. Stock-Based Compensation

We have adopted 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 for the fiscal quarters ended December 25, 2009 and December 31, 2010 was as follows:

 

     Fiscal Quarter Ended  
     December 25,
2009
       December 31,
2010
 
     (in thousands)  

Stock-based compensation

  

Stock options

       $ 3,734             $ 6,897   

Restricted stock units

     1,633           4,126   

Employee stock purchase plan

     146           182   

Stock appreciation rights

     196           55   
                   

Total stock-based compensation

       $         5,709             $         11,260   
                   

During the fiscal quarters ended December 25, 2009 and December 31, 2010, grants of stock-based awards were as follows:

 

     Fiscal Quarter Ended  
     December 25,
2009
     December 31,
2010
 

Stock options granted

     73,120             1,271,350   

Weighted average exercise price of options granted

       $ 42.73           $             66.36   

Restricted stock units granted

         14,165         326,655   

Weighted average grant price of restricted stock units granted

       $ 42.72           $             66.37   

The increase in the number of stock options and restricted stock units granted in the first quarter of fiscal 2011 compared to the first quarter of fiscal 2010 is primarily due to the timing of grants. We made broad-based grants during the first quarter of fiscal 2011 due to a shift in timing of our annual performance and compensation review cycle. In prior years, we typically made broad-based grants during the second quarter of the fiscal year.

 

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6. Restructuring

During the fiscal quarter ended June 25, 2010, we informed approximately 60 general and administrative employees of our plans to reorganize certain aspects of our global business infrastructure. As a result of this action, we offered severance benefits to the affected employees. The majority of these employees were required to render service through November 15, 2010 to receive these severance benefits. We are recognizing the total estimated severance and other associated costs of approximately $4.0 million for these employees on a ratable basis through termination dates for each employee, and have recorded $3.9 million of these total costs through December 31, 2010. These expenses are recognized in restructuring charges, net, in the condensed consolidated statements of operations. We expect to satisfy all restructuring related liabilities accrued as of the fiscal year ended September 24, 2010 in fiscal 2011.

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

 

     Severance     Facilities and
contract
termination costs
     Fixed assets
impairment
     Other associated
costs
    Total  
        
     (in thousands)  

Balance at September 24, 2010

       $         2,804      $ -       $                     -       $             230      $             3,034   

Restructuring charges

     817        -         -         (32     785   

Cash payments

     (2,803     -         -         (107     (2,910

Non-cash charges

     -        -         -         -        -   
        

Balance at December 31, 2010

       $         818      $ -       $ -       $ 91      $ 909   
        

 

7. 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. There has been no material change in the status of legal proceedings since our fiscal year ended September 24, 2010.

 

8. Geographic Data

Revenue by geographic region is determined based on the location of our licensees for licensing revenue, the location of our direct customers or distributors for products revenue, and the location where we perform our services for services revenue. Geographic data, including revenue and the concentration of revenue from individual geographic regions was as follows:

 

     Fiscal Quarter Ended  
     December 25,
2009
     December 31,
2010
 
     Revenue      Concentration      Revenue      Concentration  
                             
                 
     (in thousands)             (in thousands)         

United States

       $ 65,215         30%       $ 74,863         31%   

APAC

     110,727         50%         126,070         52%   

EMEA

     42,571         19%         39,143         16%   

Other

     2,703         1%         2,636         1%   
        

Total

       $     221,216                       100%       $         242,712                       100%   
        

 

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In the first quarter of fiscal 2010, revenue from one customer was $19.5 million, or 9% of revenue. In the first quarter of fiscal 2011, the same customer accounted for $28.5 million, or 12%, of total revenue.

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

 

     September 24,
2010
     December 31,
2010
 
        
     (in thousands)         

United States

               $ 76,257       $ 78,587   

International

     17,840         20,522   
        
Total long-lived tangible assets, net of accumulated depreciation                $             94,097       $             99,109   
                 

 

9. Guarantees and 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 obligations. Due to their varying terms and conditions, we are unable to make a reasonable estimate of the maximum potential amount we could be required to pay.

 

10. Common Stock Repurchase Program

In November 2009, we announced a stock repurchase program, whereby we may repurchase up to $250.0 million of our Class A common stock. In July 2010, our Board of Directors approved an additional $300.0 million for our stock repurchase program, for a total authorization of up to $550.0 million in share repurchases. Stock repurchases under this program may be made through open market transactions, negotiated purchases, or otherwise, at times and in amounts that we consider appropriate. The timing of repurchases and the number of shares repurchased depend upon 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. This program does not have a specified expiration date. Shares repurchased under the program will be returned to the status of authorized but unissued shares of Class A common stock.

Stock repurchase activity under the stock repurchase program during the quarter ended December 31, 2010 is summarized as follows:

 

     Shares
Repurchased
    

Cost
(in thousands)

(1)

     Average Price
Paid per Share
(2)
 

Repurchase activity for the fiscal quarter ended December 31, 2010

     732,665             $             45,966         $             62.72   
                    

Total

                 732,665             $ 45,966        
                    

(1) Cost of share repurchases includes the price paid per share and applicable commissions.

(2) Excludes commission costs.

 

11. Comprehensive Income and Supplemental Equity Information

 

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Comprehensive Income

The components of comprehensive income were as follows:

 

     Fiscal Quarter Ended  
     December 25,
2009
     December 31,
2010
 
        
     (in thousands)  

Net income including controlling interest

   $ 69,493       $ 86,765     

Other comprehensive income:

     

Foreign currency translation adjustment, net of tax

     (2,348)         1,107     

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

     (335)         (876)     

Comprehensive income

     66,810         86,996     

Less: comprehensive income attributable to controlling interest

     (407)         (378)     
        

Comprehensive income attributable to Dolby Laboratories, Inc.

       $         66,403       $         86,618     
        

Supplemental Equity Information

The following tables present the consolidated statements of changes in stockholders’ equity attributable to Dolby Laboratories, Inc. and the controlling interest:

 

     Dolby Laboratories, Inc. (in thousands)              
    

Shares

of
common
stock

    Common
stock
     Additional
paid-in
capital
    Retained
earnings
     Accumulated
other
comprehensive
income
    Total Dolby
Laboratories,
Inc.
    Controlling
Interest
    Total  
        

Balance at September 25, 2009

     113,849      $ 113       $ 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 common stock

     (345     -         (15,661     -         -        (15,661     -        (15,661
Tax benefit from the exercise of Class A and Class B stock options and vesting 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   

Exercise of Class B stock options

     347        -         769         -         -        769        -        769   
        

Balance at December 25, 2009

         114,151      $ 114       $ 482,505      $ 921,561       $ 6,858      $ 1,411,038      $ 22,299      $ 1,433,337   
        

 

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     Dolby Laboratories, Inc. (in thousands)                
     Shares of
common stock
     Common
stock
     Additional
paid-in
capital
     Retained
earnings
    

Accumulated

other

comprehensive

income

     Total Dolby
Laboratories,
Inc.
     Controlling
Interest
     Total  
        

Balance at September 24, 2010

     112,084         112         329,902         1,135,922         7,801       $ 1,473,737         20,942         1,494,679   

Net income

     -         -         -         86,387         -         86,387         378         86,765   

Translation adjustments, net of taxes of ($412)

     -         -         -         -         1,107         1,107         (166)         941   

Unrealized losses on available-for-sale securities, net of taxes of $543

     -         -         -         -         (876)         (876)         -         (876)   

Distributions to controlling interest

     -         -         -         -         -         -         -         -   

Stock-based compensation expense

     -         -         10,984         -         -         10,984         -         10,984   

Capitalized stock-based compensation expense

     -         -         141         -         -         141         -         141   

Repurchase of common stock

     (733)         (1)         (45,965)         -         -         (45,966)         -         (45,966)   

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

     -         -         9,435         -         -         9,435         -         9,435   

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

     467         1         15,068         -         -         15,069         -         15,069   

Exercise of Class B stock options

     315         -         680         -         -         680         -         680   
        

Balance at December 31, 2010

     112,133       $ 112       $ 320,245       $ 1,222,309       $ 8,032       $ 1,550,698       $ 21,154       $ 1,571,852   
        

 

12. Subsequent Event

On February 2, 2011, the Company’s stockholders voted on and approved an amendment and restatement of the Company’s 2005 Stock Plan, which made the following changes to the plan:

 

  1) Increased the maximum aggregate number of shares that may be issued under the plan from 12,000,000 to 21,000,000;

 

  2) Changed the ratio under the plan pursuant to which full value awards (including specifically any restricted stock, restricted stock unit, performance unit and performance share) granted on and after February 2, 2011 will count against the plan share reserve from 2:1 to 1.6:1; and

 

  3) Extended the term of the plan from November 2014 to November 2020.

 

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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

Dolby Laboratories develops and delivers innovative products and technologies that are used throughout the entertainment industry to produce immersive and enjoyable experiences. Over the years, Dolby has introduced innovations that have significantly improved audio entertainment, such as noise reduction for the recording and cinema industries and surround sound for cinema and home entertainment. As a result of these innovations, we believe the Dolby brand has come to symbolize a superior entertainment experience.

Our audio technologies are used throughout the global entertainment industry to deliver a premium audio experience to consumers. Use of our technologies in each step of the entertainment creation, distribution, and playback process enables the creator, the producer, and the distributor to develop and present their content to consumers in the manner they intended.

There are a number of current industry trends that provide us with opportunities for future growth, such as the transition to digital television from analog television, and the delivery of media content online and via mobile devices. These trends present us with an opportunity to extend the adoption of our technologies to new devices, as the methods by which content can be delivered and the number of devices capable of playing back the content increase.

We are developing and marketing video technologies that we believe can improve the quality of video presentation. Our offerings include video products aimed at the cinema market, such as our digital cinema server, our Dolby 3D Digital Cinema products, and our Dolby PRM-4200 Professional Reference Monitor, which we market to video professionals. In addition, we are developing and marketing voice technologies that improve voice clarity for use in online gaming and other markets.

We view the video and voice markets as early-stage opportunities for us. We believe that our well-recognized brand, our existing customer relationships, and our history of introducing successful, innovative technologies are important strengths that will help us pursue these opportunities.

Business Model

Dolby Laboratories is a global organization that generates revenue by licensing technologies to manufacturers of consumer electronics (CE) products and to software vendors, and by selling products and related services to entertainment content creators and to distributors. We work with the global entertainment industry in three principal ways:

 

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First, we offer products and services to content creators, such as studios, broadcasters, and downloadable content service providers, to encode content using Dolby’s technologies. By encoding content with our technologies, content creators are able to deliver a rich and immersive audio experience for consumers.

 

   

Second, we license our technology to CE manufacturers and to software vendors so that consumers can enjoy the content that has been encoded with our proprietary technologies. In so doing, we develop and deliver innovations directly to CE manufacturers and to software vendors.

 

   

Third, we work directly with standards bodies in an effort to have our technologies adopted in their specifications to ensure a common standard across devices that improves the overall consumer experience.

We have licensed our technologies to CE manufacturers and to software vendors in 40 countries and our licensees distribute their products incorporating our technologies throughout the world. We sell our products and provide services in over 85 countries. In fiscal 2009, 2010, and the first quarter of fiscal 2011, revenue from outside of the U.S. was 65%, 66%, and 69% of our total revenue, respectively. Geographical data for our licensing revenue is based on the location of our licensees’ headquarters. Products revenue is based on the end location where we ship our products, while services revenue is based on the location where services are performed.

We provide products and services to creators and to distributors of audio content that enable them to encode content using our technologies. Such customers include studios, television broadcasters, cable television operators, satellite television operators, and increasingly, downloadable content service providers. We then license our technologies, such as Dolby Digital, Dolby Digital Plus, and Dolby Pulse, to CE manufacturers and to software providers which enable CE products to decode and play back 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 (PC) software DVD players. In addition, the majority of cinemas around the world use our products to play back audio content.

Opportunities, Challenges, and Risks

Our revenue increased 10% in the first quarter of fiscal 2011 when compared to the first quarter of fiscal 2010, and we are optimistic about the prospects for our business. However, our business could be affected by adverse changes in general economic conditions because our technologies are incorporated in entertainment-oriented products, which are generally discretionary goods, such as PCs, digital televisions, set-top boxes, DVD players and recorders, Blu-ray Disc players, video game consoles, audio/video receivers, mobile devices, in-car entertainment systems, home-theater-in-a-box systems, camcorders, and portable media devices. Deterioration or continued weakness in economic conditions could suppress consumer demand and harm our business in the markets in which we license our technologies and sell our products.

Licensing revenue constitutes the majority of our total revenue, representing 83%, 77%, and 78% of total revenue in fiscal 2009, fiscal 2010, and the first quarter of fiscal 2011, respectively. We categorize our licensing revenue into the following markets (items listed in each market incorporate our technologies):

 

   

PC market: primarily comprised of software DVD players and Microsoft Windows operating systems

 

   

Broadcast market: primarily comprised of televisions and set-top boxes

 

   

CE market: primarily comprised of DVD players and recorders, Blu-ray Disc players, audio/video receivers, and home-theater-in-a-box systems

 

   

Other markets:

 

   

Gaming—primarily comprised of video game consoles

 

   

Mobile—primarily comprised of cell phones and other mobile devices

 

   

Licensing services—revenue from the administration of joint licensing programs

 

   

Automotive—primarily comprised of in-car DVD players.

 

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Our PC market represented approximately 35%, 36%, and 31% of our licensing revenue in fiscal 2009, fiscal 2010 and the first quarter of fiscal 2011, respectively. Revenue from our PC market is dependent on several factors, including underlying PC unit shipment growth as well as the mix of these PC units containing our technologies. In the first quarter of fiscal 2011, revenue from our PC market was driven primarily by the inclusion of our technologies in media applications or operating systems often included in these PC shipments. These media applications and operating systems include DVD playback and/or DVD authoring functionality that use our technologies. Our PC market also includes revenue from our PC Entertainment Experience (PCEE) program, a suite of technologies that enhances the audio quality of media on entertainment-oriented PCs.

Consumers, particularly those in emerging markets, are increasingly purchasing low-cost PCs and netbooks, while a number of consumers in the U.S. and Europe are purchasing tablets. Both of these trends could continue in the future. Currently, these devices do not include operating systems or media applications with our technologies. However, we believe that over time we can extend our technologies to these devices in order to improve the user entertainment experience.

Windows 7, Microsoft’s newest operating system, incorporates Dolby technologies, including Dolby Digital Plus, in four of the six available editions: Home Premium, Ultimate, Professional, and Enterprise. Prior to the release of Windows 7, our technologies were only included in premium consumer editions of Microsoft’s Vista operating system, the Windows Vista Home Premium Edition and the Windows Vista Ultimate Edition. Almost half of the world’s PC shipments are to the business market. The inclusion of our technologies in the Professional and Enterprise editions of Windows 7, which are typically purchased by the business market, increases the potential for us to receive royalties on a greater percentage of PC shipments.

Revenue risks associated with the Windows 7 opportunity include the following:

 

   

The inclusion of our technologies in Windows 7 Professional and Enterprise editions could result in our technologies residing in a greater percentage of PCs, though the benefit from this potential significant increase in reported units will be partially offset by substantial discounts, thereby reducing the average per unit royalty we would receive from Microsoft over time.

 

   

PC manufacturers have excluded, and others may exclude in the future, third-party DVD software applications from their offerings.

 

   

Business customers may take several years to upgrade to Windows 7 given the longer adoption cycles associated with enterprise customers.

Our broadcast market, driven by demand for our technologies in televisions and set-top boxes, represented approximately 25%, 27%, and 28% of our licensing revenue in fiscal 2009, fiscal 2010, and the first quarter of fiscal 2011, respectively. We view the broadcast market as an area for continued growth, primarily driven by broadcast markets outside of the U.S. We also view broadcast services, such as terrestrial broadcast or IPTV services, which operate under particular bandwidth constraints, as another area of opportunity for us to offer Dolby Digital Plus, HE AAC, and Dolby Pulse, which enable the delivery of high-quality audio content at reduced bit rates, thereby conserving bandwidth. 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 CE market, driven primarily by revenue attributable to sales of DVD players and recorders and Blu-ray Disc players, represented approximately 25%, 22%, and 25% of licensing revenue in fiscal 2009, fiscal 2010, and the first quarter of fiscal 2011, respectively. Blu-ray Disc continues to represent a revenue growth opportunity within our CE market, as Blu-ray Disc players are required to support Dolby Digital for primary audio content and Dolby Digital Plus for secondary audio content, and Dolby TrueHD is an optional audio standard. However, there is a risk that revenue growth from Blu-ray Disc players may not offset future declines in revenue from DVD players.

Revenue generated from our other markets was driven by gaming, mobile, licensing services, and automotive. Gaming and automotive revenue was primarily driven by sales of video game consoles, portable gaming devices, and in-car entertainment systems with Dolby Digital, ATRAC, Dolby TrueHD, and Dolby Digital Plus technologies. Mobile revenue was primarily driven by demand for the AAC, HE AAC, and Dolby Pulse audio compression technologies incorporated into mobile devices and Dolby Mobile, our suite of post processing technologies

 

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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. Revenue from licensing services was primarily driven by demand for standards-based audio compression technologies used in broadcast, PCs, CE and mobile devices.

We have introduced Dolby Axon, a new technology for our gaming market. Dolby Axon is a voice technology that delivers surround sound and enables online gamers to perceive the spatial location of other players, thus making the online gaming experience real and immersive. We do not anticipate generating significant revenue from this technology in fiscal 2011.

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 as consumers in these markets have more disposable income 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 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.

Products revenue consists primarily of sales of equipment to cinema operators and broadcasters representing 13%, 20%, and 19% of our total revenue in fiscal 2009, fiscal 2010, and the first quarter of fiscal 2011, respectively.

Our cinema products represented approximately 82% of total products revenue in fiscal 2009, and 90% of total products revenue in fiscal 2010 and the first quarter of fiscal 2011.

There is a trend in the cinema industry to transition to digital cinema. Digital cinema offers motion picture studios 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 screen server and central library server, which allow for the storage and playback of digital content. We expect most exhibitors, which are either constructing new theaters or upgrading existing theaters, to choose digital cinema products over traditional film cinema products. Digital cinema specifications are based on open standards, which, unlike traditional cinema standards, do not include our proprietary audio technologies. Furthermore, we are facing more pricing and other competitive pressures in the digital cinema products market than we have experienced with our traditional cinema products.

Our digital 3D products provide 3D image capabilities when combined with a digital cinema projector and server. We believe the success of recent 3D cinema releases is leading to the creation and distribution of more 3D cinema content. We expect an increase in these releases to further drive the transition to 3D enabled screens. We have shipped over 7,200 3D cinema units to equip screens around the world. We view the transition to 3D enabled screens as a growth opportunity; however, actual results may differ from our expectations.

Several competitors have introduced digital cinema products that support the presentation of movies with higher resolution “4K” digital cinema projectors. Certain major exhibitors have begun installing 4K digital cinema equipment into their theaters. In the future, other exhibitors may feel that they need to outfit some or all of their theaters with 4K digital cinema equipment to compete in the same markets where competitors are promoting 4K products. Dolby currently does not offer a 4K digital cinema solution. We are developing a 4K digital cinema solution and if we encounter delays or cancel the development of the solution, our future prospects in digital cinema may be limited and our business could be adversely affected.

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. As the cinema industry invested more in digital cinema, revenue from our traditional cinema products has declined as a percentage of total cinema products revenue. We expect this decline to continue.

Our broadcast products represented approximately 13% of products revenue in fiscal 2009 and 9% of products revenue in fiscal 2010 and the first quarter of fiscal 2011. Our broadcast products are used to encode, transmit, and

 

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decode multiple channels of high-quality audio content 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 2011, we began selling our Professional Reference Monitor product, which is a flat-panel video reference display for video professionals. Professionals use the monitor for color critical tasks, such as calibrating color accuracy to professional reference standards. Our Professional Reference Monitor uses our dynamic range imaging technologies, which enable enhanced contrast, extended brightness and dynamic range, along with reduced power consumption in LED backlit LCD televisions.

Our services revenue, which represented approximately 4%, 3%, and 3% of total revenue in fiscal 2009, fiscal 2010, and the first quarter of fiscal 2011, respectively, is primarily tied to the cinema industry and, in particular, to the number of movies being made by studios and independent filmmakers. Several factors influence the number of movies produced in a given fiscal period, including strikes and work stoppages within the cinema 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 U.S., or U.S. GAAP, and pursuant to Securities and Exchange Commission (SEC) rules and regulations. U.S. GAAP and SEC rules and regulations require us to use accounting policies and make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies as of the date of the financial statements, and the reported amounts of revenue and expenses during a fiscal period. The SEC considers an accounting policy and estimate to be critical if it is both important to a company’s financial condition and/or results of operations and if 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. There have been no material changes to our critical accounting policies and estimates as compared to those described in our Annual Report on Form 10-K for the fiscal year ended September 24, 2010. Although we believe that our judgments and estimates are appropriate and correct, actual results may differ from these estimates.

We consider the following to be 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 management judgments about matters that are uncertain. If actual results or events differ materially, our reported financial condition and results of operation for future periods could be materially affected. See our “Risk Factors” for further information on the potential risks to our future results of operations.

Revenue Recognition

We enter into revenue arrangements with our customers to license technologies, trademarks, and know-how and to sell products and services. We recognize revenue 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. Some of our revenue arrangements include multiple elements, such as hardware, software, maintenance, and other services.

Revenue recognition for transactions which involve software, such as fees we earn from integrated software vendors, requires judgment, including whether a software arrangement includes multiple elements, and if so, whether vendor specific objective evidence (VSOE) of fair value exists for those elements. For some of our multiple element (ME) arrangements, customers receive certain elements of the arrangement over a period of time or after delivery of the initial software. These elements may include support and maintenance. The fair value of these elements is recognized over the estimated period for which these elements will be delivered, which is sometimes the estimated life of the software. If we do not have VSOE of fair value for any undelivered element included in these ME arrangements for software, we defer revenue until all elements are delivered and/or services have been performed, or until we have VSOE of fair value for all remaining undelivered elements. If the undelivered element is support and we do not have fair value for the support element, revenue for the entire arrangement is bundled and recognized ratably over the support period.

For ME arrangements involving tangible products, we allocate consideration to each element based on its relative selling price, which we establish using a selling price hierarchy. We determine the selling price of each element based on its VSOE, if available, third-party evidence (TPE), if VSOE is not available, or estimated selling price (ESP), if neither VSOE nor TPE is available. We have established VSOE for a majority of the undelivered elements in our ME arrangements. For these arrangements, the VSOE and the ESP values are essentially the same. For arrangements where VSOE does not exist, we use ESP.

 

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We determine our best estimate of the selling price for an individual element within a ME revenue arrangement using the same methods utilized to determine the selling price of an element sold on a standalone basis. If we sell the element on a standalone basis, we estimate the selling price by considering actual sales prices. Otherwise, we estimate the selling price by considering internal factors such as pricing practices and margin objectives. Consideration is also given to market conditions such as competitor pricing strategies, customer demands, and industry technology lifecycles. Management applies judgment to establish margin objectives, pricing strategies, and technology lifecycles.

We evaluate each element in a ME arrangement to determine whether it represents a separate unit of accounting. An element constitutes a separate unit of accounting when it has standalone value and delivery of an undelivered element is probable and within our control. When these criteria are not met, the delivered and undelivered elements are combined and the arrangement fees are allocated to this combined single unit.

If the unit separation criteria are met, we account for each element within a ME arrangement separately and we allocate the arrangement fees based on the relative selling price of each element. For some arrangements, customers receive certain elements over a period after delivery of the initial product. These elements may include support and maintenance and/or the right to receive upgrades. Revenue allocated to the undelivered element is recognized over either its estimated service period or when the upgrade is delivered. We do not recognize revenue that is contingent upon the future delivery of products or services or upon future performance obligations. We recognize revenue for delivered elements only when we have completed all contractual obligations.

We account for the majority of our digital cinema server sales as ME arrangements that have two separate units, or elements, of accounting. The first element consists of our digital cinema server hardware and the accompanying software, which is essential to the functionality of the hardware. This element is typically delivered at the time of sale. The second element is the right to receive support and maintenance, which is included with the purchase of the hardware element and is typically delivered over a service period subsequent to the initial sale. The application of revenue accounting standards to our digital cinema server sales typically results in the allocation of a substantial majority of the arrangement fees to the delivered hardware element based on its ESP, which we recognize as revenue at the time of sale. A small portion of the arrangement fees are allocated to the undelivered support and maintenance element, based on its VSOE or ESP, and is recognized as revenue ratably over the estimated service period, which is typically three years.

Goodwill, Intangible Assets, and 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. Our operating segments are aligned with the management principles of our business. The goodwill impairment test is a two-step process. In the first step, we compare the carrying value of the net assets of a reporting unit, including goodwill, to its fair value. If we determine that the fair value of the reporting unit is less than its carrying value, we move to the second step 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 if an event occurs or circumstances change such that there is an indication of a reduction in 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, which is based on the present value of estimated future cash flows for each reporting unit. Fair value reflects the price a market participant would be willing to pay in a potential sale of the reporting unit. During our last annual goodwill impairment test, we had two reporting units—Via, which has no assigned goodwill, and Dolby Entertainment Technology (DET), with goodwill of $258.9 million. The cash flow model was based on our best estimate of future revenue and operating costs. We estimated our future revenue by applying growth rates, consistent with those used in our internal forecasts, to our current revenue 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 by using the capital asset pricing model. The primary components of this model include weighting our total asset structure between our equity and debt, the risk-free rate of return on U.S. Treasury bonds, market risk premium based on a

 

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range of historical returns and forward-looking estimates, and the beta of our common stock. Our model utilized an effective tax rate of approximately 35%. We do not believe that there have been significant changes since our last annual goodwill test which would indicate that goodwill is at risk for impairment as of December 31, 2010.

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, which are amortized on a straight-line basis over their useful lives ranging from two to fifteen years.

We review long-lived assets, including intangible assets, for impairment whenever events or a change 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 total 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 estimated fair value.

Accounting for Income Taxes

We make estimates and judgments that affect our accounting for income taxes. This includes estimating actual tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences, including the timing of the 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 establish 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 is sustainable upon examination by tax authorities. We include interest and penalties related to gross unrecognized tax benefits within our provision for income taxes. When accrued interest and penalties do not ultimately become payable, amounts accrued are reduced in the period and are reflected as a reduction of the overall income tax provision.

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

Stock-Based Compensation

We determine the expense for all employee stock-based compensation awards by estimating their fair value and by recognizing that value as an expense, on a ratable basis, in the condensed consolidated financial statements over the requisite service period in which our employees earn the awards. We utilize the Black-Scholes option pricing model to determine the fair value of employee stock options at the date of the grant. To determine the fair value of a stock-based award using the Black-Scholes option pricing model, we make 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 of the award. We estimate the expected term of our stock-based awards by evaluating historical exercise patterns of our employees. We utilize a blend of the historical volatility of our common stock and the implied volatility of our traded options 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. We reduce the stock-based compensation expense for estimated forfeitures based on our historical experience. We are required to estimate forfeitures at the time of the grant and revise our estimate, if necessary, in subsequent periods if actual forfeitures differ from our estimate.

Results of Operations

Revenue

 

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     Fiscal Quarter Ended      Change  
     December 25,
2009
     December 31,
2010
     $      %  
     ($ in thousands)                

Licensing

     $ 165,775       $ 188,176       $   22,401         14%   

Percentage of total revenue

     75%         78%         

Products

     47,657         46,027         (1,630)         -3%   

Percentage of total revenue

     21%         19%         

Services

     7,784         8,509         725         9%   

Percentage of total revenue

     4%         3%         
        

Total revenue

     $ 221,216       $ 242,712       $   21,496         10%   
        

Licensing. The 14% increase in licensing revenue from the first quarter of fiscal 2010 to the first quarter of fiscal 2011 was primarily driven by an increase in revenue from our CE, broadcast, and PC markets, and to a lesser extent, by increases in revenue from our other markets. The increase in revenue from our CE market was primarily driven by an increase in revenue from Blu-ray Disc players incorporating our technologies. The increase in revenue from our broadcast market was primarily attributable to an increase in the number of digital televisions that incorporate our technologies sold in Europe and the Asian Pacific region and shipments of Digital Transport Adapters in the first quarter of fiscal 2011 when compared to the first quarter of fiscal 2010. These increases were partially offset by decreases in revenue attributable to set-top boxes and National Telecommunications and Information Administration converter boxes in the first quarter of fiscal 2011 when compared to the first quarter of fiscal 2010. The increase in revenue from our PC market was primarily driven by a greater number of computers sold containing Windows operating systems that incorporate our technologies in the first quarter of fiscal 2011 when compared to the first quarter of fiscal 2010. These increases were partially offset by decreases in the number of notebook computer shipments with Dolby PC Entertainment Experience and decreases in the number of third party DVD software shipments containing Dolby technologies. The increase in revenue from our other markets was primarily due to an increase in our automotive, gaming and licensing administration markets. The increase in our automotive market was driven by sales of in-car entertainment systems that incorporate our technologies, while the increase in our gaming market was driven by sales of video game consoles.

Products. Products revenue decreased 3% from the first quarter of fiscal 2010 to the first quarter of fiscal 2011. In the first quarter of fiscal 2010, revenue included recognition of $14.0 million of deferred revenue related to sales prior to the beginning of fiscal 2010, which continued to be accounted for under previous revenue accounting standards, as well as $33.7 million of current period sales accounted for under the new accounting standards. In the first quarter of fiscal 2011, substantially all products revenue resulted from current period sales accounted for under the new accounting standards.

The decrease was partially offset by an increase in digital cinema video products, 3D units and digital cinema audio products sold in the first quarter of fiscal 2011.

Services. The 9% increase in services revenue from the first quarter of fiscal 2010 to the first quarter of fiscal 2011 was primarily attributable to increases in virtual print fees, which are generated from certain leased digital cinema assets, and other services revenue. These increases are partially offset by decreases in revenue from mastering services on digital and traditional films.

Gross Margin

 

     Fiscal Quarter Ended  
     December 25,
2009
     December 31,
2010
 
     ($ in thousands)  

Cost of licensing

   $ 4,026       $ 3,961   

Licensing gross margin percentage

     98%         98%   

Cost of products

     28,084         22,198   

Products gross margin percentage

     41%         52%   

Cost of services

     3,683         2,980   

Services gross margin percentage

     53%         65%   
                 

Total gross margin percentage

     84%         88%   
                 

 

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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 was essentially unchanged from the first quarter of fiscal 2010 to the first quarter of fiscal 2011.

Products Gross Margin. Cost of products primarily consists of the cost of materials related to the products sold, applied labor, manufacturing overhead and, to a lesser extent, amortization of certain intangible assets. Our cost of products also includes third-party royalty obligations paid to license intellectual property that we then include in our products. Products gross margin increased 11 points in the first quarter of fiscal 2011 when compared to the first quarter of fiscal 2010. This increase is primarily due to the recognition in the first quarter of fiscal 2010 of $14.0 million of deferred revenue and associated costs related to digital cinema and 3D product sales prior to the beginning of fiscal 2010, which had lower margins than our traditional cinema and broadcast products and our current digital cinema and 3D products. Manufacturing efficiencies also have helped us to improve margins on digital cinema and 3D products from the first quarter of fiscal 2010 to the first quarter of 2011.

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 increased 12 points in the first quarter of fiscal 2011 when compared to the first quarter of fiscal 2010 due to a higher percentage of virtual print fees, which have a higher gross margin due to lower associated costs, in the first quarter of fiscal 2011. While we continue to recognize revenue related to virtual print fee assets, the majority of these assets were classified as held for sale, and accordingly, depreciation was not recorded for these assets in the first quarter of fiscal 2011.

Operating Expenses

 

     Fiscal Quarter Ended      Change  
     December 25,
2009
     December 31,
2010
     $      %  
     ($ in thousands)  

Research and development

     $ 22,800         $ 28,327         $ 5,527         24%   

Percentage of total revenue

     10%         12%         

Sales and marketing

     30,384         38,217         7,833         26%   

Percentage of total revenue

     14%         16%         

General and administrative

     27,882         37,042         9,160         33%   

Percentage of total revenue

     13%         15%         

Restructuring charges, net

     185         785         600         324%   

Percentage of total revenue

     n/a         n/a         
        
     $ 81,251         $ 104,371         $ 23,120         28%   
        

The fiscal periods presented herein include the 13 week period ended December 25, 2009, and the 14 week period ended December 31, 2010. This additional week in the first quarter of fiscal 2011 resulted in additional expenses, primarily related to personnel costs.

Research and Development. Research and development expenses consist primarily of personnel and personnel-related costs, facility costs, consulting and temporary help, and depreciation of property, plant and equipment. The 24% increase in research and development expenses from the first quarter of fiscal 2010 to the first quarter of fiscal 2011 was primarily driven by increases in personnel costs due to increased headcount, stock-based compensation

 

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expense, and depreciation of property, plant and equipment, partially offset by decreases in prototype expenses related to the development of new products.

Sales and Marketing. Sales and marketing expenses consist primarily of personnel and personnel-related expenses, consulting and temporary help expense, travel-related expenses for our sales and marketing functions, facility costs, advertising and promotion expenses and depreciation and amortization expense. Sales and marketing expenses increased 26% from the first quarter of fiscal 2010 to the first quarter of fiscal 2011, primarily driven by increases in personnel costs due to increased headcount, consulting and temporary help expense, stock-based compensation expense and travel-related expenses.

General and Administrative. General and administrative expenses consist primarily of personnel and personnel-related expenses, consulting and temporary help, professional fees, and depreciation of property, plant and equipment. The 33% increase in general and administrative expenses from the first quarter of fiscal 2010 to the first quarter of fiscal 2011 was primarily due to increases in consulting and temporary help expense and stock-based compensation expense.

Restructuring Charges, net. Restructuring charges for the fiscal quarter ended December 31, 2010 include severance charges attributable to the reorganization of our global business infrastructure. See Note 6 “Restructuring” for additional details.

Other Income, Net

 

     Fiscal Quarter Ended      Change  
     December 25,
2009
     December 31,
2010
     $      %  
        
     ($ in thousands)  

Interest income

       $ 1,832       $ 1,614       $ (218)         (12%)   

Interest expense

     (85)         (283)         (198)         233%   

Other income, net

     460         533         73         16%   
        

Total other income, net

       $ 2,207       $ 1,864       $ (343)         (16%)   
        

Other income, net, primarily consists of interest income earned on cash, cash equivalents, and investments, as well as net gains/losses from foreign currency transactions.

Income Taxes

 

     Fiscal Quarter Ended  
     December 25,
2009
     December 31,
2010
 
        
     ($ in thousands)  

Provision for income taxes

     $36,886         $24,301   

Effective tax rate

     35%         22%   

Our effective tax rate is based upon a projection of our annual fiscal year results. Our effective tax rate was 35% and 22% for the first quarter of fiscal 2010 and the first quarter of fiscal 2011, respectively. In the first quarter of fiscal 2011, we completed the restructuring of our international operations, which resulted in the release of a

 

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deferred tax liability of $11.0 million related to the amortization of an intangible asset from a prior year acquisition. We also made an election to indefinitely reinvest a portion of our undistributed earnings in a foreign subsidiary, which resulted in a reduction to the fiscal year 2011 tax rate. This election may result in additional decreases to the effective tax rate in future years, but the decreases, if any, cannot yet be determined.

Additionally, in the first quarter of fiscal 2011, a change in the tax law retroactively reinstated the federal research and development tax credits for a portion of fiscal 2010. As a result, we recognized an increase in federal research and development tax credits for fiscal 2010 in fiscal 2011, thereby further lowering our effective tax rate.

Liquidity, Capital Resources, and Financial Condition

 

     September 24,
2010
     December 31,
2010
 
     (in thousands)  

Cash and cash equivalents

     $545,861         $433,638   

Short-term investments

     302,269         270,593   

Long-term investments

     190,837         367,727   

Accounts receivable, net

     54,257         68,638   

Accounts payable and accrued liabilities

     148,214         122,111   

Working capital(a)

     894,657         779,727   
     December 25,
2009
     December 31,
2010
 

Net cash provided by operating activities

     98,464         70,652   

Capital expenditures (b)

     (10,619)         (9,646)   

Net cash used in investing activities

     (140,873)         (162,210)   

Net cash used in financing activities

     (2,148)         (20,831)   

(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.

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 was $70.7 million for the first fiscal quarter of 2011, primarily driven by net income attributable to Dolby Laboratories, Inc. of $86.4 million. 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. Adjustments for non-cash items included stock-based compensation expense of $11.0 million, depreciation and amortization expense of $9.5 million, offset by the deferred taxes of $6.6 million. Changes in working capital were primarily driven by increases in assets of $15.7 million, an increase in accounts payable and accrued liabilities of $27.5 million, and a decrease in income taxes, net, of $20.5 million.

Cash used in investing activities was $162.2 million for the first quarter of fiscal 2011, primarily driven by net purchases of available-for-sale securities of $149.8 million. Capital expenditures were $9.6 million for the first quarter of fiscal 2011.

Cash used in financing activities was $20.8 million in the first quarter of fiscal 2011, compared to $2.1 million in the first quarter of fiscal 2010. Cash outflows from financing activities were primarily driven by our stock repurchase program of $46.0 million, compared to $15.7 million in the first quarter of fiscal 2010. These outflows were offset in the first quarter of fiscal 2011 by the exercise of employee stock options of $13.2 million, excess tax

 

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benefit from the exercise of stock options of $9.4 million, and proceeds from the issuance of stock under our employee stock purchase plan of $2.5 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 24, 2010. See our Annual Report on Form 10-K for the fiscal year ended September 24, 2010 for additional information regarding our contractual obligations.

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Sensitivity

Cash, Cash Equivalents and Investments.

As of December 31, 2010, we had cash and cash equivalents of $433.6 million, which consisted of cash and highly-liquid money market funds. In addition, we had short-term and long-term investments of $638.3 million, which consisted primarily of municipal debt securities, corporate bonds, commercial paper and U.S. agency securities. These investments are subject to fluctuations in interest rates, which could impact our results. At December 31, 2010 the weighted-average effective maturity of our investment portfolio was less than one year. Based on our investment portfolio balance as of December 31, 2010, a hypothetical change in interest rates of 1% would have approximately a $6.6 million impact, and a change of 0.5% would have approximately a $3.3 million impact on the carrying value of our portfolio.

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 U.S. through subsidiaries with functional currencies other than the U.S. dollar (primarily 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 for 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 31, 2010 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.

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

Licensing revenue constitutes the majority of our total revenue, representing 83%, 77%, and 78% in fiscal 2009, 2010, and the first quarter of fiscal 2011, respectively. We do not manufacture CE products ourselves and we depend on sales by our licensees of products that incorporate our technologies for our licensing revenue. We cannot control these manufacturers’ product development or commercialization efforts or predict their success. We also face the risk that our licensees retain product channel inventory levels that exceed future anticipated sales. If such sales do not occur in the time frame anticipated by our licensees for any reason, these licensees may substantially decrease the amount of products they sell and, consequently, technologies they license from us in subsequent periods.

In addition, our license agreements, which typically require CE manufacturers and 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, our revenue will decline if our licensees sell fewer products incorporating our technologies, or otherwise face significant economic difficulties.

Moreover, we currently have a widespread presence in the CE product market, which includes DVD players and recorders, audio/video receivers, and other home theater CE products. As a result of this widespread market presence, there is little room for us to further penetrate such markets. Changes in consumer tastes or trends, rapidly evolving technology, competing products, changes in industry standards or adverse changes in business and economic conditions, among other things, may result in lower sales of products incorporating our technologies which would adversely affect our licensing revenue.

To the extent that sales of PCs with Dolby technologies decline, our licensing revenue will be adversely affected.

Our PC market revenue depends on several factors, including underlying PC unit shipment growth and the mix of these PC units containing our technologies. PC market revenue is driven primarily by the inclusion of our technologies in media applications or operating systems (select editions of Windows 7 and Vista) often included in these PC shipments. These media applications and operating systems include DVD playback that use our technologies.

Often, PCs shipments will include both an operating system and a media application, each with DVD playback capabilities that include our technologies. Due in part to Windows 7 DVD playback enhancements and pricing pressure, a number of PC manufacturers have excluded, and we expect others in the future will exclude, DVD playback media applications on PCs that include Windows 7. Additionally, the pace of migration by consumer and business customers from their current operating systems to the Windows 7 operating system is uncertain. There is also uncertainty about the adoption rate of the Windows 7 editions that contain Dolby technologies.

If PC unit shipments decline or do not grow, or if the mix of these PC units containing our technologies decreases, our licensing revenue will be adversely affected.

 

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

We continue to be cautious regarding future general economic conditions and their potential for suppressed consumer demand in the markets in which we license our technologies and sell our products. Our business could be affected by adverse changes in general economic conditions because our technologies are incorporated in entertainment-oriented products, which are generally discretionary goods, such as PCs, digital televisions, set-top boxes, DVD players and recorders, Blu-ray Disc players, video game consoles, audio/video receivers, mobile devices, in-car entertainment systems, home-theater-in-a-box systems, camcorders, and portable media devices. The global economic environment has adversely affected consumer confidence, disposable income, and spending. While we cannot predict future macroeconomic conditions, these conditions may persist or worsen.

Furthermore, continued weakness in economic conditions may 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. Moreover, such economic conditions may result in increased underreporting and non-reporting of royalty bearing revenue by our licensees as well as increased unauthorized use of our technologies, all of which would adversely affect our earnings.

Our future success depends upon the growth of new and existing markets for our technologies and our ability to develop and adapt our technologies for those markets.

The future growth of our licensing revenue will depend, in part, upon the growth of, and our successful participation in, new and existing markets for our technologies. For example, growth of our broadcast revenue is dependent upon continued global growth of digital television broadcasting and the adoption of our technologies into emerging digital broadcast standards. In addition, our PC revenue is dependent upon the growth of the PC market and the continued adoption of our technologies into PC operating systems as well as the adoption of our technologies into emerging types of devices such as tablets.

Our ability to penetrate new and existing markets for our technologies depends on increased consumer demand for products that contain our technologies, which may not occur. Some of these markets are ones in which we have not previously participated, and we may not be able to adapt adequately our business and our technologies to consumer demand. In addition, even when our technologies are adopted as industry standards for a particular market, such market may not fully develop.

The failure of new and existing markets for our technologies to develop or the lack of growth of consumer demand for products that contain our technologies could materially adversely affect our business and prospects.

If we do not develop and deliver innovative technologies in response to industry and technology changes, our business could decline.

Our future success depends to a great extent on our ability to develop and deliver innovative technologies in a timely manner that are widely adopted in response to changes in the entertainment industry and that are compatible

 

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with the technologies or products introduced by other entertainment industry participants. The rapid change and technological evolution that characterize the markets for our products and the markets for CE products using our licensed technologies can render our technologies and products obsolete or unmarketable.

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 be unable to develop, or acquire, and effectively market new products, technologies and services in a timely manner that competitively addresses the needs of the changing marketplace. For example, we cannot ensure that Dolby Axon or Dolby Volume, 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. For example, while we view the continued advancements in online and mobile media content delivery as an area of opportunity, if we are not able to competitively address the needs of the changing online and mobile markets our ability to generate revenue from those markets would be limited, while our revenue from DVD and Blu-ray Disc players could decline. 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.

Sales of DVD players have declined significantly and we expect them to decline further, which may result in a decline in our licensing revenue that may not be offset by revenue from Blu-ray Disc players.

In the past, growth in our revenue had been the result, in large part, of the rapid growth in sales of DVD players incorporating our technologies. However, as the markets for DVD players have matured, sales of DVD players generally have declined and we expect future sales of DVD players generally to continue to decline. While revenue from Blu-ray Disc players have recently offset DVD player revenue declines, future revenue from Blu-ray Disc players may not offset future declines in revenue from standard definition DVD players which would adversely affect our operating results.

To the extent that sales of 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.

A shift in consumer content consumption from DVD and Blu-ray Disc to online media content consumption through connected televisions and set-top boxes could result in declines in revenue from DVD and Blu-ray Disc players. Such declines 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.

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 licensing 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 common 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 the recognition of a large amount of licensing revenue from a licensee in a given quarter that is not necessarily indicative of the amounts of licensing revenue to be

 

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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 all of our revenue recognition criteria were not met in prior periods. Any of the foregoing could cause our operating results to vary significantly from period-to-period.

Inaccurate licensee royalty reporting could materially adversely affect our operating results.

We generate licensing revenue primarily from CE manufacturers and software vendors who license our technologies and incorporate those technologies in their products. Our license agreements generally obligate our licensees to pay us a specified royalty for every product they ship that incorporates our technologies, and we rely on our licensees to accurately report their shipments. However, we have difficulty independently determining whether or not our licensees are reporting shipments accurately, particularly with respect to software incorporating our technologies because unauthorized copies of such software can be made relatively easily. 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 royalties by our 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, corrections of prior reports could result in reductions of royalty revenue in subsequent periods, which could also adversely affect our operating 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, or result in the termination of a license, agreement which would decrease our gross margin and adversely affect our operating results.

Unauthorized use of our intellectual property could materially adversely affect our operating results.

We have often experienced, and expect to continue to experience, problems with non-licensee CE manufacturers and 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. Manufacturers of integrated circuits, or ICs, containing our technologies occasionally sell these ICs to third parties who are not our system licensees. These sales, and the failure of such manufacturers to report the sales, facilitate the unauthorized use of our intellectual property. As emerging economies transition from analog to digital content we expect to experience increased problems with this form of piracy, which would adversely affect our operating results.

We have limited experience in non-sound technology markets which could limit our future growth.

 

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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 in the future on research and development or acquisitions in order to deliver innovative non-sound products and 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 and technologies.

In addition, many of the non-sound technology markets which we are targeting for expansion are relatively new and may not develop as we currently anticipate.

Our competitors may have more experience in developing non-sound technology products.

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 products, technologies, and services, the future growth of our business may be limited.

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.

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 digital entertainment 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 industry has widely adopted the technology, although no industry standards-setting body has explicitly mandated such standard. In addition, increasingly there are multiple 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 digital entertainment products.

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

 

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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.

If we do not obtain new patents or proprietary technologies as our existing patents expire, our licensing 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 31, 2010, we had nearly 2,040 individual issued patents and over 2,090 pending patent applications in over 45 jurisdictions throughout the world. Our issued patents are scheduled to expire at various times through July 2029. Of these, 34 patents are scheduled to expire in the remainder of calendar year 2011, 52 patents are scheduled to expire in calendar year 2012, and 31 patents are scheduled to expire in calendar year 2013. Patents relating to our Dolby Digital technologies, from which we principally derive our licensing revenue, have begun to expire and the remaining patents relating to this technology generally expire between now and 2017. Additional patents relating to our Dolby Digital Plus technologies, an extension of Dolby Digital, expire between 2018 and 2026. In addition, the remaining patents relating to Dolby Digital Live technologies, an extension of Dolby Digital, are scheduled to expire in 2021.

The markets for our technologies are highly competitive, 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: Audyssey Laboratories, DTS, Fraunhofer Institute for Integrated Circuits, Microsoft, Philips, RealNetworks, Sonic Solutions, Sony, SRS Labs, and Thomson. Competitors for our products include: Barco, Doremi, GDC, IMAX, MasterImage 3D, NEC, Panavision, QSC Audio Products, Qube Cinema, REALD, Sony, Technicolor, Texas Instruments, USL, and XpanD. Competitors for our services include DTS and Sony.

In addition, other companies, including exhibitors and film studios, may become competitors in one or more of these areas in the future. Consumers may perceive the quality of the audio experience produced by some of our competitors’ technologies to be equivalent or superior to the audio experience produced by our technologies.

In addition, some of our current 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, particularly in the market for online media content. These competitors may also be able to offer integrated system solutions in markets for sound or non-sound entertainment technologies at a lower price than our technologies, including audio, video, and rights management technologies related to PCs or the internet, which could make competing technologies that we develop unnecessary.

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 business, 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 markets, including the CE products, PC, broadcast and gaming markets. If we

 

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fail to promote and maintain the Dolby brand successfully in licensing, products or services, our business and prospects will suffer. Moreover, we believe that the strength of our brand may affect the likelihood that our technologies are adopted as industry standards in various markets and for various applications. 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 in these new markets, which we may not do successfully.

Our licensing of industry standard technologies can be subject to restrictions 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.

We have in the past, and may in the future, be subject to claims that our licenses of our industry standard technologies may not conform to the requirements of the standards-setting body. 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 China and other emerging economies.

We believe that various trends will increase our exposure to the risks of conducting business in emerging economies. For example, we expect CE manufacturers 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 and more recently Blu-ray Disc 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, and as 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 U.S., 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.

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.

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.

Our licensing revenue depends in large part upon semiconductor manufacturers incorporating our technologies into integrated circuits.

Our licensing revenue from system licensees depends in large part upon the availability of ICs, that implement our technologies. IC manufacturers incorporate our technologies into these ICs, which are then incorporated in

 

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digital entertainment 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.

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 digital entertainment products in which our technologies are incorporated are intensely competitive and price sensitive. Retail prices for digital entertainment 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 digital entertainment 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 our 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 modification or 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 legal claims related to our intellectual property rights, 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, which may not be available on reasonable terms or at all. Any license could also require us to pay significant royalties, and may significantly increase our operating expenses. As a result, we may be required to develop alternative non-infringing technologies, which could require significant effort and expense. If we cannot license or develop technologies for any aspects of our business found to be infringing, 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.

We may have disputes with our licensees regarding our licensing arrangements.

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

 

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injunctive relief asserted in claims like these could be material, and could be disruptive to our business. Any disputes with our customers or potential customers or other third parties could adversely affect our business, results of operations, and prospects.

We face many risks related to the emerging 3D cinema market.

We face many risks in the 3D cinema market which may affect our ability to successfully participate in that market, including, but not limited to the following:

 

   

Our participation in the 3D cinema market will be limited to the extent theaters do not convert from analog to digital cinema.

 

   

Demand for our 3D cinema products is driven by the number of 3D cinema releases and the commercial success of those releases.

 

   

Industry participants may perceive our reusable glasses business model as less easy to manage.

 

   

Our 3D glasses could become subject to regulation in the U.S. and other countries in the future, which could restrict how our 3D glasses are manufactured, used or marketed.

 

   

There has been increased public scrutiny of potential health risks relating to viewing 3D movies. If these potential health risks are substantiated, the popularity of 3D movies could decline. In addition, if health risks associated with our 3D products materialize, we may become subject to government regulation or product liability claims, including personal injury claims.

 

   

At least one of our competitors has exclusive licensing arrangements for 3D products with theater exhibitors, which has in the past and we expect will in the future restrict our ability to compete in the 3D market.

If we are unable to manage these risks effectively, our ability to compete profitably in the 3D cinema market may be adversely affected.

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 number of companies offer competing products for digital cinema that exhibitors may perceive to be potentially advantageous to our products. Some of these competing products are priced lower than our products or offer features, such as support for 4K presentation. At least one of our competitors 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 historically 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 products gross margins in the future.

Acquisition activities could result in operating difficulties 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. 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

 

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particular economic, political, and regulatory environment in specific countries. Also, the anticipated benefit of our acquisitions may not materialize.

We face various risks in integrating acquired businesses, including:

 

   

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.

Moreover, acquisitions may have an adverse impact on our financial condition and results of operations, including a potential adverse impact on our gross margins.

Future acquisitions could result in the need to obtain financing on unfavorable terms, including dilutive equity issuances.

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.

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 recently replaced 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 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. Any unexpected difficulties resulting from these replacement efforts, could adversely affect our operating results and the accuracy and timely reporting of those results.

We are dependent upon our relationships within the entertainment industry, and the failure to maintain such relationships could materially harm our business.

If we fail to maintain and expand our relationships with a broad range of participants throughout the entertainment industry, including film studios, broadcasters, video game designers, music producers, mobile media content producers, and CE manufacturers, 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 film studios and broadcasters, and licensing of our technologies is particularly dependent upon our relationships with system licensees, software vendors, and IC manufacturers. If we fail to maintain and strengthen these relationships, these entertainment industry participants may be less likely 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, if

 

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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 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 2009, 2010, and the first quarter of fiscal 2011, revenue from outside the U.S. was 65%, 66%, and 69% of our total revenue, respectively. We expect that international and export sales will continue to represent a substantial portion of our revenue for the foreseeable future. This future revenue will depend to a large extent on the continued use and expansion of our technologies in entertainment industries worldwide.

Due to our reliance on sales to customers outside the U.S., 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 U.S., Japan, and European countries, which increases the risk of unauthorized, and uncompensated, use of our technologies;

 

   

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

 

   

Our ability to comply with applicable international laws and regulations governing our business and operations, including local consumer and safety laws, as well as license requirements;

 

   

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 U.S. States, and other laws limiting our ability to repatriate funds to the U.S. 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 many foreign countries, particularly in those with developing economies, it is common to engage in business practices that are prohibited by U.S. 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 or these regulations. Any such violation, even if prohibited by our policies, could have an adverse effect on our business.

We face risks associated with complying with international employment laws.

A significant number of our employees are located outside the U.S. 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 U.S. 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 U.S.

 

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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. 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, recent rulings by the U.S. Supreme Court 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 rulings 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 cinema and broadcast industries may affect sales of our cinema products and other services.

Sales of our cinema products and services tend to fluctuate based on the underlying trends in the cinema industry. For example, when box office receipts for the cinema industry increase, we have typically seen a corresponding increase in sales of our cinema products, as cinema owners will be more likely to build new theaters and upgrade existing theaters with our more advanced products. 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 theaters, 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.

Our services revenue, both in the U.S. and internationally, is tied to the number of movies being made by major film studios and independent filmmakers. A number of factors can affect the number of movies that are produced, including strikes and work stoppages within the cinema 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 cinema industry adopts digital cinema.

Although only a small percentage of theaters have adopted digital cinema technologies for the distribution and exhibition of motion pictures, the number of cinema exhibitors adopting digital cinema for new theater construction or existing theater upgrades continues to grow. As exhibitors have constructed new theaters or upgraded existing theaters 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 cinema 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, many of which may not contain our technologies. If the demand for our traditional film cinema products and services continues to decrease without a meaningful increase in revenue from digital cinema products and services, our revenue stream from the cinema industry would be adversely affected.

 

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A decrease in demand for our cinema products and services could adversely affect our consumer products licensing business.

A decrease in the demand for our cinema 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 July 2010, we announced that our Board of Directors had approved an additional $300.0 million for our stock repurchase program, whereby we may continue to repurchase shares of our Class A common stock. This repurchase program may reduce the public float of shares available for trading on a daily basis. 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 stock 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, and 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 digital entertainment 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 digital entertainment 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;

 

   

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

 

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

 

   

The financial resources of cinema operators available to buy our products or to equip their theaters 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 process, including as a result of work stoppages at our facilities, our customers’ facilities, and other points throughout the entertainment distribution process;

 

   

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;

 

   

Exchange rate fluctuations between the U.S. dollar and other currencies;

 

   

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. Consequently, results from prior periods are not necessarily indicative of the results of future periods.

Changes in tax rates and exposure for additional income tax liabilities or adverse outcomes resulting from examinations of our tax returns could adversely affect our operating results and financial condition.

Changes in the valuation of our deferred tax assets and liabilities, the geographic mix of our revenue, or by changes in tax laws or their interpretation could all favorably or unfavorably affect our future effective tax rates. We file income tax returns in the U.S. and in several U.S. state and foreign jurisdictions, and must use judgment in determining our worldwide provision for income taxes. For example, the following could adversely affect our income taxes:

 

   

Earnings being lower than anticipated in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates;

 

   

Changes in the valuation of our deferred tax assets and liabilities;

 

   

Expiration of or lapses in the R&D tax credit laws;

 

   

Fluctuations in tax exempt interest income;

 

   

Transfer pricing adjustments;

 

   

Tax effects of nondeductible compensation;

 

   

Tax costs related to intercompany realignments;

 

   

Changes in accounting principles; or

 

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Changes in tax laws and regulations, including possible U.S. changes to the taxation of earnings of our foreign subsidiaries, the deductibility of expenses attributable to foreign income, or the foreign tax credit rules.

In addition, we are subject to the periodic examination of our income tax returns by tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance, however, that the outcomes from these continuous examinations will not have an adverse effect on our operating results and financial condition. Additionally, due to the evolving nature of tax rules combined with the large number of jurisdictions in which we operate, it is possible that our estimates of our tax liability and the realizability of our deferred tax assets could change in the future, which may result in additional tax liabilities and adversely affect our results of operations, financial condition and cash flows.

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.

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

Our business is dependent upon protecting our patents, trademarks, trade secrets, copyrights, and other intellectual property rights. Licensing revenue represented 83%, 77%, and 78% of our total revenue in the fiscal years 2009, 2010, and the first quarter of fiscal 2011, 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. 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, or we may choose not to protect particular innovations that later turn out to be important, due to the high costs of obtaining patent protection. 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. We also seek to maintain select intellectual property as trade secrets. Third parties or our employees could intentionally or accidentally compromise the intellectual property that we maintain as trades secrets, which would cause us to lose the competitive advantage resulting from them.

Our customers who are also our current or potential competitors may choose to use their own or competing technologies rather than ours.

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

 

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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 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 customers perceive our competitors’ solutions to provide the same advantages as our technologies at a lower or comparable price, there is a risk that these customers may treat sound encoding technologies such as ours as commodities, resulting in loss of status of our technologies, decline in their use, and significant pricing pressure. The commoditization of our audio technologies, as opposed to treatment as a premium solution, could adversely affect our business, operating results and prospects.

The loss of or delay 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 formal agreements in place with our suppliers for the 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, at times our suppliers have not been, and in the future may not be, able to meet our 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. We have a single production facility, and we use contract manufacturers to produce 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, we may not be able to manufacture products on a timely basis. A shortage of manufacturing capacity for our products could adversely affect our operating results and damage our customer relationships. We are unable to quickly adapt our manufacturing capacity to rapidly changing market conditions and a contract manufacturer may encounter similar difficulties. Likewise, we may be unable to quickly 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 effectively respond to fluctuations in customer demand for our products may adversely affect our gross margins.

 

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

Our products are complex and sometimes contain undetected software or hardware errors, particularly when first introduced or when new versions are released. In addition, 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 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 incur substantial costs in defending and settling product liability claims. 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.

Newly introduced and new versions of licensee products that incorporate our technologies are complex and may contain undetected software or hardware errors. In addition, the combination or incorporation of these newly introduced products with products from other companies can make 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 12% of total revenue for fiscal 2010. 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.

New environmental laws and regulations could impact our operating results.

We expect that new environmental laws and regulations, introduced on an ongoing basis, will have the potential to affect our manufacturing and licensing operations. Although we cannot predict the ultimate impact of any such

 

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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.

We could incur substantial costs due to regulations regarding the composition of our products, which may adversely affect our business, operating results, and financial condition.

We 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.

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. treasury and agency securities, municipal debt securities, corporate bonds, and commercial paper. 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. Any downgrades, losses, failed auctions or other significant deterioration in the fair value of our cash, cash equivalents or investments could 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.

We maintain sales, marketing, and business operations in foreign countries. Consequently, we are exposed to fluctuations in exchange rates associated with the local currencies of our foreign business operations. While we derive nearly all of our revenue 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.

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. The loss of a major distributor or the inability or unwillingness of our distributors to dedicate the resources necessary to promote our portfolio of products will adversely affect our revenue. In addition, failures of our distributors to adhere to our policies or other ethical practices 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.

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 31, 2010, Ray Dolby and his affiliates owned 100 shares of our Class A common stock and 58,700,000 shares of our Class B common stock. As of December 31, 2010, Ray Dolby and his affiliates, including his family members, had voting power of approximately 99.6% of our outstanding Class B common stock, which in the aggregate represented approximately 91.4% of the combined voting power of our outstanding Class A and Class

 

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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 our 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 31, 2010, we had a total of 112,133,769 shares of Class A and Class B common stock outstanding. Of these shares, we along with our selling stockholders sold 31,625,000 shares of Class A common stock, and our principal stock holder sold an additional 8,000,000 shares of Class A common stock in a secondary offering in May 2007.

As of December 31, 2010, our directors and executive officers beneficially held 58,710,000 shares of Class B common stock, 34,379 shares of Class A common stock, vested options to purchase 50,000 shares of Class B common stock and vested options to purchase 297,080 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.

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

Sales of Unregistered Securities

In the fiscal quarter ended December 31, 2010, we issued an aggregate of 314,975 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 January 1, 2011 through January 20, 2011, we issued an aggregate of 8,965 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 31, 2010, and less than $0.1 million in the period since January 1, 2011 through January 20, 2011 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, 2011 options to purchase an aggregate of 421,799 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

 

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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.

Purchases of Equity Securities By the Issuer and Affiliated Purchasers

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 2011:

 

     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 25, 2010 – October 29, 2010

     365,635       $ 59.55         365,635         $286.9 million   

October 30, 2010 – November 26, 2010

     167,099         65.26         167,099         276.0 million   

November 27, 2010 – December 31, 2010

     199,931         66.40         199,931         262.7 million   
                       

Total

     732,665            732,665      
                       
(1) 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*

   Separation Agreement and Release dated October 4, 2010, by and between Dolby Laboratories, Inc., a Delaware corporation, and Mark S. Anderson      

  10.2*

   Letter Agreement dated December 4, 2010, by and between Dolby Laboratories, Inc., a Delaware corporation, and Ray Dolby      

  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.      

101.INS‡

   XBRL Instance Document      

101.SCH‡

   XBRL Taxonomy Extension Schema Document      

101.CAL‡

   XBRL Taxonomy Extension Calculation Linkbase Document      

101.DEF‡

   XBRL Extension Definition      

101.LAB‡

   XBRL Taxonomy Extension Label Linkbase Document      

101.PRE‡

   XBRL Taxonomy Extension Presentation Linkbase Document      

 

* 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 9, 2011

 

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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Separation Agreement - Mark S. Anderson

Exhibit 10.1

SEPARATION AGREEMENT AND RELEASE

This Separation Agreement and Release (“Agreement”) is made by and between Mark S. Anderson (“Executive”) and Dolby Laboratories, Inc., a Delaware corporation, and its direct and indirect subsidiaries (together, the “Company”) (collectively referred to as the “Parties” or individually referred to as a “Party”).

RECITALS

WHEREAS, Executive was employed by the Company pursuant to terms of an Offer Letter dated October 23, 2003 (the “Offer Letter”);

WHEREAS, Executive previously signed an Employee Proprietary Rights and Non-Disclosure Agreement and Conflict of Interest Policy with the Company (the “Confidentiality Agreement”);

WHEREAS, Executive signed a Policy Regarding Reporting of Financial and Accounting Concerns, an Acknowledgement of Receipt of Code of Business Conduct and Ethics, and an Employee Handbook (the “Business Policies”);

WHEREAS, the Company and Executive have entered into stock option and restricted stock unit agreements on file with the Company, pursuant to the Company’s 2000 and/or 2005 Stock Plans (collectively the “Stock Agreements”);

WHEREAS, Executive will continue to perform the duties Executive has been assigned as the Executive Vice President, General Counsel and Secretary of the Company, and such other duties consistent with his historical duties, work schedule and as the Company will assign through and including January 14, 2011 (the “Transition Date”), after which Executive will discontinue being, and resign as, the (i) Executive Vice President, General Counsel, Secretary and any officer of the Company; (ii) as a member of the board of directors of each direct and indirect subsidiary of the Company; and (iii) as any officer of each direct and indirect subsidiary of the Company (collectively, the “Anderson Positions”);

WHEREAS, following the Transition Date through and including June 30, 2011 (the “Separation Date”), Executive will provide certain, primarily off-site, transitional services as an employee of the Company and as needed (the “Transitional Services”);

WHEREAS, Executive will voluntarily resign as an employee of the Company effective on the Separation Date; and

WHEREAS, the Parties wish to resolve any and all disputes, claims, complaints, grievances, charges, actions, petitions, and demands that the Executive may have against the Company and any of the Releasees as defined below, including, but not limited to, any and all claims arising out of or in any way related to Executive’s employment with or separation from the Company;

NOW, THEREFORE, in consideration of the mutual promises made herein, the Company and Executive hereby agree as follows:

COVENANTS

1. Consideration.

a. Payment. The Company agrees to pay Executive a lump sum equivalent of twelve (12) months of Executive’s base salary, for a total of Three Hundred Seventy Thousand Eight Hundred Dollars ($370,800.00), less applicable withholding. This payment will be made to Executive promptly following the Separation Date, but in no event later than eight (8) days after Executive signs and returns a Supplemental Release (as defined below), conditioned upon Executive not first revoking such Supplemental Release (as defined below).


b. Stock Option and Restricted Stock Unit Vesting Acceleration. The Company agrees to accelerate the vesting under the Stock Agreements so that the stock options and restricted stock units granted to Executive will be fully-vested and exercisable, promptly following the Transition Date, but in no event later than eight (8) days after Executive signs and returns a Supplemental Release (as defined below), conditioned upon (i) Executive not first revoking such Supplemental Release (as defined below) and (ii) Executive’s resignation from the Anderson Positions effective on the Transition Date.

c. 2010 Executive Annual Incentive Plan Payment. The Company agrees to pay Executive a cash incentive bonus pursuant to the Company’s 2010 Executive Annual Incentive Plan based on a combination of criteria applied to that of other similar executive officers and the Company’s approved corporate financial performance formula that determines award funding levels based on varying combinations of the Company’s achievement of revenue and pre-tax income goals and resulting pre-tax net income amounts (“Executive’s EAIP Payment”). The Company agrees to determine Executive’s EAIP Payment consistent with its normal determination practice pertaining to all executive officers. Executive’s EAIP Payment will be made to Executive on the same date as payments are made to the Company’s other executive officers. The Parties agree that Executive is not eligible to participate in the Company’s 2011 Executive Annual Incentive Plan or any other future cash incentive bonus plan of the Company.

d. Outplacement Services. The Company agrees that for a period of not more than two (2) years after the Effective Date of this Agreement, to pay up to an aggregate total of Twenty Five Thousand Dollars ($25,000.00) to (i) Right Management Inc. and/or (ii) Executive Edge (together, the “Outplacement Providers”) in relation to Executive’s personal use of the Outplacement Providers’ transition, coaching, and/or outplacement services (the “Outplacement Services”). Payment for Outplacement Services shall be made by the Company directly to the Outplacement Providers.

e. Professional Fees. The Company agrees to reimburse up to an aggregate total of Ten Thousand Dollars ($10,000.00) of Executive’s costs, attorneys’ fees, tax accountants’ fees and other professional fees incurred in connection with the preparation of this Agreement within two (2) weeks of final invoice(s), provided all such invoices are submitted to the Company not later than November 30, 2011.

f. COBRA Reimbursement. The Company agrees to reimburse Executive for COBRA payments incurred by the Executive through June 30, 2012.

g. Payments in the Event of Certain Terminations. The Separation Date shall accelerate and Executive or his estate shall receive all of the consideration and benefits to which Executive is entitled under this Agreement upon the occurrence of any of the following before the Separation Date: (1) the Company terminates Executive’s employment for any reason other than Cause (as defined below), (2) the Executive’s death; (3) the Executive develops a Disability (as defined below) and, as a result, is unable to perform the essential functions of his job and/or the Transitional Services. For purposes of this Section, the obligations of Section 4 shall be satisfied upon execution and effectiveness of the Supplemental Releases as described therein by Executive, or in the event of his death or incapacity due to Disability, by his estate or legal representative.

For purposes of this Agreement, “Cause” means the following occurrences which cause detriment to the Company, Executive’s (i) performance of any act, or failure to perform any act, in bad faith, (ii) dishonesty, intentional misconduct or material breach of any agreement with the Company, or (iii) commission of a crime involving dishonesty, breach of trust, or physical or emotional harm to any person. For purposes of this Agreement, “Disability” means a qualified disability under the California Fair Employment and Housing Act.

2. Resignation. Executive voluntarily resigns as Executive Vice President, General Counsel and Secretary of the Company effective January 14, 2011, and Executive voluntarily resigns as an employee of the Company effective June 30, 2011. Through the Transition Date, the Company will continue to pay Executive his base salary, and Executive will remain eligible for such standard Company-sponsored benefits as made generally available to employees of the Company and shall be entitled to reimbursement


of reasonable and documented business-related expenses incurred by Executive for services performed on behalf of the Company.

3. Transitional Services. The Parties agree that Executive shall remain employed by the Company (but shall no longer be the General Counsel or any officer of the Company) between the Transition Date and the Separation Date, for the limited purpose of transitioning Executive’s duties, subject to Executive remaining materially compliant with the terms of this Agreement, the Confidentiality Agreement, and the Business Policies (the “Transitional Period”). During the Transitional Period, the Company will continue to pay Executive his base salary, and Executive will remain eligible for such standard Company-sponsored benefits as made generally available to employees of the Company and shall be entitled to reimbursement of reasonable and documented business-related expenses incurred by Executive for services performed on behalf of the Company. Executive agrees during the Transitional Period to provide assistance with respect to the Company’s transition to new management as reasonably requested by the Company. Executive is not required or expected to provide on-site services during the Transitional Period, except as reasonably requested by the Company in advance, but Executive agrees to remain generally accessible to the Company by phone, personal email, or other standard communication means, and to cooperate with the Company to the extent reasonably requested. During the Transitional Period, Executive acknowledges and agrees that he is not authorized to act as an agent of the Company in any way outside the scope of Transitional Services requested by the Company.

4. Supplemental Releases. Executive agrees, on each of the Transition Date and the Separation Date, to sign a Supplemental Release attached hereto as Exhibit A (each, a “Supplemental Release” and collectively, the “Supplemental Releases”). Executive acknowledges and agrees that any payments or benefits provided for under Sections 1(a) and 1(b) of this Agreement are expressly conditioned upon his signing and not revoking the Supplemental Releases as required by this Section or Section 1(g) if applicable.

5. Stock. Executive should consult with the grant documents on file with the Company regarding the number of stock options and restricted stock units held by Executive. The terms and conditions, including specifically the period of post-termination exercise for the stock options, shall continue to be governed by the terms and conditions of the Stock Agreements, except as provided in Section 1(b) and except that (i) the Company acknowledges and agrees Executive shall remain a Service Provider (as defined for purposes of the Stock Agreements) through his Separation Date and notwithstanding, for example, any earlier change in his duties, responsibilities or hours of service, (ii) any restricted stock units which vest pursuant to Section 1(b) above should be timely delivered without regard to Section 10 of the Executive’s applicable restricted stock unit agreements, and (iii) Executive shall be entitled to cashless exercise opportunities and procedures concerning tax withholding consistent with the Company’s historical practices.

From the Transition Date through June 30, 2011, the Company may restrict Executive’s ability to trade his securities of the Company only if the Company reasonably believes that Executive is in possession of material, non-public information regarding the Company, provided that (i) the Company shall confer with Executive prior to providing the Executive, after the Transition Date, any material non-public information regarding the Company and prior to imposing such restriction and (ii) the Company shall have an absolute right to impose, and no obligation to confer with Executive about, a restriction relating to either (a) the period from the Effective Date through the second business day following the Company’s release of earnings for the first quarter of fiscal 2011 or (b) any material, non-public information about which Executive becomes aware prior to the Transition Date which is not otherwise publicly disclosed on or before the Company’s release of earnings for the first quarter fiscal 2011.

6. Benefits. Executive’s health insurance benefits shall cease on the Separation Date, subject to Executive’s right to continue his health insurance under COBRA, CAL-COBRA (if applicable) and entitlement to COBRA reimbursement under Section 1(f). Executive’s participation in all benefits and incidents of employment, including, but not limited to, the accrual of bonuses, vacation, and paid time off, will cease as of the Separation Date.

7. Payment of Salary and Receipt of All Benefits Through Date of Signing. Executive acknowledges and represents that, other than the consideration set forth in this Agreement, as of the date Executive


executes this Agreement, the Company has paid or provided all salary, wages, bonuses, accrued vacation/paid time off (any unused portion of which shall be paid upon the Separation Date), leave, housing allowances, relocation costs, interest, severance, outplacement costs, fees, reimbursable expenses, commissions, stock, stock options, restricted stock units, vesting, and any and all other benefits and compensation due to Executive. Executive further acknowledges and represents that he has received any leave to which he was entitled or which he requested, if any, under the California Family Rights Act and/or the Family Medical Leave Act, and that he did not sustain any workplace injury, during his employment with the Company.

8. Release of Claims. Executive agrees that the foregoing consideration represents settlement in full of all outstanding obligations owed to Executive by the Company and its current and former officers, directors, employees, agents, investors, attorneys, shareholders, administrators, affiliates, benefit plans, plan administrators, insurers, divisions, and subsidiaries, and predecessor and successor corporations and assigns (collectively, the “Releasees”). Executive, on his own behalf and on behalf of his respective heirs, family members, executors, agents, and assigns, hereby and forever releases the Releasees from, and agrees not to sue concerning, or in any manner to institute, prosecute, or pursue, any claim, complaint, charge, duty, obligation, or cause of action relating to any matters of any kind, whether presently known or unknown, suspected or unsuspected, that Executive may possess against any of the Releasees arising from any omissions, acts, facts, or damages that have occurred up until and including the Effective Date of this Agreement, including, without limitation:

a. any and all claims relating to or arising from Executive’s employment relationship with the Company and the termination of that relationship, except for those claims arising in connection with the enforcement of this Agreement;

b. any and all claims relating to, or arising from, Executive’s right to purchase, or actual purchase of shares of stock of the Company, including, without limitation, any claims for fraud, misrepresentation, breach of fiduciary duty, breach of duty under applicable state corporate law, and securities fraud under any state or federal law, except for those claims relating to, or arising from Executive’s right to purchase, or actual purchase of shares of stock of the Company arising under this Agreement;

c. any and all claims for wrongful discharge of employment; termination in violation of public policy; discrimination; harassment; retaliation; breach of contract, both express and implied; breach of covenant of good faith and fair dealing, both express and implied; promissory estoppel; negligent or intentional infliction of emotional distress; fraud; negligent or intentional misrepresentation; negligent or intentional interference with contract or prospective economic advantage; unfair business practices; defamation; libel; slander; negligence; personal injury; assault; battery; invasion of privacy; false imprisonment; conversion; and disability benefits;

d. any and all claims for violation of any federal, state, or municipal statute, including, but not limited to, Title VII of the Civil Rights Act of 1964; Sections 1981 through 1988 of Title 42 of the United States Code, as amended; the Civil Rights Act of 1991; the Rehabilitation Act of 1973; the Americans with Disabilities Act of 1990; the Equal Pay Act; the Fair Labor Standards Act, except as prohibited by law; the Fair Credit Reporting Act; the Immigration Reform and Control Act, as amended; the Occupational Safety and Health Act, as amended; the California Occupational Safety and Health Act, as amended; the Age Discrimination in Employment Act of 1967 (the “ADEA”); the Older Workers Benefit Protection Act; the Employee Retirement Income Security Act of 1974; the Worker Adjustment and Retraining Notification Act; the Family and Medical Leave Act, except as prohibited by law; the Sarbanes-Oxley Act of 2002; the Uniformed Services Employment and Reemployment Rights Act; the California Family Rights Act; the California Labor Code, except as prohibited by law; the California Workers’ Compensation Act, except as prohibited by law; and the California Fair Employment and Housing Act;

e. any and all claims for violation of the federal or any state constitution;

f. any and all claims arising out of any other laws and regulations relating to employment or employment discrimination;


g. any claim for any loss, cost, damage, or expense arising out of any dispute over the non-withholding or other tax treatment of any of the proceeds received by Executive, except for those proceeds that shall be received by Executive as a result of this Agreement; and

h. any and all claims for attorneys’ fees and costs, except as set forth in this Agreement.

Executive agrees that the release set forth in this section shall be and remain in effect in all respects as a complete general release as to the matters released. This release does not extend to any obligations incurred under this Agreement. This release does not release claims that cannot be released as a matter of law, including, but not limited to: (1) Executive’s right to file a charge with or participate in a charge by the Equal Employment Opportunity Commission, or any other local, state, or federal administrative body or government agency that is authorized to enforce or administer laws related to employment, against the Company (with the understanding that any such filing or participation does not give Executive the right to recover any monetary damages against the Company; Executive’s release of claims herein bars Executive from recovering such monetary relief from the Company); (2) claims under Division 3, Article 2 of the California Labor Code (which includes California Labor Code section 2802 regarding indemnity for necessary expenditures or losses by Executive); and (3) claims prohibited from release as set forth in California Labor Code section 206.5 (specifically “any claim or right on account of wages due, or to become due, or made as an advance on wages to be earned, unless payment of such wages has been made”). This release also does not release claims to indemnification under the Delaware General Corporation Law, the Company’s certificate of incorporation or bylaws, or the indemnification agreement between Executive and the Company dated February 2, 2005.

9. Acknowledgment of Waiver of Claims under ADEA. Executive understands and acknowledges that he is waiving and releasing any rights he may have under the ADEA, and that this waiver and release is knowing and voluntary. Executive understands and agrees that this waiver and release does not apply to any rights or claims that may arise under the ADEA after the Effective Date of this Agreement. Executive understands and acknowledges that the consideration given for this waiver and release is in addition to anything of value to which Executive was already entitled. Executive further understands and acknowledges that he has been advised by this writing that: (a) he should consult with an attorney prior to executing this Agreement; (b) he has twenty-one (21) days within which to consider this Agreement; (c) he has seven (7) days following his execution of this Agreement to revoke this Agreement and agrees that any such revocation must be in a writing by email or federal express received by Andrew Dahlkemper by midnight on the seventh day following Executive’s execution of this Supplemental Release; (d) this Agreement shall not be effective until after the revocation period has expired; and (e) nothing in this Agreement prevents or precludes Executive from challenging or seeking a determination in good faith of the validity of this waiver under the ADEA, nor does it impose any condition precedent, penalties, or costs for doing so, unless specifically authorized by federal law. In the event Executive signs this Agreement and returns it to the Company in less than the 21-day period identified above, Executive hereby acknowledges that he has freely and voluntarily chosen to waive the time period allotted for considering this Agreement.

10. California Civil Code Section 1542. Executive acknowledges that he has been advised to consult with legal counsel and is familiar with the provisions of California Civil Code Section 1542, a statute that otherwise prohibits the release of unknown claims, which provides as follows:

A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS OR HER FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM OR HER MUST HAVE MATERIALLY AFFECTED HIS OR HER SETTLEMENT WITH THE DEBTOR.

Executive, being aware of said code section, agrees to expressly waive any rights he may have thereunder, as well as under any other statute or common law principles of similar effect.

11. No Pending or Future Lawsuits. Executive represents that he has no lawsuits, claims, or actions pending in his name, or on behalf of any other person or entity, against the Company or any of the other Releasees. Executive also represents that he does not intend to bring any claims on his own behalf or on behalf of any other person or entity against the Company or any of the other Releasees.


12. Trade Secrets and Confidential Information/Company Property. Executive reaffirms and agrees to observe and abide by the terms of the Confidentiality Agreement, specifically including the provisions therein regarding nondisclosure of the Company’s trade secrets and confidential and proprietary information, and non-solicitation of Company employees. Executive’s signature below constitutes his certification under penalty of perjury that he has returned all documents and other items provided to Executive by the Company, developed or obtained by Executive in connection with his employment with the Company, or otherwise belonging to the Company.

13. Non-Disparagement and Communications with Company Employees, Customers and Business Partners. Executive agrees to refrain from any disparagement, defamation, libel, or slander of any of the Releasees, and agrees to refrain from any tortious interference with the contracts and relationships of any of the Releasees. The Company agrees to refrain from disparaging statements about Executive, and agrees to refrain from any tortious interference with Executive’s contracts and relationships. Notwithstanding, Executive understands and agrees that the Company’s obligations under the preceding sentence extend only to (i) the Company’s authorized spokesperson, when speaking on behalf of the Company; and (ii) the Company’s current officers and directors, and only for so long as each is an employee or director of the Company. Executive further agrees that he will refrain from discussing Company confidential business or financial information with third parties, including the Company’s actual and potential customers or business partners. Executive shall direct any inquiries by potential future employers to the Company’s human resources department, which shall provide only the Executive’s last position and dates of employment, in accordance with the Company’s policy and practice.

14. No Cooperation. Executive further agrees that he will not knowingly encourage, counsel, or assist any attorneys or their clients in the presentation or prosecution of any disputes, differences, grievances, claims, charges, or complaints by any third party against any of the Releasees, unless under a subpoena or other court order to do so or as related directly to the ADEA waiver in this Agreement. Executive agrees both to immediately notify the Company upon receipt of any such subpoena or court order, and to furnish, within three (3) business days of its receipt, a copy of such subpoena or other court order. If approached by anyone for counsel or assistance in the presentation or prosecution of any disputes, differences, grievances, claims, charges, or complaints against any of the Releasees, Executive shall state no more than that he cannot provide counsel or assistance. If after the Separation Date, Executive is subpoenaed or required by other legal process to assist the Company, or if the Company requests such assistance, the Company shall reimburse Executive for reasonable travel expenses, (including lodging and meals), upon Executive’s submission of receipts and will negotiate in good faith with Executive to establish a reasonable per diem rate of compensation payable to Executive in exchange for any such assistance.

15. No Admission of Liability. Executive understands and acknowledges that this Agreement constitutes a compromise and settlement of any and all actual or potential disputed claims by Executive. No action taken by the Company hereto, either previously or in connection with this Agreement, shall be deemed or construed to be (a) an admission of the truth or falsity of any actual or potential claims or (b) an acknowledgment or admission by the Company of any fault or liability whatsoever to Executive or to any third party.

16. Costs. Except as provided in Section 1(e) of this Agreement, the Parties shall each bear their own costs, attorneys’ fees, and other fees incurred in connection with the preparation of this Agreement.

17. ARBITRATION. THE PARTIES AGREE THAT ANY AND ALL DISPUTES ARISING OUT OF THE TERMS OF THIS AGREEMENT (INCLUDING THE SUPPLEMENTAL RELEASE ATTACHED AS EXHIBIT A HERETO), THEIR INTERPRETATION, AND ANY OF THE MATTERS HEREIN RELEASED, SHALL BE SUBJECT TO ARBITRATION IN SAN FRANCISCO COUNTY, BEFORE JUDICIAL ARBITRATION & MEDIATION SERVICES, INC. (“JAMS”), PURSUANT TO ITS EMPLOYMENT ARBITRATION RULES & PROCEDURES (“JAMS RULES”). THE ARBITRATOR MAY GRANT INJUNCTIONS AND OTHER RELIEF IN SUCH DISPUTES. THE ARBITRATOR SHALL ADMINISTER AND CONDUCT ANY ARBITRATION IN ACCORDANCE WITH CALIFORNIA LAW, INCLUDING THE CALIFORNIA CODE OF CIVIL PROCEDURE, AND THE ARBITRATOR SHALL APPLY SUBSTANTIVE AND PROCEDURAL CALIFORNIA LAW TO ANY DISPUTE OR CLAIM, WITHOUT REFERENCE TO ANY CONFLICT-OF-LAW PROVISIONS


OF ANY JURISDICTION. TO THE EXTENT THAT THE JAMS RULES CONFLICT WITH CALIFORNIA LAW, CALIFORNIA LAW SHALL TAKE PRECEDENCE. THE DECISION OF THE ARBITRATOR SHALL BE FINAL, CONCLUSIVE, AND BINDING ON THE PARTIES TO THE ARBITRATION. THE PARTIES AGREE THAT THE PREVAILING PARTY IN ANY ARBITRATION SHALL BE ENTITLED TO INJUNCTIVE RELIEF IN ANY COURT OF COMPETENT JURISDICTION TO ENFORCE THE ARBITRATION AWARD. THE PARTIES TO THE ARBITRATION SHALL EACH PAY AN EQUAL SHARE OF THE COSTS AND EXPENSES OF SUCH ARBITRATION, AND EACH PARTY SHALL SEPARATELY PAY FOR ITS RESPECTIVE COUNSEL FEES AND EXPENSES; PROVIDED, HOWEVER, THAT THE ARBITRATOR SHALL AWARD ATTORNEYS’ FEES AND COSTS TO THE PREVAILING PARTY, EXCEPT AS PROHIBITED BY LAW. THE PARTIES HEREBY AGREE TO WAIVE THEIR RIGHT TO HAVE ANY DISPUTE BETWEEN THEM RESOLVED IN A COURT OF LAW BY A JUDGE OR JURY. NOTWITHSTANDING THE FOREGOING, THIS SECTION WILL NOT PREVENT EITHER PARTY FROM SEEKING INJUNCTIVE RELIEF (OR ANY OTHER PROVISIONAL REMEDY) FROM ANY COURT HAVING JURISDICTION OVER THE PARTIES AND THE SUBJECT MATTER OF THEIR DISPUTE RELATING TO THIS AGREEMENT AND THE AGREEMENTS INCORPORATED HEREIN BY REFERENCE. SHOULD ANY PART OF THE ARBITRATION AGREEMENT CONTAINED IN THIS PARAGRAPH CONFLICT WITH ANY OTHER ARBITRATION AGREEMENT BETWEEN THE PARTIES, THE PARTIES AGREE THAT THIS ARBITRATION AGREEMENT SHALL GOVERN.

18. Tax Consequences. The Company makes no representations or warranties with respect to the tax consequences of the payments and any other consideration provided to Executive or made on his behalf under the terms of this Agreement. Executive agrees and understands that he is responsible for payment, if any, of local, state, and/or federal taxes on the payments and any other consideration provided hereunder by the Company and any penalties or assessments thereon. Executive further agrees to indemnify and hold the Company harmless from any claims, demands, deficiencies, penalties, interest, assessments, executions, judgments, or recoveries by any government agency against the Company for any amounts claimed due on account of (a) Executive’s failure to pay, or Executive’s delayed payment of, federal or state taxes, or (b) damages sustained by the Company by reason of any such claims, including attorneys’ fees and costs.

19. Section 409A. The severance amounts and the provision of the other benefits provided for under this Agreement are intended to satisfy the requirements of the “short-term deferral” rule set forth in Section 1.409A-1(b)(4) of the Treasury Regulations and will not constitute deferred compensation for purposes of Section 409A of the Internal Revenue Code of 1986, as amended (“Section 409A”). The foregoing provisions are intended to comply with the requirements of Section 409A so that none of the severance payments and benefits to be provided hereunder will be subject to the additional tax imposed under Section 409A, and any ambiguities herein will be interpreted to so comply. For the purpose of furthering such intent, Executive’s Supplemental Releases must be signed, returned and become irrevocable, and any payment of compensation (including the accelerated vesting of restricted stock units and any delivery of stock in connection with satisfaction of such units) which is contingent upon the effectiveness of such Supplemental Release(s) must then be paid, in any event, no later than March 15 of the calendar year following the calendar year in which Executive otherwise becomes entitled to such payment (or earlier, if otherwise required by this Agreement).

20. Authority. The Company represents and warrants that it will have secured all necessary approvals to fulfill its obligations under this Agreement prior thereto and that the undersigned has the authority to act on behalf of the Company and to bind the Company and all who may claim through it to the terms and conditions of this Agreement. Executive represents and warrants that he has the capacity to act on his own behalf and on behalf of all who might claim through him to bind them to the terms and conditions of this Agreement. Each Party warrants and represents that there are no liens or claims of lien or assignments in law or equity or otherwise of or against any of the claims or causes of action released herein.

21. No Representations. Executive represents that he has had an opportunity to consult with an attorney, and has carefully read and understands the scope and effect of the provisions of this Agreement. Executive has not relied upon any representations or statements made by the Company that are not specifically set forth in this Agreement.


22. Severability. In the event that any provision or any portion of any provision hereof or any surviving agreement made a part hereof becomes or is declared by a court of competent jurisdiction or arbitrator to be illegal, unenforceable, or void, this Agreement shall continue in full force and effect without said provision or portion of provision.

23. Attorneys’ Fees. Except with regard to a legal action challenging or seeking a determination in good faith of the validity of the waiver herein under the ADEA, in the event that either Party brings an action to enforce or effect its rights under this Agreement, the prevailing Party shall be entitled to recover its costs and expenses, including the costs of mediation, arbitration, litigation, court fees, and reasonable attorneys’ fees incurred in connection with such an action.

24. Entire Agreement. This Agreement, together with the Supplemental Release attached as Exhibit A hereto, represents the entire agreement and understanding between the Company and Executive concerning the subject matter of this Agreement and Executive’s employment with and separation from the Company and the events leading thereto and associated therewith, and supersedes and replaces any and all prior agreements and understandings concerning the subject matter of this Agreement and Executive’s relationship with the Company, with the exception of the Confidentiality Agreement, the Stock Agreements, the indemnification agreement between Executive and the Company dated February 2, 2005, and any provisions of the Business Policies that inherently survive following a separation from employment.

25. No Oral Modification. This Agreement may only be amended in a writing signed by Executive and the Company’s Chief Executive Officer.

26. Governing Law. This Agreement shall be governed by the laws of the State of California, without regard for choice-of-law provisions. The Parties consent to personal and exclusive jurisdiction and venue in the State of California.

27. Effective Date. Executive has seven (7) days after he signs this Agreement to revoke it. This Agreement will become effective on the eighth (8th) day after Executive signed this Agreement, so long as it has been signed by the Parties and has not been revoked by Executive before that date (the “Effective Date”).

28. Expiration of Agreement. This Agreement shall be null and void if the Company has not received an executed copy of the Agreement on or by the twenty-first date after which it is received by Executive (the “Expiration Date”).

29. Counterparts. This Agreement may be executed in counterparts and by facsimile, and each counterpart and facsimile shall have the same force and effect as an original and shall constitute an effective, binding agreement on the part of each of the undersigned.

30. Voluntary Execution of Agreement. Executive understands and agrees that he executed this Agreement voluntarily, without any duress or undue influence on the part or behalf of the Company or any third party, with the full intent of releasing all of his claims against the Company and any of the other Releasees. Executive acknowledges that: (a) he has read this Agreement; (b) he has been represented in the preparation, negotiation, and execution of this Agreement by legal counsel of his own choice or has elected not to retain legal counsel; (c) he understands the terms and consequences of this Agreement and of the releases it contains; and (d) he is fully aware of the legal and binding effect of this Agreement.

[SIGNATURE PAGE FOLLOWS]


IN WITNESS WHEREOF, the Parties have executed this Agreement on the respective dates set forth below.

 

      MARK S. ANDERSON, an individual
Dated:  

October 4, 2010

   

/s/ Mark S. Anderson

      Mark S. Anderson
      DOLBY LABORATORIES, INC.
Dated:  

October 4, 2010

    By  

/s/ Andrew Dahlkemper

        Andrew Dahlkemper
        SVP, Human Resources


EXHIBIT A – SUPPLEMENTAL RELEASE

In consideration for the mutual promises and consideration provided both herein and in the Separation Agreement and Release signed October 4, 2010 (the “Agreement”) between Mark S. Anderson (“Executive”) and Dolby Laboratories, Inc., a Delaware corporation, and its direct and indirect subsidiaries (together, the “Company”) (collectively the “Parties”), the Parties hereby extend by this Supplemental Release (the “Supplemental Release”) the release and waiver therein to any and all claims that may have arisen between the Effective Date of the Agreement and Executive’s signature date, below.

1. Supplemental Release. The undersigned Parties expressly acknowledge and agree that the terms of Sections 7-27, 29, and 30 of the Agreement shall apply equally to this Supplemental Release and are incorporated herein. Executive agrees that the foregoing consideration represents settlement in full of all outstanding obligations owed to Executive by the Company and its current and former officers, directors, employees, agents, investors, attorneys, shareholders, administrators, affiliates, benefit plans, plan administrators, insurers, divisions, and subsidiaries, and predecessor and successor corporations and assigns (collectively, the “Releasees”). Executive, on his own behalf and on behalf of his respective heirs, family members, executors, agents, and assigns, hereby and forever releases the Releasees from, and agrees not to sue concerning, or in any manner to institute, prosecute, or pursue, any claim, complaint, charge, duty, obligation, or cause of action relating to any matters of any kind, whether presently known or unknown, suspected or unsuspected, that Executive may possess against any of the Releasees arising from any omissions, acts, facts, or damages that have occurred up until and including the date Executive signs this Supplemental Release.

Executive acknowledges and agrees that the consideration provided to him under the Agreement fully satisfies any obligation that the Company had to pay Executive wages or any other compensation for any of the services that Executive rendered to the Company, that the amount paid is in excess of any disputed wage claim, if any, that Executive may have. To the extent any wage dispute exists, Executive specifically acknowledges that the consideration paid shall be deemed to be paid first in satisfaction of any disputed wage claim with the remainder sufficient to act as consideration for the release of claims set forth herein, and that Executive has not earned and is not entitled to receive any additional wages or other form of compensation from the Company.

2. California Civil Code Section 1542. Executive acknowledges that he has been advised to consult with legal counsel and is familiar with the provisions of California Civil Code Section 1542, a statute that otherwise prohibits the release of unknown claims, which provides as follows: “A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS OR HER FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM OR HER MUST HAVE MATERIALLY AFFECTED HIS OR HER SETTLEMENT WITH THE DEBTOR.” Executive, being aware of said code section, agrees to expressly waive any rights he may have thereunder, as well as under any other statute or common law principles of similar effect.

3. ADEA Waiver. Executive further expressly understands and acknowledges that he is waiving and releasing any rights he may have under the Age Discrimination in Employment Act of 1967 (“ADEA”), and that this waiver and release is knowing and voluntary. Executive understands and agrees that this waiver and release does not apply to any rights or claims that may arise under the ADEA after the date his executes this Supplemental Release. Executive understands and acknowledges that the consideration given for this waiver and release is in addition to anything of value to which Executive was already entitled. Executive further understands and acknowledges that he has been advised by this writing that: (a) he should consult with an attorney prior to executing this Supplemental Release; (b) he has twenty-one (21) days within which to consider this Supplemental Release, by which time the Company must receive an executed copy; (c) he has seven (7) days following his execution of this Supplemental Release to revoke this Supplemental Release, and agrees that any such revocation must be in a writing by email or federal express received by Andrew Dahlkemper by midnight on the seventh day following Executive’s execution of this Supplemental Release; (d) this Supplemental Release shall not be effective until after the revocation period has expired; and (e) nothing in this Supplemental Release prevents or precludes Executive from challenging or seeking a determination in good faith of the validity of this waiver under the ADEA, nor does it impose any condition precedent, penalties, or costs for doing so, unless specifically authorized by


federal law. In the event Executive signs this Supplemental Release and returns it to the Company in less than the 21-day period identified above, Executive hereby acknowledges that he has freely and voluntarily chosen to waive the time period allotted for considering this Supplemental Release. Executive understands and agrees that he executed this Supplemental Release voluntarily, without any duress or undue influence on the part or behalf of the Company or any third party, with the full intent of releasing all of his claims against the Releasees.

4. Voluntary Execution of Supplemental Release. Executive understands and agrees that he executed this Supplemental Release voluntarily, without any duress or undue influence on the part or behalf of the Company or any third party, with the full intent of releasing all of his claims against the Company and any of the other Releasees. Executive acknowledges that: (a) he has read this Supplemental Release; (b) he has been represented in the preparation, negotiation, and execution of this Supplemental Release by legal counsel of his own choice or has elected not to retain legal counsel; (c) he understands the terms and consequences of this Supplemental Release and of the releases it contains; and (d) he is fully aware of the legal and binding effect of this Supplemental Release.

IN WITNESS WHEREOF, the Parties have executed this Supplemental Release on the respective dates set forth below.

 

            MARK S. ANDERSON, an individual
Dated:  

 

   

 

      Mark S. Anderson
      DOLBY LABORATORIES, INC.
Dated:  

 

    By  

 

        Andrew Dahlkemper
        SVP, Human Resources
Letter Agreement - Ray Dolby

Exhibit 10.2

December 6, 2010

Ray Dolby

 

  Re: Appointment as Founder and Director Emeritus of Dolby Laboratories, Inc.

Dear Ray:

The purpose of this letter is to confirm the arrangements relating to your appointment as Founder and Director Emeritus of Dolby Laboratories, Inc. (the “Company”) after founding the Company and providing many years of distinguished service to the Company. Our goal is to permit you to reduce the level of your regular commitment and obligations to the Company, while at the same time allowing the Board to continue to benefit from your knowledge, experience, contributions and long-standing history with the Company. As we have discussed, the Company and you hereby agree to the following terms relating to your appointment:

1. Founder and Director Emeritus. By your signature below, you are providing the Company with notice that you will not stand for reelection to the Board of Directors at the Company’s 2011 Annual Meeting of Stockholders. You will be appointed to the newly-created position of “Founder and Director Emeritus” of the Company, effective as of the 2011 Annual Meeting of Stockholders. The position will be an honorary, non-compensated position in recognition of your long-standing, loyal and dedicated services, and singularly significant contributions to the Company. Your new position as Founder and Director Emeritus will be acknowledged in the Company’s Annual Report and on the Company’s website. As Founder and Director Emeritus, you will be entitled to attend meetings of the Board of Directors and its committees, as further described in paragraph 2 below. You will not be considered a “director” of the Company for any purpose, other than for purposes of the Company’s insider trading policies, as described in paragraph 3 below. Your presence at any meeting of the Board of Directors or any of its committees will not be considered in determining the presence of a quorum and you will not be entitled to vote. You will not, by virtue of being a “Founder and Director Emeritus” be eligible or entitled to receive any compensation or benefits for which “directors” of the Company are eligible.

2. Board Observer Status. You may attend meetings of the Board of Directors, including meetings of any committee of the Board of Directors, as an observer and you will receive copies of materials provided to the Board of Directors and any committees of the Board of Directors. The Board of Directors reserves the right to modify or suspend your Board and committee observer status in the event it concludes in good faith that there are valid legal or business reasons to do so (for example, in order to preserve the Company’s attorney-client privilege). The Company will seek to provide advance notice to you and your counsel prior to any such modification or suspension, except in cases where it is not practicable.


3. Confidentiality Obligations and Trading Restrictions. You acknowledge that (i) you will remain subject to the Company’s Insider Trading Compliance Program (the “Compliance Program”), as amended and restated January 30, 2008 and as amended hereafter, and the confidentiality requirements described therein, and (ii) you will be deemed a director of the Company for purposes of the Insider Trading Policy and Guidelines with respect to Certain Transactions in Company Securities, as amended from time to time, which is attached to the Compliance Program as Exhibit A.

4. Other Rights and Obligations. Your rights and obligations under any other pre-existing arrangements or agreements, including your right to use certain Company facilities as granted to you in the past by the Board of Directors, will not be affected by the terms of this letter.

5. Non-Transferable. The terms set forth in this letter are personal to you and are non-transferable.

If you agree with the terms of your appointment as set forth above, please sign and return the enclosed duplicate copy of this letter to me at your earliest convenience.

 

Sincerely,

/s/ KevinYeaman

Kevin Yeaman, Chief Executive Officer

 

ACKNOWLEDGED AND AGREED:

/s/ Ray Dolby

Ray Dolby
Dated: December 6, 2010

 

2

Certification by the CEO Pursuant to Rule 13a-14(a) or 15d-14(a)

Exhibit 31.1

CERTIFICATIONS

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 9, 2011

 

/s/ Kevin J. Yeaman                         
Kevin J. Yeaman
President and Chief Executive Officer
Certification by the CFO Pursuant to Rule 13a-14(a) or 15d-14(a)

Exhibit 31.2

CERTIFICATIONS

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 9, 2011

 

/s/ Murray J. Demo                            
Murray J. Demo
Executive Vice President and Chief Financial Officer
Certification by the CEO and CFO Pursuant to 18 U.S.C. Section 1350

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 31, 2010, 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 9, 2011

 

/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