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 26, 2008

OR

 

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

For the Transition Period From              To             

Commission File Number: 001-32431

 

 

DOLBY LABORATORIES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   90-0199783

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

100 Potrero Avenue

San Francisco, CA

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

(415) 558-0200

(Registrant’s telephone number, including area code)

 

 

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, 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 21, 2009 the registrant had 52,258,818 shares of Class A common stock, par value $0.001 per share, and 60,485,062 shares of Class B common stock, par value $0.001 per share, outstanding.

 

 

 


Table of Contents

DOLBY LABORATORIES, INC.

FORM 10-Q

TABLE OF CONTENTS

 

     PART I – FINANCIAL INFORMATION     

Item 1.

   Condensed Consolidated Financial Statements    2
   Condensed Consolidated Balance Sheets as of September 26, 2008 and December 26, 2008    2
   Condensed Consolidated Statements of Operations for the Fiscal Quarters Ended December 28, 2007 and December 26, 2008    3
   Condensed Consolidated Statements of Cash Flows for the Fiscal Quarters Ended December 28, 2007 and December 26, 2008    4
   Notes to Condensed Consolidated Financial Statements    5

Item 2.

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

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    26

Item 4.

   Controls and Procedures    27
   PART II – OTHER INFORMATION   

Item 1.

   Legal Proceedings    28

Item 1A.

   Risk Factors    28

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    47

Item 6.

   Exhibits    48

Signatures

   49

 

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Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1 – CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

DOLBY LABORATORIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

     September 26,
2008
   December 26,
2008
 
     (unaudited)  

ASSETS

  

Current assets:

     

Cash and cash equivalents

   $ 394,761    $ 402,434  

Short-term investments

     119,667      181,123  

Accounts receivable, net

     27,650      23,667  

Inventories

     18,133      16,316  

Deferred taxes

     91,824      81,536  

Prepaid expenses and other current assets

     39,834      34,236  
               

Total current assets

     691,869      739,312  

Property, plant and equipment, net

     87,915      84,809  

Intangible assets, net

     83,060      86,714  

Goodwill

     250,356      236,687  

Long-term investments

     180,996      198,371  

Deferred taxes

     24,900      32,048  

Other assets

     17,050      23,271  
               

Total assets

   $ 1,336,146    $ 1,401,212  
               

LIABILITIES AND STOCKHOLDERS’ EQUITY

     

Current liabilities:

     

Accounts payable

   $ 10,137    $ 11,060  

Accrued liabilities

     146,788      118,028  

Income taxes payable

     4,811      21,151  

Current portion of long-term debt

     1,593      1,527  

Deferred revenue

     37,344      39,481  
               

Total current liabilities

     200,673      191,247  

Long-term debt

     7,782      6,887  

Deferred revenue

     6,171      6,808  

Deferred taxes

     16,755      15,227  

Other liabilities

     33,414      33,807  
               

Total liabilities

     264,795      253,976  

Controlling interest

     22,098      20,088  

Stockholders’ equity:

     

Class A common stock

     52      52  

Class B common stock

     60      60  

Additional paid-in capital

     434,907      443,235  

Retained earnings

     609,495      687,579  

Accumulated other comprehensive income (loss)

     4,739      (3,778 )
               

Total stockholders’ equity

     1,049,253      1,127,148  
               

Total liabilities and stockholders’ equity

   $ 1,336,146    $ 1,401,212  
               

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 28,
2007
    December 26,
2008
 
     (unaudited)  

Revenue:

    

Licensing

   $ 122,430     $ 154,056  

Product sales

     20,010       17,946  

Services

     7,787       8,256  
                

Total revenue

     150,227       180,258  
                

Cost of revenue:

    

Cost of licensing

     3,263       3,248  

Cost of product sales (1)

     11,648       9,359  

Cost of services (1)

     3,055       3,206  

Gain from amended patent licensing agreement

     —         (20,041 )
                

Total cost of revenue

     17,966       (4,228 )
                

Gross margin

     132,261       184,486  
                

Operating expenses:

    

Selling, general and administrative (1)

     50,986       54,467  

Research and development (1)

     13,907       15,546  
                

Total operating expenses

     64,893       70,013  
                

Operating income:

     67,368       114,473  

Interest income

     5,821       4,132  

Interest expense

     (363 )     (263 )

Other expense, net

     (254 )     (1,382 )
                

Income before provision for income taxes and controlling interest

     72,572       116,960  

Provision for income taxes

     (24,607 )     (38,623 )
                

Income before controlling interest

     47,965       78,337  

Controlling interest in net income

     (292 )     (242 )
                

Net income

   $ 47,673     $ 78,095  
                

Earnings per share (basic)

   $ 0.43     $ 0.69  

Earnings per share (diluted)

   $ 0.42     $ 0.68  

Weighted average shares outstanding (basic)

     110,592       112,608  

Weighted average shares outstanding (diluted)

     114,700       114,870  

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

   $ 340     $ 340  

 

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

    

Cost of product sales

   $ 241     $ 156  

Cost of services

     40       27  

Selling, general and administrative

     4,295       3,463  

Research and development

     890       934  

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 28,
2007
    December 26,
2008
 
     (unaudited)  

Operating activities:

    

Net income

   $ 47,673     $ 78,095  

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

    

Depreciation and amortization

     5,168       6,519  

Stock-based compensation expense

     5,119       4,531  

Accretion of discounts/amortization of premium on investments

     (37 )     974  

Excess tax benefit from exercise of stock options

     (6,309 )     (792 )

Provision for doubtful accounts

     192       851  

Deferred taxes

     (7,035 )     6,918  

Gain on Put Rights

     —         (6,606 )

Unrealized losses on auction rate certificates

     —         8,022  

Gain from amended patent licensing agreement

     —         (20,041 )

Other non-cash items affecting net income

     229       (584 )

Changes in operating assets and liabilities:

    

Accounts receivable

     (8,123 )     1,225  

Inventories

     (462 )     (2,388 )

Prepaid expenses and other assets

     (300 )     (2,059 )

Accounts payable and accrued liabilities

     10,425       (6,456 )

Income taxes, net

     24,076       24,135  

Deferred revenue

     4,678       6,202  

Other liabilities

     972       (1,122 )
                

Net cash provided by operating activities

     76,266       97,424  
                

Investing activities:

    

Purchases of available-for-sale securities

     (66,255 )     (96,801 )

Proceeds from sale of available-for-sale securities

     140,610       17,050  

Purchases of property, plant and equipment

     (1,477 )     (996 )

Purchase of intangible assets

     —         (8,321 )

Acquisitions, net of cash acquired

     (248,715 )     —    

Other

     7       —    
                

Net cash used in investing activities

     (175,830 )     (89,068 )
                

Financing activities:

    

Payments on debt

     (379 )     (368 )

Proceeds from the exercise of stock options

     5,134       1,335  

Issuance of Class A common stock (ESPP)

     505       1,635  

Excess tax benefit from exercise of stock options

     6,309       792  
                

Net cash provided by financing activities

     11,569       3,394  
                

Effect of foreign exchange rate changes on cash and cash equivalents

     (226 )     (4,077 )
                

Net (decrease)/increase in cash and cash equivalents

     (88,221 )     7,673  

Cash and cash equivalents at beginning of period

     368,467       394,761  
                

Cash and cash equivalents at end of period

   $ 280,246     $ 402,434  
                

Supplemental disclosure:

    

Cash paid for income taxes

   $ 7,063     $ 7,663  

Cash paid for interest

     209       119  

See accompanying notes to unaudited condensed consolidated financial statements

 

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DOLBY LABORATORIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Summary of Business and Significant Accounting Policies

Dolby Laboratories develops and delivers innovative products and technologies that improve the entertainment experience. Since Ray Dolby founded Dolby Laboratories in 1965, we have been at the forefront of delivering sound technologies that are employed throughout the entertainment creation, distribution and playback process to enhance the entertainment experience. Today, Dolby technologies are standard in a wide range of entertainment platforms. Our technologies are used in virtually all DVD players and personal computer DVD playback software, increasingly in digital televisions, set top boxes, portable media devices and in a wide array of consumer electronic products such as gaming systems and audio/video receivers. Movie theatres and broadcasters around the world use Dolby’s products.

Our objective is to be an essential element in the best entertainment technologies by delivering innovative and enduring technologies that enrich the entertainment experience. We believe that our well recognized brand and established history of successful innovations position us to expand the use of our technologies in existing and new markets and to capitalize on key trends in digital entertainment, such as the transition to digital television, digital cinema, high definition home theater systems, portable media devices and downloadable content services.

We deliver innovative technologies, products and services throughout the entertainment industry, including content creation, content distribution and content playback. We work with consumer electronics manufacturers and media software vendors to help develop and incorporate innovations that are designed to improve the entertainment experience at home and on-the-go. Similarly, we focus on developing and delivering new innovations for the professional community. This community includes filmmakers and exhibitors, television producers, music producers, and video game designers, who use Dolby technologies to generate a more realistic and immersive entertainment experience. We believe that our involvement across the entertainment industry has resulted in a globally recognized brand and better positions us to meet our long-term objective of being an essential element in the best entertainment technologies.

Unaudited Interim Financial Statements

The accompanying interim condensed consolidated balance sheets as of September 26, 2008 and December 26, 2008 and the condensed consolidated statements of operations and cash flows for the fiscal quarters ended December 28, 2007 and December 26, 2008 are unaudited. These interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). In our opinion, the interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements for the fiscal year ended September 26, 2008 and include all adjustments necessary for fair presentation. The results for the fiscal quarter ended December 26, 2008 are not necessarily indicative of the results to be expected for any subsequent quarterly or annual financial period, including the fiscal year ending September 25, 2009.

The accompanying interim condensed consolidated financial statements are prepared in accordance with Securities and Exchange Commission rules and regulations, which allow certain information and footnote disclosures that are normally included in annual financial statements to be condensed or omitted. As a result, the accompanying interim condensed consolidated financial statements should be read in conjunction with our consolidated financial statements for the fiscal year ended September 26, 2008 that are included in our Annual Report on Form 10-K and filed with the Securities and Exchange Commission. Certain prior period amounts have been reclassified to conform to current year presentation.

Use of Estimates

The preparation of the condensed 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 condensed consolidated financial statements and accompanying notes. Significant items subject to such estimates and assumptions include valuation allowances for receivables, carrying values of inventories, goodwill, intangible assets, stock-based compensation, fair values of investments, put rights, accrued expenses, liabilities for unrecognized tax benefits and deferred income tax assets. Actual results could differ from our estimates.

 

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Per Share Data

Basic earnings per share is computed by dividing net income by the weighted average number of shares of Class A and Class B common stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the sum of the weighted average number of shares of Class A and Class B common stock outstanding and the potential number of shares of dilutive Class A and Class B common stock outstanding during the period.

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

 

     Fiscal Quarter Ended
     December 28,
2007
   December 26,
2008
     (in thousands, except per
share amounts)

Numerator:

     

Net income

   $ 47,673    $ 78,095
             

Denominator:

     

Weighted average shares outstanding (basic)

     110,592      112,608

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

     4,108      2,262
             

Weighted average shares outstanding (diluted)

     114,700      114,870
             

Earnings per share (basic)

   $ 0.43    $ 0.69

Earnings per share (diluted)

   $ 0.42    $ 0.68

A total of 525,538 and 3,255,835 options were excluded from the calculation of potential common shares for the first quarter of fiscal 2008 and 2009, respectively, because their inclusion would have been anti-dilutive.

Cash and Cash Equivalents

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

Investments

As of December 26, 2008, we had investments in United States government agency securities, variable rate demand notes, auction rate certificates and municipal debt securities. We account for these instruments under the provisions of Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. Investments that have original maturities between 91 days and one year from the date of purchase are classified as short-term investments and investments that have maturities of more than one year from the date of purchase are initially classified as long-term investments. We continue to classify our auction rate certificates as long-term investments. See Note 2, “Composition of Certain Financial Statement Captions” for further discussion regarding our auction rate certificates and certain put rights which provide us with the right to sell our auction rate certificates at par value. All of our investments, except for an equity investment, investments held in our supplemental retirement plan for key executives and auction rate certificates are classified as available-for-sale securities and are recorded at fair value on the condensed consolidated balance sheet. Unrealized gains or losses on our available-for-sale securities are reported as a component of accumulated other comprehensive income (loss) and realized gains or losses are reported as a component of net income. Investments held in our supplemental retirement plan for key executives and auction rate certificates are classified as trading securities. Unrealized gains or losses on trading securities are reported as a component of net income.

In accordance with FASB Staff Position FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, we review our investment portfolio in order to assess whether our investments with unrealized loss positions are other-than-temporarily impaired.

 

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Stock-Based Compensation

We account for stock-based compensation under the provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (SFAS 123R). SFAS 123R requires measurement of all employee stock-based awards using a fair-value method and recording of related compensation expense, net of estimated forfeitures, in the condensed consolidated financial statements over the requisite service period. See Note 4 “Stock-Based Compensation” for further discussion.

Income Taxes

Our quarterly provision for income taxes includes U.S. federal and state and international income taxes and is based on our estimated annual effective tax rate. We estimate our annual effective tax rate based on projections of our income before taxes for the full fiscal year. However, events that occur in a quarter are reflected as discrete items, which could impact the tax rate. In the period that we file our annual tax returns, we true up our provision for income taxes to reflect any difference between our estimated provision and our filed tax return. A deferred tax liability is recognized for all future taxable temporary differences, and a deferred tax asset is recognized for all future deductible temporary differences. A valuation allowance is recognized if it is more likely than not that some portion of the deferred tax asset will not be realized.

Goodwill and Intangible Assets

We account for goodwill in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142). As required by SFAS 142, we perform an impairment test on recorded goodwill by comparing the estimated fair value of each of our reporting units to the carrying value of the assets and liabilities of each reporting unit, including goodwill. The fair value of each of our reporting units is determined by using a discounted cash flow model which considers a number of factors, including estimated future cash flows, risks facing us and our current market capitalization. If the carrying value of the assets and liabilities of the reporting units, including goodwill, were to exceed our estimate of the fair value of the reporting units, we would record an impairment charge in an amount equal to the excess of the carrying value of goodwill over the implied fair value of the goodwill. We conduct our goodwill impairment test annually and on an interim basis if changes in events and circumstances indicate that it is more likely than not that the fair value of our reporting units may be less than their carrying amount. Our fiscal 2009 impairment test of goodwill will be performed in our third fiscal quarter.

Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), requires that long-lived assets, including intangible assets, with definite lives be amortized over their estimated useful lives and reviewed for impairment whenever events or changes in circumstances indicate an asset’s carrying value may not be recoverable. Recoverability of an asset is measured by comparison of its carrying amount to the expected future undiscounted cash flows that the asset is expected to generate. If it is determined that an asset is not recoverable, an impairment loss is recorded in the amount by which the carrying amount of the asset exceeds its fair value. Our intangible assets principally consist of acquired technology, patents, trademarks, customer relationships and contracts, and are amortized on a straight-line basis over their useful lives ranging from three to 15 years. No intangible or long-lived assets were impaired as of December 26, 2008.

Comprehensive Income

Comprehensive income includes net income, foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities. The components of comprehensive income were as follows:

 

     Fiscal Quarter Ended
     December 28,
2007
    December 26,
2008
     (in thousands)

Net income

   $ 47,673     $ 78,095

Other comprehensive income (loss):

    

Foreign currency translation adjustment

     4,987       14,324

Unrealized (losses) gains on available-for-sale securities, net of tax (See Note 2)

     (96 )     2,081

Reversal of unrealized losses on auction rate certificates, net of tax (See Note 2)

     —         3,726
              

Comprehensive income

   $ 52,564     $ 98,226
              

 

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Withholding and Sales Tax

Licensing revenue is recognized gross of withholding taxes that are remitted by our licensees directly to their local tax authorities. Withholding taxes were $4.0 million and $6.2 million in the first quarter of fiscal 2008 and 2009, respectively. Sales tax is accounted for on a net basis and is excluded from revenues.

2. Composition of Certain Financial Statement Captions

Cash, Cash Equivalents, and Investments

Cash, cash equivalents, and investments as of September 26, 2008 and December 26, 2008 consisted of the following:

 

     September 26,
2008
   December 26,
2008
     (in thousands)

Cash and cash equivalents:

     

Cash

   $ 121,676    $ 152,025

Cash equivalents:

     

Money market funds

     270,034      250,409

Municipal debt securities

     3,051      —  
             

Total cash and cash equivalents

     394,761      402,434
             

Short-term investments:

     

U.S. government agency securities

     2,514      5,757

Variable rate demand notes

     60,490      86,864

Municipal debt securities

     56,663      88,502
             

Total short-term investments

     119,667      181,123
             

Long-term investments:

     

U.S. government agency securities

     19,212      28,633

Auction rate certificates

     66,146      62,778

Municipal debt securities

     95,028      106,352

Equity investment

     610      608
             

Total long-term investments

     180,996      198,371
             

Total cash, cash equivalents and investments

   $ 695,424    $ 781,928
             

At December 26, 2008, we held tax-exempt auction rate certificates with a par value of $70.8 million. Auctions for these instruments have failed and there is no assurance that future auctions will succeed. As a result, our ability to liquidate our investment and fully recover the par value in the near term may be limited or not exist. We do not believe that the underlying issuers of our auction rate certificates are currently at risk of default. We continue to receive interest payments on the auction rate certificates in accordance with their terms. We believe we will ultimately be able to liquidate our auction rate certificates without significant loss primarily due to the collateral securing the auction rate certificates and our acceptance of the rights offering. Due to the changes and uncertainty in the auction rate certificates market, we believe the recovery period for these investments is likely to be longer than 12 months and as a result, we have classified these investments as long-term as of December 26, 2008.

In November 2008, we elected to accept a rights offering from UBS AG, which we refer to, along with its wholly owned subsidiaries UBS Financial Services, Inc. and UBS Securities LLC, as UBS. The rights offering provides us with rights (the “Put Rights”) to sell to UBS at par value our auction rate certificates purchased through UBS, at any time during a two year sale period beginning June 30, 2010. By electing to participate in the rights offering, we granted UBS the right, exercisable at any time prior to June 30, 2010 or during the two year sale period, to purchase or cause the sale of our auction rate certificates (the “Call Right”). UBS has stated that it will only exercise the Call Right for the purpose of restructurings, dispositions or other solutions that will provide us with par value for the auction rate certificates. UBS has agreed to pay us the par value of the auction rate certificates within

 

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one day of settlement of any Call Right transaction. Notwithstanding the Call Right, we are permitted to sell the auction rate certificates to parties other than UBS, in which case the Put Rights attached to the auction rate certificates that are sold would be extinguished.

We elected to measure the Put Rights under the fair value option of SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 (SFAS 159), and recorded a pre-tax gain of $6.6 million and a corresponding asset for the Put Rights. We have classified the Put Rights as a financial asset within our other assets line item on our balance sheet. Simultaneous with the acceptance of the rights offering, we reclassified our auction rate certificates from available-for-sale securities to trading securities within our long-term investments line item on our balance sheet. As a result of the reclassification, unrealized losses pertaining to our auction rate certificates at September 26, 2008 were recognized in our condensed consolidated statement of operations in the first quarter of fiscal 2009. Total losses pertaining to auction rate certificates in the first quarter of fiscal 2009 were $8.0 million. The pre-tax gain on Put Rights and the unrealized losses pertaining to the auction rate certificates are included in the other expense, net, line item on our condensed consolidated statement of operations.

At December 26, 2008, there was insufficient observable auction rate certificates market information available to determine the fair value of our auction rate certificates. Therefore, we estimated fair value by incorporating assumptions that market participants would use in their estimates of fair value. Some of these assumptions included the collateral underlying the security investments, creditworthiness of the counterparty, timing of expected future cash flows, the likelihood of a successful auction in a future period and final stated maturities.

Our investment portfolio which is recorded as cash equivalents, short-term investments, and long-term investments as of September 26, 2008 was as follows:

 

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

Money market funds

   $ 270,034    $ —      $ —       $ 270,034

U.S. government agency securities

     21,775      23      (72 )     21,726

Auction rate certificates

     72,200      —        (6,054 )     66,146

Variable rate demand notes

     60,490      —        —         60,490

Municipal debt securities

     154,870      173      (301 )     154,742

Equity investment

     610      —        —         610
                            

Cash equivalents and investments

   $ 579,979    $ 196    $ (6,427 )   $ 573,748
                            

Our investment portfolio which is recorded as cash equivalents, short-term investments, and long-term investments as of December 26, 2008 was as follows:

 

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

Money market funds

   $ 250,409    $ —      $ —       $ 250,409

U.S. government agency securities

     33,827      563      —         34,390

Auction rate certificates

     62,778      —        —         62,778

Variable rate demand notes

     86,864      —          86,864

Municipal debt securities

     193,570      1,505      (221 )     194,854

Equity investment

     608      —        —         608
                            

Cash equivalents and investments

   $ 628,056    $ 2,068    $ (221 )   $ 629,903
                            

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

 

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The following table shows the gross unrealized losses and fair value for those available-for-sale investments that were in an unrealized loss position as of December 26, 2008:

 

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

Municipal debt securities

   $ 28,863    $ (221 )   $ —      $ —      $ 28,863    $ (221 )
                                            

Total

   $ 28,863    $ (221 )   $ —      $ —      $ 28,863    $ (221 )
                                            

The unrealized losses on our investments in municipal debt securities were caused primarily by changes in interest rates. We have the ability to hold these securities until we recover any unrealized losses. As a result, we do not consider these investments in an unrealized loss position at December 26, 2008 to be other-than-temporarily impaired.

Accounts Receivable

Accounts receivable consists of the following:

 

     September 26,
2008
    December 26,
2008
 
     (in thousands)  

Trade accounts receivable

   $ 24,604     $ 22,384  

Amounts receivable related to patent administration program

     3,532       2,981  

Other accounts receivable

     1,313       876  
                
     29,449       26,241  

Less: Allowance for doubtful accounts

     (1,799 )     (2,574 )
                

Accounts receivable, net

   $ 27,650     $ 23,667  
                

Inventories

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

 

     September 26,
2008
   December 26,
2008
     (in thousands)

Raw materials

   $ 3,315    $ 4,159

Work in process

     1,891      1,628

Finished goods

     12,927      10,529
             

Inventories

   $ 18,133    $ 16,316
             

Goodwill and Intangible Assets

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

 

     Total  
     (in thousands)  

Balance at September 26, 2008

   $ 250,356  

Translation adjustments

     (13,669 )
        

Balance at December 26, 2008

   $ 236,687  
        

 

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Intangible assets consist of the following:

 

     September 26,
2008
    December 26,
2008
 
     (in thousands)  

Amortized intangible assets:

    

Acquired patents and technology

   $ 55,519     $ 54,590  

Customer relationships

     30,270       29,128  

Customer contracts

     5,300       5,850  

Other intangibles

     11,862       20,179  
                
     102,951       109,747  

Less: Accumulated amortization

     (19,891 )     (23,033 )
                

Intangible assets, net

   $ 83,060     $ 86,714  
                

Amortization expense associated with our intangible assets was $2.3 million and $3.3 million in the first quarter of fiscal 2008 and 2009, respectively, and is included in cost of licensing, cost of product sales and selling, general and administrative expenses in the accompanying condensed consolidated statements of operations. The increase in gross intangible assets from September 26, 2008 to December 26, 2008 is primarily due to the recording of an asset attributable to a lump sum payment to an unrelated patent licensor. See Accrued Liabilities for further discussion. The increase was partially offset by foreign currency translation adjustments.

Accrued Liabilities

Accrued liabilities consist of the following:

 

     September 26,
2008
   December 26,
2008
     (in thousands)

Accrued royalties

     32,064      2,040

Amounts payable to joint licensing program partners

     40,266      41,783

Accrued compensation and benefits

     47,617      50,901

Accrued professional fees

     3,749      2,762

Current portion of litigation settlement (see Note 5)

     2,686      2,791

Other accrued liabilities

     20,406      17,751
             

Accrued liabilities

   $ 146,788    $ 118,028
             

At September 26, 2008, accrued royalties included amounts related to an ongoing dispute regarding the terms of a license agreement with an unrelated patent licensor. From the third quarter of fiscal 2006 through the third quarter of fiscal 2007, we had been accruing royalties related to this matter. In the first quarter of fiscal 2009, we entered into an amendment to the license agreement with the unrelated patent licensor. Under the terms of amendment, we paid a one time lump sum amount of $17.5 million to buy out all payment obligations and each party released any claims it may have against the other with respect to the license agreement. Of the $17.5 million lump sum payment, $8.3 million was recorded as an intangible asset representing the fair value of the future benefit to be obtained from the payment. The intangible asset will be amortized to cost of revenue over a period of three years. The remaining amount of the lump sum payment, or $9.2 million, was recorded as a reduction to accrued royalties which as of September 26, 2008 was approximately $29.2 million. The remaining accrual balance of approximately $20.0 million was eliminated in the first quarter of fiscal 2009 and recorded as a gain from amended patent licensing agreement.

 

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Accumulated Other Comprehensive Income (Loss)

Accumulated foreign currency translation gains, net of tax were $9.4 million at September 26, 2008, compared to an accumulated foreign currency translation loss, net of tax of $4.9 million at December 26, 2008. Accumulated unrealized losses on investments, net, were $4.7 million at September 26, 2008, compared to accumulated unrealized gains on investments of $1.1 million, net, at December 26, 2008.

3. Fair Value Measurements

Effective September 27, 2008, we adopted SFAS 157, Fair Value Measurements, which defines fair value as the exchange price that would be received for an asset or 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. The standard describes three levels of inputs that may be used to measure fair value:

 

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 corroborated by market data.
Level 3:    Unobservable inputs are used when little or no market data is available.

The hierarchy noted above requires us to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value.

Financial assets carried at fair value as of December 26, 2008 are classified below:

 

     Level 1    Level 2    Level 3    Total
     (in thousands)

Money market funds

   $ 250,409    $ —      $ —      $ 250,409

U.S. government agency securities

     —        34,390      —        34,390

Municipal debt securities

     —        194,854      —        194,854

Variable rate demand notes

     —        86,864      —        86,864

Put Rights

     —        —        6,606      6,606

Auction rate certificates

     —        —        62,778      62,778

Investments held in supplemental retirement plan

     3,451      —        —        3,451
                           

Total

   $ 253,860    $ 316,108    $ 69,384    $ 639,352
                           

Financial liabilities carried at fair value as of December 26, 2008 are classified below:

     Level 1    Level 2    Level 3    Total
     (in thousands)

Interest rate derivative

   $ —      $ 305    $ —      $ 305
                           

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

 

     Auction rate certificates
and Put Rights
 
     (in thousands)  

Balances at September 26, 2008

   $ 66,146  

Unrealized loss included in earnings (1)

     (2,108 )

Redemption at par

     (1,400 )

Realized gain included in earnings

     140  

Recognition of Put Rights (2)

     6,606  
        

Balances at December 26, 2008

   $ 69,384  
        

 

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(1)

Represents the decrease in fair values for the period included in other expense, net, line item in our condensed consolidated statement of operations relating to auction rate certificates still held on December 26, 2008.

(2)

Represents the amount of total gains for the period included in other expense, net, line item in our condensed consolidated statement of operations relating to Put Rights still held on December 26, 2008.

The fair values of our Level 1 financial assets are based on quoted market prices of the identical underlying securities and include money market funds and trading securities held in our supplemental retirement plan with quoted prices in active markets. The fair values of our Level 2 financial assets and liabilities are obtained from professional pricing sources for these or comparable instruments, rather than direct observations of quoted prices in active markets and include U.S. government agency securities, municipal debt securities, variable rate demand notes and interest rate derivative. Fair values of auction rate certificates and put rights are classified as Level 3 because quoted prices are unobservable or no market data is available.

4. Stock-Based Compensation

We have adopted stock compensation plans which provide for grants of stock-based awards as a form of compensation to employees, officers, directors and certain non-employee consultants. Stock-based compensation expense was $5.5 million and $4.6 million for the first quarter of fiscal 2008 and 2009, respectively. 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.

Our stock-based compensation expense for the first quarter of fiscal 2008 was $5.1 million and $0.4 million related to stock options and stock appreciation rights, respectively. No restricted stock units were granted in the first quarter of fiscal 2008. Our stock-based compensation expense for the first quarter of fiscal 2009 was predominantly comprised of $3.7 million and $0.8 million for stock options and restricted stock units, respectively.

During the first quarter of fiscal 2009, we granted 78,320 stock options at a weighted average exercise price of $28.00 per share. We also granted 27,695 restricted stock units at a weighted average grant price of $28.01 per share.

5. Legal Proceedings

In March 1997, an unrelated third party filed a lawsuit against us alleging breach of a written agreement. In April 2002, we settled the dispute and agreed to pay a total of $30.0 million, without interest, in ten equal annual installments of $3.0 million per year beginning in June 2002. We recorded this liability at its present value of $24.2 million on the condensed consolidated balance sheet using a discount rate of 5.125%, which approximated our incremental cost of borrowing rate. Interest related to this liability is recorded quarterly and is included in interest expense on the accompanying condensed consolidated statements of operations. Other than such payments, neither party has any material obligations as a result of the settlement. As of September 26, 2008 and December 26, 2008, we had $9.0 million remaining to be paid under this settlement.

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

6. Geographic Data

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

 

     Revenue by Geographic Region
     Fiscal Quarter Ended
     December 28,
2007
   December 26,
2008
     (in thousands)

International

   $ 104,031    $ 125,355

United States

     46,196      54,903
             

Total revenue

   $ 150,227    $ 180,258
             

 

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

 

     Fiscal Quarter Ended  
     December 28,
2007
    December 26,
2008
 

United States

   31 %   30 %

Japan

   21 %   22 %

Europe

   19 %   16 %

Taiwan

   11 %   11 %

China

   10 %   8 %

Other

   8 %   13 %

In the first quarter of fiscal 2008, revenue from one customer represented $16.5 million, or 11%, of the total revenue for the quarter. In the first quarter of fiscal 2009, revenue from one customer represented $18.7 million, or 10%, of the total revenue for the quarter.

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

 

     Long-Lived Tangible Assets by
Geographic Region
     September 26,
2008
   December 26,
2008
     (in thousands)

United States

   $ 63,402    $ 65,210

International

     24,513      19,599
             

Total long-lived tangible assets, net of accumulated depreciation

   $ 87,915    $ 84,809
             

Long-lived tangible assets, which consist of property, plant and equipment, net of accumulated depreciation, held in the United Kingdom were $19.2 million and $15.0 million at September 26, 2008 and December 26, 2008, respectively.

7. Recently Issued Accounting Standards

In February 2008, the FASB issued FASB Staff Position FAS 157-2, Effective Date of FASB Statement No. 157 (FSP 157-2). FSP 157-2 defers the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair values in the financial statements on a recurring basis (at least annually), to fiscal years, and interim periods within those fiscal years beginning after November 15, 2008. We are evaluating the impact of adopting the provisions of FSP 157-2.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 requires unrealized gains and losses to be included in earnings for items reported using the fair value option. SFAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value which currently are not required to be measured at fair value. On September 27, 2008, we adopted SFAS 159 and elected the fair value option for Put Rights. See Note 2, “Composition of Certain Financial Statement Captions” for impact of adoption of SFAS 159 on our condensed consolidated financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141R, Business Combinations (SFAS 141R). SFAS 141R requires an entity to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. Subsequent changes to the estimated fair value of contingent consideration will be reflected in earnings until the contingency is settled. SFAS No. 141R also requires acquisition-related costs and restructuring costs to be expensed as incurred rather than treated as part of the purchase price. The adoption of SFAS No. 141R will change our accounting treatment for business combinations on a prospective basis beginning September 26, 2009.

 

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In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets (FSP FAS 142-3). FSP FAS 142-3 removes the requirement to consider whether an intangible asset can be renewed without substantial cost or material modifications to the existing terms and conditions associated with the intangible asset and, instead, requires an entity to consider its own historical experience in renewing similar arrangements. If the entity has no relevant experience, it would consider market participant assumptions regarding renewal. FSP FAS 142-3 also requires expanded disclosures relating to the determination of useful lives of intangible assets. FSP FAS 142-3 is effective for fiscal years beginning after December 15, 2008, and may impact any intangible asset we acquire in future transactions.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Non-controlling Interests in Consolidated Financial Statements (SFAS 160). SFAS 160 changes the accounting and reporting for minority interests, which will be characterized as non-controlling interests and classified as a component of equity. SFAS 160 is effective for us on a prospective basis beginning in the first quarter of fiscal year 2010. We have not yet determined the impact on our condensed consolidated financial statements of adopting SFAS 160.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (SFAS 161). SFAS No. 161 provides new disclosure requirements for an entity’s derivative and hedging activities. SFAS 161 is effective for fiscal years beginning after November 15, 2008. We do not expect the adoption of SFAS 161 will have a material impact on our condensed consolidated financial statements.

In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted Accounting Principles (SFAS 162). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements that are presented in conformity with generally accepted accounting principles in the United States. This Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” We do not expect SFAS 162 to have a material impact on our condensed consolidated financial statements.

 

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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with our 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 improve the entertainment experience. Since Ray Dolby founded Dolby Laboratories in 1965, we have been at the forefront of delivering sound technologies that are employed throughout the entertainment creation, distribution and playback process to enhance the entertainment experience. Today, Dolby technologies are standard in a wide range of entertainment platforms. Our technologies are used in virtually all DVD players and personal computer DVD playback software, increasingly in digital televisions, set top boxes, portable media devices and in a wide array of consumer electronic products such as gaming systems and audio/video receivers. Movie theatres and broadcasters around the world use Dolby’s products.

Our objective is to be an essential element in the best entertainment technologies by delivering innovative and enduring technologies that enrich the entertainment experience. We believe that our well recognized brand and established history of successful innovations position us to expand the use of our technologies in existing and new markets and to capitalize on key trends in digital entertainment, such as the transition to digital television, digital cinema, high definition home theater systems, portable media devices and downloadable content services.

We deliver innovative technologies, products and services throughout the entertainment industry, including content creation, content distribution and content playback. We work with consumer electronics manufacturers and media software vendors to help develop and incorporate innovations that are designed to improve the entertainment experience at home and on-the-go. Similarly, we focus on developing and delivering new innovations for the professional community. This community includes filmmakers and exhibitors, television producers, music producers, and video game designers, who use Dolby technologies to generate a more realistic and immersive entertainment experience. We believe that our involvement across the entertainment industry has resulted in a globally recognized brand and helps position us to meet our long-term objective of being an essential element in the best entertainment technologies.

We are a global organization. We generate revenue by licensing our technologies to manufacturers of consumer electronics products and media software vendors, and selling our professional products and related services to entertainment content creators, producers, and distributors. We have licensed our technologies to manufacturers in approximately 35 countries and our licensees distribute products incorporating our technologies throughout the world. We sell our products and services in over 50 countries. In fiscal 2007, 2008 and the first quarter of fiscal 2009 revenue from outside the United States was 70%, 66% and 70% of our total revenue, respectively.

 

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Opportunities, Challenges and Risks

Recent deteriorating macroeconomic conditions are creating uncertainty regarding consumer demand in the markets into which we license and sell products and the timing and availability of funding for system integrators to finance digital cinema rollouts in which we could participate. The extent to which these conditions will persist and the overall impact they will have on consumer spending is not clear. Our business is particularly exposed to adverse changes in general economic conditions, because products that incorporate our technologies are entertainment-oriented and generally discretionary goods, such as DVD players, personal computers, digital televisions, mobile devices, set top boxes, home-theaters-in-a-box, camcorders, portable media devices, gaming systems, audio/video receivers and in-car DVD players. We do not believe the effects of recent macroeconomic conditions are reflected in our first quarter of fiscal 2009 licensing results because our recognized licensing revenue generally lags one quarter following sales of products that incorporate our technologies. Consequently, due to a slowdown in consumer spending we do not expect to sustain historical levels of licensing growth, and licensing revenue may decrease, commencing with our second quarter of fiscal 2009. We expect that the slowdown in consumer spending could result in a lower percentage of PCs sold with our technologies and a continued decline in sales of standard definition DVD players and a potential decline in sales of game consoles, each of which would contribute to an expected decline in revenue growth or even a decline in revenue.

Licensing revenue constitutes the majority of our total revenue, representing 80%, 84% and 85% of total revenue in fiscal 2007, 2008 and the first quarter of fiscal 2009, respectively. We categorize our licensing revenue into the following markets:

 

   

Personal computer (PC) market – primarily comprised of software DVD players, Microsoft Windows Vista Home Premium and Ultimate Editions and PC Entertainment Experience.

 

   

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

 

   

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

 

   

Gaming market – primarily comprised of video game consoles.

 

   

Mobile – primarily comprised of mobile devices.

 

   

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

 

   

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

Our personal computing market, which represented just over 30% of our licensing revenue in fiscal 2006, approximately 35% in fiscal 2007 and just over 40% in fiscal 2008, has been primarily driven by sales of software DVD players and to a lesser extent, DVD authoring applications. Historically, PC manufacturers have frequently included DVD playback functionality as part of the software applications included in their products. In fiscal 2007, Microsoft introduced its Windows Vista operating system. Two of the six editions of this operating system, the Windows Vista Home Premium Edition and the Windows Vista Ultimate Edition, include Dolby technologies that help enable DVD playback functionality and DVD authoring capabilities. In addition, many major PC manufacturers continue to include additional branded software applications with DVD playback capabilities and other features which were not provided in the Microsoft operating systems.

In the future, PC manufacturers may elect to exclude additional DVD software applications on personal computers that include the Windows Vista Home Premium Edition or Windows Vista Ultimate Edition. It is unclear at what pace business customers will migrate from their current operating systems to the Windows Vista operating systems and how such adoption will impact sales of software DVD players for business PCs. In addition, a growing number of low cost PCs, particularly netbooks are being sold which do not have Microsoft Vista Home Premium or Ultimate Edition operating systems and do not always have DVD playback functionality or Dolby technologies. We expect an increasing number of consumers will elect to purchase these netbooks which would cause our PC revenue growth rate to decline.

Historically, the consumer electronics market, which is driven primarily by revenue attributable to sales of DVD players, had been our largest market, generating approximately 45% in fiscal 2006 and just under 40% in fiscal 2007. However, in fiscal 2008, it declined to just over 25% and was surpassed by our personal computing market, which represented our largest market in fiscal 2008.

 

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The decrease in the consumer electronics market as a percentage of total licensing revenue has been due primarily to faster revenue growth in our other markets, primarily the PC and broadcast markets. We expect Blu-ray Disc players for high definition content to be a potential growth opportunity in the consumer electronics market. Dolby Digital has been selected as a mandatory audio standard, Dolby Digital Plus has been selected as a mandatory audio standard for secondary track playback and Dolby TrueHD have been selected as an optional audio standard in the Blu-ray Disc format. However, the release and consumer adoption of Blu-ray Disc players has been slower than expected compared to the adoption of standard definition DVD players and sales of standard definition DVD have declined.

Our broadcast market, which is primarily driven by demand for Dolby Digital in televisions and set top boxes, represented just over 10% of our licensing revenue in fiscal 2006, just over 15% in fiscal 2007 and just under 20% in fiscal 2008. Our broadcast market has benefited from increased global shipments of set top boxes, including the contribution of revenue from digital converter boxes, and digital televisions in North America as well as an increased percentage of televisions sold in Europe that contain our technologies. In addition, we view broadcast services operating under particular bandwidth constraints, such as terrestrial broadcast or IPTV services, as an area of opportunity for us to offer Dolby Digital Plus and HE-AAC, which are able to deliver multi channel surround sound at reduced bit rates. We expect revenue from our broadcast market to increase as a percentage of licensing revenue in fiscal 2009. 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.

Revenue generated from the gaming and automotive markets have primarily been driven by sales of video game consoles and in-car entertainment systems with Dolby Digital and ATRAC technology. Revenue generated by our licensing services market has primarily been driven by demand for MPEG 4 audio and MPEG 2 audio technologies used in portable media devices. Revenue from our mobile market is primarily driven by demand for our HE-AAC technology incorporated into mobile devices. We view the mobile market as an area of opportunity to increase revenue from mobile devices, however actual results may differ from our expectations.

We have also introduced new technologies for the broadcast and consumer electronics markets, including Dolby Volume and dynamic range image technologies. Dolby Volume is a sound leveling technology that performs measurement and analysis of signals according to a model based on the characteristics of human hearing, in order to provide consistency of volume and quality across various programs. Dolby Contrast provides enhanced contrast, while Dolby Vision combines enhanced contrast with extended brightness and dynamic range for LCD televisions with LED backlit technology. We do not anticipate generating significant revenue from these technologies in fiscal 2009.

Our technologies are incorporated in consumer electronics and digital entertainment products throughout the world. We expect that sales of products incorporating our technologies in emerging economies, such as China and India, will increase in the future as consumers in these geographical markets have more disposable income available to purchase entertainment products, although there can be no assurance that this will occur. We also expect that manufacturers from lower cost manufacturing countries, including China, will increase production of consumer electronics and digital entertainment products in the future to satisfy this increased demand. There are risks associated with opportunities of doing business in these emerging economies, such as China, that have affected and will continue to affect our operating results, such as manufacturers failing to report or underreporting product shipments.

Product sales consists of revenue from sales of equipment to cinema operators and broadcasters representing 14%, 11% and 10% of total revenue in fiscal 2007, 2008 and the first quarter of fiscal 2009, respectively.

Our cinema products represented approximately 75% of product sales in fiscal 2006, 71% of product sales in fiscal 2007 and 55% of product sales in fiscal 2008. Our traditional cinema products are primarily used to read and decode a film’s soundtrack, calibrate cinema sound systems and to adapt analog cinema audio systems to digital audio formats. Our digital cinema servers load, store, decrypt and decode encrypted digital film files for presentation on a digital projector, and our digital 3D products provide 3D image capabilities. Sales of our cinema products and services tend to fluctuate based on the underlying trends in the motion picture industry. There is a current trend in the cinema industry towards the adoption of digital cinema. Digital cinema offers the motion picture industry a possible means to achieve substantial cost savings in printing and distributing movies, to combat piracy, and to enable movies to be played repeatedly without degradation in image and audio quality. In fiscal 2005, we introduced our Dolby Digital Cinema server, which allows for the storage and playback of digital content and in fiscal 2007 we introduced Dolby 3D Digital Cinema technology, which delivers a 3D experience when combined with an

 

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exhibitor’s existing digital cinema server. The cinema industry is in the early stages of adoption of digital cinema and we expect that exhibitors constructing new theatres or upgrading existing theatres will generally choose digital cinema over traditional film cinema. Digital cinema is based on open standards, which unlike traditional cinema, does not include our proprietary audio formats. As the market for digital cinema grows, we continue to face more competitive pricing pressure than we have historically experienced for traditional cinema products, which adversely impacts our product sales gross margins and digital cinema market share. If our digital cinema servers are not widely deployed, our future prospects in digital cinema will be limited and our business could be materially and adversely affected. Generally, as the film industry has adopted digital cinema the demand for our traditional cinema products and services has declined and we anticipate that the demand for film based products will continue to decline in future periods.

Our broadcast products, which represented approximately 21% of product sales in fiscal 2006, 23% of product sales in fiscal 2007 and 24% of product sales in fiscal 2008, are used to encode, transmit, and decode multiple channels of high quality audio for DTV and HDTV program production and broadcast distribution and to measure the subjective loudness of audio content within broadcast programming. In recent years, growth in consumer demand for high quality television content has increased the demand from broadcasters to deliver more content in Dolby Digital 5.1 surround sound which has contributed to sales of our professional broadcast products.

Our services revenue, which represented 6%, 5% and 5% of total revenue in fiscal 2007, 2008 and the first quarter of fiscal 2009, respectively, is primarily tied to the motion picture production industry and, in particular, to the number of films being made by studios and independent filmmakers. The number of films that are produced can be affected by a number of factors, including strikes and work stoppages within the motion picture industry as well as by the tax incentive arrangements that many foreign governments provide filmmakers to promote local filmmaking.

Critical Accounting Policies

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

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

Revenue Recognition

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

 

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

Goodwill

We account for goodwill in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142). As required by SFAS 142, we perform an impairment test on recorded goodwill by comparing the estimated fair value of each of our reporting units to the carrying value of the assets and liabilities of each unit, including goodwill. The fair value of each of our reporting units is determined by using a discounted cash flow model which considers a number of factors, including estimated future cash flows, risks facing us and our current market capitalization. If the carrying value of the assets and liabilities of the reporting units, including goodwill, were to exceed our estimation of the fair value of the reporting units, we would record an impairment charge in an amount equal to the excess of the carrying value of goodwill over the implied fair value of the goodwill. We use judgment in determining the estimated fair value of our reporting units, which include making assumptions of our future cash flows for each reporting unit. We conduct our goodwill impairment test annually and on an interim basis if changes in events and circumstances indicate that it is more likely than not that the fair value of our reporting units may be less than their carrying amount. Our fiscal 2009 impairment test of goodwill will be performed in the third quarter of fiscal 2009. Fluctuations in the fair value of our reporting units, which may result from changes in economic conditions, our results of operations and other factors, could result in an impairment charge in future periods.

Accounting for Income Taxes

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

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

Stock-Based Compensation

We account for stock-based compensation under the provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (SFAS 123R). SFAS 123R requires measurement of all employee stock-based compensation awards using a fair-value method and recording of such expense in the condensed consolidated financial statements over the requisite service period. We utilize the Black-Scholes option pricing model to determine the fair value of employee stock options at the date of grant. To determine the fair value of a stock-based award using the Black-Scholes option pricing model requires that we make certain assumptions regarding the expected term of the award, the expected future volatility of our stock price over the expected term of the award and the risk-free interest rate over the expected term. We develop our assumptions for the Black-Scholes pricing model in accordance with guidelines set forth by the SEC in Staff Accounting Bulletin No. 107, Share-Based Payment (SAB 107). We estimate the expected term of stock-based awards by evaluating historical exercise patterns of our employees and applying an assumption of future exercise patterns. We utilize a blend of our historical volatility of our common stock and implied volatility based on traded options with similar terms as an estimate of

 

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the expected volatility of our stock price over the expected term of the awards. We use an average interest rate based on U.S. Treasury instruments with terms consistent with the expected term of our awards to estimate the risk-free interest rate. The amount of stock-based compensation expense is reduced for estimated forfeitures based on historical experience. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Investments

We account for investment securities under the provisions of Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS 115) and related interpretations and staff positions. SFAS 115 requires us to record available-for-sale securities at fair value, with unrealized gains and losses being reported as a component of accumulated other comprehensive income (loss). All of our investments, except for an equity investment, investments held in our supplemental retirement plan for key executives and auction rate certificates are classified as available-for-sale securities and are recorded at fair value on the condensed consolidated balance sheet. We estimate fair value of securities with insufficient observable market information by incorporating assumptions that market participants would use in their estimates of fair value. Some of these assumptions included the collateral underlying the security investments, creditworthiness of the counterparty, timing of expected future cash flows, the likelihood of a successful auction in a future period and final stated maturities.

Results of Operations

Revenue

 

     Fiscal Quarter Ended     Change  
     December 28,
2007
    December 26,
2008
    $     %  
     ($ in thousands)  

Licensing

   $ 122,430     $ 154,056     $ 31,626     26 %

Percentage of total revenue

     82 %     85 %    

Product sales

     20,010       17,946       (2,064 )   (10 )%

Percentage of total revenue

     13 %     10 %    

Services

     7,787       8,256       469     6 %

Percentage of total revenue

     5 %     5 %    
                              

Total revenue

   $ 150,227     $ 180,258     $ 30,031     20 %
                              

Licensing. The 26% increase in licensing revenue from the first quarter of fiscal 2008 to the first quarter of fiscal 2009 was driven by increased revenue in all our markets, most notably our broadcast, PC, gaming and mobile markets. Revenue from our PC market was primarily driven by strength in shipments of notebook computers, many of which include third party DVD software and/or Microsoft Vista Home Premium and Ultimate Editions, all of which contain Dolby technologies. The increase in revenue from our broadcast market was primarily driven by sales of U.S. government coupon eligible converter boxes and an increase in the number of digital televisions in North America and Europe that incorporate Dolby Digital compared to a year ago, as well as shipments of set top boxes that incorporate our technologies. The increase in revenue from our gaming market was primarily driven by sales of game consoles. The increase in revenue from our mobile market was primarily driven by the inclusion of HE-AAC technology, obtained through our acquisition of Coding Technologies in fiscal 2008, into mobile devices. We do not believe the effects of recent macroeconomic conditions are reflected in our first quarter of fiscal 2009 licensing results because our recognized licensing revenue generally lags one quarter following sales of products that incorporate our technologies. Consequently, we do not expect to sustain such levels of licensing growth and licensing revenue may decrease in the remainder of fiscal 2009 due to a slowdown in consumer spending, an expected lower percentage of PCs sold with our technologies due to increased growth in netbooks, which do not have Microsoft Vista operating systems, and an expected decline in sales of DVD players

Product Sales. The 10% decrease in product sales from the first quarter of fiscal 2008 to the first quarter of fiscal 2009 was primarily due to a decrease in sales of our traditional cinema products and, to a lesser degree, our broadcast products. These decreases were partially offset by increased sales of our 3D products and digital cinema accessories. We have not recognized most of the revenue related to sales of our digital cinema servers due to certain obligations, which we have yet to satisfy. We currently have approximately $31.2 million of deferred revenue related to digital cinema server and certain 3D product sales.

 

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Services. The 6% increase in services revenue from the first quarter of fiscal 2008 to the first quarter of fiscal 2009 was primarily attributable to an increase in services on original films, including digital films, as well as revenue from digital cinema virtual print fees.

Gross Margin

 

     Fiscal Quarter Ended  
     December 28,
2007
    December 26,
2008
 

Licensing gross margin percentage

   97 %   111 %

Licensing gross margin percentage excluding gain from

amended patent licensing agreement

   97 %   98 %

Product sales gross margin percentage

   42 %   48 %

Services gross margin percentage

   61 %   61 %
            

Total gross margin percentage

   88 %   102 %
            

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

In the fourth quarter of fiscal 2007, we determined that it was appropriate to cease accruing royalty expense relating to an ongoing dispute with an unrelated patent licensor. From the third quarter of fiscal 2006 through the third quarter of fiscal 2007, we had been accruing royalties related to this matter. At September 26, 2008, accrued royalties included $29.2 million relating to this ongoing dispute. In the first quarter of fiscal 2009, we entered into an amendment to the license agreement with the unrelated patent licensor. Under the terms of the amendment, we paid a one time lump sum amount of $17.5 million to buy out all payment obligations and each party released any claims it may have against the other with respect to the license agreement. Of the $17.5 million lump sum payment, $8.3 million was recorded as an intangible asset representing the fair value of the future benefit to be obtained from the payment and $9.2 million was recorded as a reduction to accrued royalties. The remaining accrued royalty balance of $20.0 million was eliminated in the first quarter of fiscal 2009 and recorded as a gain from amended patent licensing agreement. The gain from amended patent licensing agreement was recorded within cost of revenue in our condensed consolidated statement of operations and resulted in increased licensing gross margin in the first quarter of fiscal 2009. For further details, see Note 2, “Composition of Certain Financial Statement Captions” for the discussion regarding accrued liabilities in the notes to our condensed consolidated financial statements.

Product Sales Gross Margin. Cost of product sales primarily consists of material costs related to the products sold, applied labor and manufacturing overhead and, to a lesser extent, amortization of certain intangible assets. Product sales gross margin increased by 6% from the first quarter of fiscal 2008 to the first quarter of fiscal 2009, due to the strengthening of the U.S. dollar against the U.K. pound sterling. This resulted in higher margins as the majority of the U.K. product revenues are dollar denominated while the related costs are primarily pound sterling denominated.

Upon satisfying certain contractual obligations, we expect to recognize revenue and associated costs related to a number of digital cinema servers and 3D products that are currently deferred. We expect that upon the eventual recognition, our product sales gross margins will be adversely impacted because these products were sold at a significantly lower margin than our other products. At December 26, 2008, we have approximately $31.2 million of deferred revenue related to these digital cinema servers and 3D products, and a corresponding $22.6 million of associated costs.

During the second quarter of fiscal 2009, management committed to a plan to consolidate all manufacturing operations into our Brisbane facility and as a result we will have limited internal manufacturing capacity for low volume products and prototypes and will work with contract manufacturers for higher volume products as necessary. This hybrid model will enable us to lower manufacturing cost and increase our average utilization rates while also giving us the capacity to scale production when needed. We believe this hybrid model may favorably impact our product sales gross margins in future periods. However, actual results may differ from our expectations.

 

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Services Gross Margin. Cost of services primarily consists of the payroll and benefits costs of employees performing our professional services, the cost of outside consultants and reimbursable expenses incurred on behalf of customers. Services gross margin was flat year over year.

Operating Expenses

 

     Fiscal Quarter Ended     Change  
     December 28,
2007
    December 26,
2008
    $    %  
     ($ in thousands)  

Selling, general and administrative

   $ 50,986     $ 54,467     $ 3,481    7 %

Percentage of total revenue

     34 %     30 %     

Research and development

     13,907       15,546       1,639    12 %

Percentage of total revenue

     9 %     9 %     
                             

Total operating expenses

   $ 64,893     $ 70,013     $ 5,120    8 %
                             

Selling, General and Administrative. Selling, general and administrative expense consists primarily of personnel and personnel-related expenses, professional service fees, travel related expenses and facility costs for our sales, marketing and administrative functions. The 7% increase in selling, general and administrative expense from the first quarter of fiscal 2008 to the first quarter of fiscal 2009 was primarily due to an increase in personnel expenses relating to an increase in headcount and an increase in professional consulting expenses relating to a third party analysis of our manufacturing operations. These increases were partially offset by decreases in bonus expense and stock-based compensation expense.

Research and Development. Research and development expense consists primarily of compensation and benefits related costs for personnel responsible for the research and development of new technologies and products. The 12% increase in research and development expense from the first quarter of fiscal 2008 to the first quarter of fiscal 2009 was primarily driven by an increase in personnel expenses due to increases in headcount and professional consulting expenses, offset by a decrease in bonus expense.

Other Income, Net

 

     Fiscal Quarter Ended     Change  
     December 28,
2007
    December 26,
2008
    $     %  
     ($ in thousands)  

Interest income

   $ 5,821     $ 4,132     $ (1,689 )   (29 )%

Interest expense

     (363 )     (263 )     100     28 %

Other expense, net

     (254 )     (1,382 )     (1,128 )   444 %
                              

Total other income, net

   $ 5,204     $ 2,487     $ (2,717 )   (52 )%
                              

Other income, net, primarily consists of interest income earned on cash, cash equivalent and investments, offset by interest expense principally attributable to the outstanding balances on our facility debt obligations. Additionally, gains or losses from foreign currency transactions are included in the balances for periods presented.

In November 2008, we accepted a rights offering from UBS. The rights offering provides us with rights (the “Put Rights”) to sell to UBS at par value our auction rate certificates purchased through UBS, at any time during a two year sale period beginning June 30, 2010. We recorded the Put Rights as a financial asset within our other assets line item on our condensed consolidated balance sheet. The related pre-tax gain of $6.6 million was recorded in other expense, net, in our condensed consolidated statement of operations in the first quarter of fiscal 2009. Simultaneous with the acceptance of the rights offering, we reclassified our auction rate certificates from available-for-sale securities to trading securities within our long-term investments line item on our condensed consolidated balance sheet. As a result of the reclassification, unrealized losses pertaining to our auction rate certificates at September 26, 2008 were recognized in our condensed consolidated statement of operations in the first quarter of fiscal 2009. Total losses of $8.0 million pertaining to auction rate certificates were recorded in other expense, net, in our condensed consolidated statement of operations in the first quarter of fiscal 2009.

 

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Income Taxes

 

     Fiscal Quarter Ended  
     December 28,
2007
    December 26,
2008
 
     ($ in thousands)  

Provision for income taxes

   $ 24,607     $ 38,623  

Effective tax rate

     34 %     33 %

Our effective tax rate is based upon a projection of our annual fiscal year results. Our effective tax rate for the first quarter of fiscal 2008 was 34% compared to 33% for the first quarter of fiscal 2009. In fiscal 2009, a change in tax law reinstated research and development tax credits for periods prior to fiscal 2009. As a result, we recognized an increase in research and development tax credits in the first quarter of fiscal 2009, thereby lowering our effective tax rate. We did not recognize a similar benefit in the first quarter of fiscal 2008.

Liquidity, Capital Resources and Financial Condition

 

     September 26,
2008
    December 26,
2008
 
     (in thousands)  

Cash and cash equivalents

   $ 394,761     $ 402,434  

Short-term investments

     119,667       181,123  

Long-term investments

     180,996       198,371  

Accounts receivable, net

     27,650       23,667  

Accounts payable and accrued liabilities

     156,925       129,088  

Working capital(a)

     491,196       548,065  

Net cash provided by operating activities

     264,474       97,424  

Capital expenditures (b)

     (13,610 )     (996 )

Net cash used in investing activities

     (271,338 )     (89,068 )

Net cash provided by financing activities

     34,896       3,394  

 

(a)

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

(b)

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

As of December 26, 2008, we had cash and cash equivalents of $402.4 million, compared to $394.8 million at September 26, 2008. In addition, at December 26, 2008, we had short-term and long-term investments of $379.5 million, compared to $300.7 million at September 26, 2008. Our principal sources of liquidity are our cash, cash equivalents and investments, as well as cash flows from our operations. We believe that our cash, cash equivalents and potential cash flows from operations will be sufficient to satisfy our currently anticipated cash requirements through at least the next 12 months.

Cash provided by operating activities were $97.4 million in the first quarter of fiscal 2009, compared to $76.3 million in the first quarter of fiscal 2008. Cash flows from operating activities consisted of net income adjusted for certain non-cash items, including stock-based compensation, depreciation and amortization, and the effect of changes in working capital and other operating activities. Cash flows from operating activities for the first quarter of fiscal 2009 were primarily driven by net income of $78.1 million. Adjustments for non-cash items included stock-based compensation expense of $4.5 million, deferred taxes of $6.9 million and depreciation and amortization expense of $6.5 million, offset by the gain from amended patent licensing agreement of $20.0 million. Changes in working capital were primarily driven by increases in assets of $3.2 million and decreases in accounts payable and accrued liabilities of $6.5 million offset by increases in deferred revenues of $6.2 million and income taxes of $24.1 million.

Cash used in investing activities for the first quarter of fiscal 2009 were primarily driven by purchases of available-for-sale securities of $79.8 million, net of sales, and cash paid for the purchase of intangible assets of $8.3 million. Capital expenditures were $1.0 million for the first quarter of fiscal 2009, a decrease of $0.5 million from the first quarter of fiscal 2008.

 

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Cash provided by financing activities were $3.4 million in the first quarter of fiscal 2009, compared to $11.6 million in the first quarter of fiscal 2008. Cash flows from financing activities were primarily driven by proceeds from the issuance of stock under our employee stock purchase plan and the exercise of stock options.

As of December 26, 2008, we held auction rate certificates with a par value totaling $70.8 million. In the event we need access to the funds invested in these securities, we will not be able to liquidate these securities until a future auction of these securities is successful, they are refinanced and redeemed by the issuers, or a buyer is found outside of the auction process. On November 11, 2008, we accepted an offer from UBS AG, which we refer to, along with its wholly owned subsidiaries UBS Financial Services, Inc. and UBS Securities LLC, as UBS, to liquidate our auction rate certificates held in UBS accounts on February 13, 2008. The UBS offer entitles us to sell our auction rate certificates for a price equal to the liquidation preference of the auction rate certificates plus accrued but unpaid dividends or interest, if any, at any time during a two year period from June 30, 2010 through July 2, 2012. There is a risk that UBS will not perform its obligations in accordance with their offer. Furthermore, there is no assurance that we will be able to recoup our investments in the auction rate certificates.

Contractual Obligations and Commitments

The following table presents a summary of our contractual obligations and commitments as of December 26, 2008.

 

     Payments Due By Period
     Remainder
of Fiscal
2009
   Fiscal 2010
to 2011
   Fiscal 2012
to 2013
   After
Fiscal 2013
   Total
     (in thousands)

Long-term debt (1)

   $ 1,136    $ 3,284    $ 3,240    $ 754    $ 8,414

Operating leases (2)

     4,619      11,904      9,623      5,538      31,684

Payments on litigation settlement (3)

     3,000      6,000      —        —        9,000
                                  

Total

   $ 8,755    $ 21,188    $ 12,863    $ 6,292    $ 49,098
                                  

 

(1) We maintain three term loans through our consolidated affiliates Dolby Properties, LLC, Dolby Properties Burbank, LLC and Dolby Properties United Kingdom, LLC, for financing commercial and real property at various locations in which we are the primary tenant.
(2) Operating lease payments include future minimum rental commitments, including those payable to our principal stockholder, for non-cancelable operating leases of office space as of December 26, 2008.
(3) In April 2002, we settled a dispute with an unrelated third party and agreed to pay a total of $30.0 million in ten equal annual installments of $3.0 million per year beginning in June 2002. Refer to Note 5 “Legal Proceedings” for further discussion.

Other Cash Obligations. Under the terms of the agreement to acquire all outstanding shares of our subsidiary, Cinea, in September 2003, we have future payment obligations that equal approximately 5% to 8% of the revenue generated from products incorporating certain technologies we acquired in the transaction through 2022. As of December 26, 2008, no additional purchase consideration had been paid and no liability is reflected on our balance sheet.

Recently Issued Accounting Standards

Refer to Note 7 of the Condensed Consolidated Financial Statements for our disclosure on “Recently Issued Accounting Standards.

 

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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Sensitivity

Cash, Cash Equivalents and Investments.

As of December 26, 2008, we had cash and cash equivalents of $402.4 million, which consisted of cash and highly-liquid money market funds. In addition, we had short-term and long-term investments of $379.5 million, which consisted primarily of municipal debt securities, auction rate certificates, variable rate demand notes and United States government agency securities with original maturities greater than 90 days. Many of these investments are subject to fluctuations in interest rates, which could impact our results. At December 26, 2008 the average investment maturity of our investment portfolio was less than six months. Based on our investment portfolio balance as of December 26, 2008, a hypothetical change in interest rates of 1% would have approximately a $2.6 million impact, and a change of 0.5% would have approximately a $1.3 million impact on the carrying value of our portfolio. Furthermore, a hypothetical change in interest rates of 1% would have approximately a $4.2 million impact, and a change of 0.5% would have approximately a $2.1 million impact on interest income over a one-year period.

As of December 26, 2008, we held auction rate certificates with a par value totaling $70.8 million. Auctions for these instruments have failed and there is no assurance that future auctions will succeed. In the event we need access to the funds invested in these securities, we will not be able to liquidate these securities until a future auction of these securities is successful, they are refinanced and redeemed by the issuers, or a buyer is found outside of the auction process. On November 11, 2008, we accepted an offer from UBS AG, which we refer to, along with its wholly owned subsidiaries UBS Financial Services, Inc. and UBS Securities LLC, as UBS, to liquidate our auction rate certificates held in UBS accounts on February 13, 2008. The UBS offer entitles us to sell our auction rate certificates for a price equal to the liquidation preference of the auction rate certificates plus accrued but unpaid dividends or interest, if any, at any time during a two year period from June 30, 2010 through July 2, 2012. There is a risk that UBS will not perform its obligations in accordance with their offer. Furthermore, there is no assurance that we will be able to recoup our investments in the auction rate certificates.

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

Foreign Currency Exchange Risk

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

 

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ITEM 4 – CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

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

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

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the fiscal quarter ended December 26, 2008, 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.

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

Our business is particularly exposed to adverse changes in general economic conditions, because products that incorporate our technologies are entertainment-oriented and generally discretionary goods, such as DVD players, personal computers, digital televisions, mobile devices, set top boxes, home-theaters-in-a-box, camcorders, portable media devices, gaming systems, audio/video receivers and in-car DVD players. The current slowdown or decline in U.S. and foreign economic growth has adversely affected consumer confidence, disposable income and spending. These conditions may persist or worsen. The overall impact they will have on consumer spending is not clear. Sales by our licensees of consumer electronics and other products incorporating our technologies may not grow as rapidly as in prior periods or may even decrease, which would adversely affect our licensing revenue. We do not believe that the effects of recent macroeconomic conditions are reflected in our financial results to date. We do not expect to sustain historical levels of licensing growth, and licensing revenue may decrease, in the remainder of fiscal 2009 due to a slowdown in consumer spending. A continued decline in sales of standard definition DVD players and a potential decline in sales of game consoles along with an expected lower percentage of PCs sold with our technologies, will contribute to an expected decline in revenue growth or even a decline in revenue. In addition, any slowdown in consumer spending will likely negatively impact the motion picture industry and cinema owners, which could result in decreased growth, or a decrease in product sales and services, which could adversely affect our revenue. Furthermore, deteriorating economic conditions result in a greater likelihood that more of our licensees and customers will become delinquent on their obligations to us or be unable to pay, which in turn, could result in a higher level of write-offs, all of which would adversely affect our earnings. Moreover, deteriorating economic conditions and other factors may result in increased underreporting and non-reporting of royalty bearing revenues by our licensees as well as increased unauthorized use of our technologies, which would adversely affect our earnings.

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

Historically, PC manufacturers have frequently included DVD playback functionality as part of the software applications included in their products. Microsoft introduced its Windows Vista operating system in 2007. Two of the six editions of this operating system, the Windows Vista Home Premium Edition and the Windows Vista Ultimate Edition, include Dolby technologies which help enable DVD playback functionality and DVD authoring capabilities. In addition, many major PC manufacturers continue to include additional DVD software applications which offer added DVD functionality not included in the Microsoft operating systems. In the future, PC manufacturers may elect to exclude additional DVD software applications on personal computers that include the Windows Vista Home Premium Edition. Additionally, it is unclear at what pace business customers will migrate from their current operating systems to the Windows Vista operating system, what the adoption rate of the Ultimate

 

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Edition will be, and how such adoption will impact sales of software DVD players for business PCs. In addition, a growing number of lower priced PCs, particularly netbooks are being sold which do not have Microsoft Vista Home Premium or Ultimate Edition operating systems or contain optical disc drives and do not always have DVD playback functionality or Dolby technologies. Consumers may elect to purchase these lower priced PCs instead of computers with DVD playback functionality and Dolby technologies. Further, equipment manufacturers experiencing pricing pressure may elect to exclude optional DVD playback functionality from their products, thereby requiring an additional cost to add this capability, which would adversely affect demand for our technologies. Future shipments of notebooks with Dolby technologies could also decline. If any of the foregoing occur, our licensing revenue will be adversely affected.

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

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

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

Growth in our revenue over the past several years had been the result, in large part, of the rapid growth in sales of DVD players and home theater systems incorporating our technologies. However, as the markets for DVD players has matured sales of DVD players have declined and we expect future sales of traditional consumer DVD players to continue to decline. As sales of DVD players and home theater systems decline our licensing revenue will be adversely affected. Additionally, rate of consumer adoption of Blu-ray Disc players is uncertain and has been and may continue to be slower than past growth rates of traditional DVD players. Slow consumer adoption of Blu-ray Disc players as well as the decline of traditional DVD player license sales could adversely affect our licensing revenue. In addition, if new technologies are developed for use with DVDs or new technologies are developed that substantially compete with or replace DVDs as a dominant medium for consumer video entertainment, and if we are unable to develop and successfully market technologies that are incorporated into or compatible with those new technologies, our business, operating results and prospects will be adversely affected.

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

We derive most of our revenue from the licensing of our technologies to consumer electronics product manufacturers. Licensing revenue represented 80%, 84% and 85% of our total revenue in fiscal 2007, 2008 and the first quarter of fiscal 2009, respectively. We do not manufacture consumer electronics products ourselves and our licensing revenue is dependent on sales by our licensees of products that incorporate our technologies. We cannot control these manufacturers’ product development or commercialization efforts or predict their success. In addition, our license agreements, which typically require manufacturers of consumer electronics products and media software vendors to pay us a specified royalty for every electronics product shipped that incorporates our technologies, do not require these manufacturers to include our technologies in any specific number or percentage of units, and only a few of these agreements guarantee us a minimum aggregate licensing fee. Accordingly, if our licensees sell fewer products incorporating our technologies, or otherwise face significant economic difficulties, our revenue will decline. Moreover, we have a widespread presence in markets for electronics products, such as the consumer electronics product market, which includes DVD players, audio/video receivers and other home theater consumer electronics products, and, as a result, there is little room for us to further penetrate such markets. Lower sales of products incorporating our technologies could occur for a number of reasons. Changes in consumer tastes or trends,

 

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changes in industry standards or adverse changes in business and economic conditions, may adversely affect our licensing revenue. Increasing market saturation, durability of products in the marketplace, competing products and alternate consumer entertainment options could adversely affect demand for new products incorporating our technologies.

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

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

 

   

Digital television and radio broadcasting;

 

   

HDTV;

 

   

Personal computer technology;

 

   

Blu-ray Disc;

 

   

Video game consoles and video games;

 

   

Imaging;

 

   

Home DVD recording;

 

   

Personal audio and video players, including internet music applications;

 

   

Broadband internet; and

 

   

Mobile devices.

Our ability to penetrate these markets depends on increased consumer demand for products that contain our technologies, which may not occur. If these markets do not develop or consumer demand does not grow, it would have a material adverse effect on our business and prospects. Whether our revenue from digital broadcast networks and broadband internet services increases depends upon the expansion of digital broadcast technologies and broadband internet as a medium of entertainment, which may not occur. In addition, even when our technologies are adopted as industry standards for a particular market, such market may not fully develop. In such case, our success depends not only on whether our technologies are adopted as industry standards for such market, but also on the development of that market, which may not occur. Demand for our technologies in any of these developing markets may not continue to grow, and a sufficiently broad base of consumers and professionals may not adopt or continue to use these technologies. In addition, our ability to generate revenue from these markets may be limited to the extent that service providers in these markets choose to provide select technologies and entertainment for little or no cost, such as many of the services provided in connection with broadband internet services. Moreover, some of these markets are ones in which we have not previously participated and, because of our limited experience, we may not be able to adequately adapt our business and our technologies to the needs of customers in these fields.

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

The markets for our products and the markets for consumer electronics products using our licensed technologies are characterized by rapid change and technological evolution. We will need to expend considerable resources on research and development, or acquisitions, in the future in order to continue to design and deliver enduring, innovative entertainment products and technologies. Despite our efforts, we may not be able to develop, or acquire, and effectively market new products, technologies and services that adequately or competitively address the needs of the changing marketplace. For example, we cannot provide assurance that Dolby Volume, Dolby’s volume leveling solution designed to address the annoyances of inconsistent loudness, Dolby 3D Digital Cinema, Dolby’s 3D digital cinema solution, Dolby Contrast or Dolby Vision, Dolby’s dynamic range image technologies for LED

 

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backlit LCD televisions, will address the needs of the marketplace, be effectively marketed or be successful technologies. In addition, we may not correctly identify new or changing market trends at an early enough stage to capitalize on market opportunities. At times such changes can be dramatic, such as the shift from VHS tapes to DVDs for consumer playback of movies in homes and elsewhere. Our future success depends to a great extent on our ability to develop, or acquire, and deliver innovative technologies that are widely adopted in response to changes in the entertainment industry and that are compatible with the technologies or products introduced by other entertainment industry participants.

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

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

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

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

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

 

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

Our quarterly operating results may fluctuate depending upon the timing of when we receive royalty reports from our licensees and of the satisfaction of our revenue recognition criteria. We recognize license revenue only after we receive royalty reports from our licensees regarding the shipment of their products that incorporate our technologies. As a result, the timing of our revenue depends upon the timing of our receipt of those reports. In addition, it is not uncommon for royalty reports to include positive or negative corrective or retroactive royalties that cover extended periods of time. Furthermore, there have been times in the past when we have recognized an unusually large amount of licensing revenue from a licensee in a given quarter because not all of our revenue recognition criteria were met in prior periods. This can result in a large amount of licensing revenue from a licensee being recorded in a given quarter that is not necessarily indicative of the amounts of licensing revenue to be received from that licensee in future quarters, thus causing fluctuations in our operating results. For example, in the second quarter of fiscal 2007 and the first quarter of fiscal 2009 we recognized approximately $7.7 million and $6.5 million, respectively, in licensing revenue from two separate licensees related to royalties on shipments in prior periods.

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

The entertainment industry depends upon industry standards to ensure the compatibility of its content across a wide variety of entertainment systems and products. Accordingly, we make significant efforts to design our products and technologies to address 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, including digital cinema. To have our products and technologies adopted as industry standards, we must convince a broad spectrum of professional organizations throughout the world, as well as our major customers and licensees who are members of such organizations, to adopt them as such and to ensure that other industry standards are consistent with our products and technologies. If our technologies are not adopted or do not remain as industry standards, our business, operating results and prospects could be materially and adversely affected. We expect that meeting, maintaining and establishing industry standard technologies will continue to be critical to our business in the future. In addition, the market for broadcast technologies has traditionally been heavily based upon industry standards, often set by governments or other regulatory bodies, and we expect this to continue to be the case in the future. If our technologies are not chosen as industry standards for broadcasting in particular geographic areas, this could adversely affect our ability to compete in these markets.

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

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

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

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

 

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

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

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

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

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

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

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

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

 

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

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

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

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

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

The cinema industry is still in the early stages of the adoption of digital cinema for the distribution and exhibition of movies. A number of companies offer competing products for digital cinema, some of which are priced lower than our products or offer features that exhibitors may perceive to be potentially advantageous to our products. At least one competitor has a significantly greater installed base of its competing digital cinema playback servers than we do and another competitor has a significantly greater installed base of its competing 3D products than we do, either of which could limit our eventual share of the digital cinema market and materially and adversely affect our operating results. As the market for digital cinema has grown, we have faced more competitive pricing pressures than we have traditionally experienced for our traditional cinema products. As a result, we have implemented and may have to continue to implement pricing strategies which will have an adverse impact on our product sales gross margins in the future.

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

If the major motion picture studios and the cinema exhibition industry cannot agree on one or more business models for digital cinema equipment financing or if funding is not available on favorable terms or at all, the broad adoption of digital cinema will be delayed further. The conversion of movie theatres from film to digital cinema will

 

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require significant capital investment and recent events in the lending market have resulted in system integrator difficulty in obtaining funding delaying broader adoption of digital cinema. We cannot predict how quickly digital cinema will become widely adopted. At present only a small percentage of movie theatres have been converted to digital cinema, and we expect the conversion of theatres to digital cinema technologies, if it occurs, to be a multi year process due to both technological and financial obstacles. If the demand for digital cinema equipment develops more slowly than expected, or if there is significant and sustained resistance by the motion picture studios or cinema exhibitors to this technology or the cost of implementation, or if funding is not available on favorable terms or at all, the broad adoption of digital cinema will continue to be delayed which could adversely affect our revenue.

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

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

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

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

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

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

 

   

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

 

   

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

 

   

Retaining employees from businesses we acquire;

 

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

 

   

Possible write-offs or impairment charges resulting from acquisitions;

 

   

Unanticipated or unknown liabilities relating to acquired businesses; and

 

   

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

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

Pricing pressures on the electronics product manufacturers who incorporate our technologies into their products could limit the licensing fees we charge for our technologies, which could adversely affect our revenues.

The markets for the consumer electronics products in which our technologies are incorporated are intensely competitive and price sensitive. Retail prices for consumer electronics products that include our sound technology, such as DVD players and home theater systems, have decreased significantly, and we expect prices to continue to decrease for the foreseeable future. In response, manufacturers have sought to reduce their product costs, which can result in downward pressure on the licensing fees we charge our customers who incorporate our technologies into the consumer electronics products that they sell. Further, while we have contractual rights with many of our licensees for cost of living adjustments to our royalty rights, we may not be able to negotiate those terms in future contracts with existing and new licensees. A decline in, or the loss of the contractual right to increase, the licensing fees we charge could materially and adversely affect our operating results.

If sales of consumer electronics products incorporating our technologies do not grow in emerging markets, our ability to increase our licensing revenue may be limited.

We also expect that growth in our licensing revenue will depend, in part, upon the growth of sales of consumer electronics products incorporating our technologies in emerging economies, as consumers in these markets have more disposable income and are increasingly purchasing entertainment products with surround sound capabilities. However, if our licensing revenue from the use of our technologies in these new markets or geographic areas does not expand, our prospects could be adversely affected.

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

If we fail to maintain and expand our relationships with a broad range of participants throughout the entertainment chain, including motion picture studios, broadcasters, video game designers, music producers and manufacturers of consumer electronics products, our business and prospects could be materially harmed. Relationships have historically played an important role in the entertainment industries that we serve. For example, sales of our products and services are particularly dependent upon our relationships with the major motion picture studios and broadcasters, and licensing of our technology is particularly dependent upon our relationships with consumer electronics product manufacturers, media software vendors and integrated circuit, or IC, manufacturers. If we fail to maintain and strengthen these relationships, these entertainment industry participants may be more likely not to purchase and use our products, services and technologies, or create content incorporating our technologies,

 

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which could materially harm our business and prospects. In addition to directly providing substantially all of our revenue, these relationships are also critical to our ability to have our technologies adopted as industry standards. In addition, if major industry participants form strategic relationships that exclude us, whether in products, services or licensing, our business and prospects could be materially adversely affected.

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

We have a relatively limited number of issued patents in particular countries, including China and India. For example, in China we have only limited patent protection, especially with respect to our Dolby Digital technologies. In India, we have no issued patents for Dolby Digital technologies. Consequently, 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 of these countries, the effectiveness of patents obtained or that may in the future be obtained, if any, is likewise uncertain.

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

We are dependent on international sales for a substantial amount of our total revenue. For fiscal 2007, 2008 and the first quarter of fiscal 2009, revenue from outside the United States was 70%, 66% and 70% of our total revenue, respectively. We expect that international and export sales will continue to represent a substantial portion of our revenue for the foreseeable future. This future revenue will depend to a large extent on the continued use and expansion of our technologies in entertainment industries worldwide. Increased worldwide use of our technologies is also an important factor in our future growth.

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

 

   

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

 

   

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

 

   

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

 

   

Foreign labor laws, regulations and restrictions;

 

   

Changes in diplomatic and trade relationships;

 

   

Difficulty in staffing and managing foreign operations;

 

   

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.

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

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

 

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

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

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

As of December 26, 2008, we had approximately 1,515 individual issued patents and 1,930 pending patent applications in nearly 45 jurisdictions throughout the world. Our issued patents are scheduled to expire at various times through September 2027. Of these, five patents are scheduled to expire in calendar year 2009, 110 patents are scheduled to expire in calendar year 2010 and 34 patents are scheduled to expire in calendar year 2011. We derive our licensing revenue principally from our Dolby Digital technologies. Patents relating to our Dolby Digital technologies generally expire between 2009 and 2017, and patents relating to our Dolby Digital Plus technologies, an extension of Dolby Digital, expire between 2019 and 2025. In addition, the remaining patents relating to Dolby Digital Live technologies, an extension of Dolby Digital, are scheduled to expire in 2021.

The impact of potential domestic patent reform legislation, USPTO reforms, imposed international patent rules and third party legal proceedings may impact our patent prosecution and licensing strategies.

Changes to certain US patent laws and regulations may occur in the future, some or all of which may impact our patent costs, the scope of future patent coverage we secure, and damages we may be awarded in patent litigation, and may require us to re-evaluate and modify our patent prosecution, licensing and enforcement strategies. Specifically, on August 21, 2007, the United States Patent and Trademark Office issued final administrative rule changes affecting the US patent application process, including among other things, the current practice regarding continuation applications. The rule changes were set to take effect on November 1, 2007; however, in the course of a lawsuit filed by GlaxoSmithKline on Tuesday, October 9, 2007, in the United Stated Federal District Court for the Eastern District of Virginia, one day before the rules changes were to take effect, the judge in that case ruled to preliminarily enjoin the USPTO from implementing these changes. The U.S. Congress is also considering modification of select patent laws relating to, among other things, how patent damages are calculated and the procedures for challenging issued patents and where patent lawsuits can be filed in the US. Specifically, The Patent Reform Act of 2007 (S.1145 and H.R.1908) is currently being considered for passage by the Congress. S.1145, as

 

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amended, was reported out of committee on July 19, 2007. H.R.1908, as amended, was reported out of committee on July 18, 2007, and was debated and passed by the House on September 7, 2007. Additionally, there have been recent U.S. Supreme Court and other court rulings relating to, among other things, the standard for determining whether an invention is obvious, which is a key issue when assessing patentability, the ability of a patent holder to obtain injunctive relief against infringers, and the ability of patent licensees to challenge the patents under which they are licensed. The ruling concerning injunctions may make it more difficult, under some circumstances, for us to obtain injunctive relief against a party that has been found to infringe one or more of our patents, and the ruling regarding patent challenges by licensees could potentially make it easier for our licensees to challenge our patents even though they have already agreed to take a license. In addition, the potential effect of rulings in legal proceedings between third parties may impact our licensing program. We continue to monitor and evaluate our prosecution and licensing strategies with regard to these proposals and changes.

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

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

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

Sales of our cinema products and services tend to fluctuate based on the underlying trends in the motion picture industry. For example, when box office receipts for the motion picture industry increase, we have typically seen sales of our cinema products increase as well, as cinema owners are more likely to build new theatres and upgrade existing theatres with our more advanced products when they are doing well financially. Conversely, when box office receipts are down cinema owners tend to scale back on plans to expand or upgrade their systems. Our cinema product sales are also subject to fluctuations based on events and conditions in the cinema exhibition industry generally that may or may not be tied to box office receipts in particular time periods. For example, the growth in piracy of motion pictures adversely affects the construction of new screens, the renovation of existing theatres and the continued production of new motion pictures. Technological advances and the conversion of motion pictures into digital formats have made it easier to create, transmit and “share” high quality unauthorized copies of motion pictures, including on pirated DVDs and on the internet. The launch of new high definition digital services by broadcasters may also influence the sale of our cinema products if consumers decide to watch content at home rather than going to the cinema to watch motion pictures. On the other hand, our services revenue, both in the United States and internationally, is tied to the number of films being made by major studios and independent filmmakers. A number of factors can affect the number of films that are produced, including strikes and work stoppages within the motion picture industry, as well as by the tax incentive arrangements that many foreign governments provide filmmakers to promote local filmmaking.

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

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

 

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

Although the cinema industry is still in the early stages of the transition to digital cinema technologies for the distribution and exhibition of motion pictures, the number of cinema exhibitors adopting digital cinema for new theatre construction or existing theatre upgrades continues to grow. As exhibitors have constructed new theatres or upgraded existing theatres they have generally chosen digital cinema over traditional film cinema and we expect this trend to continue. While our film sound formats are the de facto standard and our film soundtrack cinema processors are widely used around the world, digital cinema, which is based on open standards, does not include our proprietary audio formats. Generally, as the film industry continues to adopt digital cinema, the demand for our traditional cinema products and services has declined and we anticipate that the demand for film based products will continue to decline in future periods. Furthermore, exhibitors adopting digital cinema can choose from multiple digital cinema playback servers other than ours, none of which contain our technologies. A decrease in the demand for our traditional film cinema products and services that is not accompanied by a meaningful increase in revenue from digital cinema products and services would adversely affect our revenue stream from the cinema industry.

In addition, a decrease in the demand for our products and services could adversely affect licensing of our consumer technology, 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.

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

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

Adverse developments in general macroeconomic conditions;

 

   

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

 

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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;

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

Costs of litigation and intellectual property protection; and

 

   

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

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

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

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

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

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

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

We license some of our patents through our wholly owned subsidiary Via Licensing Corporation in joint licensing programs, or “patent pools,” with other companies in an effort to ensure that our technologies are compatible with other technologies in the entertainment industry and to promote our technologies as industry standards. These patent pools allow product manufacturers streamlined access to selected foundational technologies

 

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and are comprised of a group of patents held by a number of companies, including us in some cases, and administered by Via Licensing. If we do not identify new or changing market trends and technologies at an early enough stage to capitalize on market opportunities for joint licensing programs, we may not continue to be successful with this business model. Also, to the extent that Dolby technologies are included in patent pools, we have less control over the licensing of those technologies through the patent pools compared to licensing through our traditional business model in which we license our patents as bundles of technologies and interact directly with our customers. In addition, we may have less control over the application and quality control of our technologies included in these pools.

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

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

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

Our products are highly complex, and production difficulties or inefficiencies can interrupt production, resulting in our inability to deliver products on time in a cost effective manner, which could harm our competitive position. We recently conducted an analysis of our manufacturing footprint and, as a result, we plan to consolidate our manufacturing operations into a single location and work with a contract manufacturer for higher volume production as necessary. If production of our products is interrupted as a result of this consolidation or otherwise, we may not be able to manufacture products on a timely basis, and customers may purchase products from our competitors. A shortage of manufacturing capacity for our products could adversely affect our operating results and damage our customer relationships. We generally cannot quickly adapt our manufacturing capacity to rapidly changing market conditions and a contract manufacturer may encounter difficulties as well. Likewise, we may be unable to respond to fluctuations in customer demand. At times we underutilize our manufacturing facilities as a result of reduced demand for some of our products. Any inability to respond to fluctuations in customer demand for our products may adversely affect our gross margins.

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

Our products are complex and sometimes contain undetected software or hardware errors, particularly when first introduced or when new versions are released. In addition, to the extent that we engage contract manufacturers we will 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 face claims for product liability. Although we generally attempt to contractually limit liability for defective products to the cost of repairing or replacing these products, if these contract provisions are not enforced, or are unenforceable for any reason, or if liabilities arise that are not effectively limited, we could incur substantial costs in defending and settling product liability claims.

 

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

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

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

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

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

From time to time, one or a small number of our customers or licensees may represent a significant percentage of our products, services or licensing revenue. For example, revenue from our largest customer represented 12% of total revenue for fiscal 2008. Although we have agreements with many of these customers, these agreements typically do not require any minimum purchases or minimum royalty fees and do not prohibit customers from purchasing products and services from competitors. A decision by any of our major customers or licensees not to use our technologies, or their failure or inability to pay amounts owed to us in a timely manner, or at all, whether due to strategic redirections or adverse changes in their businesses or for other reasons, could have a significant adverse effect on our operating results.

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

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

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

 

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

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

Our business is dependent upon our patents, trademarks, trade secrets, copyrights and other intellectual property rights. Licensing revenue represented 80%, 84% and 85% of our total revenue in the fiscal years 2007, 2008 and the first quarter of fiscal 2009, respectively. Effective intellectual property rights protection, however, may not be available under the laws of every country in which our products and services and those of our licensees are distributed. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Any significant impairment of our intellectual property rights could harm our business or our ability to compete. In addition, protecting our intellectual property rights is costly and time consuming. We have taken steps in the past to enforce our intellectual property rights and expect to continue to do so in the future. However, it may not be practicable or cost effective for us to enforce our intellectual property rights fully, particularly in particular countries or where the initiation of a claim might harm our business relationships. For example, we have many times experienced, and expect to continue to experience, problems with consumer electronics product manufacturers incorporating our technologies into their products without our authorization. If we are unable to successfully identify and stop unauthorized use of our intellectual property, we could experience increased operational and enforcement costs, which could adversely affect our financial condition and results of operations. We generally seek patent protection for our innovations. However, it is possible that some of these innovations may not be protectable. In addition, given the costs of obtaining patent protection, we may choose not to protect particular innovations that later turn out to be important. Moreover, we have limited or no patent protection in particular foreign jurisdictions. For example, in China we have only limited patent protection, especially with respect to our Dolby Digital technologies, and in India we have no issued patents. Furthermore, there is always the possibility, despite our efforts, that the scope of the protection gained will be insufficient or that an issued patent may later be found to be invalid or unenforceable. Moreover, we seek to maintain select intellectual property as trade secrets. These trade secrets could be compromised by third parties, or intentionally or accidentally by our employees, which would cause us to lose the competitive advantage resulting from them.

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. government agency securities, variable rate demand notes, auction rate certificates and municipal debt securities. These investments are subject to general credit, liquidity, market and interest rate risks.

Our long-term investments include auction rate certificates at fair value. Auctions for these instruments began failing during the second quarter of fiscal 2008 and continued to fail through the end of our first quarter of fiscal 2009, resulting in our inability to liquidate these securities. Moreover, a liquid secondary market has not developed for these instruments. On November 11, 2008, we accepted an offer from UBS AG, which we refer to, along with its wholly owned subsidiaries UBS Financial Services, Inc. and UBS Securities LLC, as UBS, to liquidate our auction rate certificates held in UBS accounts on February 13, 2008. The UBS offer entitles us to sell our auction rate certificates for a price equal to the liquidation preference of the auction rate certificates plus accrued but unpaid dividends or interest, if any, at any time during a two year period from June 30, 2010 through July 2, 2012. There is a risk that UBS will not perform its obligations in accordance with their offer. Furthermore, there is no assurance that we will be able to recoup our investments in the auction rate certificates.

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

 

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We face risks associated with international trade and currency exchange.

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

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

Our operations and business practices are subject to federal, state and local government laws and regulations, as well as international laws and regulations, including those relating to consumer and other safety related compliance for electronic equipment, as well as compulsory license requirements as a prerequisite to being included as part of industry standards, such as the United States HDTV standard. Any failure by us to comply with the laws and regulations applicable to us or our products could result in our inability to sell those products, additional costs to redesign products to meet such laws and regulations, fines or other administrative actions by the agencies charged with enforcing compliance and, possibly, damages awarded to persons claiming injury as the result of our non-compliance. Changes in or enactment of new statutes, rules or regulations applicable to us could have a material adverse effect on our business.

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

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

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

Our performance is largely dependent on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization. In this regard, we currently plan to hire a number of employees throughout fiscal 2009 in response to our growth and our current initiatives. We have maintained a rigorous, highly selective and time consuming hiring process, which we believe has significantly contributed to our success to date, but has made it more difficult for us to hire a sufficient number of qualified employees. As we grow, our hiring process may prevent us from hiring the personnel we need in a timely manner. In addition, we are aware that some of our competitors have directly targeted our employees. If we are unable to hire and train a sufficient number of qualified employees or retain and motivate existing employees, our existing operations may suffer and we may be unable to grow effectively.

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

We have a complex business organization that is international in scope. Ensuring that we have adequate internal financial and accounting controls and procedures in place to help ensure that we can produce accurate financial statements on a timely basis is a costly and time consuming effort that needs to be re-evaluated frequently. On an ongoing basis, we document, review and, if appropriate, improve our internal controls and procedures in connection

 

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with Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors addressing these assessments. For example, in the first quarter of fiscal 2009 we initiated the development phase of an upgrade to our existing enterprise resource planning system which is expected to be completed during fiscal year 2009. Both we and our independent auditors periodically test our internal controls in connection with the Section 404 requirements and could, as part of that documentation and testing, identify areas for further attention or improvement. Implementing any appropriate changes to our internal controls may require specific compliance training of our directors, officers and employees, entail substantial costs in order to modify our existing accounting systems, and take a significant period of time to complete. Such changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In addition, investors’ perceptions that our internal controls are inadequate or that we are unable to produce accurate financial statements may seriously affect our stock price.

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

At December 26, 2008, Ray Dolby and his affiliates owned 100 shares of our Class A common stock and 60,000,000 shares of our Class B common stock. As of December 26, 2008, Ray Dolby and his affiliates, including his family members, had voting power of approximately 99% of our outstanding Class B common stock, which in the aggregate represented approximately 91% of the combined voting power of our outstanding Class A and Class B common stock. Under our certificate of incorporation, holders of Class B common stock are entitled to ten votes per share while holders of Class A common stock are entitled to one vote per share. Generally, shares of Class B common stock automatically convert into shares of Class A common stock upon transfer of such Class B common stock, other than transfers to certain specified persons and entities, including the spouse and descendants of Ray Dolby and the spouses and domestic partners of such descendants. Because of this dual class structure, Ray Dolby, his affiliates, and his family members and descendants will, for the foreseeable future, have significant influence over our management and affairs, and will be able to control virtually all matters requiring stockholder approval, including the election of directors and significant corporate transactions such as mergers or other sales of our company or assets, even if they come to own considerably less than 50% of the total number of outstanding shares of our Class A and Class B common stock. Ray Dolby, his affiliates, his family members and descendants will maintain this control even if in the future they come to own considerably less than 50% of the total number of outstanding shares of our Class A and Class B common stock. Moreover, these persons may take actions in their own interests that you or our other stockholders do not view as beneficial. Absent a transfer of Class B common stock that would trigger an automatic conversion as described above, there is no threshold or time deadline at which the shares of Class B common stock will automatically convert into shares of Class A common stock. Assuming conversion of all shares of Class B common stock held by persons not affiliated with Ray Dolby into shares of Class A common stock, so long as Ray Dolby and his affiliates, his family members and descendants continue to hold shares of Class B common stock representing approximately 10% or more of the total number of outstanding shares of our Class A and Class B common stock, they will hold a majority of the combined voting power of the Class A and Class B common stock.

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

If our founder, officers, directors or employees sell, or indicate an intention to sell, substantial amounts of our Class A common stock in the public market, including shares of Class A common stock issuable upon conversion of shares of Class B common stock, the trading price of our Class A common stock could decline. As of December 26, 2008, we had a total of 112,697,229 shares of Class A and Class B common stock outstanding. Of these shares, 31,625,000 shares of Class A common stock were sold in our initial public offering by us and the selling stockholders, and an additional 8,000,000 shares of Class A common stock were sold in a secondary offering in May 2007 by our principal stockholder.

As of December 26, 2008, our directors and executive officers beneficially held 60,182,750 shares of Class B common stock, 4,806 shares of Class A common stock, vested options to purchase 557,034 shares of Class B common stock and vested options to purchase 369,163 shares of Class A common stock. We expect that any sale of our Class A common stock by our directors and executive officers would be subject to compliance with Rule 144 under the Securities Act.

 

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

Sales of Unregistered Securities

In the fiscal quarter ended December 26, 2008, we issued an aggregate of 109,018 shares of our Class B common stock to certain employees, officers and directors upon the exercise of options awarded under our 2000 Stock Incentive Plan and since December 27, 2008 through January 21, 2009, we issued an aggregate of 35,415 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 $0.3 million in the fiscal quarter ended December 26, 2008, and approximately $0.1 million in the period since December 27, 2008 through January 21, 2009 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 21, 2009 options to purchase an aggregate of 2,267,566 shares of our Class B common stock remain outstanding. All issuances of shares of our Class B common stock pursuant to the exercise of these options will be made in reliance on Rule 701. All option grants made under the 2000 Stock Incentive Plan were made prior to the effectiveness of our initial public offering. No further option grants will be made under our 2000 Stock Incentive Plan.

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

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

 

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ITEM 6. EXHIBITS

 

         

Incorporated by Reference Herein

Exhibit
Number

  

Description

  

Form

   Date
10.1*    2009 Dolby Executive Annual Incentive Plan    Current Report on Form 8-K    December 17, 2008
10.2*    Employee Stock Purchase Plan, as amended and restated      
10.3    Amendment No. 2 to the License Agreement effective January 1, 1992 by and between GTE Laboratories Incorporated (now known as Verizon Corporate Services Corp.) and Dolby Laboratories Licensing Corporation      
31.1    Certification by the Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.      
31.2    Certification by the Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.      
32.1 ‡    Certification by the Chief Executive Officer and the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.      

 

* Denotes a management contract or compensatory arrangement
Furnished herewith

 

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SIGNATURES

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

Date: February 4, 2009

 

DOLBY LABORATORIES, INC.
By:  

/s/ Kevin J. Yeaman

  Kevin J. Yeaman
  Chief Financial Officer
  (Principal Financial and Accounting
  Officer and Duly Authorized Officer)

 

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INDEX TO EXHIBITS

 

         

Incorporated by Reference Herein

Exhibit
Number

  

Description

  

Form

   Date
10.1*    2009 Dolby Executive Annual Incentive Plan    Current Report on Form 8-K    December 17, 2008
10.2*    Employee Stock Purchase Plan, as amended and restated      
10.3    Amendment No. 2 to the License Agreement effective January 1, 1992 by and between GTE Laboratories Incorporated (now known as Verizon Corporate Services Corp.) and Dolby Laboratories Licensing Corporation      
31.1    Certification by the Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.      
31.2    Certification by the Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.      
32.1 ‡    Certification by the Chief Executive Officer and the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.      

 

* Denotes a management contract or compensatory arrangement
Furnished herewith

 

50

Employee Stock Purchase Plan, as amended and restated

Exhibit 10.2

DOLBY LABORATORIES, INC.

EMPLOYEE STOCK PURCHASE PLAN

Adopted Effective February 16, 2005

Amended and Restated on October 13, 2005

Amended and Restated on February 5, 2008

Amended and Restated on November 4, 2008; Effective May 18, 2009

1. Purpose. The purpose of the Plan is to provide employees of the Company and its Designated Subsidiaries and Designated Affiliates with an opportunity to purchase Common Stock of the Company. This Plan includes two components: a Code Section 423 Component (the “423 Component”) and a non-Code Section 423 Component (the “Non-423 Component”). It is the intention of the Company to have the 423 Component qualify as an “Employee Stock Purchase Plan” under Section 423 of the Code. The provisions of the 423 Component, accordingly, shall be construed so as to extend and limit participation in a uniform and nondiscriminatory basis consistent with the requirements of Section 423 of the Code. In addition, this Plan authorizes the grant of options under the Non-423 Component which do not qualify under Section 423 of the Code pursuant to rules, procedures or subplans adopted by the Administrator designed to achieve tax, securities laws or other objectives for Eligible Employees and the Company. Except as otherwise indicated, the Non-423 Component will operate and be administered in the same manner as the 423 Component.

2. Definitions.

(a) “Administrator” shall mean the Board or any Committee designated by the Board to administer the Plan pursuant to Section 14.

(b) “Affiliate” shall mean any corporation or other entity affiliated with the Company or in which the Company has an interest.

(c) “Board” shall mean the Board of Directors of the Company.

(d) “Change in Control” means the occurrence of any of the following events:

(i) Any “person” (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) other than a Permitted Transferee (as defined in the Company’s Amended and Restated Certificate of Incorporation) becomes the “beneficial owner” (as defined in Rule 13d-3 of the Exchange Act), directly or indirectly, of securities of the Company representing more than fifty percent (50%) of the total voting power represented by the Company’s then outstanding voting securities; or

(ii) The consummation of the sale or disposition by the Company of all or substantially all of the Company’s assets; or

(iii) A change in the composition of the Board occurring within a one-year period, as a result of which fewer than a majority of the directors are Incumbent Directors. “Incumbent Directors” means directors who either (A) are Directors as of the effective date of the


Plan, or (B) are elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the Directors at the time of such election or nomination (but will not include an individual whose election or nomination is in connection with an actual or threatened proxy contest relating to the election of directors to the Company); or

(iv) The consummation of a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity or its parent) at least fifty percent (50%) of the total voting power represented by the voting securities of the Company or such surviving entity or its parent outstanding immediately after such merger or consolidation.

(e) “Code” shall mean the Internal Revenue Code of 1986, as amended.

(f) “Committee” means a committee of the Board appointed by the Board in accordance with Section 14 hereof.

(g) “Common Stock” shall mean the Class A Common Stock of the Company.

(h) “Company” shall mean Dolby Laboratories, Inc., a Delaware corporation.

(i) “Compensation” shall mean all base straight time gross earnings, commissions, overtime and shift premium, but exclusive of payments for incentive compensation, bonuses and other compensation. The Administrator shall have the discretion to determine the application of this definition to participants outside the United States.

(j) “Designated Affiliate” shall mean any Affiliate selected by the Administrator as eligible to participate in the Non-423 Component.

(k) “Designated Subsidiary” shall mean any Subsidiary selected by the Administrator as eligible to participate in the 423 Component.

(l) “Director” shall mean a member of the Board.

(m) “Eligible Employee” shall mean (i) any individual who is treated as an active employee in the records of the Company or any Designated Subsidiary or (ii) any individual who is treated as an active employee in the records of any Designated Affiliate other than an individual who, as of the Offering Date, resides in a country that has been specifically excluded from participation in the Non-423 Component at the discretion of the Administrator. For the 423 Component, Eligible Employees shall include only those employees whose customary employment with the Company or Designated Subsidiary is at least fifteen (15) hours per week and more than five (5) months in any calendar year. For purposes of the Plan, the employment relationship shall be treated as continuing intact while the individual is on sick leave or other leave of absence approved by the Company. Where the period of leave exceeds three (3) months and the individual’s right to reemployment is not guaranteed either by statute, legal precedent or by contract, the employment relationship shall be deemed to have terminated on the day which is three (3) months and one (1) day after the beginning of such leave. The employment relationship shall be treated as continuing intact


where an Eligible Employee transfers employment between a Designated Subsidiary and a Designated Affiliate, and vice-versa, provided, however, that a participant who is not employed by a Designated Subsidiary on the Offering Date and through a date that is no more than three (3) months prior to the Exercise Date will participate only in the Non-423 Component. The Administrator shall establish rules to govern other such transfers consistent with the applicable requirements of Section 423 of the Code.

(n) “Exchange Act” shall mean the Securities Exchange Act of 1934, as amended.

(o) “Exercise Date” shall mean the first Trading Day on or after May 15 and November 15 of each year.

(p) “Fair Market Value” shall mean, as of any date and unless the Administrator determines otherwise, the value of Common Stock determined as follows:

(i) If the Common Stock is listed on any established stock exchange or a national market system, including without limitation the New York Stock Exchange, the Nasdaq Global Market, the Nasdaq Global Select or the Nasdaq Capital Market, its Fair Market Value shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such exchange or system on the date of determination, as reported in The Wall Street Journal or such other source as the Board deems reliable;

(ii) If the Common Stock is regularly quoted by a recognized securities dealer but selling prices are not reported, its Fair Market Value shall be the mean of the closing bid and asked prices for the Common Stock on the date of determination, as reported in The Wall Street Journal or such other source as the Board deems reliable; or

(iii) In the absence of an established market for the Common Stock, the Fair Market Value thereof shall be determined in good faith by the Board.

(q) “Offering Date” shall mean the first Trading Day of each Offering Period.

(r) “Offering Periods” shall mean the periods of approximately six (6) months during which an option granted pursuant to the Plan may be exercised, commencing on the first Trading Day after the prior Offering Period’s Exercise Date and terminating on the first Trading Day on or after May 15 or November 15 of each year, as applicable, approximately six months later. For example, the May 2009 Offering Period will commence on May 18, 2009, which is the first Trading Day after the prior Offering Period’s Exercise Date which will take place on May 15, 2009. The duration and timing of Offering Periods may be changed pursuant to Section 4 of this Plan.

(s) “Plan” shall mean this Employee Stock Purchase Plan including both the 423 and Non-423 Components.

(t) “Purchase Price” shall mean an amount equal to eighty-five percent (85%) of the Fair Market Value of a share of Common Stock on the Exercise Date; provided however, that the Purchase Price may be determined for subsequent Offering Periods by the Administrator in any manner or method it determines, pursuant to Section 20, and subject to (i) with respect to the 423 Component, compliance with Section 423 of the Code (or any successor rule or provision or any


other applicable law, regulation or stock exchange rule) or (ii) with respect to the Non-423 Component, pursuant to such manner or method as determined by the Administrator to comply with non-U.S. requirements.

(u) “Subsidiary” shall mean a “subsidiary corporation,” whether now or hereafter existing, as defined in Section 424(f) of the Code.

(v) “Trading Day” shall mean a day on which the national stock exchange upon which the Company Common Stock is listed is open for trading.

3. Eligibility. Any Eligible Employee on a given Offering Date shall be eligible to participate in the Plan. Any provisions of the Plan to the contrary notwithstanding, no Eligible Employee shall be granted an option under the Plan (i) to the extent that, immediately after the grant, such Eligible Employee (or any other person whose stock would be attributed to such Eligible Employee pursuant to Section 424(d) of the Code) would own capital stock of the Company and/or hold outstanding options to purchase such stock possessing five percent (5%) or more of the total combined voting power or value of all classes of the capital stock of the Company or of any Subsidiary, or (ii) to the extent that his or her rights to purchase stock under all employee stock purchase plans of the Company and its subsidiaries accrues at a rate which exceeds Twenty-Five Thousand Dollars ($25,000) worth of stock (determined at the fair market value of the shares at the time such option is granted) for each calendar year in which such option is outstanding at any time.

4. Offering Periods. The Plan shall be implemented by consecutive Offering Periods with a new Offering Period commencing on the first Trading Day after the prior Offering Period’s Exercise Date, or on such other date as the Board shall determine. The Board shall have the power to change the duration of Offering Periods (including the commencement dates thereof) with respect to future offerings without stockholder approval if such change is announced prior to the scheduled beginning of the first Offering Period to be affected thereafter.

5. Participation. An Eligible Employee may become a participant in the Plan by completing a subscription agreement in a form determined by the Administrator (which may be similar to the form attached hereto as Exhibit A) and filing it with the Company’s designated Plan administrator prior to the applicable Offering Date.

6. Payroll Deductions or Contributions.

(a) At the time a participant files his or her subscription agreement, he or she shall elect to have payroll deductions made on each pay day during the Offering Period in an amount not exceeding 10% of the Compensation which he or she receives on each pay day during the Offering Period, provided, however, that should a pay day occur on an Exercise Date, a participant shall have the payroll deductions made on such day applied to his or her account under the new Offering Period. Eligible Employees participating in the Non-423 Component may contribute funds to participate in the Plan through other means specified by the Administrator to comply with non-U.S. requirements, provided, however, that such contributions shall not exceed 10% of the Compensation received each pay day during the Offering Period. A participant’s subscription agreement shall remain in effect for successive Offering Periods unless terminated as provided in Section 10 hereof.


(b) Payroll deductions or contributions, as applicable, for a participant shall commence on the first pay day following the Offering Date and shall end on the last pay day in the Offering Period to which such authorization is applicable, unless sooner terminated by the participant as provided in Section 10 hereof.

(c) All payroll deductions or contributions made by a participant shall be credited to his or her account under the Plan in whole percentages only. A participant may not make any additional payments into such account.

(d) A participant may discontinue his or her participation in the Plan as provided in Section 10 hereof, or may increase or decrease the rate of his or her payroll deductions or contributions during the Offering Period by completing or filing with the Company a new subscription agreement authorizing a change in payroll deduction rate or contribution. The Administrator may, in its discretion, limit the nature and/or number of participation rate changes during any Offering Period. The change in rate shall be effective with the first full payroll period following five (5) business days after the Company’s receipt of the new subscription agreement unless the Company elects to process a given change in participation more quickly.

(e) Notwithstanding the foregoing, to the extent necessary to comply with Section 423(b)(8) of the Code and Section 3(c) hereof, a participant’s payroll deductions or contributions may be decreased to zero percent (0%) at any time during an Offering Period. Payroll deductions or contributions shall recommence at the rate provided in such participant’s subscription agreement at the beginning of the first Offering Period which is scheduled to end in the following calendar year, unless terminated by the participant as provided in Section 10 hereof.

(f) At the time the option is exercised, in whole or in part, or at the time some or all of the Company’s Common Stock issued under the Plan is disposed of, the participant must make adequate provision for the Company’s or its Subsidiary’s or Affiliate’s federal, state, or any other tax liability payable to any authority, national insurance, social security, payment on account or other tax withholding obligations, if any, which arise upon the exercise of the option or the disposition of the Common Stock including, for the avoidance of doubt, any liability of the participant to pay an employer tax or social contribution obligation, which liability has been shifted to the participant as a matter of law or contract. At any time, the Company or its Subsidiary or Affiliate, as applicable, may, but shall not be obligated to, withhold from the participant’s compensation the amount necessary for the Company or its Subsidiary or Affiliate, as applicable, to meet applicable withholding obligations, including any withholding required to make available to the Company or its Subsidiary or Affiliate, as applicable, any tax deductions or benefits attributable to sale or early disposition of Common Stock by the Eligible Employee.

7. Grant of Option. On the Offering Date of each Offering Period, each Eligible Employee participating in such Offering Period shall be granted an option to purchase on each Exercise Date during such Offering Period (at the applicable Purchase Price) up to a number of shares of the Company’s Common Stock determined by dividing such Eligible Employee’s payroll deductions or contributions accumulated prior to such Exercise Date by the applicable Purchase Price; provided that in no event shall an Eligible Employee be permitted to purchase during each Offering Period more than 1,000 shares of the Company’s Common Stock (subject to any adjustment pursuant to Section 19), and provided further that such purchase shall be subject to the


limitations set forth in Sections 3(c) and 13 hereof. The Eligible Employee may accept the grant of such option by turning in a completed Subscription Agreement (attached hereto as Exhibit A) to the Company on or prior to an Offering Date. The Administrator may, for future Offering Periods, increase or decrease, in its absolute discretion, the maximum number of shares of the Company’s Common Stock an Eligible Employee may purchase during each Offering Period. Exercise of the option shall occur as provided in Section 8 hereof, unless the participant has withdrawn pursuant to Section 10 hereof. The option shall expire on the last day of the Offering Period.

8. Exercise of Option.

(a) Unless a participant withdraws from the Plan as provided in Section 10 hereof, his or her option for the purchase of shares shall be exercised automatically on the Exercise Date, and the maximum number of full shares subject to option shall be purchased for such participant at the applicable Purchase Price with the accumulated payroll deductions or contributions in his or her account. No fractional shares shall be purchased; any payroll deductions or contributions accumulated in a participant’s account which are not sufficient to purchase a full share shall be retained in the participant’s account for the subsequent Offering Period, subject to earlier withdrawal by the participant as provided in Section 10 hereof. Any other funds left over in a participant’s account after the Exercise Date shall be returned to the participant. During a participant’s lifetime, a participant’s option to purchase shares hereunder is exercisable only by him or her.

(b) If the Administrator determines that, on a given Exercise Date, the number of shares with respect to which options are to be exercised may exceed (i) the number of shares of Common Stock that were available for sale under the Plan on the Offering Date of the applicable Offering Period, or (ii) the number of shares available for sale under the Plan on such Exercise Date, the Administrator may in its sole discretion provide that the Company shall make a pro rata allocation of the shares of Common Stock available for purchase on such Exercise Date in as uniform a manner as shall be practicable and as it shall determine in its sole discretion to be equitable among all participants exercising options to purchase Common Stock on such Exercise Date. The Company may make a pro rata allocation of the shares available on the Offering Date of any applicable Offering Period pursuant to the preceding sentence, notwithstanding any authorization of additional shares for issuance under the Plan by the Company’s stockholders subsequent to such Offering Date.

9. Delivery. As soon as reasonably practicable after each Exercise Date on which a purchase of shares occurs, the Company shall arrange the delivery to each participant the shares purchased upon exercise of his or her option in a form determined by the Administrator.

10. Withdrawal.

(a) A participant may withdraw all but not less than all the payroll deductions or contributions credited to his or her account and not yet used to exercise his or her option under the Plan at any time by giving written notice to the Company in the form determined by the Administrator (which may be similar to the form attached as Exhibit B to this Plan). All of the participant’s payroll deductions or contributions credited to his or her account shall be paid to such participant promptly after receipt of notice of withdrawal and such participant’s option for the


Offering Period shall be automatically terminated, and no further payroll deductions or contributions for the purchase of shares shall be made for such Offering Period. If a participant withdraws from an Offering Period, payroll deductions or contributions shall not resume at the beginning of the succeeding Offering Period unless the participant delivers to the Company a new subscription agreement.

(b) A participant’s withdrawal from an Offering Period shall not have any effect upon his or her eligibility to participate in any similar plan which may hereafter be adopted by the Company or in succeeding Offering Periods which commence after the termination of the Offering Period from which the participant withdraws.

11. Termination of Employment. Upon a participant’s ceasing to be an Eligible Employee, for any reason, he or she shall be deemed to have elected to withdraw from the Plan and the payroll deductions or contributions credited to such participant’s account during the Offering Period but not yet used to purchase shares of Common Stock under the Plan shall be returned to such participant or, in the case of his or her death, to the person or persons entitled thereto under Section 15, and such participant’s option shall be automatically terminated.

12. Interest. No interest shall accrue on the payroll deductions or contributions of a participant in the Plan. Notwithstanding the foregoing, if the Administrator determines that interest is required to be accrued on the payroll deductions or contributions for participants in the Non-423 Component, then the Administrator shall cause such interest to accrue to the extent required by applicable non-U.S. requirements.

13. Stock.

(a) Subject to adjustment upon changes in capitalization of the Company as provided in Section 19 hereof, the maximum number of shares of the Company’s Common Stock which shall be made available for sale under the Plan shall be 1,000,000 shares. For avoidance of doubt, the maximum number of share limitation set forth in this section may be used to satisfy exercises of options under either the 423 or the Non-423 Components.

(b) Until the shares are issued (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company), a participant shall only have the rights of an unsecured creditor with respect to such shares, and no right to vote or receive dividends or any other rights as a stockholder shall exist with respect to such shares.

(c) Shares to be delivered to a participant under the Plan shall be registered in the name of the participant or in the name of the participant and his or her spouse.

14. Administration. The Administrator shall administer the Plan and shall have full and exclusive discretionary authority to construe, interpret and apply the terms of the Plan, to determine eligibility and to adjudicate all disputed claims filed under the Plan, including whether eligible Employees shall participate in the 423 Component or the Non-423 Component and which entities shall be Designated Subsidiaries or Designated Affiliates. Every finding, decision and determination made by the Administrator shall, to the full extent permitted by law, be final and binding upon all parties. Notwithstanding any provision to the contrary in this Plan, the Administrator may adopt rules or procedures relating to the operation and administration of the Plan to accommodate the


specific requirements of local laws and procedures for jurisdictions outside of the United States. Without limiting the generality of the foregoing, the Administrator is specifically authorized to adopt rules, procedures and subplans, which for purposes of the Non-423 Component may be outside the scope of Section 423 of the Code, regarding, but not limited to, eligibility to participate, the definition of Compensation, handling of payroll deductions, making of contributions to the Plan (including, without limitation, in forms other than payroll deductions), establishment of bank or trust accounts to hold payroll deductions, payment of interest, conversion of local currency, obligations to pay payroll tax, determination of beneficiary designation requirements, withholding procedures and handling of stock certificates which vary with local requirements.

15. Designation of Beneficiary.

(a) Unless otherwise provided in the subscription agreement, and at the discretion of the Administrator prior to the beginning of an Offering Period, a participant in the 423 Component may file a designation of a beneficiary who is to receive any shares and cash, if any, from the participant’s account under the Plan in the event of such participant’s death subsequent to an Exercise Date on which the option is exercised but prior to delivery to such participant of such shares and cash. In addition, at the discretion of the Administrator prior to the beginning of an Offering Period, a participant in the 423 Component may file a designation of a beneficiary who is to receive any cash from the participant’s account under the Plan in the event of such participant’s death prior to exercise of the option. If a participant is married and the designated beneficiary is not the spouse, spousal consent shall be required for such designation to be effective.

(b) Such designation of beneficiary may be changed by the participant at any time by notice in a form determined by the Administrator. In the event of the death of a participant and in the absence of a beneficiary validly designated under the Plan who is living at the time of such participant’s death, the Company shall deliver such shares and/or cash to the executor or administrator of the estate of the participant, or if no such executor or administrator has been appointed (to the knowledge of the Company), the Company, in its discretion, may deliver such shares and/or cash to the spouse or to any one or more dependents or relatives of the participant, or if no spouse, dependent or relative is known to the Company, then to such other person as the Company may designate.

(c) All beneficiary designations shall be in such form and manner as the Administrator may designate from time to time.

16. Transferability. Neither payroll deductions nor contributions credited to a participant’s account nor any rights with regard to the exercise of an option or to receive shares under the Plan may be assigned, transferred, pledged or otherwise disposed of in any way (other than by will, the laws of descent and distribution or as provided in Section 15 hereof) by the participant. Any such attempt at assignment, transfer, pledge or other disposition shall be without effect, except that the Company may treat such act as an election to withdraw funds from an Offering Period in accordance with Section 10 hereof.

17. Use of Funds. All payroll deductions or contributions received or held by the Company under the Plan may be used by the Company for any corporate purpose, and the Company shall not be obligated to segregate such payroll deductions or contributions except for deductions or


contributions made to a Non-423 Component where, as determined by the Administrator, non-U.S. law requires segregation of such amounts. Until shares are issued, participants shall only have the rights of an unsecured creditor, although participants in the Non-423 Component may have additional rights where required under local law, as determined by the Administrator.

18. Reports. Individual accounts shall be maintained for each participant in the Plan. Statements of account shall be given to participating Eligible Employees at least annually, which statements shall set forth the amounts of payroll deductions, the Purchase Price, the number of shares purchased and the remaining cash balance, if any.

19. Adjustments Upon Changes in Capitalization, Dissolution, Liquidation, Merger or Change in Control.

(a) Changes in Capitalization. Subject to any required action by the stockholders of the Company, the maximum number of shares of the Company’s Common Stock which shall be made available for sale under the Plan, the maximum number of shares each participant may purchase each Offering Period (pursuant to Section 7), as well as the price per share and the number of shares of Common Stock covered by each option under the Plan which has not yet been exercised shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other change in the number of shares of Common Stock effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been “effected without receipt of consideration.” Such adjustment shall be made by the Administrator, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an option.

(b) Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the Company, the Offering Period then in progress shall be shortened by setting a new Exercise Date (the “New Exercise Date”), and shall terminate immediately prior to the consummation of such proposed dissolution or liquidation, unless provided otherwise by the Administrator. The New Exercise Date shall be before the date of the Company’s proposed dissolution or liquidation. The Administrator shall notify each participant in writing, at least ten (10) business days prior to the New Exercise Date, that the Exercise Date for the participant’s option has been changed to the New Exercise Date and that the participant’s option shall be exercised automatically on the New Exercise Date, unless prior to such date the participant has withdrawn from the Offering Period as provided in Section 10 hereof.

(c) Merger or Change in Control. In the event of a merger or Change in Control, each outstanding option shall be assumed or an equivalent option substituted by the successor corporation or a Parent or Subsidiary of the successor corporation. In the event that the successor corporation refuses to assume or substitute for the option, the Offering Period then in progress shall be shortened by setting a New Exercise Date and shall end on the New Exercise Date. The New Exercise Date shall be before the date of the Company’s proposed merger or Change in Control. The Administrator shall notify each participant in writing, at least ten (10) business days prior to the


New Exercise Date, that the Exercise Date for the participant’s option has been changed to the New Exercise Date and that the participant’s option shall be exercised automatically on the New Exercise Date, unless prior to such date the participant has withdrawn from the Offering Period as provided in Section 10 hereof.

20. Amendment or Termination.

(a) The Administrator may at any time and for any reason terminate or amend the Plan. Except as provided in Section 19 and this Section 20 hereof, no amendment may make any change in any option theretofore granted which adversely affects the rights of any participant unless their consent is obtained. To the extent necessary to comply with Section 423 of the Code (or any successor rule or provision or any other applicable law, regulation or stock exchange rule), the Company shall obtain stockholder approval of any amendment in such a manner and to such a degree as required.

(b) Without stockholder approval and without regard to whether any participant rights may be considered to have been “adversely affected,” the Administrator shall be entitled to change the Offering Periods, limit the frequency and/or number of changes in the amount withheld during an Offering Period, establish the exchange ratio applicable to amounts withheld in a currency other than U.S. dollars, permit payroll withholding in excess of the amount designated by a participant in order to adjust for delays or mistakes in the Company’s processing of properly completed subscription agreements, establish reasonable waiting and adjustment periods and/or accounting and crediting procedures to ensure that amounts applied toward the purchase of Common Stock for each participant properly correspond with amounts withheld from the participant’s Compensation, and establish such other limitations or procedures as the Administrator determines in its sole discretion advisable which are consistent with the Plan.

(c) Without regard to whether any participant’s rights may be considered to have been “adversely affected”, in the event the Administrator determines that the ongoing operation of the Plan may result in unfavorable financial accounting consequences, the Board may, in its discretion and, to the extent necessary or desirable, modify or amend the Plan to reduce or eliminate such accounting consequence including:

(i) increasing the Purchase Price for any Offering Period including an Offering Period underway at the time of the change in Purchase Price;

(ii) shortening any Offering Period so that Offering Period ends on a new Exercise Date, including an Offering Period underway at the time of the Board action; and

(iii) reducing the number of shares that may be purchased upon exercise of outstanding options.

Such modifications or amendments shall not require stockholder approval or the consent of any Plan participants.

21. Notices. All notices or other communications by a participant to the Company under or in connection with the Plan shall be deemed to have been duly given when received in the form and manner specified by the Company at the location, or by the person, designated by the Company for the receipt thereof.


22. Conditions Upon Issuance of Shares. Shares shall not be issued with respect to an option unless the exercise of such option and the issuance and delivery of such shares pursuant thereto shall comply with all applicable provisions of law, U.S. and non-U.S. and state and local provisions, including, without limitation, the Securities Act of 1933, as amended, the Exchange Act, the rules and regulations promulgated thereunder, and the requirements of any stock exchange upon which the shares may then be listed, and shall be further subject to the approval of counsel for the Company with respect to such compliance.

As a condition to the exercise of an option, the Company may require the person exercising such option to represent and warrant at the time of any such exercise that the shares are being purchased only for investment and without any present intention to sell or distribute such shares if, in the opinion of counsel for the Company, such a representation is required by any of the aforementioned applicable provisions of law.

23. Term of Plan. The Plan shall become effective upon the earlier to occur of its adoption by the Board of Directors or its approval by the stockholders of the Company. It shall continue in effect until terminated under Section 20 hereof.

24. Stockholder Approval. The Plan will be subject to the approval by stockholders of the Company within twelve (12) months after the date the Plan is adopted by the Board. Such stockholder approval will be obtained in the manner and to the degree required under applicable law.

Amendment No. 2 to the License Agreement effective January 1, 1992

Exhibit 10.3

VERIZON PROPRIETARY AND CONFIDENTIAL

AMENDMENT NO. 2

TO LICENSE AGREEMENT

THIS AMENDMENT NO. 2, dated December 19, 2008, to a License Agreement, having an effective date of January 1, 1992, as previously amended, is entered into by and between GTE LABORATORIES INCORPORATED (now known as Verizon Corporate Services Corp.) (“Verizon” or “GTEL”) and DOLBY LABORATORIES LICENSING CORPORATION (“Dolby” or “LICENSEE”). Verizon and Dolby are collectively referred to herein as the “Parties” or individually as a “Party.”

WHEREAS, the Parties, having entered into the above described License Agreement, as previously amended, (“License Agreement”), had a dispute regarding the payment of certain royalties by Dolby to Verizon pursuant to the License Agreement; and

WHEREAS, the Parties, having reached an amicable resolution of such dispute, now seek to amend the License Agreement upon the terms and conditions set forth herein to reflect such resolution.

 

 

NOW, THEREFORE, for good and valuable consideration as set forth in this Amendment No. 2 and in consideration of the covenants and promises set forth herein, the Parties hereby agree to amend the License Agreement as follows:

 

  1. Any capitalized term in this Amendment No. 2 not defined herein shall have the definition set forth in the License Agreement. As used herein, the term “Affiliate” shall mean with respect to any Party, any other person that, directly or indirectly, through one or more intermediaries, controls, is controlled by, or is under common control with such Party. “Control” for this purpose means the possession, directly or indirectly, of (a) ownership of fifty percent (50%) or more of the outstanding shares or securities entitled to vote for the election of directors or similar managing authority for such person; or (b) if such person does not have voting shares or other securities, ownership of fifty percent (50%) or more of the equity or other assets that represents the right to make decisions for such person.

 

  2. This Amendment No. 2 shall become effective on the date that Verizon receives from Dolby, in the form of a wire transfer to the account set forth in Exhibit A hereof, the Buy-Out Fee (as defined below) (“Effective Date”). Dolby’s failure to wire transfer the Buy-Out Fee or Verizon’s receipt thereof by December 31, 2008 shall cause all the terms of this Amendment No. 2 to be deemed null and void, ab initio, and the License Agreement, and all obligations arising thereunder, past, present and future, shall be unaffected, and the License Agreement shall have the terms as set forth therein without any effect by this Amendment No. 2.

 

  3. Article II, Paragraph A is deleted in its entirety and replaced by the following:

 

  A. GTEL hereby grants and agrees to grant to LICENSEE and Affiliated Companies of LICENSEE, and LICENSEE accepts and agrees to accept from GTEL, subject to the terms of this Agreement, nonexclusive (except as provided in Paragraph B of this Article), worldwide, royalty-free, fully paid-up, nonassignable, and nonsublicensable (except as is permitted under Paragraph C of this Article) rights and licenses under the Licensed Patents to make, have made, use, sell, lease, rent, or otherwise dispose of Licensed Products during the term of this Agreement.


VERIZON PROPRIETARY AND CONFIDENTIAL

 

4. Article III, including Paragraphs A through G, is deleted in its entirety and the following substituted therefor:

ARTICLE III

PAYMENTS AND RELEASES

 

  A. In consideration of the rights and licenses granted to Dolby pursuant to the License Agreement, as amended by this Amendment No. 2, Dolby agrees to make payment to Verizon, in the form of a wire transfer to the account set forth in Exhibit A hereof to be received by Verizon no later than December 31, 2008, the amount of Seventeen Million Five Hundred Thousand United States Dollars (USD $17,500,000) (“Buy-Out Fee”), and agrees that all prior payments made to Verizon, including to its predecessor companies, are nonrefundable and incontestable. The Parties further agree that, upon the receipt by Verizon of the payment of the amount set forth in this Paragraph A, no further payments shall be required to be made by Dolby pursuant to the License Agreement (including previous amendments thereto) and this Amendment No. 2.

 

  B. Dolby, on behalf of itself and the Dolby Affiliates and their respective officers, and directors (“Dolby Releasors”), hereby releases Verizon and the Verizon Affiliates and their respective officers, directors, managing members, employees, and attorneys (“Verizon Releasees”) from any and all claims, actions, causes of actions, past, present and future, and hereby disclaims all remedies any of the Dolby Releasors may have against any of the Verizon Releasees: (1) related to the License Agreement (including previous amendments thereto) and this Amendment No. 2, including the rights, terms and obligations arising under the License Agreement (including previous amendments thereto) and this Amendment No. 2; (2) arising from the exercise of rights, performance or failure to perform under the License Agreement (including previous amendments thereto) and this Amendment No. 2; and (3) arising from all discussions and negotiations regarding any dispute between the Parties related to the License Agreement (including previous amendments thereto), including leading up to and regarding this Amendment No. 2 (collectively, the “Dolby Released Matters”).


VERIZON PROPRIETARY AND CONFIDENTIAL

 

  C. Verizon, on behalf of itself and the Verizon Affiliates and their respective officers, and directors (“Verizon Releasors”), hereby releases Dolby and the Dolby Affiliates and their respective officers, directors, managing members, employees, and attorneys (“Dolby Releasees”) from any and all claims, actions, causes of actions, past, present and future, and hereby disclaims all remedies Verizon Releasors may have against any of the Dolby Releasees: (1) related to the License Agreement (including previous amendments thereto) and this Amendment No. 2, including the rights, terms and obligations arising under the License Agreement (including previous amendments thereto) and this Amendment No. 2; (2) arising from the exercise of rights, performance or failure to perform under the License Agreement (including previous amendments thereto) and this Amendment No. 2; and (3) arising from all discussions and negotiations regarding any dispute between the Parties related to the License Agreement (including previous amendments thereto), including leading up to and regarding this Amendment No. 2 (collectively, the “Verizon Released Matters”).

 

  D. The releases in this Amendment No. 2 include an express, informed, knowing and voluntary waiver and relinquishment to the fullest extent permitted by law. In this connection, the Parties acknowledge that they may have sustained damages, losses, costs or expenses which are presently unknown and unsuspected and that such damages, losses, costs or expenses as may have been sustained may give rise to additional damages, losses, costs or expenses in the future. The Parties hereto further acknowledge that they have negotiated this Amendment No. 2 taking into account presently unsuspected and unknown claims, counterclaims, causes of action, damages, losses, costs and expenses, and the Parties hereto voluntarily and with full knowledge of its significance, expressly waive and relinquish any and all rights they may have under any state or federal statute, rule or common law principle, in law or equity, relating to limitations on general releases. The Parties voluntarily and with full knowledge of its significance, expressly waive and relinquish any and all rights they may have under any state or federal statute, rule or common law principle, in law or equity, relating to limitations on releases. Specifically, each Party, for itself and its Affiliates, hereby expressly waives any rights it may have under California Civil Code Section 1542 which provides that: “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.”

5. Article IV is deleted in its entirety and intentionally left blank. For the avoidance of doubt, Dolby will have no reporting obligations to Verizon from and after the Effective Date of this Amendment No. 2.


VERIZON PROPRIETARY AND CONFIDENTIAL

 

6. Article V, Paragraphs B, C, D, E and H are deleted in their entirety, subsections (1), (2) and (3) of Paragraph F are deleted in their entirety and the first sentence of Paragraph G is deleted in its entirety.

7. Article VI, Paragraph C is deleted in its entirety.

8. Article VII is amended by adding the following new Paragraph I:

I. From and after the Effective Date of this Amendment No. 2, neither Party shall disclose the terms of the License Agreement (including previous amendments thereto) or this Amendment No. 2 to any person; provided, however, that each Party may disclose the terms of the License Agreement (including previous amendments thereto) and this Amendment No. 2 in the following limited circumstances: (a) with the prior written consent of the other Party; (b) to any governmental body having jurisdiction and specifically requiring such disclosure; (c) in response to a valid subpoena or as otherwise may be required by law, regulation or court order; (d) for the purposes of disclosure in connection with the Securities and Exchange Act of 1934, as amended, the Securities Act of 1933, as amended, and any other reports filed with the Securities and Exchange Commission, or any other filings, reports or disclosures that may be required under applicable laws or regulations; (e) to each Party’s accountants, legal counsel, tax advisors and other financial and legal advisors, subject to obligations of confidentiality and/or privilege; (f) as required during the course of litigation and subject to protective order; provided however, that any production under a protective order would be protected under an “Attorneys Eyes Only” or higher confidentiality designation; and (g) in confidence, in connection with a proposed merger, acquisition, financing or similar transaction; provided, however, that prior to any such disclosure pursuant to items (b) and/or (c) hereof, the disclosing Party shall promptly notify the other Party and afford it the opportunity to limit such disclosure or to secure an appropriate protective order.

9. All other provisions of the License Agreement not specifically amended herein shall remain in effect as originally drafted and previously amended, and intended by the Parties

10. This Amendment No. 2 is the result of a compromise and shall not at any time be considered as an admission of liability or responsibility on the part of either Party. By entering into this Amendment No. 2, neither Party is conceding that it acted wrongfully in any fashion whatsoever.

11. Verizon hereby represents, warrants and covenants that:

 

  a. From and after the Effective Date, Verizon and its Affiliates have no claims against Dolby arising from or related to the Verizon Released Matters.


VERIZON PROPRIETARY AND CONFIDENTIAL

 

  b. Verizon and its Affiliates have not heretofore voluntarily, by operation of law or otherwise, assigned or transferred or purported to assign or transfer to any person whomsoever any Verizon Released Matter or any part or portion thereof of any claim, demand or right against Dolby.

12. Dolby hereby represents, warrants and covenants that:

 

  a. From and after the Effective Date, Dolby and its Affiliates have no claims against Verizon arising from or related to the Dolby Released Matters.

 

  b. Dolby and its Affiliates have not heretofore voluntarily, by operation of law or otherwise, assigned or transferred or purported to assign or transfer to any person whomsoever any Dolby Released Matter or any part or portion thereof of any claim, demand or right against Verizon.

IN WITNESS WHEREOF, the Parties have executed this Amendment No. 2 on the dates set forth below:

 

DOLBY LABORATORIES LICENSING CORPORATION

/s/ Mark S. Anderson

Name:   Mark S. Anderson
Title:   EVP & General Counsel
Date: December 19, 2008
VERIZON CORPORATE SERVICES CORP.

/s/ John Thorne

Name:   John Thorne
Title:   SVP & Deputy General Counsel
Date: December 19, 2008
Certification by the Chief Executive Officer

Exhibit 31.1

CERTIFICATION

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

Date: February 4, 2009

 

/s/ N.W. Jasper, Jr.

N.W. Jasper, Jr.
Principal Executive Officer
Certification by the Chief Financial Officer

Exhibit 31.2

CERTIFICATION

I, Kevin J. Yeaman, certify that:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

Date: February 4, 2009

 

/s/ Kevin J. Yeaman

Kevin J. Yeaman
Principal Financial Officer
Certification by the Chief Executive Officer and Chief Financial Officer

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 26, 2008, as filed with the Securities and Exchange Commission (the “Report”), N.W. Jasper, Jr., President and Chief Executive Officer of the Company, and Kevin J. Yeaman, Chief Financial Officer of the Company, respectively, do each hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

 

   

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

 

   

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

 

Date: February 4, 2009

/s/ N.W. Jasper, Jr.

N.W. Jasper, Jr.
President and Chief Executive Officer

/s/ Kevin J. Yeaman

Kevin J. Yeaman
Chief Financial Officer