Q1 '13 10-Q
Table of Contents

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
 

ý
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 28, 2012
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 ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý 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 ý 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 ý
On January 23, 2013 the registrant had 46,351,339 shares of Class A common stock, par value $0.001 per share, and 55,121,632 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

 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.
 
 

2

Table of Contents

PART I – FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DOLBY LABORATORIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
 
December 28,
2012
September 28,
2012
ASSETS
 
 
Current assets:
 
 
Cash and cash equivalents
$
316,193

$
492,600

Short-term investments
118,681

302,693

Accounts receivable, net of allowance of $699 at December 28, 2012 and $956 at September 28, 2012
51,797

43,495

Inventories
21,023

16,700

Deferred taxes
82,661

80,966

Prepaid expenses and other current assets
28,203

33,832

Total current assets
618,558

970,286

Long-term investments
308,277

361,614

Property, plant and equipment, net
254,361

254,676

Intangible assets, net
52,913

56,526

Goodwill
281,763

281,375

Deferred taxes
24,362

22,634

Other non-current assets
11,716

13,687

Total assets
$
1,551,950

$
1,960,798

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
Current liabilities:
 
 
Accounts payable
$
9,900

$
14,831

Accrued liabilities
99,019

116,092

Income taxes payable
12,890

2,424

Deferred revenue
22,656

23,493

Total current liabilities
144,465

156,840

Long-term deferred revenue
18,893

18,192

Deferred taxes
2,714

2,696

Other non-current liabilities
40,078

39,837

Total liabilities
206,150

217,565

Stockholders’ equity:
 
 
Class A common stock, $0.001 par value, one vote per share, 500,000,000 shares authorized: 46,703,839 shares issued and outstanding at December 28, 2012 and 46,496,635 at September 28, 2012
47

46

Class B common stock, $0.001 par value, ten votes per share, 500,000,000 shares authorized: 55,116,153 shares issued and outstanding at December 28, 2012 and 56,598,829 at September 28, 2012
55

57

Additional paid-in capital


Retained earnings
1,316,461

1,709,479

Accumulated other comprehensive income
11,214

10,687

Total stockholders’ equity – Dolby Laboratories, Inc.
1,327,777

1,720,269

Controlling interest
18,023

22,964

Total stockholders’ equity
1,345,800

1,743,233

Total liabilities and stockholders’ equity
$
1,551,950

$
1,960,798

See accompanying notes to unaudited condensed consolidated financial statements

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Table of Contents

DOLBY LABORATORIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
 
Fiscal Quarter Ended
 
December 28,
2012
December 30,
2011
Revenue:
 
Licensing
$
204,876

$
200,424

Products
25,498

26,400

Services
6,228

7,354

Total revenue
236,602

234,178

Cost of revenue:
 
 
Cost of licensing
3,080

3,328

Cost of products
18,489

13,888

Cost of services
4,036

3,194

Total cost of revenue
25,605

20,410

Gross margin
210,997

213,768

Operating expenses:
 
 
Research and development
42,436

32,826

Sales and marketing
58,421

43,816

General and administrative
43,108

35,465

Restructuring charges, net

368

Total operating expenses
143,965

112,475

Operating income
67,032

101,293

Interest income
1,339

1,737

Interest expense
(25
)
(26
)
Other income, net
713

200

Income before income taxes
69,059

103,204

Provision for income taxes
(17,582
)
(29,838
)
Net income including controlling interest
51,477

73,366

Less: net (income) attributable to controlling interest
(128
)
(207
)
Net income attributable to Dolby Laboratories, Inc.
$
51,349

$
73,159

Net income per share:
 
 
Basic
$
0.50

$
0.67

Diluted
$
0.50

$
0.67

Weighted-average shares outstanding:
 
 
Basic
102,361

108,884

Diluted
103,523

109,443

Related party rent expense included in operating expenses
$
343

$
343

Related party rent expense included in net income attributable to controlling interest
$
732

$
754

See accompanying notes to unaudited condensed consolidated financial statements

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Table of Contents

DOLBY LABORATORIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)


 
Fiscal Quarter Ended
 
December 28,
2012
December 30,
2011
Net income including controlling interest
$
51,477

$
73,366

Other comprehensive income (loss):
 
 
Foreign currency translation adjustments, net of tax
1,234

(377
)
Unrealized gains (losses) on available-for-sale securities, net of tax
(737
)
(114
)
Comprehensive income
51,974

72,875

Less: comprehensive (income) loss attributable to controlling interest
(98
)
(141
)
Comprehensive income attributable to Dolby Laboratories, Inc.
$
51,876

$
72,734



See accompanying notes to unaudited condensed consolidated financial statements


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Table of Contents




DOLBY LABORATORIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
(unaudited)

 
Dolby Laboratories, Inc.
 
 
 
Common stock
Additional
paid-in
capital
Retained
earnings
Accumulated
other
comprehensive
income
Total Dolby
Laboratories,
Inc.
Controlling
Interest
Total
Balance at September 28, 2012
$
103

$

$
1,709,479

$
10,687

$
1,720,269

$
22,964

$
1,743,233

Net income


51,349


51,349

128

51,477

Translation adjustments, net of taxes of $328



1,264

1,264

(30
)
1,234

Unrealized losses on available-for-sale securities, net of taxes of $414



(737
)
(737
)

(737
)
Distributions to controlling interest





(5,039
)
(5,039
)
Stock-based compensation expense

17,704



17,704


17,704

Repurchase of common stock
(1
)
(17,794
)
(36,161
)

(53,956
)

(53,956
)
Cash dividends declared and paid on common stock


(408,206
)

(408,206
)

(408,206
)
Tax benefit / (deficiency) from stock incentive plans

(776
)


(776
)

(776
)
Class A common stock issued under employee stock plans

4,360



4,360


4,360

Shares repurchased for tax withholdings on vesting of restricted stock units

(3,636
)


(3,636
)

(3,636
)
Exercise of Class B stock options

142



142


142

Balance at December 28, 2012
$
102

$

$
1,316,461

$
11,214

$
1,327,777

$
18,023

$
1,345,800



 
Dolby Laboratories, Inc.
 
 
 
Common stock
Additional
paid-in
capital
Retained
earnings
Accumulated
other
comprehensive
income
Total Dolby
Laboratories,
Inc.
Controlling
Interest
Total
Balance at September 30, 2011
$
110

$
210,681

$
1,445,189

$
7,533

$
1,663,513

$
21,837

$
1,685,350

Net income


73,159


73,159

207

73,366

Translation adjustments, net of taxes of $(383)



(311
)
(311
)
(66
)
(377
)
Unrealized losses on available-for-sale securities, net of taxes of $63



(114
)
(114
)

(114
)
Stock-based compensation expense

11,323



11,323


11,323

Capitalized stock-based compensation expense

172



172


172

Repurchase of common stock
(1
)
(26,067
)


(26,068
)

(26,068
)
Tax benefit / (deficiency) from stock incentive plans

(1,347
)


(1,347
)

(1,347
)
Class A common stock issued under employee stock plans

2,745



2,745


2,745

Shares repurchased for tax withholdings on vesting of restricted stock units

(985
)


(985
)

(985
)
Exercise of Class B stock options

23



23


23

Balance at December 30, 2011
$
109

$
196,545

$
1,518,348

$
7,108

$
1,722,110

$
21,978

$
1,744,088



See accompanying notes to unaudited condensed consolidated financial statements






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Table of Contents

DOLBY LABORATORIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Fiscal Quarter Ended
 
December 28,
2012
December 30,
2011
Operating activities:
 
Net income including controlling interest
$
51,477

$
73,366

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


Depreciation and amortization
13,129

9,929

Stock-based compensation
17,704

11,439

Amortization of premium on investments
3,794

4,920

Excess tax benefit from exercise of stock options
(469
)
(57
)
Provision for doubtful accounts
(179
)
(52
)
Deferred income taxes
(2,627
)
(7,643
)
Other non-cash items affecting net income
(691
)
1,227

Changes in operating assets and liabilities:


Accounts receivable
(8,064
)
7,531

Inventories
(6,173
)
(7,271
)
Prepaid expenses and other assets
8,625

1,101

Accounts payable and other liabilities
(19,898
)
(22,860
)
Income taxes, net
9,512

24,431

Deferred revenue
(143
)
(661
)
Other non-current liabilities
1,012

392

Net cash provided by operating activities
67,009

95,792

Investing activities:


Purchases of available-for-sale securities
(204,135
)
(54,726
)
Proceeds from sales of available-for-sale securities
389,068

51,488

Proceeds from maturities of available-for-sale securities
51,325

47,645

Purchases of property, plant and equipment
(6,717
)
(12,566
)
Acquisitions, net of cash acquired

(575
)
Other investments
(3,000
)

Purchases of intangible assets
(4,048
)

Proceeds from sales of property, plant and equipment and assets held for sale
19

335

Net cash provided by investing activities
222,512

31,601

Financing activities:
 
 
Proceeds from issuance of common stock
4,502

813

Repurchase of common stock
(53,956
)
(26,068
)
Payment of cash dividend
(408,206
)

Distribution to controlling interest
(5,039
)

Excess tax benefit from the exercise of stock options
469

57

Shares repurchased for tax withholdings on vesting of restricted stock
(3,636
)
970

Net cash used in financing activities
(465,866
)
(24,228
)
Effect of foreign exchange rate changes on cash and cash equivalents
(62
)
(263
)
Net increase in cash and cash equivalents
(176,407
)
102,902

Cash and cash equivalents at beginning of period
492,600

551,512

Cash and cash equivalents at end of period
$
316,193

$
654,414

 
 
 
Supplemental disclosure:


Cash paid for income taxes
$
11,734

$
13,047

Cash paid for interest
$
1

$
36

See accompanying notes to unaudited condensed consolidated financial statements

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Table of Contents

DOLBY LABORATORIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1.  Basis of Presentation
Unaudited Interim Financial Statements
We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the U.S. (“GAAP”), and with Securities and Exchange Commission (“SEC”) rules and regulations, which allow for certain information and footnote disclosures that are normally included in annual financial statements prepared in accordance with GAAP to be condensed or omitted. In our opinion, these condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements for the fiscal year ended September 28, 2012 and include all adjustments necessary for fair presentation. The accompanying condensed consolidated financial statements should be read in conjunction with our condensed consolidated financial statements for the fiscal year ended September 28, 2012, which are included in our Annual Report on Form 10-K filed with the SEC.
The results for the fiscal quarter ended December 28, 2012 are not necessarily indicative of the results to be expected for any subsequent quarterly or annual financial period, including the fiscal year ending September 27, 2013.
Principles of Consolidation
The condensed consolidated financial statements include the accounts of Dolby Laboratories and our wholly owned subsidiaries. In addition, we have consolidated the financial results of jointly owned affiliated companies in which our principal stockholder has a controlling interest. We report these controlling interests as a separate line item in our condensed consolidated statements of operations as net income attributable to controlling interest and in our condensed consolidated balance sheets as controlling interest. We eliminate all intercompany accounts and transactions upon consolidation.
Use of Estimates
The preparation of the consolidated financial statements in accordance with accounting principles generally accepted in the U.S. (“GAAP”) requires management to make certain estimates and assumptions that affect the amounts reported and disclosed in our consolidated financial statements and accompanying notes. Significant items subject to such estimates and assumptions include estimated selling prices for elements sold in multiple-element revenue arrangements, valuation allowances for accounts receivable, carrying values of inventories and certain property, plant, and equipment, products provided under operating leases, goodwill, intangible assets, stock-based compensation, fair values of investments, accrued expenses, including liabilities for unrecognized tax benefits, and deferred income tax assets. Actual results could differ from our estimates.
Fiscal Year
Our fiscal year is a 52 or 53 week period ending on the last Friday in September. The fiscal periods presented herein include the 13 week periods ended December 28, 2012 and December 30, 2011. Our fiscal year ending September 27, 2013 (fiscal 2013) consists of 52 weeks and our fiscal year ended September 28, 2012 (fiscal 2012) consisted of 52 weeks.
Reclassifications
Beginning in the first quarter of fiscal 2013, we have recorded settlements from implementation licensees as licensing revenue rather than as an offset to sales and marketing expense. In order to conform to the current period's presentation, we have reclassified these settlements for the prior periods presented within our condensed consolidated statements of operations. For the fiscal quarters ended December 28, 2012 and December 30, 2011, licensing revenue now includes amounts recognized under settlement agreements of $6.6 million and $0.8 million, respectively. The reclassification did not impact our previously reported operating income, operating cash flows, net income, or earnings per share.
In addition to the reclassification mentioned above, we have reclassified certain prior period amounts within our condensed consolidated financial and accompanying notes to conform to our current period presentation. These reclassifications did not affect total revenue, operating income, operating cash flows, or net income.
2.  Summary of Significant Accounting Policies
Recently Issued Accounting Standards
In June 2011 the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU” No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, (“ASU 2011-05”). This new accounting standard: (1) eliminates the option to present the components of other comprehensive income as part of the

8

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statement of changes in stockholders' equity, (2) requires the consecutive presentation of the statement of net income and other comprehensive income, and (3) requires an entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income. This new standard does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income, nor does it affect how earnings per share is calculated or presented. ASU 2011-05 is required to be applied retrospectively and is effective for fiscal years and interim periods within those years beginning after December 15, 2011, with early adoption permitted. In December 2011 the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. This update temporarily defers the effective date of the requirement for presentation of reclassification adjustments, as described above. ASU 2011-05 is effective for our fiscal year beginning September 29, 2012. As this new standard only requires enhanced disclosure, the adoption of ASU 2011-05 will result only in changes in our financial statement presentation and will not impact our financial position or results of operations.
In December 2011, the FASB issued guidance to amend the disclosure requirements regarding the offsetting of assets and liabilities related to financial and derivative instruments. This new guidance requires an entity to disclose quantitative information in a tabular format about offsetting and related arrangements for recognized financial and derivative instruments to enable the users of its financial statements to evaluate the effect of those netting arrangements on its financial position. This new guidance, which is to be applied on a retrospective basis, will become effective for entities with annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. Thus, the effective date of this amended guidance will commence in the first quarter of fiscal 2014. We are currently evaluating the impact of this new guidance on our presentation of our derivative and financial instruments on our consolidated financial statements.
There have been no changes to our critical accounting policies from those described in our Annual Report on Form 10-K for the fiscal year ended September 28, 2012.

3.  Composition of Certain Financial Statement Captions
Cash, Cash Equivalents, and Investments
Cash, cash equivalents, and investments consist of the following:
 
December 28,
2012
September 28,
2012
 
(in thousands)
Cash and cash equivalents:
 
 
Cash
$
288,558

$
468,622

Cash equivalents:

 
Money market funds
9,241

17,090

U.S. agency securities
16,393


Commercial paper
1,000

4,885

Corporate bonds
1,001


Municipal debt securities

2,003

Total cash and cash equivalents
316,193

492,600

Short-term investments:
 
 
U.S. agency securities
2,003

3,999

Commercial paper
7,050

19,414

Corporate bonds
51,871

107,243

Municipal debt securities
57,757

172,037

Total short-term investments
118,681

302,693

Long-term investments (1):
 
 
U.S. agency securities
38,015

21,013

Commercial paper
2,974


Corporate bonds
104,128

112,993

Municipal debt securities
160,160

227,608

Other long-term investments (2)
3,000


Total long-term investments
308,277

361,614

Total cash, cash equivalents and investments
$
743,151

$
1,156,907


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

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(2)
Other long-term investments include a $3.0 million investment made in the first quarter of fiscal 2013, which we have accounted for under the cost method of accounting, for which there were no indicators of potential impairment at December 28, 2012.
Our investment portfolio, which is recorded as cash equivalents, short-term investments, and long-term investments, consists of the following:
 
December 28, 2012
 
Cost
Unrealized
Gains
Unrealized
Losses
Estimated Fair
Value
 
(in thousands)
Money market funds
$
9,241

$

$

$
9,241

U.S. agency securities
56,403

10

(2
)
56,411

Commercial paper
11,024



11,024

Corporate bonds
156,637

443

(80
)
157,000

Municipal debt securities
217,715

323

(121
)
217,917

Cash equivalents and investments
$
451,020

$
776

$
(203
)
$
451,593


 
September 28, 2012
 
Cost
Unrealized
Gains
Unrealized
Losses
Estimated Fair
Value
 
(in thousands)
Money market funds
$
17,090

$

$

$
17,090

U.S. agency securities
24,997

18

(3
)
25,012

Commercial paper
24,299



24,299

Corporate bonds
219,265

990

(19
)
220,236

Municipal debt securities
400,958

728

(38
)
401,648

Cash equivalents and investments
$
686,609

$
1,736

$
(60
)
$
688,285

We have classified all of our investments listed in the tables above as available-for-sale securities recorded at fair market value in our condensed consolidated balance sheets, with unrealized gains and losses reported as a component of accumulated other comprehensive income. Upon sale, amounts of gains and losses reclassified into earnings are determined based on specific identification of the securities sold.
The following tables show the gross unrealized losses and the fair value for those available-for-sale securities that were in an unrealized loss position:
 
 
December 28, 2012
 
Less than 12 months
12 months or greater
Total
 
Fair Value
Gross Unrealized Losses
Fair Value
Gross Unrealized Losses
Fair Value
Gross Unrealized Losses
 
(in thousands)
U.S. agency securities
$
26,401

$
(2
)
$

$

$
26,401

$
(2
)
Corporate bonds
53,111

(80
)


53,111

(80
)
Municipal debt securities
81,193

(121
)


81,193

(121
)
Total
$
160,705

$
(203
)
$

$

$
160,705

$
(203
)
 
September 28, 2012
 
Less than 12 months
12 months or greater
Total
 
Fair Value
Gross Unrealized
Losses
Fair Value
Gross Unrealized
Losses
Fair Value
Gross Unrealized
Losses
 
(in thousands)
U.S. agency securities
$
6,999

$
(3
)
$

$

$
6,999

$
(3
)
Corporate bonds
25,277

(19
)


25,277

(19
)
Municipal debt securities
87,705

(37
)
5,565

(1
)
93,270

(38
)
Total
$
119,981

$
(59
)
$
5,565

$
(1
)
$
125,546

$
(60
)


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The unrealized losses on our available-for-sale securities were primarily a result of unfavorable changes in interest rates subsequent to the initial purchase of these securities. As of December 28, 2012, we had certain securities that were in an unrealized loss position. We do not intend to sell, nor will we need to sell, these securities before we recover the associated unrealized losses. We expect to recover the full carrying value of these securities. As a result, we do not consider any portion of the unrealized losses at December 28, 2012 or September 28, 2012 to be an other-than-temporary impairment, nor do we consider any of the unrealized losses to be credit losses.
The following table summarizes the amortized cost and estimated fair value of short-term and long-term available-for-sale investments based on stated maturities as of December 28, 2012 and September 28, 2012:
 
 
December 28, 2012
September 28, 2012
 
Amortized Cost
Fair Value
Amortized Cost
Fair Value
 
(in thousands)
(in thousands)
Due within 1 year
$
118,494

$
118,681

$
302,154

$
302,693

Due in 1 to 2 years
167,779

168,010

209,302

209,871

Due in 2 to 3 years
$
137,112

$
137,267

$
151,174

$
151,743

Total
$
423,385

$
423,958

$
662,630

$
664,307

Accounts Receivable
Accounts receivable consists of the following:
 
December 28,
2012
September 28,
2012
 
(in thousands)
Trade accounts receivable
$
50,172

$
43,565

Accounts receivable related to patent administration program
2,324

886

Accounts receivable, gross
52,496

44,451

Less: allowance for doubtful accounts
(699
)
(956
)
Accounts receivable, net
$
51,797

$
43,495

Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market and consist of the following:
 
 
December 28,
2012
September 28,
2012
 
(in thousands)
Raw materials
$
3,933

$
4,403

Finished goods
17,090

12,297

Inventories
$
21,023

$
16,700


We have included $4.7 million and $6.5 million of raw materials inventory within other non-current assets in our condensed consolidated balance sheets as of December 28, 2012 and September 28, 2012, respectively. This inventory was purchased in bulk in fiscal 2012 to obtain a significant volume discount, and is expected to be consumed over a period that exceeds 12 months. We have reviewed anticipated consumption rates of this inventory and do not believe there to be material risk of obsolescence prior to the ultimate sale of the inventory. As a result, no valuation reserve has been recorded as of December 28, 2012.






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Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist of the following:
 
 
December 28,
2012
September 28,
2012
 
(in thousands)
Prepaid assets
$
13,884

$
14,955

Other current assets
9,358

13,165

Income tax receivable
4,961

5,712

Prepaid expenses and other current assets
$
28,203

$
33,832


Property, Plant and Equipment
Property, plant and equipment are recorded at cost and consist of the following:
 
 
December 28,
2012
September 28,
2012
 
(in thousands)
Land
$
48,219

$
48,227

Buildings
33,582

27,266

Leasehold improvements
64,467

68,352

Machinery and equipment
33,363

29,070

Computer systems and software
87,527

86,266

Furniture and fixtures
13,359

13,158

Construction in progress
80,460

79,965

 
360,977

352,304

Less: accumulated depreciation
(106,616
)
(97,628
)
Property, plant and equipment, net
$
254,361

$
254,676

Depreciation expense for our property, plant and equipment is included in cost of products, cost of services, research and development expenses, sales and marketing expenses, and general and administrative expenses in our condensed consolidated statements of operations.
Goodwill and Intangible Assets
The following table outlines changes to the carrying amount of goodwill:
 
 
Total
 
(in thousands)
Balance at September 28, 2012
$
281,375

Translation adjustments
388

Balance at December 28, 2012
$
281,763

Intangible assets consist of the following:
 
 
December 28, 2012
September 28, 2012
 
Cost
Accumulated
Amortization
Net
Cost
Accumulated
Amortization
Net
Intangible assets subject to amortization:
(in thousands)
Acquired patents and technology
$
79,631

$
(42,886
)
$
36,745

$
79,213

$
(40,071
)
$
39,142

Customer relationships
30,693

(17,195
)
13,498

30,679

(16,386
)
14,293

Other intangibles
20,943

(18,273
)
2,670

20,925

(17,834
)
3,091

Total
$
131,267

$
(78,354
)
$
52,913

$
130,817

$
(74,291
)
$
56,526

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


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As of December 28, 2012, our expected amortization expense in future periods is as follows:
 
Fiscal Year
 Amortization Expense
 
(in thousands)
Remainder of 2013
$
11,614

2014
13,473

2015
11,017

2016
8,848

2017
5,736

Thereafter
2,225

Total
$
52,913

Accrued Liabilities
Accrued liabilities consist of the following:
 
 
December 28,
2012
September 28,
2012
 
(in thousands)
Accrued royalties
$
2,432

$
2,391

Amounts payable to joint licensing program partners
33,329

35,492

Accrued compensation and benefits
32,439

47,331

Accrued professional fees
5,267

4,893

Other accrued liabilities
25,552

25,985

Accrued liabilities
$
99,019

$
116,092

Other Non-Current Liabilities
Other non-current liabilities consist of the following:
 
 
December 28,
2012
September 28,
2012
 
(in thousands)
Supplemental retirement plan obligations
$
1,964

$
2,042

Non-current tax liabilities
19,917

20,862

Other liabilities
18,197

16,933

Other non-current liabilities
$
40,078

$
39,837

See Note 7 “Income Taxes” for additional information related to tax liabilities.

4.  Fair Value Measurements
Fair value is 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. We minimize the use of unobservable inputs and use observable market data, if available, when determining fair value. We classify our inputs to measure fair value using the following three-level hierarchy: 
Level 1:
Quoted prices in active markets at the measurement date for identical assets and liabilities.
Level 2:
Prices may be based upon quoted prices in active markets or inputs not quoted on active markets but are corroborated by market data.
Level 3:
Unobservable inputs are used when little or no market data is available and reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability.



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Financial assets and liabilities carried at fair value are classified below: 

 
December 28, 2012
 
Level 1
Level 2
Level 3
Total
 
(in thousands)
Assets:
 
 
 
 
Investments held in supplemental retirement plan (1)
$
2,061

$

$

$
2,061

Money market funds (2)
9,241



9,241

Commercial paper (2), (3)

11,024


11,024

Corporate bonds (2), (3)

157,000


157,000

Municipal debt securities (3)

217,917


217,917

U.S. agency securities (2), (3)
56,411



56,411

Total
$
67,713

$
385,941

$

$
453,654


(1)
These assets are included within prepaid expenses and other current assets and within other non-current assets.
(2)
These assets are included within cash and cash equivalents.
(3)
These assets are included within short-term investments and within long-term investments.
 
December 28, 2012
 
Level 1
Level 2
Level 3
Total
 
(in thousands)
Liabilities:
 
 
 
 
Investments held in supplemental retirement plan (1)
$
2,061

$

$

$
2,061

Total
$
2,061

$

$

$
2,061


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



 
September 28, 2012
 
Level 1
Level 2
Level 3
Total
 
(in thousands)
Assets:
 
 
 
 
Investments held in supplemental retirement plan (1)
$
2,140

$

$

$
2,140

Money market funds (2)
17,090



17,090

Commercial paper (2), (3)

24,299


24,299

Corporate bonds (3)

220,236


220,236

Municipal debt securities (2), (3)

401,648


401,648

U.S. agency securities (3)
25,012



25,012

Total
$
44,242

$
646,183

$

$
690,425


(1)
These assets are included within prepaid expenses and other current assets and within other non-current assets.
(2)
These assets are included within cash and cash equivalents.
(3)
These assets are included within short-term investments and within long-term investments.
 
September 28, 2012
 
Level 1
Level 2
Level 3
Total
 
(in thousands)
Liabilities:
 
 
 
 
Investments held in supplemental retirement plan (1)
$
2,140

$

$

$
2,140

Total
$
2,140

$

$

$
2,140


(1)
These liabilities are included within accrued liabilities and within other non-current liabilities.
We base the fair value of our Level 1 financial instruments, which are traded in active markets, using quoted market prices for identical instruments. Our Level 1 financial instruments include money market funds, U.S. agency securities, U.S. government bonds, and mutual fund investments held in our supplemental retirement plan.

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Table of Contents

We obtain the fair value of our Level 2 financial instruments from a professional pricing service, which may use quoted market prices for identical or comparable instruments, or model driven valuations using observable market data or inputs corroborated by observable market data.
To validate the fair value determination provided by our primary pricing service, we perform quality controls over values received which include comparing our pricing service provider’s assessment of the fair values of our investment securities against the fair values of our investment securities obtained from another independent source, reviewing the pricing movement in the context of overall market trends, and reviewing trading information from our investment managers. In addition, we assess the inputs and methods used in determining the fair value in order to determine the classification of securities in the fair value hierarchy.
We did not own any Level 3 financial assets or liabilities as of December 28, 2012 or September 28, 2012.
5.  Stockholders’ Equity and Stock-Based Compensation
We have adopted compensation plans that provide stock-based awards as a form of compensation for employees, officers, and directors. We have issued stock-based awards in the form of stock options, restricted stock units, and stock appreciation rights under our equity incentive plans, as well as shares under our Employee Stock Purchase Plan (“ESPP”). We recognize stock-based compensation expense net of estimated forfeitures.
Stock-based compensation expense recorded in our condensed consolidated statements of operations was as follows:

 
Fiscal Quarter Ended
 
December 28,
2012 (2)
December 30,
2011 (2)
 
(in thousands)
Stock-based compensation:
 
Stock options (1)
$
8,309

$
6,058

Restricted stock units
8,340

5,264

Employee stock purchase plan
1,055

82

Stock appreciation rights

35

Total stock-based compensation

17,704

11,439

Benefit from income taxes
(5,413
)
(3,669
)
Total stock-based compensation, net of tax
$
12,291

$
7,770

 
(1)
Expense excludes $0.2 million in the first quarter of fiscal 2012 related to stock-based compensation which was capitalized to property, plant and equipment.
(2)
We also recognized $0.1 million and $0.1 million in the first quarter of fiscal 2013 and 2012, respectively, of tax benefit from certain exercises of incentive stock options and shares issued under our ESPP, which is not included in the table above.

 
Fiscal Quarter Ended
 
December 28,
2012
December 30,
2011
 
(in thousands)
Stock-based compensation expense was classified as follows:
 
Cost of products
$
248

$
166

Cost of services
151

56

Research and development
4,887

2,664

Sales and marketing
5,991

3,715

General and administrative
6,427

4,838

Total stock-based compensation expense
$
17,704

$
11,439

At December 28, 2012, total unrecorded stock-based compensation expense associated with employee stock options expected to vest was approximately $50.9 million, which is expected to be recognized over a weighted-average period of 3.2 years. At December 28, 2012, total unrecorded stock-based compensation expense associated with restricted stock units expected to vest was approximately $93.6 million, which is expected to be recognized over a weighted-average period of 2.9 years.


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Table of Contents

The following table summarizes information about stock options issued to officers, directors, and employees under our 2000 Stock Incentive Plan and 2005 Stock Plan:
 
 
Shares
Weighted Average
Exercise Price
Weighted Average
Remaining
Contractual Life
Aggregate
Intrinsic
Value
 
(in thousands)
 
(in years)
(in thousands)
Options outstanding at September 28, 2012
4,622

$
32.50

 
 
Grants (1)
2,228

30.14

 
 
Exercises
(87
)
14.87

 
$
1,605

Forfeitures and cancellations
(123
)
44.89

 
 
Options outstanding at December 28, 2012
6,640

29.54

8.0

9,650

Options vested and expected to vest at December 28, 2012
6,369

29.48

8.0

9,564

Options exercisable at December 28, 2012
2,428

27.70

5.7

8,270


(1)
Includes the additional options granted in connection with the equity award modification.
Aggregate intrinsic value is based on the closing price of our common stock on December 28, 2012 of $28.98 and excludes the impact of stock options that were not in-the-money.

 We use the Black-Scholes option pricing model to determine the fair value of employee stock options at the date of grant. The fair value of our stock-based awards was estimated using the following weighted-average assumptions:
 
 
Fiscal Quarter Ended
 
December 28,
2012
December 30,
2011
Expected life (in years)
4.37

4.53

Risk-free interest rate
0.5
%
0.8
%
Expected stock price volatility
40.6
%
44.5
%
Dividend yield



The following table summarizes information about restricted stock units issued to officers, directors, and employees under our 2005 Stock Plan:

 
Shares
Weighted Average
Grant Date
Fair Value 
 
(in thousands)
 
Non-vested at September 28, 2012
2,572

$
37.98

Granted
951

30.57

Vested
(296
)
39.20

Forfeitures
(47
)
38.65

Non-vested at December 28, 2012
3,180

35.64



Common Stock Repurchase Program
In November 2009, we announced a stock repurchase program, providing for the repurchase of up to $250.0 million of our Class A common stock. Our Board of Directors approved an additional $300.0 million for our stock repurchase program in July 2010, $250.0 million in July 2011, and an additional $100.0 million in February 2012, for a total authorization of up to $900.0 million in stock repurchases. Stock repurchases under this program may be made through open market transactions, negotiated purchases, or otherwise, at times and in amounts that we consider appropriate. The timing of repurchases and the number of shares repurchased depend upon a variety of factors, including price, regulatory requirements, the rate of dilution from our equity compensation programs, and other market conditions. We may limit, suspend, or terminate the stock repurchase program at any time without prior notice. This program does not have a specified expiration date. Shares repurchased under the program will be returned to the status of authorized but unissued shares of Class A common stock. As of December 28, 2012, the remaining authorization to purchase additional shares is $144.3 million.

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Table of Contents

Stock repurchase activity under the stock repurchase program during the first quarter of fiscal 2013 is summarized as follows:
 
 
Shares
Repurchased
Cost
(in thousands)
(1)
Average Price
Paid per Share
(2)
Repurchase activity for the fiscal quarter ended December 28, 2012
1,674,648

$
53,956

$
32.20

Total
1,674,648

$
53,956

 
 
(1)
Cost of share repurchases includes the price paid per share and applicable commissions.
(2)
Excludes commission costs.
Equity Award Modification
    
On December 11, 2012, we announced the declaration by our Board of Directors of a one-time special dividend in the amount of $4.00 per share on our Class A and Class B Common Stock. Payment of the special dividend was made on December 27, 2012 to eligible stockholders, which represented all stockholders of record as of the close of business on December 21, 2012 (the "Record Date"). Based on the 102,051,386 shares of Class A and Class B Common Stock outstanding as of the record date, the total special dividend payment was $408.2 million.

In connection with the declaration of this special dividend, we adjusted the number and exercise price of certain eligible outstanding stock options and stock appreciation rights granted under our 2005 Stock Plan in a manner intended to preserve the pre-cash dividend economic value of these awards. Eligible awards include stock options and stock appreciation rights that were granted prior to December 2012 and were outstanding as of the day following the record date, with the exception of stock options held by employees in Australia which were not adjusted due to tax considerations. The modification of these existing awards at the time of the dividend declaration date resulted in a total net incremental charge to compensation expense of approximately $7.9 million, of which approximately $3.1 million was recognized in the first quarter of fiscal 2013. This incremental charge is being recognized over the vesting periods of the original awards, determined on a grant-by-grant basis, based on the extent to which the awards were vested as of the date of modification. The incremental charge related to all fully-vested awards as of the modification date was recognized in the first quarter of fiscal 2013. The vesting period for those awards not fully-vested at the time of modification range from one to four years.

Additionally, all outstanding RSUs under the 2005 Stock Plan that were unvested on the day following the record date, including RSUs that were granted on the record date, were modified to allow for the granting of a dividend equivalent (as such term is defined in the 2005 Stock Plan) with respect to each share of our Class A Common Stock underlying the unvested RSU. The dividend equivalent was payable in cash in a per share amount equal to the per share cash dividend on the same date that the related underlying restricted stock unit shares vest. The granting of the dividend equivalent for all outstanding RSUs resulted in a total net incremental charge to compensation expense of approximately $11.9 million, of which approximately less than $0.1 million was recognized in the first quarter of fiscal 2013. This incremental charge is being recognized over the remaining vesting periods of the RSUs at the date of modification, determined on a grant-by-grant basis. These vesting periods range from one to four years beginning on the first anniversary of the grant.












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Table of Contents

6.  Earnings Per Share
We compute basic earnings per share by dividing net income attributable to Dolby Laboratories, Inc. by the weighted-average number of shares of Class A and Class B common stock outstanding during the period. For diluted earnings per share, we divide net income attributable to Dolby Laboratories, Inc. by the sum of the weighted-average number of shares of Class A and Class B common stock outstanding and the potential number of dilutive shares of Class A and Class B common stock outstanding during the period.
The following table sets forth the computation of basic and diluted earnings per share attributable to Dolby Laboratories, Inc.:
 
 
Fiscal Quarter End
 
December 28,
2012
December 30,
2011
 
 
Numerator:
 
 
Net income attributable to Dolby Laboratories, Inc.
$
51,349

$
73,159

Denominator:
 
 
Weighted-average shares outstanding—basic
102,361

108,884

Potential common shares from options to purchase Class A and Class B common stock
326

382

Potential common shares from restricted stock units
836

177

Weighted-average shares outstanding—diluted
103,523

109,443

Net income per share attributable to Dolby Laboratories, Inc.—basic
$
0.50

$
0.67

Net income per share attributable to Dolby Laboratories, Inc.—diluted
$
0.50

$
0.67

Antidilutive options excluded from calculation
5,178

6,698

Antidilutive restricted stock units excluded from calculation
1,327

1,305



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Table of Contents

7.  Income Taxes
Our effective tax rate is based on a projection of our annual fiscal year results. Our effective tax rate was 25% and 29% for the first quarters of fiscal 2013 and fiscal 2012, respectively. Our effective tax rate for the first quarter of fiscal 2013 was lower than the first quarter of fiscal 2012 primarily due to recognized tax benefits from the expired statute of limitation on some uncertain tax positions.
As of December 28, 2012, the total amount of gross unrecognized tax benefits was $16.4 million, of which $11.1 million, if recognized, would reduce our effective tax rate. Our liability for unrecognized tax benefits is classified within other non-current liabilities in our condensed consolidated balance sheets.
Withholding Tax.    We recognize licensing revenue gross of withholding taxes, which our licensees remit directly to their local tax authorities. We reduce our income tax provision for withholding taxes in various jurisdictions for allowable foreign tax credits. Withholding tax remittances were $9.4 million and $11.3 million in the fiscal quarters ended December 28, 2012 and December 30, 2011, respectively.

8.  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 impact on our operating results or financial condition. Given the unpredictable nature of legal proceedings, 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; however, based on the information known by us as of the date of this filing and the rules and regulations applicable to the preparation of our financial statements, any such amount is either immaterial or it is not possible to provide an estimated amount of any such potential loss. There has not been a material change in the status of legal proceedings since our fiscal year ended September 28, 2012.

9.  Commitments and Contingencies
The following table presents a summary of our contractual obligations and commitments as of December 28, 2012:
 
 
Payments Due By Fiscal Period
 
Remainder of Fiscal 2013
Fiscal
2014
Fiscal
2015
Fiscal
2016
Fiscal
2017
Thereafter
Total
 
(in thousands)
Naming rights (1)
$

$
7,341

$
7,432

$
7,525

$
7,619

$
126,414

$
156,331

Operating leases (2)
10,725

11,167

7,995

6,055

4,326

5,655

45,923

Purchase obligations (3)
3,860

957

355




5,172

Total
$
14,585

$
19,465

$
15,782

$
13,580

$
11,945

$
132,069

$
207,426


(1)
In April 2012, we entered into an agreement for naming rights and related benefits with respect to the Dolby Theatre in Hollywood, California, the location of the Academy Awards®. The term of the agreement is 20 years, over which we will make payments on a semi-annual basis with the exception of fiscal 2013 when no payments are due. Our payment obligations are conditioned in part on the Academy Awards® being held and broadcast from the Dolby Theatre.
(2)
Operating lease payments include future minimum rental commitments, including those payable to our principal stockholder and portions attributable to the controlling interests in our wholly owned subsidiaries, for non-cancelable operating leases of office space as of December 28, 2012.
(3)
Our purchase obligations consist of agreements to purchase goods and services, entered into in the ordinary course of business. These represent non-cancelable commitments for which a penalty would be imposed if the agreement was canceled for any reason other than an event of default as described by the agreement.
We are party to certain contractual agreements under which we have agreed to provide indemnifications of varying scope and duration to the other party relating to our licensed intellectual property. Historically, we have made no payments for these indemnification obligations and no amounts have been accrued in our condensed consolidated financial statements with respect to these obligations. Due to their varying terms and conditions, we are unable to make a reasonable estimate of the maximum potential amount we could be required to pay.




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Table of Contents


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 Quarterly Report on Form 10-Q. These discussions contain forward-looking statements reflecting our current expectations, which 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 elements of results of operations; our expectations regarding demand and acceptance for our technologies; growth opportunities and trends in the markets in which we operate; our plans, strategies, and expected opportunities; the deployment of and demand for our products and for 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 Part II, Item 1A, “Risk Factors,” 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 new developments or actual results.

Overview
Dolby Laboratories has been a leading solutions provider to the entertainment industry for more than 45 years. We provide products, services, and technologies to capture, distribute, and play back entertainment content that gives consumers a premium entertainment experience, regardless of how or where they choose to enjoy it. Our core strengths range from our expertise in digital signal processing and compression technology to our long history of providing products, tools, and technologies to participants in the entertainment industry at each stage in the content creation, distribution, and playback process. We provide products and services that enable content creators and distributors to produce, encode, and transmit content with our premium audio technologies, and we license decoding technologies to the manufacturers of entertainment devices to ensure that content is ultimately experienced as the creator and distributor intended.
Throughout our history, we have introduced numerous innovations that have significantly improved the quality of audio entertainment, such as noise reduction for the recording and cinema industries and surround sound for cinema and home entertainment. Today, we continue to derive the vast majority of our revenue from our audio technologies.
Looking forward, we see a number of industry trends that create opportunities for the continued growth of our audio business, including the ongoing global transition from analog to digital television and consumers’ increasing use of mobile devices, such as tablets and smartphones, to play back digital content. Our portfolio of technologies and solutions optimize the audio experience for mobile devices to provide consumers with a rich, clear, and immersive sound, despite the bandwidth limitations of online and cellular networks and the physical limitations of devices with small speakers.
In 2012, we announced Dolby Atmos, a new audio platform for cinema that delivers a more natural and realistic sound field. Since then, numerous movie titles have been released or announced in Dolby format from major studios such as Disney, Twentieth Century Fox, and Warner Bros.
We also see opportunities to apply our core strengths in areas beyond audio. For example, we believe that significant improvements can be made in the technology currently used to deliver and play back premium video, and we have identified solutions that may substantially improve the video experience. Similarly, we believe we can apply our existing audio technologies to improve the clarity and quality of voice communications in areas such as multi-party teleconferencing.

Business Model
We generate the majority of our revenue by licensing technologies to original equipment manufacturers (“OEM”) of consumer entertainment (“CE”) products and to software vendors. We also generate revenue by selling products and related services to creators, distributors and exhibitors of entertainment content.

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Table of Contents

We participate in the global entertainment industry in several important ways:

We offer products, services, and technologies to creators and distributors of entertainment content, such as motion picture, television, and music recording studios, television broadcasters, satellite and cable operators, cinema theatre chains, and increasingly, Internet content streaming and download service providers. These content creators and distributors use our products, services, and technologies to encode and transmit content, creating rich, clear, and immersive audio experiences for consumers upon playback.
We license technologies, such as Dolby Digital, Dolby Digital Plus, and Dolby TrueHD to OEMs and software vendors for incorporation into their CE and other products, so that consumers can play back audio content with our technologies in the rich, clear, and immersive manner the creators intended.
We work directly with standards-setting organizations in the entertainment and technology industries, as well as governments and other regulatory bodies, to promote adoption of our technologies in their standards. As a result, our technologies are included in the majority of worldwide TV shipments to support digital TV standards around the world. Our technologies are also included in virtually all DVD players, Blu-ray Disc players, audio/video receivers, and personal computer (“PC”) DVD software players.
We license our technologies to OEMs and software vendors in 49 countries, and our licensees distribute products incorporating our technologies throughout the world. We sell our products and services in over 80 countries. In the first quarter of fiscal 2013 and first quarter of fiscal 2012, revenue from outside of the U.S. represented 68% and 69% of our total revenue, respectively. Geographic data for our licensing revenue is based on the location of our licensees’ headquarters. Products revenue is based on the destination to which we ship our products, while services revenue is based on the location where services are performed.
Opportunities, Challenges, and Risks
Our licensing and product markets are characterized by rapid technological changes, new and improved product features and performance, changing customer demands, evolving industry standards, changing licensee needs, and product life cycles that can result in obsolescence. We believe that these changes present us with opportunities to provide realistic and immersive audio experiences to consumers through new and emerging delivery channels. However, as described below, our licensing revenue is subject to uncertainties and trends relating to technology and market growth, as well as the mix of CE products sold that incorporate our technologies. Our licensing business also could be affected by adverse general economic conditions, because many of the products in which our technologies are incorporated are discretionary goods. Furthermore, our products business is subject to intense competition and uncertainties relating to the transition to digital cinema and purchasing decisions by our cinema customers.
Licensing
Licensing revenue constitutes the majority of our total revenue, representing 86% of total revenue in both the first quarter of fiscal 2013 and the first quarter of fiscal 2012.
The entertainment industry is continually in transition. As consumers are presented with more options for receiving entertainment content, competition across the delivery channels has intensified. We see this reflected in the changing composition of our licensing revenue, driven by a shift away from optical disc based products. Our optical disc-based revenue is generated from the licensing of technologies that enable DVD or Blu-ray Disc playback, including the licensing of such technologies in the Microsoft Windows operating system, independent PC DVD software players, and consumer DVD and Blu-ray Disc players. However, most of these products can also receive content over mobile or online networks and we have increased our technology penetration into these other distribution channels. Non-optical disc based revenue is generated from the sale of technology solutions other than those used to enable DVD or Blu-ray Disc playback. Non-optical disc based revenue includes licensing revenue derived from products such as TVs, set-top boxes, and mobile devices, as well as from the incorporation of our post processing technologies in a range of devices. We remain focused on delivering the products, tools, and technologies needed to ensure a high quality audio experience from any device.
Looking forward, we expect continued growth in the proportion of our licensing revenue we derive from non-optical disc sources. This will be driven partly by the maturity of optical disc as a method for delivering content, but also by the significant opportunities presented by digital broadcast and online and mobile distribution, as well as the inclusion of our technologies in the Windows 8 operating system to enable the playback of online content. We also see significant opportunities to offer encode/decode solutions in video and voice that leverage our expertise in signal processing, compression, and the capture and playback of content.
Our licensing revenue comes from the following markets and primarily from the inclusion of our technologies in the products indicated for each market:

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Broadcast market: primarily televisions and set-top boxes
PC market: primarily DVD software players and Microsoft Windows operating systems
CE market: primarily DVD and Blu-ray Disc players and recorders, audio/video receivers, and home-theater-in-a-box systems
Mobile – primarily smartphones, tablets and other mobile devices
Other markets:
Gaming – primarily video game consoles
Licensing services – primarily administration of joint licensing programs
Automotive – primarily in-car DVD players
The growth of the Internet, and the related shift by consumers toward online entertainment content, has resulted in a global trend toward an array of online content streaming and download services. Today content is captured, delivered, and played back in more ways than ever before. Content creators and distributors are increasingly focused on delivering content across a multitude of media and devices with varying bandwidth and performance requirements, including PCs, connected TVs, set-top boxes, gaming consoles, connected Blu-ray Disc players, and a variety of mobile devices. Many of these mobile devices are increasingly designed to capture and distribute content through improved camera and WiFi technologies, as well as to play back rich entertainment experiences. This increasingly complex array of devices, with capability for both creating and playing back content, presents a challenge for content creators and device manufacturers seeking consistent audio quality. We believe this challenge provides an opportunity similar to that of digital broadcast, whereby we can provide solutions to optimize the audio experience across the online and portable device markets.
In the area of content creation and delivery, our technologies are included in DVD, Blu-ray Disc, and certain broadcast standards, and we are working to extend our technologies to online delivery services. Online content aggregators, including Netflix, Amazon, VUDU, Apple, HBO GO, Samsung’s Acetrax, and the Roxio Now platform, use our technologies to encode video and audio content. Leading music services such as Rhapsody and Omnifone use our audio encoding tools to deliver a rich music experience to their subscribers. In the second quarter of fiscal 2012, HBO adopted Dolby Digital Plus in its HBO GO content for select connected TVs. HBO now offers Dolby Digital Plus in its HBO GO service for content delivered to certain TV's and gaming consoles. In addition, Samsung now offers Dolby Digital Plus surround sound audio through the Acetrax Video on Demand application.
Our broadcast market, driven by demand for our technologies in televisions and set-top boxes, represented approximately 33% and 31% of our licensing revenue in the first quarter of fiscal 2013 and first quarter of fiscal 2012, respectively. Dolby technology was included in a higher percentage of televisions and set-top boxes in the first fiscal quarter of 2013, which drove increased revenue relative to the same period in the prior year. We see opportunities in working with specific operators and standards bodies across emerging markets to adopt our multichannel formats. Given the percentage of the world's population that lives in countries in emerging markets and the number of televisions and set-top boxes sold in such markets, we believe that these markets present significant opportunities for growth. While there is no guarantee that the countries in the emerging markets will convert to digital television, we believe we are well positioned to benefit from such transition if it occurs. Broadcast services, such as terrestrial broadcast or IPTV services that operate under bandwidth constraints, represent another area of opportunity for Dolby technologies, which enable the delivery of high quality audio content at reduced bit rates, thereby conserving bandwidth. We may not, however, be able to extend our current success in the broadcast market to these new opportunities.
Our PC market represented approximately 29% of our licensing revenue in both the first quarter of fiscal 2013 and first quarter of fiscal 2012. Our technologies are incorporated in the majority of PCs sold today, primarily because of the inclusion of DVD and Blu-ray Disc playback in the majority of PCs and the inclusion of Dolby technologies in the DVD and Blu-ray Disc standards.
Historically, we have licensed our technologies to a range of PC licensees, including independent software vendors (“ISV”), PC OEMs, and operating system providers. The release of new versions of major PC operating systems has often resulted in changes in the mix of our PC licensees. In 2007, Microsoft released its Windows Vista operating system, which included our technologies to enable DVD audio playback in two of its editions. In fiscal 2009, Microsoft released its Windows 7 operating system, which included our technologies within four editions. As a result, since 2007 the mix of our PC licensing revenue from operating systems has increased relative to that from OEMs and ISVs. We currently license our audio codec technologies directly to OEMs such as Apple, Toshiba, and Sony to support optical disc playback on PCs, and we license our PC Entertainment Experience (“PCEE”) technologies to multiple PC OEMs through our PCEE licensing program.

In May 2012, we entered into an agreement with Microsoft under which Dolby Digital Plus 5.1 channel decoding and Dolby Digital two-channel encoding are included in all PCs and tablets licensed to run the Windows 8 operating system. Under

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the arrangement, OEMs generally are required to directly license and pay us a base royalty rate for the right to use the Dolby technologies included in Windows 8 installed on the PCs they produce for online and file-based content. OEMs are required to pay a higher per-unit royalty for Windows 8 PCs that also include optical disc playback functionality, which is implemented by ISV applications. This higher rate is comparable to the rates paid historically for the inclusion of Dolby disc playback software in the PC market. In the near term, we expect the majority of PCs to continue to ship with optical disc drives and to include optical disc playback functionality.

We believe that the Microsoft Windows 8 arrangement provides a simple and consistent way for OEMs to enable playback with our technologies of content delivered by online services and video in local files on the device. In the current quarter, we began generating revenue from the Windows 8 arrangement, while Microsoft continues to license its Windows 7 operating systems with our technologies. The impact on our licensing revenue from the transition to Windows 8 will depend on several factors, including:
The extent and rate at which Windows 8 is adopted in the marketplace;
The extent to which OEMs include optical disc playback in Windows 8 devices;
The extent to which earlier versions of Microsoft operating systems, including Windows 7, continue to be licensed after the release of Windows 8;
Our ability to establish and extend licensing relationships directly with PC OEMs and ISVs;
The rate at which entertainment content shifts from optical disc media to online media, thus reducing the need for PCs to have optical disc drives and DVD and Blu-ray Disc software players; and
Our ability to extend the adoption of our technologies to online and mobile platforms.
In the short term, revenue from our PC market remains dependent on several factors, including underlying PC unit shipment growth and the extent to which our technologies are included in operating systems and ISV media applications. We continue to face risks relating to:
Purchasing trends away from traditional PCs and toward alternative devices without optical disc drives, such as ultrabooks and tablets, which may not include our technologies;
The prevalence of PC software that includes our technologies on an unauthorized and infringing basis, for which we receive no royalty payments; and
Continued decreasing inclusion of ISV media applications by PC OEMs in their Windows 7-based PCs, as Windows 7 already incorporates DVD playback software.
Our CE market, driven primarily by revenue attributable to Blu-ray Disc and DVD players and recorders, represented approximately 17% and 20% of licensing revenue in the first quarter of fiscal 2013 and first quarter of fiscal 2012, respectively. Sales of DVD players are declining as a result of the maturity of the DVD platform and a shift to Blu-ray players and other connected devices capable of delivering content. The decline in DVD revenue is only partly offset by revenue from Blu-ray players which have been adversely impacted by the popularity of other connected devices. At the same time, royalties on Blu-ray players have declined as licensees have migrated to products with lower average selling prices. Revenue from other home theater devices categorized in our CE market remained relatively unchanged from the first quarter of fiscal 2012.
Our Mobile market represented approximately 11% and 8% of our licensing revenue in the first quarter of fiscal 2013 and first quarter of fiscal 2012, respectively. Mobile revenue is largely driven by sales of smartphones and tablet devices that incorporate our technologies. Our growth in this market is dependent not only on the underlying growth of the mobile device market as a whole, but also on the success of the mobile devices incorporating our technologies. Under our arrangement entered into with Microsoft in May 2012 as noted above, OEMs generally are required to directly license and pay us a base royalty rate for the right to use the Dolby technologies included in Windows 8 installed on the tablets they produce for online and file-based content.
Revenue generated from our other markets stem from gaming, automotive and licensing services, and represented approximately 10% and 12% of licensing revenue in the first quarter of fiscal 2013 and first quarter of fiscal 2012, respectively. Revenue attributable to gaming and automotive is primarily driven by sales of video game consoles and in-car entertainment systems, respectively, that incorporate our Dolby Digital, Dolby Digital Plus, AAC, and Dolby TrueHD technologies. Licensing services revenue, from administration of joint licensing programs, is primarily driven by demand for standards-based audio compression technologies for broadcast, PC, CE, and mobile products.
Consumer entertainment products throughout the world incorporate our technologies. We expect that sales of such products incorporating our technologies in emerging economies such as Brazil, China, India, and Russia, will increase in the future as consumers in these markets acquire more disposable income with which to purchase entertainment products.

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However, events in these economies or in the world economy in general may contradict these expectations. Moreover, we expect that OEMs in lower-cost manufacturing countries, including China, will increase production in response to this demand and that traditional OEMs will continue to shift their manufacturing operations to these lower-cost manufacturing countries. There are substantial risks associated with doing business in such countries, including OEMs failing to report or underreporting shipments of products incorporating our technologies, that have affected and will continue to affect our operating results.
Revenue from Microsoft represented approximately 12% and 14% of our total revenue in the first quarter of fiscal 2013 and first quarter of fiscal 2012, respectively, and included licensing revenue from our PC, CE, and other markets. Additionally, revenue from Samsung represented approximately 11% of our total revenue in the first quarter of fiscal 2013, and included licensing revenue from our PC, CE, mobile, and other markets.
Products
Products revenue is driven primarily by sales of equipment to cinema operators and broadcasters and represented 11% of our total revenue in both the first quarter of fiscal 2013 and first quarter of fiscal 2012.
Our cinema products represented approximately 87% and 84% of total products revenue in the first quarter of fiscal 2013 and first quarter of fiscal 2012, respectively. Sales of our cinema products tend to fluctuate based on the underlying trends in the cinema industry, including the popularity of individual movies, as cinema owners often purchase equipment to meet expected box office demand.
Our recently introduced Dolby Atmos enhances the cinema experience through the use of a hybrid approach that combines multi-channel audio with discrete audio objects. This approach provides more flexibility and control for sound designers and mixers to deliver a more natural and realistic sound environment.
The cinema industry is transitioning from traditional film to digital cinema, and we estimate that the industry is more than halfway through this transition. Digital cinema offers motion picture studios a means to save costs in printing and distributing movies, combat piracy, and enable repeated movie playback without degradation in image and audio quality. Our cinema products include our Dolby Digital Cinema Integrated Media Block, screen server and central library server, for the storage and playback of digital content, and our digital audio processor, which provides audio control for our digital cinema servers. We expect that most cinema owners who are either constructing new theaters or upgrading existing theaters will choose digital cinema products over traditional film cinema products. However, our competitive position in the digital cinema market is not as strong as our position in the traditional film cinema market. For example, digital cinema specifications are based on open standards which, unlike traditional cinema standards, do not include our proprietary audio technologies. Furthermore, we are facing more pricing and other competitive pressures for our digital cinema products than we experience for our traditional film cinema products.
Digital cinema standards are defined by the Digital Cinema Initiative (“DCI”) specifications, and we have developed software for our currently available digital cinema server that is DCI compliant. This software was made commercially available during fiscal 2012.
Our digital 3D products provide 3D image capabilities when combined with a digital cinema projector and server. Our cinema products revenue has been negatively impacted by declines in unit shipments and lower selling prices for 3D products, as the market for 3D cinema equipment has become increasingly competitive. We also believe the decrease in revenue from our 3D products reflects a higher saturation of 3D enabled screens within the cinema industry.
Our traditional film cinema products are used primarily to read, decode, and play back film soundtracks, to calibrate cinema sound systems, and to enable soundtracks encoded in digital audio formats to be played back on analog cinema audio systems. As investment by the cinema industry in digital cinema has increased, revenue from our traditional film cinema products has declined, and we expect this decline to continue.
Our broadcast products represented approximately 9% and 13% of total products revenue in the first quarter of fiscal 2013 and first quarter of fiscal 2012, respectively. Our broadcast products are used to encode, transmit, and decode multiple channels of high quality audio content for DTV and HDTV program production and broadcast distribution and to measure the subjective loudness of audio content within broadcast programming.
Services
Services revenue represented approximately 3% of our total revenue in both the first quarter of fiscal 2013 and first quarter of fiscal 2012. The level of our services revenue is primarily tied to activity in the cinema industry, and has been adversely impacted by the industry's transition from film to digital-based production. Services are also dependent upon the volume of film production by studios and independent filmmakers. Several factors influence the number of movies produced in

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a given fiscal period, including strikes and work stoppages within the cinema industry, as well as tax incentive arrangements provided by many governments to promote local filmmaking. Services revenue is also impacted by the transition to digital cinema in some regions.

Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based on our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”), and pursuant to Securities and Exchange Commission (“SEC”) rules and regulations. GAAP and SEC rules and regulations require us to use accounting policies and make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies as of the date of the financial statements, and the reported amounts of revenue and expenses during a fiscal period. The SEC considers an accounting policy or estimate to be critical if it is both important to a company’s financial condition and/or results of operations and requires significant judgment on the part of management in its application. On a regular basis, we evaluate our assumptions, judgments, and estimates. We have discussed the selection and development of our critical accounting policies and estimates with the Audit Committee of our Board of Directors. The Audit Committee has reviewed our related disclosures of these in our Annual Report on Form 10-K for the fiscal year ended September 28, 2012. Although we believe that our judgments and estimates are appropriate and correct, actual results may differ from these estimates. There have been no changes to our critical accounting policies from those described in our Annual Report on Form 10-K for the fiscal year ended September 28, 2012.
We consider the following to be critical accounting policies and estimates because we believe they are both important to the portrayal of our financial condition and results of operations and require management judgments about matters that are uncertain. If actual results or events differ materially, our reported financial condition and results of operation for future periods could be materially affected. See our “Risk Factors” for further information on the potential risks to our future results of operations.
Revenue Recognition
We enter into revenue arrangements with our customers to license technologies, trademarks, and know-how and to sell products and services. We recognize revenue when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price to the buyer is fixed or determinable, and collectibility is probable. Judgment is required to assess whether collectibility is probable. We determine collectibility based on an evaluation of our customer’s recent payment history, the existence of a standby letter of credit between the customer’s financial institution and our financial institution, and other factors.
Our revenue arrangements may include multiple elements, such as hardware, software, maintenance, and other services. We evaluate each element in a multiple element (“ME”) arrangement to determine whether it represents a separate unit of accounting. An element constitutes a separate unit of accounting when it has standalone value and delivery of an undelivered element is both probable and within our control. When these criteria are not met, the delivered and undelivered elements are combined and the arrangement fees are allocated to a combined single unit.
If the unit separation criteria are met, we account for each element within a ME arrangement (such as hardware, software, maintenance, and other services) separately, and we allocate fees from the arrangement based on its relative selling price, which we establish using a selling price hierarchy. We determine the selling price of each element based on its vendor specific objective evidence (“VSOE”), if available, third-party evidence (“TPE”) if VSOE is not available, or estimated selling price (“ESP”) if neither VSOE nor TPE is available.
We determine our best estimate of the selling price for an individual element within a ME revenue arrangement using the same methods used to determine the selling price of an element sold on a standalone basis. If we sell the element on a standalone basis, we estimate the selling price by considering actual sales prices. Otherwise, we estimate the selling price by considering internal factors such as pricing practices and margin objectives. Consideration is also given to market conditions such as competitor pricing strategies, customer demands, and industry technology lifecycles. Management applies judgment to establish margin objectives, pricing strategies, and technology lifecycles.
For some arrangements, customers receive certain elements over a period of time, after delivery of the initial product. These elements may include support and maintenance and/or the right to receive upgrades. Revenue allocated to the undelivered element is recognized either over its estimated service period or when the upgrade is delivered. We do not recognize revenue that is contingent upon the future delivery of products or services or upon future performance obligations. We recognize revenue for delivered elements only when we have completed all contractual obligations.

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Revenue recognition for transactions which involve software, such as fees we earn from certain system licensees, requires judgment, including whether a software arrangement includes multiple elements, and if so, whether VSOE of fair value exists for those elements. For some of our ME arrangements, customers receive certain elements of the arrangement over a period of time or after delivery of the initial software. These elements may include support and maintenance. The fair values of these elements are recognized over the estimated period for which these elements will be delivered, which is sometimes the estimated life of the software. If we do not have VSOE of fair value for any undelivered element included in these ME arrangements for software, we defer revenue until all elements are delivered and/or services have been performed, or until we have VSOE of fair value for all remaining undelivered elements. If the undelivered element is support and we do not have fair value for the support element, revenue for the entire arrangement is bundled and recognized ratably over the support period.
We account for our digital cinema server sales as ME arrangements that may include up to three separate units, or elements, of accounting. The first element consists of our digital cinema server hardware and the accompanying software, which is essential to the functionality of the hardware. This element is typically delivered at the time of sale. The second element is the right to receive support and maintenance, which is included with the purchase of the hardware element and is typically delivered over a service period subsequent to the initial sale. The third element is the right to receive specified upgrades, which is included with the purchase of the hardware element and is typically delivered when a specified upgrade is available, subsequent to the initial sale. The application of the revenue accounting standards to our digital cinema server sales typically results in the allocation of a substantial majority of the arrangement fees to the delivered hardware element based on its ESP, relative to the VSOE or ESP of the other elements, which we recognize as revenue at the time of sale. A small portion of the arrangement fees is allocated to the undelivered support and maintenance element, and in some cases to the undelivered specified upgrade element, based on the VSOE or ESP of each element. The portion of the arrangement fees allocated to the support and maintenance element is recognized as revenue ratably over the estimated service period and the portion of the arrangement fees allocated to specified upgrades is recognized as revenue upon delivery of the upgrade.
Goodwill, Intangible Assets, and Long-Lived Assets
We perform our annual goodwill impairment test during the third quarter of each fiscal year, and whenever events or changes in circumstances indicate that the carrying amount may be impaired.
In performing our annual goodwill impairment test, we first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform a two-step goodwill test. We consider events and circumstances, including but not limited to, macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, changes in management or key personnel, changes in strategy, changes in customers, changes in the composition or carrying amount of a reporting unit's net assets and changes in the price of our common stock. If, after assessing the totality of events or circumstances, we determine that it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, then the two-step goodwill impairment test is not performed.
If the two-step goodwill test is performed, we evaluate and test our goodwill for impairment at a reporting-unit level using expected future cash flows to be generated by the reporting unit. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit's goodwill over the calculated fair value of the goodwill. A reporting unit is an operating segment or one level below. Our operating segments are aligned with the management principles of our business.
We completed our annual goodwill impairment assessment in the fiscal quarter ended June 29, 2012. At the time of our annual goodwill impairment test for fiscal 2012, we had two reporting units: Via, which corresponds to our wholly owned subsidiary and has no assigned goodwill, and Dolby Entertainment Technology ("DET"), with goodwill of $263.5 million. We determined, after performing a qualitative review and assessing the totality of the events and circumstances described above, that it is more likely than not that the fair value of each reporting unit is greater than its carrying amount. Accordingly there was no indication of impairment and the two-step goodwill impairment test was not performed. We did not recognize any goodwill impairment losses in the first quarter of fiscal 2013, fiscal 2012, or fiscal 2011.
Intangible assets with definite lives are amortized over their estimated useful lives. Our intangible assets principally consist of acquired technology, patents, trademarks, customer relationships, and contracts, which are amortized on a straight-line basis over their useful lives ranging from two to fifteen years.
We review long-lived assets, including intangible assets, for impairment whenever events or a change in circumstances indicate an asset’s carrying value may not be recoverable. Recoverability of an asset is measured by comparing its carrying value to the total future undiscounted cash flows that the asset is expected to generate. If it is determined that an asset is not recoverable, an impairment loss is recorded in the amount by which the carrying value of the asset exceeds its estimated fair value.

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Accounting for Income Taxes
We make estimates and judgments that affect our accounting for income taxes. This includes estimating actual tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences, including the timing of the recognition of stock-based compensation expense, result in deferred tax assets and liabilities, which are included in our condensed consolidated balance sheets. We also assess the likelihood that our deferred tax assets will be recovered from future taxable income, and to the extent that we believe that recovery is not likely, we establish a valuation allowance.
Our policy is to recognize a tax benefit from an uncertain tax position only if it is more likely than not that the tax position is sustainable upon examination by tax authorities. We include interest and penalties related to gross unrecognized tax benefits within our provision for income taxes. When accrued interest and penalties do not ultimately become payable, amounts accrued are reduced in the period that such determination is made and are reflected as a reduction of the overall income tax provision.
Significant judgment is required in determining the provision for income taxes, the deferred tax asset and liability balances, the valuation allowance against our deferred tax assets, and the reserve resulting from uncertainties in income tax positions. Our financial position and results of operations may be materially affected if actual results differ significantly from these estimates or if the estimates are adjusted in future periods.
Valuation and Classification of Investments
Fair value is 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.
We classify our financial assets and liabilities measured at fair value using a three-level hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are those that reflect the assumptions market participants would use in pricing the investment that are based on market data obtained from sources independent of the reporting entity, such as market quoted prices. GAAP establishes a three-level hierarchy prioritizing the inputs used in measuring fair value as follows: the fair value hierarchy gives the highest priority to quoted prices in active markets that are accessible by us at the measurement date for identical investments, described as Level 1, and the lowest priority to valuation techniques using unobservable inputs, described as Level 3. We obtain the fair value of our Level 2 financial instruments from a professional pricing service, which may use quoted market prices for identical or comparable instruments. Fair value from this professional pricing source can also be based on pricing models whereby all significant inputs, including maturity dates, issue dates, settlement dates, benchmark yields, reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids, offers, and other market related data, are observable or can be derived from or corroborated by observable market data for substantially the full term of the asset.
The degree to which estimates and judgment are used in determining fair value, is generally dependent upon the market pricing information available for the investments, the availability of observable inputs, the frequency of trading in the investments and the investment’s complexity. If different judgments regarding inputs were made, we could potentially reach different conclusions regarding the fair value of our investments.
Stock-Based Compensation
We determine the expense for all employee stock-based compensation awards by estimating their fair value and recognizing that value as an expense, on a ratable basis, in our condensed consolidated financial statements over the requisite service period in which our employees earn the awards. We use the Black-Scholes option pricing model to determine the fair value of employee stock options at the date of the grant. To determine the fair value of a stock-based award using the Black-Scholes option pricing model, we make assumptions regarding the expected term of the award, the expected future volatility of our stock price over the expected term of the award, and the risk-free interest rate over the expected term of the award. We estimate the expected term of our stock-based awards by evaluating historical exercise patterns of our employees. We use a blend of the historical volatility of our common stock and the implied volatility of our traded options as an estimate of the expected volatility of our stock price over the expected term of the awards. We use an average interest rate based on U.S. Treasury instruments with terms consistent with the expected term of our awards to estimate the risk-free interest rate. We reduce the stock-based compensation expense for estimated forfeitures based on our historical experience. We are required to estimate forfeitures at the time of the grant and revise our estimate, if necessary, in subsequent periods if actual forfeitures differ from our estimate.

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Recently Issued Accounting Standards
There have been no new accounting pronouncements not yet effective that have significance, or potential significance, to our condensed consolidated financial statements.
Results of Operations
Revenue
 
 
Fiscal Quarter Ended
Change
 
December 28,
2012
December 30,
2011
$
%
 
($ in thousands)
Licensing
$
204,876

$
200,424

$
4,452

2
 %
Percentage of total revenue
86
%
86
%
 
 
Products
25,498

26,400

(902
)
(3
)%
Percentage of total revenue
11
%
11
%
 
 
Services
6,228

7,354

(1,126
)
(15
)%
Percentage of total revenue
3
%
3
%
 
 
Total revenue
$
236,602

$
234,178

$
2,424

1
 %
Licensing. The 2% increase in licensing revenue from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 was primarily driven by increases in our broadcast and mobile markets, partially offset by decreases in our CE and other markets.  The increase in our broadcast and mobile markets was primarily driven by higher shipments of products that incorporate our technologies along with higher settlements from implementation licensees. Beginning in the first quarter of fiscal 2013, we have classified settlements from implementation licensees as revenue rather than an offset to sales and marketing expenses. For additional details on the change in classification, see Note 1 “Basis of Presentation” to our condensed consolidated financial statements. The decrease in our CE market was primarily attributable to declines in sales of DVD and Blu-ray Disc devices, while the decrease in our other markets was primarily attributable to declines in sales of video game consoles that incorporate our technologies.
Products. The 3% decrease in products revenue from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 was primarily driven by decreases in our film-based cinema products. The decrease in revenue from broadcast products was primarily driven by our customers' ongoing transition to software licensing solutions and to a lesser extent, lower average selling prices as a result of increased competition. The decrease in revenue from film-based products was primarily due to lower shipments, as more exhibitors converted to digital cinema, and to a lesser extent lower pricing.
Services. The 15% decrease in services revenue from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 was attributable primarily to decreases in film-based production services. This decrease was partially offset by an increase in maintenance and support services.

Gross Margin
 
 
Fiscal Quarter Ended
 
December 28,
2012
December 30,
2011
 
($ in thousands)
Cost of licensing
$
3,080

$
3,328

Licensing gross margin percentage
98
%
98
%
Cost of products
18,489

13,888

Products gross margin percentage
27
%
47
%
Cost of services
4,036

3,194

Services gross margin percentage
35
%
57
%
Total gross margin percentage
89
%
91
%
Licensing Gross Margin. We license intellectual property to our customers that may be internally developed, acquired by us, or licensed from third parties. Our cost of licensing consists principally of amortization expenses associated with purchased

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intangible assets and intangible assets acquired in business combinations. Our cost of licensing also includes third-party royalty obligations paid to license intellectual property that we then sublicense to our customers. Licensing gross margin was unchanged from the first quarter of fiscal 2012 to the first quarter of fiscal 2013.
Products Gross Margin. Cost of products primarily consists of the cost of materials related to products sold, applied labor and manufacturing overhead, and, to a lesser extent, amortization of certain intangible assets. Our cost of products also includes third-party royalty obligations paid to license intellectual property that we then include in our products. Products gross margin decreased from 47% to 27% from the first quarter of fiscal 2012 to the first quarter of fiscal 2013. This decrease was primarily due to lower average selling prices in all product markets, combined with lower gross margins on certain digital cinema products released near the end of fiscal 2012. Discrete charges related to inventory valuation were higher in the first quarter of fiscal 2013 as compared to the first quarter of fiscal 2012, partially offset by improvements in manufacturing costs in the first quarter of fiscal 2013.
Services Gross Margin. Cost of services primarily consists of personnel and personnel-related costs for employees performing our professional services such as compensation and benefits expenses, including stock-based compensation, the cost of outside consultants, and other direct expenses incurred on behalf of customers. Services gross margin decreased from 57% to 35% from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 primarily due to higher labor costs incurred in connection with exhibitor installations of equipment for Dolby Atmos-enabled theaters.

Operating Expenses
 
 
Fiscal Quarter Ended
Change
 
December 28,
2012
December 30,
2011
$
%
 
($ in thousands)
Research and development
$
42,436

$
32,826

$
9,610

29
 %
Percentage of total revenue
18
%
14
%
 
 
Sales and marketing
58,421

43,816

14,605

33
 %
Percentage of total revenue
25
%
18
%
 
 
General and administrative
43,108

35,465

7,643

22
 %
Percentage of total revenue
18
%
15
%
 
 
Restructuring charges, net

368

(368
)
(100
)%
Percentage of total revenue
n/a

%
 
 
 
$
143,965

$
112,475

$
31,490

28
 %
Research and Development. Research and development expenses consist primarily of employee compensation and benefits expenses, including stock-based compensation, consulting and contract labor costs, depreciation and amortization expenses, facilities costs, and information technology expenses. The 29% increase in research and development expenses from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 was primarily driven by increases in personnel, facilities, and information technology expenses, as the Company expanded its efforts to develop new products and technologies.
Sales and Marketing. Sales and marketing expenses consist primarily of employee compensation and benefits expenses, including stock-based compensation, marketing and promotional expenses, travel-related expenses for our sales and marketing personnel, facilities costs, depreciation and amortization expenses, and information technology expenses. The 33% increase in sales and marketing expenses from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 was primarily driven by higher consulting and marketing costs related to the recent launch of Atmos technology, as well as expenses for promotional events and naming rights associated with the Dolby Theatre. Additionally, the increase from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 was driven by additional headcount. Beginning in the first quarter of fiscal 2013, settlements from implementation licensees have been classified as licensing revenue rather than an offset to sales and marketing expenses. For additional details on the reclassification, see Note 1 “Basis of Presentation” to our condensed consolidated financial statements.
General and Administrative. General and administrative expenses consist primarily of employee compensation and benefits expenses, including stock-based compensation, depreciation, information technology expenses, professional fees, consulting and contract labor and facilities costs. The 22% increase in general and administrative expenses from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 was due primarily to higher professional fees largely related to general legal matters, and higher personnel expenses that include compensation, benefits, and stock-based compensation expenses, which increased as a result of additional headcount.

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Restructuring Charges, net. Restructuring charges for the first quarter of fiscal 2012 include severance and other associated costs attributable to the reorganization of our global business infrastructure and a strategic restructuring program.
Other Income, Net
 
 
Fiscal Quarter Ended
Change
 
December 28,
2012
December 30,
2011
$
%
 
($ in thousands)
Interest income
$
1,339

$
1,737

$
(398
)
(23
)%
Interest expense
(25
)
(26
)
1

(4
)%
Other income/(expense), net
713

200

513

257
 %
Total other income, net
$
2,027

$
1,911

$
116

6
 %
Other income, net, primarily consists of interest income earned on cash, cash equivalents, and investments, as well as net gains/losses from foreign currency transactions. Other income, net, primarily consists of interest income earned on cash, cash equivalents, and investments, as well as net gains/losses from foreign currency transactions. The increase in other income from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 was primarily driven by an increase in realized gains on investment securities sold. These securities were sold to fund the payment of a special one-time dividend to eligible stockholders in the first quarter of fiscal 2013.
Income Taxes
 
 
Fiscal Quarter Ended
 
December 28,
2012
December 30,
2011
 
($ in thousands)
Provision for income taxes
$
17,582

$
29,838

Effective tax rate
25
%
29
%
Our effective tax rate is based on a projection of our full fiscal year results. Our effective tax rate was 25% and 29% for the first quarters of fiscal 2013 and fiscal 2012, respectively.
Our effective tax rate for the first quarter of fiscal 2013 was lower than the first quarter of fiscal 2012 primarily due to recognized tax benefits from the expiration of statute of limitations on some uncertain tax positions. In January 2013, the federal research credit was retroactively re-enacted through December 31, 2013. As a result, we expect that our income tax provision for the second quarter of fiscal 2013 will include an estimated discrete tax benefit of approximately $1.5 million.

Liquidity, Capital Resources, and Financial Condition
As of December 28, 2012, we had cash and cash equivalents of $316.2 million, which consisted of cash and highly-liquid money market funds. In addition, we had short-term and long-term investments of $427.0 million, which consisted primarily of municipal debt securities, corporate bonds, and U.S. agency securities. Of our total cash, cash equivalents, and investments held as of December 28, 2012, $203.9 million, or 27%, was held by our foreign subsidiaries. This represented a $30.5 million decrease from the $234.4 million that was held by our foreign subsidiaries as of September 28, 2012. A majority of the amounts held outside of the U.S. are generally utilized to support non-U.S. liquidity needs in order to fund operations and other growth of our non-U.S. subsidiaries and acquisitions. Our policy is to indefinitely reinvest a portion of our undistributed earnings in certain foreign subsidiaries. If these undistributed earnings held by foreign subsidiaries are repatriated to the U.S., they may be subject to U.S. federal income taxes and foreign withholding taxes, less applicable foreign tax credits.


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December 28,
2012
September 28,
2012
 
(in thousands)
Cash and cash equivalents
$
316,193

$
492,600

Short-term investments
118,681

302,693

Long-term investments
308,277

361,614

Accounts receivable, net
51,797

43,495

Accounts payable and accrued liabilities
108,919

130,923

Working capital(a)
474,093

813,446

 
 
 
 
Fiscal Quarter Ended
 
December 28,
2012
December 30,
2011
 
(in thousands)
Net cash provided by operating activities
$
67,009

$
95,792

Capital expenditures (b)
(6,717
)
(12,566
)
Repurchase of common stock
(53,956
)
(26,068
)
Net cash provided by investing activities
222,512

31,601

Net cash used in financing activities
(465,866
)
(24,228
)
(a) Working capital consists of total current assets less total current liabilities.
(b) Capital expenditures consist of purchases of land, building, building fixtures, office equipment, computer hardware and software, leasehold improvements, and production and test equipment.
Our principal sources of liquidity are our cash, cash equivalents, and investments, as well as cash flows from 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.
In July 2012, we purchased an approximately 354,000 square foot property in San Francisco, California for $109.8 million, using existing cash. We are in the process of making substantial improvements to the property in order to prepare the building for its intended use as our new worldwide headquarters.
On December 11, 2012, we announced the declaration by our Board of Directors of a one-time special dividend in the amount of $4.00 per share on our Class A and Class B Common Stock. Payment of the special dividend was made on December 27, 2012 to eligible stockholders of record as of the close of business on December 21, 2012 (the "Record Date"). Based on the 102,051,386 shares of Class A and Class B Common Stock outstanding as of the record date, the total special dividend payment was $408.2 million. To fund the dividend payment, we used existing cash along with cash generated from sales of investment securities.
We retain sufficient cash holdings to support our operations and we also purchase investment grade securities diversified among security types, industries, and issuers. We have used cash generated from our operations to fund a variety of activities related to our business in addition to our ongoing operations, including business expansion and growth, acquisitions, and repurchases of our common stock. Cash provided by operations and the value of our investment portfolio could be affected by various risks and uncertainties, as described in Part II, Item 1A “Risk Factors.”
Net cash provided by operating activities during the first quarter of fiscal 2013 decreased $28.8 million from the first quarter of fiscal 2012, primarily due to the following:
A decrease in net income, as adjusted for non-cash items;
An increase in accounts receivable primarily due to timing differences
Net cash provided by investing activities during the first quarter of fiscal 2013 increased $190.9 million from the first quarter of fiscal 2012, primarily due to the following:
An increase in proceeds from the sales and maturities of available-for-sale securities; partially offset by
An increase in purchases of available-for-sale securities;
Net cash used in financing activities during the first quarter of fiscal 2013 decreased $441.6 million from the first quarter of fiscal 2012, primarily due to the following:
The payment of a one-time special dividend to holders of our Class A and Class B common stock;
An increase in share repurchases of our Class A common stock; partially offset by

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An increase in net proceeds from the exercise of employee stock options and the related tax benefit.

Off-Balance-Sheet and Contractual Obligations
Our liquidity is not dependent on the use of off-balance sheet financing arrangements.
As of December 28, 2012, we had an accrued liability for unrecognized tax benefits and related interest and penalties, net of related deferred tax assets, totaling $16.4 million. We are unable to estimate when any cash settlement with a taxing authority might occur.
There has been no material change in our contractual obligations outside the ordinary course of business since the end of our last fiscal year ended September 28, 2012. For additional details regarding our contractual obligations, see Note 9 “Commitments and Contingencies” to our condensed consolidated financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity
As of December 28, 2012, we had cash and cash equivalents of $316.2 million, which consisted of cash and highly-liquid money market funds. In addition, we had short-term and long-term investments of $427.0 million, which consisted primarily of municipal debt securities, corporate bonds, and U.S. agency securities. Our investment policy and strategy are focused on the preservation of capital and on supporting our liquidity requirements. We do not enter into investments for trading or speculative purposes, nor do we use leveraged financial instruments. Our holdings of cash and cash equivalents and marketable securities, the majority of which are managed by external managers, meet the guidelines of our investment policy. We invest in highly rated securities with a minimum credit rating of A- and our policy limits the amount of credit exposure to any one issuer other than the U.S. government. At December 28, 2012, our weighted average portfolio credit quality was AA- and the weighted average maturity of our investment portfolio was approximately fifteen months.
The investments within our fixed-income portfolio are subject to fluctuations in interest rates, which could affect our financial position, and to a lesser extent, results of operations. Based on our investment portfolio balance as of December 28, 2012, hypothetical changes in interest rates of 1% and 0.5% would have an impact on the carrying value of our portfolio of approximately $5.4 million and $2.7 million, respectively.
Foreign Currency Exchange Risk
We maintain sales, marketing, and business operations in foreign countries, most significantly in the United Kingdom, Australia, China, the Netherlands, and Germany. We also conduct a growing portion of our business outside of the U.S. through subsidiaries with functional currencies other than the U.S. dollar (primarily British Pound, Australian Dollar, Chinese Yuan Renminbi, and Euro). 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. Conversely, if the U.S. dollar strengthens against the local currency, operating expenses will decrease. 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 statements 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.
We enter into foreign currency forward contracts to hedge against assets and liabilities for which we have foreign currency exchange rate exposure, in an effort to reduce the risk that our earnings will be adversely affected by foreign currency exchange rate fluctuations. These derivative instruments are carried at fair value with changes in the fair value recorded to other income, net, in our condensed consolidated statements of operations. Our foreign currency forward contracts which are not designated as hedging instruments are used to reduce the exchange rate risk associated primarily with intercompany receivables and payables. These contracts do not subject us to material balance sheet risk due to exchange rate movements because gains and losses on these derivatives are intended to offset gains and losses on the related receivables and payables for which we have foreign currency exchange rate exposure. As of December 28, 2012 and September 28, 2012, the outstanding derivative instruments had maturities of 30 days or less and the total notional amounts of outstanding contracts were $6.8 million and $5.0 million, respectively. The fair values of these contracts were nominal as of December 28, 2012 and September 28, 2012, and were included in prepaids and other current assets and accrued liabilities in our condensed consolidated balance sheets.

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A sensitivity analysis was performed on all of our foreign currency forward contracts as of December 28, 2012. This sensitivity analysis was based on a modeling technique that measures the hypothetical market value resulting from a 10% shift in the value of exchange rates relative to the U.S. dollar. For these forward contracts, duration modeling was used where hypothetical changes are made to the spot rates of the currency. A 10% increase in the value of the U.S. dollar would lead to an increase in the fair value of our financial instruments by $0.5 million. Conversely, a 10% decrease in the value of the U.S. dollar would result in a decrease in the fair value of these financial instruments by $0.5 million.



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ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain “disclosure controls and procedures,” as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Subject to the limitations noted above, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the fiscal period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective to meet the objective for which they were designed and operate at the reasonable assurance level.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting during the fiscal quarter ended December 28, 2012 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 pending matters is not expected to have a material adverse impact on our operating results or financial condition. Given the unpredictable nature of legal proceedings, 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; however, based on the information known by us as of the date of this filing and the rules and regulations applicable to the preparation of our financial statements, any such amount is either immaterial or it is not possible to provide an estimated amount of any such potential loss.

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 occurs, our business, operating results, and financial condition could be materially adversely affected.
We depend on the sale by our licensees of products that incorporate our technologies and any reduction in those sales would adversely affect our licensing revenue.
Licensing revenue constitutes the majority of our total revenue, representing 86%, 86%, and 83% in the first quarter of fiscal 2013, fiscal 2012, and fiscal 2011, respectively. We do not manufacture consumer entertainment products ourselves and we depend on licensees and customers, including software vendors and original equipment manufacturers (“OEM”), to incorporate our technologies into their products.
Although we have license agreements with many of these companies, these agreements generally do not have minimum purchase commitments, are typically non-exclusive, and frequently do not require incorporation or use of our technologies. Accordingly, our revenue will decline if our licensees choose not to incorporate our technologies in their products, or if they sell fewer products incorporating our technologies, or if they otherwise face significant economic difficulties. Changes in consumer tastes or trends, rapidly evolving technology, competing products, changes in industry standards or adverse changes in business and economic conditions, among other things, may result in lower sales of products incorporating our technologies which would adversely affect our licensing revenue.
We also face the risk that our licensees retain product channel inventory levels that exceed future anticipated sales. If such product sales do not occur in the time frame anticipated by our licensees for any reason, these licensees may substantially decrease the number of technologies they license from us in subsequent periods.
To the extent that sales of PCs with Dolby technologies decline, our licensing revenue will be adversely affected.
Revenue from our PC market depends on several factors, including underlying PC unit shipment growth, the extent to which our technologies are included on computers, through operating systems, independent software vendors (“ISV”) media applications, or otherwise, and the terms of any royalties or other payments we receive from licensors of such software. We face many risks in the PC market that may affect our ability to successfully participate in that market, including, but not limited to the following:
 
Purchasing trends away from traditional PCs and toward computing devices without optical disc drives, such as ultrabooks and tablets, which may not include our technologies;
The prevalence of PC software that includes our technologies on an unauthorized and infringing basis, for which we receive no royalty payments; and
Continued decreasing inclusion of ISV media applications by PC OEMs in their Windows 7- based PCs, as Windows 7 already incorporates DVD playback software.

In May 2012, we entered into an agreement with Microsoft relating to the inclusion of Dolby Digital Plus decoding and Dolby Digital Consumer Encoder in the Windows 8 operating system. There are no assurances that we will derive as much licensing revenue under this model as we did under our prior licensing arrangements with Microsoft. The ultimate financial impact of these licensing arrangements for Windows 8 on our licensing revenue is subject to various risks, including:


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The extent and rate at which Windows 8 is adopted in the marketplace;
The extent to which OEMs include optical disc playback in Windows 8 devices;
The extent to which earlier versions of Microsoft operating systems, including Windows 7, continue to be licensed after the release of Windows 8;
Our ability to establish and extend licensing relationships directly with PC OEMs and ISVs;
The rate at which entertainment content shifts from optical disc media to online media, thus reducing the need for PCs to have optical disc drives and DVD and Blu-ray Disc software players; and
Our ability to extend the adoption of our technologies to online and mobile platforms and devices.

Any of these risks could adversely affect our licensing revenue.
General economic conditions may reduce our revenue and harm our business.
We continue to be cautious regarding future general economic conditions and their potential for suppressed consumer demand in the markets in which we license our technologies and sell our products. Our business could be affected by adverse changes in general economic conditions, because many of the products in which our technologies are incorporated are discretionary goods, such as PCs, digital televisions, set-top boxes, DVD players and recorders, Blu-ray Disc players, video game consoles, audio/video receivers, mobile devices, in-car entertainment systems, home-theater-in-a-box systems, camcorders, and portable media devices. The global economic environment has adversely affected consumer confidence, disposable income, and spending. While we cannot predict future general economic conditions, these conditions may persist or worsen.
Furthermore, continued weakness in general economic conditions may result in a greater likelihood that more of our licensees and customers will become delinquent on their obligations to us or be unable to pay, which in turn could result in a higher level of write-offs. Additionally, such economic conditions may result in increased underreporting and non-reporting of royalty-bearing revenue by our licensees as well as increased unauthorized use of our technologies, all of which would adversely affect our revenues.
Our future success depends upon the growth of new and existing markets for our technologies and our ability to develop and adapt our technologies for those markets.
The future growth of our licensing revenue will depend, in part, upon the growth of, and our successful participation in, new and existing markets for our technologies, such as digital broadcast, online and mobile media distribution, consumer video and voice. For example, growth of our broadcast revenue is dependent upon continued global growth of digital television broadcasting and the adoption of our technologies into emerging digital broadcast standards. In addition, our revenue is dependent upon the growth of the PC market and the continued adoption of our technologies into PCs as well as the adoption of our technologies into connected portable devices such as tablets and smartphones. Furthermore, our ability to drive OEM demand for our technologies depends in part on whether or not we are able to successfully participate in the online and mobile content delivery markets.
Our ability to penetrate new and existing markets for our technologies depends on increased consumer demand for products that contain our technologies, which may not occur. Some of these markets are ones in which we have not previously participated or have limited experience, such as voice and consumer video, and we may not adequately adapt our business and our technologies to consumer demand.
If new and existing markets for our technologies do not develop or consumer demand for products that contain our technologies does not grow, our business and prospects would be materially adversely affected.
If we do not continue to develop and deliver innovative technologies in response to industry and technology changes, our business could decline.
The markets for our technologies and products are defined by:
 
Rapid technological change;
New and improved technology and product introductions;
Changing consumer and licensee demands;
Evolving industry standards; and
Technology and product obsolescence.
Our future success depends on our ability to enhance our existing technologies and products and to develop acceptable new technologies and products that address the needs of the market in a timely manner. The development of enhanced and new

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technologies and products is a complex and uncertain process requiring high levels of innovation, highly-skilled engineering and development personnel, and the accurate anticipation of technological and market trends. We may not be able to identify, develop, acquire, market, or support new or enhanced technologies or products on a timely basis, if at all. For example, while we view the continued advancements in online and mobile media content delivery as an area of opportunity, if we are not able to competitively address the needs of the changing online and mobile markets, our ability to generate revenue from those markets would be limited. 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.
We face many risks related to the 3D cinema market.
We face many risks in the 3D cinema market which may affect our ability to successfully participate in that market, including, but not limited to the following:
 
We face risks that our customers maintain excess product inventory levels which could reduce future anticipated sales;
At least one of our competitors has exclusive licensing arrangements for 3D products with theater exhibitors, which has in the past and we expect will in the future restrict our ability to compete in the 3D market;
The 3D market has become increasingly competitive and we may lose further market share;
With the industry transition to 3D enabled screens substantially complete, demand for new 3D enabled screens has dropped significantly and the industry has entered into a replacement cycle;
Industry participants may perceive our up-front 3D equipment costs and reusable glasses business model or our 3D products as less attractive;
Our participation in the 3D cinema market will be limited to the extent that theaters do not convert from analog to digital cinema;
Demand for our 3D cinema products is driven by the number of 3D cinema releases and the commercial success of those releases;
Our 3D glasses could become subject to regulation in the U.S. and other countries in the future, which could restrict how our 3D glasses are manufactured, used, or marketed; and
There has been increased public scrutiny of potential health risks relating to viewing 3D movies. If these potential health risks are substantiated, the popularity of 3D movies could decline. In addition, if health risks associated with our 3D products materialize, we may become subject to government regulation or product liability claims, including personal injury claims.
If we are unable to manage these risks effectively, our ability to compete profitably in the 3D cinema market may be adversely affected.
Events and conditions in the cinema and broadcast industries may affect sales of our cinema products and other services.
Sales of our cinema products and services tend to fluctuate based on the underlying trends in the cinema industry. For example, when box office receipts for the cinema industry increase, we have typically seen a corresponding increase in sales of our cinema products, as cinema owners will be more likely to build new theaters and upgrade existing theaters with our more advanced products. Conversely, when box office receipts are down, cinema owners tend to scale back on plans to expand or upgrade their systems.
Our cinema product sales are also subject to fluctuations based on events and conditions in the cinema industry generally that may or may not be tied to box office receipts in particular time periods. For example, the growth in piracy of motion pictures adversely affects the construction of new screens, the renovation of existing theaters, and the continued production of new motion pictures.
Our services revenue, both in the U.S. and internationally, is tied to the number of movies being produced and distributed by studios and independent filmmakers. A number of factors can affect the number of movies that are produced, including strikes and work stoppages within the cinema industry, as well as tax incentive arrangements provided by many governments to promote local filmmaking. Services revenue is also impacted by the transition to digital cinema in some regions. For example, the 15% decrease in services revenue from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 was attributable primarily to a decrease in film based production services in EMEA, and to a lesser extent, a decrease in film-based production services revenue in the U.S. as the cinema industry transitions to digital cinema.
The demand for our cinema products and services could decline as the cinema industry adopts digital cinema.
As cinema exhibitors have constructed new theaters or upgraded existing theaters, they have generally chosen digital cinema over traditional film cinema and we expect this trend to continue. Digital cinema, which is based on open standards, does not include our proprietary audio technologies. As the cinema industry continues to adopt digital cinema, the demand for

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our traditional film cinema products and services has declined significantly and we anticipate that the demand for film based products will decline in future periods. Furthermore, exhibitors adopting digital cinema can choose from multiple digital cinema playback servers and audio processors, many of which may not contain our technologies, and our competitive position in the digital cinema market is not as strong as our position in the traditional film cinema market. Decreases in demand for our traditional film cinema products and services accompanied by decreases in revenue from digital cinema products and services would adversely affect our revenue stream from the cinema industry.
A decrease in demand for our cinema products and services could adversely affect our consumer products licensing business.
A decrease in the demand for our cinema products and services could adversely affect licensing of our consumer technologies, because the strength of our brand and our ability to use professional product developments to introduce new technologies, which can later be licensed to OEMs 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.
We face risks relating to the online and mobile content delivery markets and declines in optical disc media.
For nearly 20 years, movies have been distributed, purchased, and consumed through optical disc media, such as DVD and more recently Blu-ray Disc. However, the growth of the Internet and home computer usage, connected televisions, set-top boxes, tablets, smartphones, and other devices accompanied by the rapid advancement of online and mobile content delivery has resulted in the recent trend to movie download and streaming services in various parts of the world. We expect a further shift away from optical disc media to online and mobile media content consumption, which will result in declines in revenue from DVD and Blu-ray Disc players. Such declines would adversely affect our licensing revenue.
In addition, online and mobile media content services that compete with or replace DVD and Blu-ray Disc players as dominant media for consumer video entertainment may choose not to encode their content with our proprietary technologies, which could affect OEM and software vendor demand for our decoding technologies. Furthermore, our participation in online media content playback may be less profitable for us than DVD and Blu-ray Disc players. The online and mobile markets are characterized by intense competition, evolving industry standards and business and distribution models, disruptive software and hardware technology developments, frequent new product and service introductions, short product and service life cycles, and price sensitivity on the part of consumers, all of which may result in downward pressure on pricing. Any of the foregoing could adversely affect our business and operating results.
Our operating results may fluctuate depending upon the timing of when we receive royalty reports from our licensees, royalty report adjustments, and the satisfaction of our revenue recognition criteria.
Our quarterly operating results fluctuate based on the risks set forth in this section, as well as on:

The timing of when we receive royalty reports from our licensees and when we have met all revenue recognition criteria;
Royalty reports including positive or negative corrective adjustments;
Retroactive royalties that cover extended periods of time;
The recognition of unusually large amounts of licensing revenue from licensees in any given quarter because not all of our revenue recognition criteria were met in prior periods; and
The recognition of large amounts of products and services revenue in any given quarter because not all of our revenue recognition criteria were met in prior periods.
This can result in the recognition of a large amount of revenue in a given quarter that is not necessarily indicative of the amounts of revenue to be received in future quarters, thus causing fluctuations in our operating results.
Inaccurate licensee royalty reporting could materially adversely affect our operating results.
We generate licensing revenue primarily from OEMs and software vendors who license our technologies and incorporate those technologies in their products. Our license agreements generally obligate our licensees to pay us a specified royalty for every product they ship that incorporates our technologies, and we rely on our licensees to accurately report their shipments. However, we have difficulty independently determining whether or not our licensees are reporting shipments accurately, particularly with respect to software incorporating our technologies because unauthorized copies of such software can be made relatively easily. Most of our license agreements permit us to audit our licensees’ records, but audits are generally expensive, time consuming, and potentially detrimental to our ongoing business relationships with our licensees.

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In the past, licensees, particularly in emerging economies, such as China, have understated or failed to report the number of products incorporating our technologies that they shipped, and we have not been able to collect and recognize revenue to which we were entitled. We expect that we will continue to experience understatement and non-reporting of royalties by our licensees, which could adversely affect our operating results. Conversely, to the extent that our licensees overstate the number of products incorporating our technologies, or report the products under the wrong categories, corrections of prior reports could result in reductions of royalty revenue in subsequent periods, which could also adversely affect our operating results.
Third parties from whom we license technologies may challenge our calculation of the royalties we owe them for inclusion of their technologies in our products and licensed technologies, which could adversely affect our operating results, business, and prospects.
In some cases, the products we sell and the technologies we license to our customers include intellectual property that we have licensed from third parties. Our agreements with these third parties generally require us to pay them royalties for that use, and give the third parties the right to audit our calculation of those royalties. A third party may disagree with our interpretation of the terms of a license agreement or, as a result of an audit, a third party could challenge the accuracy of our calculation. We have in the past been, and may in the future be, involved in disputes with third-party technology licensors regarding license terms.
A successful challenge by a third party could result in the termination of a license agreement or increase the amount of royalties we have to pay to the third party, which would decrease our gross margin and adversely affect our operating results.
Unauthorized use of our intellectual property could materially adversely affect our operating results.
We have often experienced, and expect to continue to experience, problems with non-licensee OEMs and software vendors, particularly in emerging economies, such as China, incorporating our technologies and trademarks into their products without our authorization and without paying us any licensing fees. Manufacturers of integrated circuits, or ICs, containing our technologies occasionally sell these ICs to third parties who are not our system licensees. These sales, and the failure of such manufacturers to report the sales, facilitate the unauthorized use of our intellectual property. As emerging economies transition from analog to digital content, such as the transition from analog to digital broadcast, we expect to experience increased problems with this form of piracy, which would adversely affect our operating results.
We have limited experience in non-sound technology markets which could limit our future growth.
Our future growth will depend, in part, upon our expansion into areas beyond sound technologies. For example, in addition to our digital cinema and 3D digital cinema initiatives, we are exploring other areas that facilitate delivery of digital entertainment, such as video solutions for the consumer market. We will need to spend considerable resources in the future on research and development or acquisitions in order to deliver innovative non-sound products and technologies. However, we have limited experience in non-sound technology markets and, despite our efforts, non-sound products, technologies, and services we expect to develop or acquire and market may not achieve or sustain market acceptance, may not meet industry needs, and may not be accepted as industry standards. If we are unsuccessful in selling non-sound products, technologies, and services, the future growth of our business may be limited.
If our products and technologies are not adopted as industry standards, our business prospects could be limited and our operating results could be adversely affected.
The entertainment industry depends upon industry standards to ensure compatibility across delivery platforms and a wide variety of consumer entertainment products. Accordingly, we make significant efforts to design our products and technologies to address capability, quality, and cost considerations so that they either meet, or, more importantly, are adopted as, industry standards across the broad range of entertainment industry markets in which we participate, as well as the markets in which we hope to compete in the future. To have our products and technologies adopted as industry standards, we must convince a broad spectrum of standards-setting 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.
Additionally, the market for broadcast technologies has traditionally been heavily based on industry standards, often set by governments or other standards-setting organizations, and we expect this to be the case in the future. If our technologies are not chosen as industry standards for broadcasting in particular geographic areas, this could adversely affect our ability to compete in these markets.

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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.
Standards-setting organizations are increasingly adopting or establishing technology standards for use in a wide range of consumer entertainment products. As a result, it is more difficult for individual companies to have their technologies adopted wholesale as an informal industry standard. We call this type of standard a “de facto” industry standard, meaning that the industry has widely adopted the technology, although no industry standards-setting organization has explicitly mandated such standard. Increasingly there are multiple companies, including ones that typically compete against one another, involved in the development of new technologies for use in entertainment-oriented 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 entertainment products.
Even if our technologies are adopted as an explicit industry standard for a particular market, market participants may not widely adopt our technologies.
Even when a standards-setting organization 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 explicit industry standard. Accordingly, our operating results depend upon participants in that market choosing to adopt our technologies instead of competitive technologies that also may be acceptable under such standard. For example, the continued growth of our revenue from the broadcast market will depend upon both the continued global adoption of digital television generally and the choice to use our technologies where it is one of several accepted industry standards.
Our licensing revenue depends to a significant extent on patent royalties, and some of our key patents from which a significant portion of that revenue is derived have expired and will continue to expire.
Many of the technologies that we license to our system licensees are covered by patents, and the licensing revenue that we receive from those licenses depends in large part upon the life of such patents. In general, our agreements with our licensees require them to pay us a full royalty with respect to a particular technology only until the last patent covering that technology expires in a particular country. As of December 28, 2012, we had nearly 3,000 individual issued patents, and over 2,700 pending patent applications, in over 50 jurisdictions throughout the world. The currently issued patents expire at various times through November 2032.
We regularly look for opportunities to expand our patent portfolio both through organic development and acquisitions. However, to the extent that we are not able to obtain new patents or develop other proprietary technologies, or to the extent that we do not replace licensing revenue from technologies covered by expiring patents with licensing revenue based on non-expiring patents and other proprietary technologies, our operating results may be materially adversely affected.
In particular, some of our patents relating to Dolby Digital technologies, from which we derive a significant part of our licensing revenue, have expired and others will expire over the next several years. We have transitioned a number of our Dolby Digital licensees, and continue to make progress in transitioning other Dolby Digital licensees, to Dolby Digital Plus technologies, an extension of our Dolby Digital technologies, whose patents generally expire later than the Dolby Digital patents. We now derive a significant part of our licensing revenue from Dolby Digital Plus. To the extent that we are unsuccessful in having licensees continue to transition to Dolby Digital Plus, or to the extent that licensees of Dolby Digital Plus transition back to Dolby Digital as our original patents covering this technology expire, our operating results could be materially adversely affected.
The markets for our technologies are highly competitive, and if we are unable to compete successfully, our business will suffer.
The markets for entertainment industry technologies are highly competitive, and we face competitive threats and pricing pressure in our markets. Competitors for our licensed technologies include: Audyssey Laboratories, DTS, Fraunhofer Institute for Integrated Circuits, Microsoft, Monster Cable Products, Philips, RealNetworks, Sony, Technicolor, and Waves Audio. Competitors for our products include: Barco, Doremi, GDC, IMAX, MasterImage 3D, NEC, Panavision, QSC Audio Products, Qube Cinema, REALD, Rovi, Sony, Technicolor, USL, and XpanD. Competitors for our services include DTS and Sony. Consumers may perceive the quality of the audio experience produced by some of our competitors’ technologies to be equivalent or superior to the audio experience produced by our technologies. Other companies may become competitors in one or more of these areas in the future.
Additionally, some of our current or future competitors may have significantly greater financial, technical, marketing, and other resources than we do, or may have more experience or advantages in the markets in which they compete, particularly in

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the market for online media content. These competitors may also be able to offer integrated system solutions in markets for sound or non-sound entertainment technologies on a royalty-free basis or at a lower price than our technologies, including audio, video, and rights management technologies related to PCs or the Internet, which could make competing technologies that we develop unnecessary.
Our business and prospects depend on the strength of our brand, and if we do not maintain and strengthen our brand, our business will be materially harmed.
Maintaining and strengthening the Dolby brand is critical to maintaining and expanding our licensing, products, and services business, as well as to our ability to enter new markets for our sound and other technologies. Our continued success depends, in part, on our reputation for providing high quality technologies, products, and services across a wide range of entertainment markets, including the consumer entertainment, PC, broadcast, and gaming markets. If we fail to promote and maintain the Dolby brand successfully in licensing, products or services, our business and prospects will suffer. Furthermore, we believe that the strength of our brand may affect the likelihood that our technologies are adopted as industry standards in various markets and for various applications. Our ability to maintain and strengthen our brand will depend heavily on our ability to develop innovative technologies for the entertainment industry, to successfully enter into new markets, and to provide high quality products and services in these new markets, which we may not do successfully.
Our licensing of industry standard technologies can be subject to restrictions that could adversely affect our business and prospects.
When a standards-setting organization mandates our technologies as explicit industry standards, we generally must agree to license such technologies on a fair, reasonable, and non-discriminatory basis, which could limit our control over the use of these technologies. In these situations, we must often limit the royalty rates we charge for these technologies, which could adversely affect our revenue. Furthermore, we may be unable to limit to whom we license such technologies, and may be unable to restrict many terms of the license.
We have in the past, and may in the future, be subject to claims that our licensing of industry standard technologies may not conform to the requirements of the standards-setting organization. Allegations such as these could be asserted in private actions seeking monetary damages and injunctive relief, or in regulatory actions. Claimants in such cases could seek to restrict or change our licensing practices or our ability to license our technologies in ways that could injure our reputation and otherwise materially and adversely affect our business, operating results, and prospects.
We face risks in conducting business in China and other emerging economies.
We believe that various trends will increase our exposure to the risks of conducting business in emerging economies. For example, we expect the number of OEMs in emerging economies, such as China, to increase due to the availability of lower manufacturing costs as compared to those of other industrial countries and the continued industry shift by retailers towards lower end DVD and more recently Blu-ray Disc player and television offerings. We have seen OEMs shift product manufacturing to these lower cost manufacturing countries and expect more OEMs to do so in the future. We also believe that our sales of products and services in emerging economies will expand in the future to the extent that the use of digital surround sound technologies increases in these countries, including in movies and broadcast television, and as consumers there become more affluent. We face many risks associated with operating in these emerging economies, in large part due to limited recognition and enforcement of contractual and intellectual property rights. As a result, we may experience difficulties in enforcing our intellectual property rights in these emerging economies, where intellectual property rights are not as respected as they are in the U.S., Japan, and Europe. We believe that it is critical that we strengthen existing relationships and develop new relationships with entertainment industry participants worldwide to increase our ability to enforce our intellectual property and contractual rights without relying solely on the legal systems in the countries in which we operate. If we are unable to develop, maintain, and strengthen these relationships, our revenue from these countries could be adversely affected.
We have limited or no patent protection for some of our technologies in particular countries, including China, Taiwan, and India, which could limit our ability to grow our business in these markets.
In China and Taiwan we have only limited patent protection, especially with respect to our Dolby Digital technologies. In India, we have no issued patents for Dolby Digital technologies. Consequently, maintaining or growing our licensing revenue will depend on our ability to obtain patent rights in these countries for existing and new technologies, which is uncertain. Furthermore, because of the limitations of the legal systems in many countries, the effectiveness of patents obtained or that may in the future be obtained, if any, is likewise uncertain.


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Our licensing revenue depends in large part upon semiconductor manufacturers incorporating our technologies into integrated circuits.
Our licensing revenue from system licensees depends in large part upon the availability of ICs that implement our technologies. IC manufacturers incorporate our technologies into these ICs, which are then incorporated in consumer entertainment products. We do not manufacture these ICs, but rather depend on IC manufacturers to develop, produce, and then sell them to system licensees. We do not control the IC manufacturers’ decisions whether or not to incorporate our technologies into their ICs, and we do not control their product development or commercialization efforts nor predict their success. As a result, if these IC manufacturers are unable or unwilling, for any reason, to implement our technologies into their ICs, or if, for any reason, they sell fewer ICs incorporating our technologies, our operating results will be adversely affected.
Pricing pressures on the system licensees who incorporate our technologies into their products could limit the licensing fees we charge for our technologies, which could adversely affect our revenue.
The markets for the consumer entertainment products in which our technologies are incorporated are intensely competitive and price sensitive. We expect to face increased royalty pricing pressure for our technologies as we seek to drive the adoption of our technologies into online content and portable devices, such as tablets and smartphones. Retail prices for consumer entertainment products that include our sound technologies, such as DVD players and home theater systems, have decreased significantly, and we expect prices to decrease for the foreseeable future. In response, OEMs 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 entertainment products that they sell. Furthermore, while we have contractual rights with many of our licensees for cost of living adjustments to our royalty rights, we may not be able to negotiate those terms in our contracts with existing and new licensees. Additionally, downward cost of living adjustments would result in declines in the licensing fees that we charge. A decline in, or the modification or loss of the contractual right to increase, the licensing fees we charge could materially and adversely affect our operating results.
We have in the past, and may in the future be, subject to legal claims related to our intellectual property rights, which are costly to defend, could require us to pay damages, and could limit our ability to use particular technologies in the future.
Companies in the technology and entertainment industries own large numbers of patents, copyrights, trademarks, and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. We have faced such claims in the past and we expect to face similar claims in the future.
Any intellectual property claims, with or without merit, could be time consuming, expensive to litigate or settle, and could divert management resources and attention. In the past we have settled claims relating to infringement allegations and agreed to make payments in connection with such settlements. We expect that similar claims will be asserted against us in the future in the ordinary course of our business. An adverse determination in any intellectual property claim could require that we pay damages or stop using technologies found to be in violation of a third party’s rights and could prevent us from offering our products and services to others. In order to avoid these restrictions, we may have to seek a license for the technology, which may not be available on reasonable terms or at all. Any license could also require us to pay significant royalties, and may significantly increase our operating expenses. As a result, we may be required to develop alternative non-infringing technologies, which could require significant effort and expense. If we cannot license or develop technologies for any aspects of our business found to be infringing, we may be forced to limit our product and service offerings and may be unable to compete effectively.
In some instances, we have contractually agreed to provide indemnifications to licensees relating to our intellectual property. Additionally, at times in the past, we have chosen to defend our licensees from third-party intellectual property infringement claims even where such defense was not contractually required, and we may choose to take on such defense in the future. Any of these results could harm our brand, our operating results, and our financial condition.
We have in the past and may in the future have disputes with our licensees regarding our licensing arrangements.
At times, 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 based on potential antitrust claims or regarding our licensing royalty rate practices, including our adherence to licensing on fair, reasonable, and non-discriminatory terms. Damages and requests for injunctive relief asserted in claims like these could be material, and could be disruptive to our business. Any disputes with our customers or potential customers or other third parties could adversely affect our business, results of operations, and prospects.

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We face risks relating to the transition to digital cinema.
We face a number of risks relating to the transition to digital cinema, including:
 
Exhibitors may perceive competing products to be potentially advantageous to our products or they may choose lower priced competing products or competing products with different features, such as support for high frame rate content or 4K presentation;
At least one of our competitors has a significantly greater installed base of its digital cinema servers than we do, which has and likely will continue to limit our share of the digital cinema market, particularly in the U.S. market;
Pricing and other competitive pressures have caused us to implement pricing strategies which have had an adverse effect on our products gross margins;
As the industry transition to digital cinema becomes substantially complete, the demand for new digital cinema screens will drop significantly and the industry will enter into a replacement cycle.
These and other risks related to digital cinema could limit our future prospects in digital cinema and could materially and adversely affect our operating results.
Acquisition activities could result in operating difficulties and other harmful consequences.
We have evaluated, and expect to continue to evaluate, a wide array of possible strategic transactions, including acquisitions. We consider these types of transactions in connection with, among other things, our efforts to expand our business beyond sound technologies. Although we cannot predict whether or not we will complete any such acquisition or other transactions in the future, any of these transactions could be material in relation to our market capitalization, financial condition, or results of operations. The process of integrating an acquired company, business, or technology may create unforeseen difficulties and expenditures. Foreign acquisitions involve unique risks in addition to those mentioned above, including those related to integration of operations across different geographies, cultures, and languages, currency risks, and risks associated with the particular economic, political, and regulatory environment in specific countries. Also, the anticipated benefit of our acquisitions may not materialize.
We face various risks in integrating acquired businesses, including:
 
Diversion of management time and focus from operating our business to acquisition integration challenges;
Cultural and logistical challenges associated with integrating employees from acquired businesses into our organization;
Retaining employees, suppliers and customers from businesses we acquire;
The need to implement or improve internal controls, procedures, and policies appropriate for a public company at businesses that prior to the acquisition may have lacked effective controls, procedures, and policies;
Possible write-offs or impairment charges resulting from acquisitions;
Unanticipated or unknown liabilities relating to acquired businesses; and