Item 1. Business
References to "we," "us" and "our" refer to DTS, Inc. and its consolidated subsidiaries, including,
except as otherwise stated, SRS and its subsidiaries, which we acquired on July 20, 2012.
Company Overview
We are a premier audio solutions provider for high-definition entertainment experiences—anytime, anywhere, on
any device. Our audio solutions enable delivery and playback of clear, compelling high-definition audio which is incorporated by hundreds of licensee customers around the world, into an
array of consumer electronic devices, including audio/video receivers, soundbars, Blu-ray Disc players, DVD based products, PCs, automotive audio products, video game consoles,
televisions, digital media players ("DMPs"), set-top-boxes ("STBs"), mobile phones, tablets and home theater systems.
Sound,
long known to be a powerful driver of our emotional connection with movies, music and games, is emerging as an important product differentiator for a rapidly growing range of
consumer electronic devices, especially mobile or portable devices, as consumers are using these devices to watch and listen to more entertainment than ever before. After years of focus on video
quality and usability features, industry professionals and consumers alike are realizing that sound is the next frontier in the technical advancement of the high-definition entertainment
experience. Simply put, sound changes the way we see. We believe that Sound Matters, and with our recent acquisition of SRS, we have
expanded our suite of industry leading end-to-end audio solutions designed to enhance the entertainment experience for users of consumer electronic devices, particularly those subject to the physical
limitations of smaller speakers, such as TVs, PCs and mobile electronics. Additionally, we provide products and services to motion picture studios, radio and television broadcasters, game developers
and other
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content
creators to facilitate the inclusion of compelling, realistic DTS-encoded soundtracks in their content.
To
date, we have entered into licensing agreements with substantially all of the world's major consumer electronics manufacturers. We also license our technology to many of today's major
semiconductor manufacturers. As a result, our technology, trademarks, copyrights and know-how have been incorporated in billions of consumer electronics products worldwide, and we have
deeply penetrated many consumer electronic markets, as presented in the following diagram.
Our
technology was selected as the mandatory audio technology for the Blu-ray Disc standard, and we believe our mandatory position in this standard provides an important
growth driver, as it firmly establishes us as the premier audio solutions provider for high-definition entertainment on optical disc based media. We also believe that cloud-based
entertainment delivery is growing very rapidly and will drive the majority of our growth for many years to come. We have significantly broadened our market reach with new customers in the TV, PC, and
mobile markets as the trend to network-connected devices and commercial digital download and streaming of content continues to gain momentum. We are also partnering with a growing number of
cloud-based content providers to provide consumers with clear, compelling high-definition sound, despite the bandwidth limitations of on-line and cellular networks and the
physical limitations of devices with small speakers. Our goal is to become an essential ingredient in high-definition entertainment experiences by incorporating our technology into every
device that plays or delivers high-definition entertainment.
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As
a premier audio solutions provider to the entertainment industry, our history of innovating spans more than 20 years.
We
were founded in 1990 and received a key strategic investment in 1993 from a variety of investors, including Universal City Studios, Inc. The first DTS audio soundtrack was
created for the release of Steven Spielberg's Jurassic Park in 1993. From this initial release, we established a technical and marketing platform for the development of entertainment technology
solutions for the motion picture, home theater, and other consumer markets. In 1996, we launched our consumer technology licensing business, in which we license our technology to consumer electronics
manufacturers.
The
significant growth of our consumer technology licensing business, coupled with our mandatory position in the Blu-ray Disc standard, led us to decide in February 2007 to
exit our cinema and digital image processing businesses. These businesses were sold in two separate transactions during the second quarter of 2008 and were classified as Assets of Discontinued
Operations Held For Sale on our consolidated balance sheets and as Discontinued Operations on our consolidated statements of operations for all periods presented. Except as otherwise noted,
information herein is presented for the consumer business or continuing operations only.
On
July 5, 2012, we acquired substantially all of the assets of Phorus, a provider of wireless audio solutions for connected devices with expertise in such areas as acoustic
design, digital signal processing and wireless networking. On July 20, 2012, we acquired SRS, an industry leader in audio signal processing for consumer electronics devices, including TVs, PCs,
mobile phones and automotive entertainment systems. We are presently leveraging from the technologies, accomplishments, and relationships of Phorus and SRS to accelerate our growth going forward.
The
addition of the acquired businesses, coupled with our own organic product development, has enabled us to assemble a suite of technologies and services that we believe to be unequaled
in the industry. We have created product offerings specifically engineered to meet the unique needs of the
various markets that we are currently pursuing, and we expect this enhanced, industry-leading portfolio of solutions and services to drive substantial growth going forward.
Industry Background
Movie soundtracks were originally presented in mono, or one-channel, audio. In the mid-1970s, stereo was
introduced. Stereo consists of two channels and presents sound through discrete left and right speakers. Stereo was followed by matrix technology that allowed an inexpensive two-track
system to bring better sound to a large number of movie theaters. However, matrix technology allows only limited audio quality enhancement and channel separation over stereo. In the early 1990s, the
listening experience of cinema audiences was significantly enhanced through the introduction of high-definition
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surround
sound audio technology, typically with 5.1 discrete channels. Over the past 20 years, the entertainment industry has shifted to take advantage of many technical trends and innovations,
including the transition from analog to digital content, growth in broadband speed and subscriber base, an increase in the types of devices for content playback, and the transition from physical media
to network delivery via streaming and downloading. The mobilization of content consumption allows for entertainment on the go—anytime, anywhere, on any device.
Home theater systems generally consist of a display, a Blu-ray Disc, DVD or media player, an audio/video receiver with as
many as eleven discrete full-range audio channels, plus a channel dedicated to low frequency effects known as a subwoofer.
Home-theater-in-a-box systems contain one each of these elements, with the exception of the display, and are a popular offering to consumers as an
all-in-one home theater package for ease of use and installation.
Consumer
demand for high-definition home theater systems has been fueled by:
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the high-definition experience in movie theaters;
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the general decline in prices for home theater equipment;
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the growth of high-definition flat panel displays or televisions;
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the widespread availability of Blu-ray Discs and DVD with high-definition soundtracks;
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the proliferation of high-definition cable and satellite channels;
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the wide availability of high-definition audio in game consoles;
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the growth of high-definition content streaming services; and
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the growth in portable media devices with high-definition content.
Blu-ray Disc players, including stand-alone players and game consoles, are a growth driver of our revenues. Almost all
Blu-ray Disc players are now network-enabled and a number of models are 3D-capable. A growing number of network-enabled Blu-ray Disc players are being utilized to stream media.
In a recent study by Parks Associates, a market research company, 58% of U.S. broadband Blu-ray Disc households now connect their Blu-ray Disc players to access
on-line content. At retail, Blu-ray Disc players with promotional prices as low as $38.00 during the 2012 holiday season are now competitively priced for mass market
accessibility.
According
to Blu-ray.com, over 5,000 of the Blu-ray Disc releases in North America include a DTS-HD Master Audio soundtrack. In fact, according to
Nielsen, a market research company, 85% of the top 100 titles sold in 2012, including eight out of the top ten movies in 2012, were encoded with DTS-HD Master Audio. Our dominant position
on Blu-ray Discs establishes DTS as "the" high-definition audio format, and we expect this premium market position to be an important factor as content distributors expand to
include higher quality choices in their cloud-based offerings.
UltraViolet™
is the latest method for digital delivery of entertainment content, and, since its launch in 2011, Blu-ray Disc has been the primary entry point to
authenticate access to UltraViolet™. UltraViolet™ allows consumers to register their Blu-ray Disc movies or content to a personal UltraViolet™ digital
locker in the cloud, and then they can access that content on virtually any playback device. As of December 31, 2012, more than 9 million UltraViolet™ household accounts have
been created, more than doubling the number as of June 30, 2012. To date, more than 85,000
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UltraViolet™
enabled titles are available from the major Hollywood studios and other content providers.
High-definition sound is further extending into a growing number of consumer electronic environments, including homes,
automobiles, PCs, video game consoles, mobile phones, portable media devices, DMPs, and various forms of broadcast television products. Content providers in the film, television, music and video game
markets have recognized that a substantial market opportunity exists for high-definition audio entertainment content.
Virtual
surround sound technology, which allows listeners to enjoy a simulated surround sound experience using two speakers or headphones, is also being incorporated into stereo Home AV
devices, such as televisions, soundbars, portable device docking stations as well as portable media players, including mobile phones, tablets and laptops. These markets represent significant growth
opportunities as content providers and consumers become more familiar with the capability of high-definition audio on these devices to enhance the entertainment experience.
Home
networks, connected devices, cloud-based content and digital broadcast products and markets also represent significant future opportunities for deployment of our technologies and
the delivery of high-definition entertainment. With a regulatory demand for broadcasters to adopt digital distribution around the globe, we see increasing demand for our broadcast
technology solutions that allow operators to simultaneously interoperate and distribute audio on multiple media platforms. Furthermore, the proliferation of digital media distribution creates new
demand for playback enhancement technologies for many consumer electronic devices.
Our
dominance in high-definition sound is a cornerstone to our go-forward vision of making the world sound better anytime, anywhere and on any device.
Network and Cloud-Based Content
Movie and music content has been primarily purchased and consumed via optical disc based media, such as Blu-ray Disc, DVD,
and CD. Today, these are still the dominant way consumers acquire and watch or listen to their favorite content. However, with the growth of the internet and home computer usage over the last decade,
a shift to network and cloud-based content acquisition has occurred, including the recent trend toward full movie and music downloading and streaming services. Growth in the usage of network and
cloud-based services will depend on integration partnerships within the ecosystem, further developments in content delivery
methods and the ability to provide consumers with a high-definition experience on thinner, smaller devices and portability across multiple screens.
Adding advanced audio technologies to an existing or new content delivery system requires multifaceted back-end
integrations across numerous technology partners. Unlike the optical disc based media distribution business, where there are only a few parties involved in the replication and distribution of a disc,
the digital content delivery ecosystem can be vast—involving dozens of
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interrelationships
to get the entertainment content from the creator to the ultimate consumer. The illustration below represents a typical integration:
The
key components of the integration process are:
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transcoding and file preparation partners;
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streaming integration partners/protocols;
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digital rights management encryption;
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content delivery network (CDN)/content server (required where edge server transcoding is utilized); and
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client/playback runtime environment integration, including DRM Decryption.
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Responding to consumer demand, consumer electronic products beyond the traditional PC, such as Blu-ray Disc players, TVs, game consoles and mobile
devices, have added networking features to support the shift to cloud-based content. This adoption of network support in mainstream consumer electronic products has facilitated consumer demand for
enjoyment of content in multiple formats, on multiple devices and in multiple locations. This requirement for broad content portability and accessibility has opened up many large, new markets to new
media formats, such as high-definition audio, that had not been previously supported. The fundamental structure of the content ecosystem has now changed to focus on portability and
ease-of-use combined with higher quality audio and video. This change significantly expands the market for digital media format technologies, such as those provided by DTS.
According to DisplaySearch, in 2012 more than 29% of digital displays or TVs shipped worldwide were network-capable, a figure that is expected to rise to 48% by 2016.
As
the transition to digital content delivery accelerates, we continue to pursue strategic partnerships with top streaming technology companies in order to enable content delivery to as
many connected devices as possible, thereby enabling growth in licensing opportunities. In response to this growing demand and in conjunction with Digital Rapids, we announced new tool offerings to
support the Digital Entertainment Content Ecosystem's (DECE) UltraViolet™ standard. These tools serve the standard's goal to combine the benefits of cloud access with the power of an open,
industry standard—empowering consumers to use multiple content services and device brands interchangeably, at home and on-the-go. We also announced our
collaboration with Adobe to bring the DTS premium audio experience to upcoming connected TVs and Blu-ray Players powered by Adobe® AIR® 3. This newest
version of AIR will enable Flash®-based application experiences with high-definition video and up to 7.1 channels of best-in-class DTS surround sound.
This collaboration further illustrates our strong commitment to creating high-quality audio experiences for consumers across any and every connected device.
In
2012, we announced that several leading content solution providers, including Digital Rapids, Elemental Technologies, and Rovi, now support DTS Express surround sound for creation of
content in the UltraViolet™ Common File Format. DTS Express, part of the DTS-HD® family of audio solutions found on nearly all Blu-ray Disc™
movies, is fully optimized for digitally delivered content, providing a high quality immersive surround sound experience.
In
2012, we also announced an agreement with Deluxe Digital Distribution, Inc., a subsidiary of Deluxe Entertainment Services Group, Inc., to integrate our premium audio
technologies into the Deluxe Digital Media Library. This library is a complete catalog fulfillment solution of premium content, currently with thousands of titles, optimized for streaming and
downloads to smartphones, tablets, computers, game consoles, connected Blu-ray players and televisions, along with other consumer electronic devices. This integration of our technology
allows major studios and retailers the ability to offer digitally distributed content with unparalleled audio quality.
To
date, our premium audio technologies have been integrated into thousands of titles, and we are actively pursuing other partnerships to expand the integration of our premium audio
technologies into streaming content.
Thinner, Smaller Devices and Portability
In this age of convenience, devices such as TVs, PCs and mobile electronics, are becoming thinner, smaller and more portable than
previous models, but as a result, sound quality is commonly sacrificed due to greater physical limitations. While the smaller forms of these devices meet the demand for portability, or sleeker design,
consumers still believe that Sound Matters, and they demand a high quality audio experience from these sophisticated devices. With our recent acquisition of SRS, we have expanded our suite of industry
leading end-to-end audio solutions designed to enhance the
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entertainment
experience for users of thinner, smaller consumer electronic devices, and we believe that we now possess the industry's broadest range of audio technology solutions.
In addition to demanding high quality audio on thinner or smaller devices, consumer demand for multi-screen playback of purchased
content is also increasing. With the growth in cloud-based services, consumers are increasingly able to purchase content one time and play back this content on multiple devices. From our success in
Blu-ray, we are recognized as a premier audio solutions provider for high-definition entertainment, and as cloud-based service providers look to expand and differentiate their
media offerings to multi-screen platforms, such as tablets and mobile phones, we are in the unique position of being able to help them deliver high quality content for use by consumers on multiple
devices.
This
proliferation of connected devices, cloud media services and content mobility represents a huge opportunity for deployment of our solutions.
DTS Solutions
We provide a wide range of technology solutions focused on the reproduction and enhancement of sound. We launched our surround sound
format technology for the consumer market in 1996 and have continued to develop technologies, providing solutions for Blu-ray, DVD, broadcast and digital media delivery. In 2008, we moved
into the audio processing market to provide technologies and solutions for enhancing audio playback in a wide variety of devices and environments. Since our acquisition of SRS, we have expanded our
suite of industry leading end-to-end audio solutions, which include both codec and audio processing technologies, designed to enhance the entertainment experience for users of
consumer electronics devices. In particular, our audio processing technologies are capable of enhancing the audio output of today's consumer electronics products, that are subject to the physical
limitations of smaller speakers, such as TVs, PCs and mobile electronics. We have a complete range of audio playback solutions for media and consumer electronic providers, and we continue to expand
through ongoing research and development, targeted acquisitions, as well as strategic partnerships with consumer electronics manufacturers and others within the digital media market.
In 1996, we introduced our Coherent Acoustics technology to bring advanced digital audio entertainment to the home. Coherent Acoustics
is an audio compression/decompression algorithm or codec that is designed to capture, store, and reproduce audio signals. A fundamental challenge with digital audio distribution is that capturing
analog signal representations in digital form requires a tremendous amount of data. Therefore, the storage and subsequent transmission of that data presents physical space, efficiency, bandwidth and
economic challenges. We address these challenges by developing highly efficient coding algorithms and products that reduce the amount of data required to store, transmit and reproduce the audio while
maintaining the quality of the audio experience. One of our key technical strengths has been our ability to develop a system that enables the transparent reproduction of an original audio signal,
meaning that the reproduction sounds indistinguishable from its initial source.
Using
a core-plus-extensions methodology, we designed the following three attributes into the basic architecture of our Coherent Acoustics
technology:
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scalable,
meaning that parameters such as data rate can be set over a very
wide range, as applications require;
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extensible,
meaning that the structure itself accommodates additional data
for enhancements both anticipated and unknown; and
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backward compatible,
meaning that extensions and enhancements do not
preclude the ability of earlier decoders to play the core signal.
DTS Digital Surround.
DTS Digital Surround was the first product based on the Coherent Acoustics technology specification, and it
supports up to 5.1
channels of audio at up to 48kHz sampling rate and up to 1.5Mbps bit rate. From a content perspective, DTS Digital Surround is an optional format in the DVD standard. We have also further expanded on
the DTS Digital Surround offering to support 6.1 channels, which adds a center back channel for added realism.
DTS Neural Surround.
DTS Neural Surround technology is an encoder/decoder technology that takes up to 7.1 channels of audio and encodes
the
high-definition audio to stereo without use of a separate data stream. The two channel stereo audio can then be broadcasted or carried on other media that is limited to stereo tracks. In
the home, the DTS Neural Surround decoder then decodes the signal, up to 7.1 channels, providing a surround sound experience. DTS Neural Surround is also widely deployed to enhance legacy stereo
content for surround sound distribution for HDTV.
DTS-HD Master Audio.
DTS-HD Master Audio is an instantiation of the Coherent Acoustics technology specification, and it
supports 7.1 channels of audio at up to 192kHz sampling rate and up to 24.5Mbps. From a content perspective, DTS-HD Master Audio is a mandatory format in the Blu-ray standard.
DTS-HD Master Audio is capable of greater performance in other applications, and it is backward compatible with existing DTS content. Further, DTS-HD Master Audio allows
various levels of performance based on the capabilities of the home audio equipment used for playback.
DTS-HD.
DTS-
HD
enables product manufacturers to build products that can
decode DTS formats from a physical disc, file and/or streaming sources. DTS-
HD
provides playback compatibility for all current DTS formats.
Further, DTS-
HD
is split into the following two versions, as we tailor our solutions to specific product markets in order to provide the
best in class solutions to the consumer electronics industry and consumers alike.
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One version of DTS-
HD
is the premium solution for products
that output up to 7.1 channels of audio, including audio/video receivers, DMPs and media-enabled PCs. This version of DTS-
HD
provides the
complete listening experience that the artist intended, including 7.1-channel lossless surround sound playback, at sampling rates up to 192 kHz, and support of all current DTS format
extensions. This version of DTS-
HD
also features DTS Neo:6 technology for upmixing content with many products.
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The other version of DTS-
HD
is specifically tailored to
products limited to stereo and 5.1 surround sound playback, including TVs, STBs, home theater in-a-box, automotive audio and mobile products. This version of
DTS-
HD
delivers all basic DTS format playback functionalities. While its ability to reproduce extended frequencies and channels is limited
to stereo and 5.1 surround sound playback, this version of DTS-
HD
provides consumers with a quality audio listening experience utilizing all
DTS content.
Both
versions of DTS-
HD
offer optional transcoding functionality and support for multiple audio streams. For broadcast
decoding implementations, a DTS Neural Surround decoder is also required.
Since the high-definition audio experience changed consumer listening habits and expectations, the consumer electronics
marketplace has experienced a growing need for higher quality audio technology solutions. This has been magnified by the proliferation of thinner, smaller devices, such as smartphones and tablets.
With our recent acquisition of SRS, we have significantly increased our suite of industry
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leading
end-to-end audio processing solutions. Currently, our portfolio of audio processing solutions includes a wide range of advanced technologies and proprietary techniques for the processing and
delivery of audio, voice and surround sound.
Spatial Processing and Surround Technologies.
Our spatial processing and surround solutions transform audio by optimizing sound for a
customer's
speaker or headphone characteristics. By either increasing the number of channels, or virtualizing multi-channel audio over two speakers or a set of headphones, our spatial processing and surround
technologies immerse the listener in tuned audio. Our spatial component and surround sound technologies are included in several product suites, such as WOW,
Nviro, and Circle Surround. In addition to the component technologies, we license the following standalone solutions:
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DTS TruSurround—With DTS TruSurround, speakers can be tuned for peak performance and to accurately extract and
place audio cues for a realistic and immersive virtual surround experience from TVs and soundbars to automotive applications and to PCs.
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DTS Neo:X—With DTS Neo:X, an industry leading 11.1 upmixing solution, immersive sound can arc overhead to the
front-height speakers, sideways to the wide speakers, and back to the rear speakers, creating a semi-spherical soundstage.
Loudness and Dynamics.
Our loudness and dynamics solutions optimize device audio output allowing our customers to fine tune the audio
for products,
and provide the end consumer with the ability to adjust the audio for their preferences. Our component solutions included in our product suites include: TruBass, PureSound, volume leveling, and
equalizers. Additionally, we offer the following standalone solution:
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DTS TruVolume—With DTS TruVolume, a volume leveling solution for TV and STB applications, consumers can set
their desired volume level once to enjoy television, music and all other content without volume fluctuations or listener fatigue.
Voice Processing.
Our voice processing solutions, also known as VIP and VIP+, and SRS Noise Reduction technologies dramatically reduce
noise to
produce a much clearer and crisper dialog over wireless communication devices and improve the intelligibility of the human voice in a variety of listening situations, including high ambient background
environments.
Solution Suites.
Our portfolio of audio processing solution suites addresses a broad spectrum of product applications within the
markets that we have
targeted. Our solutions may be implemented in a variety of methods, including discrete analog components, chip modules, analog semiconductors, digital signal
processors and software. Our solution suites combine several technologies in order to deliver a comprehensive, easier to deploy package of post processing audio enhancement products. Solution suites
also enable us to impact the performance of the OEM products by employing multiple technologies and techniques to enhance and control the overall audio fidelity and performance of the product. We have
simplified our suite offerings across markets to two primary suites tailored specifically for each market:
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DTS Sound—Across all markets, this solution is a tailored, entry level suite of components from both our
spatial processing and loudness and dynamics portfolio of products that provides a value offering to our customers.
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DTS StudioSound—Across all markets, this solution is our premium offering that includes most of our latest
features. Our customers can use this suite to create the ultimate in sound quality.
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Mobile devices are becoming an essential ingredient in the playback and enjoyment of music, thanks to ease of use and a nearly
unlimited variety of music streaming options. With our recent acquisition of Phorus, we plan to enable mobile devices to go beyond the portable music arena to take an increasingly central role in home
entertainment. Historically, making the connection between mobile and whole-home entertainment has been challenging, due to the limitations that specific physical connections, cables,
headphone listening, and less-than-ideal point-to-point streaming have placed on consumer enjoyment and expectations for what the home audio experience
should be.
Our
Play-Fi™ solution allows the synchronized streaming of music directly from a mobile device over a standard wi-fi network to anywhere in the home.
Play-Fi leverages wi-fi's extensive range and capacity to stream audio with bit-for-bit accuracy, for a higher quality audio experience. In addition,
Play-Fi allows for multi-room, multi-source audio synchronization, again utilizing standard wi-fi capabilities that are built into most mobile devices and an
increasing number of homes. With two or more Play-Fi enabled-speakers in a home, a consumer has the option to play different content in different rooms or the same content throughout the
house from one mobile device. This solution is currently available for mobile devices that utilize the Android operating system in conjunction with a Phorus branded speaker or receiver.
Play-Fi is expanding to support Windows and iOS operating systems in 2013. We plan to transition this technology from its current product based form into a licensing business similar to
our other technologies.
Key Markets and Strategies
The Home AV market includes audio/video receivers, DVD players, soundbars and other DVD-based equipment that facilitate the
home theater experience. In 2012, Denon and Onkyo both launched DTS Neo:X, an industry leading 11.1 upmixing solution, into their audio/video receivers. The Home AV market represents our largest
penetration into the consumer electronics industry, and it continues to present numerous opportunities for continued growth for our high-definition sound compression and audio processing
technologies.
The Blu-ray Disc market includes standalone players, gaming devices and disc drives included in PCs. As a mandated
technology in the Blu-ray Disc standard, our codec is in every product that incorporates a Blu-ray optical disc drive. Almost all Blu-ray Disc players are now
network-enabled, and a number of models are 3D-capable. We believe our dominant position on Blu-ray Disc content establishes us as the premier audio format for high-definition
entertainment and is expected to drive future growth as the industry transitions to network-based high-definition content delivery.
The network-connected markets include consumer electronics devices that are network-capable, including connected TVs, mobile
electronics and PCs. Consumers are increasingly relying on central hubs to access personal digital media libraries, the internet and TV content, and they are seeking superior audio quality across all
of their consumer electronic devices. We are dedicated to the future of audio enhancement and strive to bring the high-performance sound experience to the next generation of home theaters,
powered by media center devices.
Connected TV.
Our key strategy in the connected TV market is joining forces with leading consumer electronics manufacturers like
Samsung, LG, Sony
and more recently Panasonic, allowing us to play a more significant role in the connected home entertainment market and further ensuring
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consumer
access to top-notch audio when enjoying entertainment content at home. According to DisplaySearch, in 2012 more than 29% of digital displays or TVs shipped worldwide were
network-connected, a figure that is expected to rise to 48% by 2016. In 2013, we announced our partnership with Panasonic, who now integrates our DTS 2.0 Digital Channel and DTS 2.0+ Digital
technologies into their new network-connected televisions in North America.
Mobile Electronics.
The mobile electronics market is the largest single consumer electronics device market in the world in terms of unit
volume. We
are currently focused on the high-value smartphone and tablet sub-segments of the mobile market. This market also includes other portable electronics, such as portable media
players ("PMPs").
In
years past, mobile devices had only a few entertainment services to support them over known and predictable networks. However, the explosion of media services, network topographies
and device capabilities has caused the range of audio technologies needed by our partners to increase, and we have helped to simplify their businesses by offering simple, scalable solutions to meet
their needs.
As
smartphones continue to evolve into more feature-rich and sophisticated devices, consumers are seeking the same sound quality that they are accustomed to in their home
theater or automobile. We believe that sound matters across all of these platforms; for example, with the integration of DTS Sound and DTS StudioSound into a smartphone, customers can receive
uncompromising sound at their fingertips, redefining how they use and interact with their mobile devices. Importantly, mobile product manufacturers are beginning to realize that sound, and thus, our
audio solutions can be used to differentiate their products.
Today's
consumers not only demand the best quality, they increasingly expect it in all of their electronics, including smartphones. Partnering with key manufacturers, such as Samsung,
Pantech, LG, Huawei and more recently Lenovo, allows us the opportunity to improve the mobile audio experience through our audio solutions, which is our key strategy.
In
November 2012, we announced the incorporation of our WOW HD technology into the Lenovo IdeaTab A2109 tablet. Nextreaming, a leading mobile service provider, has recently integrated a
suite of DTS audio technologies into their products, enabling studios, service providers and network operators to rapidly deploy high-definition video services with the highest quality
audio to a wide range of Android and iOS smartphones and tablets.
The
rapid growth in usage of smartphones, tablets and portable computers for entertainment consumption has led to significant growth in the use of headphones by consumers. In January
2013, we announced and demonstrated the industry's leading headphone technology: DTS Headphone:X™. DTS Headphone:X™ faithfully reproduces an immersive surround sound experience
using only a pair of headphones. With benefits for both content owners and consumers, DTS Headphone:X™ externalizes and recreates the audio from the studio or other professional lab
through a simple pair of headphones, dramatically improving the portable entertainment experience.
Personal Computers.
The PC market, composed of notebooks, ultrabooks, laptops, desktops, and all-in-one PCs, continues to
grow, with laptops and notebooks leading the way. Consumers continue to use PCs as multi-media hubs, including Blu-ray Disc drives for high-definition playback, and our
solutions are now found in all major software media players from vendors such as CyberLink and sMedio. With the launch of the DTS encoder, consumers can now encode their own content into the DTS
format and enjoy playback on DTS enabled devices.
The
PC market, like the smartphone and tablet markets, is facing shrinking device sizes and decreasing margins. As a result, it is increasingly turning to audio processing to augment
device capabilities. At the same time, the demands of consumers for PCs with improved audio for applications, such as movies, music and games, continues to rise, creating an increasing demand for
advanced audio technologies. We address these demands with solutions tailored to meet both ends of
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an
OEM's product lines. With DTS Sound, DTS StudioSound and DTS Premium Voice Pro, we are meeting the needs of major OEMs, such as HP, Toshiba, ASUS, Fujitsu and MSI. Now, consumers can hear the best
possible audio, whether they are watching television, surfing the web or playing games on their PC.
As
computers play a more versatile role in the household, consumers are becoming increasingly aware that sound matters. The integration of our solutions into a growing number of PCs, TVs
and mobile devices further reinforces our commitment to provide manufacturers a means to deliver an immersive, realistic sound experience regardless of the platform.
As
PC manufacturers continue to adopt our solutions across various platforms ranging from motherboards to AIOs to notebooks and with the newer ultrabook category, there are growing
opportunities for us to help PC manufacturers differentiate and improve audio experiences on thinner, smaller and lighter platforms.
The automotive market is comprised of infotainment systems, which typically includes navigation systems. New vehicle production has
grown from 74 million units in 2010 to 77 million units in 2011, 81 million units in 2012 and 83 million units expected in 2013, and a growing percentage of consumers are
purchasing new automobiles equipped with infotainment systems.
As
the trend toward network connectivity transitions into the automotive market, there is opportunity for us to benefit from the increase in demand for our solutions beyond optical disc
based infotainment systems. The growing prevalence of using portable consumer electronics for hosting personal music libraries and movies has prompted automobile manufacturers to enhance their
vehicles by allowing mobile devices to interact with automotive infotainment systems.
Our
key strategy in the automotive market has always been the collaboration with automobile manufacturers and their audio systems suppliers to use and incorporate our audio solutions at
the factory level. We are seeing an increase in the amount of automobile manufacturers who are offering the option of ordering factory installed Blu-ray Disc players into the rear of their
vehicles for passenger enjoyment. For example, Toyota, Chrysler and GM introduced
Blu-ray Disc systems in the 2012 model year. Since we dominate the Blu-ray Disc market, we believe that this will further expand the use of our solutions within the automotive
market, offering us even more of an opportunity to enhance the integration of mobile devices into any vehicle by enabling seamless conversion between stereo and surround sound audio for the ultimate
high-definition experience.
In
2012, we recently announced our collaboration with Mitsubishi Motors, who has integrated our DTS Neural Surround technology into the upgraded audio system of their new 2012 Delica D:5
minivan, taking our multi-channel surround sound on the road. Other Mitsubishi models with our Neural Sound technology will be launched in the U.S., allowing stereo content from MP3 players,
smartphones and CDs to be upmixed in 5.1 surround sound and played back through the Mitsubishi speaker systems. Additionally, Acura launched DTS Neural Surround in their 2012 RXL Model and all Lincoln
THX certified systems continue to support DTS Neural Surround technology. Range Rover was first to launch DTS Neo:X in the automotive market. DTS Neo:X is an advanced audio upmix solution capable of
rendering 11.1 surround sound, thereby delivering an elevated entertainment experience.
The broadcast market is generally comprised of broadcast hardware and STBs, which bring digital and high-definition
broadcasts into households. The comprehensive migration of national broadcasters to digital transmission, combined with growing interest in high-definition broadcast around the world has
set the stage for increased demand for STBs and high-definition televisions over the next few years.
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Our key strategy in the broadcast market is to actively work with broadcasters, operators, international standards organizations and STB manufacturers to expand
the penetration of our solutions in order to help them meet the increasing demand for high-definition audio delivery. In 2012, we announced our alliance with Bouygues Telecom, a leading
French telecom company, where we will provide advanced audio solutions for their video on demand service, Bbox VOD, delivering to consumers the ultimate on-demand entertainment experience.
In 2012, we collaborated with Chinese FM radio broadcasters to deliver DTS 5.1 content. By incorporating DTS Neural Sound technology, which has been widely embraced in the U.S. for live sports and HD
radio broadcasts, this makes Guangzhou Broadcasting Network (GZBN) and Anhui FM radio station the first to offer surround sound radio broadcasts in China.
Production tools are critical to the deployment of DTS-enabled content. The availability of DTS-enabled content
drives consumer demand for electronics that support DTS technologies. For example, all major North American motion picture studios use the DTS-HD Master Audio Suite, a software production
tool that has allowed DTS to secure the primary audio tracks on the majority of Blu-ray Disc titles, driving increased royalties from the adoption of 5.1 and 7.1
multi-channel DTS decoders. As content delivery has moved beyond optical disc based media, we have broadened the production tools customers that we target. In addition to traditional motion picture
studios, post-production houses and authoring facilities, this market now includes on-line services and broadcast facilities.
With
ongoing growth in cloud-based content delivery, we have maintained a strategy focused on increasing streaming solutions and tools in order to enable our audio technologies in
network-connected devices. Connected devices with varying content delivery requirements necessitate production tools capable of delivering high volumes of digital content files in multiple formats.
Our production tools include multiplexers, transcoders and automated quality control tools, an area in which we have made significant progress. Examples of our progress in tools for connected
entertainment include:
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•
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Digital Rapids' launch of its Transcode Manager 2.0 tool supporting DTS-HD encoding for the
UltraViolet™ format, as well as the new streaming format, MPEG-DASH
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•
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Elemental Technologies' launch of its Elemental Server tool supporting DTS-HD encoding for the
UltraViolet™ format
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•
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Rovi's launch of its TotalCode tools supporting DTS-HD encoding for the UltraViolet™ format, as
well as its next-generation DivX Plus Streaming format
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•
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Interra Systems' automated quality control toolset, Baton, supporting the DTS-HD codec; this tools is used to
automatically validate files prior to packaging and delivery to connected devices
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•
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Release of DTS-HD MediaPlayer, a quality control tool used to playback and validate files in
real-time prior to packaging and delivery to connected devices
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•
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Collaboration with Microsoft to add DTS-HD codec support to the Smooth Streaming format for delivering content
to connected devices
Additional
progress in tools for Blu-ray Disc includes product releases by CyberLink and Adobe:
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•
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CyberLink's PowerDirector 10 video editing toolset includes DTS 5.1 Producer, an encoding technology for surround sound
audio that delivers high quality immersive sound when creating digital content, bringing advanced professional-grade audio capabilities to the home stage for Blu-ray Disc authoring. This
partnership marks the first consumer-level tools offering for us.
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•
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Adobe added support for DTS-HD audio codec profiles into its Creative Suite 6 video tools, enabling
professionals and consumers alike to create Blu-ray Discs with the same audio technology featured on most Hollywood titles. This collaboration marks the first prosumer offering capable of
Blu-ray Disc authoring with DTS-HD Master Audio technology.
Research and Development
As demonstrated by our portfolio of industry-recognized, advanced technologies, we are centered on strong research and development
abilities. We were founded with key research and development that solved customer problems with high-definition and differentiated solutions, and we continue to develop new technologies
with that same goal in mind.
As
we have grown, new technologies have not only been developed internally, but also acquired from outside sources. Our technologies, and the talent and knowledge that created it, are
key elements of our research and development base and will continue to be a source of new solutions going forward.
We
have a group of 145 engineers and scientists, including 19 PhDs, focused on research and development. This group oversees our product development efforts and is responsible for
implementing our technology into existing and emerging products. We carry out research and development activities at our corporate headquarters in Calabasas, California and at our facilities in Los
Gatos and Santa Ana, California; Kirkland, Washington; Shanghai and Shenzhen, China; Tokyo, Japan; Seoul, South Korea; Bangor, Northern Ireland; Singapore and Taipei, Taiwan.
Our
research and development expenses totaled approximately $25.8 million during 2012, $13.5 million during 2011 and $12.1 million during 2010. We expect that we
will continue to commit significant resources to research and development applications engineering efforts in the future, particularly in support of our expansion across a wide variety of digital
audio content and playback devices.
Intellectual Property
We have developed and maintain a sizeable library of copyrighted software and other technical materials, both printed and digitized, as
well as numerous trade secrets. We also have many individual patent families resulting in hundreds of individual patents and patent applications throughout the world.
As
a provider of high-definition audio technologies to markets worldwide, we believe it is extremely important to protect our technology through the use of copyrights,
trademarks, patents, and trade secrets in many countries. We have targeted our intellectual property coverage to provide protection in the major manufacturing and commercial markets of the world.
Our
audio technologies are embodied in the form of proprietary software to which we retain the copyrights. Accordingly, copyrights are an important component of our intellectual
property.
Our
trademarks consist of many individual word marks, logos and slogans registered and in use throughout the world. The marks cover our various products, technology, improvements and
features as well as the services that we provide. Our trademarks are an integral part of our licensing program and, generally, are required to be used on licensed products to identify the technology
in the device, to provide greater consumer awareness and to advance the sales of the licensed products bearing the trademarks. In addition to over one hundred trademark registrations, we also have
numerous
trademark applications pending worldwide, with additional marks in the pre-application phase.
It
is our general practice to file patent applications for our technology in the United States and various foreign countries where our customers manufacture, distribute or sell licensed
products. We actively pursue new applications to expand our patent portfolio to address new technological
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innovations.
Most of the patents in our patent portfolio have an average life of 20 years from their date of filing. A number of our patents have expiration dates ranging from 2015 to 2030. The
patents that expire sooner primarily cover the process of producing media containing DTS and high-definition audio as well as the individual finished product. We have multiple patents
covering unique aspects and improvements for many of our technologies. We do not believe that the expiration of any single patent is likely to significantly affect our intellectual property position
or our ability to generate licensing revenues.
Governmental and Industry Standards
There are a variety of governmental and industry-related organizations that are responsible for adopting system and product standards.
Standards are important in many technology-focused industries as they help to ensure compatibility of technologies across a system or series of products. Generally, standards adoption occurs on either
a mandatory basis, requiring the existence of a particular technology or feature, or an optional basis, meaning that a particular technology or feature may be, but is not required to be, utilized.
We
believe the market for audio and audio/video products is very standards driven and our active participation with standards organizations is important as we work to include our
technology in standards or change our status from optional to mandatory, where possible. We believe our standards involvement also provides us early visibility into future opportunities.
Governmental
standards are often operated by non-governmental organizations in cooperation with regional regulatory bodies. These organizations adopt standards by validating
and publishing industry standards that are appropriate for various regions and technical requirements. The standards of this nature that we participate in include European Technical Standards
Institute (ETSI) which is an affiliated European Standards Organization under the European Union, International
Electrotechnical Commission (IEC), and the Moving Pictures Expert Group (MPEG) which is a joint working group under the IEC and International Organization for Standardization (ISO).
The
majority of standards we actively participate in are produced by industry-related organizations. These bodies adopt standards based on industry evaluations and discussions across
effected constituencies finalizing with consensus voting as to the best solution around which to standardize. The industry standards we participate in include the Alliance for Telecommunications
Industry Solutions (ATIS), Advanced Television Systems Committee (ATSC), Audio Engineering Society (AES), Blu-ray Disc Association (BDA), Connected Media Experience, Consumer Electronics
Association (CEA), DASH Industry Forum (DASH-IF), Digital Entertainment Content Ecosystem (DECE), Digital Living Network Alliance (DLNA), Digital Video Broadcast (DVB), DVD Forum, GENIVI,
High-Definition Multimedia Interface (HDMI), Hybrid Broadcast Broadband TV (HbbTV), The Khronos Group, Open IPTV Forum (OIPF), Society of Cable Telecommunications Engineers (SCTE), Society
for Motion Picture and Television Engineers (SMPTE), Telecommunications Technology Association of Korea (TTA) and Wi-Fi Alliance.,
Some
standards bodies are now considering "open standards" that require all technologies included in the standard be included on non-proprietary and intellectual-property
"free" technology platforms in which no company maintains ownership over the dominant technologies. We are actively engaging these bodies to determine how we may participate and the potential impact
on our business model and future go to market strategies.
We
anticipate being involved in a number of other standards organizations as appropriate to facilitate the deployment of our technology.
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Branding
The foundation of our marketing strategy is to broaden the awareness and reach of the DTS brand with consumers so that the DTS brand
becomes a catalyst in expanding the use of our existing technologies in new markets and in commercializing new technologies to existing markets.
In
2012, we made several key strategic decisions in order to build further equity in the DTS brand. A key element of the integration effort from the SRS acquisition was to ultimately
consolidate all product branding under the DTS brand. Our licensees positively embraced this campaign, and by the end of 2013, we expect all new products shipping with technologies from the legacy SRS
technology portfolio to carry the DTS brand.
Furthermore,
in order to maximize our opportunities in the network-connected markets, we initiated our first consumer marketing campaign. The objective of our branding campaign was to
position DTS as the company that cares about sound and the company that makes your connected devices sound better by delivering solutions that makes your media experience engaging and exciting. The
campaign "
Sound Changes the Way You See
" hit a chord with younger connected consumers and outperformed industry metrics for digital media delivery and
social media engagement.
We
believe that continued targeted investment in the DTS brand, the strong adoption of DTS as the preferred audio format for Blu-ray Disc content and our further expansion
into network-connected devices will result in the proliferation of the DTS brand into expanding categories of consumer electronics, and in turn, grow the consumer awareness of and appeal for the DTS
brand.
Licensing to Customers
We have a licensing team headquartered in Limerick, Ireland that markets our technology directly to consumer electronics product
manufacturers and to semiconductor manufacturers. We also have customer focused employees located in the United States, China, Hong Kong, Japan, the United Kingdom, South Korea, Taiwan and Singapore.
We believe that by locating staff near the leading consumer electronics and semiconductor manufacturers the global footprint of our sales and business development efforts will be enhanced.
We
license our technology to consumer electronics product manufacturers primarily through a two step process:
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•
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Semiconductor Manufacturers.
First, we license to a
substantial number of major semiconductor manufacturers the right to incorporate our technology in their semiconductors, or chips, and to sell these chips supporting DTS technology to our consumer
electronics products manufacturer licensees.
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•
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Consumer Electronics Products Manufacturers.
Our business
model typically provides for us to receive a per-unit royalty for products produced by the consumer manufacturer licensees that contain our technologies.
As
part of the licensing terms for both semiconductor and hardware manufacturer licensees, we typically receive fees for access to our developer kits and for our product certification.
Generally, we license on a non-exclusive, worldwide basis. We require that all licensees have their integrated circuits or hardware devices certified by us prior to distribution. We
reserve the right to audit their records and quality standards. Licensees are generally required to display the appropriate DTS trademark on the products they manufacture.
We
have licensed our technologies and our trademarks to substantially all of the major consumer electronics products manufacturers worldwide. Collectively, these manufacturers have sold
billions of DTS-licensed consumer electronics products. Sony Corporation and Samsung Electronics Co., Ltd. each accounted for more than 10% of total revenues for the year
ended December 31, 2012.
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We have sold or provided our digital sound encoding software to many of the leading home video and music content providers and
professional audio facilities, enabling them to create high-definition DTS-enabled content. We believe that allowing easy access to DTS encoders will result in more DTS
content, which we believe will drive consumer demand for DTS-enabled electronic products. To date, thousands of Blu-ray Disc and DVD titles have been produced with DTS
high-definition audio tracks.
Seasonality of Business
Generally, consumer electronics manufacturing activities are lowest in the first calendar quarter of each year, and increase
progressively throughout the remainder of the year. The third and fourth quarters are typically the strongest in terms manufacturing output as our technology licensees increase their manufacturing
output to prepare for the holiday buying season. Since recognition of revenues in our business generally lags manufacturing activity by one quarter due to the timing of licensee reporting to us, our
revenues and earnings are generally lowest in the second quarter.
In
general, the introduction and inclusion of DTS technologies in new and rapidly growing markets can have a material effect on quarterly revenues and profits, and can distort the
moderate seasonality described above.
Also,
from time to time, we may recognize royalty revenues that relate to licensing obligations that occurred in prior periods. These royalty recoveries may cause revenues to be higher
than expected during a particular reporting period and may not occur in subsequent periods.
Competition
We face strong competition in the consumer electronics market and expect competition to continue to intensify in the future. Our
primary competitor is Dolby Laboratories, who develops and markets, among other things, high-definition audio products and services. Dolby was founded over 40 years ago and for many
years was the only significant provider of audio technologies. Dolby's long-standing market position, brand, business relationships, resources and inclusion in various industry standards
provide it with a strong competitive position.
In
addition to Dolby, we compete in specific product markets with Fraunhofer Institut Integrierte Schaltungen, Koninklijke Philips Electronics N.V., Microsoft Corporation, Sony
Corporation, Technicolor, MPEG, open source solutions, such as Ogg Vorbis and Free Lossless Audio Codec, or FLAC, and various consumer electronics products manufacturers. Many of these competitors
have a wide variety of strengths that afford them competitive advantages, such as longer operating histories, significantly greater resources, greater name recognition, or the ability to offer their
technologies for a lower price or for free.
We
believe that the principal competitive factors in each of our markets include some or all of the following:
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•
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technology performance, flexibility, and range of application;
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•
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quality and reliability of technologies, products and services;
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•
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brand recognition and reputation;
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inclusion in industry standards;
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•
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price;
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•
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relationships with semiconductor, consumer electronics manufacturers, and content producers;
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•
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availability of encoding tools that deliver compatible high-definition audio content;
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•
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timeliness and relevance of new product introductions; and
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•
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relationships with and distribution networks for, production and post-production operators providing content
for digital broadcast.
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We have been successful in penetrating the consumer electronics markets and building and maintaining market share. A substantial portion of Blu-ray
Disc titles includes DTS soundtracks. In fact, according to Nielsen, 85% of the top 100 Blu-ray titles sold in 2012, including eight out of the top ten movies in 2012, were encoded with
DTS-HD Master Audio. Also, many top selling and premier edition DVDs contain high-definition soundtracks in our format, and a substantial majority of consumer electronics
products with high-definition or surround sound audio capability incorporate our technology, trademarks or know-how. Our success has been due in large part to our ability to
position our brand as a premium offering that contains superior proprietary technology, the quality of our customer service, our inclusion in industry standards and our industry relationships.
We
believe there are significant barriers to entry into the consumer electronic products market, such as our mandatory status in the Blu-ray Disc format. Also, the standards
relating to DVD are well established and support a limited number of technologies, including DTS Coherent Acoustics. Numerous other standards in which we participate support a limited number of
technologies, including various DTS technologies.
Employees
As of December 31, 2012, we had 369 employees, which includes 145 employees classified on our consolidated statements of
operations as research and development and 224 classified as selling, general and administrative. None of our employees are subject to a collective bargaining agreement, and we have never experienced
a work stoppage. We believe our relations with our employees are good.
Website Access To SEC Filings
We maintain an internet website at
www.dts.com.
We make available free of charge
through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and any
amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically
file such material with, or furnish it to, the SEC.
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Item 1A. Risk Factors
You should consider each of the following factors as well as the other information in this Annual Report in
evaluating our business and our prospects. 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 currently
consider immaterial may also impair our business operations. If any of the following risks actually occurs, our business, financial condition, or results of operations could suffer. In that case, the
trading price of our common stock could decline, and you may lose all or part of your investment.
Risks Related to Our Business
A continued decline in optical disc based media consummation and our inability to penetrate the on-line and mobile content delivery markets and adapt our
technologies for those markets could adversely impact our revenues and ability to grow.
Movie and music content has historically been primarily distributed, purchased and consumed via optical disc based media, such as
Blu-ray Disc, DVD, and CD. Today, these are still a dominant way consumers purchase and watch or listen to their favorite content. However, the growth of the internet and home computer
usage, connected televisions, set-top boxes, tablets, smartphones, and other devices, along with the rapid advancement of on-line and mobile content delivery has resulted in
the recent trend to entertainment download and streaming services becoming mainstream with consumers in various parts of the world. We expect the shift away from optical disc based media to
on-line and mobile media content consumption to continue, which may result in further declines in revenue from DVD and Blu-ray Disc players that incorporate our technologies.
Also,
the services that provide movie content from the cloud and that compete with or replace DVD and Blu-ray Discs as dominant media for consumer video entertainment are not
generally governed by international or national standards and are thus free to choose any media format(s) in order to deliver their products and/or services. This freedom of choice on the part of
on-line and mobile media content providers could limit our ability to grow if such content providers do not incorporate our technologies into their services, which could affect demand for
our decoding technologies.
Furthermore,
our participation in portable devices may be less profitable for us than DVD and Blu-ray Disc players. The on-line 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.
If we are unable to maintain a sufficient amount of entertainment content released with DTS audio soundtracks, demand for the technologies, products, and services that we
offer to consumer electronics product manufacturers may significantly decline, which would adversely impact our business and prospects.
We expect to derive a significant percentage of our revenues from the technologies, products, and services that we offer to
manufacturers of consumer electronics products. To date, the most significant driver for the use of our technologies in the home theater market has been the release of major movie titles with DTS
audio soundtracks. We believe that demand for our DTS audio technologies in growing markets for multi-channel audio, including automobiles, PCs, video game consoles, digital media players, tablets and
mobile handsets will be based on the number, quality, and popularity of the movies, music, and video games either released with DTS audio soundtracks or capable of being coded and played in DTS
format. Although we have existing relationships with many leading providers of movie, music, computer, and video game content, we generally do not have contracts that require these parties to develop
and release content with DTS audio soundtracks. Accordingly, our revenue could decline if
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these
parties elect not to incorporate DTS audio soundtracks into their content or if they sell less content that incorporate DTS audio soundtracks.
In
addition, we may not be successful in maintaining existing relationships or developing new relationships with other existing providers or new market entrants that provide content. As
a result, we cannot assure you that a sufficient amount of content will be released in a DTS audio format to ensure that manufacturers continue offering DTS decoders in the consumer electronics
products that they sell.
Economic downturns could disrupt and materially harm our business.
Negative trends in the general economy could cause a downturn in the market for our technologies, products and services, as many of the
products in which our technologies are incorporated are discretionary goods, including DVD and Blu-ray Disc players. Continued weakness in the global financial markets has resulted in a
tightening in the credit markets, a low level of liquidity in many financial markets and volatility in credit and equity markets. This continued weakness may adversely affect our operating results if
it results, for example, in the insolvency of a key licensee or other customer, the inability of our licensees and/or other customers to obtain credit to finance their operations, including to finance
the manufacture of products containing our technologies, and delays in reporting and/or payments from our licensees. Tight credit markets
could also delay or prevent us from acquiring or making investments in other technologies, products or businesses that could enhance our technical capabilities, complement our current products and
services, or expand the breadth of our markets. If we are unable to execute such acquisitions and/or strategic investments, our operating results and business prospects may suffer.
In
addition, global economic conditions, including increased cost of commodities, widespread employee layoffs, actual or threatened military action by the United States and the continued
threat of terrorism, have resulted in decreased consumer confidence, disposable income and spending. Continuation of or any further reduction in consumer confidence or disposable income may negatively
affect the demand for consumer electronics products that incorporate our digital audio technologies.
We
cannot predict other negative events that may have adverse effects on the global economy in general and the consumer electronics industry specifically. However, the factors described
above and such unforeseen events could negatively affect our revenues and operating results.
Declining retail prices for consumer electronics products could force us to lower the license or other fees we charge our customers or prompt our customers to exclude our
audio technologies from their products altogether, which would adversely affect our business and operating results.
The market for consumer electronics products is intensely competitive and price sensitive. Retail prices for consumer electronics
products that include our audio technologies have decreased significantly and we expect prices to continue to decrease for the foreseeable future. Declining prices for consumer electronics products
could create downward pressure on the licensing fees we currently charge our customers who integrate our technologies into the consumer electronics products that they sell and distribute. As a result
of pricing pressure, consumer electronics products manufacturers who produce products in which our audio technologies are not a mandatory standard could decide to exclude our audio technologies from
their products altogether.
Our revenue is dependent upon our customers and licensees incorporating our technologies into their products, and we have limited control over existing and potential
customers' and licensees' decisions to include our technologies in their product offerings.
Except for Blu-ray Disc products, where our technology is mandatory, we are dependent upon our customers and
licensees—including consumer electronics product manufacturers, semiconductor manufacturers, producers and distributors of content for movies, music, and games—to incorporate
our
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technologies
into their products, purchase our products and services, or release their content in our proprietary DTS audio format. Although we have contracts and license agreements with many of these
companies, these agreements do not require any minimum purchase commitments, are on a non-exclusive basis, and do not typically require incorporation or use of our technologies, trademarks
or services. Furthermore, the decision by a party dominant in the entertainment value chain to provide audio technology at very low or no cost could impact a licensee's decision to use our technology.
Our customers, licensees and other manufacturers might not utilize our technologies or services in the future. Accordingly, our revenue will decline if our customers and licensees choose not to
incorporate our technologies in their products, or if they sell fewer products incorporating our technologies.
We may not be able to evolve our technologies, products, and services or develop new technology, products, and services that are acceptable to our customers or the changing
market.
The market for our technologies, products, and services is characterized by:
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rapid technological change;
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•
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new and improved product introductions;
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•
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changing customer demands;
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increasingly competitive product landscape;
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evolving industry standards; and
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product obsolescence.
Our
future success depends upon our ability to enhance our existing technologies, products, and services and to develop acceptable new technologies, products, and services on a timely
basis. The development of enhanced and new technologies, products, and services 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, market, or support new or enhanced technologies, products, or services on a timely
basis, if at all. Furthermore, our new technologies, products, and services may never gain market acceptance, and we may not be able to respond effectively to evolving consumer demands, technological
changes, product announcements by competitors, or emerging industry standards. Any failure to respond to these changes or concerns would likely prevent our technologies, products, and services from
gaining market acceptance or maintaining market share and could lead to our technologies, products and services becoming obsolete.
Our ability to develop proprietary technology in markets in which "open standards" are adopted may be limited, which could adversely affect our ability to generate revenue.
Standards-setting bodies may require the use of so-called "open standards," meaning that the technologies necessary to meet
those standards are publicly available, free of charge and often on an "open source" basis. These standards are a relatively recent and limited occurrence and have primarily been focused on markets
and regions traditionally adverse to the notion of intellectual property ownership and the associated royalties. If the concept of "open standards" gains industry momentum in the future, the use of
open standards may reduce our opportunity to generate revenue, as open standards technologies are based upon non-proprietary technology platforms in which no one company maintains
ownership over the dominant technologies.
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A loss of one or more of our key customers or licensees in any of our markets could adversely affect our business.
From time to time, one or a small number of our customers or licensees may represent a significant percentage of our revenue. For
instance, in 2012, two customers accounted for 13% and 11%, respectively, of revenues from our continuing operations. Although we have agreements with many of our customers, these agreements typically
do not require any material minimum purchases or minimum royalty fees and do not prohibit customers from purchasing products and services from competitors. A decision by any of our major customers or
licensees not to use our technologies, or their failure or inability to pay amounts owed to us in a timely manner, or at all, could have a significant adverse effect on our business.
We face intense competition. Certain of our competitors have greater resources than we do.
The digital audio, consumer electronics and entertainment markets are intensely competitive, subject to rapid change, and significantly
affected by new product introductions and other market activities of industry participants. Our principal competitor is Dolby Laboratories, Inc., who competes with us in most of our markets. We
also compete with other companies offering digital audio technology incorporated into consumer electronics product and entertainment mediums, including Fraunhofer Institut Integrierte Schaltungen,
Koninklijke Philips Electronics N.V. (Philips), Microsoft Corporation, Sony Corporation and Thomson.
Certain
of our current and potential competitors may enjoy substantial competitive advantages, including:
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•
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greater name recognition;
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•
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a longer operating history;
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•
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more developed distribution channels and deeper relationships with our common customer base;
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a more extensive customer base;
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digital technologies that provide features that ours do not;
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broader product and service offerings;
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greater resources for competitive activities, such as research and development, strategic acquisitions, alliances, joint
ventures, sales and marketing, subsidies and lobbying industry and government standards;
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more technicians and engineers;
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greater technical support;
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open source or free codecs; and
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greater inclusion in government or industry standards.
As
a result, these current and potential competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards, or
customer requirements.
In
addition to the competitive advantages described above, Dolby also enjoys other unique competitive strengths relative to us. For example, it introduced multi-channel audio technology
before we did. It has also achieved mandatory standard status in product categories that we have not, including terrestrial digital television broadcasts in the United States. As a result of these
factors, Dolby has a competitive advantage in selling its digital multi-channel audio technology to consumer electronics products manufacturers.
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Our customers who are also our current or potential competitors may choose to use their own or competing technologies rather than ours.
We face competitive risks in situations where our customers are also current or potential competitors. For example, Sony is a
significant licensee customer, but Sony is also a competitor with respect to some of our technologies. To the extent that our customers choose to use competing technologies they have developed or in
which they have an interest, rather than use our technologies, our business and operating results could be adversely affected.
Our business and prospects depend upon the strength of our brand, and if we do not maintain and strengthen our brand, our business will be materially harmed.
Establishing, maintaining and strengthening our "DTS" brand is critical to our success. Our brand identity is key to maintaining and
expanding our business and entering new markets. Our success depends in large part on our reputation for providing high quality products, services and technologies to the consumer electronics and
entertainment industries. Our recent acquisition of SRS may cause new challenges to our brand. If we fail to promote and maintain our brand successfully, our business and prospects may suffer.
Moreover, we believe that the likelihood that our technologies will be adopted in industry standards depends, in part, upon the strength of our brand, because professional organizations and industry
participants are more likely to incorporate technologies developed by a well-respected and well-known brand into standards.
We may not successfully address problems encountered in connection with acquisitions.
We expect to consider opportunities to acquire or make investments in other technologies, products, and businesses that could enhance
our technical capabilities, complement our current products and services, or expand the breadth of our markets. While we recently acquired SRS and Phorus, our history of acquiring and integrating
businesses is limited, and there can be no assurance that we will be successful in realizing the expected benefits from an acquisition. Future success depends, in part, upon our ability to manage an
expanded business, which could pose substantial challenges for management. Acquisitions, including those of SRS and Phorus, and strategic investments involve numerous risks and potential difficulties,
including:
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problems assimilating the purchased technologies, products, or business operations;
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significant future charges relating to in-process research and development and the amortization of intangible
assets;
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significant amount of goodwill that is not amortizable and is subject to annual impairment review;
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problems maintaining and enforcing uniform standards, procedures, controls, policies and information systems;
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unanticipated costs associated with the acquisition, including accounting and legal charges, capital expenditures, and
transaction expenses;
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diversion of management's attention from our core business;
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adverse effects on existing business relationships with suppliers and customers;
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risks associated with entering markets in which we have no or limited prior experience;
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unanticipated or unknown liabilities relating to the acquired businesses;
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the need to integrate accounting, management information, manufacturing, human resources and other administrative systems
to permit effective management; and
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potential loss of key employees of acquired organizations.
If
we fail to properly evaluate and execute acquisitions and strategic investments, our management team may be distracted from our day-to-day operations, our
business may be disrupted, and our operating results may suffer. In addition, if we finance acquisitions by issuing equity or convertible debt securities, our existing stockholders would be diluted.
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, whether
because of failure to obtain stockholder approval or otherwise. Future acquisitions could result in potentially dilutive issuances of our equity securities, the incurrence of debt, contingent
liabilities or amortization expenses, or write-offs of goodwill, any of which could harm our operating results or financial condition. Future acquisitions may also require us to obtain
additional equity or debt financing, which may not be available on favorable terms or at all.
We expect our operating expenses to increase in the future, which may impact profitability.
We expect our operating expenses to increase as we, among other things:
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further integrate the SRS business;
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expand our sales and marketing activities, including the continued development of our international operations and
increased advertising;
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adopt a more customer-focused business model which is expected to entail additional hiring;
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acquire businesses or technologies and integrate them into our existing organization;
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increase our research and development efforts to advance our existing technologies, products, and services and develop new
technologies, products, and services;
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hire additional personnel, including engineers and other technical staff;
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expand and defend our intellectual property portfolio;
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upgrade our operational and financial systems, procedures, and controls; and
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continue to assume the responsibilities of being a public company.
As
a result, we will need to grow our revenues and manage our costs in order to positively impact profitability. In addition, we may fail to accurately estimate and assess our increased
operating expenses as we grow.
We may experience fluctuations in our operating results.
We have historically experienced moderate seasonality in our business due to our business mix and the nature of our products. Consumer
electronics manufacturing activities are generally lowest in the first calendar quarter of each year, and increase progressively throughout the remainder of the year. Manufacturing output is generally
strongest in the third and fourth quarters as our technology licensees increase manufacturing to prepare for the holiday buying season. Since recognition of revenues generally lags manufacturing
activity by one quarter, our revenues and earnings are generally lowest in the second quarter. The introduction of new products and inclusion of our technologies in new and rapidly growing markets can
distort and amplify the seasonality described above. Our revenues may continue to be subject to fluctuations, seasonal or otherwise, in the future. Unanticipated fluctuations, whether due to
seasonality, economic downturns, product cycles, or otherwise, could cause us to miss our earnings projections, or could lead to higher than normal variation in short-term earnings, either
of which could cause our stock price to decline.
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In
addition, we actively engage in intellectual property compliance and enforcement activities focused on identifying third parties who have either incorporated our technologies,
trademarks, or know-how without a license or who have underreported to us the amount of royalties owed under license agreements with us. As a result of these activities, from time to time,
we may recognize royalty revenues that relate to manufacturing activities from prior periods and we may incur expenditures related to enforcement activity. These royalty recoveries and expenditures,
as applicable, may cause revenues to be higher than expected, or net profit to be lower than expected, during a
particular reporting period and may not recur in future reporting periods. Such fluctuations in our revenues and operating results may cause declines in our stock price.
If we fail to protect our intellectual property rights, our ability to compete could be harmed.
Protection of our intellectual property is critical to our success. Copyright, trademark, patent, and trade secret laws and
confidentiality and other contractual provisions afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. We face numerous risks
in protecting our intellectual property rights, including the following:
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our competitors may produce competitive products or services that do not unlawfully infringe upon our intellectual
property rights;
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the laws of foreign countries may not protect our intellectual property rights to the same extent as the laws of the
United States, and mechanisms for enforcement of intellectual property rights may be inadequate in foreign countries;
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we may be unable to successfully identify or prosecute unauthorized uses of our technologies;
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efforts to identify and prosecute unauthorized uses of our technologies are time consuming, expensive, and divert
resources from the operation of our business;
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our patents may be challenged, found unenforceable or invalidated by our competitors;
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our pending patent applications may not issue, or if issued, may not provide meaningful protection for related products or
proprietary rights;
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we may not be able to practice our trade secrets as a result of patent protection afforded a third-party for such product,
technique or process; and
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we may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by
employees, consultants, and advisors.
As
a result, our means of protecting our intellectual property rights and brands may prove inadequate. Furthermore, despite our efforts, third parties may violate, or attempt to violate,
our intellectual property rights. Enforcement, including infringement claims and lawsuits would likely be expensive to resolve and would require management's time and resources. In addition, we have
not sought, and do not intend to seek, patent and other intellectual property protections in all foreign countries. In countries where we do not have such protection, products incorporating our
technology may be lawfully produced and sold without a license.
We may be sued by third parties for alleged infringement of their proprietary rights, and we may be subject to litigation proceedings that could harm our business.
Companies that participate in the digital audio, consumer electronics, and entertainment industries hold a large number of patents,
trademarks, and copyrights, and are frequently involved in litigation based on allegations of patent infringement or other violations of intellectual property rights. Intellectual property disputes
frequently involve highly complex and costly scientific matters, and each party generally has the right to seek a trial by jury which adds additional costs and uncertainty.
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Accordingly,
intellectual property disputes, with or without merit, could be costly and time consuming to litigate or settle, and could divert management's attention from executing our business plan.
In addition, our technologies and products may not be able to withstand any third-party claims or rights
against their use. If we were unable to obtain any necessary license following a determination of infringement or an adverse determination in litigation or in interference or other administrative
proceedings, we may need to redesign some of our products to avoid infringing a third party's rights and could be required to temporarily or permanently discontinue licensing our products.
In
the past, we have been a party to litigation related to protection and enforcement of our intellectual property, and we may be a party to additional litigation in the future.
Litigation is subject to inherent uncertainties, and unfavorable rulings could occur. An unfavorable ruling could include monetary damages (including treble damages under the Clayton Act) and an
injunction prohibiting us from licensing our technologies in particular ways or at all. Were an unfavorable ruling to occur, our business and results of operations could be materially harmed. In
addition, any protracted litigation could divert management's attention from our day-to-day operations, disrupt our business and cause our operating results to suffer.
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 regarding our licensing royalty
rate practices including our adherence to licensing on fair, reasonable, and non-discriminatory terms and potential antitrust claims. Damages and requests for injunctive relief asserted in
claims like these could be material, and could 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.
The licensing of patents constitutes a significant source of our revenue. If we do not replace expiring patents with new patents or proprietary technologies, our revenue
could decline.
We hold patents covering much of the technologies that we license to system licensees, and our licensing revenue is tied in large part
to the life of those patents. Our right to receive royalties related to our patents terminates with the expiration of the last patent covering the relevant technologies. Accordingly, to the extent
that we do not replace licensing revenue from technologies covered by expiring patents with licensing revenue based on new patents and proprietary technologies, our revenue could decline.
Our licensing revenue depends in large part upon semiconductor manufacturers incorporating our technologies into integrated circuits, or ICs, for sale to our consumer
electronics product licensees and if, for any reason, our technologies are not incorporated in these ICs or fewer ICs are sold that incorporate our technologies, our operating results would be
adversely affected.
Our licensing revenue from consumer electronics product manufacturers depends in large part upon the availability of ICs that implement
our technologies. IC manufacturers incorporate our technologies into these ICs, which are then incorporated into consumer electronics products. We do not manufacture these ICs, but rather depend upon
IC manufacturers to develop, produce and then sell them to licensed consumer electronic products manufacturers. We do not control the IC manufacturers' decisions whether or not to incorporate our
technologies into their ICs, and we do not control their product development or commercialization efforts. If these IC manufacturers are unable or unwilling,
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for
any reason, to implement our technologies into their ICs, or if, for any reason, they sell fewer ICs incorporating our technologies, our operating results will be adversely affected.
Our business is partially dependent upon the sales of Blu-ray Disc products, and to the extent that consumer use of Blu-ray Disc products declines,
our business will be adversely affected.
Past growth in our business has been due in large part to the rapid growth in sales of DVD based products and home theater systems
incorporating our technologies. More recently, our mandatory inclusion in the Blu-ray Disc standard represented a potentially significant opportunity. We expect markets for optical disc
based products to mature and eventually, decline in favor of an expanding market for network-based entertainment delivery. If the pace of our participation in network-based entertainment lags the
eventual decline in our optical disc based media business, our operating results and prospects could be adversely affected.
Unanticipated changes in our tax provisions or adverse outcomes resulting from examination of our income tax returns could adversely affect our net income.
We are subject to income taxes in both the United States and foreign jurisdictions. Our effective income tax rates could in the future
be adversely affected by changes in tax laws or interpretations of those tax laws, by changes in the mix of earnings in countries with differing statutory tax rates, or by changes in the valuation of
our deferred tax assets and liabilities. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions
and calculations where the ultimate tax determination is uncertain. We may come under audit by tax authorities. For instance, the Internal Revenue Service ("IRS") is examining our 2007 federal income
tax return, and we have filed a protest related to certain adjustments made by the IRS for the taxable years 2003, 2005 and 2006. The State of California is examining our 2004 and 2005 corporate tax
returns. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from our historical income tax provisions
and accruals. Based on the results of an audit or litigation, a material effect on our income tax provision, net income or cash flows in the period or periods for which that determination is made
could result. In addition, changes in tax rules may adversely affect our future reported financial results or the way we conduct our business. We earn a significant amount of our operating income from
outside the U.S., and any repatriation of funds currently held in foreign jurisdictions may result in higher effective tax rates. In addition, there have been proposals to change U.S. tax laws that
would significantly impact how U.S. multinational corporations are taxed on foreign earnings. Although we cannot predict whether or in what form this proposed legislation will pass, if enacted, it
could have a material adverse impact on our tax expense and cash flow.
We rely on the accuracy of our customers' manufacturing reports for reporting and collecting our revenues, and if these reports are untimely or incorrect, our revenues could
be delayed or inaccurately reported.
Most of our revenues are generated from consumer electronic products manufacturers who license and incorporate our technology in their
consumer electronics products. Under our existing agreements, these customers pay us per-unit licensing fees based on the number of consumer electronics products manufactured that
incorporate our technology. We rely on our customers to accurately report the number of units manufactured in collecting our license fees, preparing our financial reports, projections, budgets, and
directing our sales and product development efforts. Most of our license agreements permit us to audit our customers, but audits are generally expensive, time consuming, difficult to manage
effectively, dependent in large part upon the cooperation of our licensees and the quality of the records they keep, and could harm our customer relationships. If any of our customer reports
understate the number of products they manufacture, we may not collect and recognize revenues to which we are entitled, or may endure significant expense to obtain compliance.
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Our technologies and products are complex and may contain errors that could cause us to lose customers, damage our reputation, or incur substantial costs.
Our technologies or products could contain errors that could cause our products or technologies to operate improperly and could cause
unintended consequences. If our products or technologies contain errors we, could be required to replace them, and if any such errors cause unintended consequences, we could face claims for product
liability. Although we generally attempt to contractually limit our exposure to incidental and consequential damages, as well as provide insurance coverage for such events, if these contract
provisions are not enforced or are unenforceable for any reason, if liabilities arise that are not effectively limited, or if our insurance coverage is inadequate to satisfy the liability, we could
incur substantial costs in defending and/or settling product liability claims.
We are dependent upon our management team and technical talent.
Our success depends, in part, upon the continued availability and contributions of our management team and engineering and technical
personnel because of the
complexity of our products and services. Important factors that could cause the loss of key personnel include:
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our existing employment agreements with the members of our management team allow such persons to terminate their
employment with us at any time;
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we do not have employment agreements with a majority of our key engineering and technical personnel;
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significant portions of the equity awards held by the members of our management team are vested;
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equity awards held by some of our executive officers provide for accelerated vesting in the event of a sale or change of
control of our company; and
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dissatisfaction as a result of the business following our recent acquisitions.
The
loss of key personnel or an inability to attract qualified personnel in a timely manner could slow our technology and product development and harm our ability to execute our business
plan.
We may have difficulty managing any growth that we might experience.
As a result of a combination of internal growth and growth through acquisitions, such as our recent acquisition of SRS, we expect to
continue to experience growth in the scope of our operations and the number of our employees. If our growth continues, it may place a significant strain on our management team and on our operational
and financial systems, procedures,
and controls. Our future success will depend in part upon the ability of our management team to manage any growth effectively. This will require our management
to:
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hire and train additional personnel in the United States and internationally;
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implement and improve our operational and financial systems, procedures, and controls;
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maintain our cost structure at an appropriate level based on the revenues we generate;
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manage multiple concurrent development projects; and
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manage operations in multiple time zones with different cultures and languages.
Any
failure to successfully manage our growth could distract management's attention, and result in our failure to execute our business plan.
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We are subject to additional risks associated with our international operations.
Our licensing headquarters are located in Limerick, Ireland, and we market and sell our products and services outside the United
States. We currently have employees located in eight countries, and many of our customers and licensees are located outside the United States. As a key component of our business strategy, we intend to
expand our international sales and customer support. During the year ended December 31, 2012, nearly 90% of our revenues were derived internationally. We face numerous risks in doing business
outside the United States, including:
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unusual or burdensome foreign laws or regulatory requirements or unexpected changes to those laws or requirements;
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tariffs, trade protection measures, import or export licensing requirements, trade embargos, and other trade barriers;
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difficulties in attracting and retaining qualified personnel and managing foreign operations;
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competition from foreign companies;
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dependence upon foreign distributors and their sales channels;
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longer accounts receivable collection cycles and difficulties in collecting accounts receivable;
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less effective and less predictable protection and enforcement of our intellectual property;
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changes in the political or economic condition of a specific country or region, particularly in emerging markets;
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fluctuations in the value of foreign currency versus the U.S. dollar and the cost of currency exchange;
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potentially adverse tax consequences; and
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cultural differences in the conduct of business.
Such
factors could cause our future international sales to decline.
Our
business practices in international markets are also subject to the requirements of the Foreign Corrupt Practices Act. If any of our employees are found to have violated these
requirements, we and our employees could be subject to significant fines, criminal sanctions and other penalties.
Our
international revenue is mostly denominated in U.S. dollars. As a result, fluctuations in the value of the U.S. dollar and foreign currencies may make our technology, products, and
services more expensive for international customers, which could cause them to decrease their purchases from us. Expenses for our subsidiaries are denominated in their respective local currencies. As
a result, if the U.S. dollar weakens against the local currency, the translation of our foreign-currency-denominated expenses will result in higher operating expense without a corresponding increase
in revenue. Significant fluctuations in the value of the U.S. dollar and foreign currencies could have a material impact on our consolidated financial statements. The main foreign currencies we
encounter in our operations are the Yen, Euro, RMB, KRW, HKD, TWD, SGD and GBP. We do not currently engage in currency hedging activities to limit the risk of exchange rate fluctuations.
We have identified a material weakness in our internal control over financial reporting, which may adversely affect investor confidence in us and, as a result, the value of
our common stock.
We are required, pursuant to Section 404 of the Sarbanes-Oxley Act, to furnish a report by management on, among other things,
the effectiveness of our internal control over financial reporting. This assessment includes disclosure of any material weaknesses identified by our management in our internal control over financial
reporting, as well as a statement that our independent registered public
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accounting
firm has issued an attestation report on the effectiveness of our internal control over financial reporting.
Our
management concluded that our internal control over financial reporting was ineffective as of December 31, 2012 because a material weakness existed in our internal control
over financial reporting related to the inadequate design of internal controls over the accounting for income taxes. See Item 9A—Controls and Procedures.
If
we are unable to effectively remediate this material weakness in a timely manner, or if we identify one or more additional material weaknesses in the future, investors could lose
confidence in the accuracy and completeness of our financial reports, which could have a material adverse effect on the price of our common stock.
Our
multi-national legal structure is complex, which increases the risk of errors in financial reporting related to our accounting for income taxes. In the course of remediating the
material weakness, we may find additional errors in our accounting for income taxes or discover new facts that cause us to reach different conclusions. This could result in adjustments that could have
an adverse effect on our consolidated financial statements and the price of our common stock.
Compliance with changing securities laws, regulations and financial reporting standards will increase our costs and pose challenges for our management team.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Dodd-Frank
Wall Street Reform and Consumer Protection Act, the Sarbanes-Oxley Act of 2002, and the rules and regulations promulgated thereunder have created uncertainty for public companies and significantly
increased the costs and risks associated with operating as a publicly traded company in the United States. Our management team will need to devote significant time and financial resources to comply
with both existing and evolving standards for public companies, which will lead to increased general and administrative expenses and a diversion of management time and attention from revenue
generating activities to compliance activities. Furthermore, with such uncertainties, we cannot assure you that our system of internal control will be effective or satisfactory to our independent
registered public accounting firm. As a result, our financial reporting may not be timely and/or accurate and we may be issued an adverse or qualified opinion by our independent registered public
accounting firm. If reporting delays or errors actually occur, we could be subject to sanctions or investigation by regulatory authorities, such as the SEC, and could adversely affect our financial
results or result in a loss of investor confidence in the reliability of our financial information, which could materially and adversely affect the market price of our common stock.
Further,
the SEC has passed, promulgated and proposed new rules on a variety of subjects including the requirement that we must file our financial statements with the SEC using the
interactive data format eXtensible Business Reporting Language ("XBRL"), and the possibility that we would be required to adopt International Financial Reporting Standards ("IFRS"). In order to comply
with XBRL and IFRS requirements, we may have to add additional accounting staff, engage consultants or change our internal practices, standards and policies which could significantly increase our
costs.
We
believe that these new and proposed laws and regulations could make it more difficult for us to attract and retain qualified members of our Board of Directors, particularly to serve
on our audit committee, and qualified executive officers.
Current and future governmental and industry standards may significantly limit our business opportunities.
Technology standards are important in the audio and video industry as they help to assure compatibility across a system or series of
products. Generally, standards adoption occurs on either a mandatory basis, requiring a particular technology to be available in a particular product or medium, or
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an
optional basis, meaning that a particular technology may be, but is not required to be, utilized. For example, both our digital multi-channel audio technology and Dolby's have optional status in
Blu-ray Disc, while both our two-channel output and Dolby's technologies have been selected as mandatory standards in Blu-ray Disc. However, if either or both of
these standards are re-examined or a new standard is developed, we may not be included as mandatory in any such new or revised standard which would cause revenue growth in our consumer
business to be significantly lower than expected and could have a material adverse affect on our business.
Various
national governments have adopted or are in the process of adopting standards for all digital television broadcasts, including cable, satellite, and terrestrial. In the United
States, Dolby's audio technology has been selected as the sole, mandatory audio standard for terrestrial digital television broadcasts. As a result, the audio for all digital terrestrial television
broadcasts in the United States must include Dolby's technology and must exclude any other format, including ours. We do not know whether this standard will be reopened or amended. If it is not, our
audio technology may never be included in that standard. Certain large and developing markets, such as China, have not fully developed their digital television standards. Our technology may or may not
ultimately be included in these standards.
As
new technologies and entertainment media emerge, new standards relating to these technologies or media may develop. New standards may also emerge in existing markets that are
currently characterized by competing formats, such as the market for personal computers. We may not be successful in our efforts to include our technology in any such standards.
Our licensing of industry standard technologies can be subject to limitations that could adversely affect our business and prospects.
When a standards-setting body adopts our technologies as explicit industry standards, we generally must agree to license such
technologies on a fair, reasonable and non-discriminatory basis, which we believe means that we treat similarly situated licensees similarly. In these situations, we may be required to
limit the royalty rates we charge for these technologies, which could adversely affect our business. Furthermore, we may have limited control over whom we license such technologies to, and may be
unable to restrict many terms of the license. From time to time, we may be subject to claims that our licenses of our industry standard technologies may not conform to the requirements of the
standards-setting body. 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 have a limited operating history in certain new and evolving markets.
Our technologies have only recently been incorporated into certain markets, such as digital media players, televisions, personal
computers, digital satellite and cable broadcast products, portable electronics devices and mobile handsets. We do not have the same experience in these markets as in our traditional consumer
electronics business, nor do we have as much operating history as companies such as Dolby Laboratories, Inc. As a result, the demand for our technologies, products, and services and the income
potential of these businesses is unproven. In addition, because our participation in these markets is relatively new and rapidly evolving, we may have limited insight into trends that may emerge and
affect our business. We may make errors in predicting and reacting to relevant business trends, which could harm our business. Before investing in our common stock, you should consider the risks,
uncertainties, and difficulties frequently encountered by companies in new and rapidly evolving markets such as ours. We may not be able to successfully address any or all of these risks.
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We have incurred a significant amount of indebtedness to pay the cash consideration to SRS stockholders and to pay related fees and expenses. Our level of indebtedness, and
covenant restrictions under such indebtedness, could adversely affect our operations and liquidity.
We financed the cash consideration of the SRS acquisition through a combination of existing cash balances, liquidated investments and a
new credit facility, which we entered into on July 18, 2012. This credit facility provides us with a $30.0 million revolving line of credit, with a five million sublimit for the issuance
of standby and commercial letters of credit, to use to finance permitted acquisitions and for working capital and general corporate purposes.
Our
increased indebtedness could adversely affect our operations and liquidity, by, among other things:
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making it more difficult for us to pay or refinance our debts as they become due during adverse economic and industry
conditions because we may not have sufficient cash flows to make our scheduled debt payments;
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causing us to use a larger portion of our cash flow to fund interest and principal payments, reducing the availability of
cash to fund working capital and capital expenditures and other business activities;
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making it more difficult for us to take advantage of significant business opportunities, such as acquisition
opportunities, and to react to changes in market or industry conditions; and
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limiting our ability to borrow additional monies in the future to fund working capital, capital expenditures and other
general corporate purposes.
The
terms of our indebtedness include covenants that, among other things, restrict our ability to: (i) dispose of assets, (ii) incur additional indebtedness,
(iii) incur guarantee obligations, (iv) prepay certain other indebtedness or amend other financing arrangements, (v) pay dividends, (vi) create liens on assets,
(vii) enter into sale and leaseback transactions, (viii) make investments, loans or advances, (ix) make acquisitions, (x) engage in mergers or consolidations,
(xi) change the business conducted and (xii) engage in certain transactions with affiliates.
Our future capital needs are uncertain and we may need to raise additional funds in the future, and such funds may not be available on acceptable terms or at all.
Our capital requirements will depend upon many factors, including:
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acceptance of, and demand for, our products and technologies;
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the costs of developing new products or technologies;
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the extent to which we invest in new technologies and research and development projects;
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the number and timing of acquisitions and other strategic transactions;
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the costs associated with our expansion, if any; and
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the costs of litigation and enforcement activities to defend our intellectual property.
In
the future, we may need to raise additional funds, and such funds may not be available on favorable terms, or at all, particularly given the continuing credit crisis and downturn in
the overall global economy. Furthermore, if we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution, and the new equity or debt securities may
have rights, preferences, and privileges senior to those of our existing stockholders. If we cannot raise funds on acceptable terms, or at all, we may not be able to develop or enhance our products
and services, execute our business plan, take advantage of future opportunities, or respond to competitive pressures
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or
unanticipated customer requirements. This may materially harm our business, results of operations, and financial condition.
Natural or other disasters could disrupt our business and negatively impact our operating results and financial condition.
Natural or other disasters such as earthquakes, hurricanes, tsunamis or other adverse weather and climate conditions, whether occurring
in the U.S. or abroad, and the consequences and effects thereof, including energy shortages and public health issues, could disrupt our
operations, or the operations of our business partners and customers, or result in economic instability that may negatively impact our operating results and financial condition. Our corporate
headquarters and many of our operations are located in California, a seismically active region, potentially exposing us to greater risk of natural disasters.
Our business and operations could suffer in the event of security breaches.
Attempts by others to gain unauthorized access to information technology systems are becoming more sophisticated and successful. These
attempts can include introducing malware to computers and networks, impersonating authorized users, overloading systems and servers and data theft. While we seek to detect and investigate any security
issue, in some cases, we might be unaware of an incident or its magnitude and effects. The theft, unauthorized use or publication of our intellectual property and/or confidential business information
could harm our competitive position, reduce the value of our investment in research and development and other strategic initiatives or otherwise adversely affect our business. To the extent that any
security breach results in inappropriate disclosure of our customers' or licensees' confidential information, we may incur liability as a result.
Risks Related to Our Common Stock
We expect that the price of our common stock will fluctuate substantially.
The market price of our common stock is likely to be highly volatile and may fluctuate substantially due to many factors,
including:
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actual or anticipated fluctuations in our results of operations;
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market perception of our progress toward announced objectives;
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announcements of technological innovations by us or our competitors or technology standards;
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announcements of significant contracts by us or our competitors;
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changes in our pricing policies or the pricing policies of our competitors;
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developments with respect to intellectual property rights;
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the introduction of new products or product enhancements by us or our competitors;
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the commencement of or our involvement in litigation;
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resolution of significant litigation in a manner adverse to our business;
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our sale or purchase of common stock or other securities in the future;
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conditions and trends in technology industries;
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changes in market valuation or earnings of our competitors;
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the trading volume of our common stock;
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announcements of potential acquisitions;
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the adoption rate of new products incorporating our or our competitors' technologies, including Blu-ray Disc
players;
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changes in the estimation of the future size and growth rate of our markets; and
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general economic conditions.
In
addition, the stock market in general, and the NASDAQ Global Select Market and the market for technology companies in particular, has experienced extreme price and volume fluctuations
that have often been unrelated or disproportionate to the operating performance of those companies. Further, the market prices of securities of technology companies have been particularly volatile.
These broad market and industry factors may materially harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market
price of a company's securities, securities class-action litigation has often been instituted against that company. Such litigation, if instituted against us, could result in substantial costs and a
diversion of management's attention and resources.
Shares of our common stock are relatively illiquid.
As a result of our relatively small public float, our common stock may be less liquid than the common stock of companies with broader
public ownership. Among other things, trading of a relatively small volume of our common shares may have a greater impact on the trading price for our shares than would be the case if our public float
were larger.
Anti-takeover provisions under our charter documents and Delaware law could delay or prevent a change of control and could also limit the market price of our
stock.
Our Restated Certificate of Incorporation and Restated Bylaws contain provisions that could delay or prevent a change of control of our
company or changes in our Board of Directors that our stockholders might consider favorable. Some of these provisions:
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authorize the issuance of preferred stock which can be created and issued by the Board of Directors without prior
stockholder approval, with rights senior to those of the common stock;
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provide for a classified Board of Directors, with each director serving a staggered three-year term;
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prohibit stockholders from filling Board vacancies, calling special stockholder meetings, or taking action by written
consent; and
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require advance written notice of stockholder proposals and director nominations.
In
addition, we are governed by the provisions of Section 203 of the Delaware General Corporate Law, which may prohibit certain business combinations with stockholders owning 15%
or more of our outstanding voting stock. These and other provisions in our Restated Certificate of Incorporation,
Restated Bylaws and Delaware law could make it more difficult for stockholders or potential acquirors to obtain control of our Board or initiate actions that are opposed by the
then-current Board, and could delay or impede a merger, tender offer, or proxy contest involving our company. Any delay or prevention of a change of control transaction or changes in our
Board could cause the market price of our common stock to decline.
If securities or industry analysts publish inaccurate or unfavorable research about our business or if our operating results do not meet or exceed their projections, our
stock price could decline.
The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about
us or our business. If one or more of the analysts who cover us or our industry downgrade our stock or the stock of other companies in our industry, or publish inaccurate or unfavorable research about
our business or industry, or if our operating results do not meet or exceed their projections, our stock price would likely decline. If one or more of these analysts cease coverage of our company or
fail to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline.
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