Item 1A. Risk Factors
Set forth below and elsewhere in this report and in other documents we file with the SEC are risks and uncertainties that could cause
our actual results to differ materially from the results contemplated by the forward-looking statements contained in this report and other public statements we make. 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. We have marked with an asterisk (*) those risks described below that reflect substantive changes from the risks included in Part I, Item 1A. "Risk Factors" in our annual
report on Form 10-K for the year ended December 31, 2012, as supplemented and updated by the risk factors included in Part II, Item 1A. "Risk Factors" in our quarterly
report on Form 10-Q for the period ended March 31, 2013.
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.
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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 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.
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.
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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 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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new and improved product introductions;
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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
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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.
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.
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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greater name recognition;
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a longer operating history;
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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.
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 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.
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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 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.
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. 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.
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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, 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 federal income tax returns. The State of
California is examining our 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
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currently
held in foreign jurisdictions may result in additional tax expense. 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.
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.
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.
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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.
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.
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 nine months ended September 30, 2013, 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.
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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 material weaknesses 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 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. In addition, as of September 30, 2013, our management concluded that our
internal control over financial reporting was ineffective because a material weakness existed in our internal control over financial reporting related to the inadequate design of internal controls
over the accounting for revenue under license agreements with non-standard financial terms. See Part I, Item 4—Controls and Procedures.
In
order to remediate the material weakness in our internal control over financial reporting related to the accounting for income taxes, we implemented a plan to enhance our control
procedures with respect to the preparation and review of the income tax provision and the related deferred tax assets and liabilities. This remediation plan includes increased use of third party
advisors with appropriate expertise to assist with the preparation and review of the quarterly and annual income tax provision. In addition, in order to remediate the material weakness in our internal
control over financial reporting related to the accounting for revenue under license agreements with non-standard financial terms, we implemented a plan to enhance our control procedures with respect
to the identification and review of revenue under agreements with non-standard financial terms. This remediation plan includes additional analysis of our license agreements to evaluate the
non-standard financial terms, performance of additional accounting research and detailed checklists to ensure that all agreements with non-standard financial terms are sufficiently identified and
evaluated, and revenue is properly recognized.
If
we are unable to effectively remediate these material weaknesses 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
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us to reach different conclusions. In addition, given the complexity of certain of the Company's license agreements and the accounting standards governing revenue recognition related thereto, we
may find additional errors in our accounting for revenue under license agreements with non-standard financial terms 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 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 effect 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
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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.
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.
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.
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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 certain reporting and financial covenants, as well as other 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. If we fail to comply with any of these
covenants or restrictions, such failure may result in an event of default, which if not cured or waived, could result in the lenders increasing the interest rate as of the date of default or
accelerating the maturity of our indebtedness. If the maturity of our indebtedness is accelerated, we may not have sufficient cash resources to satisfy our debt obligations and such acceleration would
adversely affect our business and financial condition. In addition, the indebtedness under our credit facility is secured by a security interest in substantially all of our tangible and intangible
assets and therefore, if we are unable to repay such indebtedness, the lenders could foreclose on these assets, which would adversely affect our ability to operate our business.
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.
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
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.
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
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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.