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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2008
Commission File Number 000-50335
DTS, Inc.
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) | | 77-0467655 (I.R.S. Employer Identification No.) |
5171 Clareton Drive Agoura Hills, California 91301 (Address of principal executive offices and zip code) | |
(818) 706-3525 (Registrant's telephone number, including area code) |
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | | Accelerated filer ý | | Non-accelerated filer o (Do not check if a smaller reporting company) | | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
As of April 30, 2008 a total of 17,811,424 shares of the Registrant's Common Stock, $0.0001 par value, were outstanding.
DTS, INC.
FORM 10-Q
TABLE OF CONTENTS
PART I | | FINANCIAL INFORMATION | | 1 |
Item 1. | | Financial Statements (unaudited): | | 1 |
| | Consolidated Balance Sheets | | 1 |
| | Consolidated Statements of Operations | | 2 |
| | Consolidated Statements of Cash Flows | | 3 |
| | Notes to Consolidated Financial Statements | | 4 |
Item 2. | | Management's Discussion and Analysis of Financial Condition and Results of Operations | | 16 |
Item 3. | | Quantitative and Qualitative Disclosures About Market Risk | | 25 |
Item 4. | | Controls and Procedures | | 26 |
PART II. | | OTHER INFORMATION | | 27 |
Item 1. | | Legal Proceedings | | 27 |
Item 1A. | | Risk Factors | | 27 |
Item 2. | | Unregistered Sales of Equity Securities and Use of Proceeds | | 41 |
Item 3. | | Defaults Upon Senior Securities | | 41 |
Item 4. | | Submission of Matters to a Vote of Security Holders | | 41 |
Item 5. | | Other Information | | 41 |
Item 6. | | Exhibits | | 42 |
SIGNATURES | | 43 |
DTS, INC.
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
DTS, INC.
CONSOLIDATED BALANCE SHEETS
| | As of December 31, 2007
| | As of March 31, 2008
| |
---|
| | (Unaudited) (Amounts in thousands, except per share amounts)
| |
---|
ASSETS | | | | | | | |
Current assets: | | | | | | | |
| Cash and cash equivalents | | $ | 35,523 | | $ | 44,924 | |
| Short-term investments | | | 49,879 | | | 12,874 | |
| Accounts receivable, net of allowance for doubtful accounts of $81 and $74 at December 31, 2007 and March 31, 2008, respectively | | | 8,675 | | | 8,355 | |
| Deferred income taxes | | | 8,776 | | | 6,368 | |
| Prepaid expenses and other current assets | | | 1,342 | | | 1,253 | |
| Income taxes receivable, net | | | 2,085 | | | 2,060 | |
| Assets of discontinued operations held for sale | | | 8,629 | | | 9,088 | |
| |
| |
| |
| | Total current assets | | | 114,909 | | | 84,922 | |
Property and equipment, net | | | 5,861 | | | 5,845 | |
Intangible assets, net | | | 2,387 | | | 2,372 | |
Deferred income taxes | | | 8,584 | | | 6,474 | |
Long-term investments | | | — | | | 28,286 | |
Other assets | | | 3,019 | | | 2,430 | |
Assets of discontinued operations held for sale | | | 3,457 | | | 8,624 | |
| |
| |
| |
| | Total assets | | $ | 138,217 | | $ | 138,953 | |
| |
| |
| |
LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | |
Current liabilities: | | | | | | | |
| Accounts payable | | $ | 1,068 | | $ | 919 | |
| Accrued expenses and other liabilities | | | 6,118 | | | 4,537 | |
| Liabilities of discontinued operations held for sale | | | 7,503 | | | 6,888 | |
| |
| |
| |
| | Total current liabilities | | | 14,689 | | | 12,344 | |
Other long-term liabilities | | | 2,242 | | | 2,453 | |
Liabilities of discontinued operations held for sale | | | 474 | | | 474 | |
Commitments and contingencies (Note 5) | | | | | | | |
Stockholders' equity: | | | | | | | |
| Preferred stock—$0.0001 par value, 5,000 shares authorized at December 31, 2007 and March 31, 2008; no shares issued and outstanding | | | — | | | — | |
| Common stock—$0.0001 par value, 70,000 shares authorized at December 31, 2007 and March 31, 2008; 18,669 and 18,811 shares issued at December 31, 2007 and March 31, 2008, respectively; 17,669 and 17,811 shares outstanding at December 31, 2007 and March 31, 2008, respectively | | | 2 | | | 2 | |
| Additional paid-in capital | | | 140,008 | | | 141,556 | |
| Treasury stock, at cost—1,000 shares at December 31, 2007 and March 31, 2008 | | | (22,670 | ) | | (22,670 | ) |
| Accumulated other comprehensive income | | | 193 | | | 198 | |
| Retained earnings | | | 3,279 | | | 4,596 | |
| |
| |
| |
| | Total stockholders' equity | | | 120,812 | | | 123,682 | |
| |
| |
| |
| | | Total liabilities and stockholders' equity | | $ | 138,217 | | $ | 138,953 | |
| |
| |
| |
See accompanying notes to consolidated financial statements.
1
DTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
| | For the Three Months Ended March 31,
| |
---|
| | 2007
| | 2008
| |
---|
| | (Unaudited) (Amounts in thousands, except per share amounts)
| |
---|
Revenue | | $ | 12,608 | | $ | 15,210 | |
Cost of revenue | | | 255 | | | 294 | |
| |
| |
| |
Gross profit | | | 12,353 | | | 14,916 | |
Operating expenses: | | | | | | | |
| Selling, general and administrative | | | 8,072 | | | 8,797 | |
| Research and development | | | 1,604 | | | 1,763 | |
| |
| |
| |
| | Total operating expenses | | | 9,676 | | | 10,560 | |
| |
| |
| |
Income from operations | | | 2,677 | | | 4,356 | |
Interest and other income, net | | | 356 | | | 879 | |
| |
| |
| |
Income from continuing operations before income taxes | | | 3,033 | | | 5,235 | |
Provision for income taxes | | | 1,050 | | | 1,984 | |
| |
| |
| |
Income from continuing operations | | | 1,983 | | | 3,251 | |
Loss from discontinued operations, net of tax | | | (2,748 | ) | | (1,934 | ) |
| |
| |
| |
Net income (loss) | | $ | (765 | ) | $ | 1,317 | |
| |
| |
| |
Net income (loss) per common share: | | | | | | | |
Basic: | | | | | | | |
| Continuing operations | | $ | 0.11 | | $ | 0.19 | |
| Discontinued operations | | | (0.15 | ) | | (0.11 | ) |
| |
| |
| |
| Net income (loss) | | $ | (0.04 | ) | $ | 0.08 | |
| |
| |
| |
| Diluted: | | | | | | | |
| Continuing operations | | $ | 0.11 | | $ | 0.18 | |
| Discontinued operations | | | (0.15 | ) | | (0.11 | ) |
| |
| |
| |
| Net income (loss) | | $ | (0.04 | ) | $ | 0.07 | |
| |
| |
| |
Weighted average shares used to compute net income (loss) per common share: | | | | | | | |
| Basic | | | 17,965 | | | 17,527 | |
| |
| |
| |
| Diluted | | | 18,673 | | | 18,059 | |
| |
| |
| |
See accompanying notes to consolidated financial statements.
2
DTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
| | For the Three Months Ended March 31,
| |
---|
| | 2007
| | 2008
| |
---|
| | (Unaudited) (Amounts in thousands)
| |
---|
Cash flows from operating activities: | | | | | | | |
Net income (loss) | | $ | (765 | ) | $ | 1,317 | |
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | | | | | | | |
| Depreciation and amortization | | | 977 | | | 647 | |
| Adjustment to carrying value of assets held for sale | | | — | | | (4,963 | ) |
| Stock-based compensation charges | | | 1,256 | | | 1,402 | |
| Deferred income taxes | | | (328 | ) | | 4,518 | |
| Tax benefits from stock-based awards | | | 566 | | | 281 | |
| Excess tax benefits from stock-based awards | | | (561 | ) | | (295 | ) |
| Other | | | 45 | | | 24 | |
| Changes in operating assets and liabilities: | | | | | | | |
| | Accounts receivable | | | (2,748 | ) | | 1,051 | |
| | Inventories | | | 264 | | | (454 | ) |
| | Prepaid expenses and other assets | | | 171 | | | 408 | |
| | Accounts payable, accrued expenses and other liabilities | | | (3,623 | ) | | (2,616 | ) |
| | Deferred revenue | | | 34 | | | 482 | |
| | Income taxes receivable | | | (1,065 | ) | | 75 | |
| |
| |
| |
| | Net cash provided by (used in) operating activities | | | (5,777 | ) | | 1,877 | |
| |
| |
| |
Cash flows from investing activities: | | | | | | | |
| Purchases of investments: | | | | | | | |
| | Held-to-maturity | | | (14,986 | ) | | (6,015 | ) |
| | Available for sale | | | (3,561 | ) | | (12,946 | ) |
| Maturities of held-to-maturity investments | | | 16,536 | | | 9,530 | |
| Sales of available for sale investments | | | 11,800 | | | 18,150 | |
| Purchase of property and equipment | | | (2,143 | ) | | (571 | ) |
| Payment for patents and trademarks in process | | | (44 | ) | | (168 | ) |
| |
| |
| |
| | Net cash provided by investing activities | | | 7,602 | | | 7,980 | |
| |
| |
| |
Cash flows from financing activities: | | | | | | | |
| Proceeds from the issuance of common stock under stock-based compensation plans | | | 602 | | | 134 | |
| Repurchase and retirement of common stock for restricted stock award withholdings | | | (135 | ) | | (269 | ) |
| Excess tax benefits from stock-based awards | | | 561 | | | 295 | |
| |
| |
| |
| | Net cash provided by financing activities | | | 1,028 | | | 160 | |
| |
| |
| |
Net change in cash and cash equivalents of discontinued operations | | | 1,868 | | | (616 | ) |
| |
| |
| |
| | Net increase in cash and cash equivalents | | | 4,721 | | | 9,401 | |
Cash and cash equivalents, beginning of period | | | 14,392 | | | 35,523 | |
| |
| |
| |
Cash and cash equivalents, end of period | | $ | 19,113 | | $ | 44,924 | |
| |
| |
| |
See accompanying notes to consolidated financial statements.
3
DTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except per share data)
Note 1—Basis of Presentation
The accompanying unaudited consolidated financial statements of DTS, Inc. (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair statement of the Company's financial position at March 31, 2008, and the results of operations and cash flows for the periods presented. All significant intercompany transactions have been eliminated in consolidation. Operating results for the three months ended March 31, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2008. The information included in this Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2007.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain prior year amounts in previously issued financial statements have been reclassified to conform to the current year presentation.
In January 2007, the Company combined its Cinema and Digital Images businesses into a single business known as "DTS Digital Cinema." In February 2007, the Company's Board of Directors approved a plan to sell its DTS Digital Cinema business to enable the Company to focus exclusively on licensing branded entertainment technology to the large and evolving audio, game console, personal computer, portable, broadcast, and other markets. As of March 31, 2008, the Company continued to pursue the sale of its DTS Digital Cinema business. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", during the first quarter of 2007, DTS Digital Cinema's assets and liabilities were classified as held for sale and its operations began to be classified as discontinued operations. As a result, the Company has reclassified its balance sheets and statements of operations for all periods presented in this report to reflect DTS Digital Cinema as discontinued operations. Depreciation and amortization has been eliminated from discontinued operations from the date the Board of Directors approved the plan to sell this business. In the statements of cash flows, the cash flows of discontinued operations are not separately classified or aggregated. The discontinued operations are reported in the respective categories of the statements of cash flows with those of continuing operations. For additional information, refer to Footnotes 9 and 13 of the consolidated financial statements, "Discontinued Operations" and "Subsequent Events", respectively.
All discussions and amounts in the consolidated financial statements and related notes, except for cash flows, for all periods presented relate to continuing operations only, unless otherwise noted.
4
DTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
(Amounts in thousands, except per share data)
Note 2—Recent Accounting Pronouncements
Effective January 1, 2008, the Company adopted SFAS No. 157, "Fair Value Measurements". In February 2008, the Financial Accounting Standards Board ("FASB") issued FASB Staff Position No. FAS 157-2, "Effective Date of FASB Statement No. 157", which provides a one year deferral of the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, the Company has adopted the provisions of SFAS No. 157 with respect to certain financial assets only. SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under SFAS No. 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS No. 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:
- •
- Level 1—Quoted prices in active markets for identical assets or liabilities.
- •
- Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
- •
- Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Although the adoption of SFAS 157 did not materially impact its financial condition, results of operations, or cash flow, the Company is now required to provide additional disclosures as part of its financial statements. For additional information, refer to Footnote 3 of the consolidated financial statements, "Fair Value Measurements".
Effective January 1, 2008, the Company adopted SFAS No. 159 "The Fair Value Option for Financial Assets and Financial Liabilities". SFAS No. 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis. The Company did not elect to adopt the fair value option under this Statement.
In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations". SFAS 141(R) improves consistency and comparability of information about the nature and effect of a business combination by establishing principles and requirements for how an acquirer (a) recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree; (b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and (c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) applies prospectively to all business combination transactions for
5
DTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
(Amounts in thousands, except per share data)
Note 2—Recent Accounting Pronouncements (Continued)
which the acquisition date is on or after January 1, 2009. The impact of the Company's adoption of SFAS 141(R) will depend upon the nature and terms of business combinations, if any, that it consummates on or after January 1, 2009.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51", which establishes new standards governing the accounting for and reporting of noncontrolling interests (NCIs) in partially owned consolidated subsidiaries and the loss of control of subsidiaries. Certain provisions of this standard indicate, among other things, that NCIs (previously referred to as minority interests) be treated as a separate component of equity, not as a liability; that increases and decreases in the parent's ownership interest that leave control intact be treated as equity transactions, rather than as step acquisitions or dilution gains or losses; and that losses of a partially owned consolidated subsidiary be allocated to the NCI even when such allocation might result in a deficit balance. This standard also requires changes to certain presentation and disclosure requirements. SFAS No. 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008. The provisions of the standard are to be applied to all NCIs prospectively, except for the presentation and disclosure requirements, which are to be applied retrospectively to all periods presented. The Company has not yet determined the impact SFAS No. 160 may have on its results of operations or financial position.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133". This Statement requires enhanced disclosures about an entity's derivative and hedging activities, including (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company is currently evaluating the impact of this standard on its Consolidated Financial Statements; however, it does not expect that the adoption of SFAS No. 161 will have a material impact on its financial condition or results of operations.
Note 3—Fair Value Measurements
As of March 31, 2008, the Company held certain financial assets that are required to be measured at fair value on a recurring basis. These financial assets included the Company's auction rate security instruments, which are classified as available for sale investments. Due to recent events in the credit markets, the auctions for the auction rate securities failed during the first quarter of 2008. The Company attributes the failed auctions to liquidity issues rather than credit quality issues, as the auction rate securities held at March 31, 2008 are tax-exempt municipal bonds that are insured and have a AAA rating. Due to the loss of liquidity, the fair values of most of these securities are estimated utilizing a discounted cash flow analysis or level 3 inputs within the SFAS No. 157 fair value hierarchy as of March 31, 2008. The analysis considers, among other factors, the creditworthiness of the counterparty, the timing of expected future cash flows, and the expectation of the timing of the next
6
DTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
(Amounts in thousands, except per share data)
Note 3—Fair Value Measurements (Continued)
successful auction for each security. These securities were also compared, when possible, to significant other observable market data or Level 2 inputs within the SFAS No. 157 fair value hierarchy.
As a result of the Company's analysis, no valuation adjustments for unrealized or realized gains or losses were recorded as of March 31, 2008. The Company believes par value or cost is a reasonable approximation of fair value under the circumstances and given the information available in the absence of a liquid market. Further evidence includes the fact that these securities have redemption features which call for redemption at 100% of par value. The Company also believes that it has the ability to hold these securities throughout the estimated recovery period.
Due to the Company's belief that it may take 12 to 24 months for the issuers to effect redemptions at par or for the auction markets to recover, these securities have been classified as long term investments on the unaudited consolidated balance sheet at March 31, 2008. Once it is determined that the auction markets have recovered, the Company will reclassify its auction rate security holdings back to short term investments. As of March 31, 2008, the Company continues to earn interest on all of its auction rate securities. Any future fluctuation in fair value related to these securities that the Company deems to be temporary, including any recoveries of previous write-downs, will be recorded to accumulated other comprehensive income. If the Company determines that any future valuation adjustment is other than temporary, it will record a charge to earnings, as appropriate.
The Company's financial assets measured at fair value on a recurring basis subject to the disclosure requirements of SFAS No. 157 at March 31, 2008, were as follows:
| |
| | Fair Value Measurements at Reporting Date Using
|
---|
Description
| | As of March 31, 2008
| | Quoted Prices in Active Markets for Identical Assets (Level 1)
| | Significant Other Observable Inputs (Level 2)
| | Significant Unobservable Inputs (Level 3)
|
---|
Auction Rate Securities | | $ | 24,225 | | — | | 2,775 | | $ | 21,450 |
Based on market conditions, the Company changed its valuation methodology for most auction rate securities to a discounted cash flow analysis during first quarter of 2008. Accordingly, these securities changed from Level 1 to Level 3 within the SFAS No. 157 hierarchy since the Company's initial adoption of SFAS No. 157.
7
DTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
(Amounts in thousands, except per share data)
Note 3—Fair Value Measurements (Continued)
The following table presents the Company's assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as defined in SFAS No. 157 at March 31, 2008:
| | Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
| |
---|
Description
| |
---|
| Auction Rate Securities
| |
---|
Balance at December 31, 2007 | | $ | — | |
| Transfers to Level 3 | | | 26,625 | |
| Total gains or (losses) (realized or unrealized) | | | | |
| | Included in earnings | | | — | |
| | Included in other comprehensive income | | | — | |
| Purchases, issuances and settlements (net) | | | (5,175 | ) |
| |
| |
Balance at March 31, 2008 | | $ | 21,450 | |
| |
| |
The amount of total gains or (losses) for the period included in earnings (or change in net assets) attributable to the change in unrealized gains or losses relating to assets still held at March 31, 2008 | | $ | — | |
| |
| |
Note 4—Property and Equipment, Net
Property and equipment consist of the following:
| | As of December 31, 2007
| | As of March 31, 2008
| |
---|
Machinery and equipment | | $ | 1,517 | | $ | 1,568 | |
Office furniture and fixtures | | | 4,073 | | | 4,165 | |
Leasehold improvements | | | 2,848 | | | 2,993 | |
Software | | | 4,475 | | | 4,655 | |
| |
| |
| |
| | | 12,913 | | | 13,381 | |
Less: Accumulated depreciation | | | (7,052 | ) | | (7,536 | ) |
| |
| |
| |
| Property and equipment, net | | $ | 5,861 | | $ | 5,845 | |
| |
| |
| |
Note 5—Commitments and Contingencies
Indemnities, Commitments and Guarantees
In the normal course of business, the Company makes certain indemnities, commitments and guarantees under which the Company may be required to make payments in relation to certain transactions. These indemnities, commitments and guarantees include, among others, intellectual property indemnities to customers in connection with the sale of products and licensing of technology, indemnities for liabilities associated with the infringement of other parties' technology based upon the
8
DTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
(Amounts in thousands, except per share data)
Note 5—Commitments and Contingencies (Continued)
Company's products and technology, guarantees of timely performance of the Company's obligations, and indemnities to the Company's directors and officers to the maximum extent permitted by law. The duration of these indemnities, commitments and guarantees varies, and in certain cases, is indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments that the Company could be obligated to make. The Company has not recorded a liability for these indemnities, commitments or guarantees in the accompanying balance sheets, as future payment is not probable.
Note 6—Income Taxes
For the three months ended March 31, 2008, the Company recorded an income tax provision of $1,984 on pre-tax income from continuing operations of $5,235. This resulted in an annualized effective tax rate of 38%. This rate differed from the U.S. statutory rate of 35% primarily due to an increase in the effective rate associated with changes in the jurisdictional mix of income, partially offset by tax exempt interest. In determining the income tax provision for continuing operations, the continuing operations were considered a stand alone entity. The residual amount of tax expense or benefit due to the difference between the income tax provision for the Company as a whole and the income tax provision as calculated for continuing operations was recorded in discontinued operations.
In the first quarter of 2007, the Company adopted FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109" ("FIN 48"). The Company has also applied FASB Staff Position No. FIN 48-1, "Definition of Settlement in FASB Interpretation No. 48" to clarify when a tax position has been settled under paragraph 10(b) of FIN 48. Upon adoption of FIN 48, the Company recognized a $547 increase in tax reserves, which was accounted for as a reduction of $547 in the beginning retained earnings.
Upon the Company's adoption of FIN 48, its liability for uncertain tax positions was $1,392, which was recorded in other long-term liabilities. At March 31, 2008, the Company's liability for uncertain tax positions increased to $2,276, which was recorded in other long-term liabilities. The increase in unrecognized tax benefits during the three months ended March 31, 2008 was primarily attributable to uncertain tax positions on transfer pricing positions taken with respect to the Company's foreign subsidiaries. These unrecognized tax benefits would affect the Company's effective tax rate if recognized. At the beginning of 2007, there was an immaterial liability for uncertain tax positions for the possible payment of interest and penalties. The Company does not anticipate any significant changes to its total unrecognized tax benefit within the next twelve months.
The Company may from time to time be assessed interest or penalties by major tax jurisdictions, although any such assessments historically have been minimal and immaterial to the Company's financial results. In accordance with the Company's accounting policy, interest expense and penalties related to income taxes are included in income tax expense.
The Company, or one of its subsidiaries, files income tax returns in the U.S. and other foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal income tax examinations by tax authorities for the years prior to 2004. The Internal Revenue Service commenced its examination of the Company's 2005 federal tax return during the fourth quarter of 2007.
9
DTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
(Amounts in thousands, except per share data)
Note 7—Comprehensive Income (Loss)
At December 31, 2007 and March 31, 2008, accumulated other comprehensive is comprised mostly of foreign currency translation.
Comprehensive income (loss) for the three months ended March 31, 2007 and 2008 was ($725) and $1,322, respectively.
Note 8—Operating Segment and Geographic Information
The Company's revenue by geographical area, based on the customer's country of domicile, for the three months ended March 31, 2007 and 2008 was as follows:
| | For the Three Months Ended March 31,
|
---|
| | 2007
| | 2008
|
---|
United States | | $ | 1,457 | | $ | 1,078 |
International | | | 11,151 | | | 14,132 |
| |
| |
|
| Total revenue | | $ | 12,608 | | $ | 15,210 |
| |
| |
|
The following table sets forth, for the periods indicated, long-lived assets by geographic area in which the Company held assets at December 31, 2007 and March 31, 2008:
| | Long-Lived Assets
|
---|
| | As of December 31, 2007
| | As of March 31, 2008
|
---|
United States | | $ | 5,291 | | $ | 5,265 |
International | | | 570 | | | 580 |
| |
| |
|
| Total long-lived assets | | $ | 5,861 | | $ | 5,845 |
| |
| |
|
Note 9—Discontinued Operations
At March 31, 2008, the Cinema and Digital Images businesses were held for sale, combined as the DTS Digital Cinema business and presented below as discontinued operations. For additional information, refer to Footnote 13 of the consolidated financial statements, "Subsequent Events".
10
DTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
(Amounts in thousands, except per share data)
Note 9—Discontinued Operations (Continued)
The following table presents the major classes of the assets and liabilities of discontinued operations held for sale in the consolidated balance sheets as of December 31, 2007 and March 31, 2008.
| | As of December 31, 2007
| | As of March 31, 2008
| |
---|
Assets: | | | | | | | |
Cash | | $ | 333 | | $ | 949 | |
Accounts receivable, net | | | 4,820 | | | 4,089 | |
Inventories | | | 2,781 | | | 3,217 | |
Prepaid expenses and other current assets | | | 695 | | | 833 | |
| |
| |
| |
Total current assets of discontinued operations held for sale | | | 8,629 | | | 9,088 | |
Property and equipment, net | | | 3,351 | (1) | | 4,783 | (2) |
Intangible assets, net | | | — | (1) | | 3,635 | (2) |
Other | | | 106 | | | 206 | |
| |
| |
| |
Total long-term assets of discontinued operations held for sale | | | 3,457 | | | 8,624 | |
Total assets of discontinued operations held for sale | | $ | 12,086 | | $ | 17,712 | |
Liabilities: | | | | | | | |
Accounts payable | | $ | 4,071 | | $ | 3,831 | |
Accrued expenses and other liabilities | | | 3,432 | | | 3,057 | |
| |
| |
| |
Total current liabilities of discontinued operations held for sale | | | 7,503 | | | 6,888 | |
Other long-term liabilities | | | 474 | | | 474 | |
| |
| |
| |
Total long-term liabilities of discontinued operations held for sale | | $ | 474 | | $ | 474 | |
Total liabilities of discontinued operations held for sale | | $ | 7,977 | (3) | $ | 7,362 | (3) |
| |
| |
| |
Net assets of discontinued operations held for sale | | $ | 4,109 | | $ | 10,350 | |
| |
| |
| |
- (1)
- Intangible assets and property and equipment include carrying value write downs of $16,381 and $4,687, respectively, to reduce the carrying value of the assets held for sale to fair value less costs to sell. For additional discussion, see the "Adjustment to Carrying Value of Assets Held for Sale" discussion below.
- (2)
- Property and equipment and intangible assets include carrying value write ups of $1,352 and $3,611, respectively, to increase the carrying value of the assets held for sale to fair value less costs to sell. For additional discussion, see the "Adjustment to Carrying Value of Assets Held for Sale" discussion below.
- (3)
- Includes $2,069 and $2,178, respectively, from Avica Technology Corporation ("Avica"), a variable interest entity. While the Company has consolidated the liabilities of Avica in accordance with FASB Interpretation No. 46(R), "Consolidation of Variable Interest Entities—an Interpretation of
11
DTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
(Amounts in thousands, except per share data)
Note 9—Discontinued Operations (Continued)
Accounting Research Bulletin No. 51", it has no obligation to pay any amounts to any of Avica's creditors. As such, creditors of Avica lack any recourse against the Company.
In presenting discontinued operations, general corporate overhead expenses that have been allocated historically to DTS Digital Cinema for segment presentation purposes are not included in discontinued operations. The following table presents revenue and expense information for the discontinued operations of DTS Digital Cinema for the three months ended March 31, 2007 and 2008.
| | For the Three Months Ended March 31,
| |
---|
| | 2007
| | 2008
| |
---|
Revenue | | $ | 6,286 | | $ | 4,867 | |
Pre-tax income (loss) | | | (4,352 | ) | | 2,302 | (1) |
Income tax provision (benefit) | | | (1,604 | ) | | 4,236 | |
| |
| |
| |
Loss from discontinued operations, net of tax | | $ | (2,748 | ) | $ | (1,934 | ) |
| |
| |
| |
- (1)
- Includes a carrying value write up of $4,963 to increase the carrying value of the assets held for sale to fair value less costs to sell. For additional discussion, see the "Adjustment to Carrying Value of Assets Held for Sale" discussion below.
For the three months ended March 31, 2007 and 2008, $432 and $240, respectively, of depreciation and amortization was not expensed due to the cessation of such expenses upon DTS Digital Cinema being classified as held for sale.
Adjustment to Carrying Value of Assets Held for Sale
As a part of the Company's quarterly reassessment of the carrying value of the assets of its Cinema and Digital Images businesses at December 31, 2007, it had determined that several factors had converged to cause deterioration in the fair value of these assets and accordingly the Company reduced the carrying value of these assets held for sale to fair value less costs to sell. The Company's estimate of fair value reflects expected proceeds to be realized from potential buyers in a future sale, which it believed was the current market value of these assets. In accordance with SFAS No. 144, in the fourth quarter of 2007, the Company recognized a charge of $24,653, before any related tax effect, to reflect these assets at their fair value, less costs to sell. This charge was recorded in the results of discontinued operations, and it reduced the carrying values of goodwill, intangible assets and fixed assets by $3,585, $16,381 and $4,687, respectively.
In accordance with the provisions of SFAS No. 144, assets held for sale with a carrying amount of $5,387 were written up to their fair value of $10,750, less costs to sell of $400 (or $10,350), resulting in an adjustment to carrying value of assets held for sale of $4,963, which was included in the results of discontinued operations for the three months ended March 31, 2008. The Company's estimate of fair value reflects expected proceeds to be realized from potential buyers in a future sale, which it believes is the current market value of these assets. For additional information, refer to Footnote 13 of the consolidated financial statements, "Subsequent Events".
12
DTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
(Amounts in thousands, except per share data)
Note 10—Net Income (Loss) Per Common Share
Basic net income (loss) per common share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is calculated by dividing net income (loss) by the sum of the weighted average number of common shares outstanding plus the dilutive effect of unvested restricted stock, outstanding stock options, common stock warrants, and the employee stock purchase plan ("ESPP") using the "treasury stock" method.
The following table sets forth the computation of basic and diluted net income (loss) per common share:
| | For the Three Months Ended March 31,
| |
---|
| | 2007
| | 2008
| |
---|
Basic net income (loss) per common share: | | | | | | | |
| Numerator: | | | | | | | |
| | Income from continuing operations | | $ | 1,983 | | $ | 3,251 | |
| | Loss from discontinued operations | | | (2,748 | ) | | (1,934 | ) |
| |
| |
| |
| | Net income (loss) | | $ | (765 | ) | $ | 1,317 | |
| |
| |
| |
| Denominator: | | | | | | | |
| | Weighted average common shares outstanding | | | 17,965 | | | 17,527 | |
| |
| |
| |
| Continuing operations | | $ | 0.11 | | $ | 0.19 | |
| Discontinued operations | | | (0.15 | ) | | (0.11 | ) |
| |
| |
| |
| Basic net income (loss) per common share | | $ | (0.04 | ) | $ | 0.08 | |
| |
| |
| |
Diluted net income (loss) per common share: | | | | | | | |
| Numerator: | | | | | | | |
| | Income from continuing operations | | $ | 1,983 | | $ | 3,251 | |
| | Loss from discontinued operations | | | (2,748 | ) | | (1,934 | ) |
| |
| |
| |
| | Net income (loss) | | $ | (765 | ) | $ | 1,317 | |
| |
| |
| |
Denominator: | | | | | | | |
| Weighted average shares outstanding | | | 17,965 | | | 17,527 | |
| Effect of dilutive securities: | | | | | | | |
| | Common stock options | | | 664 | | | 472 | |
| | Restricted stock | | | 31 | | | 60 | |
| | Common stock warrants | | | 3 | | | — | |
| | ESPP | | | 10 | | | — | |
| |
| |
| |
Diluted shares outstanding | | | 18,673 | | | 18,059 | |
| |
| |
| |
| Continuing operations | | $ | 0.11 | | $ | 0.18 | |
| Discontinued operations | | | (0.15 | ) | | (0.11 | ) |
| |
| |
| |
| Diluted net income (loss) per common share | | $ | (0.04 | ) | $ | 0.07 | |
| |
| |
| |
13
DTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
(Amounts in thousands, except per share data)
Note 10—Net Income (Loss) Per Common Share (Continued)
For the three months ended March 31, 2007 and 2008, 155 and 452 shares, respectively, of the Company's stock options and restricted stock were excluded from the calculation of diluted earnings (loss) per share because their inclusion would have been anti-dilutive.
Note 11—Common Stock Repurchases
Common Stock Repurchase Programs
In August 2006, the Company's Board of Directors authorized, subject to certain business and market conditions, the purchase of up to 1,000 shares of the Company's common stock in the open market or in privately negotiated transactions. During the second and third quarters of 2007, the Company repurchased all shares of common stock under this authorization for an aggregate cost of $22,670. All shares repurchased under this authorization are currently considered treasury stock.
In February 2008, the Company's Board of Directors authorized, subject to certain business and market conditions, the purchase of up to 1,000 shares of the Company's common stock in the open market or in privately negotiated transactions. At March 31, 2008, there were no shares purchased under this authorization. Any shares repurchased would be considered treasury stock, unless or until retired.
Restricted Stock Award Withholdings
The Company issues restricted stock awards as part of its equity incentive plans. For a majority of the restricted stock awards granted, the number of shares released on the date the restricted stock awards vest is net of the statutory withholding requirements that the Company pays to the appropriate taxing authorities on behalf of its employees. The shares repurchased to satisfy the statutory withholding requirements are immediately retired.
Note 12—Stock-Based Compensation
During 2006 and 2007, the Company's estimate of certain assumptions for input into the Black Scholes model considered certain actuarial calculations. These considerations were determined appropriate for those periods due to the Company's limited history as a publicly traded company. Beginning in 2008 and in accordance with the Securities and Exchange Commission Staff Accounting Bulletin ("SAB") No. 107, "Share-Based Payment", the Company began estimating certain assumptions for input into the Black Scholes model without certain actuarial calculations. The Company believes that these changes in accounting estimates provide a better estimate of future option activity patterns. The impact of these changes in accounting estimates are reductions in the expected term and volatility assumptions for input into the Black Scholes model. The Company will continue to review and refine its estimates and assumptions for the Black Scholes model in accordance with SAB No. 107 and SFAS 123(R). Changes in the Company's estimate of the assumptions for input into the Black Scholes model could result in material increases or decreases in stock-based compensation costs.
14
DTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
(Amounts in thousands, except per share data)
Note 13—Subsequent Events
On April 4, 2008, the Company, DTS Digital Images, Inc. ("DI"), and Reliance Big Entertainment Private Limited ("Reliance"), entered into a Stock Purchase Agreement (the "DI Agreement") providing for the sale of DI by the Company to Reliance. The sale was consummated the same day. Pursuant to the terms of the DI Agreement, the Company received cash consideration of approximately $7,500. The Agreement contains customary representations, warranties and covenants.
On May 9, 2008, the Company, Beaufort California, Inc. ("Beaufort") and Beaufort International Group Plc. entered into an Asset Purchase Agreement (the "DC Agreement") providing for the sale of substantially all of the Company's assets used predominantly in the conduct of the DTS Digital Cinema ("DC") business to Beaufort and the assumption by Beaufort of certain liabilities of the DC business. The sale was consummated the same day. Pursuant to the terms of the DC Agreement, the Company received cash consideration of approximately $3,250 upon the closing of this sale, and it could receive an additional $11,750 in additional consideration.
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements May Prove Inaccurate
This Form 10-Q and the documents incorporated herein by reference contain forward-looking statements based on our current beliefs, expectations, estimates and projections about our industry, and certain assumptions made by us. Words such as "believes," "anticipates," "estimates," "expects," "projections," "may," "potential," "plan," "continue" and words of similar effect, constitute "forward-looking statements." The forward-looking statements contained in this report involve known and unknown risks, uncertainties and other factors that may cause our actual results to be materially different from those expressed in or implied by these statements. These factors include those listed under the "Risk Factors" section contained below and elsewhere in this Form 10-Q, and the other documents we file with the Securities and Exchange Commission, or SEC, including our most recent reports on Form 8-K and Form 10-K. We cannot guarantee future results, levels of activity, performance, or achievements. We do not intend to update these forward-looking statements to reflect future events or circumstances. You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes to those statements included elsewhere in this Form 10-Q.
Overview
We are a leading provider of high quality branded entertainment technologies, which are incorporated into an array of entertainment products by hundreds of licensee customers around the world. Our core DTS digital multi-channel audio technology enables the delivery and playback of compelling surround sound and is currently used in a variety of product applications, including audio/video receivers, Standard Definition DVD players, Blu-ray Disc players, personal computers or PCs, car audio products, video game consoles, and home theater systems. In addition, we provide products and services to studios and other content creators to facilitate the inclusion of compelling, realistic DTS-encoded soundtracks in movies and music content.
In January 2007, we combined our Cinema and Digital Images businesses into a single business known as DTS Digital Cinema. In February 2007, our Board of Directors approved a plan to sell our DTS Digital Cinema business to enable us to focus exclusively on licensing branded entertainment technology to the large and evolving audio, game console, personal computer, portable and broadcast markets. As of March 31, 2008, we continued to pursue the sale of our DTS Digital Cinema business, although at such time it seemed it would most likely consist of two distinct sale transactions—one related to the digital cinema business and one for the digital images business. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", during the first quarter of 2007, DTS Digital Cinema's assets and liabilities were classified as held for sale and its operations were reported as discontinued operations. As a result, we reclassified our balance sheets and statements of operations for all periods presented in this report to reflect DTS Digital Cinema as discontinued operations. In the statements of cash flows, the cash flows of discontinued operations are not separately classified or aggregated. The discontinued operations are reported in the respective categories of the statements of cash flows with those of continuing operations.
In August 2007, in response to changing market conditions, including tightening in the credit markets, we re-evaluated our sales strategy in an effort to maximize shareholder value, and we modified our sales approach to offer the assets of the Cinema and Digital Images businesses together or individually. Due to the changing market conditions and the decision to offer the assets of the Cinema and Digital Images businesses together or individually, we re-evaluated the businesses or assets comprising the DTS Digital Cinema business and the related operations, and we determined that these
16
businesses or assets still met the criteria for the held for sale and discontinued operations classifications, respectively.
As a part of our quarterly reassessment of the carrying value of the assets of our Cinema and Digital Images businesses, we determined that several factors had converged to cause deterioration in the fair value of these assets during the fourth quarter of 2007 and accordingly we reduced the carrying value of these assets held for sale to fair value less costs to sell, resulting in an adjustment of $24.7 million.
As a part of our quarterly reassessment of the carrying value of the assets of our Cinema and Digital Images businesses, we determined that the fair value of the assets held for sale less costs to sell had increased during the first quarter of 2008 due to feedback and negotiations from a potential buyer for the Digital Images business who emerged during the latter portion of this period. Accordingly, we increased the carrying value of the assets held for sale to fair value less costs to sell, resulting in an adjustment of $5.0 million.
Our estimate of fair value reflects expected proceeds to be realized from potential buyers in a future sale, which we believe is the current market value of these assets.
On April 4, 2008, we entered into a Stock Purchase Agreement (the "DI Agreement") providing for the sale of our DTS Digital Images ("DI") business to Reliance Big Entertainment Private Limited. The sale was consummated the same day. Pursuant to the terms of the Agreement, we received cash consideration of approximately $7.5 million.
On May 9, 2008, we entered into an Asset Purchase Agreement (the "DC Agreement") providing for the sale of substantially all of our assets used predominantly in the conduct of the DTS Digital Cinema ("DC") business to Beaufort California, Inc. ("Beaufort"), a member of Beaufort International Group Plc. in England and the assumption by Beaufort of certain liabilities of the DC business. The sale was consummated the same day. Pursuant to the terms of the DC Agreement, we received cash consideration of approximately $3.3 million upon the closing of this sale, and we could receive an additional $11.7 million in additional consideration.
All discussions and amounts in Management's Discussion and Analysis, except for Liquidity and Capital Resources, for all periods presented relate to continuing operations only, unless otherwise noted.
We derive revenues from licensing our audio technology, trademarks, and know-how under agreements with substantially all of the major consumer audio electronics manufacturers. Our business model provides for these manufacturers to pay us a per-unit amount for DTS-enabled products that they manufacture.
We actively engage in intellectual property compliance and enforcement activities focused on identifying third parties who have either incorporated our technology, trademarks, or know-how without a license or who have under-reported the amount of royalties owed under license agreements with us. We continue to invest in our compliance and enforcement infrastructure to support the value of our intellectual property to us and our licensees and to improve the long-term realization of revenue from our intellectual property. As a result of these activities, from time to time, we recognize royalty revenues that relate to consumer electronics manufacturing activities from 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. While we consider such revenues to be a regular part of our normal operations, we cannot predict such recoveries or the amount or timing of such revenues.
Our cost of revenues consists primarily of amounts paid for products and materials, salaries and related benefits for operations personnel, amortization of acquired intangibles and payments to third parties for copyrighted material.
17
Our selling, general, and administrative expenses consist primarily of salaries and related benefits for personnel engaged in sales and costs associated with promotional and other selling activities. Selling, general, and administrative expenses also include professional fees, facility-related expenses, and other general corporate expenses, including personnel engaged in corporate administration, finance, human resources, information systems and legal.
Our research and development costs consist primarily of salaries and related benefits for research and development personnel, engineering consulting expenses associated with new product and technology development, and quality assurance and testing costs. Research and development costs are expensed as incurred.
Management Discussion Regarding Trends, Opportunities, and Challenges
Our revenue is primarily dependent upon the Standard Definition DVD based home theater market, which has experienced growth over the past several years. The success of Standard Definition DVD based systems and products has fueled a demand for higher quality entertainment in the home, and this demand is extending to the car audio and personal computer markets as well. In addition, we expect the recent acceleration of the market for high definition televisions to drive demand for high definition optical disc players and advanced home theater systems over the next several years. Because we have been selected as a mandatory technology for the Blu-ray Disc standard for next generation players, our revenue growth should more closely track the growth rate for sales of these players over the next several years. We expect that the market for high definition players will yield new growth that provides an offset to the expected further decline in Standard Definition DVD player shipments. Further, we believe that mandatory inclusion in this next generation optical disc standard will help to improve the adoption rate of our technologies in other consumer products such as next generation video game consoles, personal audio and video players, personal computers and in-car entertainment systems.
While we are optimistic about the expected growth in next generation optical disc products over the next several years, we do not have near-term visibility into the precise timing of this expected growth or how smooth or linear this growth will be. Factors that could potentially affect this growth in the near term include the pace of consumer adoption of these next generation products, product pricing, manufacturer redesign cycles, competition among alternative formats, content availability, and the impact of the current economic downturn on consumer buying patterns.
We recently introduced DTS Surround Sensation, a suite of virtual surround sound technologies, that allow the playing of simulated 5.1 multi-channel content over two speakers or headphones. DTS Surround Sensation contains significant psycho-acoustic information that alters human perception, causing the listener to perceive that sounds are actually occurring outside the boundaries of the two-speaker system or headphones. Developed with a key understanding of acoustics and significant experience with the properties of sound, DTS Surround Sensation creates a three-dimensional sound field that exceeds the limitations of just two speakers, producing a surround sound experience.
Critical Accounting Policies and Estimates
Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, estimates and judgments are evaluated, including those related to revenue recognition, allowance for doubtful accounts, impairment of long-lived assets, stock-based compensation, and income taxes. These estimates and judgments are based on historical experience and on various other assumptions that we believe to
18
be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from these estimates. With the exception of our adoption of SFAS No. 157, "Fair Value Measurements" during the first quarter of 2008, there has been no material change to our critical accounting policies and estimates from the information provided in our Form 10-K filed on March 3, 2008.
- •
- Fair Value Measurements. Fair value measurements to adjust certain financial instruments are based upon Level 3 valuation models in accordance with SFAS No. 157. We hold certain financial assets that are required to be measured at fair value on a recurring basis. These financial assets include our auction rate security instruments, which are classified as available for sale. We believe fair value adjustments of financial instruments to be a critical accounting policy because the valuation model we use requires that we estimate investment terms, liquidity factors and discount rates. If any of these estimates change in the future, we may be required to record impairment charges for such assets. These charges could have a material impact on our results of operations.
Results of Continuing Operations
| |
| |
| | Change
| |
---|
| | 2008
| | 2007
| | $
| | %
| |
---|
| | ($ in thousands)
| |
---|
Three months ended March 31, | | $ | 15,210 | | $ | 12,608 | | $ | 2,602 | | 21 | % |
The increase in revenues for the quarter ended March 31, 2008, compared to the same prior year period, was primarily attributable to an increase in our royalties from next generation high definition optical disc formats, which we first began to record in 2007. These royalties comprised 21% and 5% of total revenue for the three months ended March 31, 2008 and 2007, respectively. We will continue to monitor the Blu-ray market, and remain cautious in our overall outlook due to uncertainties regarding the timing and rate of adoption of the new format. However, we expect technology licensing revenues to grow during the second half of the year, as wider availability of high definition players, PC and game console models coupled with expected aggressive pricing and promotion of these products should result in increased licensing revenues from the Blu-ray format.
| | 2008
| | %
| | 2007
| | %
| | Percentage point change in gross profit margin relative to prior period
| |
---|
| | ($ in thousands)
| |
---|
Three months ended March 31, | | $ | 14,916 | | 98 | % | $ | 12,353 | | 98 | % | 0 | % |
Consolidated gross profit for the three months ended March 31, 2008 and 2007 remained consistent as a percentage of revenues. We expect consolidated gross margins in the 97% to 98% range for 2008.
19
Selling, General and Administrative ("SG&A")
| |
| |
| | Change
| |
---|
| | 2008
| | 2007
| | $
| | %
| |
---|
| | ($ in thousands)
| |
---|
Three months ended March 31, | | $ | 8,797 | | $ | 8,072 | | $ | 725 | | 9 | % |
% of Revenue | | | 58 | % | | 64 | % | | | | | |
The dollar increase for the three months ended March 31, 2008, compared to the same prior year period, is primarily due to expanded foreign operations and additional promotional activities to support new products.
We expect SG&A expenses to continue to increase, primarily to support activities such as new technology initiatives, international expansion and intellectual property enforcement.
| |
| |
| | Change
| |
---|
| | 2008
| | 2007
| | $
| | %
| |
---|
| | ($ in thousands)
| |
---|
Three months ended March 31, | | $ | 1,763 | | $ | 1,604 | | $ | 159 | | 10 | % |
% of Revenue | | | 12 | % | | 13 | % | | | | | |
The dollar increase for the three months ended March 31, 2008, compared to the same prior year period, is primarily attributable an expanded domestic and foreign workforce to support our broadening product development agenda and ongoing support of the rollout of Blu-ray Disc.
We intend to continue to invest in R&D to support the activities mentioned above, and thus expect to see sequential growth through the remainder of the year.
Interest and Other Income, Net
| |
| |
| | Change
| |
---|
| | 2008
| | 2007
| | $
| | %
| |
---|
| | ($ in thousands)
| |
---|
Three months ended March 31, | | $ | 879 | | $ | 356 | | $ | 523 | | 147 | % |
The increase for the three months ended March 31, 2008, compared to the same prior year period, is primarily related to an adjustment recorded in the prior year period to correct an error, partially offset by lower average invested balances in the current period as a result of our stock repurchases during the second and third quarters of 2007.
Going forward, we expect interest income for the year to be in the range of $2.5 to $3.0 million, based on the current interest rate environment and current investment balances.
| | 2008
| | 2007
| |
---|
| | ($ in thousands)
| |
---|
Three months ended March 31, | | $ | 1,984 | | $ | 1,050 | |
Effective tax rate | | | 37.9 | % | | 34.6 | % |
Our effective tax rate is based upon a projection of annual fiscal year results, and these rates differed from the U.S. statutory rate of 35% primarily due to an increase in the effective rate associated with changes in the jurisdictional mix of income, partially offset by tax exempt interest. In
20
determining the income tax provision for continuing operations, the continuing operations were considered a stand alone entity. The residual amount of tax expense or benefit due to the difference between the income tax provision for the Company as a whole and the income tax provision as calculated for continuing operations was recorded in discontinued operations.
Loss from Discontinued Operations, Net
| |
| |
| | Change
| |
---|
| | 2008
| | 2007
| | $
| | %
| |
---|
| | ($ in thousands)
| |
---|
Three months ended March 31, | | $ | (1,934 | ) | $ | (2,748 | ) | $ | 814 | | 30 | % |
Revenues declined $1.4 million for the three months ended March 31, 2008, compared to the same prior year period, due to softness in our cinema hardware sales as the industry transitions to digital cinema formats. Additionally, expenses decreased $8.1 million for the three months ended March 31, 2008, compared to the same prior year period, due to a carrying value write up of $5.0 million to increase the carrying value of the assets held for sale to fair value less costs to sell. Other decreases in expenses include decreases in cost of sales associated with the overall decline in net sales and professional services associated with the potential sale of our discontinued operations. More than offsetting the increase in pre-tax income from discontinued operations is an increase in the income tax provision during the three months ended March 31, 2008, compared to the same prior year period. The increase in the income tax provision of discontinued operations results primarily from the aforementioned carrying value write up and the write-off of certain deferred tax assets related to our DTS Digital Images business, which was sold on April 4, 2008.
Liquidity and Capital Resources
At March 31, 2008, we had cash, cash equivalents and short-term investments of $57.8 million, compared to $85.4 million at December 31, 2007. Due to recent auction failures in the auction rate security markets, we classified our auction rate security holdings of $24.2 million as long term investments on the unaudited consolidated balance sheet at March 31, 2008. Once it is determined that the auction markets have recovered, we will reclassify our auction rate security holdings back to short term investments. For additional discussion, see the "Auction Rate Securities" discussion below.
Net cash used in operating activities was $5.8 million for the three months ended March 31, 2007. Cash provided by operating activities was $1.9 million for the three months ended March 31, 2008. The primary source of operating cash flow for the three months ended March 31, 2008 was net income of $1.3 million adjusted for deferred income taxes, stock-based compensation charges and depreciation and amortization, partially offset by an adjustment to the carrying value of assets held for sale. The net cash used in operating assets and liabilities during the first quarter of 2008 relates primarily to payments under our 2007 incentive compensation plan, partially offset by net collections from customers.
Net cash provided by investing activities totaled $7.6 million and $8.0 million for the three months ended March 31, 2007 and 2008, respectively. Cash provided by investing activities for the three months ended March 31, 2008 primarily consists of net sales of available for sale investments and maturation of held to maturity securities of $8.7 million in total.
Net cash provided by financing activities totaled $1.0 million and $0.2 million for the three months ended March 31, 2007 and 2008, respectively. Cash provided by financing activities for the three months ended March 31, 2008 primarily consists of proceeds from issuances of common stock under stock-based compensation plans, net, and related excess tax benefits, partially offset by the repurchase and retirement of common stock for restricted stock award withholdings.
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In February 2008, our Board of Directors authorized, subject to certain business and market conditions, the purchase of up to one million shares of our common stock in the open market or in privately negotiated transactions. Through March 31, 2008, there were no shares repurchased under this authorization.
On April 4, 2008, we entered into a Stock Purchase Agreement providing for the sale of our DTS Digital Images business to Reliance Big Entertainment Private Limited. The sale was consummated the same day. Pursuant to the terms of the DI Agreement, we received cash consideration of approximately $7.5 million.
On May 9, 2008, we entered into an Asset Purchase Agreement providing for the sale of substantially all of our assets used predominantly in the conduct of the DTS Digital Cinema business to Beaufort California, Inc., a member of Beaufort International Group Plc. in England and the assumption by Beaufort of certain liabilities of the DC business. The sale was consummated the same day. Pursuant to the terms of the DC Agreement, we received cash consideration of approximately $3.3 million upon the closing of this sale, and we could receive an additional $11.7 million in additional consideration.
We will no longer be funding the DTS Digital Images or DTS Digital Cinema businesses due to the closing of the sales transactions in April and May of 2008, respectively.
We are currently reviewing plans to relocate our corporate headquarters within the same general area as our current headquarters. These plans are expected to be finalized later in 2008, and we may incur approximately $10.0 million to $15.0 million in capitalized and non-capitalized costs during 2008 and 2009 for the relocation and build-out of the new location.
As of March 31, 2008, we held approximately $24.2 million in auction rate securities. Due to recent events in the credit markets, the auctions for the auction rate securities failed during the first quarter of 2008. We attribute the failed auctions to liquidity issues rather than credit quality issues, as the auction rate securities held at March 31, 2008 are tax-exempt municipal bonds that are insured and have a AAA rating. Due to the loss of liquidity, the fair values of most of these securities are estimated utilizing a discounted cash flow analysis as of March 31, 2008. The analysis considers, among other factors, the creditworthiness of the counterparty, the timing of expected future cash flows, and the expectation of the timing of the next successful auction for each security. These securities were also compared, when possible, to significant other observable market data.
As a result of our analysis, no valuation adjustments for unrealized or realized gains or losses were recorded as of March 31, 2008. We believe par value or cost is a reasonable approximation of fair value under the circumstances and given the information available in the absence of a liquid market. Further evidence includes the fact that these securities have redemption features which call for redemption at 100% of par value.
Due to our belief that it may take 12 to 24 months for the issuers to effect redemptions at par or for the auction markets to recover, these securities have been classified as long term investments on the unaudited consolidated balance sheet at March 31, 2008. Once it is determined that the auction markets have recovered, we will reclassify our auction rate security holdings back to short term investments. As of March 31, 2008, we continue to earn interest on all of our auction rate securities. Based on current cash, cash equivalents and short-term investment balances and expected operating cash flows, we do not anticipate a lack of liquidity associated with our auction rate securities to adversely affect our ability to conduct business, and we believe that we have the ability to hold these securities throughout the estimated recovery period.
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We believe that our cash, cash equivalents, short-term investments, and cash flows from operations will be sufficient to satisfy our working capital and capital expenditure requirements for at least the next twelve months. Beyond the next twelve months, additional financing may be required to fund working capital and capital expenditures. Changes in our operating plans including lower than anticipated revenues, increased expenses, acquisition of companies, products or technologies or other events, including those described in "Risk Factors" included elsewhere herein, in our Form 10-K filed on March 3, 2008 and in other filings, may cause us to seek additional debt or equity financing on an accelerated basis. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could negatively impact our growth plans and our financial condition and results of operations. Additional equity financing may be dilutive to the holders of our common stock and debt financing, if available, may involve significant cash payment obligations and financial or operational covenants that restrict our ability to operate our business.
There have been no material changes to our contractual obligations since December 31, 2007, with the exception of the increased obligations associated with our gross unrecognized tax benefits recorded in conjunction with the adoption of FIN 48. As of March 31, 2008, our total amount of unrecognized tax benefits was $2.3 million and is considered a long-term obligation. We are currently unable to make reasonably reliable estimates of the periods of cash settlements associated with these obligations.
Recently Issued Accounting Standards
Effective January 1, 2008, we adopted SFAS No. 157, "Fair Value Measurements". In February 2008, the Financial Accounting Standards Board ("FASB") issued FASB Staff Position No. FAS 157-2, "Effective Date of FASB Statement No. 157", which provides a one year deferral of the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, we have adopted the provisions of SFAS No. 157 with respect to certain financial assets only. SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under SFAS No. 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS No. 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:
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- Level 1—Quoted prices in active markets for identical assets or liabilities.
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- Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
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- Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Although the adoption of SFAS 157 did not materially impact our financial condition, results of operations, or cash flow, we are now required to provide additional disclosures as part of its financial statements. For additional information, refer to Footnote 3 of the consolidated financial statements, "Fair Value Measurements".
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Effective January 1, 2008, we adopted SFAS No. 159 "The Fair Value Option for Financial Assets and Financial Liabilities". SFAS No. 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis. We did not elect to adopt the fair value option under this Statement.
In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations". SFAS 141(R) improves consistency and comparability of information about the nature and effect of a business combination by establishing principles and requirements for how an acquirer (a) recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree; (b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and (c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) applies prospectively to all business combination transactions for which the acquisition date is on or after January 1, 2009. The impact of our adoption of SFAS 141(R) will depend upon the nature and terms of business combinations, if any, that we consummate on or after January 1, 2009.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51", which establishes new standards governing the accounting for and reporting of noncontrolling interests (NCIs) in partially owned consolidated subsidiaries and the loss of control of subsidiaries. Certain provisions of this standard indicate, among other things, that NCIs (previously referred to as minority interests) be treated as a separate component of equity, not as a liability; that increases and decreases in the parent's ownership interest that leave control intact be treated as equity transactions, rather than as step acquisitions or dilution gains or losses; and that losses of a partially owned consolidated subsidiary be allocated to the NCI even when such allocation might result in a deficit balance. This standard also requires changes to certain presentation and disclosure requirements. SFAS No. 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008. The provisions of the standard are to be applied to all NCIs prospectively, except for the presentation and disclosure requirements, which are to be applied retrospectively to all periods presented. We have not yet determined the impact SFAS No. 160 may have on our results of operations or financial position.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133". This Statement requires enhanced disclosures about an entity's derivative and hedging activities, including (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. We are currently evaluating the impact of this standard on our Consolidated Financial Statements; however, we do not expect that the adoption of SFAS No. 161 will have a material impact on our financial condition or results of operations.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk represents the risk of loss arising from adverse changes in market rates and foreign exchange rates.
Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since a significant portion of our investments are and will be in short-term and long-term marketable securities, U.S. government securities and corporate bonds. Due to recent events in the credit markets, the auctions for the auction rate securities failed during the first quarter of 2008. We attribute the failed auctions to liquidity issues rather than credit quality issues, as the auction rate securities held at March 31, 2008 are tax-exempt municipal bonds that are insured and have a AAA rating. Due to our belief that it may take 12 to 24 months for the issuers to effect redemptions at par or for the auction markets to recover, these securities have been classified as long term investments on the unaudited consolidated balance sheet at March 31, 2008. As of March 31, 2008, we continue to earn interest on all of our auction rate securities. We have also successfully sold some of the securities subject to failed auctions at our carrying value, with no losses. Due to the nature and maturity of our short-term investments, we have concluded that there is no material market risk exposure to our principal at March 31, 2008. Based on current cash, cash equivalents and short-term investment balances and expected operating cash flows, we do not anticipate a lack of liquidity associated with our auction rate securities to adversely affect our ability to conduct business, and we believe that we have the ability to hold these securities throughout the estimated recovery period. In the event that we are unable to sell the underlying securities at or above our carrying value, these securities may not provide us a liquid source of cash. The estimated average maturity of our investment portfolio is less than one year. As of March 31, 2008, a 1% change in interest rates throughout a one-year period would have an annual effect of approximately $0.9 million on our income before income taxes.
During the three months ended March 31, 2008, we derived over 92% of our revenues from continuing operations from sales outside the United States, and maintain international research, sales, marketing, and business development offices. Therefore, our results could be negatively affected by such factors as changes in foreign currency exchange rates, trade protection measures, longer accounts receivable collection patterns, and changes in regional or worldwide economic or political conditions. The risks of our international operations are mitigated in part by the extent to which our revenues are denominated in U.S. dollars and, accordingly, we are not exposed to significant foreign currency risk on these items. We do have foreign currency risk on certain revenues and operating expenses such as salaries and overhead costs of our foreign operations and cash maintained by these operations. Revenues denominated in foreign currencies accounted for approximately 3% of total revenues during the three months ended March 31, 2008. Operating expenses, including cost of sales, for our foreign subsidiaries were approximately $3.3 million in the three months ended March 31, 2008. Based upon the expenses for the three months ended March 31, 2008, a 1% change in foreign currency rates throughout a one-year period would have an immaterial annual effect on income from continuing operations before income taxes.
Our international business is subject to risks, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility when compared to the United States dollar. Accordingly, our future results could be materially impacted by changes in these or other factors.
We are also affected by exchange rate fluctuations as the financial statements of our foreign subsidiaries are translated into the United States dollar in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and could adversely or positively impact overall profitability. During the three months ended March 31, 2008, the impact of foreign exchange rate fluctuations related to translation of our foreign subsidiaries' financial statements was immaterial to comprehensive income.
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Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) that are designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
We carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on such evaluation, our chief executive officer and chief financial officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II
OTHER INFORMATION
Item 1. Legal Proceedings
None.
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.
The Risk Factors described below provide updated information in certain areas, including the removal of risk related to the Digital Images and Digital Cinema businesses which we no longer own, but we do not believe these updates have materially changed the type or magnitude of the risks we face in comparison to the disclosure provided in our most recent Annual Report on Form 10-K, with the exception noted above.
Risks Related to Our Business
We do not expect sales of Standard Definition DVD players to sustain their past growth rates. Our business is highly dependent on the growth in next generation optical disc products, and we do not have near-term visibility into the precise timing of this expected growth or how smooth or linear this growth will be. To the extent that sales of Standard Definition DVD players and home theater systems level off or decline, consumer adoption of next generation optical disc products fails to materialize or does not materialize as quickly as we expect, or alternative technologies in which we do not participate replace DVDs as a dominant medium for consumer video entertainment, our business will be adversely affected.
Past growth in our business has been due in large part to the rapid growth in sales of Standard Definition DVD players and home theater systems incorporating our technologies. As the markets for Standard Definition DVD players mature, we expect sales of Standard Definition DVD players to decline. To the extent that sales of Standard Definition DVD players and home theater systems level off or decline, our business will be adversely affected. Additionally, the release and consumer adoption of next-generation optical disc players has only just begun. While Toshiba Corporation recently announced that it has decided to discontinue sales and marketing of HD-DVD players, this is a very recent development and there currently remains available at retail two competing formats for high-definition optical discs and consumers may not react favorably to having to make a choice between formats. Even after the removal of HD-DVD hardware from retail outlets, there will still be pre-existing hardware and content in this format and there is a risk of consumer confusion and frustration over the inability of a given format player to play a disc in the competing format. The slow adoption by consumers of next-generation optical disc players, as well as the inability of Standard Definition DVD players to sustain their past growth rates, could adversely affect our business, as revenue and earnings derived from these new players and associated home theater system sales may not fully replace the anticipated decline in revenue and earnings associated with Standard Definition DVD players and home theater systems. Even with the recent resolution of the competing disc format conflict, the rate of consumer adoption and ultimate penetration of next-generation optical disc players is uncertain and may be slower than past growth rates of Standard Definition DVD players. In addition, if new technologies are developed for use with Standard Definition DVDs or new technologies, including direct downloads of content, are developed or deployed that substantially
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compete with or replace Standard Definition DVDs as a dominant medium for consumer video entertainment, our business, operating results and prospects could be adversely affected.
Negative trends in the general economy, including trends resulting from an actual or perceived recession, actual or threatened military action by the United States and threats of terrorist attacks in the United States and abroad, could cause a decrease in consumer spending, including entertainment generally. Any reduction in consumer confidence or disposable income in general may affect the demand for consumer electronics products that incorporate our digital audio technology and demand by film studios and movie theaters for our cinema products and services.
Our business and prospects depend on the strength of our brand, and if we do not maintain and strengthen our brand, our business will be materially harmed.
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 products industry and the entertainment industry. 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. Maintaining and strengthening our brand will depend heavily on our ability to develop innovative technologies for the entertainment industry, to continue to provide high quality products and services, and manage brand transition in connection with the sale of the business or assets that comprise our DTS Digital Cinema business, which we may not do successfully.
We may not be able to evolve our technology, products, and services or develop new technology, products, and services that are acceptable to our customers or the changing market.
The market for our technology, 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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- evolving industry standards; and
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- product obsolescence.
Our future success depends on our ability to enhance our existing technology, products, and services and to develop acceptable new technology, products, and services on a timely basis. The development of enhanced and new technology, 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 technology, products, or services on a timely basis, if at all. Furthermore, our new technology, 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. For example, we may not be able to effectively address concerns in the film and music industries relating to piracy in our current or future products. Any failure to respond to these changes or concerns would likely prevent our technology,
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products, and services from gaining market acceptance or maintaining market share and could lead to our technology, products and services becoming obsolete.
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. Patent, trademark, copyright, 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 patents may be challenged 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 prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by employees, consultants, and advisors;
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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;
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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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- our competitors may produce competitive products or services that do not unlawfully infringe upon our intellectual property rights;
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- efforts to identify and prosecute unauthorized uses of our technology are time consuming, expensive, and divert resources from the operation of our business; and
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- we may be unable to successfully identify or prosecute unauthorized uses of our technology.
As a result, our means of protecting our intellectual property rights and brands may not be adequate. Furthermore, despite our efforts, third parties may violate, or attempt to violate, our intellectual property rights. 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.
Companies that participate in the digital audio, digital image processing, 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 technology 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.
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We face intense competition. Many of our competitors have greater brand recognition and resources than we do.
The digital audio, consumer electronics, cinema 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, Thomson and SRS Labs, Inc.
Many of our current and potential competitors 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, and lobbying industry and government standards;
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- more technicians and engineers; and
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- greater technical support.
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. Its technology has been incorporated in significantly more Standard Definition DVD than our technology. It has also achieved mandatory standard status in product categories that we have not, including Standard Definition DVD, for its stereo technology and 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.
Sony Corporation is both a competitor and a significant customer in most of our markets. If Sony decides to eliminate the use of our technology in its products or to compete with us more aggressively in our markets, the revenues that we derive from Sony would be lower than expected.
We have limited control over existing and potential customers' and licensees' decisions to include our technology in their product offerings.
We are dependent on our customers and licensees—including consumer electronics product manufacturers, semiconductor manufacturers, producers and distributors of content for music, videos, and games—to incorporate our technology in 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 require incorporation or use of our technology,
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trademarks or services. Our customers, licensees and other manufacturers might not utilize our technology or services in the future.
As of March 31, 2008, we held approximately $24.2 million of auction-rate securities. Recently, there have been disruptions in the market for auction rate securities. All auctions failed related to auction rate securities purchased after December 31, 2007. In the event that we are unable to sell the underlying securities at or above our carrying value, or at all, these securities may not provide us a liquid source of cash in the future.
If we are unable to maintain and increase the amount of entertainment content released with DTS audio soundtracks, demand for the technology, products, and services that we offer to consumer electronics product manufacturers may significantly decline.
We expect to derive a significant percentage of our revenues from the technology, products, and services that we offer to manufacturers of consumer electronics products. To date, the most significant driver for the use of our technology in the home theater market has been the release of major movie titles with DTS audio soundtracks. We also believe that demand for our DTS audio technology in emerging markets for multi-channel audio, including homes, cars, personal computers, and video games and consoles, will be based on the number, quality, and popularity of the audio DVDs, computer software programs, 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 do not have contracts that require any of these parties to develop and release content with DTS audio soundtracks. In addition, we may not be successful in maintaining existing relationships or developing relationships with other existing providers or new market entrants that provide content. As a result, we cannot assure you that a significant amount of content in movies, audio DVDs, computer software programs, video games, or other entertainment mediums will be released with DTS audio soundtracks. If the amount, variety, and popularity of entertainment content released with DTS audio soundtracks do not increase, consumer electronics products manufacturers that pay us per-unit licensing fees may discontinue offering DTS playback capabilities in the consumer electronics products that they sell.
Declining retail prices for consumer electronics products or video content could force us to lower the license or other fees we charge our customers.
The market for consumer electronics products is intensely competitive and price sensitive. Retail prices for consumer electronics products that include our DTS audio technology, such as Standard Definition DVD players and home theater systems, 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 technology into the consumer electronics products that they sell and distribute. Most of the consumer electronics products that include our audio technology also include Dolby's multi-channel audio technology. As a result of pricing pressure, consumer electronics products manufacturers who manufacture products in which our audio technology is not a mandatory standard could decide to exclude our DTS audio technology from their products altogether.
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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 on IC manufacturers to develop, produce and then sell them to licensed consumer electronics product manufacturers. We do not control the IC manufacturers' decisions whether or not to incorporate our technologies into their ICs, and we do not control their product development or commercialization efforts. 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.
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.
A significant percentage of our revenues are generated from consumer electronics product manufacturers who license and incorporate our technology in their consumer electronics products. Under our existing arrangements, 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 on 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.
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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- expand our domestic and international sales and marketing activities;
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- continue developing our international operations;
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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 technology, products, and services and develop new technology, products, and services;
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- hire additional personnel, including engineers and other technical staff;
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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.
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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 on many factors, including:
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- acceptance of, and demand for, our products and technology;
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- the costs of developing new products or technology;
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- the extent to which we invest in new technology and research and development projects;
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- the number and timing of acquisitions and other strategic transactions; and
- •
- the costs associated with our expansion, if any.
In the future, we may need to raise additional funds, and such funds may not be available on favorable terms, or at all. 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, 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 or unanticipated customer requirements. This may materially harm our business, results of operations, and financial condition.
Although the first movie with a DTS audio soundtrack was released in 1993, we did not enter the home theater market until 1996, and our technology has only recently been incorporated into other consumer electronics markets, such as car audio, personal computers, video games and consoles, portable electronics devices, and digital satellite and cable broadcast products. More recently, we have entered into the "virtual" surround space with the asset acquisition of Spatializer Laboratories, Inc. and internal development of technology that we have branded DTS Surround Sensation. We do not have experience in this specific segment of the market and it is dominated by existing technologies from companies including Dolby Laboratories, Inc., SRS Labs, Inc. and BBE Sound, Inc. As a result, the demand for our technology, products, and services and the income potential of these businesses are unproven. In addition, because the market for digital audio technology is relatively new and rapidly evolving, we 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.
Our technology and products are complex and may contain errors that could cause us to lose customers, damage our reputation, or incur substantial costs.
Our technology or products could contain errors that could cause our products or technology to operate improperly and could cause unintended consequences. If our products or technology 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 to 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.
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We cannot be certain of the future effectiveness of our internal controls over financial reporting or the impact thereof on our operations or the market price of our common stock.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to include in our annual reports on Form 10-K our assessment of the effectiveness of our internal controls over financial reporting. We cannot assure you that our system of internal controls will be effective in the future as our operations and control environment change. If we cannot adequately maintain the effectiveness of our internal controls over financial reporting, our financial reporting may be inaccurate. If reporting errors actually occur, we could be subject to sanctions or investigation by regulatory authorities, such as the SEC. These results could adversely affect our financial results or the market price of our common stock.
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 more than ten countries worldwide, 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. For the year ended December 31, 2007, over 90% of our revenues from continuing operations were derived internationally. We face numerous risks in doing business outside the United States, including:
- •
- unusual or burdensome foreign laws or regulatory requirements or unexpected changes to those laws or requirements;
- •
- tariffs, trade protection measures, import or export licensing requirements, trade embargos, and other trade barriers;
- •
- difficulties in staffing and managing foreign operations;
- •
- competition from foreign companies;
- •
- dependence on foreign distributors and their sales channels;
- •
- longer accounts receivable collection cycles and difficulties in collecting accounts receivable;
- •
- less effective and less predictable protection of intellectual property;
- •
- changes in the political or economic condition of a specific country or region, particularly in emerging markets;
- •
- fluctuations in the value of foreign currency versus the U.S. dollar and the cost of currency exchange; and
- •
- potentially adverse tax consequences.
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 is found to have violated these requirements, we could be subject to significant fines 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. 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
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Yen, Euro, RMB and GBP. We do not currently engage in currency hedging activities to limit the risk of exchange rate fluctuations.
One of our key strategies is to expand our business operations in China. However, we may be unsuccessful in implementing this strategy as planned or at all. Factors that could inhibit our successful expansion into China include its historically poor recognition of intellectual property rights and poor performance in stopping counterfeiting and piracy activity. If we are unable to successfully stop unauthorized use of our intellectual property and assure compliance by our Chinese licensees, we could experience increased operational and enforcement costs both inside and outside China.
Even if we are successful in expanding into China, we may be greatly impacted by the political, economic, and military conditions in China, Taiwan, North Korea, and South Korea. Such disputes may continue or escalate, resulting in economic embargos, disruptions in shipping, or even military hostilities. This could severely harm our business by interrupting or delaying production or shipment of our products or products that incorporate our technology.
We have historically experienced moderate seasonality in our business due to our business mix and the nature of our products. In our consumer business, 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 in our consumer business generally lags manufacturing activity by one quarter, our revenues and earnings from the consumer business 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. For example, the introduction of next generation optical disc players may result in an overall near-term slowdown in our business as sales of standard definition players slow in anticipation of purchasing next generation products, but purchases of next generation products are in an early-adopter only phase. Our revenues may continue to be subject to fluctuations, seasonal or otherwise, in the future. Unanticipated fluctuations, whether due to seasonality, 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 technology, 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 consumer electronics manufacturing activities from prior periods and we may incur expenditures related to enforcement activity. These expenditures and royalty recoveries, 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.
Even if our technologies are adopted as an industry standard for a particular market, market participants may not widely adopt our technologies.
Even if a standards-setting body mandates our technologies for a particular market, our technologies may not be the sole technologies adopted for that market as an industry standard.
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Our licensing of industry standard technologies can be subject to limitations that could adversely affect our business and prospects.
When a standards-setting body adopts our technologies as explicit industry standards, we generally must agree to license such technologies on a fair, reasonable and non-discriminatory basis, which could limit our control over the use of these technologies. In these situations, we may be required to limit the royalty rates we charge for these technologies, which could adversely affect our business. Furthermore, we may be unable to limit to whom we license such technologies, and may be unable to restrict many terms of the license. From time to time, we may be subject to claims that our licenses of our industry standard technologies may not conform to the requirements of the standards- setting body. 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 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. 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.
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:
- •
- our existing employment agreements with the members of our management team allow such persons to terminate their employment with us at any time;
- •
- we do not have employment agreements with a majority of our key engineering and technical personnel;
- •
- significant portions of the equity awards held by the members of our management team are vested; and
- •
- 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.
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.
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 2007, two customers accounted for 17% and 15%, respectively, of revenues from our continuing operations. Although we have agreements with many of these 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.
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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 have recently been and 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, by discovery of new information in the course of our tax return preparation process, 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 has begun an examination of our 2005 federal income tax return during the fourth quarter of 2007. 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.
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 Standard Definition DVD and Blu-ray Disc. In the standard for Blu-ray Disc, both DTS and Dolby technologies have been selected as mandatory standards for two-channel output. 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.
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. We have a limited history of acquiring and integrating businesses. Acquisitions and strategic investments involve numerous risks, including:
- •
- problems assimilating the purchased technologies, products, or business operations;
37
- •
- significant future charges relating to in-process research and development and the amortization of intangible assets;
- •
- significant amount of goodwill that is not amortizable and is subject to annual impairment review;
- •
- problems maintaining uniform standards, procedures, controls, and policies;
- •
- unanticipated costs associated with the acquisition, including accounting and legal charges, capital expenditures, and transaction expenses;
- •
- diversion of management's attention from our core business;
- •
- adverse effects on existing business relationships with suppliers and customers;
- •
- risks associated with entering markets in which we have no or limited prior experience;
- •
- unanticipated or unknown liabilities relating to the acquired businesses;
- •
- the need to integrate accounting, management information, manufacturing, human resources and other administrative systems to permit effective management; and
- •
- 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.
As a result of a combination of internal growth and growth through acquisitions, we expect to continue to experience growth in the scope of our operations and the number of our employees. If this growth continues, it will 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 on the ability of our management team to manage any growth effectively. This will require our management to:
- •
- hire and train additional personnel in the United States and internationally;
- •
- implement and improve our operational and financial systems, procedures, and controls;
- •
- maintain our cost structure at an appropriate level based on the revenues we generate;
- •
- manage multiple concurrent development projects; and
- •
- 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 depend on several sole and limited source suppliers, manufacturers, and distributors for some of our products, and the loss of any of these suppliers, manufacturers, or distributors could harm our business.
We purchase a small number of parts from sole-source suppliers. In addition, our professional audio encoding devices are manufactured according to our specifications by single third-party manufacturers. Because we have no direct control over these third-party suppliers and manufacturers, interruptions or delays in the products and services provided by these third parties may be difficult to remedy in a timely fashion. In addition, if such suppliers or manufacturers are incapable of or unwilling to deliver the necessary parts or products, we may be unable to redesign our technology to work without such parts or find alternative suppliers or manufacturers. In such events, we could experience interruptions, delays, increased costs, or quality control problems.
We are subject to various environmental laws and regulations that could impose substantial costs upon us and may adversely affect our business, operating results and financial condition.
Some of our operations use substances regulated under various federal, state, local and international laws governing the environment, including those governing the discharge of pollutants into the air and water, the management, disposal and labeling of hazardous substances and wastes and the cleanup of contaminated sites. We could incur costs, fines and civil or criminal sanctions, third-party property damage or personal injury claims, or could be required to incur substantial investigation or remediation costs, if we were to violate or become liable under environmental laws. Liability under environmental laws can be joint and several and without regard to comparative fault. The ultimate costs under environmental laws and the timing of these costs are difficult to predict.
We also face increasing complexity in our product design as we adjust to new and future requirements relating to the materials composition of our products. For example, restrictions on lead and other hazardous substances that apply to specified electronic products put on the market in the European Union became effective as of July 1, 2006 and similar requirements related to marking of electronic products became effective in China as of March 1, 2007.
Substituting particular components containing regulated hazardous substances can be difficult or costly, and redesign efforts could result in production delays. Products that we maintain in inventory may be rendered obsolete if not in compliance with the new environmental laws, which could negatively impact our ability to generate revenue from those products. We could also face significant costs and liabilities in connection with product take-back legislation.
We also expect that our operations will be affected by other new environmental laws and regulations on an ongoing basis. Although we cannot predict the ultimate impact of any such new laws and regulations, they will likely result in additional costs or decreased revenue, and could require that we redesign or change how we manufacture our products, any of which could have a material adverse effect on our business.
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:
- •
- actual or anticipated fluctuations in our results of operations;
- •
- market perception of our progress toward announced objectives;
- •
- announcements of technological innovations by us or our competitors or technology standards;
- •
- announcements of significant contracts by us or our competitors;
39
- •
- changes in our pricing policies or the pricing policies of our competitors;
- •
- developments with respect to intellectual property rights;
- •
- the introduction of new products or product enhancements by us or our competitors;
- •
- the commencement of or our involvement in litigation;
- •
- our sale of common stock or other securities in the future;
- •
- conditions and trends in technology industries;
- •
- changes in market valuation or earnings of our competitors;
- •
- the trading volume of our common stock;
- •
- announcements of potential acquisitions;
- •
- the adoption rate of new products incorporating our or our competitors' technologies, including next generation optical disc players;
- •
- changes in the estimation of the future size and growth rate of our markets; and
- •
- 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:
- •
- 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;
- •
- provide for a classified Board of Directors, with each director serving a staggered three-year term;
- •
- prohibit stockholders from filling Board vacancies, calling special stockholder meetings, or taking action by written consent; and
- •
- require advance written notice of stockholder proposals and director nominations.
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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, including 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.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(c) Purchases of Equity Securities by the Issuer and Affiliated Purchasers.
Stock repurchase activity during the quarter ended March 31, 2008 was as follows:
Period
| | Total Number of Shares Purchased
| | Average Price Paid per Share
| | Total Number of Shares Purchased as Part of Publicly Announced Plan
| | Maximum Number of Shares that May Yet Be Purchased Under the Plan
| |
---|
January 1, 2008 through January 31, 2008 | | — | | | — | | — | | — | |
February 1, 2008 through February 29, 2008 | | 10,926 | (1) | $ | 21.45 | | — | | 1,000,000 | (2) |
March 1, 2008 through March 31, 2008 | | 1,461 | (1) | $ | 23.51 | | — | | 1,000,000 | |
| |
| |
| |
| | | |
Total | | 12,387 | | $ | 21.69 | (3) | — | | | |
| |
| | | | |
| | | |
Notes:
- (1)
- Consists of shares repurchased and retired from employees to satisfy statutory withholding requirements upon the vesting of restricted stock.
- (2)
- In February 2008, our Board of Directors approved the repurchase of up to one million shares of our common stock in the open market or in privately negotiated transactions, depending upon market conditions and other factors. We have not made any purchases under this program and did not repurchase any shares under the program during the quarter ended March 31, 2008. As of March 31, 2008, we had authority to repurchase up to one million shares under that program.
- (3)
- Represents weighted average price paid per share during the quarter ended March 31, 2008.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
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Item 6. Exhibits
Exhibit Number
| | Exhibit Description
|
---|
3.1 | | Restated Bylaws, as amended January 7, 2008 |
10.1 | | Employment Agreement, executed as of January 22, 2008, effective May 31, 2007, by and between Daniel E. Slusser and the Company.(1) |
31.1 | | Certification of the Chief Executive Officer under Securities Exchange Act Rules 13a-14(a) or 15d-14(a) |
31.2 | | Certification of the Chief Financial Officer under Securities Exchange Act Rules 13a-14(a) or 15d-14(a) |
32.1 | | Certification of the Chief Executive Officer under Securities Exchange Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. 1350 |
32.2 | | Certification of the Chief Financial Officer under Securities Exchange Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. 1350 |
- (1)
- Incorporated by reference to the Company's Report on Form 8-K filed with the Securities and Exchange Commission on January 24, 2008.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | DTS, Inc. |
Date: May 12, 2008 | | by: | /s/ JON E. KIRCHNER Jon E. Kirchner President and Chief Executive Officer (Duly Authorized Officer) |
Date: May 12, 2008 | | by: | /s/ MELVIN L. FLANIGAN Melvin L. Flanigan Executive Vice President, Finance and Chief Financial Officer (Principal Financial and Accounting Officer) |
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EXHIBIT INDEX
Exhibit Number
| | Exhibit Description
|
---|
3.1 | | Restated Bylaws, as amended January 7, 2008 |
10.1 | | Employment Agreement, executed as of January 22, 2008, effective May 31, 2007, by and between Daniel E. Slusser and the Company.(1) |
31.1 | | Certification of the Chief Executive Officer under Securities Exchange Act Rules 13a-14(a) or 15d-14(a) |
31.2 | | Certification of the Chief Financial Officer under Securities Exchange Act Rules 13a-14(a) or 15d-14(a) |
32.1 | | Certification of the Chief Executive Officer under Securities Exchange Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. 1350 |
32.2 | | Certification of the Chief Financial Officer under Securities Exchange Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. 1350 |
- (1)
- Incorporated by reference to the Company's Report on Form 8-K filed with the Securities and Exchange Commission on January 24, 2008.
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