DTS 10-Q 2008 Q3 Quarterly report

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DTS, INC. FORM 10-Q TABLE OF CONTENTS

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 September 30, 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 October 31, 2008 a total of 17,616,181 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	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	31
PART II.	OTHER INFORMATION	32
Item 1.	Legal Proceedings	32
Item 1A.	Risk Factors	32
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults Upon Senior Securities	47
Item 4.	Submission of Matters to a Vote of Security Holders	47
Item 5.	Other Information	47
Item 6.	Exhibits	48
SIGNATURES		49

DTS, INC.

PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements

DTS, INC.

CONSOLIDATED BALANCE SHEETS

				As of December 31, 2007			As of September 30, 2008
				(Unaudited) (Amounts in thousands, except per share amounts)
ASSETS
Current assets:
	Cash and cash equivalents			$	35,523		$	39,937
	Short-term investments				49,879			51,113
	Accounts receivable, net of allowance for doubtful accounts of $81 and $73 at December 31, 2007 and September 30, 2008, respectively				8,675			6,268
	Deferred income taxes				8,776			6,369
	Prepaid expenses and other current assets				1,342			1,311
	Income taxes receivable, net				2,085			1,787
	Assets of discontinued operations held for sale				8,629			—
		Total current assets			114,909			106,785
Property and equipment, net					5,861			7,139
Intangible assets, net					2,387			2,319
Deferred income taxes					8,584			12,538
Long-term investments					—			14,809
Other assets					3,019			1,494
Assets of discontinued operations held for sale					3,457			—
		Total assets		$	138,217		$	145,084
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Accounts payable			$	1,068		$	1,058
	Accrued expenses and other liabilities				6,118			6,575
	Liabilities of discontinued operations held for sale				7,503			—
		Total current liabilities			14,689			7,633
Other long-term liabilities					2,242			2,809
Liabilities of discontinued operations held for sale					474			—
Commitments and contingencies (Note 5)
Stockholders' equity:
	Preferred stock—$0.0001 par value, 5,000 shares authorized at December 31, 2007 and September 30, 2008; no shares issued and outstanding				—			—
	Common stock—$0.0001 par value, 70,000 shares authorized at December 31, 2007 and September 30, 2008; 18,669 and 19,241 shares issued at December 31, 2007 and September 30, 2008, respectively; 17,669 and 18,069 shares outstanding at December 31, 2007 and September 30, 2008, respectively				2			2
	Additional paid-in capital				140,008			150,362
	Treasury stock, at cost—1,000 and 1,172 shares at December 31, 2007 and September 30, 2008, respectively				(22,670	)		(27,669	)
	Accumulated other comprehensive income				193			312
	Retained earnings				3,279			11,635
		Total stockholders' equity			120,812			134,642
			Total liabilities and stockholders' equity	$	138,217		$	145,084

See accompanying notes to consolidated financial statements.

1

DTS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

			For the Three Months Ended September 30,					For the Nine Months Ended September 30,
			2007			2008		2007			2008
			(Unaudited) (Amounts in thousands, except per share amounts)
Revenue			$	10,714		$	13,943	$	36,233		$	41,982
Cost of revenue				288			322		842			930
Gross profit				10,426			13,621		35,391			41,052
Operating expenses:
	Selling, general and administrative			7,195			8,895		23,289			26,418
	Research and development			1,611			1,725		4,881			5,364
		Total operating expenses		8,806			10,620		28,170			31,782
Income from operations				1,620			3,001		7,221			9,270
Interest and other income, net				912			534		2,139			1,801
Income from continuing operations before income taxes				2,532			3,535		9,360			11,071
Provision for income taxes				1,692			1,526		4,174			4,437
Income from continuing operations				840			2,009		5,186			6,634
Income (loss) from discontinued operations, net of tax				(1,977	)		17		(7,746	)		1,722
Net income (loss)			$	(1,137	)	$	2,026	$	(2,560	)	$	8,356
Net income (loss) per common share:
Basic:
	Continuing operations		$	0.05		$	0.11	$	0.29		$	0.37
	Discontinued operations			(0.11	)		—		(0.43	)		0.10
	Net income (loss)		$	(0.06	)	$	0.11	$	(0.14	)	$	0.47
Diluted:
	Continuing operations		$	0.05		$	0.11	$	0.28		$	0.36
	Discontinued operations			(0.11	)		—		(0.42	)		0.10
	Net income (loss)		$	(0.06	)	$	0.11	$	(0.14	)	$	0.46
Weighted average shares used to compute net income (loss) per common share:
	Basic			17,517			17,963		17,834			17,735
	Diluted			18,207			18,509		18,524			18,310

See accompanying notes to consolidated financial statements.

2

DTS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

				For the Nine Months Ended September 30,
				2007			2008
				(Unaudited) (Amounts in thousands)
Cash flows from operating activities:
Net income (loss)				$	(2,560	)	$	8,356
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
	Depreciation and amortization				2,286			2,009
	Adjustment to carrying value of assets held for sale				—			(4,963	)
	Loss on sale of assets held for sale				—			2,099
	Stock-based compensation charges				3,833			3,543
	Deferred income taxes				(3,108	)		(1,547	)
	Tax benefits from stock-based awards				52			92
	Excess tax benefits from stock-based awards				(42	)		(75	)
	Other				593			103
	Changes in operating assets and liabilities:
			Accounts receivable		(1,751	)		5,680
			Inventories		(183	)		(556	)
			Prepaid expenses and other assets		593			(499	)
			Accounts payable, accrued expenses and other liabilities		680			(2,101	)
			Deferred revenue		826			450
			Income taxes receivable		(1,664	)		348
			Net cash provided by (used in) operating activities		(445	)		12,939
Cash flows from investing activities:
	Purchases of investments:
		Held-to-maturity			(27,351	)		(54,012	)
		Available for sale			(20,278	)		(12,931	)
	Maturities of held-to-maturity investments				35,073			24,550
	Sales of available for sale investments				55,950			26,350
	Proceeds from the sale of assets held for sale, net				—			8,780
	Cash paid for technology acquisitions, net				(1,226	)		(226	)
	Purchase of property and equipment				(3,800	)		(2,632	)
	Payment for patents and trademarks in process				(264	)		(532	)
			Net cash provided by (used in) investing activities		38,104			(10,653	)
Cash flows from financing activities:
	Proceeds from the issuance of common stock under stock-based compensation plans				4,749			7,303
	Repurchase and retirement of common stock for restricted stock award withholdings				(218	)		(584	)
	Excess tax benefits from stock-based awards				42			75
	Purchase of treasury stock				(22,670	)		(4,999	)
			Net cash provided by (used in) financing activities		(18,097	)		1,795
Net change in cash and cash equivalents of discontinued operations					2,114			333
			Net increase in cash and cash equivalents		21,676			4,414
Cash and cash equivalents, beginning of period					14,392			35,523
Cash and cash equivalents, end of period				$	36,068		$	39,937

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 September 30, 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 and nine months ended September 30, 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, filed on March 3, 2008.

        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.

        In January 2007, the Company combined its digital images and cinema businesses into a single business known as "DTS Digital Cinema." In February 2007, the Company's Board of Directors approved a plan to sell DTS Digital Cinema, which was modified in August 2007 in response to changing market conditions to offer these businesses for sale either together or individually, 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. In conformity 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. The Company has ceased depreciation and amortization 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.

        The digital images and cinema businesses were sold in two separate transactions on April 4, 2008 and May 9, 2008, respectively, and the net assets held for sale of these businesses have been eliminated from the Company's balance sheet as of these sale dates. As a result of these transactions and in conjunction with the previous carrying value adjustments, the Company realized a pre-tax loss of $2,099 during the three months ended June 30, 2008, reported in income from discontinued operations, net of

4

DTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(Amounts in thousands, except per share data)

Note 1—Basis of Presentation (Continued)

tax. For additional information, refer to Footnote 9 of the consolidated financial statements, "Discontinued Operations."

Correction of Error

        In the second quarter of 2008, errors were identified in the Company's income tax provision and benefit related to discontinued operations for the periods ended December 31, 2007 and March 31, 2008, respectively. These errors were related to the tax effects of the adjustments to the carrying value of assets of discontinued operations held for sale and were recognized in discontinued operations for those periods. These errors were corrected during the second quarter of 2008, the period in which the errors were identified and these assets were disposed. The correction of these errors had no effect on results of continuing operations in any reporting period.

        The error originating in the fourth quarter of 2007 had the effect of increasing the 2007 loss from discontinued operations and net loss and understating short-term deferred tax assets by $1,800. The error overstated the basic and diluted loss from discontinued operations and net loss per share by $0.10. Additionally, the error originating in the first quarter of 2008 had the effect of increasing the loss from discontinued operations, reducing net income and understating short-term deferred tax assets by $3,300. This error overstated the basic and diluted loss from discontinued operations and understated the basic and diluted net income per share by $0.19 and $0.18, respectively. The errors and their correction are solely the result of the originations and reversals of deferred tax differences. The Company concluded that the errors were not material to the consolidated financial statements for 2007 and are not material to the expected results for the full year 2008, and as such, corrected these errors in the second quarter of 2008. The impact in the second quarter of 2008 of this correction was to increase income from discontinued operations and net income by $5,100, or $0.29 and $0.28 per basic and diluted share, respectively. The impact for the full year 2008 will be to increase income from discontinued operations and net income by $1,800.

        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.

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

5

DTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(Amounts in thousands, except per share data)

Note 2—Recent Accounting Pronouncements (Continued)

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 the 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."

        In October 2008, the FASB issued FASB Staff Position FAS 157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active" ("FSP 157-3"). FSP 157-3 clarified the application of FAS 157. FSP 157-3 demonstrated how the fair value of a financial asset is determined when the market for that financial asset is inactive. FSP 157-3 was effective upon issuance, including prior periods for which financial statements had not been issued. The implementation of this standard did not have an impact on our consolidated financial statements.

        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) is intended to improve 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 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.

6

DTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(Amounts in thousands, except per share data)

Note 2—Recent Accounting Pronouncements (Continued)

        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.

        In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles." SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements that are presented in conformity with generally accepted accounting principles in the United States. This Statement is effective 60 days following the Security and Exchange Commission's approval of the Public Company Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles." The Company does not expect SFAS No. 162 to have a material impact on its financial condition or results of operations.

Note 3—Fair Value Measurements

        As of September 30, 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, certain auctions for the Company's auction rate security instruments failed during 2008. The Company attributes the failed auctions to liquidity issues rather than credit quality issues, as the

7

DTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(Amounts in thousands, except per share data)

Note 3—Fair Value Measurements (Continued)

auction rate securities held at September 30, 2008 are tax-exempt municipal bonds issued by governmental entities located within the United States that are insured and have a AAA rating.

        Liquidity for these auction rate security instruments is typically provided by a Dutch auction process that resets the applicable interest rate at pre-determined intervals, usually every 7, 28, or 35 days. Historically, auction rate security instruments would also be purchased or sold at these pre-determined intervals, creating a liquid market. Investment earnings paid during a given period are based upon the reset interest rate determined during the prior auction. For each unsuccessful auction, the interest rate moves to a maximum rate defined for each security, which is generally higher than short-term interest indices. To date, the Company has collected all interest receivable on its auction rate security instruments when due.

        The principal associated with failed auctions will not be accessible until successful auctions occur, a buyer is found outside of the auction process, the issuers establish a different form of financing to replace these securities, issuers repay principal over time from cash flows prior to final maturity, or final payments come due according to contractual maturities ranging from 16 to 26 years. The Company understands that issuers and financial markets are working on alternatives that may improve liquidity, although it is not yet clear when or if such efforts will be successful. The Company expects that it will receive the principal associated with these auction rate security instruments through one of the means described above.

        Due to the loss of liquidity, the fair values of certain of these securities are estimated utilizing discounted cash flow ("DCF") analyses or Level 3 inputs within the SFAS No. 157 fair value hierarchy as of September 30, 2008. The range of assumptions used in preparing the DCF analyses included estimates for the amounts and timing of future interest and principal payments and the rate of return required by investors to own these securities in the current environment. In making these assumptions the Company considered relevant factors including: the formula applicable to each security which defines the interest rate paid to investors in the event of a failed auction, the creditworthiness of the counterparty, the likely timing of the next successful auction for each security, the likely timing for the instruments to be called or refinanced by the issuer, and the timing for the instruments to be bought back at par from the investment bank holding these securities. The Company's estimate of the rate of return required by investors to own these securities also considers the current reduced liquidity for these auction rate security instruments.

        As a result of the Company's DCF analyses, the estimated fair values did not vary greater than 1.4% from par or cost, with the average fair value approximating par or cost. Therefore, no valuation adjustments for unrealized or realized gains or losses were recorded as of September 30, 2008 or for the nine months then ended. 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. Also, the investment bank holding the Company's auction rate securities has agreed to purchase these securities from it at par by January 2011. In addition, the investment bank holding these securities has agreed to provide "no net cost" loans to holders of the illiquid securities that are subject to bank repurchase, thereby providing the Company with short-term

8

DTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(Amounts in thousands, except per share data)

Note 3—Fair Value Measurements (Continued)

liquidity on its auction rate securities portfolio at no additional cost to the Company. The Company also believes that it has the ability and intent to hold these securities throughout its estimated 21 month recovery period.

        Due to the Company's belief that it may take up to 21 months for the investment bank holding these securities to repurchase them, all of the issuers to effect redemptions at par or for the auction markets to recover, $5,200 of its auction rate security instruments have been classified as long-term investments on the unaudited consolidated balance sheet at September 30, 2008. The remaining $10,825 of its auction rate security instruments have been classified as short-term investments on the consolidated balance sheet at September 30, 2008 due to their near-term sales. Once it is determined that the auction markets have recovered, the Company will reclassify its auction rate security holdings currently classified as long-term investments back to short-term investments. As of September 30, 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.

        The Company's financial assets measured at fair value on a recurring basis subject to the disclosure requirements of SFAS No. 157, were as follows:

			Fair Value Measurements at Reporting Date Using
Description	As of September 30, 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	$	16,025		—	$	10,825	$	5,200

        Based on market conditions, the Company changed its valuation methodology for many of its auction rate securities to discounted cash flow analyses 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. Subsequent to the initial adoption of SFAS No. 157, the Company has been able to determine the valuation of more than half of its auction rate security instruments with Level 2 inputs.

9

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) during the three and nine months ended September 30, 2008:

			Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
			Auction Rate Securities
Description			Three months ended September 30, 2008			Nine months ended September 30, 2008
Beginning balance			$	8,550		$	—
	Transfers in and/or out of Level 3			(2,800	)		10,925
	Total gains or (losses) (realized or unrealized)
		Included in earnings		—			—
		Included in other comprehensive income		—			—
	Purchases, issuances and settlements (net)			(550	)		(5,725	)
Balance at September 30, 2008			$	5,200		$	5,200

Note 4—Property and Equipment, Net

        Property and equipment consist of the following:

		As of December 31, 2007			As of September 30, 2008
Machinery and equipment		$	1,517		$	1,675
Office furniture and fixtures			4,073			4,705
Leasehold improvements			2,848			4,213
Software			4,475			5,088
			12,913			15,681
Less: Accumulated depreciation			(7,052	)		(8,542	)
	Property and equipment, net	$	5,861		$	7,139

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

10

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 consolidated balance sheets, as future payment is currently not probable.

Note 6—Income Taxes

        For the three months ended September 30, 2008, the Company recorded an income tax provision of $1,526 on pre-tax income from continuing operations of $3,535. For the nine months ended September 30, 2008, the Company recorded an income tax provision of $4,437 on pre-tax income from continuing operations of $11,071. This resulted in an annualized effective tax rate of 40%. 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. During the nine months ended September 30, 2008, the Company's unrecognized tax benefits increased by $231 for tax positions taken in prior periods and by $211 for tax positions taken during the current period. The increase was primarily attributable to uncertain tax position taken on tax returns that are currently being audited and 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. However, the Company notes that the resolution and the timing of closure of open audits is highly uncertain.

        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.

11

DTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(Amounts in thousands, except per share data)

Note 6—Income Taxes (Continued)

        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. However, the scope also includes certain issues that impact the years 2004 and 2006. In addition, the California Franchise Tax Board is conducting a state tax examination for the years 2004 and 2005.

        Licensing revenue is recognized gross of withholding taxes that are remitted by the Company's licensees directly to their local tax authorities. For the three months ended September 30, 2007 and 2008, withholding taxes were $553 and $687, respectively. For the nine months ended September 30, 2007 and 2008, withholding taxes were $1,450 and $2,471, respectively.

Note 7—Comprehensive Income (Loss)

        At December 31, 2007 and September 30, 2008, accumulated other comprehensive income is comprised mostly of foreign currency translation.

        Comprehensive income (loss) for the three months ended September 30, 2007 and 2008 was ($1,091) and $2,076, respectively. Comprehensive income (loss) for the nine months ended September 30, 2007 and 2008 was ($2,481) and $8,475, respectively.

Note 8—Operating Segment and Geographic Information

        The Company's revenue by geographical area, based on the customer's country of domicile, was as follows:

		For the Three Months Ended September 30,				For the Nine Months Ended September 30,
		2007		2008		2007		2008
United States		$	493	$	1,091	$	3,348	$	3,482
International			10,221		12,852		32,885		38,500
	Total revenue	$	10,714	$	13,943	$	36,233	$	41,982

        The following table sets forth long-lived assets by geographic area in which the Company held assets:

		Long-Lived Assets
		As of December 31, 2007		As of September 30, 2008
United States		$	5,291	$	5,666
International			570		1,473
	Total long-lived assets	$	5,861	$	7,139

12

DTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(Amounts in thousands, except per share data)

Note 9—Discontinued Operations

        On April 4, 2008, the Company, DTS Digital Images, Inc., a wholly owned subsidiary of the Company ("DI"), and Reliance Big Entertainment Private Limited ("Reliance"), entered into a Stock Purchase 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 Stock Purchase Agreement, the Company received cash consideration of approximately $7,500. The Agreement contains customary representations, warranties and covenants. As a result of this transaction and in conjunction with the previous carrying value adjustments, the Company realized a pre-tax gain of $21 during the three months ended June 30, 2008, reported in income from discontinued operations, net of tax. During a transition period from the sale date and ending prior to June 30, 2008, the Company provided certain transition services to Reliance related to DI. The Company has concluded that the direct cash flows resulting from these transition services were not material, and the Company did not have any continuing ownership interest or other influence over DI during this period.

        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 its digital cinema business ("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. For the purposes of measuring the pre-tax loss on this sale, the Company has not attributed any fair value to the additional consideration. As a result of this transaction and in conjunction with the previous carrying value adjustments, the Company realized a pre-tax loss of $2,120 during the three months ended June 30, 2008, reported in income from discontinued operations, net of tax. This pre-tax loss results primarily from settlement and severance obligations of the Company and working capital adjustments that were determined subsequent to the closing of this sale, in addition to losses from operations during the period from April 1, 2008 through the closing of this sale. Continuing cash flows from discontinued operations during the three months ended September 30, 2008 resulted from certain income tax adjustments, the resolution of certain estimated costs associated with the sale and other expenses. As further relevant information becomes available relating to the contingent consideration or further obligations of the Company, if any, additional adjustments and expenses may be recorded through discontinued operations in future periods.

13

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 sheet as of December 31, 2007.

	As of December 31, 2007
Assets:
Cash	$	333
Accounts receivable, net		4,820
Inventories		2,781
Prepaid expenses and other current assets		695
Total current assets of discontinued operations held for sale		8,629
Property and equipment, net		3,351	(1)
Intangible assets, net		—	(1)
Other		106
Total long-term assets of discontinued operations held for sale		3,457
Total assets of discontinued operations held for sale	$	12,086
Liabilities:
Accounts payable	$	4,071
Accrued expenses and other liabilities		3,432
Total current liabilities of discontinued operations held for sale		7,503
Other long-term liabilities		474
Total long-term liabilities of discontinued operations held for sale	$	474
Total liabilities of discontinued operations held for sale	$	7,977	(2)
Net assets of discontinued operations held for sale	$	4,109

(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)

Includes $2,069 from Avica Technology Corporation ("Avica"), a variable interest entity. While the Company has consolidated the liabilities of Avica in conformity with FASB Interpretation No. 46(R), "Consolidation of Variable Interest Entities—an Interpretation of 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

14

DTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(Amounts in thousands, except per share data)

Note 9—Discontinued Operations (Continued)

discontinued operations of DTS Digital Cinema for the three and nine months ended September 30, 2007 and 2008.

	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2007			2008(1)			2007			2008
Revenue	$	4,777		$	—		$	15,903		$	6,214
Pre-tax loss		(3,554	)		(44	)		(12,581	)		(725	)(2)
Income tax benefit		(1,577	)		(61	)		(4,835	)		(2,447	)(3)
Income (loss) from discontinued operations, net of tax	$	(1,977	)	$	17		$	(7,746	)	$	1,722

(1)

The cash flows from discontinued operations resulted from certain income tax adjustments, the resolution of certain estimated costs associated with the sale and other expenses.

(2)

Includes a pre-tax loss of $2,099 from the sales of the DI and DC businesses. Also 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.

(3)

Includes the correction of prior period errors that the Company determined were not material to the prior or current year financial statements. For additional information, refer to Footnote 1 of the consolidated financial statements, "Basis of Presentation."

        For the three months ended September 30, 2007 and 2008, $937 and $0, 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. For the nine months ended September 30, 2007 and 2008, $2,210 and $287, 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 reflected expected proceeds to be realized from potential buyers in a future sale, which it believed was the current market value of these assets. In conformity 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.

15

DTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(Amounts in thousands, except per share data)

Note 9—Discontinued Operations (Continued)

        In conformity 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 reflected expected proceeds to be realized from potential buyers in a future sale, which it believed was the current market value of these assets.

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.

16

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)

        The following table sets forth the computation of basic and diluted net income (loss) per common share:

			For the Three Months Ended September 30,					For the Nine Months Ended September 30,
			2007			2008		2007			2008
Basic net income (loss) per common share:
	Numerator:
		Income from continuing operations	$	840		$	2,009	$	5,186		$	6,634
		Income (loss) from discontinued operations		(1,977	)		17		(7,746	)		1,722
		Net income (loss)	$	(1,137	)	$	2,026	$	(2,560	)	$	8,356
	Denominator:
		Weighted average common shares outstanding		17,517			17,963		17,834			17,735
	Continuing operations		$	0.05		$	0.11	$	0.29		$	0.37
	Discontinued operations			(0.11	)		—		(0.43	)		0.10
	Basic net income (loss) per common share		$	(0.06	)	$	0.11	$	(0.14	)	$	0.47
Diluted net income (loss) per common share:
	Numerator:
		Income from continuing operations	$	840		$	2,009	$	5,186		$	6,634
		Income (loss) from discontinued operations		(1,977	)		17		(7,746	)		1,722
		Net income (loss)	$	(1,137	)	$	2,026	$	(2,560	)	$	8,356
Denominator:
	Weighted average shares outstanding			17,517			17,963		17,834			17,735
	Effect of dilutive securities:
		Common stock options		620			484		631			510
		Restricted stock		57			61		48			62
		Common stock warrants		4			—		4			—
		ESPP		9			1		7			3
Diluted shares outstanding				18,207			18,509		18,524			18,310
	Continuing operations		$	0.05		$	0.11	$	0.28		$	0.36
	Discontinued operations			(0.11	)		—		(0.42	)		0.10
	Diluted net income (loss) per common share		$	(0.06	)	$	0.11	$	(0.14	)	$	0.46

        For the three months ended September 30, 2007 and 2008, 54 and 338 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. For the nine months ended September 30, 2007 and 2008, 219 and 273 shares, respectively, of the Company's stock options and

17

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)

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.

        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. During the three and nine months ended September 30, 2008, the Company repurchased 172 shares under this authorization for an aggregate of $4,999.

        All shares repurchased under these authorizations are currently considered treasury stock.

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 option pricing 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 and its limited relevant historical information to support the expected sale and exercise behavior of its employees who had been granted options. Beginning in 2008 and in conformity 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 also began to estimate the expected term and volatility assumptions based upon the historical behavior of its employees and its own historical stock price activity, respectively. The Company believes that these changes in accounting estimates provide a better estimate of future option and stock price 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 option pricing model. The Company will continue to review its estimates and assumptions in conformity with SAB No. 107 and SFAS No. 123(R), "Share-Based Payment." Changes

18

DTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(Amounts in thousands, except per share data)

Note 12—Stock-Based Compensation (Continued)

in the Company's estimate of the assumptions for input into the Black-Scholes option pricing model could result in material increases or decreases in stock-based compensation costs.

Note 13—Subsequent Events

Property Acquisition

        On August 28, 2008, the Company entered into a Purchase and Sale Agreement with Countrywide Home Loans, Inc., a New York corporation, pursuant to which the Company agreed to purchase and Countrywide agreed to sell, subject to the terms of the Purchase and Sale Agreement, certain real property in Calabasas, California and an approximately 89,000 square foot building and certain furniture, fixtures, equipment and other personal property located on that real property, which shall be used as the Company's new corporate headquarters. On November 7, 2008, we purchased this real and personal property for an aggregate purchase price of $15,640. Pursuant to a separate lease agreement between the Company and Countrywide, dated as of November 7, 2008, the Company has agreed to lease to Countrywide approximately 59,500 square feet of space in its new building until January 31, 2009 for a monthly base rental amount of approximately $134.

Stock Repurchases

        As of November 10, 2008, the Company had repurchased an additional 528 shares, under its February 2008 Board of Directors authorization, for aggregate of $9,341. All shares repurchased under this authorization are currently considered treasury stock.

Legal Proceeding

        On October 8, 2008, Zoran Corporation filed a complaint in the U.S. District Court in the Northern District of California alleging violation of the Sherman Act and patent misuse by the Company related to the Company's Blu-ray Disc technology and seeking treble monetary damages, injunctive relief and judgment that certain of the Company's patents are unenforceable. The Company disputes Zoran's allegations and intends to defend the lawsuit vigorously. On October 29, 2008, the Company filed a motion to compel arbitration and dismiss this action for failure to state a claim.

Sale of Auction Rate Securities

        In November 2008, the Company sold $10,825 of its auction rate security holdings.

19

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.

        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.

        Our selling, general, and administrative expenses consist primarily of salaries and related benefits for personnel engaged in sales, administration, finance, human resources, information systems and legal

20

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.

        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.

        We completed the sale of our digital images and digital cinema businesses, the assets of which we have classified as held for sale and the operations of which we have reported as discontinued operations since the first quarter of 2007, in two separate transactions on April 4, 2008 and May 9, 2008, respectively. The net assets held for sale of these businesses were eliminated from our balance sheet as of the respective sale dates, and as a result of these transactions and in conjunction with the previous carrying value adjustments, we realized a pre-tax loss of $2.1 million during the three months ended June 30, 2008, reported in income from discontinued operations, net of tax. This pre-tax loss resulted primarily from settlement and severance obligations of ours and working capital adjustments that were determined subsequent to the closing of the sale of the digital cinema business, in addition to losses from operations during the period from April 1, 2008 through the closing of the sales. For the purposes of measuring the pre-tax loss, we have not attributed any fair value to the additional $11.7 million in consideration payable in connection with the sale of the assets of the digital cinema business. Cash flows from discontinued operations during the three months ended September 30, 2008 resulted from certain income tax adjustments, the resolution of certain estimated costs and other expenses associated with the sale of the digital cinema business. As further relevant information becomes available relating to the additional consideration payable in connection with the sale of the assets of the digital cinema business or further obligations of ours, if any, additional adjustments and expenses may be recorded through discontinued operations in future periods.

        In the second quarter of 2008, errors were identified in our income tax provision and benefit related to discontinued operations for the periods ended December 31, 2007 and March 31, 2008, respectively. These errors related to the tax effects of the adjustments to the carrying value of assets of discontinued operations held for sale and were recognized in discontinued operations for those periods. These errors were corrected during the second quarter of 2008, the period in which the errors were identified and these assets were disposed. The correction of these errors had no effect on results of continuing operations in any reporting period.

        The error originating in the fourth quarter of 2007 had the effect of increasing the 2007 loss from discontinued operations and net loss and understating short-term deferred tax assets by $1.8 million. The error overstated the basic and diluted loss from discontinued operations and net loss per share by $0.10. Additionally, the error originating in the first quarter of 2008 had the effect of increasing the loss from discontinued operations, reducing net income and understating short-term deferred tax assets by $3.3 million. This error overstated the basic and diluted loss from discontinued operations and understated the basic and diluted net income per share by $0.19 and $0.18, respectively. The errors and their correction are solely the result of originations and reversals of deferred tax differences. We concluded that the errors were not material to the financial statements for 2007 and are not material to the expected results for the full year 2008, and as such, corrected these errors in the second quarter of 2008. The impact in the second quarter of 2008 of this correction was to increase income from discontinued operations and net income by $5.1 million, or $0.29 and $0.28 per basic and diluted share, respectively. The impact for the full year 2008 will be to increase income from discontinued operations and net income by $1.8 million.

21

Management Discussion Regarding Trends, Opportunities, and Challenges

        Our revenue is primarily dependent upon the Standard Definition DVD based home theater market. 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 Blu-ray 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 closely track the growth rate for sales of these players over the next several years. We expect that the market for Blu-ray Disc 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 Blu-ray 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 Blu-ray 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, 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 allows 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.

        We continue to be cautious regarding the outlook for the consumer electronics industry as a whole, and the revenues we derive from that industry, in light of the turmoil in the global economic environment. Consumer spending for discretionary goods, including consumer electronics products, is generally negatively affected by falling consumer confidence, increasing unemployment, stagnant or falling salaries and wage rates and consumer perception of a protracted economic recovery.

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, fair value measurements, stock-based compensation, and income taxes. These estimates and judgments are based on historical experience and on various other assumptions that we believe to 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

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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 conformity 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. Due to recent events in the credit markets, certain auctions for the auction rate securities failed during 2008. We attribute the failed auctions to liquidity issues rather than credit quality issues, as the auction rate securities held at September 30, 2008 are tax-exempt municipal bonds issued by governmental entities located within the United States that are insured and have a AAA rating. To date we have collected all interest receivable on our auction rate security instruments when due and expect to continue to do so in the future. For each unsuccessful auction, the interest rate moves to a maximum rate defined for each security, which is generally higher than short-term interest indices.

        In estimating the fair value of certain of these auction rate security instruments as of September 30, 2008, we utilized discounted cash flow analyses, or DCF. The following are the key inputs in our DCF analyses based on our estimates of the assumptions that market participants would use in valuing these instruments:

•

Term—We estimated a 21 month expected life of the instruments, based on our expectations of the time it may take for (i) the instruments to be called or refinanced by the issuer, (ii) liquidity to be restored to the market place, or (iii) the investment bank holding these instruments to buy them back at par.

•

Discount Rate—We estimated discount rates, ranging from approximately 3.1% to 4.7%, based on quoted yields of similar publicly traded instruments and other short-term interest indices.

•

Liquidity Discount—We estimated the liquidity discount, ranging from approximately 17% to 26% of the respective annual coupon rates, based upon the difference between the one month and two year treasury yields, which represents the spread between the short-term loss of liquidity and the expected timing for the liquidity to be restored. In determining the estimated liquidity discount, we also considered yield differences for bonds within the same rating category.

        As a result of our DCF analyses, the estimated fair values did not vary greater than 1.4% from par or cost, with the average fair value approximating par or cost. Therefore, no valuation adjustments for unrealized or realized gains or losses were recorded as of September 30, 2008 or for the nine months then ended. 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. During 2008, all sales of our auction rate security instruments have been at par or cost with no gain or loss. Also, the investment bank holding our auction rate securities has agreed to purchase these securities from us at par by June 30, 2010. In addition, the investment bank holding these securities has agreed to provide "no net cost" loans to holders of the illiquid securities that are subject to bank repurchase, thereby providing us with short-term liquidity on our auction rate securities portfolio at no additional cost to us. We also believe that we have the ability and intent to hold these securities throughout the estimated 21 month recovery period.

        If we were to modify certain of the key assumptions utilized in the valuation analyses of our auction rate securities portfolio, the estimated fair values would change. Specifically, in order to understand the sensitivity of the valuation analyses related to our maturity and related discount rate assumptions (i.e., the extent to which the discount rate varies based on the term assumption), we modified the term assumption by approximately 50%, modeling both shorter and longer maturities (holding the liquidity assumption constant). Further, we modified the liquidity discount assumption

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(holding the 21 month term and discount rate assumptions constant), increasing/decreasing the liquidity discount by 50 basis points. Based on these changes to our analyses, the estimated fair values did not vary greater than 2.3% from par or cost, with the average fair value approximating par or cost.

        Our assumptions were based on a review of short-term interest indices and our estimates for the amount and timing of future interest and principal payments and the rate of return required by investors to own these auction rate security instruments in the current environment, among other relevant factors. The fair value of our auction rate security instruments and related valuation assumptions could change significantly based on market conditions and the current uncertainties in the credit markets. We will continue to monitor our auction rate security instruments, and we may be required to record a temporary or an other-than-temporary impairment. 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.

Results of Continuing Operations

Revenues

					Change
	2008		2007		$		%
	($ in thousands)
Three months ended September 30,	$	13,943	$	10,714	$	3,229		30	%
Nine months ended September 30,	$	41,982	$	36,233	$	5,749		16	%

        The increase in revenues for the quarter ended September 30, 2008, compared to the same prior year period, was primarily attributable to a $1.6 million increase in royalty recoveries from intellectual property compliance and enforcement activities and increases in royalties from our car audio systems business and Blu-ray markets. Royalties from next generation high definition optical disc formats, which we first began to record in 2007, comprised 11% and 9% of total revenue for the three months ended September 30, 2008 and 2007, respectively. In dollar terms, Blu-ray related revenues were up nearly 67% for the three months ended September 30, 2008 compared to the same period in 2007, as sales of stand-alone Blu-ray players and Blu-ray enabled PCs are now supplementing the revenues from game consoles which have for the past year constituted the majority of Blu-ray product shipments. We continue to be cautious regarding the outlook for the consumer electronics industry as a whole, and the revenues we derive from that industry, in light of the turmoil in the global economic environment. However, we expect technology licensing revenues to grow during the remainder of this year, as wider availability of high definition players, PC and game console models equipped with a Blu-ray Disc drive, coupled with expected aggressive pricing and promotion of these products, should result in increasing licensing revenues from the Blu-ray format.

        The increase in revenues for the nine months ended September 30, 2008, compared to the same prior year period, was primarily attributable an increase in royalties from next generation high definition optical disc formats. These royalties comprised 15% and 9% of total revenue for the nine months ended September 30, 2008 and 2007, respectively. We had an increase in royalties from our car audio systems business and royalty recoveries from intellectual property compliance and enforcement increased $0.7 million for the nine months ended September 30, 2008, compared to the same prior year period.

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Gross Profit

	2008		%			2007		%			Percentage point change in gross profit margin relative to prior period
	($ in thousands)
Three months ended September 30,	$	13,621		98	%	$	10,426		97	%		1	%
Nine months ended September 30,	$	41,052		98	%	$	35,391		98	%		0	%

        Consolidated gross profit for the three and nine months ended September 30, 2008 and 2007 remained fairly consistent as a percentage of total revenues. We expect consolidated gross margins in the 97% to 98% range for 2008.

Selling, General and Administrative ("SG&A")

							Change
	2008			2007			$		%
	($ in thousands)
Three months ended September 30,	$	8,895		$	7,195		$	1,700		24	%
% of Revenue		64	%		67	%
Nine months ended September 30,	$	26,418		$	23,289		$	3,129		13	%
% of Revenue		63	%		64	%

        The dollar increase for the three and nine months ended September 30, 2008, compared to the same prior year periods, is primarily due to $1.4 million and $2.7 million increases, respectively, in employee related costs including expanded foreign operations and stock-based compensation.

        We expect SG&A expenses to continue to increase in absolute dollars, primarily to support activities such as new technology initiatives, international expansion and intellectual property enforcement.

Research and Development ("R&D")

							Change
	2008			2007			$		%
	($ in thousands)
Three months ended September 30,	$	1,725		$	1,611		$	114		7	%
% of Revenue		12	%		15	%
Nine months ended September 30,	$	5,364		$	4,881		$	483		10	%
% of Revenue		13	%		13	%

        The dollar increase for the three and nine months ended September 30, 2008, compared to the same prior year periods, is primarily due to $0.1 million and $0.5 million increases, respectively, in employee related costs for an expanded 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 in absolute dollars through the remainder of the year.

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Interest and Other Income, Net

					Change
	2008		2007		$			%
	($ in thousands)
Three months ended September 30,	$	534	$	912	$	(378	)		(41	)%
Nine months ended September 30,	$	1,801	$	2,139	$	(338	)		(16	)%

        The decrease for the three months ended September 30, 2008, compared to the same prior year period, is primarily due to a decrease in interest income resulting from lower average interest rates in the current period.

        The decrease for the nine months ended September 30, 2008, compared to the same prior year period, is primarily the result of the following offsetting activities. During the current year period, we had lower average invested balances as a result of our stock repurchases during the second and third quarters of 2007 and lower average interest rates as a result of a less favorable interest rate environment. During the prior year period, a $0.7 million correction reduced interest income in order to correct our accrued interest income balances related to 2005 and 2006.

        We expect interest and other income for the year to be in the range of $2.0 to $2.5 million, based on the current interest rate environment and current investment balances. The decrease in our estimate of interest and other income for 2008 is primarily due to a decrease in our investment balances as a result of stock repurchases during the three months ended September 30, 2008, and our additional stock repurchases and our acquisition of real property and personal property located in Calabasas, California, which shall be used as our new corporate headquarters, during the three months ending December 31, 2008.

Income Taxes

	2008			2007
	($ in thousands)
Three months ended September 30,	$	1,526		$	1,692
Effective tax rate		43	%		67	%
Nine months ended September 30,	$	4,437		$	4,174
Effective tax rate		40	%		45	%

        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 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.

Income (Loss) from Discontinued Operations, Net

        Our digital images and cinema businesses were sold in two separate transactions on April 4, 2008 and May 9, 2008, respectively. Proceeds from each of these sales were $7.5 million and $3.3 million, respectively. The net assets held for sale of these businesses have been eliminated from our balance sheet as of the respective sale dates, and as a result of these transactions and in conjunction with the previous carrying value adjustments, we realized a pre-tax loss of $2,099 during the three months ended June 30, 2008. This pre-tax loss results primarily from settlement and severance obligations of ours and working capital adjustments that were determined subsequent to the closing of the sale of the DC

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Business, in addition to losses from operations during the partial quarterly period from April 1, 2008 through the closing of the sales.

        The cash flows from discontinued operations during the three months ended September 30, 2008 resulted from certain income tax adjustments, the resolution of certain estimated costs associated with the sale and other minor expenses.

        As further relevant information becomes available relating to the contingent consideration or further obligations of ours, if any, additional adjustments and expenses may be recorded through discontinued operations in future periods. As a result of the sales, the current year periods are not comparable to the same prior year periods.

Liquidity and Capital Resources

        At September 30, 2008, we had cash, cash equivalents and short-term investments of $91.1 million, compared to $85.4 million at December 31, 2007. Due to recent auction failures in the auction rate security markets, we classified $5.2 million of our auction rate security holdings as long-term investments on the unaudited consolidated balance sheet as of September 30, 2008. We classified the remaining $10.8 million of our auction rate security holdings as short-term investments due to sales that we executed in November 2008. Once it is determined that the auction markets have recovered, we will reclassify our remaining auction rate security holdings back to short-term investments. For additional information, see the "Auction Rate Securities" discussion below.

        Net cash used in operating activities was $0.4 million for the nine months ended September 30, 2007. Net cash provided by operating activities was $12.9 million for the nine months ended September 30, 2008. The increase in operating cash flows during the nine months ended September 30, 2008, compared to the same prior year period, results largely from income from operations and the increase in collections of accounts receivable. Net cash provided by operating activities for the nine months ended September 30, 2008 was also impacted by the disposition of working capital as a result of the sales of the digital images and digital cinema businesses during the second quarter of 2008. During the nine months ended September 30, 2007, an increase in accrued licensing revenues from Blu-ray Disc and other next generation based products resulted in a decrease in cash flows from accounts receivable for this period. We first began to receive licensing revenues from next generation based products during the first quarter of 2007.

        Net cash provided by investing activities totaled $38.1 million for the nine months ended September 30, 2007. Net cash used by investing activities totaled $10.7 million for the nine months ended September 30, 2008. The primary use of investing cash flow for the nine months ended September 30, 2008 was $16.0 million for the purchase of investments, net of sales and maturities, and capital expenditures. Partially offsetting this use of cash was $8.8 million of net proceeds from the sales of our digital images and cinema businesses. The primary source of investing cash flow for the nine months ended September 30, 2007 was proceeds from sales and maturities of our investments, net of purchases.

        Net cash used in financing activities was $18.1 million for the nine months ended September 30, 2007. Net cash provided by financing activities totaled $1.8 million for the nine months ended September 30, 2008. The primary source of financing cash flow for the nine months ended September 30, 2008 was $7.3 million of proceeds from the issuance of common stock under our stock-based compensation plans, resulting largely from increased option exercise activity due to the favorable market price of our common stock during that period and increased option exercise activity by former employees of the digital images and cinema businesses that were sold. Partially offsetting these proceeds was $5.0 million of cash used for the purchase of treasury stock.

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Repurchases of Common Stock

        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. During the three months ended September 30, 2008, we repurchased 0.2 million shares of our common stock for an aggregate of $5.0 million under this authorization. At September 30, 2008, we are authorized to repurchase 0.8 million more shares under this authorization. As of November 10, 2008, we have repurchased an additional 0.5 million shares under this authorization for an aggregate of $9.3 million. All shares repurchased under this authorization are currently considered treasury stock

Sales of Businesses

        On April 4, 2008, we entered into a Stock Purchase Agreement providing for the sale of the DTS Digital Images business to Reliance Big Entertainment Private Limited. The sale was consummated the same day. Pursuant to the terms of the Stock Purchase 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 the assets used predominantly in the conduct of the 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 digital cinema business. The sale was consummated the same day. Pursuant to the terms of the 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. For the purposes of measuring the pre-tax loss on this sale, we have not attributed any fair value to the additional consideration. The cash proceeds received from this sale have been partially offset by settlement and ongoing severance obligations and costs to sell.

        We are no longer funding the digital images or digital cinema businesses due to the closing of the sales transactions in April and May of 2008, respectively.

Property Acquisition

        On August 28, 2008, we entered into a Purchase and Sale Agreement with Countrywide Home Loans, Inc., a New York corporation, pursuant to which we agreed to purchase and Countrywide agreed to sell, subject to the terms of the Purchase and Sale Agreement, certain real property in Calabasas, California and an approximately 89,000 square foot building and certain furniture, fixtures, equipment and other personal property located on that property, which shall be used as our new corporate headquarters. On November 7, 2008, we purchased this real and personal property for an aggregate purchase price of $15.6 million. Additionally, 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 this new location. Pursuant to a separate lease agreement with Countrywide, which we entered into on November 7, 2008, we have agreed to lease to Countrywide approximately 59,500 square feet of space in our new building until January 31, 2009 for a monthly base rental amount of approximately $0.1 million.

Auction Rate Securities

        As of September 30, 2008, we held approximately $16.0 million in auction rate securities. Due to recent events in the credit markets, the auctions for our auction rate security instruments failed during 2008. We attribute the failed auctions to liquidity issues rather than credit quality issues, as the auction rate securities held at September 30, 2008 are tax-exempt municipal bonds issued by governmental entities located within the United States that are insured and have a AAA rating. Due to the loss of liquidity, the fair values of certain of these securities are estimated utilizing DCF analyses as of

28

September 30, 2008. Our DCF analyses is based on a review of short-term interest indices and our estimates for the amount and timing of future interest and principal payments and the rate of return required by investors to own these auction rate security instruments in the current environment, among other relevant factors. These securities were also compared, when possible, to significant other observable market data.

        As a result of our DCF analyses, no valuation adjustments for unrealized or realized gains or losses were recorded as of September 30, 2008 or for the nine months then ended. 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. Also, the investment bank holding our auction rate securities has agreed to purchase these securities from us at par by January 2011. In addition, the investment bank holding these securities has agreed to provide "no net cost" loans to holders of the illiquid securities that are subject to bank repurchase, thereby providing us with short-term liquidity on our auction rate securities portfolio at no additional cost to us. To date, approximately 68% of these securities held at September 30, 2008 have been sold at par or cost.

        Due to our belief that it may take up to 21 months for the investment bank holding these securities the repurchase them, all of the issuers to effect redemptions at par or for the auction markets to recover, $5.2 million of our auction rate security instruments have been classified as long-term investments on the unaudited consolidated balance sheet at September 30, 2008. The remaining $10.8 million of our auction rate security instruments, which have been sold since September 30, 2008, were classified as short-term investments on the consolidated balance sheet at September 30, 2008 due to their near-term sales. Once it is determined that the auction markets have recovered, we will reclassify our remaining auction rate security holdings back to short-term investments. To date we have collected all interest receivable on our auction rate security instruments when due and expect to continue to do so in the future. 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 and intent to hold these securities throughout the estimated 21 month recovery period.

        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.

Contractual obligations

        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 September 30, 2008, our total amount of unrecognized tax benefits was $2.6 million and is considered a long-term obligation. We are currently

29

unable to make reasonably reliable estimates of the periods of cash settlements associated with these obligations.

Recently Issued Accounting Standards

        Refer to Footnote 2 of the consolidated financial statements, "Recent Accounting Pronouncements."

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 our auction rate security instruments failed during 2008. We attribute the failed auctions to liquidity issues rather than credit quality issues, as the auction rate securities held at September 30, 2008 are tax-exempt municipal bonds issued by governmental entities located within the United States that are insured and have a AAA rating. Also, the investment bank holding our auction rate securities has agreed to purchase these securities from us at par by January 2011. In addition, the investment bank holding these securities has agreed to provide "no net cost" loans to holders of the illiquid securities that are subject to bank repurchase, thereby providing us with short-term liquidity on our auction rate securities portfolio at no additional cost to us. Due to our belief that it may take up to 21 months for the investment bank holding these securities the repurchase them, all of the issuers to effect redemptions at par or for the auction markets to recover, $5.2 million of our auction rate security instruments have been classified as long-term investments on the unaudited consolidated balance sheet at September 30, 2008. The remaining $10.8 million of our auction rate security instruments, which have been sold since September 30, 2008, were classified as short-term investments on the consolidated balance sheet at September 30, 2008 due to their near-term sales. To date we have collected all interest receivable on our auction rate security instruments when due and expect to continue to do so in the future. We have also successfully redeemed or sold some of the securities subject to failed auctions at par or cost, 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 September 30, 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 security instruments to adversely affect our ability to conduct business, and we believe that we have the ability and intent 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 September 30, 2008, a one percentage point change in interest rates throughout a one-year period would have an annual effect of approximately $1.1 million on our income before income taxes.

        During the nine months ended September 30, 2008, we derived over 91% 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.

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Revenues denominated in foreign currencies accounted for approximately 4% of total revenues during the nine months ended September 30, 2008. Operating expenses, including cost of sales, for our foreign subsidiaries were approximately $9.6 million in the nine months ended September 30, 2008. Based upon the expenses for the nine months ended September 30, 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 nine months ended September 30, 2008, the impact of foreign exchange rate fluctuations related to translation of our foreign subsidiaries' financial statements was immaterial to comprehensive income.

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

        On October 8, 2008, Zoran Corporation filed a complaint in the U.S. District Court in the Northern District of California alleging violation of the Sherman Act and patent misuse by us related to our Blu-ray Disc technology and seeking treble monetary damages, injunctive relief and judgment that certain of our patents are unenforceable. We dispute Zoran's allegations and intend to defend the lawsuit vigorously. On October 29, 2008, we filed a motion to compel arbitration and dismiss this action for failure to state a claim.

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 new or updated information from the risk factors described under Item 1A of Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which was filed with the SEC on March 3, 2008, including elimination of some risks related to the digital images and digital cinema businesses which we no longer own. The risk factors with the following headings have been added or materially changed since that Annual Report:

•

An economic downturn could materially harm our business.

•

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.

•

If we fail to protect our intellectual property rights, our ability to compete could be harmed.

•

We may be subject to litigation proceedings that could harm our business.

•

Our investments in auction rate securities may not provide us a liquid source of cash.

•

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.

•

We cannot be certain of the future effectiveness of our internal control over financial reporting or the impact thereof on our operations or the market price of our common stock.

•

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

•

Unanticipated changes in our tax provisions or adverse outcomes resulting from examination of our income tax returns could adversely affect our net income.

•

We may be subject to claims and lawsuits by third parties in connection with the recently sold digital images and digital cinema businesses that may result in adverse outcomes to our business.

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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 Blu-ray 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 Blu-ray 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 Blu-ray Disc players has only just begun. While Toshiba Corporation has previously announced its decision to discontinue sales and marketing of HD-DVD players, they and others continue to manufacture and sell Standard Definition DVD players with upscaling features that aim to enhance the image quality. The existence of both Blu-ray Disc players and upscaling Standard Definition DVD players can lead to consumer confusion and potentially slow the adoption of Blu-ray Disc players. The slow adoption by consumers of Blu-ray 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 Blu-ray 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 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.

An economic downturn could materially harm our business.

        Negative trends in the general economy, including trends resulting from an actual or perceived recession, tightening credit markets increased cost of commodities, including oil, 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. In addition, tight credit markets could delay or prevent us from acquiring or making investments in other technologies, products or businesses that could enhance our technical capabilities, complement our current products and services, or expand the breadth of our markets. If we are unable to execute such acquisitions and strategic investments, our operating results and business prospects may suffer.

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

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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 to manage brand transition in connection with the recently completed sales of our digital images and cinema businesses, which we may not do successfully. For example, if customers of the sold businesses do not receive the same level of service from the new owners, this may adversely affect our brand to the extent divested assets display our trademarks or are otherwise associated with our brand. We may be required to expend substantial resources to ensure our reputation for high quality products and technologies is not harmed as a result of actions or inaction on the part of the new owners. In addition, these efforts may divert management attention from our current business.

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, 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.

We may be sued by third parties for alleged infringement of their proprietary rights.

        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.

We may be subject to litigation proceedings that could harm our business.

        In addition to the litigation risks mentioned elsewhere in this report, as described in Item 1 "Legal Proceedings" in Part II of this Form 10-Q, we are currently engaged in a litigation matter with Zoran Corporation. Litigation is subject to inherent uncertainties, and unfavorable rulings could occur. An unfavorable ruling could include monetary damages (including treble damages under the Clayton Act) and an injunction prohibiting us from licensing our technology in particular ways or at all. Were an unfavorable ruling to occur, our business and results of operations could be materially harmed. In addition, any protracted litigation could divert management's attention from our day-to-day operations, disrupt our business and cause our operating results to suffer.

We 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

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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 players 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, trademarks or services. Our customers, licensees and other manufacturers might not utilize our technology or services in the future.

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Our investments in auction rate securities may not provide us a liquid source of cash.

        As of September 30, 2008, we held approximately $16.0 million of auction-rate securities. Recently, there have been disruptions in the market for auction rate securities, and all auction rate security instruments in our portfolio had failures at auction during 2008. Although we were able to sell approximately $10.8 million of these securities in November 2008, we may not be able to sell our remaining auction rate securities in a timely manner to meet a liquidity need. In the event that we are unable to sell these 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.

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

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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.

        Most 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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expand our intellectual property portfolio;

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upgrade our operational and financial systems, procedures, and controls; and

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continue to assume the responsibilities of being a public company.

        As a result, we will need to grow our revenues and manage our costs in order to positively impact profitability. In addition, we may fail to accurately estimate and assess our increased operating expenses as we grow.

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;

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the costs associated with the build-out of our new headquarters facility and our relocation to such facility; and

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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. Our ability to raise additional funds may be materially and adversely affected by current credit conditions and the turmoil and slowdown in the financial markets and overall economy. Furthermore, if we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution, and the new equity or debt securities may have rights, preferences, and privileges senior to those of our existing stockholders. If we cannot raise funds on acceptable terms, or at all, we may not be able to develop or enhance our products and services, execute our business plan, take advantage of future opportunities, or respond to competitive pressures or unanticipated customer requirements. This may materially harm our business, results of operations, and financial condition.

We have a limited operating history in our new and evolving markets.

        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 control 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 control over financial reporting. We cannot assure you that our system of internal control will be effective in the future as our operations and control environment change. If we cannot adequately maintain the effectiveness of our internal control over financial reporting, our financial reporting may not be timely and/or accurate. If reporting delays or errors actually occur, we could be subject to sanctions or investigation by regulatory authorities, such as the SEC. Moreover, even if we conclude that our internal control is effective, our independent registered public accounting firm may disagree. If our independent registered public accounting firm is not satisfied with our internal control over financial reporting or the level at which our internal control over financial reporting is documented, designed, operated or reviewed, or if the independent registered public accounting firm interprets the requirements, rules or regulations differently than we do, then it may issue an adverse or qualified opinion. Any of the above outcomes could adversely affect our financial results or result in a loss of investor confidence in the reliability of our financial information, which could materially and adversely affect the market price of our common stock.

We are subject to additional risks associated with our international operations.

        Our licensing headquarters are located in Limerick, Ireland, and we market and sell our products and services outside the United States. We currently have employees located in 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 were derived internationally. We face numerous risks in doing business outside the United States, including:

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unusual or burdensome foreign laws or regulatory requirements or unexpected changes to those laws or requirements;

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tariffs, trade protection measures, import or export licensing requirements, trade embargos, and other trade barriers;

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difficulties in staffing and managing foreign operations;

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competition from foreign companies;

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dependence on foreign distributors and their sales channels;

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longer accounts receivable collection cycles and difficulties in collecting accounts receivable;

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less effective and less predictable protection of intellectual property;

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changes in the political or economic condition of a specific country or region, particularly in emerging markets;

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fluctuations in the value of foreign currency versus the U.S. dollar and the cost of currency exchange; and

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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.

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        Our international revenue is mostly denominated in U.S. dollars. As a result, fluctuations in the value of the U.S. dollar and foreign currencies may make our technology, products, and services more expensive for international customers, which could cause them to decrease their purchases from us. Expenses for our subsidiaries are denominated in their respective local currencies. As a result, if the U.S. dollar weakens against the local currency, the translation of our foreign-currency-denominated expenses will result in higher operating expense without a corresponding increase in revenue. Significant fluctuations in the value of the U.S. dollar and foreign currencies could have a material impact on our consolidated financial statements. The main foreign currencies we encounter in our operations are the Yen, Euro, CAD, RMB and GBP. We do not currently engage in currency hedging activities to limit the risk of exchange rate fluctuations.

We face risks in expanding our business operations in China.

        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 may experience fluctuations in our operating results.

        We have historically experienced moderate seasonality in our business due to our business mix and the nature of our products. Consumer electronics manufacturing activities are generally lowest in the first calendar quarter of each year, and increase progressively throughout the remainder of the year. Manufacturing output is generally strongest in the third and fourth quarters as our technology licensees increase manufacturing to prepare for the holiday buying season. Since recognition of revenues generally lags manufacturing activity by one quarter, our revenues and earnings are generally lowest in the second quarter. The introduction of new products and inclusion of our technologies in new and rapidly growing markets can distort and amplify the seasonality described above. 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 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.

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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.

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 have limited control over 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. For example, in October 2008, Zoran Corporation filed a complaint in the U.S. District Court in the Northern District of California alleging, among other things, that we failed to license our Blu-ray Disc technology to Zoran in accordance with the requirements of the Blu-ray Disc Association, the standards-setting body for Blu-ray Disc standards. 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.

We are dependent on our management team and technical talent.

        Our success depends, in part, upon the continued availability and contributions of our management team and engineering and technical personnel because of the complexity of our products and services. Important factors that could cause the loss of key personnel include:

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our existing employment agreements with the members of our management team allow such persons to terminate their employment with us at any time;

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we do not have employment agreements with a majority of our key engineering and technical personnel;

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significant portions of the equity awards held by the members of our management team are vested; and

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equity awards held by some of our executive officers provide for accelerated vesting in the event of a sale or change of control of our company.

        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.

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

        From time to time, one or a small number of our customers or licensees may represent a significant percentage of our revenue. For instance, in 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.

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 is examining our 2005 federal income tax return and the State of California is examining our 2004 and 2005 corporate tax returns. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. Based on the results of an audit or litigation, a material effect on our income tax provision, net income or cash flows in the period or periods for which that determination is made could result.

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.

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        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 may be subject to claims and lawsuits by third parties in connection with the recently sold digital images and digital cinema businesses that may result in adverse outcomes to our business.

        We recently sold the digital images and digital cinema businesses. Although the acquirers assumed liabilities relating to those businesses, we may be subject to claims and lawsuits by third parties, including former vendors, employees and consultants of ours, related to actions or inaction by an acquirer. In addition, we agreed to indemnify the acquirers against specified losses in connection with the sold businesses and retain responsibility for various legal liabilities that accrued prior to closing. If an acquirer makes an indemnification claim or a third party commences an action against us or an acquirer, we may incur substantial expense and our management may have to devote a substantial amount of time resolving such claims or defending against such actions, which could harm our business, operating results and financial condition. In addition, we may be required to expend substantial resources trying to determine which party has responsibility for a claim, even if we are ultimately found to be not responsible.

We may not successfully address problems encountered in connection with any acquisitions.

        We expect to consider opportunities to acquire or make investments in other technologies, products, and businesses that could enhance our technical capabilities, complement our current products and services, or expand the breadth of our markets. 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;

•

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

44

geographies, cultures and languages, currency risks and risks associated with the particular economic, political and regulatory environment in specific countries. Also, the anticipated benefit of our acquisitions may not materialize, whether because of failure to obtain stockholder approval or otherwise. Future acquisitions could result in potentially dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities or amortization expenses, or write-offs of goodwill, any of which could harm our operating results or financial condition. Future acquisitions may also require us to obtain additional equity or debt financing, which may not be available on favorable terms or at all.

We may have difficulty managing any growth that we might experience.

        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.

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.

Risks Related to Our Common Stock

We expect that the price of our common stock will fluctuate substantially.

        The market price of our common stock is likely to be highly volatile and may fluctuate substantially due to many factors, including:

•

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;

•

changes in our pricing policies or the pricing policies of our competitors;

•

developments with respect to intellectual property rights;

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•

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.

Shares of our common stock are relatively illiquid.

        As a result of our relatively small public float, our common stock may be less liquid than the common stock of companies with broader public ownership. Among other things, trading of a relatively small volume of our common shares may have a greater impact on the trading price for our shares than would be the case if our public float were larger.

Anti-takeover provisions under our charter documents and Delaware law could delay or prevent a change of control and could also limit the market price of our stock.

        Our Restated Certificate of Incorporation and Restated Bylaws contain provisions that could delay or prevent a change of control of our company or changes in our Board of Directors that our stockholders might consider favorable. Some of these provisions:

•

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.

        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,

46

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 September 30, 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
July 1, 2008 through July 31, 2008		—			—			—		1,000,000
August 1, 2008 through August 31, 2008		2,146	(1)	$	33.06			—		1,000,000
September 1, 2008 through September 30, 2008		172,400	(2)	$	29.00			172,400		827,600
Total		174,546		$	29.05	(3)		172,400		827,600

Notes:

(1)

Consists of shares repurchased and retired from employees to satisfy statutory withholding requirements upon the vesting of restricted stock.

(2)

Consists of shares repurchased in open-market transactions pursuant to an authorization by our Board of Directors that we previously announced. In February 2008, our Board of Directors authorized us to 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.

(3)

Represents weighted average price paid per share during the quarter ended September 30, 2008.

Item 3.    Defaults Upon Senior Securities

        None.

Item 4.    Submission of Matters to a Vote of Security Holders

        None.

Item 5.    Other Information

        On August 28, 2008, we entered into a Purchase and Sale Agreement with Countrywide Home Loans, Inc., a New York corporation, pursuant to which we agreed to purchase and Countrywide agreed to sell, subject to the terms of the Agreement, certain real property in Calabasas, California and an approximately 89,000 square foot building and certain furniture, fixtures, equipment and other personal property located on that property, which shall be used as our new corporate headquarters. We previously described this Purchase and Sale Agreement in a current report on Form 8-K filed on September 3, 2008. On November 7, 2008, we purchased this real and personal property for an aggregate purchase price of $15.6 million.

        On November 7, 2008, we entered into a Lease Agreement with Countrywide Home Loans, Inc., pursuant to which we agreed to lease to Countrywide approximately 59,500 square feet of space in our

47

new building located at 5220 Las Virgenes Road, Calabasas, California, until January 31, 2009 for a monthly base rental amount of approximately $0.1 million.

Item 6.    Exhibits

Exhibit Number		Exhibit Description
	10.1	Purchase and Sale Agreement, dated August 28, 2008, and First Amendment to Purchase and Sale Agreement, dated October 13, 2008, between DTS, Inc. and Countrywide Home Loans, Inc.
	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*

*

This certification is being furnished solely to accompany this report pursuant to 18 U.S.C. 1350, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, and is not to be incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

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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: November 10, 2008	by:	/s/ JON E. KIRCHNER Jon E. Kirchner President and Chief Executive Officer (Duly Authorized Officer)
Date: November 10, 2008	by:	/s/ MELVIN L. FLANIGAN Melvin L. Flanigan Executive Vice President, Finance and Chief Financial Officer (Principal Financial and Accounting Officer)

49

EXHIBIT INDEX

Exhibit Number		Exhibit Description
	10.1	Purchase and Sale Agreement, dated August 28, 2008, and First Amendment to Purchase and Sale Agreement, dated October 13, 2008, between DTS, Inc. and Countrywide Home Loans, Inc.
	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*

*

This certification is being furnished solely to accompany this report pursuant to 18 U.S.C. 1350, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, and is not to be incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.