DTS 10-Q 2007 Q1 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2007

Commission File Number 000-50335

DTS, Inc.

(Exact name of registrant as specified in its charter)

Delaware	77-0467655
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
5171 Clareton Drive
Agoura Hills, California 91301	(818) 706-3525
(Address of principal executive	(Registrant’s telephone number,
offices and zip code)	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 xNo o

Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer or non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  o Accelerated filer  x Non-accelerated filer  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes oNo x

As of April 30, 2007 a total of 18,187,715 shares of the Registrant’s Common Stock, $0.0001 par value, were issued and outstanding.

DTS, INC.

FORM 10-Q

TABLE OF CONTENTS

PART I	FINANCIAL INFORMATION	3
Item 1.	Financial Statements (unaudited):	3
	Consolidated Balance Sheets	3
	Consolidated Statements of Operations	4
	Consolidated Statements of Cash Flows	5
	Notes to Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	18
Item 4.	Controls and Procedures	19
PART II.	OTHER INFORMATION	20
Item 1.	Legal Proceedings	20
Item 1A.	Risk Factors	20
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	36
Item 3.	Defaults Upon Senior Securities	36
Item 4.	Submission of Matters to a Vote of Security Holders	36
Item 5.	Other Information	36
Item 6.	Exhibits	37
SIGNATURES		38

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DTS, INC.

PART I

FINANCIAL INFORMATION

Item 1.Financial Statements

DTS, Inc.
Consolidated Balance Sheets

	As of			As of
	December 31,			March 31,
	2006			2007
	(Unaudited)
	(Amounts in thousands, except per share amounts)
ASSETS
Current assets:
Cash and cash equivalents		$	14,392	$	19,113
Short-term investments		94,368		84,579
Accounts receivable, net of allowance for doubtful accounts of $48 and $46 at December 31, 2006 and March 31, 2007, respectively		2,550		5,209
Deferred income taxes		7,059		7,059
Prepaid expenses and other current assets		1,525		1,676
Income taxes receivable, net		2,244		3,345
Assets of discontinued operations held for sale		11,290		8,910
Total current assets		133,428		129,891
Property and equipment, net		5,982		6,559
Intangible assets, net		1,852		1,812
Deferred income taxes		305		753
Other assets		989		987
Assets of discontinued operations held for sale		25,644		26,293
Total assets		$	168,200	$	166,295
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	1,142	$	516
Accrued expenses and other liabilities		3,832		4,134
Liabilities of discontinued operations held for sale		7,944		3,951
Total current liabilities		12,918		8,601
Other long-term liabilities		—		1,392
Liabilities of discontinued operations held for sale		1,466		1,469
Commitments and contingencies (Note 7)
Stockholders’ equity:
Preferred stock—$0.0001 par value, 5,000 shares authorized at December 31, 2006 and March 31, 2007; no shares issued and outstanding at December 31, 2006 and March 31, 2007		—		—
Common stock—$0.0001 par value, 70,000 shares authorized at December 31, 2006 and March 31, 2007; 18,024 and 18,174 shares issued and outstanding at December 31, 2006 and March 31, 2007, respectively		2		2
Additional paid-in capital		129,549		131,838
Retained earnings		24,265		22,953
Accumulated other comprehensive income		—		40
Total stockholders’ equity		153,816		154,833
Total liabilities and stockholders’ equity		$	168,200	$	166,295

See accompanying notes to consolidated financial statements.

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DTS, Inc.
Consolidated Statements of Operations

	For the Three Months Ended March 31,
	2006		2007
	(Unaudited) (Amounts in thousands, except per share amounts)
Revenue	$	20,682	$	12,608
Cost of revenue	409		255
Gross profit	20,273		12,353
Operating expenses:
Selling, general and administrative	7,266		8,072
Research and development	1,578		1,604
Total operating expenses	8,844		9,676
Income from operations	11,429		2,677
Interest and other income, net	1,060		356
Income from continuing operations before income taxes	12,489		3,033
Provision for income taxes	5,824		1,050
Income from continuing operations	6,665		1,983
Income (loss) from discontinued operations, net of tax	342		(2,748		)
Net income (loss)	$	7,007	$	(765	)
Net income (loss) per common share:
Basic:
Continuing operations	$	0.38	$	0.11
Discontinued operations	0.02		(0.15		)
Net income (loss)	$	0.40	$	(0.04	)
Diluted:
Continuing operations	$	0.36	$	0.11
Discontinued operations	0.02		(0.15		)
Net income (loss)	$	0.38	$	(0.04	)
Weighted average shares used to compute net income (loss) per common share:
Basic	17,495		17,965
Diluted	18,292		18,673

See accompanying notes to consolidated financial statements.

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DTS, Inc.
Consolidated Statements of Cash Flows

	For the Three Months Ended March 31,
	2006			2007
	(Unaudited)
	(Amounts in thousands)
Cash flows from operating activities:
Net income (loss)	$	7,007		$	(765	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization	1,062			977
Stock-based compensation charges	682			1,256
Deferred income taxes	121			(328		)
Tax benefits from stock-based awards	112			566
Excess tax benefits from stock-based awards	(112		)	(561		)
Other	223			45
Changes in operating assets and liabilities:
Accounts receivable	1,040			(2,748		)
Inventories	(99		)	264
Prepaid expenses and other assets	751			171
Accounts payable, accrued expenses and other liabilities	(462		)	(3,623		)
Deferred revenue	(2,388		)	34
Income taxes receivable	1,476			(1,065		)
Net cash provided by (used in) operating activities	9,413			(5,777		)
Cash flows from investing activities:
Purchases of investments	(48,616		)	(18,547		)
Maturities of investments	26,213			16,536
Sales of investments	11,139			11,800
Cash paid for business and technology acquisitions, net of cash acquired	(200		)	—
Purchase of property and equipment	(1,808		)	(2,143		)
Payment for patents and trademarks in process	(32		)	(44		)
Net cash (used in) provided by investing activities	(13,304		)	7,602
Cash flows from financing activities:
Proceeds from the issuance of common stock upon exercise of employee stock options and restricted stock vesting, net	292			467
Excess tax benefits from stock-based compensation	112			561
Net cash provided by financing activities	404			1,028
Net change in cash and cash equivalents of discontinued operations	—			1,868
Net (decrease) increase in cash and cash equivalents	(3,487		)	4,721
Cash and cash equivalents, beginning of period	33,254			14,392
Cash and cash equivalents, end of period	$	29,767		$	19,113

See accompanying notes to consolidated financial statements.

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DTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except per share data)

Note 1—Basis of Presentation

The accompanying unaudited consolidated financial statements of DTS, Inc. (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair statement of the Company’s financial position at March 31, 2007, and the results of operations and cash flows for the periods presented. All significant intercompany transactions have been eliminated in consolidation. Operating results for the three months ended March 31, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2007. 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, 2006.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain prior year amounts in previously issued financial statements have been reclassified to conform to the current year presentation.

In January 2007, the Company combined its Cinema and Digital Images businesses into a single business known as “DTS Digital Cinema.” In February 2007, the Company’s Board of Directors approved a plan to sell its DTS Digital Cinema business to enable the Company to focus exclusively on licensing branded entertainment technology to the large and evolving audio, game console, personal computer, portable, broadcast, and other markets. The sales process has begun and is expected to conclude later in 2007. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” during the first quarter of 2007, DTS Digital Cinema’s assets and liabilities were classified as held for sale and its operations were classified as discontinued operations. As a result, the Company reclassified its balance sheets and statements of operations for all periods presented in this report to reflect DTS Digital Cinema as discontinued operations. Depreciation and amortization has been eliminated from discontinued operations from the date the Board of Directors approved the plan to sell this business. In the statements of cash flows, the cash flows of discontinued operations are not separately classified or aggregated. The discontinued operations are reported in the respective categories of the statements of cash flows with those of continuing operations. For additional information, refer to Footnote 11 of the consolidated financial statements, “Discontinued Operations.”

All discussions and amounts in this report, except for cash flows, for all periods presented relate to continuing operations only, unless otherwise noted.

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Note 2—Recent Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” This Standard allows companies to elect to follow fair value accounting for certain financial assets and liabilities in an effort to mitigate volatility in earnings without having to apply complex hedge accounting provisions. SFAS 159 is applicable only to certain financial instruments and is effective for fiscal years beginning after November 15, 2007. The Company plans to adopt SFAS No. 159 effective January 1, 2008. The Company is in the process of determining the effect, if any, the adoption of SFAS No. 159 will have on its financial statements.

Note 3—Short-term Investment Income

In the first quarter of 2007, the Company’s management identified an error in its accrued interest income balances related to 2005 and 2006 that was corrected during the first quarter of 2007. The correction had the effect of reducing short-term investments and decreasing interest income by $660. The correction has decreased income from continuing operations before income taxes by $660 and income from continuing operations by $500. Although this correction was an out-of-period adjustment, the Company’s management determined that the effect on previously filed reports was not material.

Note 4—Certain Balance Sheet Items

Property and equipment consist of the following:

	As of December 31, 2006				As of March 31, 2007
Machinery and equipment		$	1,414			$	1,391
Office furniture and fixtures		3,345				3,658
Leasehold improvements		2,830				2,823
Software		3,606				4,289
		11,195				12,161
Less: Accumulated depreciation		(5,213		)		(5,602		)
Property and equipment, net		$	5,982			$	6,559

Note 5—Business Combinations

In July 2004, the Company completed the acquisition of QDesign Corporation for $1,500 in cash. Under the terms of the acquisition, the Company also contingently agreed to pay an additional amount up to a maximum of $450 in cash, which is held by the Company in a restricted account. The Company classifies the restricted cash in other current and non-current assets. The contingent payment is being accounted for as compensation expense ratably over the three-year period ending July 2007, and will be paid out if certain criteria are met. Two payments of $150 each were made, one in 2005 and the other in 2006.

Note 6—Bank Line of Credit

The Company has a $10,000 unsecured working capital facility that expires on June 30, 2007, and is renewable annually. The bank agreement requires the Company to comply with certain covenants including a tangible effective net worth of $60,000, increasing by 50% of net income on an annual basis. The covenants also require the Company to keep $2,000 in cash or securities at the issuing bank. At March 31, 2007, the Company was compliant with all covenants under the bank agreement.

At March 31, 2007, there was no balance outstanding and $10,000 of available borrowings under this credit facility. Future borrowings will bear interest based on either of the two options the Company selects

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at the time of advances 1) a rate equal to 2% above the bank’s LIBOR, or 2) a rate equal to the Base Rate as quoted from the bank less one-half percent. The annual commitment fee for this line of credit is not material.

Note 7—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 Company’s products and technology, guarantees of timely performance of the Company’s obligations, and indemnities to the Company’s directors and officers to the maximum extent permitted by law. The duration of these indemnities, commitments and guarantees varies, and in certain cases, is indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments that the Company could be obligated to make. The Company has not recorded a liability for these indemnities, commitments or guarantees in the accompanying balance sheets, as future payment is not probable.

Note 8—Income Taxes

For the three months ended March 31, 2007, the Company recorded an income tax provision of $1,050 on pre-tax income from continuing operations of $3,033. This resulted in an effective tax rate of 35%. These rates differed from the statutory rates primarily due to tax exempt interest and research and development credits. In determining the income tax provision for continuing operations, the continuing operations were considered a stand alone entity. The residual amount due to the difference between the income tax provision for the Company and the income tax provision for continuing operations was recorded in discontinued operations as its tax provision.

Effective January 1, 2007, the Company adopted FIN No. 48. The Company has also applied FSP FIN48-1, “Definition of Settlement in FASB Interpretation 48” to clarify when a tax position has been settled under paragraph 10(b) of FIN No. 48. Upon adoption of FIN No. 48, the Company recognized a $547 increase in tax reserves, which was accounted for as a reduction of $547 in the beginning retained earnings.

At the beginning of 2007, the Company’s liability for uncertain tax positions was $1.4 million, which was recorded in other long-term liabilities. The entire unrecognized tax benefits of $1.4 million 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. There were no significant changes in components of the liability in the first quarter of 2007. The Company does not currently anticipate its uncertain income tax positions will increase or decrease prior to March 31, 2008, however, developments in this area could differ from those currently expected. Such unrecognized tax positions, if ever recognized in the financial statements, would be recorded in the statement of operations as part of the income tax provision.

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 the event the Company has received an assessment for interest and penalties, such items have been classified in the financial statements as income tax expense.

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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 concluded its regular audit of the Company’s 2003 tax returns in June 2006.

Note 9—Comprehensive Income (Loss)

During the quarter ended March 31, 2007, the functional currency of one of the Company’s wholly-owned subsidiaries changed from the United States dollar to the currency of the primary economic environment in which it operates. The translation adjustments resulting from translating the functional currency into United States dollars of $40 has been deferred as a component of accumulated other comprehensive income in stockholders’ equity. Comprehensive income (loss) for the three months ended March 31, 2006 and 2007 is $7,007 and $(725), respectively.

Note 10—Operating Segment and Geographic Information

Prior to 2007, the Company operated its business in three reportable segments: the Consumer business segment, the Cinema business segment and the Digital Images business segment. In January 2007, the Company combined its Cinema and Digital Images businesses into a single business known as “DTS Digital Cinema.” In February 2007, the Company’s Board of Directors approved a plan to sell its DTS Digital Cinema business. Due to the plan of sale, DTS Digital Cinema has been classified as discontinued operations. Therefore, the Company’s continuing business operates as a single reporting unit previously known as the Consumer business.

The Company’s geographical information for the three months ended March 31, 2006 and 2007 are as follows:

	For the Three Months Ended March 31,
	2006		2007
United States	$	1,538	$	1,457
International	19,144		11,151
Total revenues	$	20,682	$	12,608

The following table sets forth, for the periods indicated, long-lived assets by geographic area in which the Company holds assets at December 31, 2006 and March 31, 2007:

	Long-Lived Assets
	As of December 31, 2006			As of March 31, 2007
United States		$	5,550		$	6,111
International		432			448
Total long-lived assets		$	5,982		$	6,559

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Note 11—Discontinued Operations

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 March 31, 2007.

	As of December 31, 2006			As of March 31, 2007
Assets:
Cash		$	2,705		$	837
Accounts receivable, net		4,922			5,011
Inventories		3,058			2,622
Prepaid expenses and other current assets		605			440
Assets of discontinued operations held for sale		11,290			8,910
Property and equipment, net		5,356			6,255
Intangible assets, net		16,572			16,341
Goodwill		3,585			3,585
Other		131			112
Assets of discontinued operations held for sale		25,644			26,293
Assets of discontinued operations held for sale		$	36,934		$	35,203
Liabilities:
Accounts payable		$	4,829		$	1,429
Accrued expenses and other liabilities		3,115			2,522
Liabilities of discontinued operations held for sale		7,944			3,951
Other long-term liabilities		1,466			1,469
Liabilities of discontinued operations held for sale		$	1,466		$	1,469
Liabilities of discontined operations held for sale		$	9,410		$	5,420
Net assets of discontinued operations held for sale		$	27,524		$	29,783

In presenting discontinued operations, general corporate overhead expenses that have been allocated historically to DTS Digital Cinema for segment presentation purposes are not included in discontinued operations. The following table presents revenue and expense information for the discontinued operations of DTS Digital Cinema for the three months ended March 31, 2006 and 2007.

	For the Three Months Ended March 31,
	2006			2007
Revenue	$	8,019		$	6,286
Pre-tax loss	(1,470		)	(4,352		)
Income tax benefit	1,812			1,604
Income (loss) from discontinued operations, net of tax	$	342		$	(2,748	)

Avica—A Variable Interest Entity

In November 2006, the Company closed a worldwide exclusive license agreement with Avica Technology Corporation (“Avica”), a provider of a suite of technologies, products and services that handle content delivery and presentation for digital distribution networks. Although the Company currently has no ownership interest in Avica, it is considered to be a variable interest entity of the Company, in conformity with FIN 46(R), “Consolidation of Variable Interest Entities—an Interpretation of Accounting

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Research Bulletin No.51,” as the Company is considered to be the primary beneficiary of Avica. Therefore, the Company has included the assets, liabilities, and results of operations of Avica in its consolidated financial statements from the date of the close of the license agreement. The Company expects the consolidation of Avica will continue to have an impact on its financial results from discontinued operations in future periods, because it will continue to recognize the operating losses generated by Avica given that Avica’s shareholders’ equity is in a net deficit position.

While the Company has consolidated the liabilities of Avica in accordance with FIN 46(R), it has no obligation to pay any amounts to any of Avica’s creditors. As such, creditors of Avica lack any recourse to the assets of the Company.

The changes to the Company’s total assets and total liabilities related to the consolidation of Avica included in the Company’s Consolidated Balance Sheets as assets and liabilities of discontinued operations held for sale as of December 31, 2006 were $3,616 and $3,878, respectively. The changes to the Company’s total assets and total liabilities related to the consolidation of Avica included in the Company’s Consolidated Balance Sheets as assets and liabilities of discontinued operations held for sale as of March 31, 2007 were $1,684 and $2,327, respectively. Included in the loss from discontinued operations, net of tax for the three months ended March 31, 2007 is Avica’s loss for this period of $381.

Note 12—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 ESPP using the “treasury stock” method.

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

	For the Three Months Ended March 31,
	2006		2007
Basic net income (loss) per common share:
Numerator:
Income from continuing operations	$	6,665	$	1,983
Income (loss) from discontinued operations	342		(2,748		)
Net income (loss)	$	7,007	$	(765	)
Denominator:
Weighted average common shares outstanding	17,495		17,965
Continuing operations	$	0.38	$	0.11
Discontinued operations	0.02		(0.15		)
Basic net income (loss) per common share	$	0.40	$	(0.04	)
Diluted net income (loss) per common share:
Numerator:
Income from continuing operations	$	6,665	$	1,983
Income (loss) from discontinued operations	342		(2,748		)
Net income (loss)	$	7,007	$	(765	)
Denominator:
Weighted average shares outstanding	17,495		17,965
Effect of dilutive securities:
Common stock options	776		664
Common stock warrants	21		3
Restricted stock	—		31
ESPP	—		10
Diluted shares outstanding	18,292		18,673
Continuing operations	$	0.36	$	0.11
Discontinued operations	0.02		(0.15		)
Diluted net income (loss) per common share	$	0.38	$	(0.04	)

For the three months ended March 31, 2006 and 2007, 1,144 and 155 shares, respectively, of the Company’s stock options and restricted stock were excluded from the calculation of diluted earnings/(loss) per share because their inclusion would have been anti-dilutive.

Note 13—Stock Repurchase Plan

In August 2006, the Company’s Board of Directors authorized, subject to certain business and market conditions, the purchase of up to one million shares of the Company’s common stock in the open market or in privately negotiated transactions. At March 31, 2007, there were no shares purchased under this authorization. Any shares repurchased would be considered treasury stock.

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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 entertainment technology, products and services to the audio and image entertainment markets worldwide. Historically we have been focused on high quality digital multi-channel audio, commonly referred to as surround sound, which provides more than two-channels of audio, allowing the listener to simultaneously hear discrete sounds from multiple speakers. Our DTS digital multi-channel audio technology delivers compelling surround sound for the motion picture and consumer electronics markets. We also provide high quality digital image processing, enhancement and restoration services for motion pictures, digital cinema, and television content.

In January 2007, we combined our Cinema and Digital Images businesses into a single business known as DTS Digital Cinema. In February 2007, our Board of Directors approved a plan to sell our DTS Digital Cinema business to enable us to focus exclusively on licensing branded entertainment technology to the large and evolving audio, game console, personal computer, portable and broadcast markets. The sales process has begun and is expected to conclude later in 2007. The DTS Digital Cinema business intends to focus on the potentially large and emerging market for digital cinema products and services. In accordance with SFAS No. 144, during the first quarter of 2007, DTS Digital Cinema’s assets and liabilities were classified as held for sale and its operations were reported as discontinued operations. As a result, we reclassified our balance sheets and statements of operations for all periods presented in this report to reflect DTS Digital Cinema as discontinued operations. In the statements of cash flows, the cash flows of discontinued operations are not separately classified or aggregated. The discontinued operations are reported in the respective categories of the statements of cash flows with those of continuing operations.

All discussions and amounts herein 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 also derive revenues from licensing our technology to consumer semiconductor manufacturers. Through our DTS Entertainment label, we derive revenues from the sale of multi-channel music titles in our digital multi-channel format.

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

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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 our normal operations, we cannot predict 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, depreciation of operations equipment, amortization of acquired intangibles and payments to third parties for licensing technology and copyrighted material.

Our selling, general, and administrative expenses consist primarily of salaries, commissions, and related benefits for personnel engaged in sales, corporate administration, finance, human resources, information systems, and legal 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 have a licensing team that markets our technology directly to large consumer electronics products manufacturers and semiconductor manufacturers. This team includes employees located in the United States, China, England, Japan, Hong Kong and Northern Ireland. We sell music content released under our DTS Entertainment label through exclusive distribution arrangements in the United States, Europe and Japan. We employ consultants to coordinate sales to independent retailers and we sell this music directly to consumers through an online store and other web-based retailers.

Management Discussion Regarding Trends, Opportunities, and Challenges

Trends, Opportunities, and Challenges

Our revenue is primarily dependent upon the DVD-based home theater market, which has experienced rapid growth over the past several years. However, we have recently experienced softness in our DVD player trademark licensing program, and expect continued softness in this area as the DVD player market transitions to high definition formats. The success of DVD-Video-based systems and products has fueled a demand for higher quality entertainment in the home, and this demand is extending to the car audio and personal computer markets as well. In addition, we expect the recent acceleration of the market for high definition televisions to drive demand for high definition optical disc players and advanced home theater systems over the next several years. Because we have been selected as a mandatory technology for next generation players, our revenue growth should more closely track the growth rate for sales of these players over the next several years. We expect that the market for high definition players will yield new growth that provides an offset to the expected further decline in DVD player shipments. Further, we believe that mandatory inclusion in next generation optical disc standards 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. If we are removed from mandatory status in next generation high definition optical disc standards, it would cause revenue growth to be significantly lower than expected and would have a material adverse effect on our business.

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In July 2004, we acquired QDesign Corporation, or QDesign, a company focused on lower bit-rate audio delivery technology. The market for higher quality entertainment is expanding into portable devices that require the use of low-bit rate audio coding systems including portable audio players, PDAs and wireless handset applications. Concurrent with this trend, there is a growing need for a good link between home and portable devices that preserves as much quality as possible and allows consumers a seamless technology solution for the storage and playback of their content. In October 2004, leveraging our existing research and development efforts and the intellectual property acquired in the QDesign acquisition, we launched our DTS-HD initiative. This technology is a scalable coding system that will allow content to be played in home and portable devices. We believe that the broad and robust nature of this offering improves the probability of inclusion of our technologies in next generation products.

In January 2007, we announced a partnership with Coding Technologies which will allow high definition broadcasts of MPEG-4 transmissions in the advanced AAC-Plus audio codec to be transcoded to DTS Digital Surround in set-top boxes for playout through DTS-capable AV receivers. This DTS/Coding Technologies solution has been adopted as a mandatory part of Norway’s digital terrestrial set-top box standard.

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, inventories, intangible assets, income taxes, impairment of long-lived assets, stock-based compensation, and contingencies and litigation. 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. There has been no material change to our critical accounting policies and estimates from the information provided in our Form 10-K filed on March 16, 2007.

Results of Operations

Revenues

Revenues for the three months ended March 31, 2007 decreased 39% to $12.6 million from $20.7 million for the three months ended March 31, 2006. The decrease in revenues was primarily attributable to a decrease in royalty recoveries of $9.2 million from intellectual property compliance and enforcement activities. We are continuing to experience solid growth in revenues from the car audio systems market, which more than doubled during the first quarter of 2007 relative to the first quarter of 2006. In addition, we received our first revenue contributions from Blu-ray Disc and HD DVD during the quarter ended March 31, 2007, with such royalties comprising over 5% of total revenue for the period. However, we remain cautious in our overall outlook due to uncertainties surrounding the consumer electronics market, particularly with respect to the timing and rate of adoption of the new high definition formats. We continue to expect technology licensing revenues to grow modestly in 2007, driven primarily by expected contributions from Blu-ray Disc and HD DVD based products such as game consoles, PCs and DVD players.

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Gross Profit

Consolidated gross profit for the three months ended March 31, 2007 and 2006, was 98% of revenues in both periods. We expect consolidated gross margins in the 97% to 98% range for 2007.

Selling, General and Administrative (“SG&A”)

SG&A expenses for the three months ended March 31, 2007 increased 11% to $8.1 million from $7.3 million for the three months ended March 31, 2006. The increase is primarily due to salaries and related costs, and increases in stock-based compensation expense related to additional employee equity grants since March 31, 2006. We also incurred additional expenses related to professional services to support our continued growth.

We expect SG&A expenses to increase to support our growth initiatives including acquisitions, international expansion and intellectual property enforcement activities related to the launch of our DTS-HD initiative.

Research and Development (“R&D”)

R&D expenses for the three months ended March 31, 2007 and 2006, was $1.6 million in both periods. During the first quarter of 2007, we received expense reimbursements under certain research grants totaling approximately $0.2 million which was offset by small spending increases in salaries and related expenses. We will continue to invest in R&D to support our broadening product development agenda and the ongoing support of the rollout of Blu-Ray Disc and HD/DVD, and thus expect to see sequential growth through the remainder of the year.

Interest and other Income, Net

Interest income, net, for the three months ended March 31, 2007 decreased 66% to $0.4 million from $1.1 million for the three months ended March 31, 2006. The decrease is primarily related to an adjustment recorded in the current period to correct an error. In the first quarter of 2007, management identified an error in our accrued interest income balances related to 2005 and 2006 that was corrected during the first quarter of 2007. The correction had the effect of reducing short-term investments and decreasing interest income by $0.7 million. The correction has decreased income from continuing operations before income taxes by $0.7 million and income from continuing operations by $0.5 million. Although this correction was an out-of-period adjustment, management determined that the effect on previously filed reports was not material. Going forward, we expect interest income for the year to be approximately $3.5 million, based on the current interest rate environment and current investment balances and allocations.

Income Taxes

For the three months ended March 31, 2007, we recorded an income tax provision of $1.1 million on pre-tax income from continuing operations of $3.0 million. For the three months ended March 31, 2006, we recorded an income tax provision of $5.8 million on pre-tax income from continuing operations of $12.5 million.

Discontinued Operations

Loss from discontinued operations, net of tax, for the three months ended March 31, 2007 was $2.8 million compared to income from discontinued operations, net of tax, of $0.3 million for the three months ended March 31, 2006. This decrease of $3.1 million from $0.5 million for the three months ended March 31, 2006 is largely the result of a decrease in net sales of $1.7 million, partially offset by a decrease

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in cost of sales of $1.0 million. There was also an increase of $1.6 million in SG&A expense and an increase in R&D expense of $0.6 million. The decrease in revenue relates primarily to the recognition of approximately $1.3 million in deferred revenue and additional revenue from one customer in the three months ended March 31, 2006. The change in cost of sales is due to the decreased sales. The increased SG&A expenses is largely the result of professional service fees relating to the sales process. The increase in R&D expenses is primarily due to severance payments, additional stock-based compensation and professional services.

While we believe the likelihood of an impairment of the DTS Digital Cinema business is remote, there can be no assurance that a sale of these assets subsequent to quarter end will not result in an impairment.

Liquidity and Capital Resources

At March 31, 2007, we had cash, cash equivalents and short-term investments of $103.7 million, compared to $108.8 million at December 31, 2006.

Net cash used in operating activities was $5.8 million for the three months ended March 31, 2007, compared to net cash provided by operating activities of $9.4 million for the three months ended March 31, 2006. The primary drivers of the cash used in operations were a combination of paying down our accounts payable in advance of converting to a new enterprise resource planning system on April 2 and an increase in accrued royalties. In April, we returned to our normal vendor payment cycle under the new system, and we should see the collection of accrued royalties in the near term.

Net cash provided by investing activities totaled $7.6 million for the three months ended March 31, 2007, compared to net cash used in investing activities of $13.3 million for the three months ended March 31, 2006. Cash provided by investing activities for the three months ended March 31, 2007 primarily consists of net sales of available for sale investments and maturation of held to maturity securities of $9.8 million in total, offset by purchases of property and equipment of $2.1 million, including capitalized costs of our new enterprise resource planning system for $0.7 million.

Net cash provided by financing activities totaled $1.0 million and $0.4 million for the three months ended March 31, 2007 and 2006, respectively, and primarily consists of the exercise of stock options and related excess tax benefits.

In 2005, we entered into an agreement for the purchase and implementation of a new enterprise resource planning system, or ERP, for approximately $0.7 million. We expect that we will incur additional costs in the range of $1 million to $2 million over the next several years in connection with our ERP implementation. From inception of this project through March 31, 2007, we incurred approximately $4.7 million, of which $3.9 million has been capitalized to software.

On August 1, 2006, our Board of Directors authorized, subject to certain business and market conditions, the purchase of up to one million shares of our common stock in the open market or in privately negotiated transactions. Through May 10, 2007, there were no shares purchased under this authorization. Any shares repurchased would be considered treasury stock.

In August 2006, we announced that we were studying the potential separation of our business and in November 2006, we announced our intent to proceed with the separation of our Cinema and Digital Images businesses from our Consumer licensing business. In January 2007, we combined our Cinema and Digital Images businesses into a single business known as “DTS Digital Cinema.” In February 2007, we announced that our Board of Directors had approved a plan to sell our DTS Digital Cinema business, which was created through the combination and restructuring of our Cinema and Digital Images businesses, to enable us to focus exclusively on licensing branded entertainment technology to the large and evolving audio, game console, personal computer, portable and broadcast markets. We are continuing to fund the obligations of the DTS Digital Cinema business, and will through the close of a sale

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transaction. All expenses incurred relating to the sales transaction while classified as discontinued operations will continue to affect our liquidity and capital resources and utilize portions of the cash that is generated or held by DTS, Inc. At this time, we are unable in good faith to make a full determination of the estimated expenses which will be incurred relating to the sales transaction. The sales process has begun and is expected to conclude later in 2007.

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 16, 2007 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.

Recently Issued Accounting Standards

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” This Standard allows companies to elect to follow fair value accounting for certain financial assets and liabilities in an effort to mitigate volatility in earnings without having to apply complex hedge accounting provisions. SFAS 159 is applicable only to certain financial instruments and is effective for fiscal years beginning after November 15, 2007. We plan to adopt SFAS No. 159 effective January 1, 2008. We are in the process of determining the effect, if any, the adoption of SFAS No. 159 will have on our financial statements.

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. At March 31, 2007, we did not have any balances outstanding under our bank line of credit arrangement; however, the amount of outstanding debt at any time may fluctuate and we may from time to time be subject to refinancing risk.

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 marketable securities, U.S. government securities and corporate bonds. 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. The average duration of our investment portfolio is typically less than 90 days. As of March 31, 2007, a 1% 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.

We derive in the range of 88% of our revenues from continuing operations from sales outside the United States, and maintain research, sales, marketing, or business development offices in nine countries. 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 limited foreign currency risk on certain revenues and operating expenses such as salaries and overhead costs of our foreign operations and cash

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maintained by these operations. Revenues denominated in foreign currencies accounted for approximately 3% of total revenues during the three months ended March 31, 2007. Operating expenses, including cost of sales, for our foreign subsidiaries were approximately $0.6 million in the three months ended March 31, 2007. Based upon the expenses for the three months ended March 31, 2007, a 1% change in foreign currency rates throughout a one-year period would have an immaterial annual effect on operating income.

Our international business is subject to risks, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility when compared to the United States dollar. Accordingly, our future results could be materially impacted by changes in these or other factors.

We are also affected by exchange rate fluctuations as the financial statements of our foreign subsidiaries are translated into the United States dollar in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and could adversely or positively impact overall profitability. During the three months ended March 31, 2007, 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

Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rules 13a-l5(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.

There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II

OTHER INFORMATION

Item 1.Legal Proceedings

None.

Item 1A.Risk Factors

Set forth below and elsewhere in this report and in other documents we file with the SEC are risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this report and other public statements we make. If any of the following risks actually occurs, our business, financial condition, or results of operations could suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.

Risks Related to Our Business

The sale of our DTS Digital Cinema business or any failure to successfully manage and complete an undertaken sales transaction could adversely affect our business and operating results.

In order to better address rapidly evolving markets, meet the needs of customers and increase stockholder value, we are proceeding with the sale of our DTS Digital Cinema business. The sales process may be costly. The sale might not be accomplished by the end of 2007 or at all. The sales process requires significant time and attention from our management, finance, accounting and legal teams, which could disrupt our day-to-day operations and shift the allocation of these resources away from matters related to our core business. In addition, implementing any transaction would involve a number of operational, legal and, possibly, regulatory steps. Implementation could be costly, cause further disruption to our day-to-day operations, and result in the loss of customers and/or sales revenue, which could cause our business and operating results to suffer. Furthermore, implementation of a sale is a complicated process and there is a risk that we may not be successful in the execution of our sales strategy, which could cause our business to suffer and our stock price to decline.

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 entertainment industry and the consumer electronics products industry. If we fail to promote and maintain our brand successfully, our business and prospects may suffer. Moreover, we believe that the likelihood that our technologies will be adopted in industry standards depends, in part, upon the strength of our brand, because professional organizations and industry participants are more likely to incorporate technologies developed by a well-respected and well-known brand into standards. Maintaining and strengthening our brand will depend heavily on our ability to develop innovative technologies for the entertainment industry, to continue to provide high quality products and services, and manage brand transition in connection with the process of selling the DTS Digital Cinema business, which we may not do successfully.

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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:

·rapid technological change;

·new and improved product introductions;

·changing customer demands;

·evolving industry standards; and

·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:

·our patents may be challenged or invalidated by our competitors;

·our pending patent applications may not issue, or if issued, may not provide meaningful protection for related products or proprietary rights;

·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;

·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;

·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;

·our competitors may produce competitive products or services that do not unlawfully infringe upon our intellectual property rights;

·efforts to identify and prosecute unauthorized uses of our technology are time consuming, expensive, and divert resources from the operation of our business; and

·we may be unable to successfully identify or prosecute unauthorized uses of our technology.

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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 face intense competition. Many of our competitors have greater brand recognition and resources than we do.

The digital audio, digital imaging, consumer electronics, cinema and entertainment markets are intensely competitive, subject to rapid change, and significantly affected by new product introductions and other market activities of industry participants. Our principal competitor is Dolby Laboratories, Inc., who competes with us in most of our markets. We also compete with other companies offering:

·digital audio technology incorporated into consumer electronics products and entertainment mediums, including Coding Technologies, Fraunhofer Institut Integrierte Schaltungen, Koninklijke Philips Electronics N.V. (Philips), Meridian Audio Limited, Microsoft Corporation, Sony Corporation, and Thomson;

·products for cinema markets, such as Smart Devices, Inc., Ultra Stereo Labs, Inc., Eastman Kodak Company, Screenvision Cinema Network LLC, National CineMedia LLC, Doremi Labs, Inc. and Unique Digital Ltd.;

·digital image processing, enhancement and restoration services, including Ascent Media Group, EFILM LLC, Imax Corporation, Laser Pacific Media Corporation, Modern Video Film, Inc., Sunset Digital, Technicolor Media Services, and Warner Bros. Entertainment, Inc.

·products for image processing including da Vinci Systems, LLC, Digital Vision AB, Mathematical Technologies, Inc., Pixel Farm Ltd., Snell and Wilcox, Teranex Incorporated, and The Foundry Visionmongers Ltd.

Many of our current and potential competitors enjoy substantial competitive advantages, including:

·greater name recognition;

·a longer operating history;

·more developed distribution channels and deeper relationships with our common customer base;

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·a more extensive customer base;

·digital technologies that provide features that ours do not;

·broader product and service offerings;

·greater resources for competitive activities, such as research and development, strategic acquisitions, alliances, joint ventures, sales and marketing, and lobbying industry and government standards;

·more technicians and engineers; and

·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 and has a larger base of installed movie theaters for its cinema playback equipment. Its technology has been incorporated in significantly more DVD-Video films than our technology. It has also achieved mandatory standard status in product categories that we have not, including DVD-Video and DVD-Audio Recordable, for its stereo technology and terrestrial digital television broadcasts in the United States. It also currently has more depth in digital cinema. As a result of these factors, Dolby has a competitive advantage in selling its digital multi-channel audio technology to consumer electronics products manufacturers and in selling products and services designed for use in the digital cinema space.

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 do not expect sales of traditional consumer DVD players to sustain their past growth rates. To the extent that sales of DVD players and home theater systems level off or decline, 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.

Growth in our business over the past several years is due in large part to the rapid growth in sales of DVD players and home theater systems incorporating our technologies. As the markets for DVD players mature, we do not expect sales of traditional consumer DVD players to sustain their past growth rates. To the extent that sales of DVD players and home theater systems level off or decline, our business will be adversely affected. Additionally, the release and consumer adoption of next-generation optical disc players has only just begun. There are currently two competing formats for high-definition optical discs and consumers may not react favorably to having to make a choice between formats. There is also the risk of consumer confusion and frustration over the inability of a given format player to play a disc in the competing format. The slow uptake by consumers of these new formats, as well as the inability of traditional 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 traditional DVD players and home theater systems. Even assuming resolution of the competing disc format conflict, the rate of consumer adoption and ultimate penetration of next-generation optical disc players is uncertain and may be slower than past growth rates of traditional DVD players. In addition, if new technologies are developed for use with DVDs or new technologies are developed that substantially compete with or replace DVDs as a dominant medium for consumer video entertainment, our business, operating results and prospects will be adversely affected.

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We have limited control over existing and potential customers’ and licensees’ decisions to include our technology in certain of their product offerings.

We are dependent on our customers and licensees—including consumer electronics products manufacturers, semiconductor manufacturers, movie theaters, producers and distributors of content for music, films, videos, and games and builders and integrators of digital cinema networks—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 other than builders and integrators of digital cinema networks, 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.

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 products 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 released with DTS audio soundtracks. 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 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.

The market for consumer video products is also intensely competitive and price sensitive. Retail prices for consumer video products have experienced price pressure and we expect this price pressure to continue for the foreseeable future. Declining retail prices for such video products could create downward pressure on the fees we charge our customers for the image processing, enhancement and restoration services we

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provide. If the motion picture studios, content owners, producers or distributors were to believe that the existing image quality is satisfactory or that the pricing for our services is too high, they could decide to not use our services 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 technologies into these ICs, which are then incorporated in consumer electronics products. We do not manufacture these ICs, but rather depend on IC manufacturers to develop, produce and then sell them to licensed consumer electronics product manufacturers. We do not control the IC manufacturers’ decisions whether or not to incorporate our technologies into their ICs, and we do not control their product development or commercialization efforts. If these IC manufacturers are unable or unwilling, for any reason, to implement our technologies into their ICs, or if, for any reason, they sell fewer ICs incorporating our technologies, our operating results will be adversely affected.

We rely on the accuracy of our customers’ manufacturing reports for reporting and collecting our revenues, and if these reports are untimely or incorrect, our revenues could be delayed or inaccurately reported.

A significant percentage of our revenues are generated from consumer electronics products 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.

Because we expect our operating expenses to increase in the future, we may not be able to sustain or increase our profitability.

Although we have been in business since 1990, we have only achieved annual profitability since fiscal 2001. We expect our operating expenses to increase as we, among other things:

·expand our domestic and international sales and marketing activities;

·develop and roll out our digital cinema products and services;

·proceed with the sale of our DTS Digital Cinema business;

·restructure our international operations;

·adopt a more product-centric business model which is expected to entail additional hiring;

·acquire businesses or technologies and integrate them into our existing organization;

·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;

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

·continue to assume the responsibilities of being a public company.

As a result, we will need to grow our revenues in order to maintain and increase our 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:

·acceptance of, and demand for, our products and technology;

·the costs of developing new products or technology;

·the extent to which we invest in new technology and research and development projects, including without limitation, digital cinema;

·the number and timing of acquisitions and other strategic transactions;

·the extent to which we deploy our digital cinema products to theaters;

·the costs associated with our expansion, if any; and

·the sale of our DTS Digital Cinema business.

In the future, we may need to raise additional funds, and such funds may not be available on favorable terms, or at all. Furthermore, if we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution, and the new equity or debt securities may have rights, preferences, and privileges senior to those of our existing stockholders. If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our products and services, execute our business plan, take advantage of future opportunities, or respond to competitive pressures or unanticipated customer requirements. This may materially harm our business, results of operations, and financial condition.

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. In addition, while we have completed over 100 digital image processing, enhancement and restoration film projects, it is only recently that a large number of these projects have been completed. 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 and image services 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

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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.

Issues arising from the implementation of our new enterprise resource planning system could affect our operating results and ability to manage our business effectively.

We recently began to implement an enterprise resource planning, or ERP, system to enhance operating efficiencies and provide more effective management of our business operations. Implementing a new ERP system is costly and involves risks inherent in the conversion to a new computer system, including disruption to our normal accounting procedures and internal control over financial reporting and problems achieving accuracy in the conversion of electronic data. Failure to properly or adequately address these issues could result in increased costs, the diversion of management’s and employees’ attention and resources and could materially adversely affect our operating results, internal control over financial reporting and ability to manage our business effectively. While the ERP system is intended to improve and enhance our information systems, large scale implementation of new information systems exposes us to the risks of start up of the new system and integration of that system with our existing systems and processes, including possible disruption of our financial reporting, which could lead to a failure to make required filings under the federal securities laws on a timely basis. In addition, if we fail to implement the ERP system or fail to implement the ERP system successfully, we will continue to rely on our current information systems.

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

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to include in our annual reports on Form 10-K our assessment of the effectiveness of our internal controls over financial reporting. We cannot assure you that our system of internal controls will be effective in the future as our operations and control environment change. If we cannot adequately maintain the effectiveness of our internal controls over financial reporting, our financial reporting may be inaccurate. If reporting errors actually occur, we could be subject to sanctions or investigation by regulatory authorities, such as the SEC. These results could adversely affect our financial results or the market price of our common stock. If our independent registered public accounting firm is unable to provide us with an unqualified report as to the adequacy of our internal controls over financial reporting as required by Section 404 of the Sarbanes Oxley Act of 2002, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our stock.

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

We market and sell our products and services outside the United States, and currently have employees located in more than ten countries worldwide. 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. During fiscal 2006, approximately 71% of our revenues were derived internationally. We face numerous risks in doing business outside the United States, including:

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

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

·difficulties in staffing and managing foreign operations;

·competition from foreign companies;

·dependence on foreign distributors and their sales channels;

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

·less effective and less predictable protection of intellectual property;

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

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

·potentially adverse tax consequences.

Such factors could cause our future international sales to decline.

Our business practices in international markets are also subject to the requirements of the Foreign Corrupt Practices Act. If any of our employees is found to have violated these requirements, we could be subject to significant fines and other penalties.

Our international revenue is mostly denominated in U.S. dollars. As a result, fluctuations in the value of the U.S. dollar and foreign currencies may make our technology, products, and services more expensive for international customers, which could cause them to decrease their purchases from us. Expenses for our subsidiaries are denominated in their respective local currencies. Significant fluctuations in the value of the U.S. dollar and foreign currencies could have a material impact on our consolidated financial statements. The main foreign currencies we encounter in our operations are the Yen, Euro, 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. These countries have periodically conducted military exercises in or near the other’s territorial waters and airspace. 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.

A prolonged economic downturn could materially harm our business.

Negative trends in the general economy, including trends resulting from 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 on entertainment in general. Any reduction in consumer confidence or disposable income in general may affect the demand for consumer electronics products that incorporate

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our digital audio technology and demand by film studios and movie theaters for our cinema products and services.

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

We acquired DTS DI in January 2005, and we expect to consider additional 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, including without limitation the potential acquisition of substantially all of the assets of Avica. 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 charges, capital expenditures, and transaction expenses;

·diversion of management’s attention from our core business;

·adverse effects on existing business relationships with suppliers and customers;

·risks associated with entering markets in which we have no or limited prior experience;

·unanticipated or unknown liabilities relating to the acquired businesses;

·the need to integrate accounting, management information, manufacturing, human resources and other administrative systems to permit effective management; and

·potential loss of key employees of acquired organizations.

If we fail to properly evaluate and execute acquisitions and strategic investments, our management team may be distracted from our day-to-day operations, our business may be disrupted, and our operating results may suffer. In addition, if we finance acquisitions by issuing equity or convertible debt securities, our existing stockholders would be diluted. Foreign acquisitions involve unique risks in addition to those mentioned above, including those related to integration of operations across different geographies, cultures and languages, currency risks and risks associated with the particular economic, political and regulatory environment in specific countries. Also, the anticipated benefit of our acquisitions may not materialize, whether because of failure to obtain stockholder approval or otherwise. Future acquisitions could result in potentially dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities or amortization expenses, or write-offs of goodwill, any of which could harm our operating results or financial condition. Future acquisitions may also require us to obtain additional equity or debt financing, which may not be available on favorable terms or at all.

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

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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. For instance, our acquisition of DTS DI required significant time and attention from our management team. Any future growth could cause similar management challenges or create distractions.

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. In our consumer business, consumer electronics manufacturing activities are generally lowest in the first calendar quarter of each year, and increase progressively throughout the remainder of the year. Manufacturing output is generally strongest in the third and fourth quarters as our technology licensees increase manufacturing to prepare for the holiday buying season. Since recognition of revenues in our consumer business generally lags manufacturing activity by one quarter, our revenues and earnings from the consumer business are generally lowest in the second quarter. Film licensing revenues are generally strongest in the second and fourth quarters due to the abundance of movies typically released during the summer and year-end holiday seasons. 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. Similar issues may affect our cinema hardware business during the expected transition to digital cinema. Our revenues may continue to be subject to fluctuations, seasonal or otherwise, in the future. Unanticipated fluctuations, whether due to seasonality, product cycles, or otherwise, could cause us to miss our earnings projections, or could lead to higher than normal variation in short-term earnings, either of which could cause our stock price to decline.

In addition, we actively engage in intellectual property compliance and enforcement activities focused on identifying third parties who have either incorporated our technology, trademarks, or know-how without a license or who have underreported to us the amount of royalties owed under license agreements with us. As a result of these activities, from time to time, we may recognize royalty revenues that relate to consumer electronics manufacturing activities from prior periods and we may incur expenditures related to enforcement activity. These expenditures and royalty recoveries, as applicable, may cause revenues to be higher than expected, or net profit to be lower than expected, during a particular reporting period and may not recur in future reporting periods. Such fluctuations in our revenues and operating results may cause declines in our stock price.

Even if our technologies are adopted as an industry standard for a particular market, market participants may not widely adopt our technologies.

Even if a standards-setting body mandates our technologies for a particular market, our technologies may not be the sole technologies adopted for that market as an industry standard. Accordingly, our

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business may depend upon participants in that market choosing to adopt our technologies instead of or in addition to competitive technologies that also may be acceptable under such 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 be unable to limit to whom we license such technologies, and may be unable to restrict many terms of the license. From time to time, we may be subject to claims that our licenses of our industry standard technologies may not conform to the requirements of the standards-setting body. Claimants in such cases could seek to restrict or change our licensing practices or our ability to license our technologies in ways that could injure our reputation and otherwise materially and adversely affect our business, operating results and prospects.

Our ability to develop proprietary technology in markets in which “open standards” are adopted may be limited, which could adversely affect our ability to generate revenue.

Standards-setting bodies, such as those for digital cinema technologies, 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:

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

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

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

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

The loss of key personnel or an inability to attract qualified personnel in a timely manner could slow our technology and product development and harm our ability to execute our business plan.

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

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

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customers or licensees not to use our technologies, or their failure or inability to pay amounts owed to us in a timely manner, or at all, could have a significant adverse effect on our business.

We may have additional tax liabilities.

We are subject to income taxes in both the United States and foreign jurisdictions. 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. 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 and High Definition-DVD and Blu-ray. In the standards for High Definition-DVD and Blu-ray, both DTS and Dolby technologies have been selected as mandatory standards for two-channel output. However, if either or both of these standards are re-examined or a new standard is developed, we may not be included as mandatory in any such new or revised standard which would cause revenue growth in our consumer business to be significantly lower than expected and could have a material adverse affect on our business.

Various national governments have adopted or are in the process of adopting standards for all digital television broadcasts, including cable, satellite, and terrestrial. In the United States, Dolby’s audio technology has been selected as the sole, mandatory audio standard for terrestrial digital television broadcasts. As a result, the audio for all digital terrestrial television broadcasts in the United States must include Dolby’s technology and must exclude any other format, including ours. We do not know whether this standard will be reopened or amended. If it is not, our audio technology may never be included in that standard. Certain large and developing markets, such as China, have not fully developed their digital television standards. Our technology may or may not ultimately be included in these standards.

As new technologies and entertainment media emerge, new standards relating to these technologies or media may develop. New standards may also emerge in existing markets that are currently characterized by competing formats, such as the market for personal computers. We may not be successful in our efforts to include our technology in any such standards.

We have limited experience in image processing, enhancement and restoration.

Although we have established relationships with a number of motion picture studios, content owners, producers and distributors, we do not have any contractual agreements that require them to provide us image content for processing. Further, the demand for image processing, enhancement and restoration of cinema, home video or broadcast television content may not materialize or accelerate as we anticipate, which would have a negative impact on our business.

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Our revenues from film producers and distributors and from the products and services that we offer to movie theaters would decline if the major U.S. film producers and distributors decrease or delay the number of films they release using DTS technology or services.

Although the major U.S. film producers and distributors are customers of ours, we generally do not have contractual arrangements that require them to use our DTS audio technology or our digital image services. Our cinema and digital images business depends on our having good relations with these film studios and other content owners. A deterioration in our relationship with any of these customers could cause them to stop using our DTS audio technology or our digital image enhancement services. Any significant decline or delay in the release of motion pictures with DTS audio soundtracks would decrease the demand for and revenues from the playback products and services that we offer to movie theaters. In addition, other motion picture studios, content owners, producers, and distributors throughout the world generally adopt and use the processes and the technologies used by the major U.S. film studios. Therefore, if the major U.S. motion picture studios, content owners, producers or distributors stop using our technology, we would not only lose the per-movie licensing fee we receive from these customers, but may also lose per-movie licensing fees from other film studios throughout the world. Furthermore, poor box-office performance caused by a weak film release calendar or declining consumer interest in the films being released could have a negative impact on the demand for the products and services we sell to the motion picture industry.

The movie theater industry has suffered and may continue to suffer from an oversupply of screens, which has affected and may continue to affect demand for the products and services we offer to movie theaters.

Our cinema business depends in part on the construction of new screens and the renovation of existing theaters that install our DTS playback systems and cinema processors. Over the past decade, aggressive building of megaplexes by companies that operate movie theaters has generated significant competition and resulted in an oversupply of screens in some domestic and international markets. The resulting oversupply of screens led to significant declines in revenues per screen and, eventually, to an inability by many major film exhibitors to satisfy their financial obligations. Several major movie theater operators have reorganized through bankruptcy proceedings, and many movie theaters have closed. As a result, our playback systems and cinema processors that we previously sold to movie theaters that have reorganized and closed have been relocated to other theaters or have been available for resale in the secondary market to movie theaters that might otherwise have purchased these products directly from us. More recently, the industry has experienced a decline in movie theater attendance. If this decline were to continue, exhibitors could see a decline in revenue per screen and, potentially, an inability to satisfy their financial obligations resulting in the closure of screens. If movie theater operators decide to close a significant number of screens in the future or cut their capital spending, demand for our playback systems and cinema processors will decline. Additionally, the expected transition to digital cinema could harm our legacy cinema business because operators may decide to delay procurement decisions as they wait to evaluate the widespread roll out of digital cinema, operators may decide to purchase digital cinema systems that do not require our existing products and services, and as existing screens are repurposed to digital cinema, the quantity of our existing products on the secondary market may increase significantly. These developments may harm our business and operating results.

The demand for our current or “legacy” cinema products and production services could decline if the film industry broadly adopts digital cinema.

If the film industry broadly adopts digital cinema, the demand for our current or “legacy” cinema products and production services could decline. If, in such circumstances, we are unable to adapt our professional products and production services or replace such business with new products for the market for digital cinema successfully, our business could be materially adversely affected.

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We depend on several sole and limited source suppliers, manufacturers, and distributors for some of our products, and the loss of any of these suppliers, manufacturers, or distributors could harm our business.

We purchase a small number of parts from sole-source suppliers. In addition, our professional audio encoding devices and movie theater playback systems are manufactured according to our specifications by single third-party manufacturers. Because we have no direct control over these third-party suppliers and manufacturers, interruptions or delays in the products and services provided by these third parties may be difficult to remedy in a timely fashion. In addition, if such suppliers or manufacturers are incapable of or unwilling to deliver the necessary parts or products, we may be unable to redesign our technology to work without such parts or find alternative suppliers or manufacturers. In such events, we could experience interruptions, delays, increased costs, or quality control problems.

We are subject to various environmental laws and regulations that could impose substantial costs upon us and may adversely affect our business, operating results and financial condition.

Some of our operations use substances regulated under various federal, state, local and international laws governing the environment, including those governing the discharge of pollutants into the air and water, the management, disposal and labeling of hazardous substances and wastes and the cleanup of contaminated sites. We could incur costs, fines and civil or criminal sanctions, third-party property damage or personal injury claims, or could be required to incur substantial investigation or remediation costs, if we were to violate or become liable under environmental laws. Liability under environmental laws can be joint and several and without regard to comparative fault. The ultimate costs under environmental laws and the timing of these costs are difficult to predict.

We also face increasing complexity in our product design as we adjust to new and future requirements relating to the materials composition of our products, including the restrictions on lead and other hazardous substances that apply to specified electronic products put on the market in the European Union, or EU, as of July 1, 2006 (Restriction on the Use of Hazardous Substances Directive 2002/95/EC, also known as the “RoHS Directive”) and similar legislation proposed for China.

For some products, substituting particular components containing regulated hazardous substances can be difficult or costly, and redesign efforts could result in production delays. Selected products that we maintain in inventory may be rendered obsolete if not in compliance with the RoHS Directive, which could negatively impact our ability to generate revenue from those products. We could also face significant costs and liabilities in connection with product take-back legislation. The European Union Directive 2002/96/EC as amended by 2003/108/EC (Waste Electrical and Electronic Equipment Directive also known as the “WEEE Directive”) requires producers of particular electrical and electronic equipment, including broadcast equipment, to be financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. As of December 2006, not all member states within the EU have enacted enabling legislation under the WEEE Directive, and in the absence of such legislation, it is difficult to determine the costs to comply with the WEEE Directive.

Other countries, such as China and the United States, may enact similar product-content and take-back legislation, the cumulative impact of which could significantly increase our operating costs and adversely affect our operating results. We also expect that our operations, whether manufacturing or licensing, will be affected by other new environmental laws and regulations on an ongoing basis. Although we cannot predict the ultimate impact of any such new laws and regulations, they will likely result in additional costs or decreased revenue, and could require that we redesign or change how we manufacture our products, any of which could have a material adverse effect on our business.

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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, including without limitation, the sale of our DTS Digital Cinema business;

·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;

·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.

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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, 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) In August 2006, our Board of Directors approved the repurchase of up to one million shares of our common stock in the open market or in privately negotiated transactions, depending upon market conditions and other factors. We have not made any purchases under this program and did not repurchase any shares under the program during the quarter ended March 31, 2007. As of March 31, 2007, we had authority to repurchase up to one million shares under that program.

Item 3.Defaults Upon Senior Securities

None.

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

None.

Item 5.Other Information

None.

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Item 6.Exhibits

Exhibit Number		Exhibit Description
	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

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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.
	by:	/s/ JON E. KIRCHNER
		Jon E. Kirchner
		President and Chief Executive Officer
		(Duly Authorized Officer)
Date: May 15, 2007
	by:	/s/ MELVIN L. FLANIGAN
		Melvin L. Flanigan
		Executive Vice President, Finance and
		Chief Financial Officer
		(Principal Financial and Accounting Officer)
Date: May 15, 2007

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