Edgar Filing: Dolby Laboratories, Inc.

Filed Pursuant to Rule 424(b)(4)

Filed Pursuant to Rule 424(b)(4)
Registration No. 333-120614

PROSPECTUS

27,500,000 Shares

LOGO

CLASS A COMMON STOCK

Dolby Laboratories, Inc. is offering 10,500,000 shares of its Class A common stock, and the selling stockholders are offering 17,000,000 shares of Class A common stock. We will not receive any proceeds from the sale of shares by the selling stockholders. This is our initial public offering, and no public market currently exists for our shares.

Following this offering, we will have two classes of authorized common stock, Class A common stock and Class B common stock. The rights of the holders of Class A common stock and Class B common stock are identical, except with respect to voting and conversion. Each share of Class A common stock is entitled to one vote per share. Each share of Class B common stock is entitled to ten votes per share and is convertible at any time at the option of the holder into one share of Class A common stock.

Our Class A common stock has been approved for listing on the New York Stock Exchange under the symbol “DLB.”

Investing in our Class A common stock involves risks. See “ Risk Factors” beginning on page 8.

PRICE $18 A SHARE


	*Price to Public*	*Underwriting* *Discounts and* *Commissions*	*Proceeds to* *Dolby* *Laboratories*	*Proceeds to* *Selling* *Stockholders*
Per Share	$18.00	$1.08	$16.92	$16.92
Total	$495,000,000	$29,700,000	$177,660,000	$287,640,000

We have granted the underwriters the right to purchase up to an additional 4,125,000 shares to cover over-allotments.

The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

Morgan Stanley & Co. Incorporated expects to deliver the shares to purchasers on February 23, 2005.


MORGAN STANLEY		GOLDMAN, SACHS & CO.


		JPMORGAN


ADAMS HARKNESS		WILLIAM BLAIR & COMPANY

February 16, 2005

LOGO

TABLE OF CONTENTS


		Page
Prospectus Summary		1
Risk Factors		8
Special Note Regarding Forward-Looking Statements and Industry Data		31
Use of Proceeds		32
Dividend Policy		32
Capitalization		33
Dilution		34
Selected Consolidated Financial Data		35
Pro Forma Unaudited Consolidated Statements of Operations Data		37
Management’s Discussion and Analysis of Financial Condition and Results of Operations		40


		Page
Business		70
Management		98
Certain Relationships and Related Party Transactions		112
Principal and Selling Stockholders		114
Description of Capital Stock		116
Shares Eligible for Future Sale		121
Underwriters		123
Legal Matters		127
Experts		127
Where You Can Find Additional Information		127
Index to Financial Statements		F-1

You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of our Class A common stock only in jurisdictions where offers and sales are permitted. The information in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of shares of our Class A common stock.

Until March 13, 2005 (25 days after the commencement of this offering), all dealers that buy, sell or trade shares of our Class A common stock, whether or not participating in this offering, may be required to deliver a prospectus. This delivery requirement is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information you should consider in making your investment decision. You should read this summary together with the more detailed information, including our financial statements and the related notes, elsewhere in this prospectus. You should carefully consider, among other things, the matters discussed in “Risk Factors.”

DOLBY LABORATORIES, INC.

Dolby Laboratories develops and delivers products and technologies that make the entertainment experience more realistic and immersive in theatres, homes, cars and elsewhere. Since Ray Dolby founded Dolby Laboratories nearly 40 years ago, we have been at the forefront of developing sound technologies that enhance the entertainment experience. Our objective is to be an essential element in the best entertainment technologies for both professionals and consumers. Our technologies are used in sound recording, distribution and playback to faithfully recreate the original audio experience and enable digital audio and surround sound in applications such as movie soundtracks, DVDs, television, satellite and cable broadcasts, video games and personal computers. Our technologies have been adopted as standards throughout the entertainment industry. For example, virtually all major movie soundtracks throughout the world are encoded using our technologies, and virtually all DVD players incorporate our technologies. We believe that the Dolby brand is recognized globally for quality sound technologies. In fiscal 2004, our total revenue was $289.0 million and our net income was $39.8 million, or $0.47 per share, basic and $0.43 per share, diluted. Our total revenue was $84.3 million and our net income was $10.4 million, or $0.12 per share, basic and $0.11 per share, diluted, for the fiscal quarter ended December 31, 2004. On a pro forma basis, our net income was $63.3 million, or $0.74 per share, basic and $0.68 per share, diluted, and $16.9 million, or $0.19 per share, basic and $0.17 per share, diluted, for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively. See “Pro Forma Unaudited Consolidated Statements of Operations Data—Pro Forma Presentation,” for a detailed explanation of our pro forma statements of operations data included in this prospectus.

Our products, services and technologies are used throughout the entertainment chain—from content creation, such as movie studios; to distribution for large-scale playback, such as movie theatres; to repackaging and distribution for consumer media, such as DVDs; to consumer playback, such as DVD players and home theatre systems. We have built strong, long-lasting relationships with industry professionals at every link in the entertainment chain. The following graphic illustrates our participation in this entertainment chain with respect to content for movies:

LOGO

On the professional side, we sell products and provide production services to filmmakers, cinema operators, broadcasters, music producers and video game designers. Our products and production services are used by artists and content creators to help them record and reproduce the sound they envision. For large-scale playback in theatres, cinema operators use our products to play back to audiences rich, realistic soundtracks the way the filmmakers intended. Television, satellite and cable broadcasters use our encoders and decoders to transmit audio encoded with our technologies throughout the broadcast infrastructure and into consumers’ homes. When entertainment content is produced for playback on consumer media, DVD producers use our professional encoders to capture the source audio on DVDs. Our professional products are distributed in over 50 countries and we have sold over 77,000 cinema processors worldwide. Our products and technologies have been used in the production of over 16,000 movies, tens of thousands of DVD titles and hundreds of video game titles worldwide. We manufacture our professional products in our Brisbane, California and Wootton Bassett, England manufacturing facilities, where our manufacturing techniques and rigorous test procedures help ensure that our products meet customer requirements. Professional products and production services revenue represented 27% and 26% of our total revenue in fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively.

On the consumer side, we license our sound technologies to consumer electronics product manufacturers who incorporate these technologies into a wide range of consumer products such as DVD players, home theatre systems, television sets, set-top boxes, video game consoles, portable audio and video players, personal computers and in-car entertainment systems. In addition, we license our technologies to software developers who implement our technologies for use in personal computer software DVD players. Our licensing arrangements typically entitle us to receive a royalty for every product shipped incorporating our technologies. Our technologies are incorporated in products sold by approximately 500 consumer electronics product manufacturers and software developers located in nearly 30 countries. Over 1.7 billion consumer electronics products sold worldwide have incorporated our licensed technologies, including over 640 million consumer electronics products since the beginning of fiscal 2002. Our Dolby Digital technologies alone have been incorporated in over 270 million DVD players and over 90 million audio/video receivers and set-top boxes. Licensing revenue represented 73% and 74% of our total revenue in fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively.

In recent years, we have expanded our business beyond sound to include other technologies that facilitate the delivery of digital entertainment, such as technologies that process digital moving images or protect content from piracy, as well as products and services to facilitate the cinema industry’s change from 35 mm film projection to digital cinema, an all digital medium for the distribution and exhibition of movies.

Key Dolby Strengths

Our ability to develop and deliver innovative technologies for both professional and consumer applications is founded on the following key strengths:

Our culture and history of innovation;

Our longstanding relationships with industry participants throughout the entertainment chain;

The widespread adoption of our technologies as industry standards;

Our global leadership in the market for surround sound technologies;

Our neutral position among competing industry participants or groups;

The global strength of the Dolby brand; and

Our experienced management team and highly skilled employee base.

Our Strategy

Key elements of our strategy include:

Encouraging the continued expansion of the markets for surround sound;

Continuing to develop new technologies for the needs of industry professionals;

Developing system solutions for digital cinema;

Developing technologies for the entertainment industry beyond sound;

Continuing to promote the adoption of our technologies as industry standards; and

Building upon the strength of the Dolby brand.

Industry

The global entertainment industry is in the midst of a transition from analog to digital technologies. New digital media formats and products, such as DVD players and recorders, HDTV, digital cable and personal computer-based video, music and game systems, have led to enhanced consumer entertainment experiences in homes, cars and elsewhere. Sales of digital-based consumer electronics products have increased significantly in recent years. For example, according to independent market research firm International Data Corporation, or IDC, worldwide DVD player shipments increased from approximately 13.5 million in 2000 to approximately 89.9 million in 2003, a compound annual growth rate of approximately 88%. IDC expects worldwide DVD player shipments to grow at a compound annual growth rate of 16.4% from 2003 through 2008. In addition, the growing installed base of home theatre systems with surround sound capabilities enables television broadcasters to offer programming with digital audio comparable in quality to that of DVDs. Governments worldwide are driving digital broadcasting by mandating that broadcasters transition to digital transmission, including in the United States, where all local terrestrial, or over-the-air, television stations are supposed to broadcast with a digital signal. Personal computers have also played an important role in driving the adoption of digital technology, especially for multi-media applications.

Corporate Information

We were founded in London, England in 1965 and incorporated as a New York corporation in 1967. We reincorporated in California in 1976 and reincorporated in Delaware in September 2004. Our principal executive offices are located at 100 Potrero Avenue, San Francisco, California 94103, and our telephone number is (415) 558-0200. Our web site address is www.dolby.com. The information on our web site is not part of this prospectus.

Dolby, Dolby Digital, Dolby Headphone, Dolby SR, Dolby Surround, EQ Assist, MLP, Surround EX and the double-D symbol are registered trademarks of Dolby Laboratories in the United States and other countries. This prospectus also includes other registered and unregistered trademarks of Dolby Laboratories and trademarks of other persons.

THE OFFERING


Shares of Class A common stock offered:
By us		10,500,000 shares
By the selling stockholders		17,000,000 shares
Total		27,500,000 shares

Shares of common stock to be outstanding after this offering:
Class A		27,500,000 shares
Class B		69,862,135 shares
Total		97,362,135 shares

Use of proceeds		General corporate purposes, including working capital, and possible acquisitions of complementary businesses, technologies or other assets. We intend to use a portion of our working capital, including cash we receive from the proceeds of the offering, as well as the cash generated from our operations, to fund the costs of operating as a public company, including the anticipated increase in legal and compliance costs. We will not receive any of the proceeds from the sale of shares by the selling stockholders. See “Use of Proceeds.”

NYSE symbol		DLB

The shares of Class A common stock offered by us and the selling stockholders in this offering will represent 28.2% of the total shares of common stock to be outstanding after this offering.

The number of shares of Class A and Class B common stock that will be outstanding after this offering is based on the number of shares outstanding at December 31, 2004, and excludes:

12,990,950 shares of Class B common stock issuable upon the exercise of options outstanding at December 31, 2004, at a weighted average exercise price of $1.89 per share;

127,000 shares of Class B common stock issuable upon the exercise of options granted after December 31, 2004, at an exercise price of $14.50 per share.

6,000,000 shares of Class A common stock available for future issuance under our 2005 Stock Plan; and

1,000,000 shares of Class A common stock available for future issuance under our Employee Stock Purchase Plan.

Unless otherwise indicated, all information in this prospectus assumes that the underwriters do not exercise their over-allotment option to purchase 4,125,000 additional shares of Class A common stock in this offering and reflects:

A five-for-one split of our common stock that occurred in January 2005; and

The conversion of all outstanding shares of our common stock into shares of Class B common stock in January 2005.

SUMMARY CONSOLIDATED FINANCIAL DATA

The following tables summarize consolidated financial data regarding our business and should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and the related notes included elsewhere in this prospectus. Our fiscal year is a 52- or 53-week period ending on the last Friday in September. The fiscal years presented include the 52-week periods ended September 27, 2002, September 26, 2003 and September 24, 2004, respectively. Our 2005 fiscal year contains 53 weeks and ends on September 30, 2005. Our first quarter of fiscal 2005 consisted of 14 weeks as compared to the first quarter of fiscal 2004, which consisted of 13 weeks.


	Actual									Actual
	Fiscal Year Ended									Fiscal Quarter Ended
	Sep 27, 2002			Sep 26, 2003			Sep 24, 2004			Dec 26, 2003			Dec 31, 2004
										(unaudited)
	(in thousands, except per share data)
Consolidated Statements of Operations Data:
Revenue:
Licensing	$	106,640		$	157,922		$	211,395		$	47,799		$	62,191
Product sales		41,377			44,403			57,981			13,392			16,487
Production services		13,851			15,147			19,665			4,232			5,585

Total revenue		161,868			217,472			289,041			65,423			84,263

Cost of revenue:
Cost of licensing		25,063			40,001			53,838			12,781			16,149
Cost of product sales (includes $0.1 million and $0.1 million in stock-based compensation for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively) (1)		26,694			26,684			30,043			6,896			8,812
Cost of production services (includes $36,000 and $26,000 in stock-based compensation for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively) (1)		5,960			6,958			7,624			1,587			2,015

Total cost of revenue		57,717			73,643			91,505			21,264			26,976

Gross margin		104,151			143,829			197,536			44,159			57,287
Operating expenses:
Selling, general and administrative (includes $5.8 million, $4,000 and $2.2 million in stock-based compensation for fiscal 2004 and the fiscal quarters ended December 26, 2003 and December 31, 2004, respectively) (1)		64,269			76,590			106,456			20,092			32,857
Research and development (includes $0.8 million and $0.7 million in stock-based compensation for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively) (1)		15,128			18,262			23,479			4,934			8,289
Settlements		24,205			—			(2,000	)		—			(2,000	)
In-process research and development		—			1,310			1,738			—			—

Total operating expenses		103,602			96,162			129,673			25,026			39,146

Operating income		549			47,667			67,863			19,133			18,141
Other income (expenses), net		(747	)		(57	)		229			224			287

Income (loss) before provision for income taxes and controlling interest		(198	)		47,610			68,092			19,357			18,428
Provision for income taxes		11			16,079			27,321			6,825			7,743

Income (loss) before controlling interest		(209	)		31,531			40,771			12,532			10,685
Controlling interest in net (income) loss		104			(562	)		(929	)		(286	)		(308	)

Net income (loss)	$	(105	)	$	30,969		$	39,842		$	12,246		$	10,377

Basic net income (loss) per common share	$	0.00		$	0.36		$	0.47		$	0.14		$	0.12
Diluted net income (loss) per common share	$	0.00		$	0.36		$	0.43		$	0.14		$	0.11

Shares used in the calculation of basic net income (loss) per share		85,008			85,009			85,556			85,010			86,788
Shares used in the calculation of diluted net income (loss) per share		85,008			86,084			92,783			90,518			97,819
(1) Stock-based compensation recorded in fiscal 2004 and the fiscal quarters ended December 26, 2003 and December 31, 2004 was classified as follows:

Cost of product sales							$	104		$	—		$	54
Cost of production services								36			—			26
Selling, general and administrative								5,843			4			2,187
Research and development								810			—			681

Total stock-based compensation							$	6,793		$	4		$	2,948

Pro Forma Presentation

On February 16, 2005, Ray Dolby, our founder, contributed to us all of the rights he held in intellectual property related to our business, which he previously licensed to us in exchange for royalty payments. Upon the completion of this asset contribution, all of our licensing arrangements with, and related royalty obligations to, Ray Dolby terminated. The following summary pro forma unaudited consolidated statements of operations data give effect to the asset contribution made by Ray Dolby, as well as the effects of a previous change in certain licensing arrangements with Ray Dolby in June 2002, as though such transactions had been completed prior to the beginning of fiscal 2002. There will be no material change to our balance sheet as a result of the asset contribution. See “Pro Forma Unaudited Consolidated Statements of Operations Data—Pro Forma Presentation.”


	Pro Forma									Pro Forma
	Fiscal Year Ended									Fiscal Quarter Ended
	Sep 27, 2002			Sep 26, 2003			Sep 24, 2004			Dec 26, 2003			Dec 31, 2004
	(unaudited)
	(in thousands, except per share data)
Pro Forma Consolidated Statements of Operations Data:
Revenue:
Licensing	$	113,361		$	157,922		$	211,395		$	47,799		$	62,191
Product sales		41,377			44,403			57,981			13,392			16,487
Production services		13,851			15,147			19,665			4,232			5,585

Total revenue		168,589			217,472			289,041			65,423			84,263

Cost of revenue:
Cost of licensing		8,685			14,875			20,070			4,668			5,998
Cost of product sales (includes $0.1 million and $0.1 million in stock-based compensation for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively) (1)		24,281			24,190			26,954			6,139			7,910
Cost of production services (includes $36,000 and $26,000 in stock-based compensation for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively) (1)		5,960			6,958			7,624			1,587			2,015

Total cost of revenue		38,926			46,023			54,648			12,394			15,923

Gross margin		129,663			171,449			234,393			53,029			68,340
Operating expenses:
Selling, general and administrative (includes $5.8 million, $4,000 and $2.2 million in stock-based compensation for fiscal 2004 and the fiscal quarters ended December 26, 2003 and December 31, 2004, respectively) (1)		70,297			76,590			106,456			20,092			32,857
Research and development (includes $0.8 million and $0.7 million in stock-based compensation for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively) (1)		15,128			18,262			23,479			4,934			8,289
Settlements		24,205			—			(2,000	)		—			(2,000	)
In-process research and development		—			1,310			1,738			—			—

Total operating expenses		109,630			96,162			129,673			25,026			39,146

Operating income		20,033			75,287			104,720			28,003			29,194
Other income (expenses), net		(747	)		(57	)		229			224			287

Income (loss) before provision for income taxes and controlling interest		19,286			75,230			104,949			28,227			29,481
Provision for income taxes		7,884			26,714			40,676			10,243			12,260

Income (loss) before controlling interest		11,402			48,516			64,273			17,984			17,221
Controlling interest in net (income) loss		104			(562	)		(929	)		(286	)		(308	)

Net income (loss)	$	11,506		$	47,954		$	63,344		$	17,698		$	16,913

Basic net income (loss) per common share	$	0.14		$	0.56		$	0.74		$	0.21		$	0.19
Diluted net income (loss) per common share	$	0.14		$	0.56		$	0.68		$	0.20		$	0.17

Shares used in the calculation of basic net income (loss) per share		85,008			85,009			85,556			85,010			86,788
Shares used in the calculation of diluted net income (loss) per share		85,010			86,084			92,783			90,518			97,819
(1) Stock-based compensation recorded in fiscal 2004 and the fiscal quarters ended December 26, 2003 and December 31, 2004 was classified as follows:

Cost of product sales							$	104		$	—		$	54
Cost of production services								36			—			26
Selling, general and administrative								5,843			4			2,187
Research and development								810			—			681

Total stock-based compensation							$	6,793		$	4		$	2,948

The consolidated balance sheet data table below presents a summary of our balance sheet as of December 31, 2004, on an actual basis and on an as adjusted basis to give effect to the receipt of net proceeds from the sale of 10,500,000 shares of Class A common stock by us in this offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, as set forth under “Use of Proceeds” and “Capitalization.”


	As of December 31, 2004
	Actual		As Adjusted
	(in thousands)
Summary Consolidated Balance Sheet Data:
Cash and cash equivalents	$	94,087	$	266,497
Working capital		77,413		249,823
Total assets		286,607		459,017
Total debt		14,800		14,800
Total stockholders’ equity		158,084		330,494

RISK FACTORS

You should carefully consider the risks described below before making an investment decision. The trading price of our Class A common stock could decline due to any of these risks and you may lose all or part of your investment as a result. In assessing the risks described below, you should also refer to the other information contained in this prospectus, including our consolidated financial statements and the related notes, before deciding to purchase any shares of our Class A common stock.

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.

Maintaining and strengthening the “Dolby” brand is critical to maintaining and expanding both our products and services business and our technology licensing business, as well as to our ability to enter new markets for our sound and other technologies. Our continued success is due, in part, to our reputation for providing high quality products, services and technologies across a wide range of entertainment industries, including the consumer electronics products industry. If we fail to promote and maintain the Dolby brand successfully on either the professional products and production services or the licensing sides of our business, our business and prospects will suffer. Moreover, we believe that the likelihood that our technologies will be adopted as industry standards in various markets and for various applications depends, in part, upon the strength of our brand, because professional organizations and industry participants are more likely to accept as an industry standard technologies developed by a well-respected and well-known brand. Maintaining and strengthening our brand will depend heavily on our ability to continue to develop innovative technologies for the entertainment industry and to continue to provide high quality products and services, which we may not do successfully. Moreover, because we engage in relatively little direct brand advertising, the promotion of our brand depends upon entertainment industry participants displaying our trademarks on their products that incorporate our technologies, such as film prints and consumer electronics products. Although we do not require our customers to place our brand on their products, we actively encourage them to do so. For example, we rely on consumer electronics product manufacturers that license our technologies to display our trademarks on their products in order to promote our brand. If our customers choose for any reason not to display our trademarks on their products, our ability to maintain or increase our brand awareness may be harmed, which would have an adverse effect on our business and prospects. In addition, if we fail to maintain high quality standards for our professional products, or if we fail to maintain high quality standards for the products that incorporate our technologies through the quality-control certification process that we require of our licensees, the strength of our brand could be adversely affected.

We are dependent on the sale by our licensees of consumer electronics products that incorporate our technologies, and a reduction in those sales would adversely affect our licensing revenue.

We derive most of our revenue from the licensing of our technologies to consumer electronics product manufacturers. We derived 66%, 73%, 73% and 74% of our total revenue from our technology licensing business in fiscal 2002, 2003, 2004 and in the fiscal quarter ended December 31, 2004, respectively. We do not manufacture consumer electronics products ourselves and our licensing revenue is dependent on sales by our licensees of consumer electronics products that incorporate our technologies. We cannot control these manufacturers’ product development or commercialization efforts or predict their success. In addition, our license agreements, which typically require manufacturers of consumer electronics products and software developers to pay us a specified royalty for every consumer electronics product shipped that incorporates our technologies, do not require these manufacturers to include our technologies in any specific number or percentage of units, and only a few of these agreements guarantee us a minimum aggregate licensing fee. Accordingly, if our licensees sell fewer products incorporating our technologies, or otherwise face significant economic difficulties, our revenue will decline. Moreover, we have a widespread presence in certain markets for consumer electronics products, such as the markets for DVD players, audio/video receivers and other home theatre consumer electronics products, and, as a result, there is little room for us to further penetrate such markets. Lower sales of products incorporating our technologies could occur for a number of reasons. Changes in

consumer tastes or trends, or changes in industry standards, may adversely affect our licensing revenue. Demand for new consumer electronics products incorporating our technologies could also be adversely affected by increasing market saturation, durability of products in the marketplace, competing products and alternate consumer entertainment options. In addition, our licensees, for whatever reason, may not choose to or may not be able to incorporate our technologies into their products in the future.

We do not expect sales of DVD players to continue to grow as quickly as they have in the past. To the extent that sales of DVD players and home theatre 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 licensing revenue will be adversely affected.

Growth in our revenue over the past several years has been the result, in large part, of the rapid growth in sales of DVD players and home theatre systems incorporating our technologies. However, as the markets for DVD players mature, we do not expect sales of DVD players to continue to grow as quickly as they have in the past. To the extent that sales of DVD players and home theatre systems level off or decline, our licensing revenue will be adversely affected. 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, and if we are unable to develop and successfully market technologies that are incorporated into or compatible with such new technologies, our business, operating results and prospects will be adversely affected.

If we fail to develop and deliver innovative technologies in response to changes in the entertainment industry, our business could decline.

The markets for our professional products and the markets for consumer electronics products utilizing our licensed technologies are characterized by rapid change and technological evolution. We will need to expend considerable resources on research and development in the future in order to continue to design and deliver enduring, innovative entertainment products and technologies. Despite our efforts, we may not be able to develop and effectively market new products, technologies and services that adequately or competitively address the needs of the changing marketplace. In addition, we may not correctly identify new or changing market trends at an early enough stage to capitalize on market opportunities. At times such changes can be dramatic, such as the shift from VHS tapes to DVDs for consumer playback of movies in homes and elsewhere. Our future success depends to a great extent on our ability to develop and deliver innovative technologies that are widely adopted in response to changes in the entertainment industry and that are compatible with the technologies or products introduced by other entertainment industry participants.

If our products and technologies fail to be adopted as industry standards, our business prospects could be limited and our operating results could be adversely affected.

The entertainment industry depends upon industry standards to ensure the compatibility of its content across a wide variety of entertainment systems and products. Accordingly, we expend significant efforts to ensure that our products and technologies have the necessary capabilities and are of sufficient quality and acceptable cost such that they either meet, or, more importantly, are adopted as, industry standards across the broad range of entertainment industry markets in which we participate, as well as the markets in which we hope to compete in the future, including digital cinema. To have our products and technologies adopted as industry standards, we must convince a broad spectrum of professional organizations throughout the world, as well as our major customers and licensees who are members of such organizations, to adopt them as such and to ensure that other industry standards are consistent with our products and technologies. If our technologies are not adopted or do not remain as industry standards, our business, operating results and prospects could be materially and adversely affected. We expect that meeting, maintaining and establishing industry standard technologies will continue to be critical to our business in the future. For example, we expect that the development of the market for digital cinema will be based upon industry standards. In addition, the market for broadcast technologies has traditionally been heavily based upon industry standards, often set by governments or other regulatory bodies, and we expect

this to continue to be the case in the future. If our technologies are not chosen as industry standards for broadcasting in particular geographic areas, this could adversely affect our ability to compete in these markets.

It may be more difficult for us, in the future, to have our technologies adopted as individual industry standards to the extent that entertainment industry participants collaborate on the development of industry standard technologies.

Increasingly, standards-setting organizations are adopting or establishing technology standards for use in a wide-range of consumer electronics products. As a result, it is more difficult for individual companies to have their technologies adopted wholesale as an informal industry standard. We call this type of standard a “de facto” industry standard, meaning that the standard is not explicitly mandated by any industry standards-setting body but is nonetheless widely adopted. In addition, increasingly there are a large number of companies, including ones that typically compete against one another, involved in the development of new technologies for use in consumer entertainment products. As a result, these companies often license their collective intellectual property rights as a group, making it more difficult for any single company to have its technologies adopted widely as a de facto industry standard or to have its technologies adopted as an exclusive, explicit industry standard for consumer electronic products.

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

Even when our technologies are mandated for a particular market by a standards-setting body, which we call an “explicit” industry standard, our technologies may not be the sole technologies adopted for that market as an industry standard. Accordingly, our operating results depend upon participants in that market choosing to adopt our technologies instead of competitive technologies that also may be acceptable under such standard. For example, the continued growth of our revenue from the broadcast market will depend upon both the continued adoption of digital television generally and the choice to use our technologies where it is an optional industry standard.

The licensing of patents constitutes a significant source of our revenue. If we are unable to replace expiring patents with new patents or proprietary technologies, our revenue could decline.

We hold patents covering much of the technology that we license to consumer electronics product manufacturers, and our licensing revenue is tied in large part to the life of those patents. Our right to receive royalties related to our patents terminates with the expiration of the last patent covering the relevant technologies. However, many of our licensees choose to continue to pay royalties for continued use of our trademarks and know-how even after the licensed patents have expired, although at a reduced royalty rate. Accordingly, to the extent that we do not continue to replace licensing revenue from technologies covered by expiring patents with licensing revenue based on new patents and proprietary technologies, our revenue could decline.

Including the patents to be assigned to us by Ray Dolby pursuant to the asset contribution described in “Certain Relationships and Related Party Transactions,” we have 895 individual issued patents and over 800 pending patent applications in nearly 40 jurisdictions throughout the world. Our issued patents are scheduled to expire at various times through April 2023. Of these, ten patents are scheduled to expire in calendar year 2005, 74 patents are scheduled to expire in calendar year 2006, and 50 patents are scheduled to expire in calendar year 2007. We derive our licensing revenue principally from our Dolby Digital technologies. Patents relating to our Dolby Digital technologies generally expire between 2008 and 2017, and patents relating to our Dolby Digital Plus technologies, an extension of Dolby Digital, expire between 2019 and 2020. In addition, two patents relating to Dolby Digital Live technologies, an extension of Dolby Digital, are scheduled to expire in 2021.

We have limited or no patent protection for our technologies in certain developing countries such as China and India, which could limit our ability to grow our business in these markets.

We have relatively few or no issued patents in certain countries, including China and India. For example, in China we have only limited patent protection, especially with respect to our Dolby Digital technologies. In India, we have no issued patents. As such, growing our licensing revenue in developing countries such as China and India will

depend on our ability to obtain patent rights in these counties for existing and new technologies, which is uncertain. Moreover, because of the limitations of the legal systems in many of these countries, the effectiveness of patents obtained or that may in the future be obtained, if any, is likewise uncertain.

We are, and may in the future be, subject to intellectual property rights claims, which are costly to defend, could require us to pay damages and could limit our ability to use certain technologies in the future.

Companies in the technology and entertainment industries own large numbers of patents, copyrights, trademarks and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. We have faced such claims in the past, we currently face such claims and we expect to face similar claims in the future. For example, Lucent has asserted that we infringe certain patents held by them, prompting us to file a complaint for declaratory judgment of non-infringement and invalidity of such Lucent patents. These patents generally involve a process and means for encoding and decoding audio signals. Lucent contends that products incorporating our AC-3 technology infringe those patents. A determination against us in the Lucent litigation could materially impact our technology licensing business, which may seriously harm our financial condition and results of operations. Any intellectual property claims, with or without merit, could be time-consuming, expensive to litigate or settle and could divert management resources and attention. For example, in the past we have settled claims relating to infringement allegations and agreed to make payments in connection with such settlements. An adverse determination could require that we pay damages or stop using technologies found to be in violation of a third party’s rights and could prevent us from offering our products and services to others. In order to avoid these restrictions, we may have to seek a license for the technology. This license may not be available on reasonable terms, could require us to pay significant royalties and may significantly increase our operating expenses. The technologies also may not be available for license to us at all. As a result, we may be required to develop alternative non-infringing technologies, which could require significant effort and expense. If we cannot license or develop technologies for any infringing aspects of our business, we may be forced to limit our product and service offerings and may be unable to compete effectively. In addition, at times in the past, we have chosen to defend our licensees from third-party intellectual property infringement claims even where such defense was not contractually required, and we may choose to take on such defense in the future. Any of these results could harm our brand, our operating results and our financial condition. In addition, from time to time we are engaged in disputes regarding the licensing of our intellectual property rights, including matters related to our royalty rates and other terms of our licensing arrangements. These types of disputes can be asserted by our customers or prospective customers or by other third parties as part of negotiations with us or in private actions seeking monetary damages or injunctive relief, or in regulatory actions. Recently InterVideo, one of our significant licensing customers with whom we recently renewed a licensing agreement, has threatened to initiate litigation against us regarding our licensing royalty rate practices, including potential antitrust claims. Damages and requests for injunctive relief asserted in a claim like this could be material, and could have a significant impact on our business. Any disputes with our customers or potential customers or other third parties could adversely affect our business, results of operations and prospects.

Third parties from whom we license technologies may challenge our calculation of the royalties we owe them for inclusion of their technologies in our products and licensed technologies, which could adversely affect our operating results, business and prospects.

In some cases, primarily in connection with the licensing of our Dolby Digital technologies, the products we sell and the technologies we license to our customers include intellectual property that we have licensed from third parties. Our agreements with these third parties generally require us to pay them royalties for that use, and give the third parties the right to audit our calculation of those royalties. As a result of such an audit, a third party could challenge the accuracy of our calculation. A successful challenge could increase the amount of royalties we have to pay to the third party, decrease our gross margin and adversely affect our operating results. Such a challenge could also impair our ability to continue to use and re-license intellectual property from that third party, which could adversely affect our business and prospects.

Our relationships with entertainment industry participants are particularly important to our professional products and production services and our technology licensing businesses, and if we fail to maintain such relationships our business could be materially harmed.

If we fail to maintain and expand our relationships with a broad range of participants throughout the entertainment chain, including motion picture studios, broadcasters, video game designers, music producers and manufacturers of consumer electronics products, our business and prospects could be materially harmed. Relationships have historically played an important role in the entertainment industries that we serve, both on the professional and consumer sides of our business. For example, our products and services business is particularly dependent upon our relationships with the major motion picture studios and broadcasters, and our technology licensing business is particularly dependent upon our relationships with consumer electronics product manufacturers, software developers and integrated circuit, or IC, manufacturers. If we fail to maintain and strengthen these relationships, these entertainment industry participants may be more likely not to purchase and use our products, services and technologies, which could materially harm our business and prospects. In addition to directly providing substantially all of our revenue, these relationships are also critical to our ability to have our technologies adopted as industry standards. Moreover, if we fail to maintain our relationships, or if we are not able to develop relationships in new markets in which we intend to compete in the future, including markets for new technologies and expanding geographic markets such as China and India, our business, operating results and prospects could be materially and adversely affected. In addition, if major industry participants form strategic relationships that exclude us, whether on the professional products and production services side or the licensing side of our business, our business and prospects could be materially adversely affected.

We rely on our licensees to accurately prepare royalty reports in determining our licensing revenue, and if these reports are inaccurate, our operating results could be materially adversely affected.

Our licensing revenue is generated primarily from consumer electronics product manufacturers and software developers who license our technologies and incorporate them in their products. Under our existing arrangements, these licensees typically pay us a specified royalty for every consumer electronics product they ship that incorporates our technologies. We rely on our licensees to accurately report the number of units shipped that incorporate our technologies. We calculate our license fees, prepare our financial reports, projections and budgets, and direct our sales and product development efforts based on these reports we receive from our licensees. However, it is often difficult for us to independently determine whether or not our licensees are reporting shipments accurately. This is especially true with respect to software incorporating our technologies because software can be copied relatively easily and we oftentimes do not have easy ways to determine how many copies have been made. Most of our license agreements permit us to audit our licensees’ records, but audits are generally expensive and time consuming and initiating audits could harm our customer relationships. To the extent that our licensees understate or fail to report the number of products incorporating our technologies that they ship, we will not collect and recognize revenue to which we are entitled, which would adversely affect our operating results.

Our operating results may fluctuate depending upon when we receive royalty reports from our licensees.

Our quarterly operating results may fluctuate depending upon when we receive royalty reports from our licensees. We recognize license revenue only after we receive royalty reports from our licensees regarding the shipment of their products that incorporate our technologies. As a result, the timing of our revenue is dependent upon the timing of our receipt of those reports. In addition, it is not uncommon for royalty reports to include corrective or retroactive royalties that cover extended periods of time. Furthermore, there have been times in the past when we have recognized an unusually large amount of licensing revenue from a licensee in a given quarter because not all of our revenue recognition criteria were met in prior periods. This can result in a large amount of licensing revenue from a licensee being recorded in a given quarter that is not necessarily indicative of the amounts of licensing revenue to be received from that licensee in future quarters, thus causing fluctuations in our operating results.

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 integrated circuits, or 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’ decision whether or not to incorporate our technologies into their ICs, and we do not control their product development or commercialization efforts nor predict their success. As a result, if these IC manufacturers are unable or unwilling, for any reason, to implement our technologies into their ICs, or if, for any reason, they sell fewer ICs incorporating our technologies, our operating results will be adversely affected.

Our future success depends, in part, upon the growth of new markets for surround sound technologies and our ability to develop and adapt our technologies for those new markets. If such markets fail to grow or we are unable to develop successful products for them, our business prospects could be limited.

We expect that the future growth of our licensing revenue will depend, in part, upon the growth of, and our successful participation in, new markets for surround sound technologies, including:

Digital broadcasting;

HDTV;

Broadband Internet;

Home DVD recording;

DVD-Audio;

Video games;

Personal audio and video players, including Internet music applications; and

In-car entertainment systems.

The development of these markets depends on increased consumer demand for surround sound products, which may not occur. Any failure of such markets to develop or consumer demand to grow would have a material adverse effect on our business and prospects. For example, only a small number of automobile manufacturers currently offer in-car entertainment systems incorporating our surround sound technologies, and those that do typically limit those systems only to certain models. Additional manufacturers may not offer surround sound entertainment systems, and, even if they do, the car models on which surround sound may be offered are likely to be, at least initially, limited to the high end of these manufacturers’ lines. Similarly, whether our revenue from digital broadcast networks and broadband Internet services increases depends upon the expansion of digital broadcast technologies and broadband Internet as a medium of entertainment, which may not occur. In addition, even when our technologies are adopted as industry standards for a particular market, such market may not be fully developed. In such case, our success depends not only on whether our technologies are adopted as industry standards for such market, but also on the development of that market, which may not occur. Demand for our technologies in any of these developing markets may not continue to grow, and a sufficiently broad base of consumers and professionals may not adopt or continue to use these technologies. In addition, our ability to generate revenue from these markets may be limited to the extent that service providers in these markets choose to provide certain technologies and entertainment for little or no cost, such as many of the services provided in connection with broadband Internet services. Moreover, some of these markets are ones in which we have not previously participated and, because of our limited experience, we may not be able to adequately adapt our business and our technologies to the needs of customers in these fields.

If the sale of consumer electronics products incorporating our technologies does not grow in emerging markets, our ability to increase our licensing revenue may be limited.

We also expect that growth in our licensing revenue will depend, in part, upon the growth of sales of consumer electronics products incorporating our technologies in other countries, including China and India, as consumers in these markets have more disposable income and are increasingly purchasing entertainment products with surround sound capabilities. However, if our licensing revenue from the use of our technologies in these new markets or geographic areas does not expand, our prospects could be adversely affected.

We face significant competition in various markets, and if we are unable to compete successfully, our business will suffer.

The markets for entertainment industry technologies are highly competitive, and we face competitive threats and pricing pressure in our markets. Competitors on the professional side of our business include Avica, Digital Theater Systems, EVS, GDC, Kodak, Microsoft, NEC, Panastereo, Sony and UltraStereo. Competitors on the consumer side of our business include Coding Technologies, Sony, Philips, Microsoft, RealNetworks, Digital Theater Systems, Fraunhofer Institute for Integrated Circuits, SRS Labs and Thomson. In addition, other companies may become competitors in the future. The quality of sound produced by some of our competitors’ technologies may be perceived by some people as equivalent or superior to that produced by ours. In addition, some of our current and/or future competitors may have significantly greater financial, technical, marketing and other resources than we do, or may have more experience or advantages in the markets in which they compete. For example, Microsoft and RealNetworks may have an advantage over us in the market for Internet technologies because of their greater experience and presence in that market. In addition, some of our current or potential competitors, such as Microsoft and RealNetworks, may be able to offer integrated system solutions in certain markets for sound or non-sound entertainment technologies, including audio, video and rights management technologies related to personal computers or the Internet, which could make competing technologies that we develop unnecessary. By offering an integrated system solution, these potential competitors also may be able to offer competing technologies at lower prices that our technologies, which could adversely affect our operating results. Further, many of the consumer electronics products that include our sound technologies also include sound technologies developed by our competitors. As a result, we must continue to invest significant resources in research and development in order to enhance our technologies and our existing products and services and introduce new high-quality products and services to meet the wide variety of such competitive pressures. Our business will suffer if we fail to do so successfully.

Some of our customers are also our current or potential competitors, and if those customers were to choose to utilize their competing technologies rather than ours, our business and operating results would be adversely affected.

We face competitive risks in situations where our customers are also current or potential competitors. For example, Sony is a significant licensee customer and is a significant purchaser of our professional products and production services, but Sony is also a competitor with respect to certain of our professional and consumer technologies. Sony’s plan to acquire Metro-Goldwyn-Mayer, which is also a significant purchaser of our professional products and production services, is expected to increase this potential competitive risk. In addition, Universal, a purchaser of our professional products and production services, has held an interest in Digital Theater Systems, one of our competitors. To the extent that our customers choose to utilize competing technologies they have developed or in which they have an interest, rather than utilizing our technologies, our business and operating results could be adversely affected.

Pricing pressures on the consumer electronics product manufacturers who incorporate our technologies into their products could limit the licensing fees we charge for our technologies, which could adversely affect our revenues.

The markets for the consumer electronics products in which our technologies are incorporated are intensely competitive and price sensitive. Retail prices for consumer electronics products that include our sound technology, such as DVD players and home theatre systems, have decreased significantly, and we expect prices to continue to decrease for the foreseeable future. In response, manufacturers have sought to reduce their product costs, which can result in downward pressure on the licensing fees we charge our customers who incorporate our technologies into the consumer electronics products that they sell. A decline in the licensing fees we charge could materially and adversely affect our operating results.

Surround sound technologies could be treated as a commodity in the future, which could adversely affect our business, operating results and prospects.

We believe that the success we have had licensing our surround sound technologies to consumer electronics product manufacturers is due, in part, to the strength of our brand and the perception that our technologies provide a high-quality solution for surround sound. However, as applications that incorporate surround sound technologies become increasingly prevalent, we expect more competitors to enter this field with other solutions. Furthermore, to the extent that competitors’ solutions are perceived, accurately or not, to provide the same advantages as our technologies, at a lower or comparable price, there is a risk that sound encoding technologies such as ours will be treated as commodities, resulting in loss of status of our technologies, decline in their use, and significant pricing pressure. To the extent that our audio technologies become a commodity, rather than a premium solution, our business, operating results and prospects could be adversely affected.

We face risks with respect to conducting business in China due to China’s historically limited recognition and enforcement of intellectual property and contractual rights.

The percentage of our licensing revenue from Chinese consumer electronics product manufacturers grew from 11% in fiscal 2002 to 16% in fiscal 2004. We expect this trend to continue in the future, as consumer electronics product manufacturing in China continues to increase due to the lower manufacturing cost structure there as compared to other industrial countries. We also expect that our sales of professional products and production services in China will expand in the future to the extent that the use of digital surround sound technologies increases in China, including in movies, broadcast television and video games. We further expect that the sale of consumer electronics products incorporating our technologies will increase in China to the extent that Chinese consumers become more affluent. However, we face many risks in China, in large part due to China’s historically limited recognition and enforcement of contractual and intellectual property rights. In particular, we have many times experienced, and expect to continue to experience, problems with Chinese consumer electronics product manufacturers failing to report or underreporting shipments of their products that incorporate our technologies or incorporating our technologies and trademarks into their products without our authorization and without paying us any licensing fees, which adversely affects our operating results. We may also experience difficulties in enforcing our intellectual property rights in China, where intellectual property rights are not as respected as they are in the United States, Japan and Europe. In addition, we have only limited patent protection in China, especially with respect to our Dolby Digital technologies, which may make it more difficult for us to enforce our intellectual property rights in China. We believe that it is critical that we strengthen existing relationships and develop new relationships with entertainment industry participants in China to increase our ability to enforce our intellectual property and contractual rights in China without relying solely on the Chinese legal system. If we are unable to develop, maintain and strengthen these relationships, our revenue from China could be adversely affected. However, developing, maintaining and strengthening relationships in China is especially difficult because of the multiple Chinese cultures and resulting fragmented nature of the Chinese economy. As a result, we must develop, maintain and strengthen relationships at each step of the entertainment chain in many different regions of China in order to successfully enforce our intellectual property and contractual rights in China.

We face diverse risks in our international business, which could adversely affect our operating results.

We are dependent on international sales for a substantial amount of our total revenue. For fiscal years ended 2002, 2003, 2004 and the fiscal quarter ended December 31, 2004, our sales outside the United States were 64%, 60%, 59% and 63%, respectively, of our professional products and production services revenue, and royalties from licensees outside the United States were 76%, 80%, 80% and 80%, respectively, of our licensing revenue. We expect that international and export sales will continue to represent a substantial portion of our revenue for the foreseeable future. This future revenue will depend to a large extent on the continued use and expansion of our technologies in entertainment industries worldwide. Increased worldwide use of our technologies is also an important factor in our future growth.

Due to our reliance on sales to customers outside the United States, we are subject to the risks of conducting business internationally, including:

Our ability to enforce our contractual and intellectual property rights, especially in those foreign countries that do not respect and protect intellectual property rights to the same extent as do the United States, Japan and European countries, which increases the risk of unauthorized, and uncompensated, use of our technology;

United States and foreign government trade restrictions, including those which may impose restrictions on importation of programming, technology or components to or from the United States;

Foreign government taxes, regulations and permit requirements, including foreign taxes that we may not be able to offset against taxes imposed upon us in the United States, and foreign tax and other laws limiting our ability to repatriate funds to the United States;

Foreign labor laws, regulations and restrictions;

Changes in diplomatic and trade relationships;

Difficulty in staffing and managing foreign operations;

Fluctuations in foreign currency exchange rates and interest rates, including risks related to any interest rate swap or other hedging activities we undertake;

Political instability, natural disasters, war and/or events of terrorism; and

The strength of international economies.

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

From time to time, one or a small number of our customers or licensees may represent a significant percentage of our professional or licensing revenue. Although we have agreements with many of these customers, these agreements typically do not require any minimum purchases or minimum royalty fees and do not prohibit customers from purchasing products and services from competitors. A decision by any of our major customers or licensees not to use our technologies, or their failure or inability to pay amounts owed to us in a timely manner, or at all, whether due to strategic redirections or adverse changes in their businesses or for other reasons, could have a significant effect on our operating results.

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

When our technologies are adopted as explicit industry standards by a standards-setting body, 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 must often limit the royalty rates we charge for these technologies, which could adversely affect our gross margins. 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. Private parties have raised this type of issue with us in the past. Allegations such as these could be asserted in private actions seeking monetary damages and injunctive relief, or in regulatory actions. 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.

Licensing some of our technologies in “patent pools” is a relatively new business model for us, and we may face many challenges in conducting this business.

In fiscal 2002, we began licensing some of our patents through our wholly-owned subsidiary Via Licensing Corporation in “patent pools” with other companies in an effort to ensure that our technologies are compatible with other technologies in the entertainment industry and to promote our technologies as industry standards. These patent pools are comprised of a group of patents held by a number of companies, including us in some cases, and administered by Via Licensing, that allow product manufacturers streamlined access to certain foundational technologies. This is a different business model for us and we cannot predict all of the challenges we may face or whether we will be successful. For instance, Via Licensing licenses patents in areas such as wireless markets in which we have not competed previously. As a result, our control over the license of our technologies from these patent pools may be limited as compared to our traditional business model in which we license our patents as bundles of technologies and interact directly with our customers. In addition, our control over the application and quality control of our technologies that are included in these pools may be limited.

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 freely available without the payment of a licensing fee or royalty. 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.

Events and conditions in the motion picture industry may affect sales of our professional products and production services.

We may be unable to significantly expand our current professional product sales in the cinema industry because our professional products are already used by the vast majority of major cinema operators and major motion picture studios in the United States and much of the rest of the world. If the cinema industry does not expand, or if it contracts, the demand for our professional products will be adversely affected.

Our ability to further penetrate the market for motion picture sound technologies is limited because of the widespread use of our current professional products by major motion picture content creators, distributors and cinema operators. As a result, our future revenue from our professional products for the cinema industry will depend, in part, upon events and conditions in that industry—specifically, the continued production and distribution of motion pictures, and the construction of new theatres and the renovation of existing theatres, using our products and services. For example, in the late 1990s cinema operators in the United States built a large number of new cinema megaplexes. This initially resulted in increased sales of our cinema processors, but also resulted in an oversupply of screens in some markets. This oversupply led to significant declines in new theatre construction in the United States in the early 2000s, resulting in a corresponding decline in sales of our cinema processors. As a result, future growth in sales of our existing cinema products may be limited, and may decrease in the future, as the number of new cinemas being built and the number of existing cinemas without our products continues to decline.

The piracy of motion pictures could adversely affect the motion picture industry and therefore our operating results.

The construction of new screens and the renovation of existing theatres, as well as the continued production of new motion pictures, are also adversely impacted by the growth in piracy of motion pictures. Technological advances and the conversion of motion pictures into digital formats have made it easier to create, transmit and “share” high-quality unauthorized copies of motion pictures, including on pirated DVDs and on the Internet. If cinema operators decide to close a significant number of screens in the future or cut their capital spending as a result of piracy, demand for our playback systems and cinema processors will decline, which could negatively impact our operating results.

If the market for digital cinema does not develop, our future prospects could be limited and our business could be adversely affected.

Digital cinema is a term used to describe movies that are delivered to and stored in movie theatres in electronic form rather than on film, and that are projected on theatre screens using digital projectors. The cinema industry is in the early stages of the adoption of digital cinema for the distribution and exhibition of movies. We are committed to helping the motion picture industry develop system solutions for digital cinema; this is our major initiative in our products and services segment. However, the conversion of movie theatres from film to digital cinema will require significant expenditures, and we cannot predict how quickly digital cinema will become widely adopted, if at all. There are at present only a very limited number of movie theatres that have been converted to digital cinema and we expect that the conversion of theatres to digital cinema technologies, if it occurs, will be a long-term process due to both technological and financial obstacles. Digital cinema may require a significant investment per screen by cinema operators. If the market for digital cinema fails to develop, or develops more slowly than expected, or if there is significant and sustained resistance by the motion picture industry or cinema operators to this technology or the cost of implementation, we may not realize significant returns on our investment in this area, which could adversely affect our operating results. In addition, because the conversion from film-based to digital cinema is in the early stages, it is impossible to predict accurately how the roles and allocation of costs among various industry participants may develop, if or how quickly digital cinema will be adopted and what, if any, industry standards may be adopted. In addition, it is possible that if a large number of cinema owners decide to convert their theatres to digital cinema over a relatively short period of time and our products are selected for these conversions, we may see an initial increase in professional product sales that will not likely be sustained over time.

If we are unable to develop successful products in the market for digital cinema, our future prospects could be limited and our business could be adversely affected.

Even if the market for digital cinema develops, we may not be successful in selling our products, technologies and services in this market, which could have a material adverse effect on our business and prospects. Our effort with respect to digital cinema is one of the areas where we are expanding our business beyond sound technology. As a result, our relative lack of experience in this area may harm our ability to compete successfully. A number of competitors and potential competitors, including Avica, EVS, GDC, Kodak, NEC, QuVis and Sony, are developing similar or alternative solutions for digital cinema, some of which may provide technological or cost advantages over our products, technologies and services. In addition, our products, technologies and services may not be compatible with the products and technologies developed by other companies for digital cinema. Moreover, it is possible that we will be selling components or technologies that will be incorporated into products sold by other companies, which would be a departure from our traditional business of manufacturing our own professional products and could limit our ability to control the distribution and use of our professional products. In addition, we are building components of the digital cinema delivery solution that are not solely related to sound and we do not have a long track record of providing these types of products, which may adversely affect our ability to compete in the digital cinema market. In this regard, our competitors may develop entire system solutions for digital cinema, which could make the technologies that we develop for incorporation in digital cinema systems unnecessary. In addition,

we expect that our digital cinema products, technologies and services may not be priced as low as those of our competitors, which may make it more difficult for us to compete or have our products and technologies become widely adopted. It is also possible that the professional products used for digital cinema will be sold pursuant to large, long-term contracts at a fixed price, which will be bid upon by potential suppliers. This would be a departure from our traditional model of selling our professional products pursuant to one-time contracts, and could expose us to various risks we have not faced in the past, including an inability to adjust the prices we charge for such services if our costs were to increase. This model also could subject us to potentially higher warranty and intellectual property rights claims.

The demand for our current professional 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 professional products and production services could decline. Such a decline in our products and services business could also adversely affect our technology licensing business, because the strength of our brand and our ability to use professional developments to advance our consumer licensing technologies would be impaired. If, in such circumstances, we are unable to adapt our professional products and production services or introduce new products for the market for digital cinema successfully, our business could be materially adversely affected.

If we are unable to expand our business into non-sound technologies, our future growth could be limited.

Our future growth will depend, in part, upon our expansion into areas beyond sound technologies. For example, in addition to our digital cinema initiative, we are exploring other areas that facilitate delivery of digital entertainment, such as technologies for processing digital moving images and content protection. We will need to spend considerable resources on research and development in the future in order to deliver innovative non-sound technologies. However, we have limited experience in these markets and, despite our efforts, we cannot predict whether we will be successful in developing and marketing non-sound products, technologies and services. In addition, many of these markets are relatively new and may not develop as we currently anticipate. Moreover, although we believe that many of the technological advances we may develop for digital cinema may have applicability in other areas, such as broadcasting or consumer electronics products, we may not ever be able to achieve these anticipated benefits in these other markets. A number of competitors and potential competitors may develop non-sound technologies similar to those that we develop, some of which may provide advantages over our products, technologies and services. Some of these competitors have much greater experience and expertise in the non-sound fields we may enter. The non-sound products, technologies and services we expect to market may not achieve or sustain market acceptance, may not meet the needs of the movie industry, and may not be accepted as industry standards. If we are unsuccessful in selling non-sound products, technologies and services, the future growth of our business may be limited. In addition, our efforts to enter or strengthen our positions in non-sound markets may be tied to the success of specific programs. For instance, our subsidiary, Cinea, is currently involved in a program to provide DVD players incorporating technologies intended to prevent the copying of DVDs to members of the Academy of Motion Picture Arts and Sciences for screening of Oscar nominated motion pictures before these DVDs are released to the general public. However, due to delays in our delivery of these DVD players to Academy members, we have received, and expect that we may continue to receive, negative publicity related to this program. If this program is not successful or there is continued adverse publicity associated with it or other programs, our reputation may be harmed and our ability to enter the market for content protection technologies, or markets for other non-sound technologies, could be adversely affected.

Fluctuations in our quarterly and annual operating results may adversely affect the value of our stock.

A number of factors, many of which are outside our control, may cause or contribute to significant fluctuations in our quarterly and annual revenue and operating results. These fluctuations may make financial planning and forecasting more difficult. In addition, these fluctuations may result in unanticipated decreases in our available cash, which could negatively impact our business and prospects. As discussed more fully below, these fluctuations also could increase the volatility of our stock price. Factors that may cause or contribute to fluctuations in our operating results and revenue include:

Fluctuations in demand for our products and for the consumer electronics products of our licensees;

Fluctuations in the timing of royalty reports we receive from our licensees, including late, sporadic or inaccurate reports;

Sporadic payments we may be able to recover from companies utilizing our technologies without a license;

Introduction or enhancement of products, services and technologies by us and our competitors, and market acceptance of these new or enhanced products, services and technologies;

Rapid, wholesale changes in technology in the entertainment industries in which we compete;

Events and conditions in the motion picture industry that affect the number of theatres constructed and the number of movies produced and exhibited, including box office receipts, the popularity of motion pictures generally and strikes by motion picture industry participants;

The financial resources of cinema operators available to buy our products or to equip their theatres to accommodate upgraded or new technologies;

Consolidation by participants in the markets in which we compete, which could result among other things in pricing pressure;

The amount and timing of our operating costs and capital expenditures, including those related to the expansion of our business, operations and infrastructure;

Variations in the time-to-market of our technologies in the entertainment industries in which we operate;

Seasonal consumer electronics product shipment patterns by our consumer electronics product licensees and seasonal product purchasing patterns by customers of our professional products;

The impact of, and our ability to react to, interruptions in the entertainment distribution chain, including as a result of work stoppages at our facilities, our customers’ facilities and other points throughout the entertainment distribution chain;

The impact of, and our ability to react to, political instability, natural disasters, war and/or events of terrorism;

Widespread illnesses such as the SARS illness and Avian Influenza, or Asian Bird Flu, in Asia that could impact our operations, or that could impact the operations of our professional products and production services customers or our consumer electronics product manufacturer licensees—for example, in the past our ability to visit our consumer electronics product manufacturer licensees in Asia was limited by travel restrictions imposed in response to SARS;

Changes in business cycles that affect the markets in which we sell our products and services or the markets for consumer electronics products incorporating our technologies;

Fluctuations in foreign currency exchange rates and interest rates, or our ability to hedge foreign currency risks through interest rate swaps or other hedging activities we undertake;

Adverse outcomes of litigation or governmental proceedings, including any foreign, federal, state or local tax assessments or audits; and

Costs of litigation and intellectual property protection.

One or more of the foregoing or other factors may cause our operating expenses to be disproportionately higher or lower or may cause our revenue and operating results to fluctuate significantly in any particular quarterly or annual period. Results from prior periods are thus not necessarily indicative of the results of future periods.

The loss of or interruption in operations of one or more of our key suppliers could materially delay or stop the production of our professional products and impair our ability to generate revenue.

Our reliance on outside suppliers for some of the key materials and components we use in manufacturing our professional products involves risks, including limited control over the price, timely delivery and quality of such components. We have no agreements with our suppliers to ensure continued supply of materials and components. Although we have identified alternate suppliers for most of our key materials and components, any required changes in our suppliers could cause material delays in our production operations and increase our production costs. In addition, our suppliers may not be able to meet our future production demands as to volume, quality or timeliness. Moreover, we rely on sole source suppliers for some of the components that we use to manufacture our professional products, including certain charged coupled devices, light emitting diodes and digital signal processors. These sole source suppliers may become unable or unwilling to deliver these components to us at an acceptable cost or at all, which could force us to redesign certain of our products. Our inability to obtain timely delivery of key components of acceptable quality, any significant increases in the prices of components, or the redesign of our professional products could result in material production delays, increased costs and reductions in shipments of our products, any of which could increase our operating costs, harm our customer relationships or materially and adversely affect our business and operating results.

Revenue from our professional products may suffer if our production processes encounter problems or if we are not able to match our production capacity to fluctuating levels of demand.

Our professional products are highly complex, and production difficulties or inefficiencies can interrupt production, resulting in our inability to deliver products on time in a cost effective manner, which could harm our competitive position. If production is interrupted at one of our two manufacturing facilities, we may not be able to shift production to the other facility on a timely basis, and customers may purchase products from our competitors. A shortage of manufacturing capacity for our professional products could adversely affect our operating results and damage our customer relationships. We generally cannot quickly adapt our manufacturing capacity to rapidly changing market conditions. Likewise, we may be unable to respond to fluctuations in customer demand. At times we underutilize our manufacturing facilities as a result of reduced demand for certain of our professional products. Any inability to respond to fluctuations in customer demand for our professional products may adversely affect our gross margins.

Our professional products, from time to time, experience quality problems that can result in decreased sales and higher operating expenses.

Our professional products are complex and sometimes contain undetected software or hardware errors, particularly when first introduced or when new versions are released. In addition, our professional products are sometimes combined with or incorporated into products from other vendors, sometimes making it difficult to identify the source of a problem. These errors could result in a loss of or delay in market acceptance of our professional products or cause delays in delivering them and meeting customer demands, any of which could reduce our revenue and raise significant customer relations issues. In addition, if our professional products contain errors we could be required to replace or reengineer them, which could increase our costs. Moreover, if any such errors cause unintended consequences, we could face claims for product liability. Although we generally attempt to contractually limit liability for defective products to the cost of repairing or replacing these products, if these contract provisions are not enforced or are unenforceable for any reason, or if liabilities arise that are not effectively limited, we could incur substantial costs in defending and settling product liability claims.

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. Certain of our products are subject to various federal, state and international laws governing chemical substances in electronic products. 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 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.

Our operating results may be adversely affected as a result of our compliance with the recently adopted European Waste Electrical and Electronic Equipment Directive and Restriction on Use of Hazardous Substances Directive.

The European Parliament has recently finalized the Waste Electrical and Electronic Equipment Directive, or WEEE Directive, which makes producers of electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. As a producer of electronic equipment, we will incur financial responsibility for the collection, recycling, treatment or disposal of products covered under the WEEE Directive. In addition, the European Parliament has enacted the Restriction on Use of Hazardous Substances Directive, or RoHS Directive, which restricts the use of certain hazardous substances in electrical and electronic equipment that are vital components in products we manufacture, including mercury, lead, cadmium and hexavalent chromium. We may need to redesign or reformulate products containing hazardous substances regulated under the RoHS Directive to reduce or eliminate those regulated hazardous substances in our products. For some products, substitutions for regulated hazardous substances may be difficult or costly to obtain or redesign efforts could result in production delays. Individual European member states are required to enact legislation to implement the two directives. Although the United Kingdom has not yet enacted legislation to implement these two directives, we are continuing to review the applicability and impact of both directives on the manufacturing of our professional products in our Wootton Bassett, England facility. We expect to incur increased manufacturing costs or production delays to comply with future legislation which implements these directives, but we cannot currently estimate the extent of such increased costs or production delays. However, to the extent that such cost increases or delays are substantial, our operating results could be materially adversely affected. In addition, similar legislation may be enacted in other countries, including federal and state legislation in the United States, the cumulative impact of which could significantly increase our operating costs and adversely affect our operating results.

The WEEE Directive and the RoHS Directive likely will impact some customers who license our technology and pay us royalties upon the sale of electronic products. If the directives result in fewer licensed consumer electronics products being sold, whether due to price increases, production delays, compromised product performance due to reformulation or redesign, or for other reasons, then we will receive less revenue in royalties. If the directives materially impair or inhibit such sales, the reduction in licensing revenue could adversely affect our operating results.

Any inability to protect our intellectual property rights could reduce the value of our products, services and brand.

Our business is dependent upon our patents, trademarks, trade secrets, copyrights and other intellectual property rights. We derived 66%, 73%, 73% and 74% of our total revenue from licensing revenue in fiscal years 2002, 2003, 2004 and in the fiscal quarter ended December 31, 2004, respectively. Effective intellectual property rights protection, however, may not be available under the laws of every country in which our products and services and those of our licensees are distributed. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Any significant impairment of our intellectual property rights could harm our business or our ability to compete. In addition, protecting our intellectual property rights is costly and time consuming. We have taken steps in the past to enforce our intellectual property rights and expect to continue to do so in the future. However, it may not be practicable or cost effective for us to enforce our intellectual property rights fully, particularly in certain developing countries or where the initiation of a claim might harm our business relationships. For example, we have many times experienced, and expect to continue to experience, problems with Chinese consumer electronics product manufacturers incorporating our technologies into their products without our authorization. If we are unable to successfully identify and stop unauthorized use of our intellectual property, we could experience increased operational and enforcement costs both inside and outside China, which could adversely affect our financial condition and results of operations. We generally seek patent protection for our innovations. It is possible, however, that some of these innovations may not be protectable. In addition, given the costs of obtaining patent protection, we may choose not to protect certain innovations that later turn out to be important. Moreover, we have limited or no patent protection in certain foreign jurisdictions. For example, in China we have only limited patent protection, especially with respect to our Dolby Digital technologies, and in India we have no issued patents. Furthermore, there is always the possibility, despite our efforts, that the scope of the protection gained will be insufficient or that an issued patent may later be found to be invalid or unenforceable. Moreover, we seek to maintain certain intellectual property as trade secrets. These trade secrets could be compromised by third parties, or intentionally or accidentally by our employees, which would cause us to lose the competitive advantage resulting from them.

It is possible that we may be treated as a personal holding company, which could adversely affect our operating results and financial condition.

The Internal Revenue Service may assert that we or any of our subsidiaries are currently, or previously have been, liable for personal holding company tax, plus interest and penalties, if applicable. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Accounting for Income Taxes” for a further explanation of matters relating to personal holding company tax issues. In addition, we and our subsidiaries may be liable for personal holding company tax in the future. The treatment of certain items of our income, and the income of our subsidiaries, for purposes of the personal holding company tax may be subject to challenge. In the event that we or any of our subsidiaries were determined to be a personal holding company, or for prior taxable years, to have been a personal holding company, we or the subsidiary could be liable for additional taxes, and possibly interest and penalties, based on the undistributed income and the tax rate in effect at that time, but only if we or our subsidiary, as the case may be, decides not to fully abate the tax by the payment of a dividend, although such a dividend will not eliminate interest and penalties. In addition, we believe that there exists a meaningful risk that in the relatively near future the mix of our revenue will change so that more of our adjusted ordinary gross income may be classified as personal holding company income. In such event, it is possible that we or one of our subsidiaries could become liable for the personal holding company tax, assuming the ownership test continues to be met. In that case, we or our subsidiary, as the case may be, may be required to pay additional tax, in the event we or the subsidiary decides not to fully abate the tax by the payment of a dividend. Because no claim or assessment has been made against us with respect to personal holding company taxes, we are unable to quantify the amount of any additional taxes, and possibly interest and penalties, for which we may be liable in the future for past periods or the amount of the dividend that we may pay to abate the tax. Furthermore, we are unable to quantify the amount of personal holding company tax that we may be liable for or the dividend that we may elect to pay for future periods as such

amounts, if any, would be based upon the application of the rules discussed above to the results of our future operations. We are currently exploring options to reduce our exposure, and the exposure of our subsidiaries, to the personal holding company tax in the future.

If we or any of our subsidiaries were to pay personal holding company tax (and possibly interest and penalties), this could significantly increase our consolidated tax expense and adversely affect our operating results. In addition, if the statutory tax rate increases in the future, the amount of any personal holding company tax we or any of our subsidiaries may have to pay could increase significantly, further impairing our operating results. In that regard, the statutory tax rate, which is currently 15%, is scheduled to return to ordinary income tax rate levels for tax years beginning on or after January 1, 2009. If we are deemed to be a personal holding company and, instead of paying the personal holding company tax, we elect to pay a dividend to our stockholders in an amount equal to all or a significant part of our undistributed personal holding company income, we may consume a significant amount of cash resources and be unable to retain or generate working capital. This would adversely affect our financial condition. As a result, if we pay such a dividend, we may decide to seek additional financing, although that financing may not be available to us when and as required on commercially reasonable terms, if at all.

Failure to comply with applicable current and future government regulations could have a negative effect on our business.

Our operations and business practices are subject to federal, state and local government laws and regulations, as well as international laws and regulations, including those relating to consumer and other safety-related compliance for electronic equipment, as well as compulsory license requirements as a prerequisite to being included as part of the industry standards, such as the United States HDTV standard. Any failure by us to comply with the laws and regulations applicable to us or our products could result in our inability to sell those products, additional costs to redesign products to meet such laws and regulations, fines or other administrative actions by the agencies charged with enforcing compliance and, possibly, damages awarded to persons claiming injury as the result of our non-compliance. Changes in or enactment of new statutes, rules or regulations applicable to us could have a material adverse effect on our business.

Acquisitions could result in operating difficulties, dilution to our stockholders and other harmful consequences.

We have evaluated, and expect to continue to evaluate, a wide array of possible strategic transactions and acquisitions. For example, we consider these types of transactions in connection with our efforts to expand our business beyond sound technologies, such as in digital cinema and other technologies related to the delivery of digital entertainment. Although we cannot predict whether or not we will complete any such acquisition or other transactions in the future and have no current plans for any specific strategic transactions or acquisitions, any of these transactions could be material in relation to our financial condition and results of operations. The process of integrating an acquired company, business or technology may create unforeseen difficulties and expenditures. The areas where we may face risks include:

Diversion of management time and focus from operating our business to acquisition integration challenges;

Cultural challenges associated with integrating employees from acquired businesses into our organization;

Retaining employees from businesses we acquire;

The need to implement or improve internal controls, procedures and policies appropriate for a public company at businesses that prior to the acquisition lacked these controls, procedures and policies;

Possible write-offs or impairment charges resulting from acquisitions;

Unanticipated or unknown liabilities relating to acquired businesses; and

The need to integrate acquired businesses’ accounting, management information, manufacturing, human resources and other administrative systems to permit effective management.

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. 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.

The loss of members of our management team could substantially disrupt our business operations.

Our success depends to a significant degree upon the continued individual and collective contributions of our management team. A limited number of individuals have primary responsibility for managing our business, including our relationships with key customers and licensees. We have a number of key executives and senior technical people who have been with us for a number of years, including over 150 employees who have been with us for over 10 years. These individuals, as well as the rest of our management team and key employees, are at-will employees, and we do not maintain any key-person life insurance policies. Losing the services of any key member of our team, whether from retirement, competing offers or other causes, could prevent us from executing our business strategy, cause us to lose key customer or licensee relationships, or otherwise materially affect our operations.

We rely on highly skilled personnel, and if we are unable to retain or motivate key personnel or hire qualified personnel, we may not be able to maintain our operations or grow effectively.

Our performance is largely dependent on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization. In this regard, we currently plan to hire a significant number of employees prior to the end of calendar 2005 in response to our growth and our current initiatives and if we are unable to hire and train a sufficient number of qualified employees for any reason, we may not be able to implement our current initiatives or grow effectively. In this regard, we have in the past maintained a rigorous, highly selective and time-consuming hiring process. We believe that our approach to hiring has significantly contributed to our success to date. However, our highly selective hiring process has made it more difficult for us to hire a sufficient number of qualified employees, and, as we grow, our hiring process may prevent us from hiring the personnel we need in a timely manner. In addition, we are aware that certain of our competitors have directly targeted our employees. Moreover, the high cost of living in the San Francisco Bay Area, where our corporate headquarters and a significant portion of our operations are located, has been an impediment in attracting new employees and retaining existing employees in the past, and we expect that this high cost of living will continue to impair our ability to attract and retain employees in the future. Furthermore, for much of our history we have relied upon cash compensation arrangements, such as cash bonuses, rather than option grants, to motivate our employees. In recent years, we have granted options to key employees. Nonetheless, there is no assurance that either of these approaches will provide adequate incentives to attract, retain and motivate employees in the future. If we do not succeed in attracting excellent personnel and retaining and motivating existing personnel, our existing operations may suffer and we may be unable to grow effectively.

If we cannot maintain our corporate culture as we grow, we could lose the innovation, teamwork and focus that we believe our culture fosters, and our business may be harmed.

We believe that a critical contributor to our success has been our corporate culture, which we believe fosters innovation, teamwork and a focus both on developing and strengthening long-term relationships with entertainment industry participants and on developing practical, enduring technology solutions for the entertainment industry. As we grow and change in response to the requirements of being a public company, we may find it difficult to maintain important aspects of our corporate culture, which could negatively affect our future success. We intend to continue to focus on developing technologies for the entertainment industries that provide long-term benefits, and we intend to keep our focus on long-term results.

We will incur increased costs and demands upon management as a result of complying with the laws and regulations affecting public companies, which could affect our operating results.

As a public company we will incur significant legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements. We also have incurred and will incur costs associated with recently adopted corporate governance requirements, including requirements under the Sarbanes-Oxley Act, as well as new rules implemented by the SEC and the NYSE. In addition, our management team will also have to adapt to the requirements of being a public company, as none of our senior executive officers has significant experience in the public company environment. The expenses incurred by public companies generally for reporting and corporate governance purposes have been increasing. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly, although we are unable to currently estimate these costs with any degree of certainty. We do believe, however, that we will be able to fund these costs out of our available working capital. We also expect these new rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage than used to be available. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as our executive officers.

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements could be impaired, which could adversely affect our operating results, our ability to operate our business and investors’ views of us.

We have a complex business organization that is international in scope. Ensuring that we have adequate internal financial and accounting controls and procedures in place to help ensure that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. We are in the process of documenting, reviewing and, if appropriate, improving our internal controls and procedures in connection with Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors addressing these assessments. Both we and our independent auditors will be testing our internal controls in connection with the Section 404 requirements and could, as part of that documentation and testing, identify areas for further attention or improvement. Implementing any appropriate changes to our internal controls may require specific compliance training of our directors, officers and employees, entail substantial costs in order to modify our existing accounting systems, and take a significant period of time to complete. Such changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In addition, investors’ perceptions that our internal controls are inadequate or that we are unable to produce accurate financial statements may seriously affect our stock price.

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 are currently implementing a PeopleSoft enterprise resource planning, or ERP, system over a three-year period ending in 2007 that is critical to our accounting, financial, operating and manufacturing functions. Implementing a new ERP system raises costs and risks inherent in the conversion to a new computer system, including disruption to our normal accounting procedures 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 attention and resources and could materially adversely affect our operating results and ability to manage our business effectively. In addition, we do not know whether or not the acquisition of PeopleSoft by Oracle will affect the implementation and future use of our ERP system. To the extent that this acquisition delays, complicates or prevents the full implementation, future use or service of our ERP system, our operating results and financial condition could be adversely affected.

Calamities, power shortages or power interruptions at our San Francisco and Burbank offices or our Brisbane manufacturing facilities could disrupt our business and adversely affect our operations, and could disrupt the businesses of our major professional products and production services customers.

Our principal operations are located in Northern California, including our corporate headquarters in San Francisco and one of our manufacturing facilities in Brisbane, California. Many of our motion picture production services operations are located in Burbank, California. In addition, many of our major professional products and production services customers in the motion picture and broadcast industries are located in Burbank and other Southern California locations. All of these locations are in areas of seismic activity near active earthquake faults. Any earthquake, terrorist attack, fire, power shortage or other calamity affecting our facilities or our customers’ facilities may disrupt our business and substantially affect our operations.

Accounting for employee stock options using the fair value method could significantly reduce our net income.

There has been ongoing public debate whether stock options granted to employees should be treated as a compensation expense and, if so, how to properly value such charges. Currently, we account for options using the intrinsic value method, which, given that we have generally granted employee options with exercise prices equal to the fair market value of the underlying stock at the time of grant, results in no compensation expense. If, however, we had used the fair value method of accounting for stock options granted to employees using a Black-Scholes option valuation formula, our net income would have been reduced to $37.0 million, rather than the $39.8 million reported, for the fiscal year ended September 24, 2004, and to $9.6 million, rather than the $10.4 million reported, for the fiscal quarter ended December 31, 2004. If in the future we elect or are required to record expenses for our stock-based compensation plans using the fair value method, we could have on-going accounting charges significantly greater than those we would have recorded under our current method of accounting for stock options, which could have a material adverse affect on our operating results.

Holders of our Class A common stock, which is the stock we are selling in this offering, are entitled to one vote per share, and holders of our Class B common stock are entitled to ten votes per share. The lower voting power of the Class A common stock may negatively affect the attractiveness of our Class A common stock to investors and, as a result, its market value.

Upon consummation of this offering, we will have two classes of common stock: Class A common stock, which is the stock we are selling in this offering and which is entitled to one vote per share, and Class B common stock, which is held primarily by Ray Dolby and persons and entities affiliated with Ray Dolby and which is entitled to ten votes per share. Except in certain limited circumstances required by applicable law, holders of Class A common stock and Class B common stock vote together as a single class on all matters to be voted on by our stockholders. As of December 31, 2004, 86,862,135 shares of Class B common stock are outstanding, and 12,990,950 shares of Class B common stock are issuable upon the exercise of outstanding options. Therefore, assuming the exercise of all outstanding options as of December 31, 2004, after completion of this offering approximately 96.8% of the total voting power of our outstanding shares will be held by the Class B common stockholders. Accordingly, our Class B common stockholders constitute, and are expected to continue to constitute, a significant portion of the shares entitled to vote on all matters requiring approval by our stockholders. The difference in the voting power of our Class A common stock and Class B common stock could diminish the market value of our Class A common stock if investors attribute value to the superior voting rights of our Class B common stock and the power those rights confer. There is no threshold or time deadline at which the shares of Class B common stock will automatically convert into shares of Class A common stock.

For the foreseeable future, Ray Dolby or his affiliates will be able to control the selection of all members of our board of directors, as well as virtually every other matter that requires stockholder approval, which will severely limit the ability of other stockholders to influence corporate matters.

Immediately following the completion of this offering, Ray Dolby and persons and entities affiliated with Ray Dolby will own approximately 97.3% of our Class B common stock, representing 93.6% of the combined voting power of our outstanding Class A and Class B common stock. Under our charter, holders of shares of Class B common stock may generally transfer such shares to family members, including spouses and descendents or the spouses or domestic partners of such descendents, without having the shares automatically convert into shares of Class A common stock. Because of this dual class structure, Ray Dolby, his affiliates, and his family members and descendents will, for the foreseeable future, have significant influence over our management and affairs, and will be able to control virtually all matters requiring stockholder approval, including the election of directors and significant corporate transactions such as mergers or other sales of our company or assets, even if they come to own considerably less than 50% of the total number of outstanding shares of our Class A and Class B common stock. Moreover, these persons may take actions in their own interests that you or our other stockholders do not view as beneficial. There is no threshold or time deadline at which the shares of Class B common stock will automatically convert into shares of Class A common stock. Assuming conversion of all shares of Class B common stock held by persons not affiliated with Ray Dolby into shares of Class A common stock, so long as Ray Dolby and his affiliates continue to hold shares of Class B common stock representing approximately 9% or more of the total number of outstanding shares of our Class A and Class B common stock, they will hold a majority of the combined voting power of the Class A and Class B common stock. See “Description of Capital Stock.”

An active, liquid and orderly trading market for our common stock may not develop.

Prior to this offering, there has been no public market for shares of our Class A common stock. We, the selling stockholders, and the representative of the underwriters determined the initial public offering price of our Class A common stock through negotiation. This price will not necessarily reflect the price at which investors in the market will be willing to buy and sell our shares following this offering. In addition, the trading price of our Class A common stock following this offering is likely to be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. These factors include:

Quarterly variations in our results of operations or those of our competitors;

Our ability to develop and market new and enhanced products on a timely basis;

Announcements by us or our competitors of acquisitions, new products, significant contracts, commercial relationships or capital commitments;

Whether we are successful in establishing our technologies as part of industry standards in new markets;

The emergence of new markets, such as digital cinema, that may affect our existing business or in which we may not be able to compete effectively;

Commencement of, or our involvement in, litigation;

Changes in governmental regulations or in the status of our regulatory approvals;

Changes in earnings estimates or recommendations by securities analysts;

Any major change in our board or management;

General economic conditions and slow or negative growth of our markets; and

Political instability, natural disasters, war and/or events of terrorism.

In addition, the stock market in general, 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. Broad market and industry factors may seriously affect the market price of companies’ stock, including ours, regardless of actual operating performance. These fluctuations may be even more pronounced in the trading market for our stock shortly following this offering. In addition, in the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:

Our amended and restated certificate of incorporation provides for a dual class common stock structure. As a result of this structure, Ray Dolby and his affiliates, family members and descendants will have control for the foreseeable future over virtually all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or its assets. This concentrated control could discourage others from initiating any potential merger, takeover or other change of control transaction that our other stockholders may view as beneficial.

Our board of directors has the sole right to elect a director to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors.

After such time as the holders of our Class B common stock hold less than a majority of the combined voting power of our outstanding shares of Class A and Class B common stock, our stockholders may not act by written consent. As a result, a holder or holders controlling a majority of the combined voting power of our outstanding shares of Class A and Class B common stock at such time would not be able to take certain actions except at a stockholders’ meeting.

Our amended and restated certificate of incorporation prohibits cumulative voting in the election of directors. This limits the ability of holders of Class A common stock and minority stockholders to elect director candidates.

Stockholders must provide advance notice to nominate individuals for election to the board of directors or to propose matters to be acted upon at a stockholders’ meeting. These provisions may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror’s own slate of directors or otherwise attempting to obtain control of our company.

Our amended and restated certificate of incorporation provides that, unless otherwise required by law, special meetings of stockholders may be called only by the chairman of the board, the chief executive officer, the president or the board of directors acting pursuant to a resolution adopted by a majority of the board members. A stockholder may not call a special meeting, which may delay the ability of our stockholders to force consideration of a proposal or for holders controlling a majority of our capital stock to take action, including the removal of directors.

As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may, in general, not engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction.

Purchasers in this offering will experience immediate and substantial dilution in the book value of their investment.

The initial public offering price of our Class A common stock is substantially higher than the net tangible book value per share of our Class A common stock immediately after this offering. Therefore, if you purchase our Class A common stock in this offering, you will incur an immediate dilution of $15.03 in net tangible book value per share from the price you paid. In addition, following this offering, purchasers in the offering will have contributed 99.1% of the total consideration paid by stockholders to the Company to purchase shares of common stock. The exercise of outstanding options and warrants will result in further dilution. For a further description of the dilution that you will experience immediately after this offering, see “Dilution.”

Future sales of shares by existing stockholders could cause our stock price to decline.

If our existing stockholders sell, or indicate an intention to sell, substantial amounts of our Class A common stock, including shares of Class A common stock issuable upon conversion of shares of Class B common stock, in the public market after the lock-up and other legal restrictions on resale discussed in this prospectus lapse, the trading price of our Class A common stock could decline. Based on shares outstanding as of December 31, 2004, upon completion of this offering, we will have outstanding a total of 97,362,135 shares of Class A and Class B common stock, assuming no exercise of the underwriters’ over-allotment option, an increase of 12.1% from the number of shares outstanding prior to the offering. Of these shares, only the 27,500,000 shares of Class A common stock sold in this offering by us and the selling stockholders will be freely tradable, without restriction, in the public market. Our underwriters, however, may, in their sole discretion, permit our officers, directors and other current stockholders who are subject to the contractual lock-up to sell shares prior to the expiration of the lock-up agreements.

We expect that the lock-up agreements pertaining to this offering will expire 180 days from the date of this prospectus, although those lock-up agreements may be extended for up to an additional 35 days under certain circumstances. After the lock-up agreements expire, up to an additional 69,862,135 shares of Class A common stock issuable upon conversion of outstanding shares of our Class B common stock will be eligible for sale in the public market, 69,077,405 of which shares of Class B common stock are held by directors, executive officers and other affiliates and will be subject to volume limitations under Rule 144 under the Securities Act and various vesting agreements. In addition, 20,117,950 shares of Class A or Class B common stock that are either subject to outstanding options or reserved for future issuance under our employee benefit plans will become eligible for sale in the public market to the extent permitted by the provisions of various vesting agreements, the lock-up agreements and Rules 144 and 701 under the Securities Act. If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the trading price of our Class A common stock could decline.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA

This prospectus includes forward-looking statements. All statements other than statements of historical facts contained in this prospectus, including statements regarding our future results of operations and financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short term and long term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in “Risk Factors.” In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this prospectus may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

This prospectus contains statistical data regarding the consumer electronics product industry that we obtained from industry reports generated by Arbitron, the Consumer Electronics Association and International Data Corporation. These reports generally indicate that their information has been obtained from sources believed to be reliable, but do not guarantee the accuracy and completeness of their information. Although we believe that the reports are reliable, we have not independently verified their data.

USE OF PROCEEDS

We estimate that we will receive net proceeds of approximately $172.4 million from our sale of the 10,500,000 shares of Class A common stock offered by us in this offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters’ over-allotment option is exercised in full, we estimate that we will receive net proceeds of approximately $242.2 million. We will not receive any of the net proceeds from the sale of the shares by the selling stockholders.

The principal purposes of this offering are to create a public market for our Class A common stock, to facilitate our future access to the public equity markets and to obtain additional capital. We currently have no specific plans for the use of the net proceeds of this offering. We anticipate that we will use the net proceeds received by us from this offering, including any net proceeds we receive from the exercise of the underwriters’ over-allotment option, for general corporate purposes, including working capital. We intend to use a portion of our working capital, including cash we receive from the proceeds of this offering, as well as the cash generated from our operations, to fund the costs of operating as a public company, including the anticipated increase in legal and administrative costs. In addition, we may use a portion of the proceeds of this offering for acquisitions of complementary businesses, technologies or other assets. We have no current agreements or commitments with respect to any material acquisitions. Pending such uses, we plan to invest the net proceeds in highly liquid, investment grade securities.

DIVIDEND POLICY

We have never declared or paid any cash dividend on our capital stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future. However, if we are deemed to be a personal holding company for tax purposes, we may elect to pay a dividend to our stockholders in an amount equal to all or a significant part of our undistributed personal holding company income (which could be significant), rather than paying personal holding company tax on such undistributed personal holding company income, if any. See both “Risk Factors—It is possible that we may be treated as a personal holding company, which could adversely affect our operating results and financial condition” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity, Capital Resources and Financial Condition—Personal Holding Company Tax Matters.”

CAPITALIZATION

The following table sets forth our cash and cash equivalents and our capitalization as of December 31, 2004, as follows:

On an actual basis;

On an as adjusted basis to give effect to the issuance by us of 10,500,000 shares of Class A common stock in this offering and the receipt of the net proceeds from our sale of these shares, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

You should read this table together with the sections of this prospectus entitled “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited and pro forma consolidated financial statements and the related notes included elsewhere in this prospectus.


	As of December 31, 2004
	Actual			As Adjusted
	(in thousands, except share data)
Cash and cash equivalents	$	94,087		$	266,497

Total debt	$	14,800		$	14,800
Stockholders’ equity:
Class A common stock, $0.001 par value, one vote per share, 500,000,000 shares authorized: no shares issued and outstanding, actual; 27,500,000 shares issued and outstanding, as adjusted.		—			28
Class B common stock, $0.001 par value, ten votes per share, 500,000,000 shares authorized: 86,862,135 shares issued and outstanding, actual; 69,862,135 shares issued and outstanding, as adjusted		87			70
Additional paid-in capital		54,856			227,255
Deferred stock-based compensation		(36,509	)		(36,509	)
Retained earnings		135,453			135,453
Accumulated other comprehensive income		4,197			4,197

Total stockholders’ equity		158,084			330,494

Total capitalization	$	172,884		$	345,294

The table above excludes the following shares:

12,990,950 shares of Class B common stock issuable upon the exercise of options outstanding at December 31, 2004, at a weighted average exercise price of $1.89 per share;

127,000 shares of Class B common stock issuable upon the exercise of options granted after December 31, 2004, at an exercise price of $14.50 per share.

6,000,000 shares of Class A common stock available for future issuance under our 2005 Stock Plan; and

1,000,000 shares of Class A common stock available for future issuance under our Employee Stock Purchase Plan.

If the underwriters were to exercise their over-allotment option in full, our as adjusted cash and cash equivalents, Class A common stock, additional paid-in capital, total stockholders’ equity and total capitalization as of December 31, 2004 would be approximately $336.3 million, $32,000, $297.0 million, $400.3 million and $415.1 million, respectively.

DILUTION

If you invest in our Class A common stock, your interest will be diluted to the extent of the difference between the initial public offering price per share of our Class A common stock and the as adjusted net tangible book value per share of our Class A and Class B common stock immediately after this offering. Net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the number of shares of Class A and Class B common stock outstanding at December 31, 2004.

Our net tangible book value was $117.1 million, computed as total stockholders’ equity less goodwill and other intangible assets, or $1.35 per share of Class A and Class B common stock outstanding, at December 31, 2004. Assuming the sale by us of 10,500,000 shares of Class A common stock offered in this offering at the initial public offering price of $18.00 per share, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us, our as adjusted net tangible book value at December 31, 2004 would have been $289.5 million, or $2.97 per share of common stock. This represents an immediate increase in net tangible book value of $1.62 per share to our existing stockholders and an immediate dilution of $15.03 per share to the new investors purchasing shares in this offering. The following table illustrates this per share dilution:


Assumed initial public offering price per share of Class A common stock			$	18.00
Net tangible book value per share of Class A and Class B common stock at December 31, 2004	$	1.35
Increase in net tangible book value per share attributable to this offering		1.62

As adjusted net tangible book value per share after the offering				2.97

Dilution per share to new investors			$	15.03

The following table sets forth on an as adjusted basis, as of December 31, 2004, the number of shares of common stock purchased or to be purchased from us, the total consideration paid or to be paid and the average price per share paid or to be paid by existing holders of common stock and by the new investors, before deducting underwriting discounts and estimated offering expenses payable by us.


	Shares Purchased			Total Consideration				Average Price Per Share
	Number	Percent		Amount		Percent		Average Price Per Share
	($ in thousands)
Existing stockholders	86,862,135	89.2	%	$	1,723	0.9	%	$	0.02
New investors	10,500,000	10.8			189,000	99.1			18.00

Total	97,362,135	100	%	$	190,723	100	%

The discussion and tables above are based on the number of shares of Class B common stock outstanding at December 31, 2004. The discussion and tables above exclude the following shares:

12,990,950 shares of Class B common stock issuable upon the exercise of options outstanding at December 31, 2004, at a weighted average exercise price of $1.89 per share;

127,000 shares of Class B common stock issuable upon the exercise of options granted after December 31, 2004, at an exercise price of $14.50 per share.

6,000,000 shares of Class A common stock available for future issuance under our 2005 Stock Plan; and

1,000,000 shares of Class A common stock available for future issuance under our Employee Stock Purchase Plan.

To the extent outstanding options are exercised, new investors will experience further dilution.

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and the accompanying notes included elsewhere in this prospectus. The consolidated statements of operations data for the fiscal years ended September 27, 2002, September 26, 2003 and September 24, 2004 and balance sheet data as of such dates were derived from our audited consolidated financial statements that are included elsewhere in this prospectus. Our fiscal 2004 operating results have been restated solely to reflect a reduction in stock-based compensation expense from the data that was originally reported. See Note 1 to the Consolidated Financial Statements. The consolidated statements of operations for the fiscal years ended September 29, 2000 and September 28, 2001 and balance sheet data as of such dates were derived from our unaudited consolidated financial statements. The unaudited consolidated financial statements were prepared on a basis consistent with our audited consolidated financial statements contained in this prospectus and include, in the opinion of management, all adjustments necessary for the fair presentation of the financial information contained in those statements. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods. In our opinion, the unaudited interim consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments necessary for fair presentation. The results for the fiscal quarter ended December 31, 2004 are not necessarily indicative of the results to be expected for any subsequent quarterly or annual financial period, including for the fiscal year ending September 30, 2005. Our first quarter of fiscal 2005 consisted of 14 weeks as compared to the first quarter of fiscal 2004, which consisted of 13 weeks.


	Fiscal Year Ended															Fiscal Quarter Ended
	Sep 29, 2000			Sep 28, 2001			Sep 27, 2002			Sep 26, 2003			Sep 24, 2004			Dec 26, 2003			Dec 31, 2004
													(as restated)			(as restated)
	(unaudited)			(unaudited)												(unaudited)
	(in thousands, except per share data)
Consolidated Statements of Operations Data:
Revenue:
Licensing	$	49,489		$	73,277		$	106,640		$	157,922		$	211,395		$	47,799		$	62,191
Product sales		50,538			39,300			41,377			44,403			57,981			13,392			16,487
Production services		11,088			12,076			13,851			15,147			19,665			4,232			5,585

Total revenue		111,115			124,653			161,868			217,472			289,041			65,423			84,263

Cost of revenue:
Cost of licensing		10,520			19,644			25,063			40,001			53,838			12,781			16,149
Cost of product sales (includes $0.1 million and $0.1 million in stock-based compensation for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively) (1)		30,219			25,754			26,694			26,684			30,043			6,896			8,812
Cost of production services (includes $36,000 and $26,000 in stock-based compensation for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively) (1)		4,604			5,044			5,960			6,958			7,624			1,587			2,015

Total cost of revenue		45,343			50,442			57,717			73,643			91,505			21,264			26,976

Gross margin		65,772			74,211			104,151			143,829			197,536			44,159			57,287
Operating expenses:
Selling, general and administrative (includes $5.8 million, $4,000 and $2.2 million in stock-based compensation for fiscal 2004 and the fiscal quarters ended December 26, 2003 and December 31, 2004, respectively) (1)		44,714			48,244			64,269			76,590			106,456			20,092			32,857
Research and development (includes $0.8 million and $0.7 million in stock-based compensation for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively) (1)		16,744			16,106			15,128			18,262			23,479			4,934			8,289
Settlements		—			—			24,205			—			(2,000	)		—			(2,000	)
In-process research and development		—			—			—			1,310			1,738			—			—

Total operating expenses		61,458			64,350			103,602			96,162			129,673			25,026			39,146

Operating income		4,314			9,861			549			47,667			67,863			19,133			18,141
Other income (expenses), net		(356	)		(3,369	)		(747	)		(57	)		229			224			287

Income (loss) before provision for income taxes and controlling interest		3,958			6,492			(198	)		47,610			68,092			19,357			18,428
Provision for income taxes		621			1,230			11			16,079			27,321			6,825			7,743

Income (loss) before controlling interest		3,337			5,262			(209	)		31,531			40,771			12,532			10,685
Controlling interest in net (income) loss		(371	)		389			104			(562	)		(929	)		(286	)		(308	)

Net income (loss)	$	2,966		$	5,651		$	(105	)	$	30,969		$	39,842		$	12,246		$	10,377

Basic net income (loss) per common share	$	0.03		$	0.07		$	0.00		$	0.36		$	0.47		$	0.14		$	0.12
Diluted net income (loss) per common share	$	0.03		$	0.07		$	0.00		$	0.36		$	0.43		$	0.14		$	0.11

Shares used in the calculation of basic net income (loss) per share		85,000			85,000			85,008			85,009			85,556			85,010			86,788
Shares used in the calculation of diluted net income (loss) per share		85,000			85,000			85,008			86,084			92,783			90,518			97,819


(1) Stock-based compensation recorded in fiscal 2004 and the fiscal quarters ended December 26, 2003 and December 31, 2004 was classified as follows:
	Fiscal Year Ended		Fiscal Quarter Ended
	Sep 24, 2004		Dec 26, 2003		Dec 31, 2004
	(as restated)		(as restated)
			(unaudited)

Cost of product sales	$	104	$	—	$	54
Cost of production services		36		—		26
Selling, general and administrative		5,843		4		2,187
Research and development		810		—		681

Total stock-based compensation	$	6,793	$	4	$	2,948


	September 29, 2000		September 28, 2001		September 27, 2002		September 26, 2003		September 24, 2004		December 31, 2004
									(as restated)
	(unaudited)		(unaudited)								(unaudited)
	(in thousands)
Summary Consolidated Balance Sheet Data:
Cash and cash equivalents	$	13,675	$	22,602	$	37,394	$	61,922	$	78,711	$	94,087
Working capital		17,918		23,484		35,854		54,213		80,281		77,413
Total assets		115,030		125,635		157,313		202,707		261,866		286,607
Total debt		21,461		19,510		16,775		15,598		14,870		14,800
Total stockholders’ equity		54,508		60,645		61,742		93,775		143,327		158,084

PRO FORMA UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS DATA

Pro Forma Presentation

The selected pro forma unaudited consolidated statements of operations data set forth below give effect to the asset contribution made by Ray Dolby on February 16, 2005, as well as the effects of a previous change in certain licensing arrangements with Ray Dolby in June 2002, as though such transactions had been completed prior to the beginning of fiscal 2002. The pro forma results presented below are not necessarily indicative of financial results to be achieved in future periods.

Throughout our history, Ray Dolby has retained ownership of the intellectual property rights he has created relating to our business. We had licensed these intellectual property rights from him and paid him royalties in return. On February 16, 2005, Ray Dolby contributed to us all intellectual property rights he held related to our business. Upon completion of this asset contribution, all of our licensing arrangements with, and royalty obligations to, Ray Dolby terminated.

Prior to June 2002, we also administered the licensing of certain intellectual property rights for Ray Dolby, remitting to him the revenue derived from licensing these rights, net of the related administrative costs we incurred. As a result, prior to June 2002 these revenues were not recorded in our consolidated financial statements, and Ray Dolby’s reimbursement to us of the administrative costs was reported as an offset in selling, general and administrative expense in our consolidated statements of operations. In June 2002, we terminated this licensing administration arrangement and amended our licensing agreements with Ray Dolby to license from him the intellectual property rights we had previously administered on his behalf. In exchange, we agreed to pay him royalties in an amount that was intended to approximate the net revenue he would have received under our prior licensing administration arrangement.

The pro forma unaudited consolidated statements of operations and other pro forma data contained in this prospectus were prepared on the basis that both the June 2002 amendment to our licensing agreements with Ray Dolby and his asset contribution occurred prior to the beginning of fiscal 2002. The results of giving effect to the June 2002 amendment as though that amendment had occurred prior to the beginning of fiscal 2002 are a $6.7 million increase in our pro forma licensing revenue, representing the payment to us rather than to Ray Dolby of the royalties described above, and a $6.0 million increase in our selling, general and administrative expense in fiscal 2002, reflecting the absence of the reimbursement of administrative costs by Ray Dolby described above, in each case as compared to our actual results. In the absence of the asset contribution, the pro forma effect of the June 2002 amendment would also have resulted in an increase in our cost of licensing, representing the royalties we would have paid Ray Dolby under the amended licensing agreements. This increase, however, is not reflected in the pro forma unaudited consolidated statement of operations for fiscal 2002 because the pro forma effect of the asset contribution extinguishes all royalty payments to Ray Dolby.

The results of giving effect to the asset contribution as though that transaction had occurred prior to the beginning of fiscal 2002 are adjustments to our consolidated results of operations to reverse the effects of $18.8 million, $27.6 million, $36.9 million and $11.1 million in royalties payable to Ray Dolby that we recorded in fiscal 2002, 2003, 2004 and the fiscal quarter ended December 31, 2004, respectively. There will be no material change to our balance sheet as a result of the asset contribution. Because there is no historical accounting cost basis for the assets contributed, we expect to record the transaction at approximately $1.0 million, representing acquisition costs, including legal, tax and other professional fees we incurred as a result of the asset contribution.

The following table shows the pro forma effects of the transactions described above on the respective line items of our consolidated statements of operations:


	Fiscal Year Ended									Fiscal Quarter Ended
Increase (decrease):	September 27, 2002			September 26, 2003			September 24, 2004			December 26, 2003			December 31, 2004
	(unaudited)
	(in thousands)
Licensing revenue	$	6,721		$	—		$	—		$	—		$	—
Cost of licensing		(16,378	)		(25,126	)		(33,768	)		(8,113	)		(10,151	)
Cost of product sales		(2,413	)		(2,494	)		(3,089	)		(757	)		(902	)
Selling, general and administrative		6,028			—			—			—			—
Provision for income taxes		7,873			10,635			13,355			3,418			4,517
Net income		11,611			16,985			23,502			5,452			6,536

The selected pro forma unaudited consolidated statements of operations data should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and the related notes included elsewhere in this prospectus.


	Pro Forma
	Fiscal Year Ended									Fiscal Quarter Ended
	September 27, 2002			September 26, 2003			September 24, 2004			December 26, 2003			December 31, 2004
	(unaudited)
	(in thousands, except per share data)
Consolidated Statements of Operations Data:
Revenue:
Licensing	$	113,361		$	157,922		$	211,395		$	47,799		$	62,191
Product sales		41,377			44,403			57,981			13,392			16,487
Production services		13,851			15,147			19,665			4,232			5,585

Total revenue		168,589			217,472			289,041			65,423			84,263

Cost of revenue:
Cost of licensing		8,685			14,875			20,070			4,668			5,998
Cost of product sales (includes $0.1 million and $0.1 million in stock-based compensation for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively) (1)		24,281			24,190			26,954			6,139			7,910
Cost of production services (includes $36,000 and $26,000 in stock-based compensation for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively) (1)		5,960			6,958			7,624			1,587			2,015

Total cost of revenue		38,926			46,023			54,648			12,394			15,923

Gross margin		129,663			171,449			234,393			53,029			68,340
Operating expenses:
Selling, general and administrative (includes $5.8 million, $4,000 and $2.2 million in stock-based compensation for fiscal 2004 and the fiscal quarters ended December 26, 2003 and December 31, 2004, respectively) (1)		70,297			76,590			106,456			20,092			32,857
Research and development (includes $0.8 million and $0.7 million in stock-based compensation for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively) (1)		15,128			18,262			23,479			4,934			8,289
Settlements		24,205			—			(2,000	)		—			(2,000	)
In-process research and development		—			1,310			1,738			—			—

Total operating expenses		109,630			96,162			129,673			25,026			39,146

Operating income		20,033			75,287			104,720			28,003			29,194
Other income (expenses), net		(747	)		(57	)		229			224			287

Income before provision for income taxes and controlling interest		19,286			75,230			104,949			28,227			29,481
Provision for income taxes		7,884			26,714			40,676			10,243			12,260

Income before controlling interest		11,402			48,516			64,273			17,984			17,221
Controlling interest in net (income) loss		104			(562	)		(929	)		(286	)		(308	)

Net income	$	11,506		$	47,954		$	63,344		$	17,698		$	16,913

Basic net income per common share	$	0.14		$	0.56		$	0.74		$	0.21		$	0.19
Diluted net income per common share	$	0.14		$	0.56		$	0.68		$	0.20		$	0.17

Shares used in the calculation of basic net income per share		85,008			85,009			85,556			85,010			86,788
Shares used in the calculation of diluted net income per share		85,010			86,084			92,783			90,518			97,819
(1) Stock-based compensation recorded in fiscal 2004 and the fiscal quarters ended December 26, 2003 and December 31, 2004 was classified as follows:

Cost of product sales							$	104		$	—		$	54
Cost of production services								36			—			26
Selling, general and administrative								5,843			4			2,187
Research and development								810			—			681

Total stock-based compensation							$	6,793		$	4		$	2,948

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with our audited consolidated financial statements and the related notes that appear elsewhere in this prospectus. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. Actual results may differ materially from those discussed in these forward-looking statements due to a number of factors, including those set forth in the section entitled “Risk Factors” and elsewhere in this prospectus. Our fiscal year is a 52- or 53-week period ending on the last Friday in September. The fiscal years presented herein include the 52-week periods ended September 27, 2002, September 26, 2003 and September 24, 2004. Our 2005 fiscal year consists of 53 weeks and ends on September 30, 2005. Our first quarter of fiscal 2005 consisted of 14 weeks as compared to the first quarter of fiscal 2004, which consisted of 13 weeks.

Solely as a result of our board of directors’ decision to change the methodology for reassessing the value of Class B common stock underlying the equity awards granted subsequent to the beginning of fiscal 2004, we have restated our consolidated financial statements for fiscal 2004. As a result of this restatement, the stock-based compensation recorded by us in fiscal 2004 decreased by $7.3 million to $6.8 million from $14.1 million, and our net income increased by $5.2 million to $39.8 million from the $34.6 million originally reported. For further information regarding the restatement, see Note 1 of the Notes to Consolidated Financial Statements.

Overview

Dolby Laboratories develops and delivers innovative products and technologies that enrich the entertainment experience in theatres, homes, cars and elsewhere. Ray Dolby founded Dolby Laboratories in 1965 to develop noise reduction technologies. Today, we deliver a broad range of sound technologies for use in both professional and consumer applications. In addition, in recent years we have expanded our focus to include other technologies that facilitate the delivery of digital entertainment.

We conduct our business in two segments: our products and services segment and our technology licensing segment.

In our products and services segment, we sell professional products and related production services to filmmakers, broadcasters, music producers, video game designers, cinema operators and DVD producers. These products are used in sound recording, distribution and playback to improve sound quality, provide surround sound and increase the efficiency of sound storage and distribution. Our production services engineers work alongside artists and content producers throughout the world to help them record and reproduce the high quality sound they envision. Our engineers also work with cinema operators to help ensure that movie soundtracks are replayed with consistent high quality sound in their theatres.

In our technology licensing segment, we work with manufacturers of integrated circuits, or ICs, to help them incorporate our technologies into their ICs. These manufacturers then sell ICs to consumer electronics product manufacturers that license our technologies for incorporation in products such as DVD players, DVD recorders, audio/video receivers, television sets, set-top boxes, video game consoles, portable audio and video players, personal computers and in-car entertainment systems. We also license our technologies to software developers who implement our technologies for use in personal computer software DVD players. Our licensing arrangements typically entitle us to receive a royalty for every product that incorporates our technology shipped by our manufacturer and software developer licensees. We do not receive royalties from IC manufacturers.

We are a global organization. We sell our professional products and production services in over 50 countries. In fiscal 2002, 2003, 2004 and the fiscal quarter ended December 31, 2004, revenue from sales outside

the United States represented 64%, 60%, 59% and 63% of our professional products sales and production services revenue, respectively. We have licensed our technologies to manufacturers of consumer electronics products in nearly 30 countries, including countries in North America, Europe and Asia. In fiscal 2002, 2003, 2004 and the fiscal quarter ended December 31, 2004, revenue from licensees outside the United States represented 76%, 80%, 80% and 80% of our licensing revenue, respectively. Our licensees distribute consumer electronics products incorporating our technologies throughout the world. Nearly all of our revenue is derived from transactions denominated in United States dollars.

Management Discussion Regarding Opportunities, Challenges and Risks

Our Technology Licensing Segment

Revenue from our technology licensing segment constitutes the majority of our total revenue, representing 66%, 73%, 73% and 74% of total revenue in fiscal 2002, 2003, 2004 and the fiscal quarter ended December 31, 2004, respectively. Our licensing revenue has grown from $49.5 million in fiscal 2000 to $211.4 million in fiscal 2004, principally as a result of the increase in sales of DVD players and in-home theatre systems that incorporate our surround sound technologies. Our licensing revenue is primarily dependent upon our licensees’ sales of DVD players, audio/video receivers and home theatre systems. We anticipate that the DVD player, recordable DVD player and home theatre system markets will continue to grow in fiscal 2005 and 2006. However, we do not expect our licensing revenue growth rates attributable to DVD player sales to remain as high as they have been in recent years as the markets for DVD players mature. Because our technology is so widely adopted in DVD players, audio/video receivers and other home theatre consumer electronics products, our licensing revenue is subject to fluctuations based on consumer demand for these products. We are continuing to actively promote the incorporation of our surround sound technologies for use in other consumer products such as video game consoles, personal audio and video players, personal computers and in-car entertainment systems.

We license our sound technologies to consumer electronics product manufacturers throughout the world. Under our revenue recognition policy, we generally book licensing revenue upon receipt of our licensees’ royalty statements. As a result, our recognition of licensing revenue is dependent upon our receipt of royalty reports from our licensees, and our operating results can fluctuate based on the timing of our receipt of those reports. Moreover, our licensees are required to report to us within 30 to 60 days following the end of the quarter in which they ship the product incorporating our technologies, resulting in a time lag between when our licensees ship their products and when they report those shipments to us. Sometimes this time lag can be significant. In the past we have experienced lags of greater than one year. In addition, it is not uncommon for royalty reports to include corrective or retroactive royalties that cover extended periods of time. Also, there have been times when we have recognized an unusually large amount of licensing revenue from a licensee in a given quarter because not all of our revenue recognition criteria were met in prior periods. This can result in a large amount of licensing revenue from a licensee being recorded in a given quarter that is not necessarily indicative of the amounts of licensing revenue to be received from that licensee in future quarters, thus causing fluctuations in our operating results.

We expect that sales of consumer electronics products incorporating our technologies in China and India will increase in the future, as consumers in these markets have more disposable income and are increasingly purchasing entertainment products with surround sound capabilities for use in homes, cars and elsewhere, although there can be no assurance that this will in fact occur. The percentage of our revenue derived from licenses to consumer electronics product manufacturers located in China has increased from 11% in fiscal 2002 to 16% in fiscal 2004. We expect that the percentage of our licensing revenue from Chinese consumer electronics product manufacturers will increase in fiscal 2005 as a result of the increasing percentage of consumer electronics products being produced in China due to the lower manufacturing cost structure there as compared to other industrial countries. Doing business in China involves unique risks that have and will continue to affect our operating results. For example, we have experienced problems in the past with Chinese consumer electronics product manufacturers failing to report or underreporting shipments of their products that incorporate our

technologies, and we expect to continue to experience such problems in the future. In addition, we may experience similar problems in other countries where intellectual property rights are not as respected as they are in the United States, Europe and Japan. We actively attempt to enforce our intellectual property rights and also focus on strengthening existing relationships and developing new ones with entertainment industry participants in these countries to increase our ability to enforce our intellectual property and contractual rights without relying solely on the legal systems in such countries. We do not recognize revenue until royalties are reported and are deemed collectible. See “Critical Accounting Policies—Revenue Recognition.”

We must continue to develop and deliver enduring, innovative entertainment technologies for use in consumer electronics products. As technologies for DVD players and other consumer electronics products with surround sound capabilities evolve, we must continue to design and deliver sound technologies that are sought by manufacturers and consumers alike. In addition, the widespread adoption of alternative formats to DVDs, or our inability to develop sound technology for these new formats successfully, could adversely affect our licensing revenue. We must also continue to strive to have our entertainment technologies adopted either as explicit or de facto industry standards for use in consumer electronics products. Increasingly, standards-setting organizations are adopting or establishing technology standards for use in a wide range of consumer electronics products. As a result, it is more difficult for individual companies to have their technologies adopted wholesale as an informal industry standard. We call this type of standard a “de facto” industry standard, meaning that the standard is not explicitly mandated by any industry standards-setting body but is nonetheless widely adopted. In addition, increasingly there are a large number of companies, including ones that typically compete against one another, involved in the development of new technologies for use in consumer entertainment products. As a result, these companies often end up licensing their collective intellectual property rights as a group, making it more difficult for any single company to have its technologies adopted widely as a de facto industry standard or to have its technologies adopted as an exclusive, explicit industry standard for consumer electronic products. Generally, in order for a technology to be chosen as an industry standard, the royalty rates that can be charged for that technology will be limited, either explicitly or implicitly, because industry standards will be adopted only if they are not excessively costly as compared to other potential alternatives. As a result, the royalty rates we can charge for our technologies that have been adopted as industry standards or that are adopted as industry standards in the future will likely be lower than the royalty rates received for technologies not adopted as industry standards, and our ability to raise royalty rates for our industry standard technologies will likewise be limited. However, having technologies adopted as explicit industry standards may help increase the volume of products sold that incorporate these technologies. Furthermore, as we continue to expand our focus to include entertainment technologies that are not solely related to sound, such as technologies that process digital moving images and that protect content from piracy, we will be competing with many companies with longer experience and greater expertise in these areas, and there is a risk that we will not be able to develop technology innovations that are widely adopted in these markets.

Our licensing revenue is tied in large part to the life of our patents. Including the patents to be assigned to us by Ray Dolby pursuant to the asset contribution described in “Certain Relationships and Related Party Transactions,” we have 895 individual issued patents and over 800 pending patent applications in nearly 40 jurisdictions throughout the world. Our issued patents are scheduled to expire at various times through April 2023. Of these, ten patents are scheduled to expire in calendar year 2005, 74 patents are scheduled to expire in calendar year 2006, and 50 patents are scheduled to expire in calendar year 2007. We derive our licensing revenue principally from our Dolby Digital technologies. Patents relating to our Dolby Digital technologies generally expire between 2008 and 2017, and patents relating to our Dolby Digital Plus technologies, an extension of Dolby Digital, expire between 2019 and 2020. In addition, two patents relating to Dolby Digital Live technologies, another extension of Dolby Digital, are scheduled to expire in 2021. Our right to receive royalties related to our patents terminates with the expiration of the last patent covering the relevant technologies. However, many of our licensees choose to continue to pay royalties for continued use of our trademarks and know-how even after the licensed patents have expired, although at a reduced royalty rate. To the extent that we do not continue to replace licensing revenue from technologies covered by expiring patents with licensing revenue based on new patents and proprietary technologies, our revenue could decline.

Our Products and Services Segment

Revenue from our products and services segment represented 34%, 27%, 27% and 26% of total revenue in fiscal 2002, 2003, 2004 and the fiscal quarter ended December 31, 2004, respectively. We remain committed to developing technologies for use by professionals in the entertainment industry. We believe that filmmakers, broadcasters, music producers and video game designers will continue to push for technology solutions to help create, distribute and play back rich, high quality sounds and images. As a result, we believe that major advances in sound, imaging and other technologies for the recording, delivery and playback of entertainment will likely first be introduced in products designed for use by professionals.

Sales of our professional products and production services tend to fluctuate based on the underlying trends in the motion picture industry. In part, this is because our products have been so widely adopted in this industry. When box office receipts for the motion picture industry increase, we have typically seen sales of our professional products increase as well, as cinema owners are more likely to build new theatres and upgrade existing theatres with our more advanced cinema products when they are doing well financially. Our professional product sales are also subject to fluctuations based on events and conditions in the theatre industry generally that may or may not be tied to box office receipts in particular periods. For example, in the late 1990s cinema operators in the United States built a large number of new cinema megaplexes. This initially resulted in increased sales of our cinema processors, but also resulted in an oversupply of screens in some markets. This oversupply led to significant declines in new theatre construction in the United States in the early 2000s, resulting in a corresponding decline in sales of our cinema processors. Our production services revenue, both in the United States and internationally, is also tied to the strength of the motion picture production industry and, in particular, to the number of films being made by studios and independent filmmakers. The number of films that are produced can be affected by a number of factors, including strikes and work-stoppages within the motion picture industry as well as by the tax incentive arrangements that many foreign governments provide filmmakers to promote local filmmaking.

We are committed to helping the motion picture industry develop system solutions for digital cinema; this is our major initiative in our products and services segment. We believe that our experience and expertise developing and delivering technology solutions for both the motion picture and broadcast industries position us well to deliver technologies for digital cinema. Digital cinema offers the motion picture industry possible means to achieve substantial cost savings in printing and distributing movies, to combat piracy, and to enable movies to be played repeatedly without degradation in image quality. It also provides additional revenue opportunities for cinema operators, as concerts and sporting events already in digital format could be broadcast live via satellite to digitally equipped theatres. However, digital cinema may require a significant investment per screen by cinema operators. If the market for digital cinema develops more slowly than we anticipate, or if our technologies, products and services for this market are not widely adopted, our significant investment in developing digital cinema technology may not yield the returns we anticipate. In addition, if a large number of cinema owners decide to convert their theatres to digital cinema over a relatively short period of time and our products are selected for these conversions, we may see an initial increase in professional product sales that will not likely be sustained over time.

In recent years, our products and services segment has grown more slowly than our technology licensing segment. From fiscal 2002 to fiscal 2004, our annual revenue from professional product sales and production services grew at a compound annual growth rate of 19%, compared to a compound annual growth rate of 41% for our licensing revenue over that period. In addition, the profit margin for our products and services segment has been lower than our technology licensing segment. Our gross margin for our products and services segment was 41%, 44%, 51% and 51% in fiscal 2002, 2003, 2004 and the fiscal quarter ended December 31, 2004, respectively, compared to a gross margin of 76%, 75%, 75% and 74% for our technology licensing segment in those periods. On a pro forma basis, our gross margin for our products and services segment was 45%, 48%, 55% and 55% in fiscal 2002, 2003, 2004 and the fiscal quarter ended December 31, 2004, respectively, compared to a gross margin of 92%, 91%, 91% and 90% for our technology licensing segment in those periods.

Transition to Being a Public Company

Since Ray Dolby founded Dolby Laboratories in 1965, we have been a privately held company and Ray Dolby has owned nearly all of our outstanding capital stock. As a privately held company with a highly concentrated ownership base, we have always run Dolby Laboratories with a view to the long term, consistent with the goals of our founder. We intend to keep our focus on long-term results.

We believe that a critical contributor to our success has been our corporate culture, which we believe fosters innovation, teamwork and a focus both on developing and strengthening long-term relationships with entertainment industry participants and on developing practical, enduring technology solutions for the entertainment industry. As we grow and change in response to the requirements of being a public company, we may find it difficult to maintain important aspects of our corporate culture, which could negatively affect our future success. We intend to continue to focus on developing technologies for entertainment industries that provide long-term benefits.

Our management team will also have to adapt to the requirements of being a public company, as none of our senior executive officers has significant experience in the public company environment. In addition, as part of our transition to being a public company, we expect our general and administrative expenses to increase, as we respond to the requirements of being a public company, including increased expenses associated with comprehensively documenting and analyzing our system of internal controls and maintaining our disclosure controls and procedures as a result of the requirements of the Sarbanes-Oxley Act. Furthermore, we are converting all of our systems to a new enterprise resource planning platform over a three-year period, and we expect to incur increased general and administrative expenses during this transition.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. The preparation of these financial statements in accordance with U.S. GAAP requires us to utilize accounting policies and make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies as of the date of the financial statements and the reported amounts of revenue and expenses during a fiscal period. The SEC considers an accounting policy to be critical if it is important to a company’s financial condition and results of operations, and if it requires significant judgment and estimates on the part of management in its application. We have discussed the selection and development of the critical accounting policies with the audit committee of our board of directors, and the audit committee has reviewed our related disclosures in this prospectus. Although we believe that our judgments and estimates are appropriate and correct, actual results may differ from those estimates.

We believe the following to be our critical accounting policies because they are both important to the portrayal of our financial condition and results of operations and they require critical management judgments and estimates about matters that are uncertain. If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operation for future periods could be materially affected. See “Risk Factors” for certain matters bearing risks on our future results of operations.

Revenue Recognition

We evaluate revenue recognition for transactions to sell products and services and to license technology, trademarks and know-how using the criteria set forth by the SEC in Staff Accounting Bulletin 104, “Revenue Recognition,” or SAB 104. SAB 104 states that revenue is recognized when each of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price to the buyer is fixed or determinable, and collectibility is reasonably assured.

Licensing. Our licensing revenue is primarily derived from royalties paid to us by licensees of our intellectual property rights, including patents, trademarks and know-how. Royalties are recorded at their gross amounts and are recognized when all revenue recognition criteria have been met. We make judgments as to whether collectibility can be reasonably assured based on the licensee’s recent payment history or the existence of a standby letter-of-credit between the licensee’s financial institution and our financial institution. In the absence of a favorable collection history or a letter-of-credit, we recognize revenue upon receipt of cash, provided that all other revenue recognition criteria have been met.

Product Sales and Production Services. Our revenue from the sale of products is recognized when the risk of ownership has transferred to our customer as provided under the terms of the governing purchase agreement, typically the invoice we deliver to the customer, and all the other revenue recognition criteria have been met. Generally, these purchase agreements provide that the risk of ownership is transferred to the customer when the product is shipped. Production services revenue is recognized as the services related to a given project are performed and all the other revenue recognition criteria have been met.

Allowance for Doubtful Accounts

We continually monitor customer payments and maintain a reserve for estimated losses resulting from our customers’ inability to make required payments. In determining the reserve, we evaluate the collectibility of our accounts receivable based upon a variety of factors. In cases where we are aware of circumstances that may impair a specific customer’s ability to meet its financial obligations, we record a specific allowance against amounts due, and thereby reduce the net recognized receivable to the amount reasonably believed to be collectible. For all other customers, we recognize allowances for doubtful accounts based on our actual historical write-off experience in conjunction with the length of time the receivables are past due, customer creditworthiness, geographic risk and the current business environment. Actual future losses from uncollectible accounts may differ from our estimates and may have a material effect on our consolidated statements of operations and our financial condition. Our allowance for doubtful accounts totaled $2.8 million at December 31, 2004. An incremental change of 1% in our allowance for doubtful accounts as a percentage of accounts receivable would have a $0.3 million increase or decrease in our operating results.

Goodwill

In September 2002, we adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” or SFAS 142, which, among other things, establishes new standards for goodwill acquired in a business combination, eliminates the amortization of goodwill and requires the carrying value of goodwill and certain non-amortizing intangibles to be evaluated for impairment on an annual basis. As required by SFAS 142, we perform an impairment test on recorded goodwill by comparing the estimated fair value of each of our reporting units to the carrying value of the assets and liabilities of each unit, including goodwill. Our management is responsible for determining the fair value of the reporting units, and makes this determination principally based upon the most recent determination by our board of directors of the value of Dolby Laboratories as a whole. This value is determined by considering a number of factors, including our historical and projected financial results, valuation analyses, risks facing us and the liquidity of our common stock. If the carrying value of the assets and liabilities of the reporting units, including goodwill, were to exceed our estimation of the fair value of the reporting units, we would record an impairment charge in an amount equal to the excess of the carrying value of goodwill over the implied fair value of the goodwill. Our fiscal 2004 impairment test of goodwill, which was performed in the third fiscal quarter, resulted in no impairment charge. Fluctuations in our fair value, which may result from changes in economic conditions, our results of operations and other factors, relative to the carrying value, could result in impairment charges in future periods. As of the last test for impairment, our estimated fair value would need to have decreased by approximately 65% in order for goodwill impairment to have been recognized.

Accounting for Income Taxes

Generally. In preparing our consolidated financial statements, we are required to make estimates and judgments that affect our accounting for income taxes. This process includes estimating actual current tax

exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences, including differences in the timing of recognition of stock-based compensation expense, result in deferred tax assets and liabilities, which are included in our consolidated balance sheets. We also assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent that we believe that recovery is not likely, we have established a valuation allowance.

Significant judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance against our deferred tax assets. Our financial position and results of operations may be materially impacted if actual results significantly differ from these estimates or the estimates are adjusted in future periods.

Personal Holding Company Tax Matters. For United States federal income tax purposes, a corporation is generally considered to be a “personal holding company” under the United States Internal Revenue Code if (i) at any time during the last half of its taxable year more than 50% of its stock by value is owned, directly or indirectly, by virtue of the application of certain stock ownership attribution rules set forth in the Internal Revenue Code for purposes of applying the personal holding company rules, by five or fewer individuals and (ii) at least 60% of its adjusted ordinary gross income, as defined for United States federal income tax purposes, is “personal holding company income.” Personal holding company income is generally passive income, including royalty income, subject to certain exceptions such as qualifying software royalties. A personal holding company is subject to an additional tax on its undistributed after-tax income, calculated at the statutory tax rate, which is currently 15%. Since the personal holding company tax is imposed only on undistributed income, a personal holding company can avoid or mitigate liability for the tax, but not interest or penalties, by paying a dividend to its stockholders.

Before this offering, more than 50% of the value of our stock was held by Ray Dolby and stockholders considered affiliated with him pursuant to the stock ownership attribution rules applicable to personal holding companies. We expect this will continue to be the case immediately after this offering. In addition, a significant portion of our income is from licensing fees, which may constitute personal holding company income. Currently, however, less than 60% of Dolby Laboratories’ adjusted ordinary gross income is personal holding company income. Consequently, given our current sources of revenue, we believe that neither we nor any of our subsidiaries is currently liable for personal holding company tax. Moreover, we do not believe that we or any of our subsidiaries have previously been liable for personal holding company tax.

However, the Internal Revenue Service may assert that we or one of our subsidiaries are currently, or previously have been, liable for personal holding company tax, plus interest and penalties, if applicable. In addition, we or our subsidiaries may be liable for personal holding company tax in the future. The treatment of certain items of our income, and the income of our subsidiaries, for purposes of the personal holding company tax may be subject to challenge. In the event that we or any of our subsidiaries were determined to be a personal holding company, or, for prior taxable years, to have been a personal holding company, we or the subsidiary could be liable for additional taxes, and possibly interest and penalties, based on the undistributed income and the tax rate in effect at that time, but only if we or the subsidiary, as the case may be, decides not to fully abate the personal holding company tax by the payment of a dividend (although such a dividend will not eliminate interest and penalties). In addition, we believe that there exists a meaningful risk that in the relatively near future the mix of our revenue will change so that more of our adjusted ordinary gross income may be classified as personal holding company income. In such event, it is possible that we or one of our subsidiaries could become liable for the personal holding company tax, assuming the ownership test continues to be met. In that case, we or our subsidiary, as the case may be, may be required to pay additional tax in the event we or our subsidiary decides not to fully abate the tax by the payment of a dividend. We are currently exploring options to reduce our exposure, and that of our subsidiaries, to the personal holding company tax in the future. See “Liquidity, Capital Resources and Financial Condition—Personal Holding Company Tax Matters.”

Stock-Based Compensation

Valuation at the Time of Grant. We have granted to our employees options to purchase Class B common stock at exercise prices equal to the values of the underlying stock at the time of each grant, as determined by our board of directors at that time. Our board determined these values principally based on valuation reports we obtained effective as of July each year.

In determining values of Dolby Laboratories at each of July 2003 and July 2004, the annual valuation reports relied primarily on comparisons between our financial metrics with those of comparable companies, referred to as a market approach, and a discounted cash flow analysis, referred to as an income approach. The market approach used two common methods of comparisons, known as the guideline public company method and the guideline transaction method. Once our valuation had been derived, the reports applied a 20% marketability discount factor to reflect the illiquid nature of private company equity securities.

In valuing the Class B common stock and evaluating the valuation reports, our board of directors considered a number of factors, including:

The illiquidity of our capital stock as a private company;

The vesting restrictions imposed upon the equity awards;

The extreme minority position of the recipients of the equity awards, given that Ray Dolby beneficially held over 97% of our outstanding capital stock throughout this period;

Business risks we faced;

The likelihood of a liquidity event, such as an initial public offering, and

The lack of comparative, arms’-length transactions involving our capital stock, such as sales or issuances of shares in merger or acquisition transactions.

Reassessment of Fair Value. As described above, at the time we granted stock options, we believed that the per share exercise price of the shares of Class B common stock subject to options represented the fair value of that stock as of the grant date. However, in connection with the preparation of the financial statements for our initial public offering and solely for the purposes of accounting for employee stock-based compensation, we considered whether the equity awards granted subsequent to the beginning of fiscal 2004 had a compensatory element that should be reflected in our financial statements. We noted that the fair value of the shares subject to the equity awards granted during this period, as determined by our board of directors at the time of grant and principally based upon the valuation reports, were significantly less than the valuations that our underwriters were discussing with us in connection with our preparations for this offering. We believed we should not ignore the discrepancies in valuation in determining whether the equity awards granted during this time had a compensatory element. As a result, we applied hindsight to reassess the fair value of our Class B common stock for all equity awards granted subsequent to the beginning of fiscal 2004.

In reassessing the fair value of the shares of Class B common stock underlying the equity awards granted subsequent to the beginning of fiscal 2004, our board of directors used a valuation methodology it believes is consistent with the practices recommended by the AICPA Audit and Accounting Practice Aid Series Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or the practice aid. The board reviewed the guidance set forth in the practice aid and determined that using the annual valuation reports was a reasonable starting point for reassessing the value of the common stock. In making this determination, the board noted that during the review period there were no quoted market prices in active markets for the Class B common stock and there were no arms’-length cash transactions with unrelated parties for issuances of our equity securities. In these circumstances, the practice aid recommends engaging an unrelated valuation specialist for the purpose of assisting management in determining fair value of common stock. The board also noted that the annual valuation reports contained all of the required content for valuation reports outlined in the practice aid, as well as much of the additional content recommended to be included.

In addition, according to the practice aid, for enterprises like us that have established financial histories of profitable operations or generation of positive cash flows, the use in the valuation reports of both market and income approaches is appropriate, and the particular methodologies used in the valuation reports for each of these approaches were consistent with the methodologies described in the practice aid.

In light of the recommendations detailed in the practice aid, the board decided to give substantially more weight to the valuation reports than the underwriters’ anticipated initial public offering price in reassessing equity award valuations. Nonetheless, the board also determined that it should examine the underlying assumptions made in the valuation reports to determine whether these assumptions were appropriate as of the dates the equity awards were granted after taking into consideration our circumstances at each date.

In particular, our board of directors reexamined the various assumptions made in the valuation reports. In order to ensure consistency in valuation between the July 2003 and July 2004 calculations and to reconcile the differences between the valuations detailed in the reports and the estimated initial public offer price, the board focused on two items:

The use of a different discount rate in the income approach calculation in the July 2003 valuation report from the discount rate used in the same calculation in the July 2004 valuation report; and

The use of a three-year average of our financial metrics rather than our financial metrics for only the most recent year, when comparing those results to those of comparable companies in the market approach calculation in the July 2004 report.

As to the first item, the board determined that, given our status as an enterprise with an established financial history of profitable operations and generation of positive cash flow, the risk profile of our future income stream did not change materially in the space of one year from July 2003 to July 2004. As a result, the board determined that the same discount rate should be used in both calculations. Further, in considering which discount rate was more appropriate, the board determined that the lower rate was more appropriate, again in view of our status as an established enterprise. As to the second item, the board determined that using a three-year average of financial metrics for a company like us, whose results have been substantially increasing in recent years, would not result in an appropriate valuation. The board therefore determined to use only our most recent year’s financial results in applying the market approach calculation.

As a result of the foregoing, our board of directors instructed management to adjust the original valuation methodologies used in the July 2003 and July 2004 valuation reports using a consistent discount rate and only one year of financial metrics, but otherwise leaving the original methodology unchanged.

In applying this reassessment methodology to value the shares of Class B common stock underlying the awards granted since the beginning of fiscal 2004, our board grouped the awards into four categories based on chronology: awards granted in December 2003 and January 2004; awards granted in April 2004; awards granted in June 2004 and August 2004; and awards granted in October 2004 and November 2004. The board of directors determined that it was appropriate to group the awards in this way, as no material event occurred in the intervening period between each pair of dates that would necessitate a material change in the value of the Class B common stock. The following is a description of the board of directors’ reassessment of the value of the Class B common stock for each of the four categories.

Equity awards granted in December 2003 and January 2004. For the equity awards granted in December 2003 and January 2004, the board applied the reassessment methodology described above, and also used updated financial information. In particular, the board noted that, at the time of these grants, we possessed financial information that was more current than the financial information that was used as the basis for the income approach in the July 2003 valuation report. The income approach methodology used in the July 2003 valuation report was based on our projected fiscal 2004 financial results. Our actual pre-tax income for the

quarter ended December 26, 2003 exceeded the projected results by 66%. Accordingly, the board believed that it was appropriate to use this updated financial information in reassessing the value of the shares of Class B common stock for the December 2003 and January 2004 equity award grants and adjusted the reassessment methodology to take this information into account. The board also noted that no material events had occurred between July 2003 and January 2004 that would necessitate a material change in the value of the shares of Class B common stock, other than the improvement in our first quarter financial results.

Equity awards granted in April 2004. For the equity awards granted in April 2004, our board of directors first looked at our financial results for the first and second quarters of fiscal 2004 as compared to the projected fiscal 2004 revenue and pre-tax income used in the July 2003 valuation report. Our board of directors noted that our financial results for the second quarter of fiscal 2004, which ended in March 2004, were record financial results and improved upon our results of operations for the first quarter of fiscal 2004. The board also noted that our third quarter results were in line with our second quarter results — in fact, our earnings per share were the same for the second and third quarters of fiscal 2004. The board of directors then noted that these more recent results, as well as projected financial results for future periods, were the bases for the July 2004 valuation report, and that no material events had occurred between April 2004 and July 2004 that would necessitate a material change in the value of the shares of Class B common stock. As a result, our board determined that it was appropriate to use the results from the reassessment methodology as applied to the July 2004 report to determine the value of the shares of Class B common stock in April 2004.

To test the reasonableness of this determination, we performed our own market approach analyses for both April 2004 and July 2004 using substantially the same comparable companies used in the market approach calculation of the July 2004 valuation report. We determined an average price-to-earnings ratio for this group of companies and then applied that ratio to our projected fiscal 2004 results based on our most recent quarterly results, to determine our market valuation for both times. This analysis showed little change in that market valuation between these two dates, thus supporting the use of the same valuation for the Class B common stock in both April 2004 and July 2004.

In addition to the foregoing, the board also took into consideration that in March 2004 we began substantive conversations with underwriters regarding an initial public offering, even though we did not formally begin our initial public offering process until the fall of 2004. Our board of directors noted that both the July 2003 and July 2004 valuation reports applied a 20% illiquidity discount to reflect that our shares of Class B common stock were not freely tradable. The appropriateness of that discount lessened as it became more likely that we would undertake an initial public offering, which would result in a liquidity event for our Class B common stock. Accordingly, the board determined that the illiquidity discount used in the July 2003 and July 2004 valuation reports should not be applied for all equity awards granted subsequent to the time we began holding substantive conversations regarding the initial public offering process, including the equity awards granted in April 2004.

Equity awards granted in June 2004 and August 2004. For the equity awards granted in June 2004 and August 2004, which were granted reasonably close in time to the effective time of the July 2004 valuation report, our board of directors determined that the per share value of the July 2004 valuation report, adjusted to give effect to the application of the reassessment methodology described above, as well as to eliminate the illiquidity discount, should be used as the value of the common stock underlying the June 2004 and August 2004 awards.

Equity awards granted in October 2004 and November 2004. For the equity awards granted in October 2004 and November 2004, our board noted that, prior to the time these grants were made, Ray Dolby had decided to contribute to us certain intellectual property rights related to our business without receiving any consideration in return. Since the beginning of fiscal 2004, it was contemplated that Ray Dolby would transfer these intellectual property rights to us in connection with the initial public offering. Prior to his decision to contribute these rights to us without receiving consideration in return, our negotiations with Ray

Dolby had contemplated that we would issue to him shares of Class B common stock equal to the value of the intellectual property rights contributed. Had we done so, our overall valuation would have increased, but the dilution from the issuance of these additional shares would have resulted in no change in the per share valuation. As a result of Ray Dolby’s October 2004 decision to contribute these rights without consideration, our board therefore decided that this event caused a significant step-up in value of the shares of Class B common stock for purposes of equity award valuations. For a further discussion of the asset contribution, see “Certain Relationships and Related Party Transactions.”

The July 2004 valuation report had already included an alternative valuation, in which we were valued without any obligation to pay Ray Dolby any royalties under our intellectual property licensing agreements with him. This was a separate analysis from the analysis valuing us with continued royalty obligations to Ray Dolby. Our board of directors decided that applying the reassessment methodology to this alternative valuation, after eliminating the illiquidity discount, was an appropriate method to determine the step-up in value of the shares of Class B common stock as a result of Ray Dolby’s decision to contribute the intellectual property rights to us without receiving consideration in return.

Results of Reassessment. Based upon this reassessment of the fair value of our Class B common stock, we have recorded deferred stock-based compensation to the extent that the reassessed value of our Class B common stock at the date of grant exceeded the exercise price of the equity awards. Reassessed values are inherently uncertain and highly subjective. If we had made different assumptions, the amount of our deferred stock-based compensation, stock-based compensation expense, gross margin, net income and net income per share amounts could have been significantly different. We recorded deferred compensation of $38.4 million during fiscal 2004. The deferred stock-based compensation expense is being amortized on a straight-line basis over the stock option vesting period of four years. In fiscal 2004, we recognized $4.7 million in stock-based compensation expense related to Class B common stock options granted to employees based upon the reassessed values of the Class B common stock underlying the stock option awards. We also issued shares of fully vested Class B common stock to an executive officer in fiscal 2004. We recorded stock-based compensation expense in connection with the award calculated based on the reassessed value of our Class B common stock at the date the shares were issued, which resulted in $2.1 million expense recorded in selling, general and administrative expense in fiscal 2004. Utilizing the reassessed value of our common stock as of September 24, 2004, the intrinsic value of our outstanding vested and unvested options to purchase Class B common stock was $54.3 million and $93.4 million, respectively.

In the first quarter of fiscal 2005, we granted additional options to purchase Class B common stock to our employees at exercise prices that were below the reassessed fair value at the date of grant. We recorded deferred compensation of $5.5 million related to these equity awards, which will be amortized on a straight-line basis over the vesting schedule of the awards.

The amount of deferred stock-based compensation expected to be recognized in the next five fiscal years related to awards previously issued to employees is as follows:


	Expense by Fiscal Year
	2005		2006		2007		2008		2009
	(in thousands)
Amortization of deferred stock-based compensation related to stock options granted to employees	$	10,820	$	10,949	$	10,949	$	6,286	$	114

Note 1 of the Notes to Consolidated Financial Statements included as part of this prospectus describes what the effect would have been had we accounted for stock-based awards under the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation.”

Results of Operations

Fiscal Years Ended September 27, 2002, September 26, 2003 and September 24, 2004 and the Fiscal Quarters Ended December 26, 2003 and December 31, 2004

The following table presents our audited actual and pro forma unaudited operating results as a percentage of total revenue for the periods indicated:


	Actual										Pro Forma
	Fiscal Year Ended						Fiscal Quarter Ended				Fiscal Year Ended						Fiscal Quarter Ended
	Sep 27, 2002		Sep 26, 2003		Sep 24, 2004		Dec 26, 2003		Dec 31, 2004		Sep 27, 2002		Sep 26, 2003		Sep 24, 2004		Dec 26, 2003		Dec 31, 2004
					(as restated)		(as restated)
							(unaudited)				(unaudited)
Consolidated Statements of Operations Data:
Revenue:
Licensing	66	%	73	%	73	%	73	%	74	%	67	%	73	%	73	%	73	%	74	%
Product sales	25		20		20		20		19		25		20		20		20		19
Production services	9		7		7		7		7		8		7		7		7		7

Total revenue	100		100		100		100		100		100		100		100		100		100

Cost of revenue:
Cost of licensing	16		19		19		20		19		5		7		7		7		7
Cost of product sales (1)	16		12		10		11		11		14		11		9		10		10
Cost of production services (1)	4		3		3		2		2		4		3		3		2		2

Total cost of revenue	36		34		32		33		32		23		21		19		19		19

Gross margin	64		66		68		67		68		77		79		81		81		81
Operating expenses:
Selling, general and administrative (includes 2% and 2% in stock-based compensation for fiscal 2004 and the fiscal quarter ended December 31, 2004, respectively) (1)	40		35		37		31		39		42		35		37		31		39
Research and development (includes 1% in stock-based compensation for the fiscal quarter ended December 31, 2004 (1))	9		8		8		7		10		9		8		8		7		10
Settlements	15		—		—		—		(2	)	14		—		—		—		(2	)
In-process research and development	—		1		—		—		—		—		1		—		—		—

Total operating expenses	64		44		45		38		47		65		44		45		38		47

Operating income	0		22		23		29		21		12		35		36		43		34
Other income (expenses), net	0		0		0		0		0		0		0		0		0		0

Income (loss) before provision for income taxes and controlling interest	0		22		23		29		21		12		35		36		43		34
Provision for income taxes	0		8		9		10		9		5		13		14		16		14

Income (loss) before controlling interest	0		14		14		19		12		7		22		22		27		20
Controlling interest in net (income) loss	0		0		0		0		0		0		0		0		0		0

Net income (loss)	0	%	14	%	14	%	19	%	12	%	7	%	22	%	22	%	27	%	20	%

(1) Stock-based compensation recorded in fiscal 2004 and the fiscal quarters ended December 26, 2003 and December 31, 2004 was classified as follows:

Cost of product sales					0	%	—	%	0	%					0	%	—	%	0	%
Cost of production services					0		—		0						0		—		0
Selling, general and administrative					2		0		2						2		0		2
Research and development					0		—		1						0		—		1

Total stock-based compensation					2	%	0	%	3	%					2	%	0	%	3	%

Fiscal Quarters Ended December 26, 2003 and December 31, 2004

Revenue


	Fiscal Quarter Ended						Change
	December 26, 2003			December 31, 2004			In Dollars		Percentage
	(unaudited)
	($ in thousands)
Revenue:
Licensing	$	47,799		$	62,191		$	14,392	30	%
Percentage of total revenue		73	%		74	%
Product sales		13,392			16,487			3,095	23	%
Percentage of total revenue		20	%		19	%
Production services		4,232			5,585			1,353	32	%
Percentage of total revenue		7	%		7	%

Total revenue	$	65,423		$	84,263		$	18,840	29	%

Licensing. The $14.4 million, or 30%, increase in licensing revenue from the first quarter of fiscal 2004 to the first quarter of fiscal 2005 resulted primarily from increased sales by our licensees of their consumer electronics products that incorporate our technologies, principally attributable to the continued growth in sales of DVD players worldwide. Virtually all DVD players incorporate our Dolby Digital technologies. Nonetheless, we do not expect our licensees’ sales of DVD players, and thus our licensing revenue related to these products, to grow as rapidly in future periods as they have in the past. Aside from the growth in sales of DVD players, the increase in our licensing revenue was also attributable to growth in sales of personal computer software DVD players and, to a lesser extent, home theatre systems, set-top boxes and recordable DVD players. Sales of products such as home-theatre-in-a-box and audio/video receivers that incorporate multiple Dolby technologies also helped increase our licensing revenue, as we typically receive royalties for each of our technologies incorporated into a licensee’s product. To a lesser extent, the increase in licensing revenue was attributable to increases in our royalty rates resulting from cost of living license rate increases that are generally provided for in our licensing agreements. In addition, contributing to the increase in licensing revenue in the fiscal 2005 first quarter was our receipt of corrective and/or retroactive royalty payments for prior periods. During the quarter we received late reports from some of our consumer electronics manufacturer licensees reporting their June 2004 quarter shipments. Normally we would expect to receive these reports in the September quarter. We also recognized revenues relating to some reports received during the September 2004 quarter, which we would otherwise recognize upon receipt, because we did not have reasonable assurance of collectibility until the later quarter. While we receive such corrective and/or retroactive royalty payments from time to time, the occurrence and timing of our receipt is unpredictable and we may not experience similar corrective or retroactive royalty reports in future periods to the same extent we received them in the quarter ended December 31, 2004.

Product Sales. The $3.1 million, or 23%, increase in our revenue from product sales from the first quarter of fiscal 2004 to the first quarter of fiscal 2005 was principally attributable to a $2.1 million increase in sales of our cinema products, primarily related to new theatre construction both in the United States and Asia and the decisions by certain cinema operators to retrofit their existing theatres. To a lesser extent, the increase in product sales revenue was attributable to a $1.0 million increase in sales of our broadcast products to local television stations and cable networks. We believe that the growth in sales of our broadcast products to terrestrial, or over-the-air, broadcasters in the United States was principally attributable to their efforts to comply with the requirement of the FCC that such stations broadcast digital signals. We also believe that sales of our broadcast products have increased throughout the world as terrestrial, cable and satellite broadcasters seek to deliver programming that can utilize the capabilities of viewers’ home theatre systems. The decrease in product sales as a percentage of revenue from the first quarter of fiscal 2004 to the first quarter of fiscal 2005 was due to licensing revenue increasing at a faster rate than revenue from product sales.

Production Services. The $1.4 million, or 32%, increase in production services revenue from the first quarter of fiscal 2004 to the first quarter of fiscal 2005 was primarily attributable to a $0.8 million increase in production by foreign content providers related to original foreign films, foreign language versions of original films, commercials and film trailers, including the impact of favorable exchange rate fluctuations. In addition, our revenue from our other service offerings such as print checking, screening services and digital cinema services increased $0.5 million in the first quarter of fiscal 2005 as compared to the first quarter of fiscal 2004, as some of these services were not offered in the first quarter of fiscal 2004.

Gross Margin


	Actual						Pro Forma
	Fiscal Quarter Ended						Fiscal Quarter Ended
	December 26, 2003			December 31, 2004			December 26, 2003			December 31, 2004
	(as restated)
	(unaudited)
	($ in thousands)
Gross margin:
Licensing gross margin	$	35,018		$	46,042		$	43,131		$	56,193
Licensing gross margin percentage		73	%		74	%		90	%		90	%
Product sales gross margin (includes $0.1 million in stock-based compensation expense in the fiscal quarter ended December 31, 2004)		6,496			7,675			7,253			8,577
Product sales gross margin percentage		49	%		47	%		54	%		52	%
Production services gross margin (includes $26,000 in stock-based compensation expense in the fiscal quarter ended December 31, 2004)		2,645			3,570			2,645			3,570
Production services gross margin percentage		63	%		64	%		63	%		64	%

Total gross margin	$	44,159		$	57,287		$	53,029		$	68,340
Total gross margin percentage		67	%		68	%		81	%		81	%

Licensing Gross Margin. We license intellectual property rights that may be internally developed, acquired by us or licensed from other parties. Our cost of licensing consists principally of royalty payments we make to Ray Dolby and to other third parties for the licensing of intellectual property rights that we sublicense as part of our licensing arrangements with our customers. Our cost of licensing also includes amortization expenses associated with purchased intangibles. The increase in licensing gross margin from the first quarter of fiscal 2004 to the first quarter of fiscal 2005 was due to a decrease in the relative proportion of licensing revenue derived from royalties for product sales that incorporate technologies that we license from third parties. Our pro forma licensing gross margin for the first quarter of fiscal 2004 and 2005 excludes $8.1 million and $10.2 million, respectively, of expenses we recorded for sublicensing royalty payments we made to Ray Dolby.

Product Sales Gross Margin. Cost of product sales primarily consists of material costs related to the products sold, applied labor and manufacturing overhead and, to a lesser extent, royalty obligations for technologies we license from Ray Dolby. The decrease in our product sales gross margin for the first quarter of fiscal 2005 as compared to the first quarter of fiscal 2004 was primarily due to the impact of foreign exchange rates on cost of product sales denoted in foreign currencies. In particular, our cost of product sales in the United Kingdom increased as a result of the weaker value of the United States dollar relative to the United Kingdom pound — we manufacture our professional products at our Wootton Bassett facility in England as well as at our Brisbane, California facility. In addition, gross margin for the first quarter of fiscal 2005 was adversely affected by stock-based compensation expense of $0.1 million. These decreases were partially offset by increased production levels, which were able to absorb greater amounts of relatively fixed labor and overhead costs. Pro forma product sales gross margin for the first quarter of fiscal 2004 and 2005 excludes $0.8 million and $0.9 million, respectively, of expenses we recorded for royalty payments we made to Ray Dolby.

Production Services Gross Margin. Cost of production services consists of the payroll and benefit costs of employees performing our professional services, the cost of outside consultants and reimbursable expenses incurred on behalf of the customer. The increase in production services gross margin in the first quarter of fiscal 2005 compared to the first quarter of fiscal 2004 was primarily due to an increase in content production and the corresponding amount of engineering services provided by our professional services organization.

Operating Expenses


	Fiscal Quarter Ended						Change
	December 26, 2003			December 31, 2004			In Dollars			Percentage
	(as restated)
	(unaudited)
	($ in thousands)
Operating expenses:
Selling, general and administrative (includes $4,000 and $2.2 million in stock-based compensation expense in the fiscal quarter ended December 26, 2003 and December 31, 2004, respectively)	$	20,092		$	32,857		$	12,765		64	%
Percentage of total revenue		31	%		39	%
Research and development (includes $0.7 million in stock-based compensation expense in the fiscal quarter ended December 31, 2004)		4,934			8,289			3,355		68	%
Percentage of total revenue		8	%		10	%
Settlements		—			(2,000	)		(2,000	)	—
Percentage of total revenue		0	%		(2	)%

Total operating expenses	$	25,026		$	39,146		$	14,120		56	%

Selling, General and Administrative. Selling, general and administrative expense consists primarily of personnel and personnel-related expenses, facility costs and professional service fees for our sales, marketing and administrative functions. The $12.8 million, or 64%, increase in selling, general and administrative expense from the first quarter of fiscal 2004 to the first quarter of fiscal 2005 was principally due to a $3.4 million increase in payroll and benefits costs as a result of increased headcount and related performance based awards and $3.1 million in promotional expenses primarily associated with our secure DVD player technology. In addition, our selling, general and administrative expense also increased due to an increase of $2.2 million in stock-based compensation expenses, as well as an increase of $1.5 million of professional and consulting expenses related primarily to intellectual property rights enforcement activities and our preparations for being a public company and a $0.8 million increase in bad debt expense. In part, the remaining increase in selling, general and administrative expense was also due to an additional week of activity, as the first quarter of fiscal 2005 consisting of 14 weeks compared to the first quarter of fiscal 2004, which consisted of 13 weeks. We expect that our selling, general and administrative expense will continue to increase in absolute dollars in fiscal 2005 as compared to fiscal 2004, as we continue to build our infrastructure in order to accommodate growth and to meet the requirements of being a public company. We expect to continue to incur additional costs associated with Sarbanes-Oxley Act compliance efforts, as well as consulting fees and ancillary ERP implementation costs related to implementing recommendations resulting from a consultant’s report on our royalty reporting processes, such as enhanced data collection and compliance tracking tools and improved licensee training and communications. We intend to fund these additional costs from our available working capital.

Research and Development. Research and development expense consists primarily of salary and related costs for personnel responsible for the research and development of new technologies and products. The $3.4 million, or 68%, increase in research and development expense in the first quarter of fiscal 2005 as compared to the first quarter of fiscal 2004 was primarily due to a $2.0 million increase in payroll and benefit costs as a result of increased headcount and related performance-based awards and, to a lesser extent, to a $0.7 million charge

related to stock-based compensation expense. In part, this increase was also due to an additional week of activity, with the first quarter of fiscal 2005 consisting of 14 weeks compared to the first quarter of fiscal 2004, which consisted of 13 weeks. We anticipate that research and development expense will continue to increase in absolute dollars in fiscal 2005 as compared to fiscal 2004, as we expect to hire additional personnel to support the development of new technologies. We intend to fund this increase in research and development expense from our available working capital.

Settlements. Settlements include interest and penalties related to the collection of royalties and resolution of disputes in our favor or against us. Settlements of royalty disputes from licensees that specifically represent unpaid royalties are recorded as licensing revenue in the period payment is received, if all other revenue recognition criteria have been met. Settlements of other disputes, such as disputes with implementation licensees from which we typically do not receive royalties, are recorded in settlements. In the first quarter of fiscal 2005, we recognized $2.0 million in connection with the settlement of disputes with two of our implementation licensees regarding violation of the terms of their implementation licensing agreements with us.

Other Income (Expenses), Net

Other income (expenses), net primarily consists of interest income earned on cash and cash equivalent balances, gains and losses on interest rate swap agreements, offset by interest expense on outstanding balances on our facility debt obligations. Other income, net was $0.2 million for the first quarter of fiscal 2004 compared to $0.3 million for first quarter of fiscal 2005.

Income Taxes


	Actual						Pro Forma
	Fiscal Quarter Ended						Fiscal Quarter Ended
	December 26, 2003			December 31, 2004			December 26, 2003			December 31, 2004
	(as restated)
				(unaudited)
	($ in thousands)
Income taxes:
Provision for income taxes	$	6,825		$	7,743		$	10,243		$	12,260
Effective tax rate		36	%		43	%		37	%		42	%

Our effective tax rate in the first quarter of fiscal 2005 was higher than in the first quarter of fiscal 2004 primarily due to the impact of stock-based compensation expense, which is nondeductible, and losses from foreign subsidiaries that were not present in the first quarter of fiscal 2004. Excluding the effect of stock-based compensation expense, our effective tax rate for the first quarter of fiscal 2005 would have been 40%, actual and 39%, pro forma. Our pro forma provision for income taxes and pro forma effective tax rate for the first quarter of fiscal 2004 and 2005 reflect the increase in operating income due to the exclusion of $8.9 million and $11.1 million, respectively, in royalty expense payable to Ray Dolby.

Fiscal Years Ended September 26, 2003 and September 24, 2004

Revenue


	Fiscal Year Ended						Change
	September 26, 2003			September 24, 2004			In Dollars		Percentage
	($ in thousands)
Revenue:
Licensing	$	157,922		$	211,395		$	53,473	34	%
Percentage of total revenue		73	%		73	%
Product sales		44,403			57,981			13,578	31	%
Percentage of total revenue		20	%		20	%
Production services		15,147			19,665			4,518	30	%
Percentage of total revenue		7	%		7	%

Total revenue	$	217,472		$	289,041		$	71,569	33	%

Licensing. The $53.5 million, or 34%, increase in licensing revenue from fiscal 2003 to fiscal 2004 resulted from increased sales by our licensees of their consumer electronics products that incorporate our technologies, principally attributable to the growth in sales of DVD players worldwide. The increase in licensing revenue was primarily attributable to increases in the volume of units shipped by our licensees, and to a lesser extent to increases in our royalty rates, resulting from cost of living license rate increases that are generally provided for in our licensing agreements. Virtually all DVD players incorporate our Dolby Digital technologies. Aside from the growth in sales of DVD players, the increase in our licensing revenue was also attributable to growth in sales of personal computer software DVD players and, to a lesser extent, home theatre systems, set-top boxes and recordable DVD players. Sales of products such as home-theatre-in-a-box and audio/video receivers that incorporate multiple Dolby technologies also helped increase our licensing revenue, as we typically receive royalties for each of our technologies incorporated into a licensee’s product.

Product Sales. The $13.6 million, or 31%, increase in our revenue from product sales from fiscal 2003 to fiscal 2004 was principally attributable to a $10.0 million increase in sales of our cinema products, primarily related to new theatre construction and the decisions by cinema operators to retrofit their existing theatres to include our cinema processors. To a lesser extent, the increase in product sales revenue was also attributable to $2.0 million in sales of sound reinforcement products by one of our consolidated subsidiaries, which was acquired in fiscal 2004 and was therefore not included in prior periods, and a $1.6 million increase in sales of our broadcast products to local television stations, cable networks and European satellite broadcasters.

Production Services. The $4.5 million, or 30%, increase in production services revenue from fiscal 2003 to fiscal 2004 was primarily attributable to a $3.4 million increase in production by foreign content providers, including the impact of favorable exchange rate fluctuations. Of the $3.4 million increase, $2.0 million related to original foreign films, $0.8 million to foreign language versions of original films, and $0.6 million to commercials and film trailers. Service revenue from acquired companies contributed an additional $0.4 million in fiscal 2004. Additionally, our other service offerings such as print checking and screening services increased $0.4 million in fiscal 2004 as compared to fiscal 2003, as some of these services related to digital cinema had not previously been offered.

Gross Margin


	Actual						Pro Forma
	Fiscal Year Ended						Fiscal Year Ended
	September 26, 2003			September 24, 2004			September 26, 2003			September 24, 2004
				(as restated)			(unaudited)
	($ in thousands)
Gross margin:
Licensing gross margin	$	117,921		$	157,557		$	143,047		$	191,325
Licensing gross margin percentage		75	%		75	%		91	%		91	%
Product sales gross margin (includes $0.1 million in stock-based compensation expense in fiscal 2004)		17,719			27,938			20,213			31,027
Product sales gross margin percentage		40	%		48	%		46	%		54	%
Production services gross margin (includes $36,000 in stock-based compensation expense in fiscal 2004)		8,189			12,041			8,189			12,041
Production services gross margin percentage		54	%		61	%		54	%		61	%

Total gross margin	$	143,829		$	197,536		$	171,449		$	234,393
Total gross margin percentage		66	%		68	%		79	%		81	%

Licensing Gross Margin. Our pro forma licensing gross margin for fiscal 2003 and 2004 excludes $25.1 million and $33.8 million, respectively, of expenses we recorded for sublicensing royalty payments we made to Ray Dolby.

Product Sales Gross Margin. The increase in our product sales gross margin in fiscal 2004 was the result of increased production levels, but was partially offset by a $0.1 million stock-based compensation expense recorded in fiscal 2004. The increased production levels led to increased gross margins, as the higher production volumes were able to absorb greater amounts of relatively fixed labor and overhead costs due to the high level of automation in our manufacturing processes. Pro forma product sales gross margin excludes $2.5 million and $3.1 million for fiscal 2003 and 2004, respectively, in expenses we recorded for royalty payments we made to Ray Dolby.

Production Services Gross Margin. The increase in production services gross margin in fiscal 2004 resulted primarily from an increase in content production and the corresponding amount of engineering services provided by our professional services organization during the fiscal year.

Operating Expenses


	Fiscal Year Ended						Change
	September 26, 2003			September 24, 2004			In Dollars			Percentage
				(as restated)
	($ in thousands)
Operating expenses:
Selling, general and administrative (includes $5.8 million in stock-based compensation expense in fiscal 2004)	$	76,590		$	106,456		$	29,866		39	%
Percentage of total revenue		35	%		37	%
Research and development (includes $0.8 million in stock-based compensation expense in fiscal 2004)		18,262			23,479			5,217		29	%
Percentage of total revenue		8	%		8	%
Settlements		—			(2,000	)		(2,000	)	—
Percentage of total revenue		—			(1	)%
In-process research and development		1,310			1,738			428		33	%
Percentage of total revenue		1	%		1	%

Total operating expenses	$	96,162		$	129,673		$	33,511		35	%