**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549**

**Form 10-Q**

**QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**Forthe Quarterly Period Ended June 30, 2007**

**CommissionFile Number 000-50335**

**DTS, Inc.**

(Exact name of registrantas specified in its charter)

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

 

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Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x   No o

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

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o   No x

Asof July 31, 2007 a total of 17,631,579 shares of the Registrant’s CommonStock, $0.0001 par value, were issued and outstanding.

 

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**DTS, INC.FORM 10-QTABLE OF CONTENTS**
| **PART I**   | ** ** | **FINANCIAL  INFORMATION**                                                                      | ** ** | **1**  | ** ** |
|-------------------|------------|-------------------------------------------------------------------------------------------------|------------|--------|------------|
| **Item 1.**  | ** ** | **Financial  Statements (unaudited):**                                                          | ** ** | **1**  | ** ** |
|              | ** ** | **Consolidated Balance Sheets**                                                                 | ** ** | **1**  | ** ** |
|              | ** ** | **Consolidated  Statements of Operations**                                                      | ** ** | **2**  | ** ** |
|              | ** ** | **Consolidated  Statements of Cash Flows**                                                      | ** ** | **3**  | ** ** |
|              | ** ** | **Notes to Consolidated  Financial Statements**                                                 | ** ** | **4**  | ** ** |
| **Item 2.**  | ** ** | **Management’s Discussion and  Analysis of Financial Condition and Results of Operations** | ** ** | **12** | ** ** |
| **Item 3.**  | ** ** | **Quantitative and Qualitative  Disclosures About Market Risk**                                 | ** ** | **19** | ** ** |
| **Item 4.**  | ** ** | **Controls  and Procedures**                                                                    | ** ** | **20** | ** ** |
| **PART II.** | ** ** | **OTHER  INFORMATION**                                                                          | ** ** | **21** | ** ** |
| **Item 1.**  | ** ** | **Legal  Proceedings**                                                                          | ** ** | **21** | ** ** |
| **Item 1A.**      | ** ** | **Risk  Factors**                                                                               | ** ** | **21** | ** ** |
| **Item 2.**  | ** ** | **Unregistered Sales of Equity  Securities and Use of Proceeds**                                | ** ** | **37** | ** ** |
| **Item 3.**  | ** ** | **Defaults Upon Senior  Securities**                                                            | ** ** | **37** | ** ** |
| **Item 4.**  | ** ** | **Submission of Matters to a  Vote of Security Holders**                                        | ** ** | **38** | ** ** |
| **Item 5.**  | ** ** | **Other  Information**                                                                          | ** ** | **38** | ** ** |
| **Item 6.**  | ** ** | **Exhibits**                                                                                    | ** ** | **38** | ** ** |
| **SIGNATURES**    |       | **39**                                                                                          |       |

 

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**DTS, INC.**

**PART I**

**FINANCIALINFORMATION**

**Item 1.**                        FinancialStatements

**DTS, Inc.Consolidated Balance Sheets**

| ** **                                                                                                                                                                                                                                        | ** ** | **As of**                                                                 | ** ** | **As of**    | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                                                        | ** ** | **December 31,**                                                          | ** ** | **June 30,** | ** ** |
| ** **                                                                                                                                                                                                                                        | ** ** | **2006**                                                                       | ** ** | **2007**          | ** ** |
| ** **                                                                                                                                                                                                                                        | ** ** | **(Unaudited)**                                                                | ** ** |
| ** **                                                                                                                                                                                                                                        | ** ** | **(Amounts in thousands,  except per share amounts)** | ** ** |
| ASSETS                                                                                                                                                                                                                                            |       |                                                                           |       |              |       |   |   |
| Current assets:                                                                                                                                                                                                                                   |       |                                                                           |       |              |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                                        |       |                                                                           | $          | 14,392            |       |   | $ | 18,677 |   |
| Short-term  investments                                                                                                                                                                                                                           |       |                                                                           | 94,368     |              |       | 83,769 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $48 and $100 at  December 31, 2006 and June 30, 2007, respectively                                                                                                 |       |                                                                           | 2,550      |              |       | 6,662 |   |
| Deferred income  taxes                                                                                                                                                                                                                            |       |                                                                           | 7,059      |              |       | 7,059 |   |
| Prepaid expenses  and other current assets                                                                                                                                                                                                        |       |                                                                           | 1,525      |              |       | 1,562 |   |
| Income taxes  receivable, net                                                                                                                                                                                                                     |       |                                                                           | 2,244      |              |       | 2,466 |   |
| Assets of  discontinued operations held for sale                                                                                                                                                                                                  |       |                                                                           | 11,290     |              |       | 8,925 |   |
| Total current  assets                                                                                                                                                                                                                             |       |                                                                           | 133,428    |              |       | 129,120 |   |
| Property and  equipment, net                                                                                                                                                                                                                      |       |                                                                           | 5,982      |              |       | 5,393 |   |
| Intangible assets,  net                                                                                                                                                                                                                           |       |                                                                           | 1,852      |              |       | 1,655 |   |
| Deferred income  taxes                                                                                                                                                                                                                            |       |                                                                           | 305        |              |       | 2,394 |   |
| Other assets                                                                                                                                                                                                                                      |       |                                                                           | 989        |              |       | 1,968 |   |
| Assets of  discontinued operations held for sale                                                                                                                                                                                                  |       |                                                                           | 25,644     |              |       | 27,792 |   |
| Total assets                                                                                                                                                                                                                                      |       |                                                                           | $          | 168,200           |       |   | $ | 168,322 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                                                        |       |                                                                           |       |              |       |   |   |
| Current liabilities:                                                                                                                                                                                                                              |       |                                                                           |       |              |       |   |   |
| Accounts payable                                                                                                                                                                                                                                  |       |                                                                           | $          | 1,142             |       |   | $ | 821 |   |
| Accrued expenses  and other liabilities                                                                                                                                                                                                           |       |                                                                           | 3,832      |              |       | 4,643 |   |
| Liabilities of  discontinued operations held for sale                                                                                                                                                                                             |       |                                                                           | 7,944      |              |       | 6,184 |   |
| Total current  liabilities                                                                                                                                                                                                                        |       |                                                                           | 12,918     |              |       | 11,648 |   |
| Other long-term  liabilities                                                                                                                                                                                                                      |       |                                                                           | —     |              |       | 1,750 |   |
| Liabilities of  discontinued operations held for sale                                                                                                                                                                                             |       |                                                                           | 1,466      |              |       | 1,253 |   |
| Commitments and contingencies (Note 8)                                                                                                                                                                                                            |       |                                                                           |       |              |       |   |   |
| Stockholders’ equity:                                                                                                                                                                                                                        |       |                                                                           |       |              |       |   |   |
| Preferred  stock—$0.0001 par value, 5,000 shares authorized at December 31, 2006  and June 30, 2007; no shares issued and outstanding at  December 31, 2006 and June 30, 2007                                  |       |                                                                           | —     |              |       | — |   |
| Common  stock—$0.0001 par value, 70,000 shares authorized at December 31, 2006  and June 30, 2007; 18,024 and 18,145 shares issued and  outstanding at December 31, 2006 and June 30, 2007,  respectively |       |                                                                           | 2          |              |       | 2 |   |
| Additional paid-in  capital                                                                                                                                                                                                                       |       |                                                                           | 129,549    |              |       | 135,021 |   |
| Treasury stock, at  cost                                                                                                                                                                                                                          |       |                                                                           | —     |              |       | (3,680 | ) |
| Accumulated other  comprehensive income                                                                                                                                                                                                           |       |                                                                           | —     |              |       | 33 |   |
| Retained earnings                                                                                                                                                                                                                                 |       |                                                                           | 24,265     |              |       | 22,295 |   |
| Total  stockholders’ equity                                                                                                                                                                                                                  |       |                                                                           | 153,816    |              |       | 153,671 |   |
| Total liabilities  and stockholders’ equity                                                                                                                                                                                                  |       |                                                                           | $          | 168,200           |       |   | $ | 168,322 |   |

 

See accompanying notes to consolidated financial statements.

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**DTS, Inc.Consolidated Statements of Operations**

| ** **                                                                   | ** ** | **For the Three Months  Ended June 30,**                               | ** ** | **For the Six Months  Ended June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                                                                        | ** ** | **2007**                                                        | ** ** | **2006** | ** ** | **2007** | ** ** |
| ** **                                                                   | ** ** | **(Unaudited)  (Amounts in thousands, except per share amounts)** | ** ** |
| Revenue                                                                      |       | $                                                                                               | 9,580      |                                                            | $          | 12,911 |   | $ | 30,262 |   | $ | 25,519 |   |
| Cost of revenue                                                              |       | 532                                                                                             |       | 299                                                             |       | 941 |   | 554 |   |
| Gross profit                                                                 |       | 9,048                                                                                           |       | 12,612                                                          |       | 29,321 |   | 24,965 |   |
| Operating expenses:                                                          |       |                                                                                            |       |                                                            |       |   |   |   |   |
| Selling, general and administrative                                          |       | 7,044                                                                                           |       | 8,022                                                           |       | 14,310 |   | 16,094 |   |
| Research and development                                                     |       | 1,733                                                                                           |       | 1,666                                                           |       | 3,311 |   | 3,270 |   |
| Total operating expenses                                                     |       | 8,777                                                                                           |       | 9,688                                                           |       | 17,621 |   | 19,364 |   |
| Income from  operations                                                      |       | 271                                                                                             |       | 2,924                                                           |       | 11,700 |   | 5,601 |   |
| Interest and  other income, net                                              |       | 1,246                                                                                           |       | 871                                                             |       | 2,306 |   | 1,227 |   |
| Income from  continuing operations before income taxes                       |       | 1,517                                                                                           |       | 3,795                                                           |       | 14,006 |   | 6,828 |   |
| Provision for  income taxes                                                  |       | 507                                                                                             |       | 1,432                                                           |       | 6,331 |   | 2,482 |   |
| Income from  continuing operations                                           |       | 1,010                                                                                           |       | 2,363                                                           |       | 7,675 |   | 4,346 |   |
| Income (loss)  from discontinued operations, net of tax                      |       | 873                                                                                             |       | (3,021                                                          | )          | 1,215 |   | (5,769 | ) |
| Net income (loss)                                                            |       | $                                                                                               | 1,883      |                                                            | $          | (658 | ) | $ | 8,890 |   | $ | (1,423 | ) |
| Net income (loss)  per common share:                                         |       |                                                                                            |       |                                                            |       |   |   |   |   |
| Basic:                                                                       |       |                                                                                            |       |                                                            |       |   |   |   |   |
| Continuing operations                                                        |       | $                                                                                               | 0.06       |                                                            | $          | 0.13 |   | $ | 0.44 |   | $ | 0.24 |   |
| Discontinued operations                                                      |       | 0.05                                                                                            |       | (0.17                                                           | )          | 0.07 |   | (0.32 | ) |
| Net income (loss)                                                            |       | $                                                                                               | 0.11       |                                                            | $          | (0.04 | ) | $ | 0.51 |   | $ | (0.08 | ) |
| Diluted:                                                                     |       |                                                                                            |       |                                                            |       |   |   |   |   |
| Continuing operations                                                        |       | $                                                                                               | 0.06       |                                                            | $          | 0.13 |   | $ | 0.42 |   | $ | 0.23 |   |
| Discontinued operations                                                      |       | 0.04                                                                                            |       | (0.17                                                           | )          | 0.07 |   | (0.31 | ) |
| Net income (loss)                                                            |       | $                                                                                               | 0.10       |                                                            | $          | (0.04 | ) | $ | 0.49 |   | $ | (0.08 | ) |
| Weighted average  shares used to compute net income (loss) per common share: |       |                                                                                            |       |                                                            |       |   |   |   |   |
| Basic                                                                        |       | 17,547                                                                                          |       | 18,026                                                          |       | 17,521 |   | 17,996 |   |
| Diluted                                                                      |       | 18,340                                                                                          |       | 18,698                                                          |       | 18,316 |   | 18,685 |   |

 

See accompanying notes to consolidated financial statements.

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**DTS, Inc.Consolidated Statements of Cash Flows**

| ** **                                                                                          | ** ** | **For the Six Months  Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2006**                                                        | ** ** | **2007** | ** ** |
| ** **                                                                                          | ** ** | **(Unaudited)**                                                 | ** ** |
| ** **                                                                                          | ** ** | **(Amounts in thousands)**                            | ** ** |
| Cash flows from  operating activities:                                                              |       |                                                            |       |   |   |
| Net income (loss)                                                                                   |       | $                                                               | 8,890      |   | $ | (1,423 | ) |
| Adjustments to reconcile  net income (loss) to net cash provided by (used in) operating activities: |       |                                                            |       |   |   |
| Depreciation and amortization                                                                       |       | 2,199                                                           |       | 1,617 |   |
| Stock-based compensation charges                                                                    |       | 1,755                                                           |       | 2,628 |   |
| Deferred income taxes                                                                               |       | (598                                                            | )          | (1,969 | ) |
| Tax benefits from stock-based awards                                                                |       | 222                                                             |       | 712 |   |
| Excess tax benefits from stock-based awards                                                         |       | (222                                                            | )          | (706 | ) |
| Other                                                                                               |       | 233                                                             |       | 335 |   |
| Changes in  operating assets and liabilities:                                                       |       |                                                            |       |   |   |
| Accounts receivable                                                                                 |       | 293                                                             |       | (4,028 | ) |
| Inventories                                                                                         |       | (272                                                            | )          | 252 |   |
| Prepaid expenses and other assets                                                                   |       | 819                                                             |       | (81 | ) |
| Accounts payable, accrued expenses and other  liabilities                                           |       | (452                                                            | )          | (1,007 | ) |
| Deferred revenue                                                                                    |       | (2,570                                                          | )          | 833 |   |
| Income taxes receivable                                                                             |       | 1,509                                                           |       | (222 | ) |
| Net cash provided by (used in) operating activities                                                 |       | 11,806                                                          |       | (3,059 | ) |
| Cash flows from  investing activities:                                                              |       |                                                            |       |   |   |
| Purchases of investments                                                                            |       | (80,057                                                         | )          | (36,774 | ) |
| Maturities of investments                                                                           |       | 36,238                                                          |       | 32,573 |   |
| Sales of investments                                                                                |       | 38,833                                                          |       | 13,800 |   |
| Cash paid for business and technology acquisitions,  net of cash acquired                           |       | (958                                                            | )          | (226 | ) |
| Purchase of property and equipment                                                                  |       | (3,577                                                          | )          | (3,264 | ) |
| Payment for patents and trademarks in process                                                       |       | (88                                                             | )          | (158 | ) |
| Net cash provided by (used in) investing activities                                                 |       | (9,609                                                          | )          | 5,951 |   |
| Cash flows from financing activities:                                                               |       |                                                            |       |   |   |
| Proceeds from the issuance of common stock upon  exercise of employee stock options            |       | 364                                                             |       | 1,562 |   |
| Proceeds from the issuance of common stock under  employee stock purchase plan                      |       | 480                                                             |       | 570 |   |
| Excess tax benefits from stock-based compensation                                                   |       | 222                                                             |       | 706 |   |
| Purchase of treasury stock                                                                          |       | —                                                          |       | (3,680 | ) |
| Net cash provided by (used in) financing activities                                                 |       | 1,066                                                           |       | (842 | ) |
| Net change in cash and cash equivalents of  discontinued operations                                 |       | —                                                          |       | 2,235 |   |
| Net increase in cash and cash equivalents                                                           |       | 3,263                                                           |       | 4,285 |   |
| Cash and cash  equivalents, beginning of period                                                     |       | 33,254                                                          |       | 14,392 |   |
| Cash and cash  equivalents, end of period                                                           |       | $                                                               | 36,517     |   | $ | 18,677 |   |

 

See accompanying notes to consolidated financial statements.

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

**Note 1—Basisof Presentation**

The accompanying unaudited consolidated financialstatements of DTS, Inc. (the “Company”) have been prepared in accordancewith accounting principles generally accepted in the United States and with theinstructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the informationand footnotes required by accounting principles generally accepted in theUnited States for complete financial statements. In the opinion of management,the unaudited consolidated financial statements reflect all adjustments,consisting only of normal recurring adjustments, considered necessary for afair statement of the Company’s financial position at June 30, 2007, andthe results of operations and cash flows for the periods presented. Allsignificant intercompany transactions have been eliminated in consolidation.Operating results for the three and six months ended June 30, 2007 are notnecessarily indicative of the results that may be expected for the fiscal yearending December 31, 2007. The information included in this Form 10-Qshould be read in conjunction with the consolidated financial statements andnotes thereto included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2006.

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities, and disclosures of contingent assets and liabilitiesat the date of the financial statements, and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ fromthose estimates. Certain prior year amounts in previously issued financialstatements have been reclassified to conform to the current year presentation.

In January 2007, the Company combined its Cinemaand Digital Images businesses into a single business known as “DTS DigitalCinema.” In February 2007, the Company’s Board of Directors approved aplan to sell its DTS Digital Cinema business to enable the Company to focusexclusively on licensing branded entertainment technology to the large andevolving audio, game console, personal computer, portable, broadcast, and othermarkets. The sales process has begun and management is working to conclude thisprocess in 2007. In accordance with Statement of Financial Accounting Standards(“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets,” during the first quarter of 2007, DTS Digital Cinema’s assets andliabilities were classified as held for sale and its operations were classifiedas discontinued operations. As a result, the Company reclassified its balancesheets and statements of operations for all periods presented in this report toreflect DTS Digital Cinema as discontinued operations. Depreciation andamortization has been eliminated from discontinued operations from the date theBoard of Directors approved the plan to sell this business. In the statementsof cash flows, the cash flows of discontinued operations are not separatelyclassified or aggregated. The discontinued operations are reported in therespective categories of the statements of cash flows with those of continuingoperations. For additional information, refer to Footnote 12 of theconsolidated financial statements, “Discontinued Operations.”

All discussions andamounts in the consolidated financial statements and related notes, except forcash flows, for all periods presented relate to continuing operations only,unless otherwise noted.

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**Note 2—SignificantAccounting Policy**

***Treasury Stock***

Repurchased shares of theCompany’s common stock are held as treasury shares until they are reissued orretired. Should the Company reissue treasury stock, and the proceeds from thesale exceed the average price that was paid by the Company to acquire theshares, the Company would record such excess as increase in additional paid-incapital. Conversely, if the proceeds from the sale are less than the averageprice the Company paid to acquire the shares, the Company would record suchdifference as a decrease in additional paid-in capital to the extent ofincreases previously recorded and the balance as a decrease in retainedearnings.

***Foreign Currency Translation***

During the quarter ended March 31,2007, the functional currency of one of the Company’s wholly-owned subsidiarieschanged from the United States dollar to the currency of the primary economicenvironment in which it operates. The translation adjustments resulting fromtranslating the functional currency into United States dollars has been deferredas a component of accumulated other comprehensive income in stockholders’equity. The functional currency of the Company’s other wholly-ownedsubsidiaries is the United States dollar and accordingly, gains and lossesresulting from the translation of accounts denominated in currencies other thanthe functional currency are reflected in the determination of net income. Todate, annual gains and losses have not been significant.

**Note 3—RecentAccounting Pronouncements**

In September 2006, the FASB issued SFAS No. 157, “FairValue Measurements.” SFAS No. 157 defines fair value, establishes a frameworkfor measuring fair value, and expands disclosures about fair valuemeasurements. This statement is effective for financial statements issued forfiscal years beginning after November 15, 2007. The Company plans to adopt SFASNo. 157 effective January 1, 2008. The Company is in the process of determiningthe effect, if any, the adoption of SFAS No. 157 will have on its financialstatements.

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

**Note 4—Short-termInvestment Income**

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

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**Note 5—Propertyand Equipment, Net**

Propertyand equipment consist of the following:

| ** **                      | ** ** | **As of  December 31,  2006** | ** ** | **As of  June 30,  2007** | ** ** |
|---------------------------------|------------|-----------------------------------------|------------|-------------------------------------|------------|
| Machinery and  equipment        |       |                                    | $          | 1,414                               |       |   | $ | 1,415 |   |
| Office furniture  and fixtures  |       |                                    | 3,345      |                                |       | 3,767 |   |
| Leasehold  improvements         |       |                                    | 2,830      |                                |       | 2,830 |   |
| Software                        |       |                                    | 3,606      |                                |       | 3,548 |   |
|                            |       |                                    | 11,195     |                                |       | 11,560 |   |
| Less: Accumulated  depreciation |       |                                    | (5,213     | )                                   |       | (6,167 | ) |
| Property and  equipment, net    |       |                                    | $          | 5,982                               |       |   | $ | 5,393 |   |

 

**Note 6—BusinessCombinations**

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

**Note 7—Bank Line ofCredit**

The Company had a $10,000unsecured working capital facility that it allowed to expire on June 30,2007.

**Note 8—Commitmentsand Contingencies**

**Indemnities,Commitments and Guarantees**

In the normal course ofbusiness, the Company makes certain indemnities, commitments and guaranteesunder which the Company may be required to make payments in relation to certaintransactions. These indemnities, commitments and guarantees include, amongothers, intellectual property indemnities to customers in connection with thesale of products and licensing of technology, indemnities for liabilitiesassociated with the infringement of other parties’ technology based upon theCompany’s products and technology, guarantees of timely performance of theCompany’s obligations, and indemnities to the Company’s directors and officersto the maximum extent permitted by law. The duration of these indemnities, commitmentsand guarantees varies, and in certain cases, is indefinite. The majority ofthese indemnities, commitments and guarantees do not provide for any limitationof the maximum potential future payments that the Company could be obligated tomake. The Company has not recorded a liability for these indemnities,commitments or guarantees in the accompanying balance sheets, as future paymentis not probable.

**Note 9—Income Taxes**

For the three months ended June 30, 2007, theCompany recorded an income tax provision of $1,432 on pre-tax income fromcontinuing operations of $3,795. For the six months ended June 30, 2007,the Company recorded an income tax provision of $2,482 on pre-tax income fromcontinuing operations of $6,828. This resulted in an annualized effective taxrate of 36.4%. This rate differed from the U.S. statutory rate of 35% primarilydue to tax exempt interest and research and development credits. In determiningthe 

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income tax provision forcontinuing operations, the continuing operations were considered a stand aloneentity. The residual amount of tax expense or benefit due to the differencebetween the income tax provision for the Company as a whole and the income taxprovision as calculated for continuing operations was recorded in discontinuedoperations.

Effective January 1, 2007, the Company adoptedFASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—anInterpretation of FASB Statement No. 109” (“FIN 48”). The Company has alsoapplied FASB Staff Position No. FIN 48-1, “Definition of Settlementin FASB Interpretation No. 48” to clarify when a tax position has beensettled under paragraph 10(b) of FIN 48. Upon adoption of FIN 48, theCompany recognized a $547 increase in tax reserves, which was accounted for asa reduction of $547 in the beginning retained earnings.

Upon the Company’s adoption of FIN 48 during the firstquarter of 2007, its liability for uncertain tax positions was $1,392, whichwas recorded in other long-term liabilities. At June 30, 2007, the Company’sliability for uncertain tax positions increased to $1,750, which was recordedin other long-term liabilities. These unrecognized tax benefits would affectthe Company’s effective tax rate if recognized. At the beginning of 2007, therewas an immaterial liability for uncertain tax positions for the possiblepayment of interest and penalties. There were no significant changes incomponents of the liability in the first two quarters of 2007. The Company doesnot anticipate any significant changes to its total unrecognized tax benefitwithin the next twelve months.

The Company may from time to time be assessed interestor penalties by major tax jurisdictions, although any such assessmentshistorically have been minimal and immaterial to the Company’s financial results.In accordance with the Company’s accounting policy, interest expense andpenalties related to income taxes are included in income tax expense.

The Company, or one of itssubsidiaries, files income tax returns in the U.S. and other foreignjurisdictions. With few exceptions, the Company is no longer subject to U.S.federal income tax examinations by tax authorities for the years prior to 2004.The Internal Revenue Service concluded its regular audit of the Company’s 2003tax returns in June 2006.

**Note 10—ComprehensiveIncome (Loss)**

At June 30, 2007, the Company had a net $33deferred benefit as a component of accumulated other comprehensive income instockholders’ equity. This net deferred benefit is comprised mostly of foreigncurrency translation.

Comprehensive income(loss) for the three months ended June 30, 2006 and 2007 was $1,883 and $(665),respectively. Comprehensive income (loss) for the six months ended June 30,2006 and 2007 was $8,890 and $(1,390), respectively.

**Note 11—OperatingSegment and Geographic Information**

Prior to 2007, the Company operated its business inthree reportable segments: the Consumer business segment, the Cinema businesssegment and the Digital Images business segment. In January 2007, theCompany combined its Cinema and Digital Images businesses into a singlebusiness known as “DTS Digital Cinema.” In February 2007, the Company’sBoard of Directors approved a plan to sell its DTS Digital Cinema business. Dueto the plan of sale, DTS Digital Cinema has been classified as discontinuedoperations. Therefore, the Company’s continuing business operates as a singlereporting unit previously known as the Consumer business.

7

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TheCompany’s geographical information for the three and six months endedJune 30, 2006 and 2007 were as follows:

| ** **     | ** ** | **For the Three Months  Ended June 30,** | ** ** | **For the Six Months  Ended June 30,** | ** ** |
|----------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **     | ** ** | **   2006   **                      | ** ** | **   2007   **                    | ** ** | **2006** | ** ** | **2007** | ** ** |
| United States  |       |                                                              | $          | 935                                                             |       |   | $ | 1,398 |   | $ | 2,473 |   | $ | 2,855 |   |
| International  |       |                                                              | 8,645      |                                                            |       | 11,513 |   | 27,789 |   | 22,664 |   |
| Total revenues |       |                                                              | $          | 9,580                                                           |       |   | $ | 12,911 |   | $ | 30,262 |   | $ | 25,519 |   |

 

Thefollowing table sets forth, for the periods indicated, long-lived assets bygeographic area in which the Company held assets at December 31, 2006 andJune 30, 2007:

| ** **               | ** ** | **Long-Lived Assets**              | ** ** |
|--------------------------|------------|-----------------------------------------|------------|
| ** **               | ** ** | **As of  December 31,  2006** | ** ** | **As of  June 30,  2007** | ** ** |
| United States            |       |                                    | $          | 5,550 |   |   |   | $ | 4,963 |   |   |
| International            |       |                                    | 432        |   |   |   | 430 |   |   |
| Total long-lived  assets |       |                                    | $          | 5,982 |   |   |   | $ | 5,393 |   |   |

 

**Note 12—DiscontinuedOperations**

Thefollowing table presents the major classes of the assets and liabilities ofdiscontinued operations held for sale in the consolidated balance sheets as of December 31,2006 and June 30, 2007.

| ** **                                                            | ** ** | **As of  December 31,  2006** | ** ** | **As of  June 30,  2007** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------|------------|-------------------------------------|------------|
| Assets:                                                               |       |                                    |       |                                |       |   |   |
| Cash                                                                  |       |                                    | $          | 2,705                               |       |   | $ | 470 |   |
| Accounts  receivable, net                                             |       |                                    | 4,922      |                                |       | 4,838 |   |
| Inventories                                                           |       |                                    | 3,058      |                                |       | 2,651 |   |
| Prepaid expenses  and other current assets                            |       |                                    | 605        |                                |       | 966 |   |
| Total current  assets of discontinued operations held for sale        |       |                                    | 11,290     |                                |       | 8,925 |   |
| Property and equipment, net                                           |       |                                    | 5,356      |                                |       | 7,715 |   |
| Intangible  assets, net                                               |       |                                    | 16,572     |                                |       | 16,380 |   |
| Goodwill                                                              |       |                                    | 3,585      |                                |       | 3,585 |   |
| Other                                                                 |       |                                    | 131        |                                |       | 112 |   |
| Total long-term  assets of discontinued operations held for sale      |       |                                    | 25,644     |                                |       | 27,792 |   |
| Total assets of discontinued operations held for  sale                |       |                                    | $          | 36,934                              |       |   | $ | 36,717 |   |
| Liabilities:                                                          |       |                                    |       |                                |       |   |   |
| Accounts payable                                                      |       |                                    | $          | 4,829                               |       |   | $ | 2,829 |   |
| Accrued expenses  and other liabilities                               |       |                                    | 3,115      |                                |       | 3,355 |   |
| Total current  liabilities of discontinued operations held for sale   |       |                                    | 7,944      |                                |       | 6,184 |   |
| Other long-term liabilities                                           |       |                                    | 1,466      |                                |       | 1,253 |   |
| Total long-term  liabilities of discontinued operations held for sale |       |                                    | $          | 1,466                               |       |   | $ | 1,253 |   |
| Total liabilities of discontinued operations held  for sale           |       |                                    | $          | 9,410                               |       |   | $ | 7,437 |   |
| Net assets of discontinued  operations held for sale                  |       |                                    | $          | 27,524                              |       |   | $ | 29,280 |   |

 

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Inpresenting discontinued operations, general corporate overhead expenses thathave been allocated historically to DTS Digital Cinema for segment presentationpurposes are not included in discontinued operations. The following tablepresents revenue and expense information for the discontinued operations of DTSDigital Cinema for the three and six months ended June 30, 2006 and 2007.

| ** **                                              | ** ** | **For the Three Months  Ended March 31,** | ** ** | **For the Six Months  Ended March 31,** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **2006**                                                           | ** ** | **2007**                                                         | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenue                                                 |       | $                                                                  | 7,317      |                                                             | $          | 4,840 |   | $ | 15,336 |   | $ | 11,126 |   |
| Pre-tax loss                                            |       | (1,408                                                             | )          | (4,675                                                           | )          | (2,878 | ) | (9,027 | ) |
| Income tax  benefit                                     |       | 2,281                                                              |       | 1,654                                                            |       | 4,093 |   | 3,258 |   |
| Income (loss) from  discontinued operations, net of tax |       | $                                                                  | 873        |                                                             | $          | (3,021 | ) | $ | 1,215 |   | $ | (5,769 | ) |

 

For the three and sixmonths ended June 30, 2007, $841 and $1,273, respectively, of depreciation and amortizationwas not expensed due to the cessation of such expenses upon DTS Digital Cinemabeing classified as held for sale.

**Avica—A VariableInterest Entity**

In November 2006, the Company closed a worldwideexclusive license agreement with Avica Technology Corporation (“Avica”), aprovider of a suite of technologies, products and services that handle contentdelivery and presentation for digital distribution networks. Although theCompany currently has no ownership interest in Avica, it is considered to be avariable interest entity of the Company, in conformity with FIN 46(R), “Consolidationof Variable Interest Entities—an Interpretation of Accounting Research BulletinNo. 51,” as the Company is considered to be the primary beneficiary ofAvica. Therefore, the Company has included the assets, liabilities, and resultsof operations of Avica in its consolidated financial statements from the dateof the close of the license agreement. The Company expects the consolidation ofAvica will continue to have an impact on its financial results fromdiscontinued operations in future periods, because it will continue torecognize the operating losses generated by Avica given that Avica’sshareholders’ equity is in a net deficit position.

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

The changes to the Company’stotal assets and total liabilities related to the consolidation of Avicaincluded in the Company’s Consolidated Balance Sheets as assets and liabilitiesof discontinued operations held for sale as of December 31, 2006 were$3,616 and $3,878, respectively. The changes to the Company’s total assets andtotal liabilities related to the consolidation of Avica included in the Company’sConsolidated Balance Sheets as assets and liabilities of discontinuedoperations held for sale as of June 30, 2007 were $1,617 and $2,410,respectively. Included in the loss from discontinued operations, net of tax forthe three and six months ended June 30, 2007 are Avica’s losses for theseperiods of $150 and $531, respectively.

**Note 13—Net Income(Loss) Per Common Share**

Basic net income (loss) per common share is calculatedby dividing net income (loss) by the weighted average number of common sharesoutstanding during the period. Diluted net income (loss) per common share iscalculated by dividing net income (loss) by the sum of the weighted averagenumber of common shares outstanding plus the dilutive effect of unvested restrictedstock, outstanding stock options, common stock warrants, and the ESPP using the“treasury stock” method.

9

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

| ** **                                   | ** ** | **For the Three Months  Ended June 30,** | ** ** | **For the Six Months  Ended June 30,** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                                          | ** ** | **2007**                                                        | ** ** | **2006** | ** ** | **2007** | ** ** |
| Basic net income  (loss) per common share:   |       |                                                              |       |                                                            |       |   |   |   |   |
| Numerator:                                   |       |                                                              |       |                                                            |       |   |   |   |   |
| Income from continuing operations            |       | $                                                                 | 1,010      |                                                            | $          | 2,363 |   | $ | 7,675 |   | $ | 4,346 |   |
| Income (loss) from discontinued operations   |       | 873                                                               |       | (3,021                                                          | )          | 1,215 |   | (5,769 | ) |
| Net income (loss)                            |       | $                                                                 | 1,883      |                                                            | $          | (658 | ) | $ | 8,890 |   | $ | (1,423 | ) |
| Denominator:                                 |       |                                                              |       |                                                            |       |   |   |   |   |
| Weighted average common shares outstanding   |       | 17,547                                                            |       | 18,026                                                          |       | 17,521 |   | 17,996 |   |
| Continuing operations                        |       | $                                                                 | 0.06       |                                                            | $          | 0.13 |   | $ | 0.44 |   | $ | 0.24 |   |
| Discontinued operations                      |       | 0.05                                                              |       | (0.17                                                           | )          | 0.07 |   | (0.32 | ) |
| Basic net income (loss) per common share     |       | $                                                                 | 0.11       |                                                            | $          | (0.04 | ) | $ | 0.51 |   | $ | (0.08 | ) |
| Diluted net  income (loss) per common share: |       |                                                              |       |                                                            |       |   |   |   |   |
| Numerator:                                   |       |                                                              |       |                                                            |       |   |   |   |   |
| Income from continuing operations            |       | $                                                                 | 1,010      |                                                            | $          | 2,363 |   | $ | 7,675 |   | $ | 4,346 |   |
| Income (loss) from discontinued operations   |       | 873                                                               |       | (3,021                                                          | )          | 1,215 |   | (5,769 | ) |
| Net income (loss)                            |       | $                                                                 | 1,883      |                                                            | $          | (658 | ) | $ | 8,890 |   | $ | (1,423 | ) |
| Denominator:                                 |       |                                                              |       |                                                            |       |   |   |   |   |
| Weighted average shares outstanding          |       | 17,547                                                            |       | 18,026                                                          |       | 17,521 |   | 17,996 |   |
| Effect of dilutive securities:               |       |                                                              |       |                                                            |       |   |   |   |   |
| Common stock options                         |       | 764                                                               |       | 610                                                             |       | 769 |   | 637 |   |
| Common stock warrants                        |       | 22                                                                |       | 3                                                               |       | 22 |   | 3 |   |
| Restricted stock                             |       | 7                                                                 |       | 55                                                              |       | 4 |   | 43 |   |
| ESPP                                         |       | —                                                            |       | 4                                                               |       | — |   | 6 |   |
| Diluted shares  outstanding                  |       | 18,340                                                            |       | 18,698                                                          |       | 18,316 |   | 18,685 |   |
| Continuing operations                        |       | $                                                                 | 0.06       |                                                            | $          | 0.13 |   | $ | 0.42 |   | $ | 0.23 |   |
| Discontinued operations                      |       | 0.04                                                              |       | (0.17                                                           | )          | 0.07 |   | (0.31 | ) |
| Diluted net  income (loss) per common share  |       | $                                                                 | 0.10       |                                                            | $          | (0.04 | ) | $ | 0.49 |   | $ | (0.08 | ) |

 

For the three months endedJune 30, 2006 and 2007, 1,643 and 476 shares, respectively, of the Company’sstock options and restricted stock were excluded from the calculation ofdiluted earnings (loss) per share because their inclusion would have been anti-dilutive.For the six months ended June 30, 2006 and 2007, 1,395 and 316 shares,respectively, of the Company’s stock options and restricted stock were excludedfrom the calculation of diluted earnings (loss) per share because theirinclusion would have been anti-dilutive.

**Note 14—StockRepurchase Plan**

In August 2006, theCompany’s Board of Directors authorized, subject to certain business and marketconditions, the purchase of up to 1,000 shares of the Company’s common stock inthe open market or in privately negotiated transactions. During the three andsix months ended June 30, 2007, the Company repurchased 165 shares underthis authorization for an aggregate of $3,680.

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**Note 15—SubsequentEvents**

**Spatializer AssetPurchase**

On July 2, 2007, theCompany acquired certain assets of Spatializer Audio Laboratories, Inc. (“Spatializer”)and its wholly-owned subsidiary, Desper Products, Inc (“Desper”) for a cashpayment of $1,000. These assets consist primarily of intellectual property andassumed customer contracts. The Company also assumed certain performanceobligations under assumed customer contracts arising after the closing date.Spatializer and Desper have been developers, licensors and marketers ofvirtualization technologies, proprietary advanced audio signal processingtechnologies and products for consumer electronics. The Company is in theprocess of assigning carrying values.

**Stock RepurchasePlan**

As of August 9, 2007, the Company had repurchasedthe remaining 835 shares, under its Board of Directors authorization, for $18,990.

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**Item 2.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

**Forward-LookingStatements May Prove Inaccurate**

This Form 10-Qand the documents incorporated herein by reference contain forward-lookingstatements based on our current beliefs, expectations, estimates andprojections about our industry, and certain assumptions made by us. Words suchas “believes,” “anticipates,” “estimates,” “expects,” “projections,” “may,” “potential,”“plan,” “continue” and words of similar effect, constitute “forward-lookingstatements.” The forward-looking statements contained in this report involveknown and unknown risks, uncertainties and other factors that may cause ouractual results to be materially different from those expressed in or implied bythese statements. These factors include those listed under the “Risk Factors”section contained below and elsewhere in this Form 10-Q, and theother documents we file with the Securities and Exchange Commission, or SEC,including our most recent reports on Form 8-K and Form 10-K.We cannot guarantee future results, levels of activity, performance, orachievements. We do not intend to update these forward-looking statements toreflect future events or circumstances. You should read the following discussionof our financial condition and results of operations in conjunction with theconsolidated financial statements and the notes to those statements includedelsewhere in this Form 10-Q.

**Overview**

We are a leading provider of entertainment technology,products and services to the audio and image entertainment markets worldwide.Historically we have been focused on high quality digital multi-channel audio,commonly referred to as surround sound, which provides more than two-channelsof audio, allowing the listener to simultaneously hear discrete sounds frommultiple speakers. Our DTS digital multi-channel audio technology deliverscompelling surround sound for the motion picture and consumer electronicsmarkets. We also provide high quality digital image processing, enhancement andrestoration services for motion pictures, digital cinema, and televisioncontent.

In January 2007, we combined our Cinema andDigital Images businesses into a single business known as DTS Digital Cinema.In February 2007, our Board of Directors approved a plan to sell our DTSDigital Cinema business to enable us to focus exclusively on licensing brandedentertainment technology to the large and evolving audio, game console,personal computer, portable and broadcast markets. The sales process has begunand we are working to conclude this process in 2007. The DTS Digital Cinemabusiness intends to focus on the potentially large and emerging market fordigital cinema products and services. In accordance with SFAS No. 144,during the first quarter of 2007, DTS Digital Cinema’s assets and liabilitieswere classified as held for sale and its operations were reported asdiscontinued operations. As a result, we reclassified our balance sheets andstatements of operations for all periods presented in this report to reflectDTS Digital Cinema as discontinued operations. In the statements of cash flows,the cash flows of discontinued operations are not separately classified oraggregated. The discontinued operations are reported in the respectivecategories of the statements of cash flows with those of continuing operations.

All discussions and amounts in Management’s Discussionand Analysis, except for Liquidity and Capital Resources, for all periodspresented relate to continuing operations only unless otherwise noted.

We derive revenues from licensing our audiotechnology, trademarks, and know-how under agreements with substantially all ofthe major consumer audio electronics manufacturers. Our business model providesfor these manufacturers to pay us a per-unit amount for DTS-enabled productsthat they manufacture. Through our DTS Entertainment label, we derive revenuesfrom the sale of multi-channel music titles in our digital multi-channelformat.

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We actively engage in intellectual property complianceand enforcement activities focused on identifying third parties who have eitherincorporated our technology, trademarks, or know-how without a license or whohave under-reported the amount of royalties owed under license agreements with us.We continue to invest in our compliance and enforcement infrastructure tosupport the value of our intellectual property to us and our licensees and toimprove the long-term realization of revenue from our intellectual property. Asa result of these activities, from time to time, we recognize royalty revenuesthat relate to consumer electronics manufacturing activities from priorperiods. These royalty recoveries may cause revenues to be higher than expectedduring a particular reporting period and may not occur in subsequent periods.While we consider such revenues to be a regular part our normal operations, wecannot predict such recoveries or the amount or timing of such revenues.

Our cost of revenues consists primarily of amountspaid for products and materials, salaries and related benefits for operationspersonnel, depreciation of operations equipment, amortization of acquiredintangibles and payments to third parties for licensing technology andcopyrighted material.

Our selling, general, and administrative expensesconsist primarily of salaries, commissions, and related benefits for personnelengaged in sales and costs associated with promotional and other selling activities.Selling, general, and administrative expenses also include professional fees,facility-related expenses, and other general corporate expenses, includingpersonnel engaged in corporate administration, finance, human resources,information systems and legal.

Our research and development costs consist primarilyof salaries and related benefits for research and development personnel,engineering consulting expenses associated with new product and technologydevelopment, and quality assurance and testing costs. Research and developmentcosts are expensed as incurred.

We have a licensing teamthat markets our technology directly to consumer electronics productsmanufacturers and semiconductor manufacturers. This team includes employeeslocated in the United States, China, England, Japan, Hong Kong, Ireland andNorthern Ireland. We sell music content released under our DTS Entertainmentlabel through exclusive distribution arrangements in the United States, Europeand Japan. We employ consultants to coordinate sales to independent retailersand we sell this music to consumers through web-based retailers anddistributors.

**ManagementDiscussion Regarding Trends, Opportunities, and Challenges**

***Trends, Opportunities, and Challenges***

Our revenue is primarily dependent upon the DVD-basedhome theater market, which has experienced rapid growth over the past severalyears. However, we have recently experienced softness in our DVD playertrademark licensing program, and expect continued softness in this area as theDVD player market transitions to high definition formats. The success ofDVD-Video-based systems and products has fueled a demand for higher qualityentertainment in the home, and this demand is extending to the car audio andpersonal computer markets as well. In addition, we expect the recentacceleration of the market for high definition televisions to drive demand forhigh definition optical disc players and advanced home theater systems over thenext several years. Because we have been selected as a mandatory technology fornext generation players, our revenue growth should more closely track thegrowth rate for sales of these players over the next several years. We expectthat the market for high definition players will yield new growth that providesan offset to the expected further decline in DVD player shipments. Further, webelieve that mandatory inclusion in next generation optical disc standards willhelp to improve the adoption rate of our technologies in other consumerproducts such as next generation video game consoles, personal audio and videoplayers, personal computers and in-car entertainment systems.

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In July 2004, we acquired QDesign Corporation, orQDesign, a company focused on lower bit-rate audio delivery technology. The marketfor higher quality entertainment is expanding into portable devices thatrequire the use of low-bit rate audio coding systems including portable audioplayers, PDAs and wireless handset applications. Concurrent with this trend,there is a growing need for a good link between home and portable devices thatpreserves as much quality as possible and allows consumers a seamlesstechnology solution for the storage and playback of their content. In October 2004,leveraging our existing research and development efforts and the intellectualproperty acquired in the QDesign acquisition, we launched our DTS-HDinitiative. This technology is a scalable coding system that will allow contentto be played in home and portable devices. We believe that the broad and robustnature of this offering improves the probability of inclusion of ourtechnologies in next generation products.

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

**Critical AccountingPolicies and Estimates**

Management’s Discussionand Analysis of Financial Condition and Results of Operations is based upon ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof our financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues, and expenses, andrelated disclosure of contingent assets and liabilities. On an on-going basis,estimates and judgments are evaluated, including those related to revenuerecognition, inventories, intangible assets, income taxes, impairment oflong-lived assets, stock-based compensation, and contingencies and litigation.These estimates and judgments are based on historical experience and on variousother assumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources. Bytheir nature, estimates are subject to an inherent degree of uncertainty.Actual results may differ from these estimates. There has been no material changeto our critical accounting policies and estimates from the information providedin our Form 10-K filed on March 16, 2007.

**Results ofContinuing Operations**

***Revenues***

| ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | **Change** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|------------|------------|------------|------------|
| ** **                        | ** ** | **2007**                       | ** ** | **2006**   | ** ** | **$**      | ** ** | **%** | ** ** |
| ** **                        | ** ** | **($ in thousands)** | ** ** |
| Three months  ended June 30, |       | $                              | 12,911     |       | $          | 9,580      |       | $ | 3,331 |   | 35 | % |
| Six months ended  June 30,   |       | $                              | 25,519     |       | $          | 30,262     |       | $ | (4,743 | ) | (16 | )% |

 

The increase in revenues for the quarter ended June 30,2007, compared to the second quarter of 2006, was attributable to solid growthin revenues from the car audio systems market, which more than doubled duringthe second quarter of 2007 relative to the same prior year period. Additionallyin 2007, we began to receive royalties from the Blu-ray Disc and HD DVDformats, with such royalties comprising 12% of total revenue for the quarterended June 30, 2007. We remain cautious in our overall outlook due touncertainties regarding the timing and rate of adoption of the new highdefinition formats. However, we expect technology licensing revenues to growmodestly during the second half of 2007, as wider availability of player modelscoupled with aggressive pricing and promotion of Blu-ray Disc and HD DVDproducts 

14

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should result in anacceleration of licensing revenues from those formats, and from continued strengthin the car audio systems market.

The decrease in revenues for the six months ended June 30,2007, compared to the same prior year period, was primarily attributable to a$8.9 million decrease in royalty recoveries from intellectual propertycompliance and enforcement activities, partially offset by increased revenuesfrom the car audio market and the Blu-ray and HD DVD market. Revenues from thecar audio market more than doubled during the six months ended June 30,2007, compared to the same prior year period. Additionally, royalties from Blu-rayand HD DVD comprise over 8% of total revenue for the six months ended June 30,2007.

***Gross Profit***

| ** **                        | ** ** | **2007**                       | ** ** | **%**  | ** ** | **2006** | ** ** | **%**  | ** ** | **Percentage point   change in gross   profit margin relative   to prior period** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|--------|------------|----------|------------|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                        | ** ** | **($ in thousands)** | ** ** |
| Three months  ended June 30, |       | $                              | 12,612     |   | 98         | %        | $          | 9,048  |       | 94                                                                                                                                  | %          |   | 4 | % |   |
| Six months ended  June 30,   |       | $                              | 24,965     |   | 98         | %        | $          | 29,321 |       | 97                                                                                                                                  | %          |   | 1 | % |   |

 

The increase in grossprofit margin in the current year relates to a reduction of prepaid productioncosts and related amortization for DTS Entertainment, which were substantiallywritten-off in the fourth quarter of 2006. We expect consolidated gross profitmargins in the 97% to 98% range for 2007.

***Selling, Generaland Administrative (“SG&A”)***

| ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | **Change** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|------------|------------|------------|------------|
| ** **                        | ** ** | **2007**                       | ** ** | **2006**   | ** ** | **$**      | ** ** | **%** | ** ** |
| ** **                        | ** ** | **($ in thousands)** | ** ** |
| Three months  ended June 30, |       | $                              | 8,022      |       | $          | 7,044      |       | $ | 978 |   | 14 | % |
| *% of  Revenue*                   | * *   | *62*                           | *%*        | *74*       | *%*        | * *   | * *   | * * | * * |
| Six months ended June 30,    |       | $                              | 16,094     |       | $          | 14,310     |       | $ | 1,784 |   | 12 | % |
| *% of Revenue*                    | * *   | *63*                           | *%*        | *47*       | *%*        | * *   | * *   | * * | * * |

 

The increase for the three months ended June 30,2007, compared to the same prior year period, is primarily due to increases instock-based compensation expense related to additional employee equity grantssince June 30, 2006 and in employee related costs. Additionally,depreciation on our enterprise resource planning system or ERP began during thethree months ended June 30, 2007.

The increase for the six months ended June 30,2007, compared to the same prior year period, is primarily due to the factorsmentioned above. We also incurred more expenses for audit related servicesduring this period.

We expect SG&Aexpenses to continue to increase to support activities such as new technologyinitiatives, international expansion and intellectual property enforcement.

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***Research andDevelopment (“R&D”)***

| ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | **Change** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|------------|------------|------------|------------|
| ** **                        | ** ** | **2007**                       | ** ** | **2006**   | ** ** | **$**      | ** ** | **%** | ** ** |
| ** **                        | ** ** | **($ in thousands)** | ** ** |
| Three months  ended June 30, |       | $                              | 1,666      |       | $          | 1,733      |       | $ | (67 | ) | (4)% |   |
| *% of  Revenue*                   | * *   | *13*                           | *%*        | *18*       | *%*        | * *   | * *   |   |   |
| Six months ended June 30,    |       | $                              | 3,270      |       | $          | 3,311      |       | $ | (41 | ) | (1)% |   |
| *% of Revenue*                    | * *   | *13*                           | *%*        | *11*       | *%*        | * *   | * *   |   |   |

 

The decrease for the three months ended June 30,2007, compared to the same prior year period, is primarily attributable todecreases in professional fees during the current quarter, partially offset byincreases in employee related expenses, compared to the same prior year period.

The decrease for the sixmonths ended June 30, 2007, compared to the same prior year period, isprimarily attributable to decreases in professional fees and expensereimbursements under certain research grants, partially offset by increases inemployee related expenses. We intend to continue to invest in R&D tosupport our broadening product development agenda and the ongoing support ofthe rollout of Blu-Ray Disc and HD DVD, and thus expect to see sequentialgrowth through the remainder of the year.

***Interest and Other Income, Net***

Interest and other income, net, for the three monthsended June 30, 2007 decreased 30% to $0.9 million from $1.2 million forthe three months ended June 30, 2006. The decrease is primarilyattributable to a greater focus on tax exempt investments in 2007, which havelower nominal interest rates, but greater after-tax yields, and lower averageinvested balances.

Interest and other income,net, for the six months ended June 30, 2007 decreased 47% to $1.2 millionfrom $2.3 million for the six months ended June 30, 2006. The decrease isprimarily related to an adjustment recorded in the first quarter of 2007 tocorrect an error. In the first quarter of 2007, management identified an errorin our accrued interest income balances related to 2005 and 2006 that wascorrected during the first quarter of 2007. The correction had the effect ofreducing short-term investments and decreasing interest income by $0.7 million.The correction has decreased income from continuing operations before incometaxes by $0.7 million and income from continuing operations by $0.5 million forthe six months ended June 30, 2007. Although this correction was anout-of-period adjustment, management determined that the effect on previously filedreports was not material. Additionally, we had lower average investmentbalances during the six months ended June 30, 2007, compared to the sameprior year period. Going forward, we expect interest income for the year to bein the range of $2.5 to $3.0 million, based on the current interest rateenvironment, current investment balances, and giving effect to the cash used toexecute stock repurchases in the May to August timeframe.

***Income Taxes***

For the three months ended June 30, 2007, werecorded an income tax provision of $1.4 million on pre-tax income fromcontinuing operations of $3.8 million. For the three months ended June 30,2006, we recorded an income tax provision of $0.5 million on pre-tax incomefrom continuing operations of $1.5 million.

For the six month ended June 30,2007, we recorded an income tax provision of $2.5 million on pre-tax incomefrom continuing operations of $6.8 million. This resulted in an annualizedeffective tax rate of 36.4%. For the six month ended June 30, 2006, we recordedan income tax provision of $6.3 million on pre-

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taxincome from continuing operations of $14.0 million. This resulted in anannualized effective tax rate of 45.2%. These rates differed from the U.S.statutory rate of 35% primarily due to tax exempt interest and research anddevelopment credits. In determining the income tax provision for continuingoperations, the continuing operations were considered a stand alone entity. Theresidual amount of tax expense or benefit due to the difference between the incometax provision for the Company as a whole and the income tax provision ascalculated for continuing operations was recorded in discontinued operations.We expect the effective tax rate for 2007 will be approximately 39% to 40%.

**Results ofDiscontinued Operations**

Loss from discontinued operations, net of tax, for thethree months ended June 30, 2007 was $3.0 million, compared to income fromdiscontinued operations, net of tax, of $0.9 million for the three months endedJune 30, 2006. Revenues declined $2.5 million for the three months ended June 30,2007, compared to the same prior year period due to softness in our cinemahardware and image restoration activities, and because we recognized $1.3million in deferred revenues in our images business in the second quarter of2006. Additionally, operating expenses increased $0.7 million for thethree months ended June 30, 2007, compared to the same prior year perioddue to increased employee related expenses including stock-based compensationexpense, professional service fees relating to the sales process and the inclusionof Avica’s losses. Partially offsetting the increased operating expenses duringthe current quarter was the cessation of depreciation and amortization duringthe current year upon the discontinued operations being classified as held forsale. The remaining decline in results from discontinued operations, net oftax, relates primarily to a decrease in the income tax benefit during the threemonths ended June 30, 2007, compared to the same prior year period.

Loss from discontinued operations, net of tax, for thesix months ended June 30, 2007 was $5.8 million, compared to income fromdiscontinued operations, net of tax, of $1.2 million for the six months ended June 30,2006. Net sales decreased $4.2 million for the six months ended June 30,2007, compared to the same prior year period. Operating expenses increased $1.9 millionfor the six months ended June 30, 2007, compared to the same prior yearperiod. The decrease in sales and increase in operating expenses are largelydue to the factors mentioned above. The remaining decline in results fromdiscontinued operations, net of tax, relates primarily to a decrease in theincome tax benefit during the six months ended June 30, 2007, compared tothe same prior year period.

While we believe thelikelihood is remote for an impairment resulting from the net assets of the DTSDigital Cinema business, less costs to sell, exceeding a potential sale price,there can be no assurance that a sale of these assets subsequent to quarter endwill not result in an impairment.

**Liquidity andCapital Resources**

At June 30, 2007, we had cash, cash equivalentsand short-term investments of $102.4 million, compared to $108.8 millionat December 31, 2006.

Net cash used in operating activities was$3.1 million for the six months ended June 30, 2007, compared to netcash provided by operating activities of $11.8 million for the six monthsended June 30, 2006. The decrease in operating cash flows during the sixmonths ended June 30, 2007, compared to the same prior year period,results largely from $8.9 million more royalty settlements that were receivedduring the first half of the prior year, compared to the first half of thecurrent year. Additionally, cash flows from accounts receivable decreased $4.3million during the six months ended June 30, 2007, compared to the sameprior year period, due primarily to accrued licensing revenues from Blu-rayDisc and HD DVD based products, which began in 2007, and current year accruedrevenues relating to licensing enforcement settlements.

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Net cash provided by investing activities totaled$6.0 million for the six months ended June 30, 2007, compared to netcash used in investing activities of $9.6 million for the six months endedJune 30, 2006. Cash provided by investing activities for the six monthsended June 30, 2007 primarily consists of net sales of available for saleinvestments and maturation of held to maturity securities of $9.6 millionin total, offset by purchases of property and equipment of $3.3 million.

Net cash used by financing activities totaled$0.8 million for the six months ended June 30, 2007, compared to netcash provided by financing activities of $1.1 million for the six months ended June 30,2006. Cash used by financing activities for the six months ended June 30,2007 primarily consists of stock repurchases, offset by proceeds from issuancesof common stock under the employee stock purchase plan, exercise of stockoptions and related excess tax benefits.

In 2005, we entered into an agreement for the purchaseof a new ERP, for approximately $0.7 million. From inception of thisproject through June 30, 2007, we incurred approximately $5.4 millionfor the purchase of the ERP and implementation costs. We expect that we willincur additional costs over the next several years to continually refine thesystem’s functionality.

In August 2006, our Board of Directorsauthorized, subject to certain business and market conditions, the purchase ofup to one million shares of our common stock in the open market or in privatelynegotiated transactions. During the three months ended June 30, 2007, werepurchased 0.2 million shares of our common stock for an aggregate of $3.7million under this authorization. At June 30, 2007, we are authorized torepurchase 0.8 million more shares under this authorization. As of August 9,2007, we have re-purchased the remaining 0.8 million shares under thisauthorization for an aggregate of $19.0 million.

On July 2, 2007, we acquired certain assets ofSpatializer Audio Laboratories, Inc. (“Spatializer”) and its wholly-ownedsubsidiary, Desper Products, Inc (“Desper”) for a cash payment of $1.0 million.

We are continuing to fund the obligations of the DTSDigital Cinema business, and will continue to do so through the close of a saletransaction. All expenses incurred relating to the sales transaction whileclassified as discontinued operations will continue to affect our liquidity andcapital resources and utilize portions of the cash that is generated or held byDTS, Inc. At this time, we are unable in good faith to make a fulldetermination of the estimated expenses which will be incurred relating to thesales transaction. The sales process has begun and we are working to concludethis process in 2007.

We believe that our cash,cash equivalents, short-term investments, and cash flows from operations willbe sufficient to satisfy our working capital and capital expenditurerequirements for at least the next twelve months. Beyond the next twelvemonths, additional financing may be required to fund working capital andcapital expenditures. Changes in our operating plans including lower thananticipated revenues, increased expenses, acquisition of companies, products ortechnologies or other events, including those described in “Risk Factors”included elsewhere herein, in our Form 10-K filed on March 16,2007 and in other filings may cause us to seek additional debt or equityfinancing on an accelerated basis. Financing may not be available on acceptableterms, or at all, and our failure to raise capital when needed could negativelyimpact our growth plans and our financial condition and results of operations.Additional equity financing may be dilutive to the holders of our common stockand debt financing, if available, may involve significant cash paymentobligations and financial or operational covenants that restrict our ability tooperate our business.

*Contractualobligations*

There have been no materialchanges to our contractual obligations since December 31, 2007, with theexception of the increased obligations associated with our gross unrecognizedtax benefits recorded in conjunction with the adoption of FIN 48. As of June30, 2007, our total amount of 

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unrecognizedtax benefits was $1.8 million and is considered a long-term obligation. We arecurrently unable to make reasonably reliable estimates of the periods of cashsettlements associated with these obligations. 

**Recently IssuedAccounting Standards**

In September 2006, the FASB issued SFASNo. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value,establishes a framework for measuring fair value, and expands disclosures aboutfair value measurements. This statement is effective for financial statementsissued for fiscal years beginning after November 15, 2007. We plan toadopt SFAS No. 157 effective January 1, 2008. We are in the processof determining the effect, if any, the adoption of SFAS No. 157 will haveon our financial statements.

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

**Item 3.**                        Quantitativeand Qualitative Disclosures About Market Risk

Market risk represents the risk of loss arising fromadverse changes in market rates and foreign exchange rates. At June 30,2007, we did not have any long-term debt; however, the amount of outstandingdebt at any time may fluctuate and we may from time to time be subject torefinancing risk.

Our interest income is sensitive to changes in thegeneral level of U.S. interest rates, particularly since a significant portionof our investments are and will be in short-term marketable securities, U.S.government securities and corporate bonds. Due to the nature and maturity ofour short-term investments, we have concluded that there is no material marketrisk exposure to our principal. The average duration of our investmentportfolio is typically less than 90 days. As of June 30, 2007, a 1% changein interest rates throughout a one-year period would have an annual effect ofapproximately $1.0 million on our income from continuing operations beforeincome taxes.

We derive nearly 90% of our revenues from continuingoperations from sales outside the United States, and maintain internationalresearch, sales, marketing, and business development offices. Therefore, our resultscould be negatively affected by such factors as changes in foreign currencyexchange rates, trade protection measures, longer accounts receivablecollection patterns, and changes in regional or worldwide economic or politicalconditions. The risks of our international operations are mitigated in part bythe extent to which our revenues are denominated in U.S. dollars and,accordingly, we are not exposed to significant foreign currency risk on theseitems. We do have limited foreign currency risk on certain revenues andoperating expenses such as salaries and overhead costs of our foreignoperations and cash maintained by these operations. Revenues denominated inforeign currencies accounted for approximately 3% of total revenues during thesix months ended June 30, 2007. Operating expenses, including cost ofsales, for our foreign subsidiaries were approximately $2.1 million in thesix months ended June 30, 2007. 

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Based upon the expensesfor the six months ended June 30, 2007, a 1% change in foreign currencyrates throughout a one-year period would have an immaterial annual effecton income from continuing operations before income taxes.

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

We are also affected byexchange rate fluctuations as the financial statements of our foreignsubsidiaries are translated into the United States dollar in consolidation. Asexchange rates vary, these results, when translated, may vary from expectationsand could adversely or positively impact overall profitability. During the sixmonths ended June 30, 2007, the impact of foreign exchange ratefluctuations related to translation of our foreign subsidiaries’ financialstatements was immaterial to comprehensive income.

**Item 4.**                        Controlsand Procedures

**Evaluation ofDisclosure Controls and Procedures**

We maintain disclosure controls and procedures (asdefined in Rules 13a-l5(e) and 15d-15(e) of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”)) that are designed toensure that information required to be disclosed in the reports we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in the rules and forms of the SEC andthat such information is accumulated and communicated to our management,including our chief executive officer and chief financial officer, asappropriate, to allow timely decisions regarding required disclosure.

We carried out anevaluation, under the supervision and with the participation of our management,including our chief executive officer and chief financial officer, of theeffectiveness of our disclosure controls and procedures as of the end of theperiod covered by this report. Based on such evaluation, our chief executiveofficer and chief financial officer concluded that as of the end of the periodcovered by this report our disclosure controls and procedures were effective.

**Changes in InternalControl over Financial Reporting**

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

In April 2007, we implemented a new ERP system inour US and UK operations. We believe that we have adequately controlled thetransition and that there will be no negative impact to our internal controlenvironment. We expect this ERP system to further advance our controlenvironment by automating certain aspects of our internal controls, improvingmanagement visibility to detailed financial information and standardizingprocesses as its full capabilities are utilized.

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**PART II**

**OTHERINFORMATION**

**Item 1.**                        LegalProceedings

None.

**Item1A.**                Risk Factors

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

**Risks Related toOur Business**

***The sale of our DTSDigital Cinema business or any failure to successfully manage and complete anundertaken sales transaction could adversely affect our business and operatingresults.***

In order to better addressrapidly evolving markets, meet the needs of customers and increase stockholdervalue, we are proceeding with the sale of our DTS Digital Cinema business. Thesales process may be costly. The sale might not be accomplished by the end of2007 or at all. The sales process requires significant time and attention fromour management, finance, accounting and legal teams, which could disrupt ourday-to-day operations and shift the allocation of these resources away frommatters related to our core business. In addition, implementing any transactionwould involve a number of operational, legal and, possibly, regulatory steps.Implementation could be costly, cause further disruption to our day-to-dayoperations, and result in the loss of customers and/or sales revenue, whichcould cause our business and operating results to suffer. Furthermore,implementation of a sale is a complicated process and there is a risk that wemay not be successful in the execution of our sales strategy, which could causeour business to suffer and our stock price to decline.

***Our business andprospects depend on the strength of our brand, and if we do not maintain andstrengthen our brand, our business will be materially harmed.***

Establishing, maintainingand strengthening our “DTS” brand is critical to our success. Our brandidentity is key to maintaining and expanding our business and entering newmarkets. Our success depends in large part on our reputation for providing highquality products, services and technologies to the entertainment industry andthe consumer electronics products industry. If we fail to promote and maintainour brand successfully, our business and prospects may suffer. Moreover, webelieve that the likelihood that our technologies will be adopted in industrystandards depends, in part, upon the strength of our brand, becauseprofessional organizations and industry participants are more likely toincorporate technologies developed by a well-respected and well-known brandinto standards. Maintaining and strengthening our brand will depend heavily onour ability to develop innovative technologies for the entertainment industry,to continue to provide high quality products and services, and manage brandtransition in connection with the process of selling the DTS Digital Cinemabusiness, which we may not do successfully.

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***We may not be ableto evolve our technology, products, and services or develop new technology,products, and services that are acceptable to our customers or the changingmarket.***

The market for ourtechnology, products, and services is characterized by:

·       rapidtechnological change;

·       newand improved product introductions;

·       changingcustomer demands;

·       evolvingindustry standards; and

·       productobsolescence.

Our future success dependson our ability to enhance our existing technology, products, and services andto develop acceptable new technology, products, and services on a timely basis.The development of enhanced and new technology, products, and services is acomplex and uncertain process requiring high levels of innovation,highly-skilled engineering and development personnel, and the accurateanticipation of technological and market trends. We may not be able to identify,develop, market, or support new or enhanced technology, products, or serviceson a timely basis, if at all. Furthermore, our new technology, products, andservices may never gain market acceptance, and we may not be able to respondeffectively to evolving consumer demands, technological changes, productannouncements by competitors, or emerging industry standards. For example, wemay not be able to effectively address concerns in the film and musicindustries relating to piracy in our current or future products. Any failure torespond to these changes or concerns would likely prevent our technology,products, and services from gaining market acceptance or maintaining marketshare and could lead to our technology, products and services becoming obsolete.

***If we fail toprotect our intellectual property rights, our ability to compete could beharmed.***

Protection of ourintellectual property is critical to our success. Patent, trademark, copyright,and trade secret laws and confidentiality and other contractual provisionsafford only limited protection and may not adequately protect our rights orpermit us to gain or keep any competitive advantage. We face numerous risks inprotecting our intellectual property rights, including the following:

·       ourpatents may be challenged or invalidated by our competitors;

·       ourpending patent applications may not issue, or if issued, may not providemeaningful protection for related products or proprietary rights;

·       wemay not be able to prevent the unauthorized disclosure or use of our technicalknowledge or other trade secrets by employees, consultants, and advisors;

·       wemay not be able to practice our trade secrets as a result of patent protectionafforded a third-party for such product, technique or process;

·       thelaws of foreign countries may not protect our intellectual property rights tothe same extent as the laws of the United States, and mechanisms forenforcement of intellectual property rights may be inadequate in foreigncountries;

·       ourcompetitors may produce competitive products or services that do not unlawfullyinfringe upon our intellectual property rights;

·       effortsto identify and prosecute unauthorized uses of our technology are timeconsuming, expensive, and divert resources from the operation of our business;and

·       wemay be unable to successfully identify or prosecute unauthorized uses of ourtechnology.

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As a result, our means ofprotecting our intellectual property rights and brands may not be adequate.Furthermore, despite our efforts, third parties may violate, or attempt toviolate, our intellectual property rights. Infringement claims and lawsuitswould likely be expensive to resolve and would require management’s time andresources. In addition, we have not sought, and do not intend to seek, patentand other intellectual property protections in all foreign countries. Incountries where we do not have such protection, products incorporating ourtechnology may be lawfully produced and sold without a license.

***We may be sued bythird parties for alleged infringement of their proprietary rights.***

Companies that participatein the digital audio, digital image processing, consumer electronics, andentertainment industries hold a large number of patents, trademarks, andcopyrights, and are frequently involved in litigation based on allegations ofpatent infringement or other violations of intellectual property rights.Intellectual property disputes frequently involve highly complex and costlyscientific matters, and each party generally has the right to seek a trial byjury which adds additional costs and uncertainty. Accordingly, intellectualproperty disputes, with or without merit, could be costly and time consuming tolitigate or settle, and could divert management’s attention from executing ourbusiness plan. In addition, our technology and products may not be able towithstand any third-party claims or rights against their use. If we were unableto obtain any necessary license following a determination of infringement or anadverse determination in litigation or in interference or other administrativeproceedings, we may need to redesign some of our products to avoid infringing athird party’s rights and could be required to temporarily or permanentlydiscontinue licensing our products.

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

Thedigital audio, digital imaging, consumer electronics, cinema and entertainmentmarkets are intensely competitive, subject to rapid change, and significantly affectedby new product introductions and other market activities of industryparticipants. Our principal competitor is Dolby Laboratories, Inc., whocompetes with us in most of our markets. We also compete with other companiesoffering:

·       digitalaudio technology incorporated into consumer electronics products andentertainment mediums, including Coding Technologies, Fraunhofer InstitutIntegrierte Schaltungen, Koninklijke Philips Electronics N.V. (Philips),Meridian Audio Limited, Microsoft Corporation, Sony Corporation, and Thomson;

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

·       digitalimage processing, enhancement and restoration services, including Ascent MediaGroup, EFILM LLC, Imax Corporation, Laser Pacific Media Corporation, ModernVideo Film, Inc., Sunset Digital, Technicolor Media Services, and WarnerBros. Entertainment, Inc.

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

Manyof our current and potential competitors enjoy substantial competitiveadvantages, including:

·       greatername recognition;

·       alonger operating history;

·       moredeveloped distribution channels and deeper relationships with our commoncustomer base;

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·       amore extensive customer base;

·       digitaltechnologies that provide features that ours do not;

·       broaderproduct and service offerings;

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

·       moretechnicians and engineers; and

·       greatertechnical support.

As a result, these currentand potential competitors may be able to respond more quickly and effectivelythan we can to new or changing opportunities, technologies, standards, orcustomer requirements.

In addition to thecompetitive advantages described above, Dolby also enjoys other uniquecompetitive strengths relative to us. For example, it introduced multi-channelaudio technology before we did and has a larger base of installed movietheaters for its cinema playback equipment. Its technology has beenincorporated in significantly more DVD-Video films than our technology. It hasalso achieved mandatory standard status in product categories that we have not,including DVD-Video and DVD-Audio Recordable, for its stereo technology andterrestrial digital television broadcasts in the United States. It alsocurrently has more depth in digital cinema. As a result of these factors, Dolbyhas a competitive advantage in selling its digital multi-channel audiotechnology to consumer electronics products manufacturers and in sellingproducts and services designed for use in the digital cinema space.

Sony Corporation is both acompetitor and a significant customer in most of our markets. If Sony decidesto eliminate the use of our technology in its products or to compete with usmore aggressively in our markets, the revenues that we derive from Sony wouldbe lower than expected.

***We do not expect sales of traditional consumer DVD playersto sustain their past growth rates. To the extent that sales of DVD players andhome theater systems level off or decline, or alternative technologies in whichwe do not participate replace DVDs as a dominant medium for consumer videoentertainment, our business will be adversely affected.***

Growth in our businessover the past several years is due in large part to the rapid growth in salesof DVD players and home theater systems incorporating our technologies. As themarkets for DVD players mature, we do not expect sales of traditional consumerDVD players to sustain their past growth rates. To the extent that sales of DVDplayers and home theater systems level off or decline, our business will beadversely affected. Additionally, the release and consumer adoption ofnext-generation optical disc players has only just begun. There are currentlytwo competing formats for high-definition optical discs and consumers may notreact favorably to having to make a choice between formats. There is also therisk of consumer confusion and frustration over the inability of a given formatplayer to play a disc in the competing format. The slow uptake by consumers ofthese new formats, as well as the inability of traditional DVD players tosustain their past growth rates, could adversely affect our business, asrevenue and earnings derived from these new players and associated home theatersystem sales may not fully replace the anticipated decline in revenue andearnings associated with traditional DVD players and home theater systems. Evenassuming resolution of the competing disc format conflict, the rate of consumeradoption and ultimate penetration of next-generation optical disc players isuncertain and may be slower than past growth rates of traditional DVD players.In addition, if new technologies are developed for use with DVDs or newtechnologies are developed that substantially compete with or replace DVDs as adominant medium for consumer video entertainment, our business, operatingresults and prospects will be adversely affected.

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***We have limitedcontrol over existing and potential customers’ and licensees’ decisions toinclude our technology in certain of their product offerings.***

We are dependent on ourcustomers and licensees—including consumer electronics products manufacturers,semiconductor manufacturers, movie theaters, producers and distributors ofcontent for music, films, videos, and games and builders and integrators ofdigital cinema networks—to incorporate our technology in their products,purchase our products and services, or release their content in our proprietaryDTS audio format. Although we have contracts and license agreements with manyof these companies other than builders and integrators of digital cinemanetworks, these agreements do not require any minimum purchase commitments, areon a non-exclusive basis, and do not require incorporation or use of ourtechnology, trademarks or services. Our customers, licensees and othermanufacturers might not utilize our technology or services in the future.

***If we are unable tomaintain and increase the amount of entertainment content released with DTSaudio soundtracks, demand for the technology, products, and services that weoffer to consumer electronics products manufacturers may significantly decline.***

We expect to derive asignificant percentage of our revenues from the technology, products, andservices that we offer to manufacturers of consumer electronics products. Todate, the most significant driver for the use of our technology in the hometheater market has been the release of major movie titles with DTS audiosoundtracks. We also believe that demand for our DTS audio technology inemerging markets for multi-channel audio, including homes, cars, personalcomputers, and video games and consoles, will be based on the number, quality,and popularity of the audio DVDs, computer software programs, and video gamesreleased with DTS audio soundtracks. Although we have existing relationshipswith many leading providers of movie, music, computer, and video game content,we do not have contracts that require any of these parties to develop andrelease content with DTS audio soundtracks. In addition, we may not besuccessful in maintaining existing relationships or developing relationshipswith other existing providers or new market entrants that provide content. As aresult, we cannot assure you that a significant amount of content in movies,audio DVDs, computer software programs, video games, or other entertainmentmediums will be released with DTS audio soundtracks. If the amount, variety,and popularity of entertainment content released with DTS audio soundtracks donot increase, consumer electronics products manufacturers that pay us per-unitlicensing fees may discontinue offering DTS playback capabilities in theconsumer electronics products that they sell.

***Declining retailprices for consumer electronics products or video content could force us tolower the license or other fees we charge our customers.***

The market for consumer electronics products is intenselycompetitive and price sensitive. Retail prices for consumer electronicsproducts that include our DTS audio technology, such as DVD players and hometheater systems, have decreased significantly and we expect prices to continueto decrease for the foreseeable future. Declining prices for consumerelectronics products could create downward pressure on the licensing fees wecurrently charge our customers who integrate our technology into the consumerelectronics products that they sell and distribute. Most of the consumerelectronics products that include our audio technology also include Dolby’smulti-channel audio technology. As a result of pricing pressure, consumerelectronics products manufacturers who manufacture products in which our audiotechnology is not a mandatory standard could decide to exclude our DTS audiotechnology from their products altogether.

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

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provide.If the motion picture studios, content owners, producers or distributors wereto believe that the existing image quality is satisfactory or that the pricingfor our services is too high, they could decide to not use our servicesaltogether.

***Our licensingrevenue depends in large part upon semiconductor manufacturers incorporatingour technologies into integrated circuits, or ICs, for sale to our consumerelectronics product licensees and if, for any reason, our technologies are notincorporated in these ICs or fewer ICs are sold that incorporate ourtechnologies, our operating results would be adversely affected.***

Our licensing revenue fromconsumer electronics product manufacturers depends in large part upon theavailability of ICs, that implement our technologies. IC manufacturersincorporate our technologies into these ICs, which are then incorporated inconsumer electronics products. We do not manufacture these ICs, but ratherdepend on IC manufacturers to develop, produce and then sell them to licensedconsumer electronics product manufacturers. We do not control the ICmanufacturers’ decisions whether or not to incorporate our technologies intotheir ICs, and we do not control their product development or commercializationefforts. If these IC manufacturers are unable or unwilling, for any reason, toimplement our technologies into their ICs, or if, for any reason, they sellfewer ICs incorporating our technologies, our operating results will beadversely affected.

***We rely on theaccuracy of our customers’ manufacturing reports for reporting and collectingour revenues, and if these reports are untimely or incorrect, our revenuescould be delayed or inaccurately reported.***

A significant percentageof our revenues are generated from consumer electronics products manufacturerswho license and incorporate our technology in their consumer electronicsproducts. Under our existing arrangements, these customers pay us per-unitlicensing fees based on the number of consumer electronics productsmanufactured that incorporate our technology. We rely on our customers toaccurately report the number of units manufactured in collecting our licensefees, preparing our financial reports, projections, budgets, and directing oursales and product development efforts. Most of our license agreements permit usto audit our customers, but audits are generally expensive, time consuming,difficult to manage effectively, dependent in large part on the cooperation ofour licensees and the quality of the records they keep, and could harm ourcustomer relationships. If any of our customer reports understate the number ofproducts they manufacture, we may not collect and recognize revenues to whichwe are entitled.

***Because we expectour operating expenses to increase in the future, we may not be able to sustainor increase our profitability.***

Although we havebeen in business since 1990, we have only achieved annual profitability sincefiscal 2001. We expect our operating expenses to increase as we, among otherthings:

·       expandour domestic and international sales and marketing activities;

·       developand roll out our digital cinema products and services;

·       proceedwith the sale of our DTS Digital Cinema business;

·       restructureour international operations;

·       adopta more product-centric business model which is expected to entail additionalhiring;

·       acquirebusinesses or technologies and integrate them into our existing organization;

·       increaseour research and development efforts to advance our existing technology,products, and services and develop new technology, products, and services;

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·       hireadditional personnel, including engineers and other technical staff;

·       upgradeour operational and financial systems, procedures, and controls; and

·       continueto assume the responsibilities of being a public company.

As a result, we will needto grow our revenues in order to maintain and increase our profitability. Inaddition, we may fail to accurately estimate and assess our increased operatingexpenses as we grow.

***Our future capitalneeds are uncertain and we may need to raise additional funds in the future,and such funds may not be available on acceptable terms or at all.***

Our capitalrequirements will depend on many factors, including:

·       acceptanceof, and demand for, our products and technology;

·       thecosts of developing new products or technology;

·       theextent to which we invest in new technology and research and developmentprojects, including without limitation, digital cinema;

·       thenumber and timing of acquisitions and other strategic transactions;

·       theextent to which we deploy our digital cinema products to theaters;

·       thecosts associated with our expansion, if any; and

·       thesale of our DTS Digital Cinema business.

In the future, we may needto raise additional funds, and such funds may not be available on favorableterms, or at all. Furthermore, if we issue equity or debt securities to raiseadditional funds, our existing stockholders may experience dilution, and thenew equity or debt securities may have rights, preferences, and privilegessenior to those of our existing stockholders. If we cannot raise funds onacceptable terms, we may not be able to develop or enhance our products andservices, execute our business plan, take advantage of future opportunities, orrespond to competitive pressures or unanticipated customer requirements. Thismay materially harm our business, results of operations, and financialcondition.

***We have a limitedoperating history in our new and evolving markets.***

Although the first moviewith a DTS audio soundtrack was released in 1993, we did not enter the hometheater market until 1996, and our technology has only recently beenincorporated into other consumer electronics markets, such as car audio,personal computers, video games and consoles, portable electronics devices, anddigital satellite and cable broadcast products. In addition, while we havecompleted over 100 digital image processing, enhancement and restoration filmprojects, it is only recently that a large number of these projects have beencompleted. As a result, the demand for our technology, products, and servicesand the income potential of these businesses are unproven. In addition, becausethe market for digital audio technology and image services is relatively newand rapidly evolving, we have limited insight into trends that may emerge andaffect our business. We may make errors in predicting and reacting to relevantbusiness trends, which could harm our business. Before investing in our commonstock, you should consider the risks, uncertainties, and difficultiesfrequently encountered by companies in new and rapidly evolving markets such asours. We may not be able to successfully address any or all of these risks.

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***Our technology andproducts are complex and may contain errors that could cause us to losecustomers, damage our reputation, or incur substantial costs.***

Our technology or productscould contain errors that could cause our products or technology to operate improperlyand could cause unintended consequences. If our products or technology containerrors we could be required to replace them, and if any such errors causeunintended consequences we could face claims for product liability. Although wegenerally attempt to contractually limit our exposure to incidental andconsequential damages, as well as provide insurance coverage to such events, ifthese contract provisions are not enforced or are unenforceable for any reason,if liabilities arise that are not effectively limited, or if our insurancecoverage is inadequate to satisfy the liability, we could incur substantialcosts in defending and/or settling product liability claims.

***Issues arising fromthe implementation of our new enterprise resource planning system could affectour operating results and ability to manage our business effectively.***

We recently implemented anew enterprise resource planning, or ERP, system to enhance operatingefficiencies and provide more effective management of our business. Theimplementation of this new ERP system is costly and involves numerous risksincluding: disruption to our normal accounting procedures and internal controlover financial reporting, inaccuracies in the conversion of electronic data,difficulties integrating the systems and processes, additional costs tocontinually refine the systems functionality, and disruption of our financialreporting process. Failure to adequately address these issues could materiallyadversely affect our operating results, internal control over financialreporting, ability to manage our business effectively, and ability to meetregulatory filing deadlines.

***We cannot becertain of the future effectiveness of our internal controls over financialreporting or the impact thereof on our operations or the market price of ourcommon stock.***

Pursuant to Section 404of the Sarbanes-Oxley Act of 2002, we are required to include in our annualreports on Form 10-K our assessment of the effectiveness of ourinternal controls over financial reporting. We cannot assure you that oursystem of internal controls will be effective in the future as our operationsand control environment change. If we cannot adequately maintain theeffectiveness of our internal controls over financial reporting, our financialreporting may be inaccurate. If reporting errors actually occur, we could besubject to sanctions or investigation by regulatory authorities, such as theSEC. These results could adversely affect our financial results or the marketprice of our common stock. If our independent registered public accounting firmis unable to provide us with an unqualified report as to the adequacy of ourinternal controls over financial reporting as required by Section 404 ofthe Sarbanes Oxley Act of 2002, investors could lose confidence in thereliability of our financial statements, which could result in a decrease inthe value of our stock.

***We are subject toadditional risks associated with our international operations.***

We market and sellour products and services outside the United States, and currently haveemployees located in more than ten countries worldwide. Many of our customersand licensees are located outside the United States. As a key component of ourbusiness strategy, we intend to expand our international sales. During fiscal2006, approximately 71% of our revenues were derived internationally. We facenumerous risks in doing business outside the United States, including:

·       unusualor burdensome foreign laws or regulatory requirements or unexpected changes tothose laws or requirements;

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

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·       difficultiesin staffing and managing foreign operations;

·       competitionfrom foreign companies;

·       dependenceon foreign distributors and their sales channels;

·       longeraccounts receivable collection cycles and difficulties in collecting accountsreceivable;

·       lesseffective and less predictable protection of intellectual property;

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

·       fluctuationsin the value of foreign currency versus the U.S. dollar and the cost ofcurrency exchange; and

·       potentiallyadverse tax consequences.

Such factors could cause our future internationalsales to decline.

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

Our international revenueis mostly denominated in U.S. dollars. As a result, fluctuations in the valueof the U.S. dollar and foreign currencies may make our technology, products,and services more expensive for international customers, which could cause themto decrease their purchases from us. Expenses for our subsidiaries aredenominated in their respective local currencies. Significant fluctuations inthe value of the U.S. dollar and foreign currencies could have a materialimpact on our consolidated financial statements. The main foreign currencies weencounter in our operations are the Yen, Euro, RMB and GBP. We do not currentlyengage in currency hedging activities to limit the risk of exchange rate fluctuations.

***We face risks inexpanding our business operations in China.***

One of our key strategies is to expand our businessoperations in China. However, we may be unsuccessful in implementing thisstrategy as planned or at all. Factors that could inhibit our successfulexpansion into China include its historically poor recognition of intellectualproperty rights and poor performance in stopping counterfeiting and piracyactivity. If we are unable to successfully stop unauthorized use of ourintellectual property and assure compliance by our Chinese licensees, we couldexperience increased operational and enforcement costs both inside and outsideChina.

Even if we are successfulin expanding into China, we may be greatly impacted by the political, economic,and military conditions in China, Taiwan, North Korea, and South Korea. Suchdisputes may continue or escalate, resulting in economic embargos, disruptionsin shipping, or even military hostilities. This could severely harm ourbusiness by interrupting or delaying production or shipment of our products orproducts that incorporate our technology.

***A prolongedeconomic downturn could materially harm our business.***

Negative trends in thegeneral economy, including trends resulting from actual or threatened militaryaction by the United States and threats of terrorist attacks in the UnitedStates and abroad, could cause a decrease in consumer spending on entertainmentin general. Any reduction in consumer confidence or disposable income ingeneral may affect the demand for consumer electronics products thatincorporate our digital audio technology and demand by film studios and movietheaters for our cinema products and services.

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***We may notsuccessfully address problems encountered in connection with any acquisitions.***

We expect toconsider opportunities to acquire or make investments in other technologies,products, and businesses that could enhance our technical capabilities,complement our current products and services, or expand the breadth of ourmarkets, including without limitation the potential acquisition ofsubstantially all of the assets of Avica. We have a limited history ofacquiring and integrating businesses. Acquisitions and strategic investmentsinvolve numerous risks, including:

·       problemsassimilating the purchased technologies, products, or business operations;

·       significantfuture charges relating to in-process research and development and theamortization of intangible assets;

·       significantamount of goodwill that is not amortizable and is subject to annual impairmentreview;

·       problemsmaintaining uniform standards, procedures, controls, and policies;

·       unanticipatedcosts associated with the acquisition, including accounting and legal charges,capital expenditures, and transaction expenses;

·       diversionof management’s attention from our core business;

·       adverseeffects on existing business relationships with suppliers and customers;

·       risksassociated with entering markets in which we have no or limited priorexperience;

·       unanticipatedor unknown liabilities relating to the acquired businesses;

·       theneed to integrate accounting, management information, manufacturing, humanresources and other administrative systems to permit effective management; and

·       potentialloss of key employees of acquired organizations.

If we fail to properlyevaluate and execute acquisitions and strategic investments, our managementteam may be distracted from our day-to-day operations, our business may bedisrupted, and our operating results may suffer. In addition, if we financeacquisitions by issuing equity or convertible debt securities, our existingstockholders would be diluted. Foreign acquisitions involve unique risks inaddition to those mentioned above, including those related to integration ofoperations across different geographies, cultures and languages, currency risksand risks associated with the particular economic, political and regulatoryenvironment in specific countries. Also, the anticipated benefit of ouracquisitions may not materialize, whether because of failure to obtainstockholder approval or otherwise. Future acquisitions could result inpotentially dilutive issuances of our equity securities, the incurrence ofdebt, contingent liabilities or amortization expenses, or write-offs ofgoodwill, any of which could harm our operating results or financial condition.Future acquisitions may also require us to obtain additional equity or debtfinancing, which may not be available on favorable terms or at all.

***We may havedifficulty managing any growth that we might experience.***

As a result of acombination of internal growth and growth through acquisitions, we expect tocontinue to experience growth in the scope of our operations and the number ofour employees. If this growth continues, it will place a significant strain onour management team and on our operational and financial systems, procedures,and controls. Our future success will depend in part on the ability of ourmanagement team to manage any growth effectively. This will require our managementto:

·       hireand train additional personnel in the United States and internationally;

·       implementand improve our operational and financial systems, procedures, and controls;

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·       maintainour cost structure at an appropriate level based on the revenues we generate;

·       managemultiple concurrent development projects; and

·       manageoperations in multiple time zones with different cultures and languages.

Any failure tosuccessfully manage our growth could distract management’s attention, andresult in our failure to execute our business plan.

***We may experiencefluctuations in our operating results.***

We have historically experienced moderate seasonalityin our business due to our business mix and the nature of our products. In ourconsumer business, consumer electronics manufacturing activities are generallylowest in the first calendar quarter of each year, and increase progressivelythroughout the remainder of the year. Manufacturing output is generallystrongest in the third and fourth quarters as our technology licensees increasemanufacturing to prepare for the holiday buying season. Since recognition ofrevenues in our consumer business generally lags manufacturing activity by onequarter, our revenues and earnings from the consumer business are generallylowest in the second quarter. Film licensing revenues are generally strongestin the second and fourth quarters due to the abundance of movies typicallyreleased during the summer and year-end holiday seasons. The introduction ofnew products and inclusion of our technologies in new and rapidly growingmarkets can distort and amplify the seasonality described above. For example,the introduction of next generation optical disc players may result in anoverall near-term slowdown in our business as sales of standard definitionplayers slow in anticipation of purchasing next generation products, butpurchases of next generation products are in an early-adopter only phase.Similar issues may affect our cinema hardware business during the expectedtransition to digital cinema. Our revenues may continue to be subject tofluctuations, seasonal or otherwise, in the future. Unanticipated fluctuations,whether due to seasonality, product cycles, or otherwise, could cause us tomiss our earnings projections, or could lead to higher than normal variation inshort-term earnings, either of which could cause our stock price to decline.

In addition, we activelyengage in intellectual property compliance and enforcement activities focusedon identifying third parties who have either incorporated our technology,trademarks, or know-how without a license or who have underreported to us theamount of royalties owed under license agreements with us. As a result of theseactivities, from time to time, we may recognize royalty revenues that relate toconsumer electronics manufacturing activities from prior periods and we mayincur expenditures related to enforcement activity. These expenditures androyalty recoveries, as applicable, may cause revenues to be higher thanexpected, or net profit to be lower than expected, during a particularreporting period and may not recur in future reporting periods. Suchfluctuations in our revenues and operating results may cause declines in ourstock price.

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

Even if astandards-setting body mandates our technologies for a particular market, ourtechnologies may not be the sole technologies adopted for that market as anindustry standard. Accordingly, our business may depend upon participants inthat market choosing to adopt our technologies instead of or in addition tocompetitive technologies that also may be acceptable under such standard.

***Our licensing ofindustry standard technologies can be subject to limitations that couldadversely affect our business and prospects.***

When a standards-settingbody adopts our technologies as explicit industry standards, we generally mustagree to license such technologies on a fair, reasonable and non-discriminatorybasis, which could 

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limitour control over the use of these technologies. In these situations, we may berequired to limit the royalty rates we charge for these technologies, whichcould adversely affect our business. Furthermore, we may be unable to limit towhom we license such technologies, and may be unable to restrict many terms ofthe license. From time to time, we may be subject to claims that our licensesof our industry standard technologies may not conform to the requirements ofthe standards-setting body. Claimants in such cases could seek to restrict orchange our licensing practices or our ability to license our technologies inways that could injure our reputation and otherwise materially and adversely affectour business, operating results and prospects.

***Our ability todevelop proprietary technology in markets in which “open standards” are adoptedmay 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 thosestandards are publicly available. The use of open standards may reduce ouropportunity to generate revenue, as open standards technologies are based uponnon-proprietary technology platforms in which no one company maintainsownership over the dominant technologies.

***We are dependent onour management team and technical talent.***

Our successdepends, in part, upon the continued availability and contributions of ourmanagement team and engineering and technical personnel because of thecomplexity of our products and services. Important factors that could cause theloss of key personnel include:

·       ourexisting employment agreements with the members of our management team allowsuch persons to terminate their employment with us at any time;

·       wedo not have employment agreements with a majority of our key engineering andtechnical personnel;

·       significantportions of the equity awards held by the members of our management team arevested; and

·       equityawards held by some of our executive officers provide for accelerated vestingin the event of a sale or change of control of our company.

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

***A loss of one ormore of our key customers or licensees in any of our markets could adverselyaffect our business.***

From time to time, one ora small number of our customers or licensees may represent a significantpercentage of our revenue. Although we have agreements with many of thesecustomers, these agreements typically do not require any material minimumpurchases or minimum royalty fees and do not prohibit customers from purchasingproducts and services from competitors. A decision by any of our majorcustomers or licensees not to use our technologies, or their failure orinability to pay amounts owed to us in a timely manner, or at all, could have asignificant adverse effect on our business.

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***We may haveadditional tax liabilities.***

We are subject to incometaxes in both the United States and foreign jurisdictions. Significant judgmentis required in determining our worldwide provision for income taxes. In theordinary course of our business, there are many transactions and calculationswhere the ultimate tax determination is uncertain. We may come under audit bytax authorities. Although we believe our tax estimates are reasonable, thefinal determination of tax audits and any related litigation could bematerially different from our historical income tax provisions and accruals.Based on the results of an audit or litigation, a material effect on our incometax provision, net income or cash flows in the period or periods for which thatdetermination is made could result.

***Current and futuregovernmental and industry standards may significantly limit our businessopportunities.***

Technology standards are important in the audio andvideo industry as they help to assure compatibility across a system or seriesof products. Generally, standards adoption occurs on either a mandatory basis,requiring a particular technology to be available in a particular product ormedium, or an optional basis, meaning that a particular technology may be, butis not required to be, utilized. For example, both our digital multi-channelaudio technology and Dolby’s have optional status in Standard and HighDefinition-DVD and Blu-ray. In the standards for High Definition-DVD andBlu-ray, both DTS and Dolby technologies have been selected as mandatorystandards for two-channel output. However, if either or both of these standardsare re-examined or a new standard is developed, we may not be included asmandatory in any such new or revised standard which would cause revenue growthin our consumer business to be significantly lower than expected and could havea material adverse affect on our business.

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

As new technologies andentertainment media emerge, new standards relating to these technologies ormedia may develop. New standards may also emerge in existing markets that arecurrently characterized by competing formats, such as the market for personalcomputers. We may not be successful in our efforts to include our technology inany such standards.

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

Although we haveestablished relationships with a number of motion picture studios, contentowners, producers and distributors, we do not have any contractual agreementsthat require them to provide us image content for processing. Further, thedemand for image processing, enhancement and restoration of cinema, home videoor broadcast television content may not materialize or accelerate as weanticipate, which would have a negative impact on our business.

***Our revenues fromfilm producers and distributors and from the products and services that weoffer to movie theaters would decline if the major U.S. film producers anddistributors decrease or delay the number of films they release using DTStechnology or services.***

Althoughthe major U.S. film producers and distributors are customers of ours, wegenerally do not have contractual arrangements that require them to use our DTSaudio technology or our digital image services. Our cinema and digital imagesbusiness depends on our having good relations with these film 

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studios and other content owners. A deterioration inour relationship with any of these customers could cause them to stop using ourDTS audio technology or our digital image enhancement services. Any significantdecline or delay in the release of motion pictures with DTS audio soundtrackswould decrease the demand for and revenues from the playback products andservices that we offer to movie theaters. In addition, other motion picturestudios, content owners, producers, and distributors throughout the worldgenerally adopt and use the processes and the technologies used by the majorU.S. film studios. Therefore, if the major U.S. motion picture studios, contentowners, producers or distributors stop using our technology, we would not onlylose the per-movie licensing fee we receive from these customers, but may alsolose per-movie licensing fees from other film studios throughout the world.Furthermore, poor box-office performance caused by a weak film release calendaror declining consumer interest in the films being released could have anegative impact on the demand for the products and services we sell to themotion picture industry.

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

Our cinema businessdepends in part on the construction of new screens and the renovation ofexisting theaters that install our DTS playback systems and cinema processors.Over the past decade, aggressive building of megaplexes by companies thatoperate movie theaters has generated significant competition and resulted in anoversupply of screens in some domestic and international markets. The resultingoversupply of screens led to significant declines in revenues per screen and,eventually, to an inability by many major film exhibitors to satisfy theirfinancial obligations. Several major movie theater operators have reorganizedthrough bankruptcy proceedings, and many movie theaters have closed. As aresult, our playback systems and cinema processors that we previously sold tomovie theaters that have reorganized and closed have been relocated to othertheaters or have been available for resale in the secondary market to movietheaters that might otherwise have purchased these products directly from us.More recently, the industry has experienced a decline in movie theaterattendance. If this decline were to continue, exhibitors could see a decline inrevenue per screen and, potentially, an inability to satisfy their financialobligations resulting in the closure of screens. If movie theater operatorsdecide to close a significant number of screens in the future or cut theircapital spending, demand for our playback systems and cinema processors willdecline. Additionally, the expected transition to digital cinema could harm ourlegacy cinema business because operators may decide to delay procurementdecisions as they wait to evaluate the widespread roll out of digital cinema,operators may decide to purchase digital cinema systems that do not require ourexisting products and services, and as existing screens are repurposed todigital cinema, the quantity of our existing products on the secondary marketmay increase significantly. These developments may harm our business andoperating results.

***The demand for ourcurrent or “legacy” cinema products and production services could decline ifthe film industry broadly adopts digital cinema.***

If the film industrybroadly adopts digital cinema, the demand for our current or “legacy” cinemaproducts and production services could decline. If, in such circumstances, weare unable to adapt our professional products and production services orreplace such business with new products for the market for digital cinemasuccessfully, our business could be materially adversely affected.

***We depend onseveral sole and limited source suppliers, manufacturers, and distributors forsome of our products, and the loss of any of these suppliers, manufacturers, ordistributors could harm our business.***

We purchase a small numberof parts from sole-source suppliers. In addition, our professional audio encodingdevices and movie theater playback systems are manufactured according to ourspecifications by single third-party manufacturers. Because we have no directcontrol over these third-party suppliers and 

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manufacturers,interruptions or delays in the products and services provided by these thirdparties may be difficult to remedy in a timely fashion. In addition, if suchsuppliers or manufacturers are incapable of or unwilling to deliver thenecessary parts or products, we may be unable to redesign our technology towork without such parts or find alternative suppliers or manufacturers. In suchevents, we could experience interruptions, delays, increased costs, or qualitycontrol problems.

***We are subject tovarious environmental laws and regulations that could impose substantial costsupon us and may adversely affect our business, operating results and financialcondition.***

Some of our operations use substances regulated undervarious 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 andthe cleanup of contaminated sites. We could incur costs, fines and civil orcriminal sanctions, third-party property damage or personal injury claims, orcould be required to incur substantial investigation or remediation costs, ifwe were to violate or become liable under environmental laws. Liability underenvironmental laws can be joint and several and without regard to comparativefault. The ultimate costs under environmental laws and the timing of thesecosts are difficult to predict.

We also face increasing complexity in our productdesign as we adjust to new and future requirements relating to the materialscomposition of our products. For example, restrictions on lead and otherhazardous substances that apply to specified electronic products put on themarket in the European Union became effective as of July 1, 2006 andsimilar requirements related to marking of electronic products became effectivein China as of March 1, 2007.

Substituting particular components containingregulated hazardous substances can be difficult or costly, and redesign effortscould result in production delays. Products that we maintain in inventory maybe rendered obsolete if not in compliance with the new environmental laws,which could negatively impact our ability to generate revenue from thoseproducts. We could also face significant costs and liabilities in connection withproduct take-back legislation. The European Union Directive 2002/96/EC asamended by 2003/108/EC (Waste Electrical and Electronic EquipmentDirective also known as the “WEEE Directive”) requires producers of particularelectrical and electronic equipment, including broadcast equipment, to befinancially responsible for specified collection, recycling, treatment anddisposal of past and future covered products. As of December 2006, not allmember states within the EU have enacted enabling legislation under the WEEEDirective, and in the absence of such legislation, it is difficult to determinethe costs to comply with the WEEE Directive.

Other countries, such asChina and the United States, may enact similar product-content and take-backlegislation, the cumulative impact of which could significantly increase ouroperating costs and adversely affect our operating results. We also expect thatour operations, whether manufacturing or licensing, will be affected by othernew environmental laws and regulations on an ongoing basis. Although we cannotpredict the ultimate impact of any such new laws and regulations, they willlikely result in additional costs or decreased revenue, and could require thatwe redesign or change how we manufacture our products, any of which could havea material adverse effect on our business.

**Risks Related toOur Common Stock**

***We expect that the price of our common stock willfluctuate substantially.***

The market price ofour common stock is likely to be highly volatile and may fluctuate substantiallydue to many factors, including:

·       actualor anticipated fluctuations in our results of operations;

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·       marketperception of our progress toward announced objectives, including withoutlimitation, the sale of our DTS Digital Cinema business;

·       announcementsof technological innovations by us or our competitors or technology standards;

·       announcementsof significant contracts by us or our competitors;

·       changesin our pricing policies or the pricing policies of our competitors;

·       developmentswith respect to intellectual property rights;

·       theintroduction of new products or product enhancements by us or our competitors;

·       thecommencement of or our involvement in litigation;

·       oursale of common stock or other securities in the future;

·       conditionsand trends in technology industries;

·       changesin market valuation or earnings of our competitors;

·       thetrading volume of our common stock;

·       announcementsof potential acquisitions;

·       theadoption rate of new products incorporating our or our competitors’technologies, including next generation optical disc players;

·       changesin the estimation of the future size and growth rate of our markets; and

·       generaleconomic conditions.

In addition, the stockmarket in general, and the Nasdaq Global Select Market and the market fortechnology companies in particular, has experienced extreme price and volumefluctuations that have often been unrelated or disproportionate to theoperating performance of those companies. Further, the market prices ofsecurities of technology companies have been particularly volatile. These broadmarket and industry factors may materially harm the market price of our commonstock, regardless of our operating performance. In the past, following periodsof volatility in the market price of a company’s securities, securitiesclass-action litigation has often been instituted against that company. Suchlitigation, if instituted against us, could result in substantial costs and adiversion of management’s attention and resources.

***Shares of our common stock are relatively illiquid.***

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

***Anti-takeoverprovisions under our charter documents and Delaware law could delay or preventa change of control and could also limit the market price of our stock.***

Our RestatedCertificate of Incorporation and Restated Bylaws contain provisions that coulddelay or prevent a change of control of our company or changes in our Board ofDirectors that our stockholders might consider favorable. Some of theseprovisions:

·       authorizethe issuance of preferred stock which can be created and issued by the Board ofDirectors without prior stockholder approval, with rights senior to those ofthe common stock;

·       providefor a classified Board of Directors, with each director serving a staggeredthree-year term;

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·       prohibit stockholders fromfilling Board vacancies, calling special stockholder meetings, or taking actionby written consent; and

·       require advance writtennotice of stockholder proposals and director nominations.

In addition, we aregoverned by the provisions of Section 203 of the Delaware GeneralCorporate Law, which may prohibit certain business combinations withstockholders owning 15% or more of our outstanding voting stock. These andother provisions in our Restated Certificate of Incorporation, Restated Bylawsand Delaware law could make it more difficult for stockholders or potentialacquirors to obtain control of our Board or initiate actions that are opposedby the then-current Board, including delay or impede a merger, tenderoffer, or proxy contest involving our company. Any delay or prevention of achange of control transaction or changes in our Board could cause the marketprice of our common stock to decline.

**Item 2.**                        UnregisteredSales of Equity Securities and Use of Proceeds

**(c)**           Purchases of EquitySecurities by the Issuer and Affiliated Purchasers.

Stockrepurchase activity during the quarter ended June 30, 2007 was as follows:

| **Period**                                       | ** ** | ** ** | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average  Price Paid  per Share** | ** ** | **Total Number of  Shares  Purchased as   Part of Publicly  Announced Plan** | ** ** | **Maximum Number   of Shares that May  Yet Be Purchased  Under the Plan** | ** ** |
|--------------------------------------------------|------------|------------|------------|--------------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|
| April 1,  2007 through  April 30, 2007 |       |       | —     |                                             |       |                                         | —     |                                                                                                            |       |                                                                                                                   | —     |   |   |   | 1,000,000 |   |   |
| May 1, 2007 through   May 31, 2007     |       |       | 4,000      |                                             |       |                                         | $          | 21.71                                                                                                           |       |                                                                                                                   |       | 4,000 |   |   |   | 996,000 |   |   |
| June 1, 2007 through   June 30, 2007   |       |       | 161,000    |                                             |       |                                         | $          | 22.32                                                                                                           |       |                                                                                                                   |       | 161,000 |   |   |   | 835,000 |   |   |
| Total                                            |       |       | 165,000    |                                             |       |                                         | $          | 22.30                                                                                                           | (2)        |                                                                                                                   |       | 165,000 |   |   |   |   |   |   |

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**Note:**

(1)          All shares purchasedduring the three months ended June 30, 2007 were repurchased under ourBoard of Directors authorization that we announced in August 2006, underwhich we are authorized to repurchase ofup to one million shares of our common stock in the open market or in privatelynegotiated transactions, depending upon market conditions and other factors.

(2)          Represents weightedaverage price paid per share during the quarter ended June 30, 2007.

**Item 3.**                        DefaultsUpon Senior Securities

None.

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**Item 4.**                        Submissionof Matters to a Vote of Security Holders

The Annual Meeting of Stockholders of DTS, Inc.was held on May 17, 2007. The following matters were voted upon and wereapproved as set forth below.

The stockholders electedtwo Class I directors to hold office until the 2010 Annual Meeting ofStockholders, or until their successors are duly elected and qualified or untiltheir earlier death, resignation or removal, by the following votes:

| ** **                                   | ** ** | **Number of Shares** | ** ** |
|----------------------------------------------|------------|--------------------------------|------------|
| **Name of Directors Elected** | ** ** | ** **                     | ** ** | **For** | ** ** | **Withheld** | ** ** |
| Daniel E. Slusser                            |       | 17,262,452                     |       | 205,406 |   |
| Joseph A. Fischer                            |       | 17,292,844                     |       | 175,014 |   |
|                                              |            |                                |            |  |  |  |  |

 

The following individuals are continuing directorswith terms expiring upon the 2008 Annual Meeting of Stockholders: Joerg D. Aginand C. Ann Busby.

The following individuals are continuing directorswith terms expiring upon the 2009 Annual Meeting of Stockholders: Jon E.Kirchner, James B. McElwee and Ronald N. Stone.

Thestockholders ratified PricewaterhouseCoopers LLP as the independent registeredpublic accounting firm of DTS, Inc. for the 2007 fiscal year by thefollowing vote:

| **Number of Shares** | ** ** |
|--------------------------------|------------|
| **For**                        | ** ** | **Against** | ** ** | **Abstain** | ** ** | **No Vote** | ** ** |
| 17,395,047                     |       | 72,358 |   | 453 |   | — |   |

 

Thestockholders approved the DTS, Inc. 2003 Equity Incentive Plan forpurposes of Section 162(m) of the Internal Revenue Code by thefollowing vote:

| **Number of Shares** | ** ** |
|--------------------------------|------------|
| **For**                        | ** ** | **Against** | ** ** | **Abstain** | ** ** | **No Vote** | ** ** |
| 11,494,077                     |       | 3,595,411 |   | 1,024,225 |   | 1,354,145 |   |

 

**Item 5.**                        OtherInformation

None.

**Item 6.**                        Exhibits
| Exhibit  Number | ** ** | **Exhibit Description** |
|-----------------|------------|------------------------------|
|            | 10.73      |                         |   | Amendment to Employment Agreement, dated as of  February 28, 2007, between the Registrant and William Neighbors |
|            | 31.1       |                         |   | Certification of the  Chief Executive Officer under Securities Exchange Act Rules 13a-14(a)  or 15d-14(a) |
|            | 31.2       |                         |   | Certification of the  Chief Financial Officer under Securities Exchange Act Rules 13a-14(a)  or 15d-14(a) |
|            | 32.1       |                         |   | Certification of the  Chief Executive Officer under Securities Exchange Act Rules 13a-14(b)  or 15d-14(b) and 18 U.S.C. 1350 |
|            | 32.2       |                         |   | Certification of the  Chief Financial Officer under Securities Exchange Act Rules 13a-14(b)  or 15d-14(b) and 18 U.S.C. 1350 |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                           | DTS, INC. |
|---------------------------|----------------|
|                      | by:            | /s/ JON E. KIRCHNER |
|                      |           | Jon E. Kirchner |
|                      | * *       | *President and Chief Executive Officer* |
| Date: August 9, 2007 | * *       | *(Duly Authorized Officer)* |
|                      | by:            | /s/ MELVIN L. FLANIGAN |
|                      |           | Melvin L. Flanigan |
|                      | * *       | *Executive Vice President, Finance and* |
|                      | * *       | *Chief Financial Officer* |
| Date: August 9, 2007 | * *       | *(Principal Financial and Accounting Officer)* |

 

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**EXHIBITINDEX**

| Exhibit   Number | ** ** | ** **                                                                                                                                       | ** ** | **Exhibit Description** |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|
| 10.73            |       | Amendment to Employment  Agreement, dated as of February 28, 2007, between the Registrant and  William Neighbors                            |
| 31.1             |       | Certification of  the Chief Executive Officer under Securities Exchange Act Rules 13a-14(a) or  15d-14(a)                              |
| 31.2             |       | Certification of  the Chief Financial Officer under Securities Exchange Act Rules 13a-14(a) or  15d-14(a)                              |
| 32.1             |       | Certification of  the Chief Executive Officer under Securities Exchange Act Rules 13a-14(b) or  15d-14(b) and 18 U.S.C. 1350      |
| 32.2             |       | Certification of the  Chief Financial Officer under Securities Exchange Act Rules 13a-14(b) or  15d-14(b) and 18 U.S.C. 1350 |

 

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