**SECURITIES 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 September 30, 2004**

**CommissionFile Number 000-50335**

----

Digital Theater Systems, Inc.

(Exact name of registrantas specified in its charter)

| **Delaware**                                                     | **77-0467655**                                              |
|------------------------------------------------------------------|-------------------------------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) | (I.R.S. employer  identification number)                    |
| ** **                                                       | ** **                                                  |
| **5171  Clareton Drive  Agoura Hills, California 91301**         | **(818) 706-3525**                                     |
| (Address of  principal executive offices  and zip code)          | (Registrant’s  telephone number,  Including area code) |

 

----

Indicate by check mark whetherthe 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 the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act). Yes  o   No  x

As of October 31, 2004 a total of 17,025,534shares of the Registrant’s Common Stock, $0.0001 par value, were issued andoutstanding.

 

----

 

**DIGITAL THEATERSYSTEMS, INC.FORM 10-QTABLE OF CONTENTS**
| **PART I**   | ** ** | **FINANCIAL INFORMATION**                                                                        | ** ** |   | ** ** |
|-------------------|------------|--------------------------------------------------------------------------------------------------|------------|--------|------------|
| **Item 1.**  | ** ** | **Financial Statements:**                                                                        | ** ** |   | ** ** |
| ** **        | ** ** | **Condensed Consolidated Balance Sheets**                                                        | ** ** | 3      | ** ** |
| ** **        | ** ** | **Condensed Consolidated Statements of  Operations**                                             | ** ** | 4      | ** ** |
| ** **        | ** ** | **Condensed Consolidated Statements of Cash Flows**                                              | ** ** | 5      | ** ** |
| ** **        | ** ** | **Notes to Condensed  Consolidated Financial Statements**                                        | ** ** | 6      | ** ** |
| **Item 2.**  | ** ** | **Management’s Discussion and Analysis of Financial  Condition and Results of  Operations** | ** ** | 13     | ** ** |
| **Item 3.**  | ** ** | **Quantitative and Qualitative Disclosures About  Market Risk**                                  | ** ** | 31     | ** ** |
| **Item 4.**  | ** ** | **Controls and Procedures**                                                                      | ** ** | 32     | ** ** |
| **PART II.** | ** ** | **OTHER INFORMATION**                                                                            | ** ** |   | ** ** |
| **Item 1.**  | ** ** | **Legal Proceedings**                                                                            | ** ** | 33     | ** ** |
| **Item 2.**  | ** ** | **Unregistered Sales of Equity Securities and Use  of Proceeds**                                 | ** ** | 33     | ** ** |
| **Item 3.**  | ** ** | **Defaults Upon Senior Securities**                                                              | ** ** | 33     | ** ** |
| **Item 4.**  | ** ** | **Submission of Matters to a Vote of Security Holders**                                          | ** ** | 33     | ** ** |
| **Item 5.**  | ** ** | **Other Information**                                                                            | ** ** | 33     | ** ** |
| **Item 6.**  | ** ** | **Exhibits**                                                                                     | ** ** | 34     | ** ** |
| **SIGNATURES**    | ** ** | 35                                                                                               | ** ** |

 

2

----

**DIGITAL THEATERSYSTEMS, INC.PART IFINANCIAL INFORMATION**

**Item 1.   *Financial Statements***

**Digital TheaterSystems, Inc.Condensed Consolidated Balance Sheets**
| ** **                                                                                                                                                                                                                                               | ** ** | **As of   December 31,  2003**                                                  | ** ** | **As of  September 30,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                               | ** ** | ** **                                                                                     | ** ** | **(Unaudited)**                          | ** ** |
| ** **                                                                                                                                                                                                                                               | ** ** | **(Amounts in thousands,  except share and per share  amounts)** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                               |       |                                                                                           |       |                                     |       |   |   |   |   |
| Current assets:                                                                                                                                                                                                                                          |       |                                                                                           |       |                                     |       |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                                               |       |                                                                                           | $          | 89,341                                   |       |   |   | $ | 69,558 |   |   |
| Short-term  investments                                                                                                                                                                                                                                  |       |                                                                                           | 10,048     |                                     |       |   | 27,268 |   |   |
| Accounts receivable, net  of allowance for doubtful accounts of $429 and $408 at December 31, 2003  and September 30, 2004, respectively                                                                                                       |       |                                                                                           | 3,962      |                                     |       |   | 5,321 |   |   |
| Inventories                                                                                                                                                                                                                                              |       |                                                                                           | 7,552      |                                     |       |   | 8,275 |   |   |
| Deferred tax assets, net                                                                                                                                                                                                                                 |       |                                                                                           | 6,025      |                                     |       |   | 6,610 |   |   |
| Prepaid expenses and  other                                                                                                                                                                                                                              |       |                                                                                           | 1,846      |                                     |       |   | 2,301 |   |   |
| Income tax receivable                                                                                                                                                                                                                                    |       |                                                                                           | 660        |                                     |       |   | — |   |   |
| Total current assets                                                                                                                                                                                                                                     |       |                                                                                           | 119,434    |                                     |       |   | 119,333 |   |   |
| Long-term  investments                                                                                                                                                                                                                                   |       |                                                                                           | 2,998      |                                     |       |   | 16,649 |   |   |
| Property and equipment,  net                                                                                                                                                                                                                             |       |                                                                                           | 3,092      |                                     |       |   | 3,324 |   |   |
| Intangibles, net                                                                                                                                                                                                                                         |       |                                                                                           | 424        |                                     |       |   | 1,809 |   |   |
| Deferred tax assets                                                                                                                                                                                                                                      |       |                                                                                           | 1,527      |                                     |       |   | 2,969 |   |   |
| Other assets                                                                                                                                                                                                                                             |       |                                                                                           | 20         |                                     |       |   | 441 |   |   |
| Total assets                                                                                                                                                                                                                                             |       |                                                                                           | $          | 127,495                                  |       |   |   | $ | 144,525 |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                           |       |                                                                                           |       |                                     |       |   |   |   |   |
| Current liabilities:                                                                                                                                                                                                                                     |       |                                                                                           |       |                                     |       |   |   |   |   |
| Accounts payable                                                                                                                                                                                                                                         |       |                                                                                           | $          | 2,829                                    |       |   |   | $ | 2,589 |   |   |
| Accrued expenses                                                                                                                                                                                                                                         |       |                                                                                           | 5,795      |                                     |       |   | 7,248 |   |   |
| Income tax payable                                                                                                                                                                                                                                       |       |                                                                                           | —     |                                     |       |   | 975 |   |   |
| Total current  liabilities                                                                                                                                                                                                                               |       |                                                                                           | 8,624      |                                     |       |   | 10,812 |   |   |
| Commitments and contingencies (Note 6)                                                                                                                                                                                                              |       |                                                                                           |       |                                     |       |   |   |   |   |
| Stockholders’ equity:                                                                                                                                                                                                                               |       |                                                                                           |       |                                     |       |   |   |   |   |
| Preferred stock—$0.0001  par value, 5,000,000 shares authorized at December 31, 2003 and  September 30, 2004; no shares outstanding at December 31, 2003 and  September 30, 2004                                                |       |                                                                                           | —     |                                     |       |   | — |   |   |
| Common stock—$0.0001 par  value, 70,000,000 shares authorized at December 31, 2003 and  September 30, 2004; 16,512,885 and 17,015,933 shares issued and  outstanding at December 31, 2003 and September 30, 2004,  respectively |       |                                                                                           | 2          |                                     |       |   | 2 |   |   |
| Additional paid-in  capital                                                                                                                                                                                                                              |       |                                                                                           | 115,512    |                                     |       |   | 120,570 |   |   |
| Retained earnings                                                                                                                                                                                                                                        |       |                                                                                           | 3,357      |                                     |       |   | 13,141 |   |   |
| Total stockholders’  equity                                                                                                                                                                                                                         |       |                                                                                           | 118,871    |                                     |       |   | 133,713 |   |   |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                          |       |                                                                                           | $          | 127,495                                  |       |   |   | $ | 144,525 |   |   |

 

See accompanying notes to condensed consolidated financial statements.

3

----

**Digital TheaterSystems, Inc.Condensed Consolidated Statements of Operations**
| ** **                                                                                                 | ** ** | **For the Three Months  Ended September 30,**                                 | ** **             | **For the Nine Months  Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2003**                                                                                               | ** **             | **2004**                                                              | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                                                                 | ** ** | **(Unaudited) **                                                                                  | ** **             |
| ** **                                                                                                 | ** ** | **(Amounts in thousands, except share and per share amounts)** | ** **             |
| Revenues:                                                                                                  |       |                                                                                                   |                   |                                                                  |       |   |   |   |   |
| Technology and film licensing                                                                              |       | $                                                                                                      | 10,632                 |                                                                  | $          | 13,058 |   | $ | 30,310 |   | $ | 36,275 |   |
| Product sales and other revenues                                                                           |       | 2,702                                                                                                  |                   | 2,894                                                                 |       | 6,481 |   | 8,526 |   |
| Total revenues                                                                                             |       | 13,334                                                                                                 |                   | 15,952                                                                |       | 36,791 |   | 44,801 |   |
| Cost of goods  sold:                                                                                       |       |                                                                                                   |                   |                                                                  |       |   |   |   |   |
| Technology and film licensing                                                                              |       | 1,294                                                                                                  |                   | 1,199                                                                 |       | 3,179 |   | 3,345 |   |
| Product sales and other revenues                                                                           |       | 1,596                                                                                                  |                   | 1,911                                                                 |       | 4,913 |   | 5,578 |   |
| Total cost of goods sold                                                                                   |       | 2,890                                                                                                  |                   | 3,110                                                                 |       | 8,092 |   | 8,923 |   |
| Gross profit                                                                                               |       | 10,444                                                                                                 |                   | 12,842                                                                |       | 28,699 |   | 35,878 |   |
| Operating  expenses:                                                                                       |       |                                                                                                   |                   |                                                                  |       |   |   |   |   |
| Selling, general and administrative                                                                        |       | 5,092                                                                                                  |                   | 6,746                                                                 |       | 14,948 |   | 19,984 |   |
| Research and development                                                                                   |       | 1,304                                                                                                  |                   | 1,501                                                                 |       | 3,648 |   | 4,401 |   |
| Total operating expenses                                                                                   |       | 6,396                                                                                                  |                   | 8,247                                                                 |       | 18,596 |   | 24,385 |   |
| Income from operations                                                                                     |       | 4,048                                                                                                  |                   | 4,595                                                                 |       | 10,103 |   | 11,493 |   |
| Interest income,  net                                                                                      |       | 116                                                                                                    |                   | 373                                                                   |       | 139 |   | 1,122 |   |
| Other income  (expense), net                                                                               |       | (65                                                                                                    | )                      | 31                                                                    |       | (142 | ) | — |   |
| Legal settlement  (Note 10)                                                                           |       | —                                                                                                 |                   | —                                                                |       | — |   | 2,601 |   |
| Income before provision for income taxes                                                                   |       | 4,099                                                                                                  |                   | 4,999                                                                 |       | 10,100 |   | 15,216 |   |
| Provision for  income taxes                                                                                |       | 1,407                                                                                                  |                   | 1,774                                                                 |       | 3,534 |   | 5,432 |   |
| Net income                                                                                                 |       | 2,692                                                                                                  |                   | 3,225                                                                 |       | 6,566 |   | 9,784 |   |
| Accretion and  accrued dividends on preferred stock                                                        |       | (299                                                                                                   | )                      | —                                                                |       | (1,234 | ) | — |   |
| Net income  attributable to common stockholders                                                            |       | $                                                                                                      |  2,393            |                                                                  | $          |  3,225 |   | $ |  5,332 |   | $ |  9,784 |   |
| Net income  attributable to common stockholders per common share:                                          |       |                                                                                                   |                   |                                                                  |       |   |   |   |   |
| Basic                                                                                                      |       | $                                                                                                      |    0.19 |                                                                  | $          |    0.19 |   | $ |    0.74 |   | $ |    0.58 |   |
| Diluted                                                                                                    |       | $                                                                                                      |    0.16 |                                                                  | $          |    0.18 |   | $ |    0.59 |   | $ |    0.54 |   |
| Weighted average shares used to compute net income  attributable to common  stockholders per common share: |       |                                                                                                   |                   |                                                                  |       |   |   |   |   |
| Basic                                                                                                      |       | 12,691,607                                                                                             |                   | 17,005,750                                                            |       | 7,227,480 |   | 16,805,643 |   |
| Diluted                                                                                                    |       | 15,134,737                                                                                             |                   | 18,217,995                                                            |       | 9,058,898 |   | 18,129,068 |   |

 

See accompanying notes to condensed consolidated financial statements.

4

----

**Digital TheaterSystems, Inc.Condensed Consolidated Statements of Cash Flows**
| ** **                                                                                                    | ** ** | **For the Nine Months  Ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                                    | ** ** | **2003**                                                              | ** ** | **2004** | ** ** |
| ** **                                                                                                    | ** ** | **(Unaudited) **                                                 | ** ** |
| ** **                                                                                                    | ** ** | **(Amounts in thousands)**                                  | ** ** |
| Cash flows from  operating activities:                                                                        |       |                                                                  |       |   |   |
| Net income                                                                                                    |       | $                                                                     | 6,566      |   | $ | 9,784 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities:                            |       |                                                                  |       |   |   |
| Depreciation and amortization                                                                                 |       | 685                                                                   |       | 919 |   |
| Stock-based compensation charges                                                                              |       | 497                                                                   |       | 267 |   |
| Allowance for doubtful accounts                                                                               |       | 109                                                                   |       | 45 |   |
| Loss on disposal of property and equipment                                                                    |       | 82                                                                    |       | — |   |
| Deferred income taxes                                                                                         |       | (305                                                                  | )          | (2,025 | ) |
| Tax benefit from employee stock plans                                                                         |       | —                                                                |       | 3,878 |   |
| Changes in  operating assets and liabilities:                                                                 |       |                                                                  |       |   |   |
| Accounts receivable                                                                                           |       | 1,372                                                                 |       | (1,389 | ) |
| Inventories                                                                                                   |       | (1,657                                                                | )          | (723 | ) |
| Prepaid expenses and other assets                                                                             |       | (1,155                                                                | )          | (884 | ) |
| Accounts payable and accrued expenses                                                                         |       | 1,411                                                                 |       | 1,146 |   |
| Income taxes                                                                                                  |       | (601                                                                  | )          | 1,634 |   |
| Net cash provided by operating activities                                                                     |       | 7,004                                                                 |       | 12,652 |   |
| Cash flows from  investing activities:                                                                        |       |                                                                  |       |   |   |
| Purchase of investments                                                                                       |       | (1,897                                                                | )          | (30,871 | ) |
| Purchase of property and equipment                                                                            |       | (495                                                                  | )          | (1,036 | ) |
| Acquisitions, net of cash acquired                                                                            |       | —                                                                |       | (1,384 | ) |
| Payment for patents and trademarks in process                                                                 |       | (70                                                                   | )          | (57 | ) |
| Net cash used in investing activities                                                                         |       | (2,462                                                                | )          | (33,348 | ) |
| Cash flows from  financing activities:                                                                        |       |                                                                  |       |   |   |
| Payment of dividends to preferred stockholders                                                                |       | (6,758                                                                | )          | — |   |
| Redemption of preferred stock                                                                                 |       | (15,778                                                               | )          | — |   |
| Proceeds from the sale of common stock in connection  with the initial public offering, net of offering costs |       | 63,029                                                                |       | — |   |
| Follow-on public offering costs                                                                               |       | —                                                                |       | (30 | ) |
| Proceeds from the issuance of common stock upon  exercise of employee stock options                           |       | 9                                                                     |       | 470 |   |
| Proceeds from the issuance of common stock upon  exercise of warrants                                         |       | 4                                                                     |       | — |   |
| Proceeds from the issuance of common stock under  employee stock purchase plan                           |       | —                                                                |       | 473 |   |
| Net cash provided by (used in) financing activities                                                           |       | 40,506                                                                |       | 913 |   |
| Net increase (decrease) in cash and cash equivalents                                                          |       | 45,048                                                                |       | (19,783 | ) |
| Cash and cash  equivalents, beginning of period                                                               |       | 1,907                                                                 |       | 89,341 |   |
| Cash and cash  equivalents, end of period                                                                     |       | $                                                                     | 46,955     |   | $ | 69,558 |   |

 

See accompanying notes to condensed consolidated financial statements.

5

----

**DIGITAL THEATERSYSTEMS, INC.NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS(Amounts in thousands, except share and per share data)**

**Note 1—Basis of Presentation**

The accompanying unaudited condensed consolidatedfinancial statements of Digital Theater Systems, Inc. (the “Company”) havebeen prepared in accordance with accounting principles generally accepted inthe United States of America and with the instructions to Form 10-Q and Article 10of Regulation S-X. Accordingly, they do not include all of the informationand footnotes required by accounting principles generally accepted in theUnited States of America for complete financial statements. In the opinion ofmanagement, the unaudited condensed consolidated financial statements reflectall adjustments considered necessary for a fair presentation, consisting onlyof normal and recurring adjustments. All significant intercompany transactionshave been eliminated in consolidation. Operating results for the three and ninemonths ended September 30, 2004 are not necessarily indicative of theresults that may be expected for the fiscal year ending December 31, 2004.For further information, refer to the consolidated financial statements andfootnotes thereto for the year ended December 31, 2003 filed on Form 10-Kfiled on March 30, 2004.

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities, anddisclosures of contingent assets and liabilities at the date of the financialstatements, and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

**Note 2—Recent Accounting Pronouncements**

In November 2003, theEITF reached a consensus on Issue No. 03-10, “Application ofEITF 02-16 by Resellers to Sales Incentives Offered to Consumers byManufacturers.” EITF No. 03-10 addresses the accounting for manufacturer salesincentives offered directly to consumers, including manufacturer coupons. EITF No. 03-10is effective for the first interim period beginning after November 25,2003. Adoption of the provisions of EITF No. 03-10 did not have a materialimpact on the Company’s financial position, results of operations, or cashflows for the nine months ended September 30, 2004.

**Note 3—Certain Balance Sheet Items**

Inventoriesconsist of the following:
| ** **        | ** ** | **As of  December 31,  2003** | ** ** | **As of  September 30,  2004** | ** ** |
|-------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|
| ** **        | ** ** | ** **                              | ** ** | **(Unaudited)**                          | ** ** |
| Raw materials     |       |                                    | $          | 1,370                                    |       |   |   | $ | 1,647 |   |   |
| Work in process   |       |                                    | 8          |                                     |       |   | 8 |   |   |
| Finished goods    |       |                                    | 6,174      |                                     |       |   | 6,620 |   |   |
| Total inventories |       |                                    | $          | 7,552                                    |       |   |   | $ | 8,275 |   |   |

 

6

----

Propertyand equipment consist of the following:
| ** **                      | ** ** | **As of  December 31,  2003** | ** ** | **As of  September 30,  2004** | ** ** |
|---------------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|
| ** **                      | ** ** | ** **                              | ** ** | **(Unaudited)**                          | ** ** |
| Machinery and  equipment        |       |                                    | $          | 2,511                                    |       |   |   | $ | 2,932 |   |   |
| Office furniture  and fixtures  |       |                                    | 1,963      |                                     |       |   | 2,487 |   |   |
| Leasehold  improvements         |       |                                    | 2,599      |                                     |       |   | 2,711 |   |   |
|                            |       |                                    | 7,073      |                                     |       |   | 8,130 |   |   |
| Less: Accumulated  depreciation |       |                                    | (3,981     | )                                        |       |   | (4,806 | ) |   |
| Property and  equipment, net    |       |                                    | $          | 3,092                                    |       |   |   | $ | 3,324 |   |   |

 

Intangibles,net consist of the following:
| ** **                                        | ** ** | **As of   December 31,  2003** | ** ** | **As of   September 30,  2004** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                        | ** ** | ** **                                    | ** ** | **(Unaudited)**                                | ** ** |
| Acquired  technology                              |       |                                          | $          | —                                         |       |   |   | $ | 1,427 |   |   |
| Patents and  trademarks                           |       |                                          | 909        |                                           |       |   | 982 |   |   |
|                                              |       |                                          | 909        |                                           |       |   | 2,409 |   |   |
| Less:                                             |       |                                          |       |                                           |       |   |   |   |   |
| Accumulated  amortization, acquired technology    |       |                                          | —     |                                           |       |   | 45 |   |   |
| Accumulated  amortization, patents and trademarks |       |                                          | 485        |                                           |       |   | 555 |   |   |
| Intangibles, net                                  |       |                                          | $          | 424                                            |       |   |   | $ | 1,809 |   |   |

 

During the third quarter of 2004, the Companycompleted an acquisition (Note 11) for net cash consideration of approximately$1.4 million, of which approximately $1.4 million was allocated to acquiredtechnology with an estimated useful life of eight years. Aggregate amortizationexpense for acquired technology totaled $45 for the three and nine months endedmonths ended September 30, 2004.

As of September 30,2004, expected future amortization of acquired technology is as follows:
| **Fiscal year:**          | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------|------------|------------|------------|
| 2004 (remaining  three months) |       | $          | 45         |       |
| 2005                           |       | 178        |       |
| 2006                           |       | 178        |       |
| 2007                           |       | 178        |       |
| 2008                           |       | 178        |       |
| Thereafter                     |       | 625        |       |
|                           |       | $          | 1,382      |       |

 

**Note 4—Bank Line of Credit**

The Company replaced its prior working capital creditfacility with a new $10,000 facility that matures on June 30, 2005. Thebank agreement provides for working capital financing and is unsecured. Thebank agreement requires the Company to comply with certain covenants includinga tangible effective net worth of $60,000, increasing by 50% of net income onan annual basis. The covenants also require the Company to keep $2,000 in cashor securities at the bank.

At  September 30, 2004, there were nobalances outstanding under this agreement and there was $10,000 of availableborrowings under this credit facility. Future borrowings will bear interestbased on either of the two options the Company selects at the time of advances1) a rate equal to 2% above the 

7

----

Bank’sLIBOR, or 2) a rate equal to the Base Rate as quoted from the bank lessone-half percent. A commitment fee of $10 was paid for this line of credit.

**Note 5—IncomeTaxes**

For the three and ninemonths ended September 30, 2004, the Company recorded an income taxprovision of $1,774 and $5,432, respectively on pre-tax income of $4,999 and$15,216, respectively. This resulted in an annualized effective tax rate of36%. For the three months and nine months ended September 30, 2003, theCompany recorded an income tax provision of $1,407 and $3,534, respectively onpre-tax income of $4,099 and $10,100, respectively. This resulted in anannualized effective tax rate of 35%. These rates differed from the statutoryrates primarily due to state income taxes offset by benefits associated withthe foreign rate differentials and research and development credits.

**Note 6—Commitments and Contingencies**

**Indemnities,Commitments and Guarantees**

In the normal course of business, the Company makescertain indemnities, commitments and guarantees under which the Company may berequired to make payments in relation to certain transactions. Theseindemnities, commitments and guarantees include, among others, intellectualproperty indemnities to customers in connection with the sale of products andlicensing of technology, indemnities for liabilities associated with theinfringement of other parties’ technology based upon the Company’s products andtechnology, guarantees of timely performance of the Company’s obligations, andindemnities to the Company’ directors and officers to the maximum extentpermitted by law. The duration of these indemnities, commitments and guaranteesvaries, and in certain cases, is indefinite. The majority of these indemnities,commitments and guarantees do not provide for any limitation of the maximumpotential future payments that the Company could be obligated to make. TheCompany has not recorded a liability for these indemnities, commitments orguarantees in the accompanying balance sheets, as future payment is notprobable.

In August 2004, theInternal Revenue Service (“IRS”) initiated a regular examination of the Company’stax return for the year 2002. As of September 30, 2004, the IRS had notissued any proposed adjustments to the amounts reflected by the Company onthese returns. However, the calculation of the Company’s tax liabilitiesinvolves dealing with uncertainties in the application of complex taxregulations. If the IRS audit results in assessment of additional taxes due,there exists the possibility of a material adverse impact on the results inoperations of the period in which the matter is ultimately resolved  oran unfavorable outcome becomes probable and reasonably estimable.

**Note 7—Stock-Based Compensation**

The Company accounts for its employee stock option andstock purchase plans in accordance with the provisions of Accounting PrincipalsBoard (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”and the related FASB Interpretation No. 44, “Accounting for CertainTransactions Involving Stock Compensation.” Accordingly, compensation expenserelated to employee stock options is recorded if, on the date of the grant, thefair value of the underlying stock exceeds the exercise price.

8

----

Todate, options have been granted at exercise prices that equal or exceed themarket value of the underlying common stock on the grant date. The followingtable illustrates the effect on net income attributable to common stockholdersand net income per common share if the Company had applied the fair valuerecognition provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation,” to stock-based employee compensation.
| ** **                                                                                                          | ** ** | **For the Three  Months Ended  September 30,** | ** ** | **For the Nine  Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                                                          | ** ** | **2003**                                                           | ** ** | **2004**                                                          | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                                                                          | ** ** | **(Unaudited)**                                                    | ** ** |
| Net income attributable  to common stockholders:                                                                    |       |                                                               |       |                                                              |       |   |   |   |   |
| As reported                                                                                                         |       | $                                                                  | 2,393      |                                                              | $          | 3,225 |   | $ | 5,332 |   | $ | 9,784 |   |
| Additional stock-based compensation expense  determined under the fair value method, net of tax                     |       | (264                                                               | )          | 117                                                               |       | (350 | ) | (1,054 | ) |
| Pro forma                                                                                                           |       | $                                                                  | 2,129      |                                                              | $          | 3,342 |   | $ | 4,982 |   | $ | 8,730 |   |
| Net income  attributable to common stockholders per common share-basic:                                             |       |                                                               |       |                                                              |       |   |   |   |   |
| As reported                                                                                                         |       | $                                                                  | 0.19       |                                                              | $          | 0.19 |   | $ | 0.74 |   | $ | 0.58 |   |
| Per share effect of additional stock-based  compensation expense determined under the fair value method, net of tax |       | (0.02                                                              | )          | 0.01                                                              |       | (0.05 | ) | (0.06 | ) |
| Pro forma                                                                                                           |       | $                                                                  | 0.17       |                                                              | $          | 0.20 |   | $ | 0.69 |   | $ | 0.52 |   |
| Net income  attributable to common stockholders per common share-diluted:                                           |       |                                                               |       |                                                              |       |   |   |   |   |
| As reported                                                                                                         |       | $                                                                  | 0.16       |                                                              | $          | 0.18 |   | $ | 0.59 |   | $ | 0.54 |   |
| Per share effect of additional stock-based  compensation expense determined under the fair value method, net of tax |       | (0.02                                                              | )          | 0.01                                                              |       | (0.04 | ) | (0.06 | ) |
| Pro forma                                                                                                           |       | $                                                                  | 0.14       |                                                              | $          | 0.19 |   | $ | 0.55 |   | $ | 0.48 |   |

 

The Company accounts for stock, stock options andwarrants issued to non-employees in accordance with the provisions of SFAS No. 123and EITF Issue No. 96-18 “Accounting for Equity Instruments That AreIssued to Other Than Employees for Acquiring, or in Conjunction with Selling,Goods and Services.” Under SFAS No. 123 and EITF Issue No. 96-18,stock option awards issued to non-employees are accounted for at fair valueusing the Black-Scholes pricing model. Management believes that the fairvalue of the stock options is more reliably measured than the fair value of theservices received. The fair value of each non-employee equity award isremeasured each period until a commitment date is reached, which is generallythe vesting date. For non-employee equity awards, deferred stock-basedcompensation is not reflected in stockholders’ deficit until a commitment dateis reached. For the three months ended September 30, 2003 and 2004, theCompany recorded stock-based compensation expense of $72 and $49,respectively, related to non-employee equity awards. For the nine months ended September 30,2003 and 2004, the Company recorded stock-based compensation expense of$497 and $267 respectively, related to non-employee equity awards.

9

----

**Note 8—Operating Segment and GeographicInformation**

The Company operates its business in two reportablesegments: the Theatrical business segment and the Consumer business segment.The Theatrical business segment provides digital playback systems and cinemaprocessor equipment to movie theaters, and provides film licensing services tofilm production and distribution companies. The Company’s Consumer businesssegment licenses audio technology, trademarks and know-how to consumerelectronics, personal computer, broadcast and professional audio companies, andsells multi-channel audio content and products to consumers.

The Company does not have separately identifiablecapital expenditures or long-lived assets related to these two businesssegments.

TheCompany’s reportable segments and geographical information for the three andnine months ended September 30, 2003 and 2004 are as follows:
| ** **           | ** ** | **Revenues**                                                           | ** ** |
|----------------------|------------|------------------------------------------------------------------------|------------|
| ** **           | ** ** | **For the Three Months  Ended September 30,** | ** ** | **For the Nine Months  Ended September 30,** | ** ** |
| ** **           | ** ** | **2003**                                                               | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **           | ** ** | **(Unaudited)**                                                        | ** ** |
| Theatrical  business |       | $                                                                      | 4,079      |   | $ | 5,135 |   | $ | 11,489 |   | $ | 14,438 |   |
| Consumer business    |       | 9,255                                                                  |       | 10,817 |   | 25,302 |   | 30,363 |   |
| Total revenues       |       | $                                                                      | 13,334     |   | $ | 15,952 |   | $ | 36,791 |   | $ | 44,801 |   |

 
| ** **           | ** ** | **Gross Profit**                                                  | ** ** |
|----------------------|------------|------------------------------------------------------------------------|------------|
| ** **           | ** ** | **For the Three Months  Ended September 30,** | ** ** | **For the Nine Months  Ended September 30,** | ** ** |
| ** **           | ** ** | **2003**                                                               | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **           | ** ** | **(Unaudited)**                                                        | ** ** |
| Theatrical  business |       | $                                                                      | 1,796      |   | $ | 2,443 |   | $ | 5,063 |   | $ | 6,755 |   |
| Consumer business    |       | 8,648                                                                  |       | 10,399 |   | 23,636 |   | 29,123 |   |
| Total gross profit   |       | $                                                                      | 10,444     |   | $ | 12,842 |   | $ | 28,699 |   | $ | 35,878 |   |

 
| ** **                   | ** ** | **Income (Loss) From Operations**                       | ** ** |
|------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                   | ** ** | **For the Three Months  Ended September 30,** | ** ** | **For the Nine Months  Ended September 30,** | ** ** |
| ** **                   | ** ** | **    2003    **               | ** ** | **    2004    ** | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                   | ** ** | **(Unaudited)**                                                        | ** ** |
| Theatrical  business         |       | $                                                                      | (740       | ) | $ | (898 | ) | $ | (2,766 | ) | $ | (3,704 | ) |
| Consumer business            |       | 4,788                                                                  |       | 5,493 |   | 12,869 |   | 15,197 |   |
| Total income from operations |       | $                                                                      | 4,048      |   | $ | 4,595 |   | $ | 10,103 |   | $ | 11,493 |   |

 
| ** **     | ** ** | **Revenues by Geographic Region**                       | ** ** |
|----------------|------------|------------------------------------------------------------------------|------------|
| ** **     | ** ** | **For the Three Months  Ended September 30,** | ** ** | **For the Nine Months  Ended September 30,** | ** ** |
| ** **     | ** ** | **2003**                                                               | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **     | ** ** | **(Unaudited)**                                                        | ** ** |
| United States  |       | $                                                                      | 2,443      |   | $ | 5,045 |   | $ | 8,587 |   | $ | 13,635 |   |
| International  |       | 10,891                                                                 |       | 10,907 |   | 28,204 |   | 31,166 |   |
| Total revenues |       | $                                                                      | 13,334     |   | $ | 15,952 |   | $ | 36,791 |   | $ | 44,801 |   |

 

10

----

Thefollowing table sets forth, for the periods indicated, long-lived assets by geographicarea in which the Company holds assets at December 31, 2003 and September 30,2004:
| ** **               | ** ** | **Long-Lived Assets**                    | ** ** |
|--------------------------|------------|-----------------------------------------------|------------|
| ** **               | ** ** | **As of   December 31,  2003** | ** ** | **As of   September 30,  2004** | ** ** |
| ** **               | ** ** | ** **                                    | ** ** | **(Unaudited)** | ** ** |
| United States            |       |                                          | $          | 3,150 |   |   |   | $ | 3,160 |   |   |
| International            |       |                                          | 366        |   |   |   | 1,973 |   |   |
| Total long-lived  assets |       |                                          | $          | 3,516 |   |   |   | $ | 5,133 |   |   |

 

**Note 9—Net Income Attributable to CommonStockholders Per Common Share**

Thefollowing table sets forth the computation of basic and diluted net incomeattributable to common stockholders per common share:
| ** **                                                                | ** ** | **For the Three Months  Ended September 30,** | ** ** | **For the Nine Months  Ended September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                | ** ** | **2003**                                                               | ** ** | **2004**                                                              | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                                | ** ** | **(Unaudited)**                                                        | ** ** |
| Basic net income  attributable to common stockholders per common share:   |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Numerator:                                                                |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Net income                                                                |       | $                                                                      | 2,692      |                                                                  | $          | 3,225 |   | $ | 6,566 |   | $ | 9,784 |   |
| Preferred stock dividends accrued                                         |       | (61                                                                    | )          | —                                                                |       | (844 | ) | — |   |
| Accretion on preferred stock                                              |       | (238                                                                   | )          | —                                                                |       | (390 | ) | — |   |
| Net income attributable to common stockholders                            |       | $                                                                      | 2,393      |                                                                  | $          | 3,225 |   | $ | 5,332 |   | $ | 9,784 |   |
| Denominator:                                                              |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Weighted average common shares outstanding                                |       | 12,691,607                                                             |       | 17,005,750                                                            |       | 7,227,480 |   | 16,805,643 |   |
| Basic net income attributable to common stockholders  per common share    |       | $                                                                      | 0.19       |                                                                  | $          | 0.19 |   | $ | 0.74 |   | $ | 0.58 |   |
| Diluted net income  attributable to common stockholders per common share: |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Numerator:                                                                |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Net income                                                                |       | $                                                                      | 2,692      |                                                                  | $          | 3,225 |   | $ | 6,566 |   | $ | 9,784 |   |
| Preferred stock dividends accrued                                         |       | (61                                                                    | )          | —                                                                |       | (844 | ) | — |   |
| Accretion on preferred stock                                              |       | (238                                                                   | )          | —                                                                |       | (390 | ) | — |   |
| Net income attributable to common stockholders                            |       | $                                                                      | 2,393      |                                                                  | $          | 3,225 |   | $ | 5,332 |   | $ | 9,784 |   |
| Denominator:                                                              |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Weighted average shares outstanding                                       |       | 12,691,607                                                             |       | 17,005,750                                                            |       | 7,227,480 |   | 16,805,643 |   |
| Effect of  dilutive securities:                                           |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Common stock options                                                      |       | 1,792,576                                                              |       | 994,463                                                               |       | 1,682,055 |   | 1,034,550 |   |
| Common stock warrants                                                     |       | 650,554                                                                |       | 217,782                                                               |       | 149,363 |   | 288,875 |   |
| Diluted shares outstanding                                                |       | 15,134,737                                                             |       | 18,217,995                                                            |       | 9,058,898 |   | 18,129,068 |   |
| Diluted net income  attributable to common stockholders per common share  |       | $                                                                      | 0.16       |                                                                  | $          | 0.18 |   | $ | 0.59 |   | $ | 0.54 |   |

 

11

----

**Note 10—Legal Settlement**

In May 2004, theCompany reached a settlement with Mintek Digital, Inc. (“Mintek”) for$3,500 for Trademark Infringement, False Designation of Origin, TrademarkDilution, and Unfair Competition relating to Mintek’s distribution of DVDplayers bearing the Company’s registered trademarks without obtaining a licensefrom the Company. The Company recognized $899 in revenue under the settlementfor royalties due on units that could be identified as using the Company’strademark and accounted for the excess $2,601 portion of the settlement asother income. Selling, general and administrative expenses for the nine monthsended September 30, 2004 included approximately $300 in legal fees relatedto the Mintek case. Legal fees related to Mintek were approximately $200 for2003.

**Note 11—Acquisition**

In July 2004, the Company completed theacquisition of QDesign Corporation for $1,500 in cash. Under the terms of theacquisition, the Company has also contingently agreed to pay an additionalamount up to a maximum of $450 in cash. The contingent payment will beaccounted for as compensation expenseratably over the three-year period ending July 2007, and will be paid outif certain criteria are met.

Thepreliminary allocation of the purchase price to the assets acquired andliabilities assumed based on the estimated fair values was as follows:
| Cash acquired           |   | $     | 117    |   |
|-------------------------|--------|-------|--------|--------|
| Property and  equipment |   | 15    |   |
| Acquired  technology    |   | 1,426 |   |
| Other assets            |   | 8     |   |
| Total assets acquired   |   | 1,566 |   |
| Liabilities  assumed    |   | 66    |   |
| Total                   |   | $     | 1,500  |   |

 

Amortizable intangible assets consist of acquiredtechnology with a useful life of eight years.

The results of operations of this acquisition havebeen included in the Company’s condensed consolidated statements of operationssince the completion of the acquisition in July 2004. Results ofoperations for the acquisition for periods prior to the acquisition were notmaterial to the Company and, accordingly, pro forma results of operations havenot been presented.

12

----

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

**Forward-Looking Statements May ProveInaccurate**

This report and the documents incorporated herein byreference contain forward-looking statements based on our currentexpectations, estimates and projections about our industry, beliefs, andcertain assumptions made by us. Words such as “believes,” “anticipates,” “estimates,”“expects,” “projections,” “may,” “potential,” “plan,” “continue” and words ofsimilar import, constitute “forward-looking statements.” The forward-lookingstatements contained in this report involve known and unknown risks,uncertainties and other factors that may cause our actual results to bematerially different from those expressed or implied by these statements. Thesefactors include those listed under the “Risk Factors” section contained belowand in our Form 10-K filed on March 30, 2004 with theSecurities and Exchange Commission, or SEC, and the other documents we filewith the SEC, including our most recent reports on Form 8-K and Form 10-Q.We cannot guarantee future results, levels of activity, performance orachievements. We do not undertake any obligation to revise these forward-lookingstatements to reflect future events or circumstances.

You should read thefollowing discussion of our financial condition and results of operations inconjunction with the Form 10-K filed on March 30, 2004.

**Overview**

We are a leading provider of entertainment technology,historically focused on high-quality digital multi-channel audiotechnology, products, and services for entertainment markets worldwide. Multi-channelaudio, commonly referred to as surround sound, provides more than two-channelsof audio, allowing the listener to simultaneously hear discrete sounds frommultiple speakers. Our DTS digital multi-channel audio technologydelivers compelling surround sound for the motion picture and consumerelectronics markets.

We manage our business through two reportablesegments—our theatrical business and our consumer business. Historically, wehave derived a majority of our revenues from the theatrical business. Beginningin 2001, however, we have derived a majority of our revenues from our consumerbusiness.

In our consumer business, we derive revenues fromlicensing our audio technology, trademarks, and know-how under agreements withsubstantially all of the major consumer audio electronics manufacturers. Ourbusiness model provides for these manufacturers to pay us a per-unit amount forDTS-enabled products that they manufacture. We also derive revenues fromlicensing our technology to consumer semiconductor manufacturers. Through ourDTS Entertainment label, we derive revenues from the sale of music titles inour digital multi-channel format.

In our theatrical business, we derive revenues fromsales of our playback equipment and cinema processors to movie theaters andspecial venues. In addition, we sell encoding and duplication services to filmproducers and distributors for the creation of digital multi-channelmotion picture soundtracks. We also derive revenues from the sale of systemsand encoding services for pre-show advertising, alternative content,subtitling, captioning, and descriptive narration.

We present revenues in our consolidated financialstatements and in this “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” as derived from (1) technology andfilm licensing and (2) product sales and other revenues. Our technologyand film licensing revenues are derived from each of our consumer andtheatrical business segments. Revenues from technology licensing in connectionwith our consumer business segment include revenues derived from licensing ouraudio technology, trademarks, and know-how to consumer electronics, personalcomputer, video game and console, digital satellite and cable broadcast, andprofessional audio companies as well as to semiconductor manufacturers.Revenues from technology and film licensing in connection with our theatricalbusiness 

13

----

segment include revenuesderived from film licensing and services that we provide to film studios forthe production of soundtracks in our digital multi-channel format. Ourproduct sales and other revenues also are derived from each of our consumer andtheatrical business segments. Revenues from product sales and other revenues inconnection with our consumer business segment include revenues derived fromsales of music titles that we produce in our digital multi-channel formatand sales of our professional audio products and services. Revenues fromproduct sales and other revenues in connection with our theatrical businesssegment include revenues derived from sales of our digital playback systems,cinema processor equipment, and systems for subtitling, captioning, anddescriptive narration to movie theaters and special venues.

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 to us the amount of royalties owed under licenseagreements with us. As a result of these activities, from time to time, werecognize royalty revenues that relate to consumer electronics manufacturingactivities from prior periods. These royalty recoveries may cause revenues tobe higher than expected during a particular reporting period and may not occurin subsequent periods. We cannot predict the amount or timing of such revenues.

Our cost of goods sold consists primarily of amountspaid for products and materials, salaries and related benefits for productionpersonnel, depreciation of production equipment, and payments to third partiesfor licensing technology and copyrighted material.

Our selling, general, and administrative expensesconsist primarily of salaries, commissions, and related benefits for personnelengaged in sales, corporate administration, finance, human resources, informationsystems, legal, and operations, and costs associated with promotional and otherselling activities. Selling, general, and administrative expenses also includeprofessional fees, facility-related expenses, and other general corporateexpenses.

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.

In our consumer business, we have a licensing teamthat markets our technology directly to large consumer electronics productsmanufacturers and semiconductor manufacturers. This team includes employeeslocated in the United States, China, England, Japan, and Northern Ireland. Wesell music content released under our DTS Entertainment label throughdistributors. In the United States and Canada, Navarre Corporation is ourexclusive distributor of DTS Entertainment label products to major nationalretail accounts and in Europe, Cadiz Music Limited is our exclusive distributorof DTS Entertainment label products. We also employ consultants to coordinatesales to independent retailers. We are in the process of establishingdistribution channels in other international territories. We expect thatdistribution in Asia will be handled through established distributors locatedin Asia. We also sell this music directly to consumers through an online storeand other web-based retailers. We intend to expand the number of retail outletsthat carry our products and broaden our distribution network worldwide.

In our theatrical business, our post-productiondepartment, senior management, and liaison offices market our products andservices directly to individual film producers and distributors worldwide. Wesell our digital multi-channel playback systems to movie theaters througha direct sales force and a network of independent dealers. To date, most of oursales and marketing efforts have been focused in the United States andCanada, Western Europe, and in targeted markets in Asia and Latin America.

We have also begun tofocus our efforts on pursuing theater companies that have a large concentrationof movie theaters in selected foreign countries such as India, China, and inEastern Europe.

14

----

**Critical Accounting Policies and Estimates**

Management’s Discussion and Analysis of FinancialCondition and Results of Operations is based upon our consolidated financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States. The preparation of our financialstatements requires us to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues, and expenses, and related disclosureof contingent assets and liabilities. On an on-going basis, estimates areevaluated, including those related to revenue recognition, allowance fordoubtful accounts, inventories, deferred taxes, impairment of long-lived assets,product warranty, stock-based compensation, contingencies and litigationand income taxes. These estimates are based on historical experience and onvarious other assumptions that we believe to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. Actual results may differ from these estimates. The onlysignificant addition to our critical accounting policies and estimates from theinformation provided in our Form 10-K filed on March 30, 2004is the critical accounting policy of income taxes listed below.

*IncomeTaxes.**  *Wemust make certain estimates and judgments in determining income tax expense forfinancial statement purposes. These estimates and judgments occur in thecalculation of certain tax assets and liabilities, which arise from differencesin the timing of recognition of revenue and expense for tax and financialstatement purposes.

We must assess the likelihood that we will be able torecover our deferred tax assets. If recovery is not likely, we must increaseour provision for taxes by recording a valuation allowance against the deferredtax assets that we estimate will not ultimately be recoverable. As of September 30,2004, we believed that all of the deferred tax assets recorded on our balancesheet would ultimately be recovered. However, should there be a change in ourability to recover our deferred tax assets, our tax provision would increase inthe period in which we determine that the recovery is not probable.

In addition, thecalculation of our tax liabilities involves dealing with uncertainties in theapplication of complex tax regulations. We recognize liabilities foranticipated tax audit issues in the U.S. and other tax jurisdictions based onour estimate of whether, and the extent to which, additional taxes will be due.If we ultimately determine that payment of these amounts is unnecessary, wereverse the liability and recognize a tax benefit during the period in which wedetermine that the liability is no longer necessary. We record an additionalcharge in our provision for taxes in the period in which we determine that therecorded tax liability is less than we expect the ultimate assessment to be. See  “Note 6: Contingencies” in the Notes toConsolidated Condensed Financial Statements.

**Results of Operations**

***Revenues***

Total revenues for the three months ended September 30,2004 increased 20% to $16.0 million from $13.3 million for the three monthsended September 30, 2003. The increase in revenues in 2004 resulted from a23% increase in technology and film licensing revenues to $13.1 millionfor the three months ended September 30, 2004 from $10.6 million forthe three months ended September 30, 2003 and a 7% increase in our productsales and other revenues to $2.9 million for the three months ended September 30,2004 from $2.7 million for the three months ended September 30, 2003.The increase in revenues from technology and film licensing was primarilyattributable to continued growth in consumer electronics licensing, driven byan increase in the number of DVD-based home entertainment systems thatincorporate DTS technology, such as audio/video receivers, DVD players, andhome-theater-in-a-box systems, and by revenues recognized as a result ofintellectual property compliance and enforcement activities. In addition, ourfilm licensing revenues increased significantly due to revenues generated fromincreases in the number of U.S. films released, foreign language dubbedversions of major U.S. films, and 

15

----

foreign original-versionfilms released with a DTS soundtrack. Theatrical product sales for the threemonths ended September 30, 2004 increased 20% relative to the prior year’s third quarter, which waspartially offset by a decrease in disc sales by our DTS Entertainment label dueto slower than expected growth in the overall market for DVD-Audio andmulti-channel music.

Revenues from our consumer business totaled$10.8 million for the three months ended September 30, 2004, anincrease of 17% from $9.3 million in the third quarter of the prior year.The increase in revenues was driven by the growth in consumer electronicstechnology licensing as mentioned above. Theatrical revenues were$5.1 million for the three months ended September 30, 2004, up 26%from the same period last year due primarily to growth in the sales of our theatrical audio products andfilm licensing mentioned above.

Total revenues for the nine months ended September 30,2004 increased 22% to $44.8 million from $36.8 million for the ninemonths ended September 30, 2003. The increase in revenues in 2004 resultedfrom a 20% increase in technology and film licensing revenues to$36.3 million for the nine months ended September 30, 2004 from$30.3 million for the nine months ended September 30, 2003 and a 32%increase in our product sales and other revenues to $8.5 million for thenine months ended September 30, 2004 from $6.5 million for the ninemonths ended September 30, 2003. The increase in revenues from technologyand film licensing was primarily attributable to continued growth in consumerelectronics licensing, driven by an increase in the number of DVD-based homeentertainment systems that incorporate DTS technology, such as audio/videoreceivers, DVD players, and home-theater-in-a-box systems, and by revenuesrecognized as a result of intellectual property compliance and enforcementactivities. In addition, our film licensing revenues increased moderately dueto the reasons mentioned above. Shipments of our theatrical playback equipment,aided by the continuing recovery of the North American film exhibitionindustry, contributed to the increase in revenues from product sales.

Revenues from our consumerbusiness totaled $30.4 million for the nine months ended September 30,2004, an increase of 20% from $25.3 million for the nine months ended September 30,2003. The increase in revenues was driven by the growth in consumer electronicstechnology licensing as mentioned above. Theatrical revenues were$14.4 million for the nine months ended September 30, 2004, up 26%from the same period last year due primarily to growth in the sales of our theatrical audio products,driven by the continuing recovery of the North American film exhibitionindustry, as mentioned above.

***Gross Profit***

Consolidated gross profit improved to 81% of revenuesfor the three months ended September 30, 2004, from 78% for the threemonths ended September 30, 2003. The increase is due to an increase ingross profit on technology and filmlicensing.

Gross profit associated with technology and filmlicensing revenues improved to 91% from 88% of related revenues for the threemonths ended September 30, 2004 and 2003, respectively. Gross profitassociated with product sales and other revenues decreased to 34% of relatedrevenues for the three months ended September 30, 2004 from 41% in theprior year period due primarily to the mix of lower margin versus higher marginproducts sold during the quarter. In general, cinema processor products such asthe DTS-6AD carry a lower margin than our audio playback systems, andsales of the DTS-6AD were relatively strong during the third quarter of2004.

Gross profit for our consumer business improved to 96%of related revenues for the three months ended September 30, 2004, from93% in the prior year period. The increase is due to a favorable mix of ourhigher margin technology and film licensing revenues as compared to productsales in our consumer business. Theatrical business gross profit increased to48% of related revenues for the quarter ended September 30, 2004 from 44%in the prior year period due to an increase in higher margin film licensingrelative to hardware product sales.

16

----

For the nine months ended September 30,2004, consolidated gross profit improved to 80% of revenues, compared to 78%for the same period in 2003. Changes in the mix between higher margintechnology and film licensing and lower margin product sales and other revenuesresulted in the improved gross margin.

***Selling, General and Administrative***

Selling, general and administrative expenses increased32% to $6.7 million for the three months ended September 30, 2004,compared to $5.1 million in the prior year period. The increase isprimarily due to increases in professional services of $776,000 which includesincreases in costs associated with our increased intellectual propertycompliance and enforcement activities, Sarbanes-Oxley related costs andother additional costs associated with operating as a public company. Alsocontributing to the increase is salaries and related costs of $299,000 as weincreased headcount to support our growth. The quarter to quarter increase alsoincludes increases in advertising and promotion costs related to new productintroductions and insurance costs. Salaries and related costs include stock-basedcompensation.

Selling, general and administrative expenses increased34% to $20.0 million for the nine months ended September 30, 2004,compared to $14.9 million in the prior year period. The increase isprimarily due to increases in professional services of $2.0 million, whichincludes costs associated with our increased intellectual property complianceand enforcement activities, Sarbanes-Oxley related costs and other costsassociated with operating as a public company.  Also contributing to the increase is salariesand related costs of $1.7 million as we increased headcount to support ourgrowth. The increase also includes increases in advertising and promotion costsrelated to new product introductions, and insurance costs. Salaries and relatedcosts include stock-based compensation, which decreased to $267,000 forthe nine months ended September 30, 2004 from $497,000 in the prior yearperiod. Stock-based compensation for the priorperiod primarily consists of a charge of $345,000 related to the issuance of awarrant. Included in professional services for the nine months ended September 30,2004 is approximately $300,000 in legal costs related to our settlement with Mintek that was reached in May 2004.

Costs of compliance withthe Sarbanes-Oxley Act, particularly Section 404 of that Act, areanticipated to cause an estimated increase in administration costs of between$700,000 and $900,000 during 2004, up to half of which may represent recurringcosts of compliance. Through the first nine months of the year, we haveincurred approximately $460,000 in Section 404 compliance costs.

***Research and Development***

Research and development expenses increased to$1.5 million for the three months ended September 30, 2004, comparedto $1.3 million for the three months ended September 30, 2003. Forthe nine months ended September 30, 2004, research and developmentexpenses were $4.4 million, compared to $3.6 million for the ninemonths ended September 30, 2003. The increase for both periods isprimarily due to increased labor costs associated with new product initiativesand the optimization of our Coherent Acoustics technology for new consumerelectronics applications.

We expect to continue toincrease our investment in research and development activities overall and willaccelerate those initiatives in future quarters to support the roll out of thenext generation standards.

***Interest (Income) Expense, Net***

Interest income, net, forthe three and nine months ended September 30, 2004 increased significantlyover the same period for the prior year due to increased investment incomerelating to proceeds from our initial and follow-on public offerings in 2003.

17

----

***Legal Settlement***

In May 2004, wereached a settlement with Mintek for $3.5 million for TrademarkInfringement, False Designation of Origin, Trademark Dilution, and UnfairCompetition relating to Mintek’s distribution of DVD players bearing ourregistered trademarks without obtaining a license from us. In the secondquarter of 2004, we recognized $899,000 in revenue under the settlementagreement for royalties due on known units that could be identified as usingour trademark and accounted for the excess $2.6 million portion of thesettlement as other income. Selling, general and administrative expenses forthe nine months ended September 30, 2004 included approximately $300,000in legal fees related to the Mintek case. Legal fees related to Mintek wereapproximately $200,000 for 2003.

***Income Taxes***

For the three months andnine months ended September 30, 2004, we recorded an income tax provisionof $1.8 million and $5.4 million, respectively, on pre-tax income of$5.0 million and $15.2 million, respectively. This resulted in anannualized effective tax rate of 36%. For the three months and nine monthsended September 30, 2003, we recorded an income tax provision of$1.4 million and $3.5 million, respectively, on pre-tax income of$4.1 million and $10.1 million, respectively. This resulted in anannualized effective tax rate of 35%. These rates differed from the statutoryrates primarily due to state income taxes offset by benefits associated withthe foreign rate differentials and research and development credits.

**Liquidity and Capital Resources**

At September 30, 2004, we had cash, cashequivalents and short-term investments of $96.8 million, compared to$99.4 million at December 31, 2003.

Net cash provided by operating activities was$12.7 million for the nine months ended September 30, 2004, comparedto $7.0 million for the nine months ended September 30, 2003. Theimprovement in cash flows from operations was primarily a result of increasednet income generated in the first nine months of 2004 relative to the sameperiod in the prior year as well as the tax benefit from the exercise ofemployee stock options of $3.9 million. Accounts receivable decreased$1.4 million for the nine months ended September 30, 2004 due topayments received from consumer license fees. Inventory increased $723,000 forthe nine months ended September 30, 2004 as a result of inventorypurchases related to our new product offerings as wellas slower than expected sales of our newer theatrical products.

Net cash used in investing activities totaled$33.3 million and $2.5 for the nine months ended September 30, 2004and 2003, respectively. The increase in cash used in investing activities forthe nine months ended September 30, 2004 is primarily a result of thepurchases of investment instruments with maturities greater than 90 daysof $30.9 million, the closing of an acquisition of $1.4 million, andpurchases of property and equipment related to the establishment of an officein Japan and internal computer network improvements.

Net cash provided by financing activities totaled$914,000 and $40.5 million for the nine months ended September 30, 2004and 2003, respectively. Net cash provided by financing activities for the ninemonths ended September 30, 2004 primarily consisted of cash received fromoption exercises and shares issued under the employee stock purchase plan. Netcash provided by financing activities for the nine months ended September 30,2003 consisted of proceeds from our initial public offering of $63.0 million offset by theredemption of the preferred stock and payment of dividends to the preferredstockholders totaling $22.5 million.

We believe that our cash,cash equivalents, short-term investments, funds available under our existingbank line of credit facility, and cash flows from operations will be sufficientto satisfy our working capital 

18

----

andcapital expenditure requirements for at least the next twelve months. Beyondthe next twelve months, additional financing may be required to fund workingcapital and capital expenditures. Changes in our operating plans, lower thananticipated revenues, increased expenses, acquisition of companies, products ortechnologies or other events, including those described in “Risk Factors”included in our Form 10-K filed on March 30, 2004 and in andother filings may cause us to seek additional debt or equity financing on anaccelerated basis. Financing may not be available on acceptable terms, or atall, and our failure to raise capital when needed could negatively impact ourgrowth plans and our financial condition and results of operations. Additionalequity financing may be dilutive to the holders of our common stock and debtfinancing, if available, may involve significant cash payment obligations andfinancial or operational covenants that restrict our ability to operate ourbusiness.

**Recently Issued Accounting Standards**

In November 2003, theEITF reached a consensus on Issue No. 03-10, “Application ofEITF 02-16 by Resellers to Sales Incentives Offered to Consumers byManufacturers.” EITF No. 03-10 addresses the accounting formanufacturer sales incentives offered directly to consumers, includingmanufacturer coupons. EITF No. 03-10 is effective for the firstinterim period beginning after November 25, 2003. Adoption of theprovisions of EITF No. 03-10 did not have a material impact on ourfinancial position, results of operations, or cash flows for the nine monthsended September 30, 2004.

**RISKFACTORS**

*Set forth below and elsewhere in this report and inother documents we file with the Securities and Exchange Commission are risksand uncertainties that could cause our actual results to differ materially fromthe results contemplated by the forward-looking statements contained inthis report 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 to Our Business**

***We face intense competition from companies withgreater brand recognition and resources.***

The digital audio,consumer electronics, and entertainment markets are intensely competitive,subject to rapid change, and significantly affected by new productintroductions and other market activities of industry participants. Ourprincipal competitor is Dolby Laboratories, Inc., who competes with us inmost of our markets. We also compete with other companies offering:

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

·       productsfor theatrical markets, such as Smart Devices, Inc., Sony Corporation, andUltra Stereo Labs, Inc.

19

----

Many of our current andpotential competitors, including Dolby, enjoy substantial competitiveadvantages, including:

·       greatername recognition;

·       alonger operating history;

·       moredeveloped distribution channels and deeper relationships with semiconductor andconsumer electronics products manufacturers;

·       amore extensive customer base;

·       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; and

·       moretechnicians and engineers.

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. It 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 a few product categories, includingDVD-Video and DVD-Audio Recordable, for its stereo technology and terrestrialdigital television broadcasts in the United States. As a result of thesefactors, Dolby has a competitive advantage in selling its digital multi-channeltechnology to consumer electronics products manufacturers.

Sony Corporation is both acompetitor and a significant customer in all of our markets. If Sony decides toeliminate the use of our technology in its products or to compete with us moreaggressively in our markets, the revenues that we derive from Sony would belower than expected.

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

Technology standards areimportant in the audio industry as they help to assure compatibility across asystem or series of products. Generally, standards adoption occurs on either amandatory basis, requiring a particular audio technology to be available in aparticular product or medium, or an optional basis, meaning that a particularaudio technology may be, but is not required to be, utilized. For example,Dolby’s technology for stereo playback has been selected as a mandatorystandard for DVD-Video and DVD-Audio Recordable. Both Dolby’s and our digitalmulti-channel technology have optional status in the DVD-Video standard.

Various nationalgovernments have adopted or are in the process of adopting standards for alldigital television broadcasts, including cable, satellite, and terrestrial. Inthe United States, Dolby’s technology has been selected as the sole, mandatorystandard for terrestrial digital television broadcasts. As a result, 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, ourtechnology may never be included. Certain large and developing markets, such asChina, have not fully developed their digital television standards. Ourtechnology may or may not ultimately be included in these standards.

Adoption of our technologyis not mandatory as part of many governmental or industry accepted standards.

20

----

As new technologies andentertainment mediums emerge, including future generations of DVD technology,new standards relating to these technologies or mediums may develop. Newstandards may also emerge in existing markets that are currently characterizedby competing formats, such as the market for personal computers. We may not besuccessful in our efforts to include our technology in any such standards.

While wemay be successful in obtaining mandatory status for our technology in  one or moreindustry standards, there is no guarantee that products associated with these standards willbe successful in the market.

***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.***

Themarket for our technology, products, and services is generally characterizedby:

·       rapidtechnological change;

·       shortproduct lifecycles;

·       changingcustomer demands;

·       evolvingindustry standards; and

·       productobsolescence.

Our future success willdepend on our ability to enhance our existing technology, products, andservices and to develop acceptable new technology, products, and services on atimely basis. The development of enhanced and new technology, products, andservices is a complex and uncertain process requiring high levels ofinnovation, highly-skilled engineering and development personnel, and theaccurate anticipation of technological and market trends. We may not be able toidentify, develop, market, or support new or enhanced technology, products, orservices on a timely basis, if at all. Furthermore, our new technology,products, and services may never gain market acceptance, and we may not be ableto respond effectively to evolving consumer demands, technological changes,product announcements by competitors, or emerging industry standards. For example,we may not be able to effectively address concerns in the film and 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.

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

Protectionof our intellectual property is critical to our success. Patent, trademark,copyright, and trade secret laws and confidentiality and other contractualprovisions afford only limited protection and may not adequately protect ourrights or permit us to gain or keep any competitive advantage. We face numerousrisks in protecting 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;

·       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; and

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

21

----

As a result, we cannotassure you that our means of protecting our intellectual property rights andbrands will be adequate. Furthermore, despite our efforts, third parties mayviolate, or attempt to violate, our intellectual property rights. Infringementclaims and lawsuits would likely be expensive to resolve and would requiremanagement’s time and resources. In addition, we have not sought, and do notintend to seek, patent and other intellectual property protections in allforeign countries. In countries where we do not have such protection, productsincorporating our technology may be lawfully produced and sold without alicense.

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

Companies that participatein the digital audio, consumer electronics, and entertainment industries hold alarge number of patents, trademarks, and copyrights, and are frequently involvedin litigation based on allegations of patent infringement or other violationsof intellectual property rights. Intellectual property disputes frequentlyinvolve highly complex and costly scientific matters, and each party generallyhas the right to seek a trial by jury which adds additional costs anduncertainty. Accordingly, intellectual property contests, with or withoutmerit, could be costly and time consuming to litigate or settle, and coulddivert management’s attention from executing our business plan. In addition,our technology and products may not be able to withstand any third-partyclaims or rights against their use. If we were unable to obtain any necessarylicense following a determination of infringement or an adverse determinationin litigation or in interference or other administrative proceedings, we mayneed to redesign some of our products to avoid infringing a third party’spatent and could be required to temporarily or permanently discontinuelicensing our products.

***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 relations withmany leading providers of movie, music, computer, and video game content, noneof our existing contracts require these parties to develop and release contentwith DTS audio soundtracks. In addition, we may not be successful inmaintaining existing relationships or developing relationships with otherexisting providers or new market entrants that provide content. As a result, wecannot assure you that a significant amount of content in movies, audio DVDs,computer software programs, video games, or other entertainment mediums will bereleased with DTS audio soundtracks. If the amount, variety, and popularity ofentertainment content released with DTS audio soundtracks do not increase,consumer electronics products manufacturers that pay us per-unit licensing feesmay discontinue offering DTS playback capabilities in the consumer electronicsproducts that they sell.

***If our DTS-CSSsystem for subtitles, captions, and descriptive narration for films is notadopted widely, our business may be harmed.***

Our DTS-CSS system for subtitles, captions, anddescriptive narration for films is a key new product. To date, sales andrevenues from this system have not been significant and we have limitedexperience to indicate whether or not this system will be widely adopted, or the rate at which such adoption may occur.Nonetheless, we have anticipated significant future sales of this system andour revenue and growth projections contemplate that it will generatesignificant future revenues. If we are unsuccessful in selling 

22

----

ourDTS-CSS system, our future revenues will be lower than expected and we may be requiredto write-down or reserve against obsolete or excess systems in inventory.

***If our independentauditors are unable to provide us with an unqualified report as to the adequacyof our internal controls over financial reporting as of December 31, 2004and future year-ends as required by Section 404 of the Sarbanes-OxleyAct of 2002, investors could lose confidence in the reliability of ourfinancial statements, which could result in a decrease in the value of ourshares.***

As directed by Section 404of the Sarbanes-Oxley Act of 2002, the SEC adopted rules requiringpublic companies to include a report by management on our internal controlsover financial reporting in their annual reports on Form 10-K thatcontains an assessment by our management of the effectiveness of internalcontrols over financial reporting. In addition, the public accounting firmauditing our financial statements must attest to and report on our management’sassessment of the effectiveness of internal controls over financial reporting. Thisrequirement will apply to our annual report onForm 10-K for the fiscal year ending December 31, 2004. Whilewe are conducting a rigorous review of our internal controls over financialreporting in order to comply with the Section 404requirements, our independent auditors may interpret the Section 404requirements and the related rules and regulations differently from us, orour independent auditors may not be satisfied with our internal controls overfinancial reporting or with the level at which these controls are documented,operated or reviewed. In addition, many uncertainties remain regarding therequirements for auditor attestation, and guidance provided by the publicaccounting profession has changed frequently and materially to date. Further,the demand for competent audit resources has grown dramatically as a result ofthe requirements of Section 404, and such demand may exceed availablesupply. Finally, in the event we make a significant acquisition, or a series ofinsignificant acquisitions, we may face significant challenges in implementingthe required processes and procedures in the acquired operations. As a result,our independent auditors may decline or be unable to attest to management’sassessment or may issue a qualified report. This could result in an adversereaction in the financial markets due to a loss of confidence in thereliability of our financial statements, which could cause the market price ofour shares to decline.

If the Internal RevenueService audit results in assessment of additional taxes due,there exists the possibility of a material adverse impact on the future results ofoperations.

In August 2004, the Internal Revenue Service, or IRS,  initiated aregular examination of the our tax return for the year 2002. As of September 30,2004, the IRS had not issued any proposed adjustments to the amounts reflectedby us on these returns. However, the calculation of our taxliabilities involves dealing with uncertainties in the application of complextax regulations. If the IRS audit results in assessment of additional taxesdue, there exists the possibility of a material adverse impact on the resultsin operations of the period in which the matter is ultimately resolved or an unfavorable outcomebecomes probable and reasonably estimable.

***We have limitedexperience in licensing, re-mixing, marketing, and directly selling multi-channelaudio content.***

Although we haveestablished relations with a number of artists and music labels, we do not haveany contractual agreements that require artists or music labels to provide uswith music content to re-mix and release in our proprietary DTS audio format.Music companies may in the future be unwilling to license titles from theirmusic catalogs to us. In addition, our audio content competes with other multi-channelformats, including Super Audio CD, which is a format developed jointly byPhilips and Sony Corporation. As a result, we may have difficulty in obtainingrights to release a significant amount of audio content, and any content thatwe do release may not be commercially successful.

23

----

***Declining retailprices for consumer electronics products could force us to lower the licensefees we charge our customers.***

The market for consumerelectronics products is intensely competitive and price sensitive. Retailprices for consumer electronics products that include our DTS audio technology,such as DVD players and home theater systems, have decreased significantly andprices may continue to decrease for the foreseeable future. Declining pricesfor consumer electronics products could create downward pressure on thelicensing fees we currently charge our customers who integrate our technologyinto the consumer electronics products that they sell and distribute.

Most of the consumerelectronics products that include our audio technology also include Dolby’smulti-channel audio. As a result of pricing pressure, consumerelectronics products manufacturers could decide to exclude our DTS audiotechnology from their products altogether.

***We have limited control over existing and potentialcustomers’ and licensees’ decision to include our technology in their productofferings.***

Ingeneral we are dependent on our customers andlicensees—including consumer electronics products manufacturers, semiconductormanufacturers, movie theaters, and producers and distributors of content formusic, films, videos, and games—to incorporate our technology in theirproducts, purchase our products and services, or release their content in ourproprietary DTS audio format. Although we have license agreements with many ofthese companies, these license agreements do not require any minimum purchasecommitments, and are on a non-exclusive basis, and do not require incorporationof our technology or trademarks in their products. Furthermore, while we may be successful inobtaining mandatory status for our technology in one or more industrystandards, there is no guarantee that products associated with these standardswill be successful in the market. Our licensees and othermanufacturers might not utilize our technology in the future.

***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 the number of films they release with DTS audiosoundtracks.***

Although all nine majorfilm producers and distributors are customers of ours, we generally do not havecontractual arrangements that require them to use our DTS audio technology. Ourtheatrical business depends on our having good relations with these filmstudios. Deterioration in our relationship with any of these film studios couldcause these customers to stop using our DTS audio technology. Any significant declinein the release of motion pictures with DTS audio soundtracks would decrease thedemand for and revenues from the playback products and services that we offerto movie theaters. In addition, other film studios throughout the worldgenerally adopt the technologies used by the major U.S. film studios.Therefore, if the major U.S. film studios stop using our technology, we wouldnot only lose the per-movie licensing fee we receive from these customers, butmay also lose per-movie licensing fees from other film studios throughout theworld.

***If the movieindustry adopts new digital cinema technology in place of current filmtechnology, demand for our theatrical products and services could decline.***

The movie theater industrymay transition from film-based media to electronic-based, or digital,media. If this transition occurs, we may be unable to meaningfully respond withcompetitive product offerings. In addition, if the film industry broadly adoptsdigital cinema, our technology and current product offerings could be renderedobsolete. In such an event, demand by movie theaters for our playback systems,cinema processors, and systems for subtitling, captioning, and descriptivenarration would decline.

24

----

***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 theatrical businessdepends in part on the construction of new screens and the renovation ofexisting theaters that install our DTS playback systems and cinema processors.In recent years, aggressive building of megaplexes by companies that operatemovie 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.If movie theater operators decide to close a significant number of screens inthe future or cut their capital spending, demand for our playback systems andcinema processors will decline.

***We are dependent on our management team and keytechnical employees, and the loss of any of them could harm our business.***

Oursuccess depends, in part, upon the continued availability and contributions ofour management team, particularly Jon Kirchner, our President and ChiefExecutive Officer, and W. Paul Smith, our Senior Vice President, Research andDevelopment. We also rely on the skills and talents of our engineering and technicalpersonnel because of the complexity of our products and services. Several ofour key engineers have been instrumental in the development of our technology.Important factors that could cause the loss 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;

·       wedo not maintain key-man life insurance on any of our employees;

·       significantportions of the stock options held by the members of our management team arevested; and

·       manyof the stock options held by our executive officers provide for acceleratedvesting in 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.

***We have a limitedoperating history in many of our key 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. As a result, the demand for ourtechnology, products, and services and the income potential of these businessesare unproven. In addition, because the market for digital audio technology isrelatively new and rapidly evolving, we have limited insight into trends thatmay emerge and affect our business. We may make errors in predicting andreacting to relevant business trends, which could harm our business. Beforeinvesting in our common stock, you should consider the risks, uncertainties,and difficulties frequently encountered by companies in new and rapidlyevolving markets such as ours. We may not be able to successfully address anyor all of these risks.

25

----

***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 operateimproperly and could cause unintended consequences. If our products ortechnology contain errors we could be required to replace them, and if any sucherrors cause unintended consequences we could face claims for productliability. Although we generally attempt to contractually limit our exposure toincidental and consequential damages, if these contract provisions are notenforced or are unenforceable for any reason, or if liabilities arise that arenot effectively limited, we could incur substantial costs in defending and/orsettling product liability claims.

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

Althoughwe have been in business since 1990, we have only achieved profits from ourbusiness operations in the last thirteen fiscal quarters. We expect ouroperating expenses to increase as we, among other things:

·       expandour domestic and international sales and marketing activities;

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

·       hireadditional personnel, including engineers and other technical staff;

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

·       continueto implement the requirements of the Sarbanes-Oxley Act; 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.

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

Wemarket and sell our products and services outside the United States, andcurrently have employees located in China, England, Japan, Mexico, NorthernIreland, Canada andSpain. Many of our customers and licensees are located outside the UnitedStates. As a key component of our business strategy, we intend to expand ourinternational sales. We face numerous risks in doing business outside theUnited 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;

·       difficultiesin staffing and managing foreign operations;

·       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, particularlyin emerging markets;

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

26

----

·       potentiallyadverse tax consequences.

Such factors could causeour future international sales 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 besubject to significant fines and other penalties.

Our international revenue is mostly denominated inU.S. dollars. As a result, fluctuations in the value of the U.S. dollar andforeign currencies may make our technology, products, and services moreexpensive for international customers, which could cause them to decrease theirpurchases from us. Expenses for our subsidiaries are denominated in theirrespective local currencies. Significant fluctuations in the value of the U.S.dollar and foreign currencies could have a material impact on our consolidatedfinancial statements. We do not currently engage in currency hedging activitiesto limit the risk of exchange rate fluctuations.

***We face risks in expanding our business operations inChina.***

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 successful in expanding into China, wemay be greatly impacted by the political, economic, and military conditions inChina, Taiwan, North Korea, and South Korea. These countries have recentlyconducted military exercises in or near the other’s territorial waters andairspace. Such disputes may continue or escalate, resulting in economicembargos, disruptions in shipping, or even military hostilities. This couldseverely harm our business by interrupting or delaying production or shipmentof our products or products that incorporate our technology.

***We depend on single suppliers, manufacturers, anddistributors for some of our products, and the loss of any of these suppliers,manufacturers, or distributors could harm our business.***

We purchase a small number of parts from sole-sourcesuppliers. In addition, our professional audio encoding devices and movietheater playback systems are manufactured according to our specifications bysingle third-party manufacturers. Because we have no direct control overthese third-party suppliers and manufacturers, interruptions or delays inthe products and services provided by these third parties may be difficult toremedy in a timely fashion. In addition, if such suppliers or manufacturers areincapable of or unwilling to deliver the necessary parts or products, we may beunable to redesign our technology to work without such parts or find alternativesuppliers or manufacturers. In such events, we could experience interruptions,delays, increased costs, or quality control problems.

In addition, we have entered into agreements with twocompanies to serve as our sole distributors for our DTS Entertainment productsin the United States and Canada and in Europe, respectively. We have no directcontrol over these distributors and any problems with their performance maytake time to identify and/or remedy, and any remedial measures that we take maybe unsuccessful. In addition, if either or both of these distributors were togo out of business, as our last distributor did, or otherwise becomes incapableof continuing as our distributor, we could experience delays in distributingour DTS Entertainment products to the retail market, loss of inventory, andloss of revenue.

27

----

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

A significant percentage of our revenues are generatedfrom our consumer electronics products manufacturer customers who license andincorporate our technology in their consumer electronics products. Under ourexisting arrangements, these customers pay us a per-unit licensing fee based onthe number of consumer electronics products manufactured that incorporate ourtechnology. We rely on our customers to accurately report the number of unitsmanufactured in collecting our license fees, preparing our financial reports,projections, budgets, and directing our sales and product development efforts.Most of our license agreements permit us to audit our customers, but audits aregenerally expensive and time consuming and could harm our customerrelationships. If any of our customer reports understate the number of productsthey manufacture, we may not collect and recognize revenues to which we areentitled.

***A prolonged economic downturn could materially harmour business.***

Negative trends in the general economy, includingtrends resulting from actual or threatened military action by the United Statesand threats of terrorist attacks on the United States and abroad, could cause adecrease in consumer spending on entertainment in general. Any reduction inconsumer confidence or disposable income in general may affect the demand forconsumer electronics products that incorporate our digital audio technology,audio DVDs that we produce and distribute through our DTS Entertainment label,and demand by film studios and movie theaters for our theatrical products andservices.

***We may not successfully address problems encounteredin connection with any current or future 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. We have limited experience in making acquisitions and/or strategicinvestments, and therefore our ability as an organization to make acquisitionsor strategic investments is unproven. Acquisitions and strategic investmentsinvolve numerous risks, including:

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

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

·       unanticipatedcosts associated with the acquisition, including accounting charges andtransaction 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; and

·       potentialloss of key employees of acquired organizations.

If we fail to properly evaluate and executeacquisitions and strategic investments, our management team may be distractedfrom our day-to-day operations, our business may be disrupted, and ouroperating results may suffer. In addition, if we finance acquisitions by issuingequity or convertible debt securities, our existing stockholders would bediluted.

***We may have difficulty managing any growth that wemight experience.***

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 ourmanagement to:

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

28

----

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

·       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 to successfully manage our growth coulddistract management’s attention, and result in our failure to execute ourbusiness plan.

***We may experience fluctuations in our operatingresults.***

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 the moderate seasonality described above. Our revenues maycontinue to be subject to seasonal fluctuations in the future. Unanticipatedfluctuations in seasonality could cause us to miss our earnings projectionswhich 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 recognize royalty revenues that relate toconsumer electronics manufacturing activities from prior periods. These royaltyrecoveries may cause revenues to be higher 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.

**Risks Related to Our 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 fluctuatesubstantially due to many factors, including:

·       actualor anticipated fluctuations in our results of operations;

·       announcementsof technological innovations 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;

29

----

·       conditionsand trends in technology industries;

·       changesin market valuation or earnings of our competitors;

·       thetrading volume of our common stock;

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

·       generaleconomic conditions.

In addition, the stock market in general, and theNasdaq National Market and the market for technology companies in particular,has experienced extreme price and volume fluctuations that have often beenunrelated or disproportionate to the operating performance of those companies.Further, the market prices of securities of technology companies have beenparticularly volatile. These broad market and industry factors may materiallyharm the market price of our common stock, regardless of our operatingperformance. In the past, following periods of volatility in the market priceof a company’s securities, securities class-action litigation has oftenbeen instituted against that company. Such litigation, if instituted againstus, could result in substantial costs and a diversion of management’s attentionand resources.

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

As of September 30, 2004, we have 17,015,933shares of common stock outstanding. As a result of our relatively small publicfloat, our common shares may be less liquid than the common shares of companieswith broader public ownership. Among other things, trading of a relativelysmall volume of our common shares may have a greater impact on the tradingprice for our shares than would be the case if our public float were larger.

***Our future capital needs are uncertain and we may needto raise additional funds in the future, and such funds may not be available onacceptable 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;

·       thenumber and timing of acquisitions and other strategic transactions; and

·       thecosts associated with our expansion, if any.

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

***Anti-takeover provisions under our charter documentsand Delaware law could delay or prevent a change of control and could alsolimit 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;

30

----

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

·       prohibitstockholders from filling board vacancies, calling special stockholdermeetings, or taking action by written consent; and

·       requireadvance written notice of stockholder proposals and director nominations.

Inaddition, we are governed by the provisions of Section 203 of the DelawareGeneral Corporate 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, tender offer, orproxy contest involving our company. Any delay or prevention of a change ofcontrol transaction or changes in our Board could cause the market price of ourcommon stock to decline.

***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 September 30,2004, we did not have any balances outstanding under our bank line of creditarrangement; however, the amount of outstanding debt at any time may fluctuateand we may from time to time be subject to refinancing 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 maturity of our investmentportfolio is less than one month. As of September 30, 2004, a 1% change ininterest rates throughout a one-year period would have an annual effect ofapproximately $1.1 million on our income.

We derive more than half of our revenues from salesoutside the United States, and maintain research, sales, marketing, or businessdevelopment offices in nine countries. Therefore, our results could benegatively affected by such factors as changes in foreign currency exchangerates, trade protection measures, longer accounts receivable collectionpatterns, 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 a small amount of cash maintained by these operations. Revenuesdenominated in foreign currencies accounted for approximately 16%of total revenues during the nine months ended September 30, 2004.Operating expenses, including cost of sales, for our foreign subsidiaries wereapproximately $4.9 million for the nine months ended September 30,2004. Based upon the expenses for the nine months ended September 30,2004, a 1% change in foreign currency rates throughout a one-year period wouldhave an annual effect of approximately $67,000.

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 by exchange rate fluctuations asthe financial statements of our foreign subsidiaries are translated into theUnited States dollar in consolidation.

31

----

As exchange rates vary,these results, when translated, may vary from expectations and could adverselyimpact overall profitability. During the three and nine months ended September 30,2004 the impact of foreign exchange rate fluctuations related to translation ofour foreign subsidiaries’ financial statements was not significant.

***Item*****4**.   **Controls and Procedures**

**Disclosure Controls and Procedures**

*Evaluation of disclosure controlsand procedures.  *Under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, we evaluated the effectiveness of the design andoperation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)).Based upon that evaluation, the Chief Executive Officer and Chief FinancialOfficer concluded that, as of the end of the period covered by this Report, ourdisclosure controls and procedures are adequately designed to ensure thatinformation required to be disclosed by us in the reports we file or submitunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in applicable rules and forms.

32

----

**PART II**

**OTHERINFORMATION**

***Item*****1.   LegalProceedings**

None.

***Item*****2.   Unregistered Sales of Equity Securities and Use ofProceeds**

(a)   During thethird quarter of 2004, pursuant to the exemption from registration provided in Section 3(a)(9) ofthe Securities Act, the Registrant issued an aggregate of 7,852 shares ofcommon stock to various individuals upon the cashless exercise of warrants topurchase an aggregate of 16,834 shares of common stock.

(b)   On July 15,2003, we closed the sale of an aggregate of 4,091,410 shares of our CommonStock, $0.0001 par value, in our initial public offering, which included thesale of 251,410 shares of our Common Stock pursuant to the exercise of theunderwriters’ overallotment option in the offering. The offering also includedthe sale by certain of our stockholders of an aggregate of 324,590 shares ofour Common Stock in connection with the exercise by the underwriters of theiroverallotment option. The managing underwriters in the offering were SG CowenSecurities Corporation, William Blair & Company, L.L.C., and Thomas WeiselPartners LLC. All of the shares of Common Stock sold in the offering wereregistered under the 1933 Act on a Registration Statement on Form S-1(Reg. No. 333-104761) that was declared effective by the SEC on July 9,2003 and a Registration Statement filed pursuant to Rule 462(b) underthe Securities Act that was filed on July 10, 2003 (Reg. No. 333-106920).All 4,416,000 shares of Common Stock registered under the RegistrationStatement, including shares sold by us and by selling stockholders upon exerciseof the overallotment option, were sold at a price per share of $17.00.

The aggregate price of theoffering amount registered on our behalf was $69.6 million. In connectionwith the offering, we paid an aggregate of $4.9 million in underwritingdiscounts and commissions to the underwriters and incurred approximately$1.7 million in other offering expenses. After deducting the underwritingdiscounts and commissions and offering expenses, we received net proceeds fromthe offering of approximately $63.0 million. Subsequent to the offering,we used approximately $22.5 million of our net proceeds to redeem alloutstanding shares of redeemable preferred stock and to pay all accrued butunpaid dividends on such shares through the date of redemption. The remainingproceeds to us have conformed with our intended use outlined in the prospectusrelated to the offering. As of September 30, 2004, we have approximately$40.5 million remaining from the proceeds of the offering.

***Item*****3.   DefaultsUpon Senior Securities**

None.

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

None.

***Item*****5.   OtherInformation**

None.

33

----

***Item*****6.   Exhibits**

*Exhibits:*
| Exhibit  Number | ** ** | **Exhibit Description**                                                                                                                |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1            |       | Certification of  Principal Executive Officer Pursuant to Exchange  Act Rules 13a-14(a) or 15d-14(a)                                        |
| 31.2            |       | Certification of  Principal Financial Officer Pursuant to Exchange  Act Rules 13a-14(a)  or 15d-14(a)                                  |
| 32.1            |       | Certification of  Principal Executive Officer Pursuant to Exchange  Act Rules 13a-14(b) or  15d-14(b) and 18 U.S.C.  Section 1350 |
| 32.2            |       | Certification of  Principal Financial Officer Pursuant to Exchange  Act Rules 13a-14(b) or  15d-14(b) and 18 U.S.C.  Section 1350 |

 

34

----

 

**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.
|                               | Digital Theater  Systems, Inc. |
|-------------------------------|-------------------------------------|
| Date: November 10,  2004 | By:                                 | /s/  Jon E. Kirchner |
|                          |                                | Jon E. Kirchner*President and Chief Executive Officer  (Duly Authorized Officer)* |
| Date: November 10,  2004 | By:                                 | /s/  Melvin L. Flanigan |
|                          |                                | Melvin L.  Flanigan*Executive Vice President, Finance and  Chief Financial Officer  (Principal Financial and Accounting Officer)* |

 

35

----