Dolby Laboratories ANNUAL REPORT 2005 To Our Stockholders: Fiscal 2005 was a year of change and progress for Dolby Laboratories. After going public on the New York Stock Exchange in February—marking a new and important chapter in our forty-year history—we achieved solid financial performance, leveraged our brand into new and diversified markets, and delivered on our reputation for technology leadership and innovation. Fiscal 2005 was a successful year for us financially. Total revenues grew 13 percent to a record $328 million. Dolby’s profitability remained strong with 84 percent licensing gross margins, 76 percent total gross margins, 26 percent operating margins, and earnings of $0.50 per diluted share. In addition, we generated $80 million in cash from operations and ended the year with a balance of $372 million in cash and equivalents. During the year, we expanded our technology portfolio and diversified into new markets by leveraging our strong industry positions and our well-known brand. In our core consumer electronics market, both next-generation DVD formats will include Dolby Digital. In addition, Dolby Digital Plus and Dolby TrueHD are mandated standards in HD DVD and optional in Blu-ray Discs. We experienced similar success in the broadcasting market, as the Advanced Television Systems Committee (ATSC) added Dolby Digital Plus to their digital television standard for new delivery systems in North America. In Europe, the European Broadcasters Union recommended Dolby Digital 5.1 audio decoding in new televisions and set-top boxes that receive HDTV signals. Today, 61 European broadcasters feature Dolby Digital multichannel sound on their satellite, cable, and digital terrestrial services. In Asia, China’s Shanghai Media Group announced that it will feature Dolby Digital 5.1, making it the first company in this rapidly emerging market to broadcast in Dolby Digital 5.1 surround sound. We have also made significant progress in the personal computer, gaming, automotive, and mobile markets. In the PC market, we launched our PC Entertainment Experience, working with Intel and systems integrators to provide Dolby technology and quality testing in next-generation Intel-based motherboards. In gaming, Microsoft announced that its Xbox 360 console will include Dolby Digital surround sound for both games and movies. In the automotive market, Dolby Pro Logic II has been included as an option in 43 models worldwide, and Volvo has announced that it will include Dolby Pro Logic II in its entire line of cars. Finally, our subsidiary Via Licensing is benefiting from the inclusion of the AAC-based compression technology in the Apple iPod and other music-based devices. Dolby’s success in these consumer markets is largely due to our history of innovation. In 2005, we continued to innovate in the consumer as well as the professional realms. In addition to recent developments in the consumer market, including Dolby Headphone, Dolby TrueHD, and Dolby Virtual Speaker technologies, we introduced a significant product in the professional market: the Dolby Digital Cinema system. Dolby Digital Cinema provides the highest-quality digital experience available to cinema operators and moviegoers. Earlier this year, we teamed up with Lucasfilm and Twentieth Century Fox to feature Star Wars: Episode III—Revenge of the Sith on our digital equipment in key theatres throughout Europe and the United States. In November, we led the rollout of 84 installations featuring our digital equipment in conjunction with Disney Studios’ release of Chicken Little in 3-D. This was the largest US implementation for the industry—it included 22 theatre chains and 38 US markets—and demonstrated to partners, moviegoers, and our diverse customer base that we remain as committed as ever to enabling the highest-quality entertainment experience possible. Our success across this broad range of professional and consumer markets is diversifying our revenue stream while we remain focused on our long-term objective of being an essential element in the best entertainment technologies used by professionals and consumers. Through our focus on innovation, diversified markets, and a strong financial model, we are firmly committed to delivering value to our stockholders. We thank our employees for your dedication and hard work throughout our first year as a publicly traded company, and thank you, our stockholders, for your valued support. Sincerely, Bill Jasper, President and Chief Executive Officer UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ____________________ FORM 10-K ____________________ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended September 30, 2005 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period From _______ To _______ Commission File Number: 001-32431 DOLBY LABORATORIES, INC. (Exact name of registrant as specified in its charter) Delaware 90-0199783 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 100 Potrero Avenue San Francisco, CA 94103-4813 (Address of principal executive offices) ( Zip Code) (Registrant's telephone number, including area code) (415) 558-0200 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Class A common stock, $0.001 par value The New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Indicate by check mark whether Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b−2 of the Exchange Act). Yes No 1 The aggregate market value of the voting common equity held by non-affiliates of the registrant as of April 1, 2005 was $808,561,206. This calculation excludes the shares of Class A and Class B common stock held by executive officers, directors and stockholders whose ownership exceeds 5% of the Class A and Class B common stock outstanding at April 1, 2005. This calculation does not reflect a determination that such persons are affiliates for any other purposes. On December 13, 2005 the Registrant had 34,175,120 shares of Class A common stock and 70,478,187 shares of Class B common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's Definitive Proxy Statement to be filed with the Commission pursuant to Regulation 14A in connection with the registrant's 2006 Annual Meeting of Stockholders, to be filed subsequent to the date hereof, are incorporated by reference into Part III of this Report. Such Definitive Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the conclusion of the registrant's fiscal year ended September 30, 2005. DOLBY LABORATORIES, INC. FORM 10-K TABLE OF CONTENTS PART I Item1 – Business..................................................................................................... 4 Item1A – Risk Factors ............................................................................................ 17 Item1B – Unresolved Staff Comments ................................................................... 35 Item 2 – Properties.................................................................................................. 35 Item 3 – Legal Proceedings..................................................................................... 35 Item 4 – Submission of Matters to a Vote of Security Holders. ............................. 35 PART II Item 5 – Market for Registrant’s Common Equity and Related Stockholder Matters...................................................................................................... 36 Item 6 – Selected Financial Data ............................................................................ 38 Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operation .......................................................................... 42 Item 7A – Quantitative and Qualitative Disclosures About Market Risk............... 56 Item 8 – Financial Statements and Supplementary Data......................................... 57 Item 9 – Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................................................... 82 Item 9A – Controls and Procedures ........................................................................ 82 Item 9B – Other