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[November 15, 2012]
DOLBY LABORATORIES, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results may differ substantially from those referred to herein due to a number of factors, including but not limited to risks described in Item 1A, "Risk Factors" and elsewhere in this Annual Report on Form 10-K. We disclaim any duty to update any of the forward-looking statements to conform our prior statements to actual results.
Overview Dolby Laboratories has been a leading solutions provider to the entertainment industry for more than 45 years. We provide products, services, and technologies to capture, distribute, and play back entertainment content that gives consumers a premium entertainment experience, regardless of how or where they choose to enjoy it. Our core strengths range from our expertise in digital signal processing and compression technology to our long history of providing products, tools, and technologies to participants in the entertainment industry at each stage in the content creation, distribution, and playback process. We provide products and services that enable content creators and distributors to produce, encode, and transmit content with our premium audio technologies, and we license decoding technologies to the manufacturers of entertainment devices to ensure that content is ultimately experienced as the creator and distributor intended.
Throughout our history, we have introduced numerous innovations that have significantly improved the quality of audio entertainment, such as noise reduction for the recording and cinema industries and surround sound for cinema and home entertainment. Today, we continue to derive the vast majority of our revenue from our audio technologies.
Looking forward, we see a number of industry trends that create opportunities for the continued growth of our audio business, including the ongoing global transition from analog to digital television and consumers' increasing use of mobile devices, such as tablets and smartphones, to play back digital content.
Our portfolio of technologies and solutions optimize the audio experience for portable devices to provide consumers with a rich, clear, and immersive sound, despite the bandwidth limitations of online and cellular networks and the physical limitations of devices with tiny speakers.
We also see opportunities to apply our core strengths in areas beyond audio. For example, we believe that significant improvements can be made in the technology currently used to deliver and play back premium video, and we have identified solutions that may substantially improve the video experience. Similarly, we believe we can apply our existing audio technologies to improve the clarity and quality of voice communications in areas such as multi-party teleconferencing.
Business Model We generate the majority of our revenue by licensing technologies to original equipment manufacturers ("OEM") of consumer entertainment ("CE") products and to software vendors. We also generate revenue by selling products and related services to creators and distributors and exhibitors of entertainment content.
We participate in the global entertainment industry in three important ways: • We offer products, services, and technologies to creators and distributors of entertainment content, such as motion picture, television, and music recording studios, television broadcasters, satellite and cable operators, cinema theatre chains, and increasingly, Internet content streaming and download service providers. These content creators and distributors use our products, services, and technologies to encode and transmit content, creating rich, clear, and immersive audio experiences for consumers upon playback.
• We license technologies, such as Dolby Digital, Dolby Digital Plus, Dolby TrueHD, to OEMs and software vendors for incorporation into their CE and other products, so that consumers can play back audio content with our technologies in the rich, clear, and immersive manner the creators intended.
• We work directly with standards-setting organizations in the entertainment and technology industries, as well as governments and other regulatory bodies, to promote adoption of our technologies in their standards. As a result, our technologies are included in the majority of worldwide TV shipments to support digital TV standards around the world that mandate our formats. Our technologies are also included in virtually all DVD players, Blu-ray Disc players, audio/video receivers, and personal computer ("PC") DVD software players.
We license our technologies to OEMs and software vendors in 44 countries and our licensees distribute products incorporating our technologies throughout the world. We sell our products and services in over 80 countries. In fiscal 2012, 2011, and 2010 revenue from outside of the U.S. was 68%, 68%, and 66% of our total revenue, respectively. Our licensing business is our most significant revenue stream, representing 86%, 83%, and 77% of our total revenue in fiscal 2012, 2011, and 32-------------------------------------------------------------------------------- Table of Contents 2010, respectively. Geographic data for our licensing revenue is based on the location of our licensees' headquarters. Product revenue is based on the destination to which we ship our products, while services revenue is based on the location where services are performed.
Opportunities, Challenges, and Risks Our licensing and product markets are characterized by rapid technological changes, new and improved product introductions, changing customer demands, evolving industry standards, changing licensee needs, and product obsolescence.
We believe that these changes present us with opportunities to provide realistic and immersive audio experiences to consumers through new and emerging delivery channels. However, as described below, our licensing revenue is subject to uncertainties and trends relating to technology and market growth, as well as the mix of CE products sold that incorporate our technologies. Our licensing business also could be affected by adverse general economic conditions, because many of the products in which our technologies are incorporated are discretionary goods. Furthermore, our products business is subject to intense competition and uncertainties relating to the transition to digital cinema and purchasing decisions by our cinema customers. We expect recent declines in our 3D revenue to continue, as the market for 3D products becomes increasingly saturated.
Licensing Licensing revenue constitutes the majority of our total revenue, representing 86%, 83%, and 77% of total revenue in fiscal 2012, 2011, and 2010, respectively.
The entertainment industry is in transition. As consumers are presented with more options for receiving entertainment content, competition across the delivery channels has intensified. We see this reflected in the changing composition of our licensing revenue, driven by a shift away from optical disc based products. Our optical disc based revenue is generated from the sale of technology solutions that enable DVD or Blu-ray Disc playback functionality, licensing including the Windows 7 operating system, independent PC DVD software players, DVD, and Blu-ray Disc technologies included in consumer products.
However, most of these products can also receive content over mobile or online networks and we have increased our technology penetration into these other distribution channels. Non-optical disc based revenue is generated from the sale of technology solutions other than those used to enable DVD or Blu-ray Disc playback functionality. Non-optical disc based revenue includes licensing revenue derived from products such as TVs, set-top boxes, and mobile devices, as well as from the incorporation of our post processing technologies in a range of devices. We remain focused on delivering the products, tools, and technologies needed to ensure a high quality audio experience from any device.
Looking forward, we expect continued growth in the proportion of our licensing revenue we derive from non-optical disc sources. This will be driven partly by the maturity of optical disc as a method for delivering content, but also by the significant opportunities presented by digital broadcast and online and mobile distribution, as well as the inclusion of our technologies in the Windows 8 operating system to enable the playback of online content. We also see significant opportunities to offer encode/decode solutions in video and voice that leverage our expertise in signal processing, compression, and the capture and playback of content.
Our licensing revenue comes from the following markets and primarily from the inclusion of our technologies in the products indicated for each market: • Broadcast market: primarily televisions and set-top boxes • PC market: primarily DVD software players and Microsoft Windows operating systems • CE market: primarily DVD and Blu-ray Disc players and recorders, audio/video receivers, and home-theater-in-a-box systems • Other markets: • Mobile - primarily cell phones, tablets and other mobile devices • Gaming - primarily video game consoles • Licensing services - primarily administration of joint licensing programs • Automotive - primarily in-car DVD players The growth of the Internet, and the related shift by consumers toward online entertainment content, has resulted in a global trend toward an array of online content streaming and download services. Today content is captured, delivered, and played back in more ways than ever before. Content creators and distributors are increasingly focused on delivering content across a multitude of media and devices with varying bandwidth and performance requirements, including PCs, connected TVs, set-top boxes, gaming consoles, connected Blu-ray Disc players, and a variety of mobile devices. Many of these mobile devices 33-------------------------------------------------------------------------------- Table of Contents are increasingly designed to capture and distribute content through improved camera and WiFi technologies, as well as to play back rich entertainment experiences. This increasingly complex array of devices, with capability for both creating and playing back content, presents a challenge for content creators and device manufacturers seeking consistent audio quality. We believe this challenge provides an opportunity similar to that of digital broadcast, whereby we can provide solutions to optimize the audio experience across the online and portable device ecosystem.
In the area of content creation and delivery, our technologies are included in DVD, Blu-ray Disc, and certain broadcast standards, and we are working to extend our technologies to online delivery services. Online content aggregators, including Netflix, Amazon, VUDU, Apple, HBO GO, Samsung's Acetrax, and the Roxio Now platform, use our technologies to encode video and audio content. Leading music services such as Rhapsody and Omnifone use our audio encoding tools to deliver a rich music experience to their subscribers. In the second quarter of fiscal 2012, HBO adopted Dolby Digital Plus in its HBO GO content for select connected TVs. HBO will also offer Dolby Digital Plus in its HBO GO service for content delivered to Blu-ray Disc players. In addition, Samsung now offers Dolby Digital Plus surround sound audio through the Acetrax Video on Demand application.
Our broadcast market, driven by demand for our technologies in televisions and set-top boxes, represented approximately 34%, 31%, and 27% of our licensing revenue in fiscal 2012, 2011, and 2010, respectively. Dolby technology was included in a higher percentage of televisions and set-top boxes in fiscal 2012 which drove increased revenue relative to fiscal 2011. We view the broadcast market as an area for potential continued growth, primarily in geographic markets outside of the U.S. We see opportunities in working with specific operators and standards bodies across emerging markets to adopt our multichannel formats. Given, the percentage of the world's population that lives in countries in emerging markets and the number of televisions and set-top boxes sold in such markets, we believe that these markets present significant opportunities for growth. While there is no guarantee that the counties in the emerging markets will convert to digital television, we intend to ensure that we are well positioned to benefit from such transition if it occurs. We also view broadcast services, such as terrestrial broadcast or IPTV services, which operate under bandwidth constraints, as another area of opportunity for Dolby Digital Plus.
These technologies enable the delivery of high quality audio content at reduced bit rates, thereby conserving bandwidth. We may not, however, be able to extend our current success in the broadcast market to these new opportunities.
Our PC market represented approximately 28%, 30%, and 36% of our licensing revenue in fiscal 2012, 2011, and 2010, respectively. Our technologies are incorporated in the majority of PCs sold today, primarily because of the inclusion of DVD and Blu-ray Disc playback in the majority of PCs and the inclusion of Dolby technologies in the DVD and Blu-ray Disc standards.
Historically, we have licensed our technologies to a range of PC licensees, including independent software vendors ("ISV"), PC OEMs, and operating system providers. The release of new versions of major PC operating systems has often resulted in changes in the mix of our PC licensees. In 2007, Microsoft introduced its Windows Vista operating system, which included our technologies to enable DVD audio playback in two of its editions. In fiscal 2009, Microsoft released its current operating system, Windows 7, which includes our technologies within four editions. As a result, since 2007 the mix of our PC licensing revenue from operating systems has increased relative to that from OEMs and ISVs. We currently license our audio codec technologies directly to OEMs such as Apple, Toshiba, and Sony to support optical disc playback on PCs, and we license our PC Entertainment Experience ("PCEE") technologies to multiple PC OEMs through our PCEE licensing program.
In May 2012, we entered into an agreement with Microsoft under which Dolby Digital Plus 5.1 channel decoding and Dolby Digital two-channel encoding will be included in all PCs and tablets licensed to run the Windows 8 operating system.
Under the arrangement, OEMs generally will be required to directly license and pay us a base royalty rate for the right to use the Dolby technologies included in Windows 8 installed on the PCs and tablets they produce for online and file-based content. OEMs will be required to pay a higher per-unit royalty for Windows 8 PCs that also include optical disc playback functionality, which will be implemented by ISV applications. This higher rate is consistent with rates paid historically for the inclusion of Dolby disc playback software in the PC market. In the near term, we expect the majority of PCs to continue to ship with optical disc drives and to include optical disc playback functionality.
We believe the Microsoft Windows 8 arrangement provides a simple and consistent way for OEMs to enable playback with our technologies of content delivered by online services and video in local files on the device. This is a different licensing arrangement than the one we have for Windows 7. The release of Windows 8 did not have a material financial impact in fiscal 2012, as Microsoft continued to license its Windows 7 operating systems with our technologies. The ultimate financial impact of these licensing arrangements for Windows 8 on our licensing revenue is uncertain and will depend on several factors, including: • The extent and rate at which Windows 8 is adopted in the marketplace; • The extent to which OEMs include optical disc playback in Windows 8 devices; • The extent to which earlier versions of Microsoft operating systems, including Windows 7, continue to be licensed after the release of Windows 8; 34-------------------------------------------------------------------------------- Table of Contents • Our ability to establish and extend licensing relationships directly with PC OEMs and ISVs; • The rate at which entertainment content shifts from optical disc media to online media, thus reducing the need for PCs to have optical disc drives and DVD and Blu-ray Disc software players; and • Our ability to extend the adoption of our technologies to online and mobile platforms.
In the short term, revenue from our PC market remains dependent on several factors, including underlying PC unit shipment growth and the extent to which our technologies are included in operating systems and ISV media applications.
We continue to face risks relating to: • Purchasing trends away from traditional PCs and towards portable devices without optical disc drives, such as ultrabooks and tablets, which may not include our technologies; • The prevalence of PC software that includes our technologies on an unauthorized and infringing basis, for which we receive no royalty payments; and • Continued decreasing inclusion of ISV media applications by PC OEMs in their Windows 7-based PCs, as Windows 7 already incorporates DVD playback software.
Our CE market, driven primarily by revenue attributable to sales of DVD and Blu-ray Disc players and recorders, represented approximately 18%, 21%, and 22% of licensing revenue in fiscal 2012, 2011, and 2010, respectively. Blu-ray Disc players continue to represent an important source of revenue within our CE market, as these players are required by the applicable standards of the Blu-ray Disc Association to include Dolby Digital technology for primary audio content and our Dolby Digital Plus technology for secondary audio content. In addition, our Dolby TrueHD technology is an optional audio standard for Blu-ray Disc.
Sales of DVD players are declining, as a result of the maturity of the DVD platform and a shift to Blu-ray Disc players and other connected devices capable of delivering content; however, our revenue from sales of Blu-ray Disc players is also decreasing and has not offset the decline in revenue from DVD.
Revenue generated from our other markets includes revenue attributable to mobile, gaming, licensing services, and automotive, and represented approximately 20%, 18%, and 15% of licensing revenue in fiscal 2012, 2011, and 2010, respectively. Mobile revenue is primarily driven by demand for the Dolby Digital Plus, AAC, Dolby Mobile, and Dolby Digital. We view the mobile device market as an area of opportunity for us to increase revenue; however, actual results may differ from our expectations. In addition, because the mobile device market is a relatively new market for us, our growth in this market is dependent not only on the anticipated growth of the mobile device market as a whole, but also on the success of the mobile devices incorporating our technologies.
Revenue attributable to gaming and automotive is primarily driven by sales of video game consoles and in-car entertainment systems, respectively, that incorporate our Dolby Digital, Dolby Digital Plus, AAC, and Dolby TrueHD technologies. Licensing services revenue, from administration of joint licensing programs, is primarily driven by demand for standards-based audio compression technologies for broadcast, PC, CE, and mobile products.
Consumer entertainment products throughout the world incorporate our technologies. We expect that sales of such products incorporating our technologies in emerging economies such as Brazil, China, India, and Russia, will increase in the future as consumers in these markets acquire more disposable income with which to purchase entertainment products. However, events in these economies or in the world economy in general may contradict these expectations. Moreover, we expect that OEMs in lower-cost manufacturing countries, including China, will increase production in response to this demand and that traditional OEMs will continue to shift their manufacturing operations to these lower-cost manufacturing countries. There are substantial risks associated with doing business in such countries, including OEMs failing to report or underreporting shipments of products incorporating our technologies, that have affected and will continue to affect our operating results.
Revenue from Microsoft represented approximately 14%, 13%, and 12% of our total revenue in fiscal 2012, 2011, and 2010, respectively, and included licensing revenue from our PC, CE, and other markets.
Products Products revenue is driven primarily by sales of equipment to cinema operators and broadcasters and represented 11%, 14%, and 20% of our total revenue in fiscal 2012, 2011, and 2010, respectively.
Our cinema products represented approximately 87%, 87%, and 90% of total products revenue in fiscal 2012, 2011, and 2010, respectively. Sales of our cinema products tend to fluctuate based on the underlying trends in the cinema industry, including the popularity of individual movies, as cinema owners often purchase equipment to meet expected box office demand.
The cinema industry is transitioning from traditional film to digital cinema, and we estimate that the industry is more than halfway through this transition.
Digital cinema offers motion picture studios a means to save costs in printing and distributing movies, combat piracy, and enable repeated movie playback without degradation in image and audio quality. Our cinema 35-------------------------------------------------------------------------------- Table of Contents products include our Dolby Digital Cinema screen server and central library server, for the storage and playback of digital content, and our digital audio processor, which provides audio control for our digital cinema servers. We expect that most cinema owners who are either constructing new theaters or upgrading existing theaters will choose digital cinema products over traditional film cinema products. However, our competitive position in the digital cinema market is not as strong as our position in the traditional film cinema market.
For example, digital cinema specifications are based on open standards which, unlike traditional cinema standards, do not include our proprietary audio technologies. Furthermore, we are facing more pricing and other competitive pressures for our digital cinema products than we experience for our traditional film cinema products.
Digital cinema standards are defined by the Digital Cinema Initiative ("DCI") specifications, and we have developed software for our currently available digital cinema server that is DCI compliant. This software was made commercially available during fiscal 2012. We do not have significant contractual provisions arising from the sale of products relating to DCI compliance that would require additional performance from us.
Our digital 3D products provide 3D image capabilities when combined with a digital cinema projector and server. Our cinema products revenue has been negatively impacted by declines in unit shipments and lower selling prices for 3D products, as the market for 3D cinema equipment has become increasingly competitive. We also believe the decrease in revenue from our 3D products reflects the increasing saturation of 3D enabled screens within the cinema industry.
Our traditional film cinema products are used primarily to read, decode, and play back film soundtracks, to calibrate cinema sound systems, and to enable soundtracks encoded in digital audio formats to be played back on analog cinema audio systems. As investment by the cinema industry in digital cinema has increased, revenue from our traditional film cinema products has declined, and we expect this decline to continue.
Our broadcast products represented approximately 10%, 10%, and 9% of products revenue in fiscal 2012, 2011, and 2010, respectively. Our broadcast products are used to encode, transmit, and decode multiple channels of high quality audio content for DTV and HDTV program production and broadcast distribution and to measure the subjective loudness of audio content within broadcast programming.
In fiscal 2011, we began selling our Professional Reference Monitor product, a flat-panel video reference display for video professionals. These video professionals use the monitor for color critical tasks, such as calibrating color accuracy to professional reference standards. Our Professional Reference Monitor uses our dynamic range imaging technologies, which enhance contrast and extend brightness and dynamic range, while reducing power consumption in LED backlit LCD televisions. We did not generate significant revenue from this product in fiscal 2012.
Services Services revenue represented approximately 3% of total revenue in each of fiscal 2012, 2011, and 2010. The level of our services revenue is primarily tied to activity in the cinema industry, and in particular, to the number of movies being produced and distributed by studios and independent filmmakers. Several factors influence the number of movies produced in a given fiscal period, including strikes and work stoppages within the cinema industry, as well as tax incentive arrangements provided by many governments to promote local filmmaking.
Services revenue is also impacted by the transition to digital cinema in some regions.
Other We are party to an agreement under which we obtained naming rights and related benefits with respect to the Dolby Theatre in Hollywood, California. Under the agreement, we made one annual payment in fiscal 2012 and will subsequently make semi-annual payments over the term, which will be recorded as marketing expenses. Our payment obligations are conditioned in part on the Academy Awards® being held and broadcast from the Dolby Theatre. For additional details, see Note 10 "Commitments and Contingencies" to our consolidated financial statements. In addition to these contractual obligations, we anticipate that we will continue to incur increased marketing expenses associated with promoting our products, technologies, and brand at the Dolby Theatre.
Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. ("GAAP"), and pursuant to Securities and Exchange Commission ("SEC") rules and regulations. GAAP and SEC rules and regulations require us to use accounting policies and make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies as of the date of the financial statements, and the reported amounts of revenue and expenses during a fiscal period. The SEC considers an accounting policy and estimate to be critical if it is both important to a company's financial condition and/or results of operations and requires significant judgment on the part of management in its application. On a regular basis, we evaluate our assumptions, judgment, and estimates. We have discussed the selection and 36-------------------------------------------------------------------------------- Table of Contents development of the critical accounting policies and estimates with the Audit Committee of our Board of Directors. The Audit Committee has reviewed our related disclosures in this Annual Report on Form 10-K. Although we believe that our judgments and estimates are appropriate and correct, actual results may differ from these estimates.
We consider the following to be critical accounting policies and estimates because we believe they are both important to the portrayal of our financial condition and results of operations and require management judgments about matters that are uncertain. If actual results or events differ materially, our reported financial condition and results of operation for future periods could be materially affected. See our "Risk Factors" for further information on the potential risks to our future results of operations.
Revenue Recognition We enter into revenue arrangements with our customers to license technologies, trademarks, and know-how and to sell products and services. We recognize revenue when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller's price to the buyer is fixed or determinable, and collectibility is probable. Judgment is required to assess whether collectibility is probable. We determine collectibility based on an evaluation of our customer's recent payment history, the existence of a standby letter of credit between the customer's financial institution and our financial institution, and other factors. Some of our revenue arrangements include multiple elements, such as hardware, software, maintenance, and other services.
We evaluate each element in a multiple element ("ME") arrangement to determine whether it represents a separate unit of accounting. An element constitutes a separate unit of accounting when it has standalone value and delivery of an undelivered element is both probable and within our control. When these criteria are not met, the delivered and undelivered elements are combined and the arrangement fees are allocated to this combined single unit.
If the unit separation criteria are met, we account for each element within a ME arrangement (such as hardware, software, maintenance, and other services) separately, and we allocate fees from the arrangement based on its relative selling price, which we establish using a selling price hierarchy. We determine the selling price of each element based on its VSOE, if available, third-party evidence ("TPE"), if VSOE is not available, or estimated selling price ("ESP"), if neither VSOE nor TPE is available.
For some arrangements, customers receive certain elements over a period of time, after delivery of the initial product. These elements may include support and maintenance and/or the right to receive upgrades. Revenue allocated to the undelivered element is recognized either over its estimated service period or when the upgrade is delivered. We do not recognize revenue that is contingent upon the future delivery of products or services or upon future performance obligations. We recognize revenue for delivered elements only when we have completed all contractual obligations.
We determine our best estimate of the selling price for an individual element within a ME revenue arrangement using the same methods used to determine the selling price of an element sold on a standalone basis. If we sell the element on a standalone basis, we estimate the selling price by considering actual sales prices. Otherwise, we estimate the selling price by considering internal factors such as pricing practices and margin objectives. Consideration is also given to market conditions such as competitor pricing strategies, customer demands, and industry technology lifecycles. Management applies judgment to establish margin objectives, pricing strategies, and technology lifecycles.
Revenue recognition for transactions which involve software, such as fees we earn from certain system licensees, requires judgment, including whether a software arrangement includes multiple elements, and if so, whether vendor specific objective evidence ("VSOE") of fair value exists for those elements.
For some of our ME arrangements, customers receive certain elements of the arrangement over a period of time or after delivery of the initial software.
These elements may include support and maintenance. The fair values of these elements are recognized over the estimated period for which these elements will be delivered, which is sometimes the estimated life of the software. If we do not have VSOE of fair value for any undelivered element included in these ME arrangements for software, we defer revenue until all elements are delivered and/or services have been performed, or until we have VSOE of fair value for all remaining undelivered elements. If the undelivered element is support and we do not have fair value for the support element, revenue for the entire arrangement is bundled and recognized ratably over the support period.
We account for our digital cinema server sales as ME arrangements that may include up to three separate units, or elements, of accounting. The first element consists of our digital cinema server hardware and the accompanying software, which is essential to the functionality of the hardware. This element is typically delivered at the time of sale. The second element is the right to receive support and maintenance, which is included with the purchase of the hardware element and is typically delivered over a service period subsequent to the initial sale. The third element is the right to receive specified upgrades, which is included with the purchase of the hardware element and is typically delivered when a specified upgrade is available, subsequent to the initial sale.
The application of the revenue accounting standards to our digital cinema server sales typically results in the allocation of a substantial majority of the arrangement fees to the delivered hardware element based on 37-------------------------------------------------------------------------------- Table of Contents its ESP, relative to the VSOE or ESP of the other elements, which we recognize as revenue at the time of sale. A small portion of the arrangement fees is allocated to the undelivered support and maintenance element, and in some cases to the undelivered specified upgrade element, based on the VSOE or ESP of each element. The portion of the arrangement fees allocated to the support and maintenance element is recognized as revenue ratably over the estimated service period and the portion of the arrangement fees allocated to specified upgrades is recognized as revenue upon delivery of the upgrade.
Goodwill, Intangible Assets, and Long-Lived Assets We test goodwill for impairment annually during our third fiscal quarter and whenever events or changes in circumstances indicate that the carrying amount may be impaired. In September 2011, the FASB issued ASU 2011-08 which amends the rules for testing goodwill for impairment. We adopted the provisions of ASU 2011-08 for our annual goodwill impairment test performed in the third quarter of fiscal 2012. ASU 2011-08 permits entities to first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test.
In performing the qualitative assessment, we consider events and circumstances, including but not limited to, macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, changes in management or key personnel, changes in strategy, changes in customers, changes in the composition or carrying amount of a reporting unit's net assets and changes in the price of our common stock. If, after assessing the totality of events or circumstances, we determine that it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, then the two-step goodwill impairment test is not performed.
If the two-step goodwill test is performed, we evaluate and test our goodwill for impairment at a reporting-unit level using expected future cash flows to be generated by the reporting unit. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit's goodwill over the calculated fair value of the goodwill. A reporting unit is an operating segment or one level below.
Our operating segments are aligned with the management principles of our business.
We completed our annual goodwill impairment assessment in the fiscal quarter ended June 29, 2012. At the time of our annual goodwill impairment test for fiscal 2012, we had two reporting units: Via, which corresponds to our wholly owned subsidiary and has no assigned goodwill, and Dolby Entertainment Technology ("DET"), with goodwill of $263.5 million. We determined, after performing a qualitative review and assessing the totality of the events and circumstances described above, that it is more likely than not that the fair value of each reporting unit is greater than its carrying amount. Accordingly, there was no indication of impairment and the two-step goodwill impairment test was not performed. We did not recognize any goodwill impairment losses in fiscal 2012, 2011, or 2010.
Intangible assets with definite lives are amortized over their estimated useful lives. Our intangible assets principally consist of acquired technology, patents, trademarks, customer relationships, and contracts, which are amortized on a straight-line basis over their useful lives ranging from two to fifteen years.
We review long-lived assets, including intangible assets, for impairment whenever events or a change in circumstances indicate an asset's carrying value may not be recoverable. Recoverability of an asset is measured by comparing its carrying value to the total future undiscounted cash flows that the asset is expected to generate. If it is determined that an asset is not recoverable, an impairment loss is recorded in the amount by which the carrying value of the asset exceeds its estimated fair value.
Accounting for Income Taxes We make estimates and judgments that affect our accounting for income taxes.
This includes estimating actual tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences, including the timing of the recognition of stock-based compensation expense, result in deferred tax assets and liabilities, which are included in our consolidated balance sheets. We also assess the likelihood that our deferred tax assets will be recovered from future taxable income, and to the extent that we believe that recovery is not likely, we establish a valuation allowance.
Our policy is to recognize a tax benefit from an uncertain tax position only if it is more likely than not that the tax position is sustainable upon examination by tax authorities. We include interest and penalties related to gross unrecognized tax benefits within our provision for income taxes. When accrued interest and penalties do not ultimately become payable, amounts accrued are reduced in the period that such determination is made and are reflected as a reduction of the overall income tax provision.
Significant judgment is required in determining the provision for income taxes, the deferred tax asset and liability balances, the valuation allowance against our deferred tax assets, and the reserve resulting from uncertainties in income tax positions. Our financial position and results of operations may be materially affected if actual results differ significantly from 38-------------------------------------------------------------------------------- Table of Contents these estimates or if the estimates are adjusted in future periods.
Valuation and Classification of Investments Fair value is the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants at the measurement date.
We classify our financial assets and liabilities measured at fair value using a three-level hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are those that reflect the assumptions market participants would use in pricing the investment that are based on market data obtained from sources independent of the reporting entity, such as market quoted prices. GAAP establishes a three-level hierarchy prioritizing the inputs used in measuring fair value as follows: the fair value hierarchy gives the highest priority to quoted prices in active markets that are accessible by us at the measurement date for identical investments, described as Level 1, and the lowest priority to valuation techniques using unobservable inputs, described as Level 3. We obtain the fair value of our Level 2 financial instruments from a professional pricing service, which may use quoted market prices for identical or comparable instruments. Fair value from this professional pricing source can also be based on pricing models whereby all significant inputs, including maturity dates, issue dates, settlement dates, benchmark yields, reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids, offers, and other market related data, are observable or can be derived from or corroborated by observable market data for substantially the full term of the asset.
The degree to which estimates and judgment are used in determining fair value, is generally dependent upon the market pricing information available for the investments, the availability of observable inputs, the frequency of trading in the investments and the investment's complexity. If different judgments regarding inputs were made, we could potentially reach different conclusions regarding the fair value of our investments.
Stock-Based Compensation We determine the expense for all employee stock-based compensation awards by estimating their fair value and recognizing that value as an expense, on a ratable basis, in our consolidated financial statements over the requisite service period in which our employees earn the awards. We use the Black-Scholes option pricing model to determine the fair value of employee stock options at the date of the grant. To determine the fair value of a stock-based award using the Black-Scholes option pricing model, we make assumptions regarding the expected term of the award, the expected future volatility of our stock price over the expected term of the award, and the risk-free interest rate over the expected term of the award. We estimate the expected term of our stock-based awards by evaluating historical exercise patterns of our employees. We use a blend of the historical volatility of our common stock and the implied volatility of our traded options as an estimate of the expected volatility of our stock price over the expected term of the awards. We use an average interest rate based on U.S. Treasury instruments with terms consistent with the expected term of our awards to estimate the risk-free interest rate. We reduce the stock-based compensation expense for estimated forfeitures based on our historical experience. We are required to estimate forfeitures at the time of the grant and revise our estimate, if necessary, in subsequent periods if actual forfeitures differ from our estimate.
Results of Operations Revenue Fiscal Year Fiscal Year Fiscal Year Ended Change Ended Change Ended September 28, September 30, September 24, 2012 $ % 2011 $ % 2010 ($ in thousands) Licensing $ 794,563 $ 4,223 1 % $ 790,340 $ 79,866 11 % $ 710,474 Percentage of total revenue 86 % 83 % 77 % Products 103,388 (28,223 ) (21 )% 131,611 (48,791 ) (27 )% 180,402 Percentage of total revenue 11 % 14 % 20 % Services 28,313 (5,241 ) (16 )% 33,554 1,717 5 % 31,837 Percentage of total revenue 3 % 3 % 3 % Total revenue $ 926,264 $ (29,241 ) (3 )% $ 955,505 $ 32,792 4 % $ 922,713 Licensing. The 1% increase in licensing revenue from fiscal 2011 to fiscal 2012 was primarily driven by increases in revenue from our broadcast and other markets, partially offset by decreases from our CE and PC markets. The increase in 39-------------------------------------------------------------------------------- Table of Contents revenue from our broadcast market was primarily driven by higher shipments in fiscal 2012 of digital televisions and set-top boxes that incorporate our technologies. The increase in revenue from our other markets was primarily driven by increases in sales of mobile and tablet devices incorporating our technologies. The decrease in revenue from our CE market was primarily driven by decreases in revenue from DVD and Blu-Ray Disc players, as more content is delivered on devices that do not contain optical drives. The decrease in revenue from our PC market was primarily driven by decreased ISV media applications in PC shipments.
The 11% increase in licensing revenue from fiscal 2010 to fiscal 2011 was primarily driven by an increase in revenue from our broadcast and other markets, and to a lesser extent, by increases in revenue from our CE market, partially offset by decreases from our PC market. The increase in revenue from our broadcast market was primarily driven by higher shipments in fiscal 2011 of digital televisions and set-top boxes that incorporate our technologies. The increase in revenue from our other markets was primarily driven by higher back royalties, in addition to increases in sales of devices incorporating our Dolby Mobile technology. The increase in revenue from our CE market was primarily driven by increases in revenue from shipments of Blu-Ray Disc players, home-theater-in-a-box systems, digital media adaptors, and audio/video receivers that incorporate our technologies, which were partially offset by a decrease in revenue from shipments of standard DVD players. The decrease in revenue from our PC market was primarily driven by decreased ISV media applications in PC shipments.
Products. The 21% decrease in products revenue from fiscal 2011 to fiscal 2012 was primarily due to decreases in our 3D and traditional cinema products driven by lower shipments and lower selling prices.
The 27% decrease in products revenue from fiscal 2010 to fiscal 2011 was due to decreases in 3D and traditional cinema products revenue in fiscal 2011, coupled with our adoption of new revenue recognition accounting standards in fiscal 2010. Decreases in 3D products revenue in fiscal 2011 resulted from increased competition and promotional pricing, while decreases in traditional cinema products revenue were primarily due to lower shipments, as more exhibitors converted to digital cinema. In addition, products revenue in fiscal 2010 included recognition of $29.7 million of deferred revenue related to sales prior to the beginning of the year, which were accounted for under previous revenue accounting standards. In fiscal 2011 substantially all products revenue resulting from current period sales were accounted for under the new accounting standards.
Services. The 16% decrease in services revenue from fiscal 2011 to fiscal 2012 was attributable primarily to a decrease in film-based production services revenue as the cinema industry transitions to digital cinema as well as decreases in virtual print fees, which were generated from certain leased digital cinema assets, as we discontinued this program in fiscal 2011. This decrease was partially offset by an increase in maintenance and support services.
The 5% increase in services revenue from fiscal 2010 to fiscal 2011 was primarily driven by increases in revenue from support and maintenance for digital cinema equipment and from other theater services.
Gross Margin Fiscal Year Ended September 28, September 30, September 24, 2012 2011 2010 ($ in thousands) Cost of licensing $ 12,924 $ 17,620 $ 17,565 Licensing gross margin percentage 98 % 98 % 98 % Cost of products 66,325 81,328 90,695 Products gross margin percentage 36 % 38 % 50 % Cost of services 12,778 12,223 13,961 Services gross margin percentage 55 % 64 % 56 % Impairment of products provided - - 9,594 under operating leases Total gross margin percentage 90 % 88 % 86 % Licensing Gross Margin. We license intellectual property to our customers that may be internally developed, acquired by us, or licensed from third parties. Our cost of licensing consists principally of amortization expenses associated with purchased intangible assets and intangible assets acquired in business combinations. Our cost of licensing also includes third-party royalty obligations paid to license intellectual property that we then sublicense to our customers. Licensing gross margin was unchanged from fiscal 2011 to fiscal 2012 and from fiscal 2010 to fiscal 2011.
Product Gross Margin. Cost of products primarily consists of the cost of materials related to products sold, applied labor and manufacturing overhead, and, to a lesser extent, amortization of certain intangible assets. Our cost of products also includes third-party royalty obligations paid to license intellectual property that we then include in our products. Products gross 40-------------------------------------------------------------------------------- Table of Contents margin decreased from 38% to 36% from fiscal 2011 to fiscal 2012, due to lower selling prices for digital cinema and traditional cinema products, lower shipments of 3D, traditional cinema and broadcast products and excess manufacturing capacity charges in fiscal 2012, partially offset by a decrease in discrete charges related to inventory valuation and other inventory adjustments.
Product gross margin decreased from 50% to 38% from fiscal 2010 to fiscal 2011, due in part to promotional pricing on 3D and digital cinema products in fiscal 2011. The decrease in gross margin for fiscal 2011 is further attributable to discrete charges of $6.4 million, consisting primarily of $6.2 million related to 3D and broadcast inventory valuation and other inventory adjustments.
Services Gross Margin. Cost of services primarily consists of personnel and personnel-related costs for employees performing our professional services, the cost of outside consultants, and reimbursable expenses incurred on behalf of customers. Services gross margin decreased from 64% to 55% from fiscal 2011 to fiscal 2012, primarily due to decreased revenues from certain higher margin service offerings.
Services gross margin increased from 56% to 64% from fiscal 2010 to fiscal 2011, primarily due to a higher percentage of support and maintenance revenue, which has higher gross margins due to lower associated costs. In addition, depreciation expense related to digital cinema equipment leased to exhibitors was lower in fiscal 2011.
Impairment of Products Provided Under Operating Leases. Our products provided under operating leases represent digital cinema equipment that we leased to exhibitors beginning in fiscal 2005 in an effort to encourage the cinema industry to transition to digital cinema. We receive a virtual print fee from participating film studios for each digital print delivered for exhibition on this equipment. Based on our estimates of future cash flows from virtual print fees and the potential sale value of this equipment, we determined that the equipment was impaired in fiscal 2010. Accordingly, we recorded the $9.6 million excess of the carrying value over the estimated fair market value of the equipment as an impairment charge. We had historically recorded the depreciation of our products provided under operating leases to cost of services.
Operating Expenses Fiscal Year Fiscal Year Fiscal Year Ended Change Ended Change Ended September 28, 2012 $ % September 30, 2011 $ % September 24, 2010 ($ in thousands) Research and development $ 140,143 $ 16,223 13 % $ 123,920 $ 18,942 18 % $ 104,978 Percentage of total revenue 15 % 13 % 11 % Sales and marketing 181,736 32,094 21 % 149,642 19,482 15 % 130,160 Percentage of total revenue 20 % 16 % 14 % General and administrative 149,175 11,542 8 % 137,633 18,280 15 % 119,353 Percentage of total revenue 16 % 14 % 13 % Restructuring charges, net 1,191 (2,215 ) (65 )% 3,406 (3,620 ) (52 )% 7,026 Percentage of total revenue - % - % 1 % $ 472,245 $ 57,644 14 % $ 414,601 $ 53,084 15 % $ 361,517 Research and Development. Research and development expenses consist primarily of employee compensation and benefits expenses, including stock-based compensation, consulting and contract labor costs, depreciation and amortization expenses, facilities costs, and information technology expenses. The 13% increase in research and development expenses from fiscal 2011 to fiscal 2012 was primarily driven by increases in compensation and benefits expenses related to increased headcount, higher information and technology expenses, higher facilities and related costs resulting from an increase in the number of offices, and increases in prototype expenses relating to new Cinema and Professional Reference Monitor products.
The 18% increase in research and development expenses from fiscal 2010 to fiscal 2011 was primarily driven by increases in personnel, facilities, and information technology expenses related to increased headcount, as well as stock-based compensation expense. These increases were partially offset by a decrease in performance-based compensation.
Sales and Marketing. Sales and marketing expenses consist primarily of employee compensation and benefits expenses, including stock-based compensation, marketing and promotional expenses, travel-related expenses for our sales and marketing personnel, facilities costs, depreciation and amortization expenses, and information technology expenses. The 21% increase in sales and marketing expenses from fiscal 2011 to fiscal 2012 was primarily driven by increases in compensation and benefits expenses related to increased headcount, including stock-based compensation, higher consulting and marketing costs due to promotional events and expenses associated with the agreement for naming rights related to the Dolby Theatre and due to the 41-------------------------------------------------------------------------------- Table of Contents launch of Dolby Atmos, as well as increased facilities costs resulting from an increase in the number of offices. Increased settlements from implementation licensees in fiscal 2012 slightly offset the increases noted above. These settlements are recorded as an offset to sales and marketing expenses.
The 15% increase in sales and marketing expenses from fiscal 2010 to fiscal 2011 was primarily driven by increases in personnel costs, due to increased headcount, and stock-based compensation expense, as well as higher facilities and information technology expenses resulting from worldwide expansion. Also contributing to the increase in fiscal 2011 were lower gains on settlements from implementation licensees, which are reductions to sales and marketing expenses, of $5.6 million in fiscal 2011, compared to $7.8 million in fiscal 2010. These increases in fiscal 2011 were partially offset by a decrease in performance-based compensation.
General and Administrative. General and administrative expenses consist primarily of employee compensation and benefits expenses, including stock-based compensation, depreciation, information technology expenses, professional fees, consulting and contract labor and facilities costs. The 8% increase in general and administrative expenses from fiscal 2011 to fiscal 2012 was primarily due to increases in compensation and benefit expenses related to increased headcount, higher professional fees primarily related to patent filings and litigation, and to a lesser extent, an increase in depreciation expense primarily related to implementation of recent IT projects. These were partially offset by decreases in consulting and external labor costs.
The 15% increase in general and administrative expenses from fiscal 2010 to fiscal 2011 was primarily due to increases in consulting and contract labor, stock-based compensation expense, and professional fees related to patent filings and litigation, partially offset by a decrease in performance-based compensation.
Restructuring Charges, net. Restructuring charges for fiscal 2012 and fiscal 2011 primarily include severance charges attributable to the reorganization of our global business infrastructure and a strategic restructuring program.
Restructuring charges for fiscal 2010 also include an impairment charge related to the decision to sell one of our buildings in the U.K. For additional details, see Note 7 "Restructuring" to our consolidated financial statements.
Other Income, Net Fiscal Year Fiscal Year Fiscal Year Ended Change Ended Change Ended September 28, September 30, September 24, 2012 $ % 2011 $ % 2010 ($ in thousands) Interest income $ 6,411 $ (2,565 ) (29 )% $ 8,976 $ 1,678 23 % $ 7,298 Interest expense (196 ) (1,223 ) (119 )% 1,027 1,730 246 % (703 ) Other income/(expense), net 784 (123 ) (14 )% 907 (129 ) (12 )% 1,036 Total other income, net $ 6,999 $ (3,911 ) (36 )% $ 10,910 $ 3,279 43 % $ 7,631 Other income, net, primarily consists of interest income earned on cash, cash equivalents, and investments. In fiscal 2010, this income was offset by interest expense principally attributable to debt balances on certain of our facilities.
All facility-related debt was fully paid in fiscal 2010. In fiscal 2011 interest expense reflects a $1.4 million reversal of interest expense related to VAT reserve releases. Also included are net gains/losses from foreign currency transactions, net gains/losses from sales of available-for-sale securities, net gains/losses from trading securities, and net gains/losses from derivative instruments.
The decrease in other income, net from fiscal 2011 to fiscal 2012 was primarily due to a decrease in interest income and an increase in interest expense. The decrease in interest income was due to a decrease in cash, cash equivalents and investment balances, in aggregate, compared to fiscal 2011 and lower average interest rates on our investments. The interest expense increased in fiscal 2012, when compared to fiscal 2011, as the interest expense in fiscal 2011 included the impact of reversal of interest expense related to VAT reserve releases.
The increase in other income, net from fiscal 2010 to fiscal 2011 was primarily due to $2.2 million of interest income related to back royalties, as well as the reversal of interest expense related to VAT reserve releases. In addition, interest expense decreased in fiscal 2011, when compared to fiscal 2010, as all long-term debt was repaid in the fourth quarter of fiscal 2010.
42-------------------------------------------------------------------------------- Table of Contents Income Taxes Fiscal Year Ended September 28, September 30, September 24, 2012 2011 2010 ($ in thousands) Provision for income taxes $ 103,857 $ 130,061 $ 154,185 Effective tax rate 28 % 30 % 35 % Our effective tax rate for fiscal 2012 was 28%, as compared to 30% in fiscal 2011. Our effective tax rate reflects additional benefits from our election to indefinitely reinvest a portion of our undistributed earnings in certain foreign subsidiaries. We also benefited from a change in the State of California apportionment sourcing rules, which began to affect our current California taxes beginning in the first quarter of fiscal 2012. These benefits were partially offset by the expiration of the federal research and development tax credits, beginning January 1, 2012, which resulted in an increase in our effective tax rate.
Our effective tax rate for fiscal 2011 was 30%, as compared to 35% in fiscal 2010. In the fiscal quarter ended December 31, 2010, we initiated a policy to indefinitely reinvest a portion of our undistributed earnings in certain foreign subsidiaries, which are subject to tax rates lower than those in the U.S. As a result, our fiscal 2011 tax rate decreased. In the fourth quarter of fiscal 2011, we reduced our current deferred tax assets to reflect a change to our expected California tax rate for fiscal 2012 and subsequent years, increasing our effective tax rate for fiscal 2011 by 1.4%. Additionally, in the fiscal quarter ended December 31, 2010, a change in the tax law retroactively reinstated the federal research and development tax credits. As a result, we recognized an increase in federal research and development tax credits for fiscal 2011, as compared to fiscal 2010, thereby further lowering our effective tax rate for fiscal 2011 by 0.5%.
Further, in the fiscal quarter ended December 31, 2010, we released $11.0 million of our deferred tax liability related to the amortization of an intangible asset from a prior year acquisition, as a result of the restructuring of our international operations, which also favorably impacted our effective tax rate for fiscal 2011 by 2.5%. For additional information related to effective tax rates, see Note 8 "Income Taxes" to our consolidated financial statements.
Liquidity, Capital Resources, and Financial Condition As of September 28, 2012, we had cash and cash equivalents of $492.6 million, which consisted of cash and highly-liquid money market funds. In addition, we had short-term and long-term investments of $664.3 million, which consisted primarily of municipal debt securities, corporate bonds, and U.S. agency securities. Of our total cash, cash equivalents, and investments held as of September 28, 2012, approximately $234.4 million, or 20%, was held by our foreign subsidiaries. This represented a $88.1 million increase from the $146.3 million that was held by our foreign subsidiaries as of September 30, 2011. A majority of the amounts held outside of the U.S. are generally utilized to support non-U.S. liquidity needs in order to fund operations and other growth of our non-U.S. subsidiaries and acquisitions. Our policy is to indefinitely reinvest a portion of our undistributed earnings in certain foreign subsidiaries. If these undistributed earnings held by foreign subsidiaries are repatriated to the U.S., they may be subject to U.S. federal income taxes and foreign withholding taxes, less applicable foreign tax credits.
Fiscal Year Ended September 28, September 30, 2012 2011 (in thousands) Cash and cash equivalents $ 492,600 $ 551,512 Short-term investments 302,693 391,281 Long-term investments 361,614 272,797 Accounts receivable, net 43,495 61,815Accounts payable and accrued liabilities 130,923 127,922 Working capital(a) 813,446 999,213 Net cash provided by operating activities 389,797 403,688 Capital expenditures(b) (167,349 ) (47,362 ) Net cash used in investing activities (194,679 ) (236,702 ) Net cash used in financing activities (254,318 ) (162,498 ) (a) Working capital consists of total current assets less total current liabilities.
(b) Capital expenditures consist of purchases of land, building, building fixtures, office equipment, computer hardware and software, leasehold improvements, and production and test equipment.
43-------------------------------------------------------------------------------- Table of Contents Our principal sources of liquidity are our cash, cash equivalents, and investments, as well as cash flows from operations. We believe that our cash, cash equivalents, and potential cash flows from operations will be sufficient to satisfy our currently anticipated cash requirements through at least the next 12 months.
We have historically generated significant cash from our operations; however, there can be no assurance that our operations will continue to generate significant cash flows in the future. We retain sufficient cash holdings to support our operations and we also purchase investment grade securities diversified among security types, industries, and issuers. We have used cash generated from our operations to fund a variety of activities related to our business in addition to our ongoing operations, including business expansion and growth, acquisitions, and repurchases of our common stock. Cash provided by operations and the value of our investment portfolio could also be affected by various risks and uncertainties, as described in Part II, Item 1A "Risk Factors." Net cash provided by operating activities during fiscal 2012 decreased $13.9 million when compared to fiscal 2011, primarily due to the following: • A decrease in net income, as adjusted for non-cash items, • A decrease in deferred revenue in fiscal 2012 due to timing of licensing contracts, offset by • A decrease in accounts receivable due to timing differences and higher collections in fiscal 2012.
Net cash used in investing activities during fiscal 2012 decreased $42.0 million when compared to fiscal 2011, primarily due to the following: • An increase in proceeds from the sale and maturities of available-for-sale securities, offset by • An increase in capital expenditures in fiscal 2012 which includes the purchase of the 1275 Market Street Building, and • Acquisition of IMM Sound.
Net cash used in financing activities during fiscal 2012 increased $91.8 million when compared to fiscal 2011, primarily due to the following: • An increase in share repurchases of our Class A common stock, and • A decrease in net proceeds from the exercise of stock options granted to employees and the related tax benefit.
Off-Balance-Sheet and Contractual Obligations Our liquidity is not dependent on the use of off-balance sheet financing arrangements.
The following table presents a summary of our contractual obligations and commitments as of September 28, 2012: Payments Due By Period 2-3 4-5 More than 1 Year Years Years 5 Years Total (in thousands) Naming rights (1) $ - $ 14,773 $ 15,144 $ 126,414 $ 156,331 Operating leases (2) 13,751 18,700 10,008 5,981 48,440 Purchase obligations (3) 3,832 712 - - 4,544 Total $ 17,583 $ 34,185 $ 25,152 $ 132,395 $ 209,315 (1) In April 2012, we entered into an agreement for naming rights and related benefits with respect to the Dolby Theatre in Hollywood, California, the location of the Academy Awards®. In exchange for these rights and other benefits, we made one annual payment in fiscal 2012 and will subsequently make semi-annual payments over the term. Our payment obligations are conditioned in part on the Academy Awards® being held and broadcast from the Dolby Theatre. The term of the agreement is 20 years.
(2) Operating lease payments include future minimum rental commitments, including those payable to our principal stockholder and portions attributable to the controlling interests in our wholly owned subsidiaries, for non-cancelable operating leases of office space as of September 28, 2012.
(3) Our purchase obligations consist of agreements to purchase goods and services, entered into in the ordinary course of business. These represent non-cancelable commitments for which a penalty would be imposed if the agreement was canceled for any reason other than an event of default as described by the agreement.
As of September 28, 2012, we had an accrued liability for unrecognized tax benefits and related interest and penalties, net of related deferred tax assets, totaling $14.2 million. We are unable to estimate when any cash settlement with a taxing authority might occur.
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