Dolby Laboratories, Inc. 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 key challenges listed below and 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. Investors and others should note that we disseminate information to the public about our company, our products, services and other matters through various channels, including our website (www.dolby.com), our investor relations website (http://investor.dolby.com), SEC filings, press releases, public conference calls, and webcasts, in order to achieve broad, non-exclusionary distribution of information to the public. We encourage investors and others to review the information we make public through these channels, as such information could be deemed to be material information. COVID-19 In December 2019, a novel coronavirus disease was first reported and in January 2020, the World Health Organization ("WHO") declared it a Public Health Emergency of International Concern. On March 11, 2020, the WHO characterized COVID-19 as a pandemic. COVID-19 has triggered worldwide shutdowns, job losses, and other disruptions which in turn have negatively affected the global economy, including consumer purchasing activity. Because Dolby technologies are featured in a wide array of electronic products that are primarily purchased by consumers, our revenues have been negatively affected by COVID-19. The issues and circumstances relating to COVID-19 continue to change rapidly and are difficult to predict. We continue to monitor the evolving situation and the impact on our business. The outbreak of COVID-19 has also affected many of our partners, resulting in the disruption of consumer products' supply chains and delays in shipments, product development, and product launches. Consumer demand for products that include our technologies may continue to be negatively impacted due to economic uncertainty resulting from COVID-19. These factors have resulted in decreased revenue pertaining to royalties on consumer devices and may cause delays in the adoption of our technologies by partners. The overall cinema market has been adversely impacted by COVID-19 shelter-in-place and social distancing mandates. Our exhibition partners and customers have had to either partially or fully discontinue operations. This has resulted in a significant reduction in box office receipts at Dolby Cinema sites and lower demand for our cinema products and services. Though select cinema locations have been permitted to resume operations, many such locations are operating significantly below capacity. It remains uncertain when the cinemas will be able to operate at full capacity. At Dolby, we implemented work-from-home policies within all our offices in locations with ongoing outbreaks and put in place additional safety measures and global travel restrictions to ensure the well-being of our employees. We have enabled our employees with the tools and infrastructure they need to carry on our critical operations and progress the business forward in this remote working environment. Select Dolby offices in certain locations have resumed in-office work at less than full capacity, dependent on local progress against COVID-19 and applicable rules and regulations in those jurisdictions, as well as the readiness of our facilities to accommodate appropriate safety measures for our employees. We expect COVID-19 will continue to have an impact for the foreseeable future. The degree of impact on our business will depend on several factors, such as the full duration and the extent of the pandemic, as well as actions taken by governments, businesses and consumers in response to the pandemic, all of which continue to evolve and remain uncertain at this time. Further discussion of the potential impacts of COVID-19 on our business can be found in Part I, Item 1A " Risk Factors ." EXPANDING OUR LEADERSHIP IN AUDIO AND IMAGING EXPERIENCES We are focused on expanding our leadership in audio and imaging solutions for premium entertainment content by increasing the number of Dolby experiences that people can enjoy, which will drive revenue growth across the 32 Table of Contents markets we serve. We aim to drive revenue growth by broadening Dolby experiences to more types of content, such as music and gaming, that can increase our value proposition in our existing device categories and create opportunities in new device categories that can accelerate adoption of our technologies. We are also beginning to leverage our audio and imaging expertise to expand the reach of our technologies to address content beyond premium entertainment that can create new revenue generating opportunities. Following is a discussion of the key markets that we address and the various Dolby technologies and solutions that serve these markets. LICENSING The majority of our licensing revenue is derived from the licensing of audio and imaging technologies for premium entertainment playback. Our audio technologies are primarily comprised of DD+, Dolby Atmos, AC-4, and our AAC and HE-AAC technologies. Our imaging technologies are primarily comprised of Dolby Vision and our AVC and HEVC technologies. The following are certain highlights from fiscal 2020 and key challenges related to audio and imaging licensing, by market. Broadcast Highlights: We have an established global presence with respect to our DD+ and HE-AAC audio technologies in broadcast services and devices. In recent years, we have expanded our offerings in the broadcast market through the introduction of newer technologies, including our Dolby Atmos and AC-4 audio technologies, Dolby Vision, as well as AVC and HEVC imaging technologies which we license through patent pools. We continue to add new TV partners for Dolby Vision and Dolby Atmos. For example, during fiscal 2020, Xiaomi launched their first TV model that supports both Dolby Vision and Dolby Atmos. In addition, many of our existing partners expanded their support of the combined Dolby Vision and Dolby Atmos experience by releasing more models and expanding into international markets, such as India. As a result, the adoption of Dolby Vision and Dolby Atmos within 4K TV shipments grew compared to the previous year. Also this year, we launched Dolby Vision IQ along with our TV partners LG and Panasonic. Dolby Vision IQ automatically adjusts the TV picture according to the surrounding light and the type of content being viewed, creating an enhanced viewing experience. We continued to see engagement with partners supporting our newer technologies in STBs. In fiscal 2020, Free, a broadcast service provider in France, as well as Deutsche Telekom in Germany, both launched their first STBs supporting Dolby Vision and Dolby Atmos. Key Challenges : Our pursuit of growth and further adoption of our technologies may be impacted by a number of factors. In certain countries, such as China, we face difficulties enforcing our contractual and IP rights, including instances in which our licensees fail to accurately report the shipment of products using our technologies. We must continue to present compelling reasons for consumers to demand our audio and imaging technologies, including ensuring that there is a breadth of available content in our formats and such content is being widely distributed. To the extent that OEMs do not incorporate our technologies in current and future products, our revenue could be impacted. Additionally, in the broadcast market, as well as other markets, we face geopolitical challenges including changes in diplomatic and trade relationships, trade protection measures, and import or export licensing requirements. Further, COVID-19 is causing uncertainty about consumer demand for devices and services in the broadcast market, the ability of our partners to manufacture such devices due to supply chain disruption, timing of the adoption of our technologies into new products by partners and licensees, and the timing of launches for new products. Mobile Highlights: We continue to focus on adoption of our technologies across major mobile ecosystems, including Apple and Android. HE-AAC and HEVC are widely adopted audio and video technologies across mobile devices. We offer these technologies through our patent licensing programs. We also continue to focus on expanding adoption of our DD+, AC-4, Dolby Atmos, and Dolby Vision technologies in the mobile market. The breadth of mobile devices supporting Dolby technologies continues to increase globally. In fiscal 2020, Apple continued to adopt Dolby Vision and Dolby Atmos across their portfolio of devices, leading to support for Dolby Vision capture and playback on Apple’s newest iPhone, and AirPods Pro support of Dolby Atmos with the 33 Table of Contents release of iOS14. In addition, a majority of Apple's other iOS product offerings support the combined experience of Dolby Vision and Dolby Atmos. Additional Dolby Atmos-enabled mobile devices are available in the market from partners such as Samsung, Amazon, Oppo, and Sony. Key Challenges: Growth in this market is dependent on several factors. Due to short product life cycles, mobile device OEMs can readily add or remove certain of our technologies from their devices. Our success depends on our ability to address the rapid pace of change in mobile devices, and we must continuously collaborate with mobile device OEMs to incorporate our technologies. We rely on a small number of partnerships with key participants in the mobile market. If we are unable to maintain these key relationships, we may experience a decline in mobile devices incorporating our technologies. To the extent that OEMs do not incorporate our technologies in current and future products, our revenue could be impacted. Additionally, we must continue to support the development and distribution of Dolby enabled content via various ecosystems. Further, COVID-19 is causing uncertainty about consumer demand for devices in the mobile market, the ability of our partners to manufacture such devices due to supply chain disruption, timing of the adoption of our technologies into new products by partners and licensees, and the timing of launches for new products. Consumer Electronics Highlights : We have an established presence in the home entertainment market across devices such as AVRs, soundbars, smart speakers, Blu-Ray players, and DMAs, through the inclusion of our DD+ technology, and increasingly through the inclusion of our Dolby Atmos technology. AAC and HE-AAC technologies also have broad adoption through our patent licensing programs. These home entertainment devices can be paired with a growing array of Dolby enabled content via OTT services and Blu-ray discs. In fiscal 2020, the breadth of devices in the home entertainment market supporting Dolby Atmos continued to expand. Sonos launched a new soundbar that supports Dolby Atmos, and Roku launched their new DMA supporting Dolby Vision and Dolby Atmos. In addition, content available in Dolby Vision and Dolby Atmos continued to grow in fiscal 2020, broadening our opportunities for increased adoption in more devices. Google Play, Showtime, and CBS began supporting Dolby Vision content. Additional OTT services currently supporting the combined experience of Dolby Vision and Dolby Atmos include Netflix, Disney+, Amazon, and Apple TV+. We have also expanded our global presence with Hotstar supporting Dolby Vision within their Disney+ content in India, and Tencent and iQiYi supporting Dolby Vision and Dolby Atmos in China. We continue to focus on expanding the availability of Dolby technologies to new devices and new forms of content such as music, bringing new Dolby experiences to the market. In fiscal 2020, TIDAL began enabling Dolby Atmos for music to a growing number of TVs, soundbars, and AVR devices through their streaming app. In addition, Dolby Atmos music is available on the Amazon Echo Studio smart speaker streaming from Amazon Music HD. Key Challenges : We must continue to present compelling reasons for consumers to demand our technologies wherever they enjoy entertainment content, while promoting creation and broad availability of content in our formats. To the extent that OEMs do not incorporate our technologies in current and future products, our revenue could be impacted. Further, COVID-19 is causing uncertainty about consumer demand for devices in the home entertainment market, the ability of our partners to manufacture such devices due to supply chain disruption, timing of the adoption of our technologies into new products by partners and licensees, and the timing of launches for new products. Personal Computers Highlights : DD+ continues to enhance playback in both Mac and Windows operating systems, including native support in their respective Safari and Microsoft Edge browsers. Dolby's presence in these browsers enables us to reach more users through various types of content, including streaming video entertainment. In fiscal 2020, Lenovo and ASUS released a number of gaming laptops with Dolby Atmos broadening the consumer base that can experience Dolby technologies. Also during the year, a number of gaming titles enabled in Dolby Atmos were released across multiple gaming platforms such as PCs. In addition, a number of PCs from partners such as Apple, Lenovo, Dell, and ASUS support Dolby Vision and Dolby Atmos. 34 Table of Contents Key Challenges : PC revenues have been impacted by a decline in the portion of PCs that have optical disc functionality in recent years, which has resulted in a decline in our ASPs, and we expect this decline in ASPs to continue. If declining conditions and trends persist, and OEMs do not incorporate our technologies in current and future products, our PC revenues will face continuing downward pressure. We must continuously collaborate and maintain our key partnership relationships with PC manufacturers to incorporate our technologies, and we must continue to support the development and distribution of Dolby content via various ecosystems. Further, COVID-19 is causing uncertainty about consumer demand for devices in the PC market, the ability of our partners to manufacture such devices due to supply chain disruption, timing of the adoption of our technologies into new products by partners and licensees, and the timing of launches for new products. Other Markets Highlights : DD+ is incorporated in the Xbox and PlayStation gaming consoles and streaming platforms for movie and television content. In fiscal 2020, Microsoft announced that their next generation Xbox Series X and Series S will be the first gaming consoles to support Dolby Vision and Dolby Atmos for gaming content. We also generate revenue from the automotive industry primarily through disc playback devices as well as other elements of the entertainment system, and are focused on expanding our presence in music in the automotive industry. Key Challenges : Consumer demand for devices in the gaming industry is impacted by the anticipation of console refresh cycles. In addition, the gaming console market has competition from mobile devices and gaming PCs, which have faster refresh cycles and appeal to a broader consumer base. These factors may impact our future revenues. If OEMs do not incorporate our technologies in current and future products, our revenues will face downward pressure. Further, COVID-19 is causing uncertainty about consumer demand for devices in the gaming industry, the ability of our partners to manufacture such devices due to supply chain disruption, timing of the adoption of our technologies into new products by partners and licensees, and the timing of launches for new products. In addition to licensing revenue derived from the licensing of audio and imaging technologies from the markets discussed above, we offer our audio and imaging technologies to create Dolby experiences through Dolby Cinema. Dolby Cinema Highlights: We continued to expand our global presence for Dolby Cinema. In fiscal 2020, the first Dolby Cinemas were opened in South Korea and Saudi Arabia, and we established more partnerships with global exhibitors. At the end of the fiscal year, we had over 250 Dolby Cinema locations established across 13 countries. The breadth of motion pictures for Dolby Cinema continues to grow with over 300 theatrical titles in Dolby Vision and Dolby Atmos having been announced or released from all the major studios. Key Challenges: Although the premium large format market for the cinema industry has been growing, Dolby Cinema competes with other existing offerings. Our success depends on our partners and their success and our ability to differentiate our offering, deploy new sites in accordance with plans, and attract and retain a global viewing audience. In addition, the success of our Dolby Cinema offering will be tied to global box office performance generally. COVID-19 has had, and is likely to continue to have, a significant effect on theatrical exhibition. The response to COVID-19 including the closure of cinemas, shelter-in-place mandates and government-imposed social-distancing restrictions have had, and are likely to continue to have, a negative impact on our cinema-related revenues and consumer demand. Further, studios have delayed the release of a number of new movie titles and temporarily suspended the production of future releases. It is uncertain whether consumer demand for the cinema and other forms of indoor recreation will return to previous levels. In addition, when cinemas reopen, exhibitor partners may operate fewer screens in response to decreased attendance. 35 Table of Contents PRODUCTS & SERVICES A majority of our products and services revenues are derived from the sale of audio and imaging products for the cinema, television, broadcast, communication, and entertainment industries. Revenues from the sale of Dolby Conference Phones, Dolby Voice Room, as well as our recently launched Developer Platform are included in products and services. Cinema Products & Services Highlights: To help enable the playback of content in Dolby formats, we offer a range of servers and audio processors to cinema exhibitors globally. Dolby Atmos has been adopted broadly across studios, content creators, post-production facilities, and exhibitors. As of the end of fiscal 2020, there are over 6,000 Dolby Atmos screens installed or committed and over 1,800 Dolby Atmos theatrical titles have been announced or released. We also offer a variety of other cinema products, which include the IMS3000, an integrated imaging and audio server with Dolby Atmos, the Dolby Multichannel Amplifier, and our high-power flexible line of speakers. These products allow us to offer exhibitors a more complete Dolby Atmos solution that is often more cost effective than what was previously available to them. Key Challenges: Demand for our cinema products is dependent upon our partners and their success in the market, industry and economic cycles, box office performance, and our ability to develop and introduce new technologies, further our relationships with content creators, and promote new cinematic audio and imaging experiences. A significant portion of our growth opportunity lies in international markets, such as China, which are subject to economic risks as well as geo-political risks. We may also be faced with pricing pressures or competing technologies, which would affect our revenue. Additionally, the effects of COVID-19 such as the closure of cinemas, social distancing requirements, and shelter-in-place mandates have had, and are likely to continue to have, a negative impact on demand for cinema products and services. COVID-19 has also negatively impacted the financial health of our cinema customers and partners. If cinemas permanently close, our equipment may be available for resale on the secondary market, and erode the demand for new products. These conditions are likely to continue after the end of government-imposed restrictions. Dolby Voice Highlights: In fiscal 2020, we sold hardware products such as the Dolby Conference Phone and the Dolby Voice Room, which include our Dolby Voice technology. In response to the changing market opportunities, in the first quarter of fiscal 2021 we decided to begin exiting the sale and leasing of conference hardware. Going forward, our Dolby Voice efforts will be focused on expanding the availability of our technologies through our developer platform and our software solutions for enterprise communications partners. Key Challenges: As we shift away from hardware solutions, we may face challenges in how we expand our technologies to new offerings and solutions. Our success will depend on our ability to attract a robust developer community and new industry relationships as we to bring our services and technologies to market. 36 Table of Contents Other Services Highlights: We are focused on bringing our expertise in media and communications to a broader range of digital experiences. In fiscal 2020 we launched our developer platform, Dolby.io, which enables developers to access our technologies through APIs. The initial offerings include media processing APIs for analyzing and improving the sound of recorded audio files, and interactivity APIs for enabling developers to embed enhanced communications experiences within their applications. Following the initial launch of Dolby.io, we have seen increased customer engagement with our media and interactivity APIs for use cases such as entertainment, online education and telehealth. For example, we have partnered with SoundCloud to incorporate our music mastering APIs within their online music distribution platform. Key Challenges: Our success in this market will depend on the number of developers we are able to attract, the volume of usage of the service, and our ability to monetize our services. Although the market for online experiences has been growing, Dolby's interactivity API technologies compete with other offerings. In addition, our pursuit of growth and further adoption depends on our ability to continue to innovate and add additional value to our services. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our consolidated financial statements and accompanying notes are prepared in accordance with U.S. GAAP, pursuant to SEC rules and regulations. The preparation of these financial statements requires us to establish accounting policies and make certain estimates and assumptions that affect the reported amounts of assets and liabilities, revenue and expenses. The SEC considers an accounting policy and estimate to be critical if it is both important to a company’s financial condition or results of operations and requires significant judgment by management in its application. On a regular basis, we evaluate our assumptions, judgments, and estimates, and historically, actual results have not differed significantly from them. If actual results or events differ materially from our judgments and estimates, our reported financial condition and results of operation for future periods could be materially affected. We have reviewed the selection and development of the critical accounting policies and estimates discussed below with the Audit Committee of our Board of Directors. Revenue Recognition We derive our revenue primarily from the licensing of our technologies and patents . In determining how revenue should be recognized, a five-step process is used, which requires judgment and estimates within the revenue recognition process. Generally, revenue is recognized upon transfer of control of promised products, services or intellectual property and technologies (“IP”) rights to customers in an amount that reflects the consideration that we expect to receive in exchange for those products, services or licensing of the IP rights. The primary judgments include estimating sales-based revenues in advance of receiving statements from our licensees, estimating variable consideration, identifying the performance obligations in the contract, and determining whether the performance obligations are distinct, and allocating consideration accordingly. Most of our licensing arrangements are structured as sales-based whereby we are paid a unit-based royalty. The unit-based sales data that triggers the royalty obligation is generally reported to us in the quarter after triggering the royalty obligation. We apply the royalty exception to these arrangements, which requires that we recognize sales-based royalties at the later of when the sales occur based on our estimates or the completion of our performance obligations. Our estimates of royalty-based revenue take into consideration the macroeconomic effect of global events, such as COVID-19 or other natural disasters which may impact supply chain activities as well as demand for shipments. These estimates also involve the use of historical data and judgment for several key attributes including industry estimates of expected shipments, the percentage of markets using our technologies, and average sale prices. Generally, our estimates represent the current period’s shipments for which we expect our licensees to submit royalty statements in the following quarter. Upon receipt of royalty statements from the licensees with the actual reporting of sales-based royalties that we previously estimated, we record a favorable or unfavorable adjustment based on the difference, if any, between estimated and actual sales. We also enter into fixed and guaranteed licensing fees arrangements, which require the licensee to pay a fixed, non-refundable fee. In these cases, control is transferred and the transaction price - the amount we expect to be entitled to in exchange for the license right - is recognized upon the later of contract execution or the effective date. Transaction price is determined at contract execution and, to the extent variable consideration applies, is updated 37 Table of Contents each subsequent reporting period until the completion of the contract. In addition, we evaluate whether a significant financing component exists when we recognize revenue in advance of customer payments that occur over time and extend beyond one year. In general, if the payment arrangements extend beyond the first year of the contract, we treat a portion of the payments as a financing component. The discount rate used for each arrangement reflects the rate that would be used in a separate financing transaction between us and the licensee at contract inception and takes into account the credit characteristics of the licensee and market interest rates as of the date of the agreement. As such, the amount of fixed fee revenue recognized at the beginning of the license term will be reduced by the calculated financing component. The portion related to the financing component is recorded as interest income, and is not material to our consolidated financial statements. For additional information, see Note 3 “ Revenue Recognition ” to our consolidated financial statements in Part II, Item 8 of this Annual Report. IMPACT OF NEW ACCOUNTING STANDARDS NOT YET ADOPTED Collaborative Arrangements. In November 2018, the FASB issued ASU 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606 , which clarifies that certain transactions between participants in a collaborative arrangement should be accounted for under ASC 606 when the counterparty is a customer. In addition, ASU 2018-18 precludes an entity from presenting consideration from a transaction in a collaborative arrangement as revenue from contracts with customers if the counterparty is not a customer for that transaction. This standard will be effective for Dolby beginning September 26, 2020. While we have a number of collaborative arrangements, we do not believe that this standard will have a material impact on our consolidated financial statements. Financial Instruments. In June 2016, the FASB issued ASU 2016-13, Financial Instruments (Topic 326): Measurement of Credit Losses on Financial Instruments , which modifies the measurement of expected credit losses of certain financial instruments, including trade receivables, contract assets, and lease receivables. This standard will be effective for Dolby beginning September 26, 2020. We do not believe that this standard will have a material impact on our consolidated financial statements. Income Taxes. In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes , which modifies and eliminates certain exceptions to the general principles of ASC 740, Income Taxes. This standard will be effective for Dolby beginning September 25, 2021. We are currently evaluating the impact of the standard on our consolidated financial statements. 38 Table of Contents RESULTS OF OPERATIONS For each line item included on our consolidated statements of operations described and analyzed below, the significant factors identified as the leading drivers contributing to the overall fluctuation are presented in descending order of their impact on the overall change (from an absolute value perspective). This discussion and analysis highlights comparisons of material changes in the consolidated financial statements for years ended September 25, 2020, September 27, 2019, and September 28, 2018. Note that adjustments related to previously under-reported sales-based royalties as well as unlicensed settlement activity, are collectively referred to as "recoveries." Amounts displayed, except percentages, are in thousands. Revenue and Gross Margin Licensing Licensing revenue consists of fees earned from licensing our technologies to customers who incorporate them into their products and services to enable and enhance audio and imaging capabilities. The technologies that we license are either internally developed, acquired, or licensed from third parties. A significant portion of our licensing revenue pertains to customer-shipment royalties that we recognize based on estimates of our licensees’ shipments. To the extent that shipment data reported by licensees differs from estimates we made and recorded, we recognize an adjustment to revenue for such difference. Our cost of licensing consists mainly of amortization of certain purchased intangible assets and intangible assets acquired in business combinations, depreciation, third party royalty obligations, and associated fees. Fiscal Year Ended 2020 vs. 2019 2019 vs. 2018 Licensing September 25, 2020 September 27, 2019 September 28, 2018 $ % $ % Revenue $1,078,577 $1,107,280 $940,777 $(28,703) (3)% $166,503 18% Percentage of total revenue 93% 89% 89% Cost of licensing 50,822 57,531 42,583 (6,709) (12)% 14,948 35% Gross margin 1,027,755 1,049,749 898,194 (21,994) (2)% 151,555 17% Gross margin percentage 95% 95% 95% 2020 vs. 2019 Factor Licensing Revenue Gross Margin Other â Lower revenues from Dolby Cinema resulting from the closure of cinemas and lower attendance due to COVID-19, lower automotive recoveries, and gaming, partially offset by higher patent administration fees from Via Licensing ßà No significant fluctuations Mobile á Higher revenues from increased adoption of our patent licensing technologies and increased adoption of Dolby Atmos and Dolby Vision, partially offset by lower recoveries PC á Higher revenues from recoveries, higher adoption of Dolby Vision and Dolby Atmos in more PC models, and higher revenues from patent licensing technologies Broadcast â Lower revenues from patent licensing and decreased market volume of STBs, partially offset by higher adoption of Dolby Atmos and Dolby Vision, primarily in TVs CE â Lower market volumes of AVRs and home theater equipment, partially offset by increased adoption of our patent licensing technologies, and increased adoption of Dolby Atmos and Dolby Vision in DMAs and soundbars 2019 vs. 2018 Factor Licensing Revenue Gross Margin Mobile á Higher revenues from increased adoption of our patent licensing technologies and the adoption of our technologies into more devices, partially offset by lower recoveries ßà No significant fluctuations Broadcast á Higher revenues from increased adoption of our patent licensing technologies, recoveries, and TVs, partially offset by lower market volume of STBs Other á Higher revenues from Dolby Cinema, gaming, and automotive recoveries, partially offset by lower licensing in Dolby Voice CE á Higher volume of DMAs and increased adoption of our patent licensing technologies, partially offset by lower recoveries PC á Higher revenues from recoveries and increased adoption of our patent licensing technologies, partially offset by lower ASP from decreasing number of PCs with optical disc functionality 39 Table of Contents Products and Services Products revenue is generated from the sale of audio, imaging, and voice products for the cinema, television broadcast, communications, and consumer products industries. Also included in products revenue are amounts relating to certain Dolby Cinema arrangements that are considered sales-type leases that involve fixed or minimum fees. Cost of products consists of materials, labor, and manufacturing overhead, amortization of certain intangible assets, as well as third party royalty obligations. Services revenue consists of fees charged to support theatrical and television production for cinema exhibition, broadcast, and home entertainment, including equipment training and maintenance, mixing room alignment, equalization, as well as audio, color, and light image calibration. Services revenue also includes PCS for products sold and equipment installed at Dolby Cinema theaters operated by exhibitor partners and support for the implementation of our technologies into products manufactured by our licensees. Cost of services consists of personnel and personnel-related costs for providing our professional services, software maintenance and support, external consultants, and other direct expenses incurred on behalf of customers. Fiscal Year Ended 2020 vs. 2019 2019 vs. 2018 Products and Services September 25, 2020 September 27, 2019 September 28, 2018 $ % $ % Revenue $83,215 $134,340 $113,823 $(51,125) (38)% $20,517 18% Percentage of total revenue 7% 11% 11% Cost of products and services 95,676 103,323 84,979 (7,647) (7)% 18,344 22% Gross margin (12,461) 31,017 28,844 (43,478) (140)% 2,173 8% Gross margin percentage (15)% 23% 25% 2020 vs. 2019 Factor Products and Services Revenue Gross Margin Products â Lower sales of cinema equipment attributable to COVID-19 and lower revenues from Dolby Cinema sales-type leases (hybrid agreements), partially offset by higher units of Dolby Voice products â Lower utilization of manufacturing capacity and higher excess & obsolescence charges Services ßà No significant fluctuations â Lower utilization of available capacity 2019 vs. 2018 Factor Products and Services Revenue Gross Margin Products á Higher revenues from Dolby Cinema and Dolby Voice products, and higher units of cinema equipment â Higher excess & obsolescence charges Services ßà No significant fluctuations á Higher utilization of available capacity Operating Expenses Research and Development R&D expenses consist primarily of employee compensation and benefits expenses, stock-based compensation, consulting and contract labor costs, depreciation and amortization, facilities costs, costs for outside materials, and information technology expenses. Fiscal Year Ended 2020 vs. 2019 2019 vs. 2018 September 25, 2020 September 27, 2019 September 28, 2018 $ % $ % Research and development $239,045 $237,871 $236,794 $1,174 —% $1,077 —% Percentage of total revenue 21% 19% 22% 40 Table of Contents 2020 vs. 2019 Category Key Drivers Compensation & Benefits á Higher headcount and annual merit increases across the existing employee base Travel â Lower costs due to COVID-19 travel restrictions Professional & Consulting â Lower costs for external professional and consulting services for new product development 2019 vs. 2018 Category Key Drivers Research & Development ßà No significant fluctuations Sales and Marketing S&M expenses consist primarily of employee compensation and benefits expenses, stock-based compensation, marketing and promotional expenses for events such as trade shows and conferences, marketing campaigns, travel-related expenses, consulting fees, facilities costs, depreciation and amortization, information technology expenses, and legal costs associated with the protection of our IP. Fiscal Year Ended 2020 vs. 2019 2019 vs. 2018 September 25, 2020 September 27, 2019 September 28, 2018 $ % $ % Sales and marketing $335,933 $343,835 $309,762 $(7,902) (2)% $34,073 11% Percentage of total revenue 29% 28% 29% 2020 vs. 2019 Category Key Drivers Travel â Lower costs due to COVID-19 travel restrictions Marketing Programs á Higher costs related to marketing efforts for company growth initiatives and branding activities Legal, Professional, & Consulting â Lower costs for IP recovery activities 2019 vs. 2018 Category Key Drivers Legal, Professional, & Consulting á Increased IP related activities aimed at revenue generation Marketing Programs á Higher costs related to marketing programs, including branding activities, and new product launches General and Administrative G&A expenses consist primarily of employee compensation and benefits expenses, stock-based compensation, depreciation, facilities and information technology costs, as well as professional fees and other costs associated with external consulting and contract labor. Fiscal Year Ended 2020 vs. 2019 2019 vs. 2018 September 25, 2020 September 27, 2019 September 28, 2018 $ % $ % General and administrative $219,753 $205,425 $197,423 $14,328 7% $8,002 4% Percentage of total revenue 19% 17% 19% 2020 vs. 2019 Category Key Drivers Compensation & Benefits á Higher headcount and annual merit increases across the existing employee base Bad Debt á Higher charges recorded in the current period 2019 vs. 2018 Category Key Drivers Legal, Professional, & Consulting á Higher costs associated with various legal activities and patent filings Compensation & Benefits á Higher headcount and annual merit increases across the existing employee base Bad Debt á Higher charges recorded in the current period 41 Table of Contents Restructuring Restructuring charges/(credits) recorded as operating expenses in our statements of operations represent costs associated with separate individual restructuring plans implemented in various fiscal periods. The extent of our costs arising as a result of these actions, including fluctuations in related balances between fiscal periods, is based on the nature of activities under the various plans. Fiscal Year Ended 2020 vs. 2019 2019 vs. 2018 September 25, 2020 September 27, 2019 September 28, 2018 $ % $ % Restructuring charges/(credits) $1,821 $36,558 $(446) $ (34,737) (95) % $ 37,004 (8,297) % Percentage of total revenue —% 3% —% Subsequent to the fiscal year ended September 25, 2020, we approved a plan to reduce certain activities in order to reallocate those resources towards higher priority investment areas and growth opportunities for the future of our business. Restructuring charges associated with this plan will be reflected in fiscal 2021 financial statements. For additional information on this restructuring program, see Note 20 " Subsequent Events " to our consolidated financial statements. Restructuring charges recorded in fiscal 2019 of $33.5 million represents costs incurred as a result of our early exit of leased facilities. Included in those costs are the write-off of the carrying value of the leasehold improvements associated with the facilities and other expenses associated with the exit of the facilities. Restructuring charges recorded in fiscal 2019 also include $3.1 million associated with a reorganization of our marketing function that resulted in severance and other related benefits for approximately 50 positions that were eliminated. For additional information on our Restructuring programs, see Note 13 " Restructuring " to our consolidated financial statements. Other Income/Expense Other income/(expense) primarily consists of interest income earned on cash and investments and the net gains/(losses) from foreign currency transactions, derivative instruments, and sales of marketable securities from our investment portfolio. Fiscal Year Ended 2020 vs. 2019 2019 vs. 2018 Other Income/Expense September 25, 2020 September 27, 2019 September 28, 2018 $ % $ % Interest income $12,725 $24,919 $18,970 $(12,194) (49)% $5,949 31% Interest expense (186) (170) (198) (16) 9% 28 (14)% Other income/(expense), net 8,434 481 (5,903) 7,953 1,653% 6,384 (108)% Total $20,973 $25,230 $12,869 $(4,257) (17)% $12,361 96% 2020 vs. 2019 Category Key Drivers Interest Income â Lower yields on current year investment balances due to decreased interest rates Other Income á Increase in realized gains from sales of investments and higher valuation on equity method investments 2019 vs. 2018 Category Key Drivers Other Income/(Expense) á Decrease in other expense due to impairment charges recorded in the prior year on cost method equity investments that did not re-occur in 2019, higher valuation of current year equity method investment, and lower foreign currency translation losses Interest Income á Higher yields on investment balances Income Taxes 42 Table of Contents Our effective tax rate is based on our fiscal year results and is affected by several factors. These reflect the current statutory rates in our domestic and foreign jurisdictions, the relative income earned in our foreign jurisdictions, and nonrecurring items such as changes to our unrecognized tax benefits that may occur in but are not necessarily consistent between periods. Our fiscal 2020 income tax provision reflects a decrease in unrecognized tax benefits due to a lapse in the statute of limitations. Our fiscal 2018 income tax provision reflects amounts accrued in connection with the Tax Act enacted in December 2017. For additional information related to effective tax rates, see Note 12 “ Income Taxes ” to our consolidated financial statements. Fiscal Year Ended September 25, 2020 September 27, 2019 September 28, 2018 Provision for income taxes $(8,096) $(26,802) $(154,069) Effective tax rate 3% 9% 78% 2020 vs. 2019 Factor Impact On Effective Tax Rate Unrecognized Tax Benefits â Additional benefit in the current year attributable to reversals of unrecognized tax benefits in the third quarter due to a lapse in the statute of limitations. 2019 vs. 2018 Factor Impact On Effective Tax Rate Enactment of Tax Act â Lower tax expense due to a large tax charge for US tax reform in the prior year, a large tax benefit in the current year, and the reduction of the federal statutory rate LIQUIDITY, CAPITAL RESOURCES, AND FINANCIAL CONDITION Our principal sources of liquidity are cash, cash equivalents, and investments, as well as cash flows from operations. We believe that these sources will be sufficient to satisfy our currently anticipated cash requirements through at least the next twelve months. As of September 25, 2020, we had cash and cash equivalents of $1,071.9 million, which mainly consisted of cash and highly-liquid money market funds. In addition, we had short and long-term investments of $99.1 million, which consisted primarily of municipal debt securities, certificates of deposit, government bonds, commercial paper, corporate bonds, and U.S. agency securities. The following table presents selected financial information as of the fiscal years ended September 25, 2020 and September 27, 2019 (amounts displayed are in thousands): September 25, 2020 September 27, 2019 Cash and cash equivalents $ 1,071,876 $ 797,210 Short-term investments 46,948 119,146 Long-term investments 52,149 179,587 Accounts receivable, net 180,340 189,115 Accounts payable and accrued liabilities 232,591 283,356 Working capital 1,280,087 1,074,687 Capital Expenditures and Uses of Capital Our capital expenditures consist of purchases of land, building, building fixtures, laboratory equipment, office equipment, computer hardware and software, leasehold improvements, and production and test equipment. Included in capital expenditures are amounts associated with Dolby Cinema locations. We continue to invest in S&M and R&D to promote the overall growth of our business and technological innovation. 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 Class A common stock. We have historically generated significant cash from operations. However these cash flows and the value of our investment portfolio could be affected by various risks and uncertainties, as described in Part I, Item 1A “ Risk Factors .” 43 Table of Contents Shareholder Return We have returned cash to stockholders through both repurchases of Class A common stock under our repurchase program initiated in fiscal 2010 and our quarterly dividend program initiated in fiscal 2015. Refer to Note 9 " Stockholders' Equity & Stock-Based Compensation " of our consolidated financial statements for a summary of dividend payments made under the program during fiscal 2020 and additional information regarding our stock repurchase program. Stock Repurchase Program. Our stock repurchase program was approved in fiscal 2010, and since then we have completed approximately $1.8 billion of stock repurchases under the program. Quarterly Dividend Program. During the first quarter of fiscal 2015, we initiated a recurring quarterly cash dividend program for our stockholders. For fiscal 2020, quarterly dividends of $0.22 per share were paid on our Class A and Class B common stock to eligible stockholders of record. Cash Flows Analysis For the following comparative analysis performed for each of the sections of the statement of cash flows, the significant factors identified as the leading drivers contributing to the fluctuation are presented in descending order of their impact relative to the overall change (amounts displayed in thousands). Operating Activities Fiscal Year Ended September 25, 2020 September 27, 2019 Net cash provided by operating activities $ 343,849 $ 327,674 Net cash provided by operating activities increased $16.2 million in fiscal 2020 compared to fiscal 2019, primarily due to the following: Factor Impact On Cash Flows Working Capital á Higher inflows due to decreases in accounts receivable and contract assets, partially offset by higher outflows to settle remaining exit obligations for a terminated lease of an office building Investing Activities Fiscal Year Ended September 25, 2020 September 27, 2019 Net cash provided by (used in) investing activities $ 134,374 $ (56,229) Net cash provided by investing activities was $190.6 million greater in fiscal 2020 compared to fiscal 2019, primarily due to the following: Factor Impact On Cash Flows Proceeds From Investments á Higher inflows from the sale & maturity of marketable investment securities Capital Expenditures á Lower expenditures for PP&E Purchase of Investments â Higher outflows for the purchase of marketable investment securities Financing Activities Fiscal Year Ended September 25, 2020 September 27, 2019 Net cash used in financing activities $ (207,775) $ (385,281) Net cash used in financing activities was $177.5 million lower in fiscal 2020 compared to fiscal 2019, primarily due to the following: Factor Impact On Cash Flows Share Repurchases á Lower outflows for common stock repurchases Common Stock Issuance á Higher inflows from employee stock option exercises 44 Table of Contents Off-Balance Sheet Arrangements and Contractual Obligations Our liquidity is not dependent upon the use of off-balance sheet financing arrangements, and we have not entered into any arrangements that are expected to have a material effect on liquidity or the availability of capital resources. The following table presents a summary of our contractual obligations and commitments as of September 25, 2020 (in thousands): Payments Due By Fiscal Period 1 Year 2 - 3 Years 4 - 5 Years More Than 5 Years Total Naming rights $ 7,915 $ 16,131 $ 16,541 $ 61,277 $ 101,864 Operating leases, including imputed interest 18,098 28,167 21,616 22,484 90,365 Purchase obligations 17,305 3,130 — — 20,435 Donation commitments 4,803 310 310 1,002 6,425 Total $ 48,121 $ 47,738 $ 38,467 $ 84,763 $ 219,089 Naming Rights. We are party to an agreement for naming rights and related benefits with respect to the Dolby Theatre in Hollywood, California, the location of the Academy Awards®. The term of the agreement is 20 years, over which we will make payments on a semi-annual basis until fiscal 2032. Our ongoing annual payment obligations are conditioned in part on the Academy Awards being held and broadcast from the Dolby Theatre. Our payment obligations may be suspended or reduced in certain circumstances, including protracted closure of the Dolby Theatre. Operating Leases. Operating lease payments represent our commitments for future minimum rent made under non-cancelable leases for office space, including those payable to our principal stockholder and portions attributable to the controlling interests in our wholly owned subsidiaries. For additional details regarding our leases, see Note 7 " Leases " to our consolidated financial statements. Purchase Obligations. Purchase obligations primarily consist of our commitments made under agreements to purchase goods and services related to Dolby Cinema and for purposes that include IT and telecommunications, marketing and professional services, and manufacturing and other R&D activities. Donation Commitments. Our donation commitments relate to non-cancelable obligations that consist of maintenance services and installation of imaging and audio products in exchange for various marketing, branding, and publicity benefits. The recipients of these donations participate in or promote the cinema and entertainment industry and our commitments vary in length, lasting up to 15 years. Unrecognized Tax Benefits. As of September 25, 2020, we had an accrued liability for unrecognized tax benefits without interest, penalties, and related deferred tax assets, totaling $60.7 million. We are unable to estimate when any cash settlement with a taxing authority might occur and, therefore, have not reflected these anticipated future outflows in the table above. For additional details regarding our contractual obligations, see Note 14 “ Commitments & Contingencies ” to our consolidated financial statements. Indemnification Clauses We are party to certain contractual agreements under which we have agreed to provide indemnification of varying scope and duration to the other party relating to our licensed IP. Historically, we have not made any payments for these indemnification obligations and no amounts have been accrued in our consolidated financial statements with respect to these obligations. Since the terms and conditions of the indemnification clauses do not explicitly specify our obligations, we are unable to reasonably estimate the maximum potential exposure for which we could be liable. In addition, we have entered into indemnification agreements with our officers, directors, and certain employees, and our certificate of incorporation and bylaws contain similar indemnification obligations. For additional details regarding indemnification clauses within our contractual agreements, see Note 14 “ Commitments & Contingencies ” to our consolidated financial statements.