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Dolby Laboratories, Inc. (DLB)

Q2 2006 Earnings Call· Thu, Apr 27, 2006

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Transcript

Operator

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Dolby Laboratories' conference call discussing fiscal second quarter 2006 results. (Operator Instructions) I would now like to turn the conference call over to Paula Dunn, Director of Corporate Communications for Dolby Laboratories.

Paula Dunn

Management

Thank you. Good afternoon, everyone. Welcome to Dolby Laboratories' second quarter fiscal 2006 earnings conference call. Joining me today are Bill Jasper, Dolby Laboratories' President and CEO; Marty Jaffe, Executive Vice President Business Affairs; and Kevin Yeaman, Chief Financial Officer. In addition to Tim Partridge, Dolby's Senior Vice President and General Manager of the Professional Division, is here to participate in today's Q&A. On this conference call, we will be making forward-looking statements that include: projections of future operating results for our fiscal year ending September 29, 2006; market trends for the industries in which we compete; our ability to expand our presence in existing markets and to penetrate new markets; the impact of inclusion of our technologies in certain HD and DVD technology standards; DVD player sales and sales of our professional broadcast products; trends in the PC, broadcast, gaming, automotive and portable entertainment device market; our expectations regarding the success of our Digital Cinema initiative; the capabilities and market acceptance of our products and technologies and our strategic and operational plans. Important factors could cause actual results to differ materially from those in the forward-looking statements. These factors are detailed under the section captioned 'Risk Factors' in our quarterly report on Form 10-Q for the fiscal quarter ended December 30, 2005 available at www.sec.gov. Dolby disclaims any obligation to update information contained in these forward-looking statements whether as the result of new information, future events or otherwise. In this call we will describe certain pro forma financial measures which should be considered in addition to and not in lieu of comparable actual financial measures. Please refer to our earnings release for the second quarter of fiscal 2006 at our website at www.Dolby.com under the Investor Relations section for the most directly comparable actual financial measure and related reconciliation. As for the structure of this call, Bill will begin with a discussion of Dolby's strategy and focus, and Kevin will follow with a rundown of Dolby's financial results. So with introduction behind us I'll now turn the call over to Bill.

Bill Jasper

Management

Thank you, Paula. Good afternoon, everybody. I am pleased to announce a strong second quarter for Dolby as we continue to make progress towards our long-term objective of being an essential element in the best entertainment technologies available. Our second quarter benefited from a robust holiday season, reflecting growing consumer interest in digital electronics. Consumers are embracing a wider array of digital devices, which in the long run expands Dolby's addressable market. The proliferation of digital media and content is creating near term and longer term opportunities for Dolby. Today I would like to discuss how we are further positioning Dolby to benefit from this growth. First, we are extending Dolby digital further into existing markets. In broadcast, we have advanced Dolby Digital Plus to be included in the ATSC digital tuner standard in the North American and Korean markets. In addition, we continue to make progress in making Dolby Digital a de facto standard in Europe for HD broadcast, while winning new customers in China with Dolby Digital. Today, the China Movie Channel launched the China Home Theater Channel HD Movie Channel, China's third HD channel. This is the first broadcaster in China to commit to broadcasting 100% of its programming in Dolby Digital. This illustrates a growing opportunity for Dolby to benefit from the delivery of HD set-top boxes using Dolby Digital 5.1 decoders in China. In Europe, we continued to see high demand for our professional broadcast products in preparation for broadcast of FIFA World Cup matches in Dolby Digital 5.1. In April, the Canal Plus group launched its first HD station on satellite with Dolby Digital 5.1 so that any set-top box it deploys receiving an HD signal must contain a Dolby Digital decoder. In our core DVD market, we will benefit from in the shipment…

Question-and-Answer Period

Management

Operator

Operator

(Operator Instructions) Our first question comes from Ralph Schackart - William Blair. Ralph Schackart - William Blair : Can you give us a little bit more color on the underlying licensing growth, specifically within the PC HDTV and DVD end market? I believe from the prepared remarks you had mentioned that PC potentially could be flat to down in the back half of the year? I am just curious as to what is driving that. Kevin Yeaman: So as we said on the call, PC was strong in the first half on strong unit volumes. We are expecting flat to slightly down. Basically we are expecting pretty similar unit volumes. There is a lot of shifting between the OEM providers, which just gives us cause to be cautious in terms of who our licensees are. We still see that as a good growth area going forward. In terms of HDTV, we continue to see good growth out of broadcast. The second half of the year is typically a slower part of the year for television sales. Hard to tell how much HD may change that, if at all. The other thing that drives our broadcast segment is set-top box sales, and it is our understanding that most of the cable manufacturers are looking at their major roll outs in '07 so that looks good going forward. Ralph Schackart - William Blair : One follow up on the Chinese enforcement activity, can you give us a little bit of an update there? And additionally too, were there any one-time royalties that we should be aware of in the quarter.

Bill Jasper

Management

On the Chinese government enforcement activities, we are really pleased with the results to date that we've had. We've started our audit programs, we've had some good success. I think we think the real measure of that is going to be to see how much more of the royalties we are collecting from those under the lower-cost manufacturing regions compared to what our expectations were, everything else being equal. Ralph Schackart - William Blair : Any one-time royalties in the quarter?

Bill Jasper

Management

Every quarter, as part of our business on an ongoing basis, there are always going to be cash up payments, late payments, a lot of these things. It is just a normal part of our business, so there is nothing that we want to call out at this point in time, out of the normal. Ralph Schackart - William Blair : Sounds like nothing material. Great. Thanks. Great quarter, guys.

Operator

Operator

Our next question comes from Steve Lidberg - Pacific Crest Securities. Steve Lidberg - Pacific Crest Securities : [Inaudible - technical difficulties] Was it in higher end, home theatre or I guess more traditional DVD players? And then with regard to Digital Cinema, the Utah installation -- how is that being financed? Is this different than what we saw from your first relationship with Disney and the roll out of 100 screens? Thanks.

Bill Jasper

Management

Steve, we missed about the first five seconds of the first part of your question, it didn't come through. Steve Lidberg - Pacific Crest Securities : Sure, just with regards to the consumer electronics business, where did you see strength? Was it in the higher end segment of home theatre, or more traditional, standard volume DVD player growth? Kevin Yeaman: We saw strength across the consumer electronics. Really, it did pretty well across both of those product lines.

Bill Jasper

Management

We don't really break it out. As to the Digital Cinema, Tim Partridge is with us, the head of the Pro division, I will let him address Utah.

Tim Partridge

Management

Yes, David it is under a different arrangement to the other Chicken Little roll out in that this will be treated as an operating lease, so it will be depreciated over time and the VPS coming in over time will offset that depreciation. Steve Lidberg - Pacific Crest Securities : Thank you.

Operator

Operator

(Operator instructions) We will go next to Anthony Noto - Goldman Sachs. Ingrid Jones - Goldman Sachs: Just again on DVD, just a little bit more color. My question specifically is about the U.S. Do you see some stabilization in the U.S. with most of the growth in CE coming Internationally?

Bill Jasper

Management

Well we don't really break it out in terms of the market. We are just addressing the total market. We've never broken it out geographically. But as Kevin said, we did see higher than anticipated growth overall in that CE market on a worldwide basis. Ingrid Jones - Goldman Sachs: What was in your other income item? Kevin Yeaman: Mostly it is interest income. Ingrid Jones - Goldman Sachs: Great, thanks.

Operator

Operator

We will take our next question from Daniel Ernst - Hudson Square Research. Daniel Ernst - Hudson Square Research : Good afternoon, thanks for taking the call and congrats on a great quarter. Kevin, congrats on the new baby. I can't believe you are on the call here. My wife would kill me. That aside, two questions. One, maybe you can just give us a little bit of a break out here on what percentage of the licensing revenue came out of CE versus broadcast and other NPC? I think you've given us some ranges in the past, maybe a deviation from those ranges because obviously it seems like broadcast is on a roll, both domestically and abroad. My follow-up question, on the Digital Cinema side, what is the hurdle on getting to the DCI specification from here? Kevin Yeaman: As a reminder, when we came into the year we said that in '05 our consumer electronics market had made up just over 50% of our revenue. PC made up 25% to 30% and that are other markets, including broadcast, gaming, automotive made up the balance. Coming into this year, we saw consumer electronics being flat to slightly down, and the growth coming roughly evenly between PC on the one hand and those other markets on the other hand. That is pretty consistent with what we've seen, except that CE we now see being flat to slightly up on the strong holiday season. Within that, let me just clarify an earlier point because I think I misheard the question. The one underlying trend is from industry reports, we have seen from them that they are expecting home theatre in a box sales to be a little bit softer, but DVD sales and building home theatres in the broader sense, we had good business. So all told, that probably means that CE is still headed to be less than 50% of our business going into next year, because we see good growth from these other markets and are getting better diversification.

Bill Jasper

Management

Tim, DCI.

Tim Partridge

Management

There are probably three hurdles to meeting full DCI compliance. The first was JPEG that was announced relatively late in the DCI process, so when the DCI recommendations were published, it had JPEG in it and we needed to engineer that into the product. As you’ve seen, we did do that and we demonstrated that at Show West and we will be converting our theatres over to JPEG in the coming months. There are also some of the standards that were recommended by DCI in their publication, still need to be formalized by the standards bodies such as SMPCE so that is ongoing work that will also come to completion in the next few months. Finally, the industry needs some kind of compliance program such that so all of these manufacturers can submit their equipment to some kind of compliance agency that can give a stamp of approval that it does actually meet the DCI standards. That is also work that is in progress with bodies employed by DCI to develop a compliance program, which we expect also to come to completion in the next few months. Daniel Ernst - Hudson Square Research : So just to clarify, you don't see yourself currently at a disadvantage to some competition, particularly with Doremi who had press releases out recently on a number of deployments?

Tim Partridge

Management

Yes, there are a lot of people out there that are claiming DCI compliance, of course, but without a compliance agency that can actually certify that, it is difficult to know what is compliance and what isn't. So we are striving to get there and hopefully at the same time there will be some way of proving compliance. The market is still rolling out very slowly, so we don't see ourselves at a disadvantage at this point. Daniel Ernst - Hudson Square Research :

Operator

Operator

Our next question comes from Michael Kern - Canaccord Adams. Michael Kern - Canaccord Adams: Hi, guys. Sorry I missed the answer on this, but with Digital Cinema, are the Megaplex rollouts that you have, are you financing that or are they buying that outright?

Tim Partridge

Management

No, we're financing it but unlike the previous roll out that we did with Disney, we are doing this under an operating lease treatment so the equipment will be depreciated over time and the revenue stream, the virtual print fees coming in from the studios, will offset that depreciation.

Michael Kern - Canaccord Adams

Management

Thank you very much for the clarification.

Operator

Operator

(Operator Instructions) Our next question comes from Mark Anderson - Atfield Capital. Mark Anderson - Atfield Capital : I was hoping you could address the longer term opportunities within the mobile space, whether it is in handhelds or gaming devices and how you see that potentially playing out and when we might see traction in that part of your business?

Bill Jasper

Management

Well as you well know, the mobile market is a huge market. If you are talking specifically mobile headphones, we do see some opportunities from technologies such as Dolby Headphone and some of the Audistry products we've talked about. Those will probably, to the extent we can be successful there, would be taking place in the next year or two. As we mentioned, we've already seen one model of phones from Nokia which are including some AAC technology, so we expect to hopefully move the market forward in terms of more use of AAC. It is not something that happens overnight. There are cost issues in terms of the cost of implementing those technologies; royalty costs, et cetera. We are looking very hard at getting into that market. Mark Anderson - Atfield Capital : In the AAC, what are your splits on that right now? What is in the JV?

Bill Jasper

Management

I'm not sure what you mean by JV. Our licensing -- Mark Anderson - Atfield Capital : Yes, your licensing subsidiary, rather.

Bill Jasper

Management

The licensing subsidiary, which is Via, handles the MPEG licensing for AAC and as such, all of the patent pool owners who have contributed patents to the pool share in the royalties that come in; and they share in the royalties after Via has taken a small administrative fee off of the top. Mark Anderson - Atfield Capital : And your share of the patent pool is roughly how much?

Bill Jasper

Management

It is in the neighborhood of 30-35%. Mark Anderson - Atfield Capital : That's great.

Bill Jasper

Management

That's including our administrative fee that Via gets. Mark Anderson - Atfield Capital : Your administrative fee is a percent of the total revenue or it is just a basic fee?

Bill Jasper

Management

It is percentage of the pool. Mark Anderson - Atfield Capital : Great, thank you.

Operator

Operator

Our next question comes from Eric Mentz - Eagle Asset. Eric Mentz - Eagle Asset : Great quarter, guys.

Bill Jasper

Management

Thank you. Eric Mentz - Eagle Asset : The cash is obviously mounting here on the balance sheet. Anything interesting in the acquisition pipeline you want to allude to?

Bill Jasper

Management

Just that we are taking a hard look at potential acquisitions in a number of the areas which we see as being our future. Eric Mentz - Eagle Asset : Previously you had indicated that Digital Cinema in Europe might get traction sooner than the U.S. Anything to speak of there?

Tim Partridge

Management

Not really, Eric. Still lots of ongoing initiatives that we are involved in on both sides of the pond, and certainly actual roll outs, it is happening right now here before it is in Europe. Eric Mentz - Eagle Asset : Thanks a lot, guys.

Operator

Operator

At this time there are no further questions. I would now like to turn the conference back over to Mr. Bill Jasper for any closing remarks.

Bill Jasper

Management

Thank you everybody for participating. We appreciate your time and we look forward to speaking with you next quarter. Thanks for joining us today. Good bye.

Operator

Operator

That does conclude today's conference. We thank you for your participation. You may now disconnect.